Subject: FINANCIAL MANAGEMENT

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  • 20 Marks

FM – Mar2025 – L2 – Q5 – Working Capital Management

Compute Gagba LTD's working capital requirement after a 15% sales increase using provided financial and operational data.

a) Gagba LTD, a manufacturing company, is planning to expand its operations to meet increasing demand for its products. As part of this expansion, the company needs to determine its working capital requirements to ensure smooth operations and avoid liquidity issues. The company has provided the following financial and operational data for the year ended 31 December 2023:

  1. Sales Data:
  • Annual Sales: GH₵18,000,000
  1. Cost Data:
  • Cost of goods sold (COGS): 70% of sales
  • Inventory turnover ratio: 8 times per annum
  • Accounts receivable turnover ratio: 6 times per annum
  • Accounts payable turnover ratio: 4 times per annum
  1. Operation Data:
  • Average inventory: GH₵1,500,000
  • Average Accounts receivable: GH₵2,000,000
  • Average accounts payable: GH₵1,200,000
  1. Additional Information:
  • Desired Cash balance: GH₵500,000
  • Projected Increase in Sales due to expansion: 15%
  • Cost of capital: 12% per annum Required: Compute the working capital requirement for Gagba LTD after the planned expansion. (10 marks)

b) The Ministry of Health in Ghana is conducting a review of its procurement practices and the overall performance of its Public Financial Management (PFM) system. The review aims to enhance value for money in public spending while adhering to the principles outlined by the Public Expenditure and Financial Accountability (PEFA) framework. You are provided with the following data for the fiscal year 2023:

    1. Budgeted Public Expenditure: GH₵50 billion
    2. Actual Public Expenditure: GH₵52 billion
    3. Total Procurement Expenditure: GH₵25 billion
    4. Value of Contracts Awarded through Competitive Tendering: GH₵15 billion (60 contracts)
    5. Value of Contracts Awarded through Restricted Tendering: GH₵5 billion (20 contracts)
    6. Value of Contracts Awarded through Single-Source Procurement: GH₵5 billion (20 contracts)
    7. Number of Procurement Violations Detected: 15 (with a total value of GH₵300 million)
    8. Disposal of Stores and Equipment: GH₵100 million Required: i) Analyse the variance in the public expenditure and its implications for the PFM system in Ghana. (3 marks) ii) Discuss which procurement method appears to provide the best value for money with suitable computations. (7 marks)

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  • 20 Marks

FM – Mar2025 – L2 – Q4 – Business valuations

Estimate the value of Obuorba LTD's stock at the end of Year 4 using dividend valuation model.

a) Mama Lomo is trying to value Obuorba LTD’s stock. She uses a spreadsheet model to easily see how a change in one or more assumptions affects the stock’s estimated value. The model has projections for the next four years based on the following assumptions.

  • Sales will be GH₵300 million in Year 1.
  • Sales will grow at 15% in Years 2 and 3 and 10% in Year 4.
  • Operating profits (EBIT) will be 17% of sales in each year.
  • Interest expense will be GH₵10 million per year.
  • Income tax rate is 30%.
  • Earnings retention ratio will stay at 60%.
  • The per-share dividend growth rate will be constant from Year 4 onwards, and the final growth rate will be 200 bps (2%) less than the growth rate from Year 3 to Year 4. This final growth rate should be used to derive the dividend growth from year 4 onwards.
    The company has 10 million shares outstanding. Mama Lomo has estimated the required return on Obuorba LTD’s stock to be 13%.
    Required:
    i) Estimate the value of the stock at the end of Year 4 based on the foregoing assumptions. (6 marks)

ii) Estimate the current value of the stock using the foregoing assumptions. (4 marks)

b) State THREE limitations of the dividend discount model of stock valuation. (5 marks)

c) In the healthcare sector, efficient inventory management and resource utilisation are critical to providing timely and high-quality patient care. The Korle-Bu Teaching Hospital, the largest teaching hospital in West Africa, has recently implemented a Just-in-Time (JIT) system to enhance its operational efficiency. The hospital adopted JIT production and purchasing strategies to manage its medical supplies and pharmaceuticals more effectively. The goal is to reduce inventory holding costs, minimise wastage and ensure that critical medical supplies are available when needed without overstocking.

However, the implementation of JIT systems in a healthcare setting like Korle-Bu Teaching Hospital presents several challenges. While JIT aims to streamline operations and reduce costs, it also introduces potential risks and problems, particularly in an environment where the timely availability of medical supplies is crucial for patient care.

Required:

i) Explain JIT purchasing. (2 marks)

ii) Discuss TWO potential problems associated with implementing JIT systems in a hospital environment. (3 marks)

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  • 20 Marks

FM – Mar 2025 – L2 – Q3 – Foreign exchange risk and currency risk management

Determine outcomes of forward contract and money market hedge for GPL's USD payment and recommend the best technique.

a) Gyenyame Pharmaceuticals LTD (GPL), a Ghanaian company, imports raw materials from the United States of America to produce generic drugs for the local market. Due to recent fluctuations in the foreign exchange market, the company’s management is concerned about the impact of exchange rate movements on its costs and profitability.
The company is expected to pay USD750,000 in three months for a shipment of Active Pharmaceutical Ingredients (APIs). GPL also exports locally produced herbal medicine called ‘Koo-pile’ to the Ghanaian community in Oklahoma, USA on credit basis. The company is expecting a receipt of USD250,000 in three months for a consignment exported a month ago.
GPL is considering two hedging strategies to manage the foreign exchange risk: a forward contract and a money market hedge.
The following financial information is available:

  • Current Spot Rate (GHS/USD): 12.00
  • 3-Month Forward Rate (GHS/USD): 12.20
  • 3-Month USD Interest Rate: 3% per annum
  • 3-Month GHS Interest Rate: 14% per annum
  • Expected Future Spot Rate in 3 Months (GHS/USD): 12.50

Required:
i) Determine the outcome of the two hedging techniques and recommend the appropriate technique to GPL based on your computations.
(9 marks)

ii) Explain THREE internal hedging techniques that GPL could use to manage its foreign exchange risk.

b) Technological advancements have significantly transformed financial markets, enhancing the way transactions are conducted, information is accessed and risks are managed. As financial institutions and individual investors increasingly depend on digital tools and innovative technologies, financial markets have become more efficient, accessible and transparent.

Required:
Explain FIVE positive impacts of technological development on financial markets.
(5 marks)

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  • 20 Marks

FM – Mar 2025 – L2 – Q2 – Investment Appraisal and Financing Options

Compute loan balance, bond redemption, and NPV for a university hostel project with two financing options

The Governing Board of Dominase Agriculture University is considering a capital project and related financing options. The project involves the construction of a candidate hostel, which requires capital outlays of GH¢20 million in the first year and GH¢30 million in the second year.

The hostel will become operational in the third year. Net operating cash flows from the hostel are expected to be GH¢20 million annually for the first three years of operation (i.e. Years 3, 4, and 5) and then begin to grow at a constant rate of 10% annually to perpetuity.

The project finance advisory team has presented the following two financing options for the consideration by the Governing Board:

Option 1: A Syndicated Bank Loan

Through a syndication arrangement led by the National Investment Bank, the university can borrow the required GH¢50 million from five local banks at an annual interest rate of 28% with quarterly compounding. The loan amount will be released to the university immediately. The university will be given a moratorium (grace period) of two years to complete the construction of the hostel before it is required to start paying off the loan balance in equal instalments at the end of each quarter for ten years. Interest will accumulate on the loan during the grace period.

Option 2: Bond Issuance

The university can issue a bond to raise the GH¢50 million required to finance the construction of the hostel. The bonds will be issued in 50,200 units of GH¢1,000 face value each. The annual coupon rate on the bond will be set at 26%, but coupons will be paid semiannually starting as soon as the bond is issued. The bonds will be issued now and redeemed in 15 years at a premium of 10%. Although the total redemption value will be paid to the bondholders at maturity, the university will be required to establish a sinking fund to raise enough money to redeem the bonds. The university can deposit equal sums of money into the fund at the beginning of every six months, starting from the third year until the fifteenth year when the bond will be redeemed. The fund will be invested at an annual interest rate of 20%.

Required:

a) Regarding the syndicated loan,

i) Compute the loan’s balance at the end of the moratorium.

(3 marks)

ii) Compute the quarterly instalment required to amortise the loan over the ten-year repayment period.

(4 marks)

b) Regarding the bond issue,

i) Compute the total redemption value of the bond.

(3 marks)

ii) Compute the size of each semi-annual instalment into the sinking fund.

(4 marks)

c) Compute the project’s net present value (NPV) and provide an investment recommendation based on it. Assume the required rate of return on the project is 30%.

(6 marks)

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  • 20 Marks

FM – Mar2025 – L2 – Q1 – Sources of finance: debt Level

Explain four types of risks in PPP arrangements in Ghana's healthcare sector.

a) In Ghana, the collaboration between public institutions and private entities in the healthcare sector has become increasingly noteworthy, particularly through Public-Private Partnership (PPP) arrangements. These partnerships are essential for expanding healthcare infrastructure, improving service delivery and ensuring access to quality healthcare for all citizens. For instance, the Government of Ghana has agreements with private companies to build hospitals, supply medical equipment, or manage healthcare facilities. One of the critical aspects of PPP arrangements in healthcare is allocating risks between the public and private partners. Effective risk allocation is crucial to the success of these partnerships, guaranteeing that both parties are driven to fulfil their obligations and that the project can deliver the expected benefits to the public. Required: Explain FOUR types of risks associated with a PPP arrangement in the health sector.

b) Kakape LTD (Kakape), a leading Information Technology firm known for its innovative technology solutions, has $50,000,000$ shares in issue with an equity market value of GH£87,000,000 at the end of 2023. The company is forecasting its profit after tax to grow by 15% per year for the next three years (2024-2026) and onwards by 8% per year. Kakape’s cost of equity capital is estimated to be 12% per year. Dividends may be assumed to grow at the same rate as profits. Assume that the 2023 dividend per share ended up as GH$0.07 and that all dividends will be paid at the end of the financial year. Required: Using the dividend valuation model, determine whether Kakape’s shares are under or overvalued in 2023. (7 marks)

c) In the healthcare sector, hospitals are expected to provide high-quality medical care and uphold corporate social responsibility (CSR) principles that guide them in making decisions that align with their values and responsibilities to patients, staff and the broader community. Required: Explain THREE core principles of corporate social responsibility as applied in the healthcare sector.

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  • 5 Marks

FM – Nov 2024 – L2 – Q5c – Public-Private Partnerships (PPP)

Discuss types of PPP arrangements and their suitability for a highway project.

Public-Private Partnerships (PPP) involve collaboration between government and a private sector company that can be used to finance, build and operate projects. Financing a project (for example, a highway) through PPP can allow a project to be completed sooner or make it a possibility in the first place.

Required:
Given the following types of PPP arrangements, discuss each of them and how they can be suitable for a highway project:

i) Build-Operate-Transfer (BOT) 
ii) Design-Build-Finance-Operate (DBFO) 
iii) Service Concession

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  • 5 Marks

FM – Nov 2024 – L2 – Q5b – Overdue Debt Collection

Steps to collect overdue debts in financial management.

Outline the steps to be followed to collect overdue debts.

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  • 10 Marks

FM – Nov 2024 – L2 – Q5a – Management of Receivables

Evaluate the financial implications of different strategies for managing Abaa LTD's accounts receivable.

Abaa LTD, a company that manufactures and sells electronic appliances, has been facing challenges with its accounts receivable management. Currently, the company allows its customers 60 days of credit. Due to the highly competitive market, Abaa LTD has been experiencing an increasing amount of bad debts and delayed payments, which has adversely affected its cash flow and profitability. To address these issues, the company’s Finance Manager is considering several strategic changes:

  1. Reduction in Credit Period: Reducing the credit period from 60 days to 45 days. It is estimated that this change could reduce sales by 5% due to the stricter credit terms, but it would also decrease the bad debt ratio from 4% to 2% of sales.
  2. Offering Early Payment Discounts: Introducing a 2% discount for customers who pay within 30 days. The company anticipates that 30% of its customers will take advantage of this discount, which would improve cash flow and reduce the average collection period by 15 days.
  3. Engagement of a Factor: The company is also considering engaging a factoring company to manage its receivables. The factor would advance 80% of the invoice value upon the sale of goods at 200 basis points below the company’s cost of capital and charge a 3% fee on all sales. The factor is expected to reduce the bad debt ratio to 1% of sales and further reduce the average collection period by 20 days. Engaging the factor will lead to annual administrative savings of GH¢90,000.

Abaa LTD’s current annual sales are GH¢20 million, and the variable cost of sales is 60% of sales. The company’s cost of capital is 12% per annum.

Required:
Evaluate the financial implications of the following:
i) Reduction in Credit Period
ii) Offering Early Payment Discounts
iii) Engagement of a Factor
iv) Recommend the appropriate method to manage the credit sales

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  • 5 Marks

FM – Nov 2024 – L2 – Q4b – Procurement and Tendering Procedures

Discuss circumstances under which single-source procurement is appropriate and functions of the Entity Tender Committee.

The Farms and Gardens Authority (FGA), a public entity, wants to buy 100 computers and 20 printers for its administrative offices. The Chief Executive Officer (CEO) is considering using the single-source procurement method to procure the computers and printers while pushing back on the recommendations of the Entity Tender Committee.

Required:

i) State TWO circumstances under which single-source procurement would be appropriate for the goods the FGA wants to procure.

ii) Advise the CEO on TWO functions the Entity Tender Committee is expected to perform in the FGA’s procurements.

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  • 11 Marks

FM – Nov 2024 – L2 – Q4a – Business Valuation

Valuing a company using the discounted cash flow model and price multiples.

Djokoto PLC (Djokoto) has 12 million ordinary shares outstanding and no other long-term debt. The Finance Director of Djokoto, Adepa, estimates that Djokoto’s free cash flows at the end of the next three years will be GH¢0.5 million, GH¢0.6 million, and GH¢0.7 million, respectively. After Year 3, the free cash flow will grow at 5% yearly forever. The appropriate discount rate for this free cash flow stream is determined to be 15% annually.

In a separate analysis based on ratios, Adepa estimates that Djokoto will be worth 10 times its Year 3 free cash flow at the end of the third year. Adepa gathered data on two companies comparable to Djokoto: Mesewa and Dunsin. It is believed that these companies’ price-to-earnings, price-to-sales, and price-to-book-value per share should be used to value Djokoto.

The relevant data for the three companies are given in the table below:

Variables Mesewa Dunsin Djokoto
Current Price Per Share 7.20 4.50 2.40
Earnings Per Share 0.20 0.15 0.10
Revenue Per Share 3.20 2.25 1.60
Book Value Per Share 1.80 1.00 0.80

Required:
i) Estimate Djokoto’s fair value based on the discounted cash flows model. (5 marks)
ii) Compute the following ratios for the comparable companies:

  • P/E Ratio (2 marks)
  • Price-to-Sales Ratio (2 marks)
  • Price-to-Book-Value Ratio (2 marks)
    iii) Based on the valuation results, discuss whether an investor should buy, sell, or hold Djokoto shares. Justify your recommendation. (4 marks)
    iii) Identify two advantages and two disadvantages of business combinations.

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  • 30 Marks

FM – Nov 2014 – L3 – SA – Q1 – Investment Appraisal Techniques

Evaluate the financial feasibility of a cement production project using cost of capital, NPV, and MIRR methods.

AK Plc is a company listed on the Nigerian Stock Exchange. It is involved in property development and sales.

The company currently imports more than 60% of its cement requirements. At a recent meeting of the board of directors, a decision was taken to establish a division for the production of cement in Ore, Ondo State. If the division is set up and the cement production goes ahead, output from the division will be sold to AK Plc and external customers at market price. For planning purposes, it has been decided that the financial viability of the project over the next five years should be determined.

The sum of N2 billion will be required. The sum of N500 million will be spent to acquire an existing factory considered suitable for the project. The balance of N1.5 billion will be applied for the procurement and installation of essential plant and equipment. Tax allowance can be claimed on plant and equipment at a uniform amount over 5 years with NIL scrap value.

A total of N20 million has been spent on various surveys (market, technical, financial, etc.) to date out of which N10 million has been paid. The balance of N10 million is due for payment at the end of year 1.

Production of cement for the next five years is projected as follows:

Year Bags
1 500,000
2 600,000
3 650,000
4 800,000
5 700,000

A bag of cement sells currently for N2,000 in the open market. This price is expected to increase at the rate of 5% per annum. Variable cost is now N1,000 per bag. This will increase at 4% per annum. Fixed overhead costs will be N50 million at current prices but will rise by 8% per annum. Apportioned head office charges of N25 million at current prices will rise by 10% per annum. Fifty per cent (50%) of the total initial outlay of N2 billion is to be funded with a loan from a Federal Government Development Bank at a concessionary fixed interest rate of 8%, payable at the end of each year. Half of the loan will be repaid at the end of year 3 while the balance will be paid at the end of year 5. The project will require a working capital of 10% of annual revenue, and this should be available at the beginning of each year.

The company uses a current Weighted Average Cost of Capital (WACC) of 11% to appraise all capital projects. The asset beta of the company is 1.2, equity beta is 1.6, risk-free rate is 5%, while the market risk premium is 7%.

The Finance Director is of the view that it is not appropriate to use the existing WACC to appraise the new project. He has identified a listed company that currently produces cement and packaged fruit drinks. The company has the following financial statistics:

  • Equity beta: 1.82
  • Debt beta: 0.4
  • Debt/Equity ratio: 40%
  • 60% of the market value of the company is attributed to cement production, while 40% of the value is attributed to the fruit drinks division.
  • The fruit drinks division has an equity beta of 0.8.

The new project is expected to move AK Plc to the target Debt/Equity ratio of 30%. Tax rate is 25% for the two companies and is paid in the year profit is made.

Required:

a. Compute the appropriate cost of capital that AK Plc should use to appraise the cement project and state why you consider this rate more appropriate than the existing WACC of 11%.

  • Note: Your final cost of capital should be rounded up to the nearest whole number. State any assumptions made. (12 Marks)

b. Compute the Net Present Value (NPV) and Modified Internal Rate of Return (MIRR) of the project, assuming a cost of capital of 13%.

  • (Work to the nearest N million). (16 Marks)

c. Recommend whether the project should be accepted or not, using both NPV and MIRR methods. (2 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

Tico Plc is comprised of only four major investment projects, details of which are as follows:

Project % of Company Market Value Annual % Return During Last 5 Years Risk % Standard Deviation Correlation with the Market
1 28 10 15 0.55
2 17 18 20 0.75
3 31 15 14 0.84
4 24 13 18 0.62

The risk-free rate is expected to be 5% per year, the market return 14% per year, and the standard deviation of market returns 13%.

Required:

a. Assume that Tico Plc’s shares are currently priced based upon the assumption that the last five years’ experience of returns will continue for the foreseeable future. Evaluate whether or not the share price of Tico Plc is undervalued or overvalued. (8 Marks)

b. Discuss why your results in (a) above might not correctly identify whether or not the share price of Tico Plc is undervalued or overvalued. (6 Marks)

c. Briefly discuss the key limitations of portfolio theory in the analysis of physical investment decisions in practice. (6 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q5 – Mergers and Acquisitions

Evaluate takeover bids from shareholder perspectives, assess failure to achieve synergies, and suggest risk minimisation steps.

Ponk Plc is a market research company. It has seen significant growth in recent years and obtained a stock market listing 5 years ago. Due to current economic and political turmoil in the country, there has been a significant drop in revenue and profit.

Ponk Plc is planning a takeover bid for XY, a rival market research company specialising in the telecommunication industry – an industry that has been very resistant to the current economic turbulence in the country. XY has an advanced information technology and information system which was developed in-house and which Ponk Plc would acquire the rights to use. Ponk Plc plans to adopt XY’s information technology and information system following the acquisition, and this is expected to be a major contributor to the overall estimated synergistic benefits of the acquisition. These benefits are believed to be worth ₦8 million (in cash flow) at the end of the first year of acquisition and growing annually at 5%.

Ponk Plc has 30 million shares in issue and a current share price of ₦69 before any public announcement of the planned takeover.
XY has 5 million shares in issue and a current share price of ₦128.40.
It is believed that the WACC of the combined company will be 15% p.a.

The directors of Ponk are considering 2 alternative bid offers:

  • Bid offer 1 – Share-based bid of 2 Ponk Plc shares for each of XY share.
  • Bid offer 2 – Cash offer of ₦135 per XY share.

Required:

a. Assuming synergistic benefits are realised, evaluate bid offer 1 and bid offer 2 from the viewpoint of:
(i) Ponk’s existing shareholders
(ii) XY’s shareholders. (6 Marks available for calculations)

b. Advise the directors of Ponk Plc on:
(i) The potential impact on the shareholders of both Ponk and XY of not successfully realising the potential synergistic benefits after the takeover. (6 Marks)
(Up to 4 marks are available for calculations)

(ii) The steps that could be taken to minimise the risk of failing to realise the potential synergistic benefits arising from the adoption of XY’s information technology and information system. (4 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate economic exposure, forecast exchange rates with inflation, calculate expected receipts using forward and money-market hedges, and discuss problems with futures contracts.

Kingston Plc. (KP) is a Nigerian company based in Aba. KP exports finished products to and imports raw materials from a company Central Africa, with currency of Central Dollar (C$).

KP has the following expected transactions:

You have collected the following information:

Money market rate for KP:

a. Discuss the significance to a multinational company of economic exposure. (5 Marks)

b. Explain how inflation rates can be used to forecast exchange rates. (3 Marks)

c. Calculate the expected naira receipts in one month and in three months using the forward market. (3 Marks)

d. Calculate the expected naira receipts in three months using a money-market hedge and recommend whether a forward market hedge or a money-market hedge should be used. (5 Marks)

e. Discuss FOUR possible problems of using futures contracts to hedge exchange rate risks. (4 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q3 – Ethical Issues in Financial Management

Discuss non-financial and ethical issues affecting financial objectives and outline financial objectives in not-for-profit organizations.

Question:

a. Discuss and provide examples of the types of non-financial, ethical, and environmental issues that might influence the objectives of companies. Consider the impact of these non-financial, ethical, and environmental issues on the achievement of primary financial objectives such as the maximisation of shareholder wealth. (12 Marks)

b. Discuss generally, the nature of the financial objectives that may be set in a not-for-profit organisation such as a charity or a hospital. (8 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for Gap Plc, including rights issue and debt issue, using CAPM, market dynamics, and strategic implications.

You should assume that the current date is 31 December 2019.
You work for Eko Corporate Finance (ECF). One of the clients for whom you are responsible is Gap Plc (GP).

Gap Plc is a listed company and is seeking to raise ₦560 million to invest in new projects during 2020. Currently, Gap Plc is financed by equity. However, at a recent board meeting, the finance director stated that, since other companies in Gap Plc’s industry have average gearing ratios (measured by debt/equity by market value) of 30% (with a maximum of 40%) and an average interest cover of 6 times (with a minimum of 5 times), perhaps the company should access the debt markets. The finance director presented to the board two alternative sources of finance to raise the ₦560 million.

Equity Issue:
The ₦560 million would be raised by a 1 for 2 rights issue, priced at a discount on the current market value of GP’s shares.

Debt Issue:
The ₦560 million would be raised by an issue of 7% coupon bonds, redeemable on 31 December 2029. The yield to maturity (YTM) of the bonds would be equal to the YTM of the bonds of Eko Ventures (EV), another listed company in Gap Plc’s market sector. Eko Ventures has a similar risk profile to Gap Plc and has recently issued its bonds. Eko Ventures’ bonds have a coupon of 7%, will be redeemed in four years at par, and their current market price is ₦110 per ₦100 nominal value.

There were concerns expressed by a number of board members regarding the debt issue since it has been the long-standing policy of the company not to borrow. Their concerns were how Gap Plc’s shareholders and the stock market would react. The company’s cost of capital would increase as a result of the borrowing, leading to a fall in the company’s value.

An extract from Gap Plc’s most recent management accounts is shown below:

₦m
Operating profit 200
Taxation at 20% (40)
Profit after tax 160

Additional Information:

  1. Gap Plc has an equity beta of 1.1
  2. The risk-free rate is expected to be 3% p.a.
  3. The market return is expected to be 8% p.a.
  4. Gap Plc’s current share price is ₦5 per share ex-dividend.
  5. Gap Plc has 320 million ordinary shares in issue.

Required:

a. Calculate, using the CAPM, Gap Plc’s cost of capital on 31 December 2019. (1 Mark)

b. Assuming a 1 for 2 rights issue is made on 1 January 2020:
i. Calculate the discount the rights issue represents on Gap Plc’s current share price. (1 Mark)
ii. Calculate the theoretical ex-rights price per share. (1 Mark)
iii. Discuss whether the actual share price is likely to be equal to the theoretical ex-rights price. (4 Marks)

c. Alternatively, assuming debt is issued on 1 January 2020:
i. Calculate the issue price and total nominal value of the bonds that will have to be issued to give a YTM equal to that of Eko Ventures’ bonds in the above calculation. (5 Marks)
ii. Discuss the validity of the use of the YTM of Eko Ventures’ bonds in the above calculations. (3 Marks)

d. Outline the advantages and disadvantages of the two alternative sources for raising the ₦560 million, discuss the concerns of the board regarding the bond issue (using the gearing and interest cover information provided by the finance director), and advise Gap Plc’s board on which source of finance should be used. (5 Marks)

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  • 40 Marks

FM – May 2021 – L3 – Q1 – Business Valuation Techniques

Evaluate the value of Zinco Limited using various valuation techniques and estimate the coupon rate for bond financing.

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components.
The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry-recognized techniques.

Summarized financial statements of Zinco Limited for the last two years are shown below:

Statements of Profit or Loss for the years ended 30 June

2020 (N’000) 2019 (N’000)
Sales Revenue 112,400 101,090
Opening Profit before exceptional items 6,510 4,100
Exceptional Items (10,025) –
Interest Paid (Net) (1,400) (890)
Profit/(Loss) before Tax (4,915) 3,210
Taxation (1,050) (890)
Profit/(Loss) after Tax (5,965) 2,320
Note: Dividend 1,000 500

Statement of Financial Position as at 31 March (N’000)

Additional Information Relating to Zinco:

  1. If the acquisition succeeds, there will be revenue synergy leading to an increase in annual sales revenue of Zinco of 25% for three years, and 10% per year thereafter.
  2. Non-cash expenses, including depreciation, were N4,100,000 in 2020.
  3. Income tax rate is 30% p.a.
  4. Capital expenditure was N5 million in 2020 and is expected to grow at approximately the same rate as revenue.
  5. Working capital, interest payments, and non-cash expenses are expected to increase at the same rate as revenue.
  6. Zinco has a patent with a current market value of N50 million. This has not been included in the non-current assets.
  7. Operating profit is expected to be approximately 8% of revenue in 2021 and to remain at the same percentage in future years.
  8. Dividends are expected to grow at the same rate as revenue.
  9. The realizable value of inventory is expected to be 70% of its book value.
  10. The estimated cost of equity is 12%.
  11. The average P/E ratio of listed companies of similar size to Zinco is 30:1.
  12. Average earnings growth in the industry is 6% per year.

Required:

a. Prepare a report that gives an estimate of Zinco using:
(i) Asset-based valuation (8 Marks)
(ii) P/E ratios (6 Marks)
(iii) Dividend-based valuation (6 Marks)
(iv) The present value of expected future cash flows (5 Marks)
(v) Discuss the potential accuracy of each of the methods used and recommend, with reasons, a value or range of values that PT might bid for Zinco. State clearly any assumptions that you make.

b. The directors of PT are considering issuing some ₦100 nominal value ten-year bonds to finance the purchase of Zinco. To make the bonds look attractive to potential investors, the bonds are to be issued at a discount of 10%. Based on PT’s credit rating, investors are expected to require a return of 7% per year from such bonds.

You are required:
To estimate the coupon rate that PT will have to pay on these bonds in order to satisfy the investors. (5 Marks)

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  • 15 Marks

FM – May 2022 – L3 – Q7 – Dividend Policy

Brief on various dividend concepts, including residual theory, clientele effect, and signaling.

You are required to provide a briefing on the following dividend concepts:
a. Residual theory of dividends (3 Marks)
b. Clientele effect (3 Marks)
c. Asymmetric information (2 Marks)
d. Signaling properties of dividends (3 Marks)
e. The ‘bird-in-the-hand’ argument (4 Marks)

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  • 3 Marks

FM – May 2022 – L3 – Q6b – Financial Risk Management

Calculate the number of put options needed to delta-hedge a short position.

In your personal investment portfolio, you have gone short (i.e., you have sold) 110,000 units of Big Bank plc. Call and put options exist on the bank’s shares. You decide to hedge your position using put options on the bank’s shares. For the relevant option, you know that:
N(d1) = 0.45

You are required to calculate how many put options you will need to buy or sell to delta-hedge. Be specific.

 

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  • 12 Marks

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

a. You have worked with a major oil servicing company in Nigeria, with headquarters in the USA, for the past six years. Recently you completed your ICAN examinations, and you have been asked to join the international treasury department in New York City for a two-year attachment. The company is due to pay a UK supplier the sum of ₤5million in three months’ time. Your team is considering alternative methods of hedging the expected payment against adverse movements in exchange rate.

You are required to advise the company which of the following hedging strategies should be adopted for the payment due to be made in three months. Show all workings:
i. Forward contract (2 Marks)
ii. Currency futures (5 Marks)
iii. Currency options (5 Marks)

 

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