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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  • 20 Marks

FM – May 2023 – L3 – Q3 – Investment Appraisal Techniques

Evaluate Tinco Limited's expansion project using financial metrics, assess sensitivity to contribution and tax rate changes, and incorporate capital allowances.

Tinco Limited (TL) is considering an expansion project. The project will involve the acquisition of an automated production machine costing ₦11,000,000 and payable now. The machine is expected to have a disposal value at the end of 5 years, which is equal to 10% of the initial expenditure.

The following schedule reflects a recent market survey regarding the estimated annual sales revenue from the expansion project over the project’s five-year life:

Level of Demand ₦’000 Probability
High 16,000 0.25
Medium 12,000 0.50
Low 8,000 0.25

It is expected that the contribution to sales ratio will be 50%. Additional expenditure on fixed overheads is expected to be ₦1,800,000 per annum. TL incurs a 20% tax rate on corporate profits. Corporate tax is paid one year in arrears.

TL’s after-tax nominal (money) discount rate is 15.5% per annum. A uniform inflation rate of 5% per annum will apply to all costs and revenues during the life of the project. All of the values above have been expressed in terms of current prices.

You can assume that all cash flows occur at the end of each year and that the initial investment does not qualify for capital allowances.

Required:

a.
i. Evaluate the proposed expansion from a financial perspective. (10 Marks)
ii. Calculate and interpret the sensitivity of the project to changes in:

  • The expected annual contribution (3 Marks)
  • The tax rate (2 Marks)

b.
You have now been advised that the capital cost of the expansion will qualify for written down allowances at the rate of 25% per annum on a reducing balance basis. Also, at the end of the project’s life, a balancing charge or allowance will arise equal to the difference between the scrap proceeds and the tax written down value.

You are required to calculate the financial impact of these allowances. (5 Marks)

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  • 20 Marks

FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

You are a Financial Analyst at Tayo Research Group (TRG). You begin valuing Aba Hotels Plc (AHP), a thinly and infrequently traded stock currently selling at 217 kobo, cum 2021 dividend.

For estimating AHP’s required return on equity, TRG uses the capital asset pricing model (CAPM) approach, but you think its equity beta of 1.20 is not reliable because of the stock’s extremely thin trading volume. You have therefore obtained the beta and other pertinent data for Eko Hotel Plc (EHP) – (See Table 1), a midsized company in the same industry with high liquidity trading on the Nigerian Stock Exchange.

Table 1: Valuation Data for EHP

Parameter Value
Asset beta 0.763
Debt beta 0.150
Debt ratio (D/D+E) 0.60
Effective tax rate (%) 30%

Summarised financial data for AHP is shown below:

Statement of Profit or Loss Account

Year 2019 2020 2021*
Sales (₦’000) 305,500 357,600 409,200
Taxable income (₦’000) 40,500 49,000 56,700
Taxation (₦’000) (14,175) (17,150) (19,845)
Post-tax income (₦’000) 26,325 31,850 36,855
Dividend (₦’000) (9,340) (10,228) (11,200)
Retained earnings (₦’000) 16,985 21,622 25,655

Statement of Financial Position

Year 2021*
Non-current assets (₦’000) 216,800
Current assets (₦’000) 158,000
Current liabilities (₦’000) (104,800)
Net assets (₦’000) 270,000
Ordinary shares (₦0.50 par value) 80,000
Reserves (₦’000) 130,000
15% Bond 2026 (₦100 par value) 60,000

(*2021 figures are unaudited)

Other Relevant Information:

  1. It has been estimated that the debt/equity ratio of AHP is 0.16 and the beta of its debt is 0.2.
  2. The risk-free rate is 12% and the market risk premium is 5%.
  3. AHP has an effective tax rate of 35%.
  4. As a result of recent capital investment, stock market analysts expect post-tax earnings and dividends to increase by 25% for two years and then revert to the company’s existing growth rates.

Required:

a. Stock market analysts sometimes use fundamental analysis and sometimes technical analysis to forecast future share prices.
What are fundamental analysis and technical analysis? (4 Marks)

b. Using the dividend valuation model, estimate what a fundamental analyst might consider to be the intrinsic (or realistic) value of the company’s shares.
Comment upon the significance of your estimate for the fundamental analyst. (12 Marks)

c. Explain whether your answer to (b) above is consistent with the semi-strong and strong forms of the efficient markets hypothesis (EMH), and comment upon whether financial analysts serve any useful purpose in an efficient market. (4 Marks)

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  • 4 Marks

FM – May 2023 – L3 – Q1b – Mergers and Acquisitions

Discuss the typical factors included in takeover regulations across countries.

b. The regulation of takeovers varies from country to country.

Outline the typical factors that such a regulation includes. (4 Marks)

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  • 26 Marks

FM – May 2023 – L3 – Q1a – Business Valuation Techniques

Evaluate ZL's valuation using multiple methods and recommend whether KK should acquire ZL. Discuss takeover regulation factors.

KK, a company quoted on the Stock Exchange, has cash balance of ₦230 million which are currently invested in short-term money market deposits. The cash is intended to be used primarily for strategic acquisitions, and the company has formed an acquisition committee with a remit to identify possible acquisition targets. The committee has suggested the purchase of ZL, a company in a different industry that is quoted on the AIM (Alternative Investment Market). Although ZL is quoted, approximately 50% of its shares are still owned by three directors. These directors have stated that they might be prepared to recommend the sale of ZL, but they consider that its shares are worth ₦220 million in total.

Summarised financial data:

Economic data:

  • Risk-free rate of return: 6% p.a.
  • Market return: 14% p.a.
  • Inflation rate: 2.4% p.a., expected to remain stable.

Expected effects of the acquisition:

  1. 50 employees of ZL would immediately be made redundant at an after-tax cost of ₦12 million. Pre-tax annual wage savings are expected to be ₦7.50 million (at current prices) for the foreseeable future.
  2. Some land and buildings of ZL would be sold for ₦8 million (after tax).
  3. Pre-tax advertising and distribution savings of ₦1.50 million per year (at current prices) would be possible.
  4. The three existing directors of ZL would each be paid ₦1 million per year for three years for consultancy services. This amount would not increase with inflation.

Required:

a. Calculate the value of ZL based upon:
i. The use of comparative P/E ratios (3 Marks)
ii. The dividend valuation model (4 Marks)
iii. The present value of relevant operating cash flows over a 10-year period (10 Marks)
iv. Provide an evaluation of each of the three valuation methods in (i) to (iii) above. (7 Marks)
v. Recommend whether KK should go ahead with the offer for ZL. (2 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – Q7 – Mergers and Acquisitions

Advise Inkline Plc on expansion through mergers or acquisitions, potential benefits, demerits, alternatives, and target criteria.

One of the means by which companies expand is through mergers and acquisitions. However, there are other means of expansion aside from these methods.

Inkline Plc, one of your client companies, is intending to expand its business by means of a merger or acquisition. Your firm of management consultants has been asked to advise the management of the company on what steps to take while considering the merger and acquisition methods and whether it should go ahead with the expansion program or otherwise.

Required:

(a) Advise your client on:
(i) Four benefits derivable from its proposed means of expansion. (4 Marks)
(ii) Three probable demerits of employing its proposed method of expansion. (3 Marks)

(b) State two alternatives to merger and acquisition in your report. (2 Marks)

(c) Where the company decides to go ahead with either of these methods, indicate three criteria the company may consider in choosing its target company. (6 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – Q6 – Strategic Performance Measurement

Evaluate Osamco Limited's financial performance and discuss reasons for its potential stock exchange listing.

Osamco Limited, a manufacturer of wire and cables, was bought from its conglomerate parent company in a management buyout deal in August 2010. Six years later, the managers are considering the possibility of listing the company’s shares on the Nigerian Stock Exchange.

The following financial information is made available:

OSAMCO LIMITED
Income Statement for the Year Ended June 30, 2016

Item Amount (N’million)
Turnover 91.25
Cost of sales (79.00)
Profit before interest and taxation 12.25
Interest (3.25)
Profit before taxation 9.00
Taxation (1.25)
Profit attributable to ordinary shareholders 7.75
Dividend (0.75)
Retained profit 7.00

Statement of Financial Position as at June 30, 2016

Average performance ratios for the industry sector in which Osamco Limited operates are as stated below:

Industry Sector Ratios

Ratio Industry Average
Return before interest and tax on long-term capital employed 24%
Return after tax on equity 16%
Operating profit as a percentage of sales 11%
Current ratio 1.6:1
Quick (acid test) ratio 1.0:1
Total debt: equity (gearing) 24%
Dividend cover 4.0
Interest cover 4.5

Required:

  1. (a) Evaluate the financial state and performance of Osamco Limited by comparing it with that of its industry sector. (10 Marks)
  2. (b) Discuss four probable reasons why the management of Osamco Limited is considering Stock Exchange listing. (5 Marks)

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  • 6 Marks

FM – Nov 2016 – L3 – Q5a – Portfolio Management

Explanation of the basic assumptions of the Capital Asset Pricing Model (CAPM).

(a) Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.

What are the basic assumptions on which this model is based?

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  • 20 Marks

FM – Nov 2016 – L3 – Q4 – International Financial Management

Evaluate a foreign investment decision for Gugi Plc, including cash flow, tax, and exchange rate considerations.

Gugi Plc. is a highly successful manufacturing company operating in Nigeria. In addition to sales within Nigeria, the company also exports to a foreign country (with currency F$) along the ECOWAS sub-region. The export sales generate annual net cash inflow of ₦50,000,000.

Gugi Plc. is now considering whether to establish a factory in the foreign country and stop export from Nigeria to the country. The project is expected to cost F$1 billion, including F$200 million for working capital.

A suitable existing factory has been located, and production could commence immediately. A payment of F$950 million would be required immediately, with the remainder payable at the end of year one. The following additional information is available:

Details Figures
Annual production and sales 110,000 units
Unit selling price F$5,000
Unit variable cost F$2,000
Unit royalty payable to Gugi Plc ₦300
Incremental annual cash fixed costs F$50 million

Assume that the above cash items will remain constant throughout the expected life of the project of 4 years. At the end of year 4, it is estimated that the net realizable value of the non-current assets will be F$1.40 billion.

It is the policy of the company to remit the maximum funds possible to the parent (i.e., Gugi Plc.) at the end of each year. Assume that there are no legal complications to prevent this.

If the new factory is set up and export to the foreign country is stopped, it is expected that new export markets of a similar worth in North Africa could replace the existing exports. Production in Nigeria is at full capacity, and there are no plans for further capacity expansion.

Tax on the company’s profits is at a rate of 40% in both countries, payable one year in arrears. A double taxation agreement exists between Nigeria and the foreign country, and no double taxation is expected to arise. No withholding tax is levied on royalties payable from the foreign country to Nigeria.

Tax-allowable “depreciation” is at a rate of 25% on a straight-line basis on all non-current assets.

The Directors of Gugi Plc. believe that the appropriate risk-adjusted cost of capital of the project is 13%.

Annual inflation rates in Nigeria and the foreign country are currently 5.6% and 10%, respectively. These rates are expected to remain constant in the foreseeable future. The current spot exchange rate is F$1.60 = ₦1. You may assume that the exchange rate reflects the purchasing power parity theorem.

Required:

(a) Evaluate the proposed investment from the viewpoint of Gugi Plc.
Notes:

  • Show all workings and calculations to the nearest million.
  • State all reasonable assumptions. (18 Marks)

(b) State two further information and analysis that might be useful in evaluating this project. (2 Marks)

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  • 20 Marks

FM – Nov 2016 – L3 – Q3 – Strategic Performance Measurement

Calculation of EVA for Jack Limited using adjusted financial data and WACC to assess value creation.

Jack Limited is a family-owned business which has grown strongly in the last 50 years. The key objective of the company is to maximize the family’s wealth through their shareholdings. Recently, the directors introduced value-based management, using Economic Value Added (EVA) as the index for measuring performance.

You are provided with the following financial information:

Statement of Profit or Loss and Other Comprehensive Income for the Year Ended December 31, 2015

Item Amount (₦’million)
Operating profit 340.0
Finance charges (115.0)
Profit before tax 225.0
Tax at 25% (56.3)
Profit after tax 168.7

Notes

Description 2015 (₦’m) 2014 (₦’m)
(i) Capital employed – from the Statement of Financial Position 6,285 6,185
(ii) Operating costs: Depreciation 295 285
Provision for doubtful debts 10 2.5
Research and development 60 –
Other non-cash expenses 35 30
Marketing expenses 50 45
  1. Economic depreciation is assessed to be ₦415 in 2015. Economic depreciation includes any appropriate amortization adjustments. In previous years, it can be assumed that economic and accounting depreciation were the same.
  2. Tax: The cash paid in the current year is ₦45 million, with an adjustment of ₦2.5 million for deferred tax provisions. There was no deferred tax balance prior to 2015.
  3. The provision for doubtful debts was ₦22.5 million on the 2015 Statement of Financial Position.
  4. Research and development cost is not capitalized in the accounts. It relates to a new project that will be developed over five years and is expected to be of long-term benefit to the company. The first year of this project is 2015.
  5. The company has been spending heavily on marketing each year to build its brand long-term.
  6. Estimated cost of capital for the company:
    • Equity: 16%
    • Debt (pre-tax): 5%
  7. Gearing (Debt/Equity) Ratio: 1.5:1

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  • 20 Marks

SFM – Nov 2016 – L3 – Q2 – Capital Structure Decisions

Evaluation of convertible loan stock value and growth rate for investment decision-making in Honey Comb Plc

Honey Comb Plc has issued 10% convertible loan stock, redeemable in 10 years on December 31, 2025. The conversion option is available only until December 31, 2017. The issue was sold at ₦920 per ₦1000 of convertible stock. Conversion rate as of January 1, 2016, is 250 equity shares per ₦1000 stock. Non-convertible loan stock with similar risk yields 12%. Current convertible stock price is ₦960, with each equity share priced at ₦3.00 and dividends of ₦0.30 per share.

A holder of this convertible loan stock is contemplating selling or retaining it. Ignore taxation.

Required:

  • (a) What is the value of the security as simple unconvertible loan stock? (5 Marks)
  • (b) What is the expected minimum annual rate of growth in the equity share price to justify holding the security before the option expires? (12 Marks)
  • (c) Recommend a course of action to the security holder with justification. (3 Marks)

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