Subject: FINANCIAL MANAGEMENT

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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.

Question

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:

Sales Data:

Annual Sales: GH₵18,000,000

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

Operation Data:

Average inventory: GH₵1,500,000
Average Accounts receivable: GH₵2,000,000
Average accounts payable: GH₵1,200,000

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)

Answer

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Tags: Budget Variance, Procurement Efficiency, Public Financial Management, Value for Money
Level: Level 2

Topic: Introduction to Financial Management
Series: MAR 2025

FM – Mar2025 – L2 – Q4 – Business valuations

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

Question

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)

Answer

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Tags: Healthcare operations, Inventory Management, Just-in-Time, Supply chain risks
Level: Level 2

Topic: Inventory Management
Series: MAR 2025

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.

Question

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)

Answer

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Tags: Efficiency, Financial Markets, Risk Management, Technological advancements, Transparency
Level: Level 2

Topic: Financial markets
Series: MAR 2025

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

Question

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)

Answer

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Tags: Bond issuance, Capital Project, Financing Options, NPV, Sinking Fund, Syndicated Loan
Level: Level 2

Topic: Investment Appraisal
Series: MAR 2025

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

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

Question

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.

Answer

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Tags: Corporate Social Responsibility, Ethical Practices, Healthcare sector
Level: Level 2

Topic: Introduction to Financial Management
Series: MAR 2025

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

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

Question

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

Answer

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Tags: BOT, DBFO, Infrastructure Financing, Public-Private Partnerships, Service Concession
Level: Level 2

Topic: Public-Private Partnerships (PPP)
Series: Nov 2024

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

Steps to collect overdue debts in financial management.

Question

Outline the steps to be followed to collect overdue debts.

Answer

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Tags: Credit control, Debt Collection, Financial management, Late Payments, Payment Recovery, Receivables
Level: Level 2

Topic: Management of receivables and payables
Series: Nov 2024

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

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

Question

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:

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.
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.
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

Answer

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Tags: Accounts Receivable, Bad Debts, Cash Flow, Cost of Capital, Credit Period, Early Payment Discounts, Factoring, Working Capital
Level: Level 2

Topic: Management of receivables and payables
Series: Nov 2024

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.

Question

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.

Answer

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Tags: Procurement, Procurement Laws, Public Financial Management, Public Sector, Single source procurement, Tender Committee, Tendering
Level: Level 2

Topic: Public sector financial management reforms
Series: Nov 2024

FM – Nov 2024 – L2 – Q4a – Business Valuation

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

Question

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.

Answer

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Tags: Business Valuation, Discounted Cash Flow, Financial Modelling, Price-Earnings ratio, Price-to-Book Ratio, Price-to-Sales Ratio
Level: Level 2

Topic: Business valuations
Series: Nov 2024

FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

Question

Tinko Plc (TP) repairs and maintains heavy-duty trucks, with workshops in Nigeria and several other African countries. TP is considering an expansion project in response to the government’s recent policy aimed at encouraging mechanized farming through the “Graduates Back To Land (GBTL)” program, which will likely increase demand for heavy-duty machinery.

Below are extracts from the most recent Statement of Financial Position of TP:

Item	₦’million
Share capital	200
Reserves	320
Non-current liabilities	760
Current liabilities	60
Total	1,340

TP’s Free Cash Flows to Equity (FCFE) is currently estimated at ₦153 million, and it is expected to grow at 2.5% per annum indefinitely. The equity shareholders require a return of 11%.

The non-current liabilities consist entirely of bonds redeemable in four years at par with a coupon rate of 5.4%. The debt is rated BB, and the credit spread on BB-rated debt is 80 basis points above the risk-free rate.

In light of the GBTL program, TP is contemplating entry into the mechanized farming support industry through a four-year project, recognizing that after four years, competition may intensify significantly.

The project requires an initial investment of ₦84 million and is expected to generate the following after-tax cash flows:

Additional Information:

Scenario Adjustments:
- There is a 25% probability that the GBTL program will not grow as expected in the first year. If this occurs, the present value of the project’s cash flows over its four-year life will be 50% of the original estimates.
- If the GBTL program grows as expected in the first year, there is still a 20% probability that growth will slow in subsequent years, reducing the present value of cash flows to 40% of the original estimates for those years.
Sale Option: Feedwell Limited (FL) has offered ₦100 million to buy the project from TP at the start of the second year. TP is evaluating if this option adds strategic value to the project.
Abako Plc, a comparable company, operates primarily in non-agricultural services, similar to TP, and has an equity beta of 1.6. Abako derives approximately 80% of its revenues from services outside agriculture, with an asset beta of 0.80. Abako’s capital structure consists of 80 million shares trading at ₦4.50 per share and debt of ₦340 million.
The debt is trading at ₦1,050 per ₦1,000 with a zero debt beta.
Risk-free rate: 4%; Market risk premium: 6%; Corporate tax rate: 20%.

Requirements: a. Calculate TP’s current total market value of:

i. Equity (3 Marks)
ii. Bonds (4 Marks) b. Determine the risk-adjusted cost of capital for the new project (to the nearest percent) (10 Marks) c. Estimate the value of the project:
i. Without factoring in the potential strategic value or synergy from the project (5 Marks)
ii. With FL’s offer, assuming it reflects the market’s view of the project’s value (5 Marks) d. Clearly state the assumptions made in your calculations (3 Marks)

Answer

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Tags: Cost of Capital, Debt Valuation, Equity Valuation, Market Value, Project Valuation, Risk Adjustment
Level: Level 3

Topic: Investment Appraisal Techniques

FM – Nov 2021 – L3 – Q7 – Financing Decisions and Capital Markets

Analyze the effects of a 1-for-5 rights issue for James Obasi plc, calculate theoretical ex-rights price, and assess investor options and impacts.

Question

James Obasi plc, a medium-sized drone manufacturing firm, is considering a 1-for-5 rights issue at a 15% discount to the current market price of N4.00 per share. Expected issue costs are N2 million, payable from the funds raised. The proceeds from the rights issue will be used to redeem some of the company’s existing bonds at par.

Financial Information:

Statement of Financial Position (N’000):

Required:

a. Ignoring issue costs and any use of the funds raised by the rights issue, calculate: i. The theoretical ex-rights price per share. ii. The value of rights per existing share. (4 Marks)

b. Identify the alternative actions available to an owner of 1,500 shares in James Obasi plc concerning the rights issue and determine the effect of each action on the investor’s wealth. (6 Marks)

c. Calculate the current earnings per share and the revised earnings per share if the rights issue funds are used to redeem some of the existing bonds.
(5 Marks)

Answer

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Tags: Corporate Tax, Debt Redemption, Debt-equity ratio, Ex-Rights Price, Financial Position, Interest Cover, Investor Options, Rights Issue, Shareholder Wealth
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – Nov 2021 – L3 – Q6 – Portfolio Management

Analyze the risk profile of Bettaluck plc's short-term equity portfolio and assess investment adjustments based on market returns and financial strategy.

Question

Bettaluck plc is experiencing a substantial net cash inflow, which has been temporarily invested in a short-term equity portfolio. This portfolio consists of investments in four Nigerian listed companies. The funds are intended to meet tax obligations, dividend payments, and future capital expenditures in several months.

Portfolio Details:

Required:

a. Based on the data provided, calculate the risk (i.e., Beta) of Bettaluck’s short-term investment portfolio relative to the market. (4 Marks)

b. Recommend whether the composition of Bettaluck’s short-term investment portfolio should be adjusted. Provide reasons for your recommendation, including relevant calculations. (6 Marks)

c. Discuss the factors a financial manager should consider when investing in marketable securities. (5 Marks)

Answer

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Tags: Capital Gains, Dividend Yield, Financial management, Investment Portfolio, Market Return, Marketable Securities, Portfolio Beta, Risk Assessment, Short-Term Strategy, Treasury bills
Level: Level 3

Topic: Portfolio Management

FM – Nov 2021 – L3 – Q5 – Corporate Governance and Stakeholder Management

Analyze criteria for setting objectives in public and private sectors, addressing stakeholder needs and potential consequences of unmet objectives.

Question

a. Ibile is a local government entity financed approximately equally by central government funding and local taxation. The central government funding allocation is primarily determined on a per capita basis, adjusted for the level of deprivation or special needs within Ibile’s region. A small portion of Ibile’s revenue comes from the private sector, such as renting out City Hall for private events.

Ibile’s Main Objectives:

Enhance the region’s economic prosperity and attractiveness as a place to live and work.
Provide service excellence in health and education for the local community.

b. Layo is a large, publicly listed entity with extensive commercial and geographical interests. It has historically established its headquarters in Ibile’s region, which is unusual for a company of its size, as such entities typically base their HQ in a capital or major city.

Layo’s Main Objectives:

Financial: Achieve an average annual increase of 10% in shareholder wealth.
Non-Financial: Maintain favorable treatment of various stakeholders, including local communities where it operates.

Layo’s total net assets are valued at ₦1.5 billion with a gearing ratio of 45% (debt to debt plus equity), consistent with industry norms. The company is currently exploring options to raise significant capital to fund an acquisition.

Required:

Discuss the criteria that each entity (Ibile and Layo) must consider when setting objectives, taking into account the needs of their main stakeholder groups. Reference the consequences each might face if it fails to achieve its stated objectives.

Answer

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Topic: Corporate Governance and Stakeholder Management

FM – Nov 2021 – L3 – Q4 – Corporate Governance and Financial Strategy

Assess LL's corporate objectives, the finance director's view, and treasury strategies within a low-interest economic environment.

Question

Leye Limited (LL) is a privately-owned toy manufacturer in Nigeria, operating internationally as both a supplier and a customer. While privately owned, LL’s revenue and asset base are comparable to some publicly listed companies. It has numerous shareholders but has no plans for public listing. Major shareholders have expressed an interest in buying out smaller investors.

LL has a strong history of profitability, which satisfies both directors and shareholders. They avoid strategies that increase risk significantly, such as acquisitions or overseas manufacturing setups, accepting a comparatively lower growth rate than competitors.

The company’s capital structure is composed of 70% equity and 30% debt (based on book values), with debt comprising secured and unsecured bonds carrying interest rates between 7% and 8.5%, maturing in 5 to 10 years. In a low-inflation and potentially declining interest rate environment, the company treasurer is exploring refinancing options.

LL’s primary financial objective is annual dividend growth, with a non-financial objective of treating all stakeholders with fairness and equality. The Board is currently reassessing these objectives. While the new Finance Director advocates for shareholder wealth maximization as the sole objective, other directors favor a balanced approach, including goals such as profit after tax, return on investment, and operational performance improvements.

Required:

a. Evaluate the appropriateness of LL’s current objectives and the Finance Director’s suggestion. Discuss the issues the Board should consider in setting new corporate objectives, concluding with a recommendation. (10 Marks)

b. Discuss factors the treasury department should consider when formulating financing or refinancing strategies in the given economic context. Explain how these factors might influence the determination of corporate objectives. (10 Marks)

Answer

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Topic: Corporate Governance and Financial Strategy

FM – Nov 2021 – L3 – Q3 – Financing Decisions and Capital Markets

Analyze financing alternatives for ZY Plc's new investment and assess rights issue and bond issue implications.

Question

ZY Plc is an all-equity financed, publicly listed company in the food processing industry. The ZY family holds 40% of its ordinary shares, with the remainder owned by large financial institutions. ZY Plc currently has 10 million ₦1 ordinary shares in issue.

Recently, the company secured a long-term contract to supply food products to a large restaurant chain, necessitating an investment in new machinery costing ₦24 million. This machinery will be operational starting January 1, 2022, with payment due the same day, and sales commencing shortly afterward.

The company’s policy is to distribute all profits as dividends. If ZY Plc continues as an all-equity financed company, it will pay an annual dividend of ₦9 million indefinitely, starting December 31, 2022.

To finance the ₦24 million investment, ZY Plc is considering two options:

A 2-for-5 rights issue, where the annual dividend would remain at ₦9 million. The cum-rights price per share is expected to be ₦6.60.
Issuing 7.5% irredeemable bonds at par with interest payable annually in arrears. For this option, interest would be paid out of the ₦9 million otherwise allocated to dividends.

Under either financing method, the cost of equity is anticipated to remain at its current rate of 10% annually, with no tax implications.

Required:

a. Calculate the issue and ex-rights share prices of ZY Plc., assuming a 2-for-5 rights issue is used to finance the new project as of January 1, 2022. Ignore taxation. (4 Marks)

b. Calculate the value per ordinary share in ZY Plc on January 1, 2022, if 7.5% irredeemable bonds are issued to finance the new project. Assume that the cost of equity remains at 10% each year. Ignore taxation. (4 Marks)

c. Write a report to the directors of ZY Plc that includes: i. A comparison and contrast of the rights issue and bond issue methods for raising finance, referencing calculations from parts (a) and (b) and any assumptions. (6 Marks)
ii. A discussion on the appropriateness of the following alternative methods of issuing equity finance in the specific context of ZY Plc: – A placing – An offer for sale – A public offer for subscription (6 Marks)

Answer

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Tags: Bond Issue, Cost of Equity, Dividend Policy, Equity Financing, Financial strategy, Financing Alternatives, Investment Financing, Public Offering, Rights Issue, Share Valuation
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – Nov 2021 – L3 – Q2 – Mergers and Acquisitions

Advise on financial synergies from KP's acquisition of TE and evaluate cash vs. share-for-share offers.

Question

You run a financial consultancy firm and have been approached by a new client for advice on a potential acquisition. Kola Plc (KP) is a large engineering company that was listed on the stock market ten years ago, with the founders retaining a 20% stake in the business. KP initially experienced rapid growth in earnings before tax, but soon after listing, competition intensified, leading to a significant decline in growth, which currently stands at 4%. Concerned about limited future growth opportunities, the board has decided to adopt a market development strategy for growth by acquiring companies in less competitive regions using KP’s significant cash reserves. The board has identified Temidayo Engineering (TE) as a potential acquisition target.

Temidayo Engineering (TE):

TE is a private engineering company established eight years ago, with early accumulated losses that have now turned profitable, achieving an 8% annual growth in earnings before tax. Cash reserves remain low, and capital access has been a constraint on TE’s investment potential. The founders and their families own 70% of the shares, while a venture capitalist holds the remaining 30%.

Acquisition Information:

KP’s board prefers that TE’s founders remain as directors post-acquisition and has sufficient cash reserves to purchase TE outright. A cash offer of ₦13.10 per share is considered likely to encourage TE’s shareholders to approve the acquisition. Alternatively, KP’s board is exploring a share-for-share exchange to preserve cash for future acquisitions and dividends. Recent mergers in the industry have attracted a 25-30% acquisition premium, with TE’s shareholders expecting a premium towards the higher end for a share-for-share offer. KP has asked you to design a share-for-share offer scheme with a 30% premium.

Extracts from the Latest Financial Statements:

Additional Financial Information:

KP has ₦0.50 ordinary shares totaling ₦7,500 million, with each share trading at ₦5.28. It is expected that KP’s price-to-earnings (P/E) ratio will increase by 10% if the acquisition proceeds.
TE upgraded its main manufacturing facility last year, expecting annual pre-tax cost savings of ₦50 million from the current financial year. TE has ₦0.25 ordinary shares totaling ₦700 million. TE’s P/E ratio is estimated to be 20% higher than KP’s current P/E ratio based on comparable company analysis.
KP’s CEO estimates annual pre-tax revenue and cost synergies of ₦304 million post-acquisition, while the finance director anticipates additional pre-tax financial synergies of ₦106 million, though cautiously, following reports that many acquisitions overestimate synergies. The tax rate is 20%.

Required:

a. Discuss possible sources of financial synergy arising from KP’s acquisition of TE. (6 Marks)

b. Advise the directors on a suitable share-for-share exchange offer that meets TE’s shareholders’ criteria and calculate the impact of both cash and share-for-share offers on the post-acquisition wealth of KP’s and TE’s shareholders. (14 Marks)

Answer

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Tags: Acquisition strategy, Cash Reserves, Cost savings, Financial Synergies, Price-Earnings ratio, Revenue Synergies, Share-for-Share Exchange, Wealth Impact
Level: Level 3

Topic: Mergers and acquisitions

FM – Nov 2021 – L3 – Q1 – Strategic Cost Management

Analyze costs and investment requirements for Femi Appliances Ltd's new motor vehicle vacuum cleaner product line.

Question

Femi Appliances Limited (FAL) is a Nigerian-based manufacturer of household appliances with many distribution centers across various locations in Nigeria and along the ECOWAS sub-region. FAL is now considering the development of a new motor vehicle vacuum cleaner – VC4.

The product can be introduced quickly and has an expected life of four years, after which it may be replaced with a more efficient model. Costs associated with the product are estimated as follows:

Direct Costs (per unit):

Labour:
- 3.5 skilled labour hours at ₦500 per hour
- 4 unskilled labour hours at ₦300 per hour
Materials:
- 6 kilos of material Z at ₦146 per kilo
- Three units of component P at ₦480 per unit
- One unit of component Q at ₦640
Other variable costs: ₦210 per unit

Indirect Costs:

Apportionment of management salaries: ₦10,500,000 per year
Tax allowable depreciation of machinery: ₦21,000,000 per year
Selling expenses (excluding salaries): ₦16,600,000 per year
Apportionment of head office costs: ₦5,000,000 per year
Rental of buildings: ₦10,000,000 per year
Annual interest charges: ₦10,400,000
Other annual overheads: ₦7,000,000 (includes building rates ₦2,000,000)

If the new product is introduced, it will be manufactured in an existing factory, having no effect on rates payable. The factory could be rented out for ₦12,000,000 per year to another company if the product is not introduced.

New machinery costing ₦86,000,000 will be required, depreciated on a straight-line basis over four years with a salvage value of ₦2,000,000. The machinery will be financed by a four-year fixed-rate bank loan at 12% interest per year. Additional working capital requirements may be ignored.

The new product will require two additional managers at an annual gross cost of ₦2,500,000 each, while one current manager (₦2,000,000) will be transferred and replaced by a deputy manager at ₦1,700,000 per year. Material Z totaling 70,000 kilos is already in inventory, valued at ₦9,900,000.

FAL will utilize the existing advertising campaigns for distribution centers to also market the new product, saving approximately ₦5,000,000 per year in advertising expenses.

The unit price of the product in the first year will be ₦11,000, with projected demand as follows:

Year 1: 12,000 units
Year 2: 17,500 units
Year 3: 18,000 units
Year 4: 18,500 units

An inflation rate of 5% per year is anticipated, with prices rising accordingly. Wage costs are expected to increase by 7% per year, and other costs (including rent) by 5% annually. No price or cost increases are expected in the first year of production.

Income tax is set at 35%, payable in the year the profit occurs. Assume all sales and costs are on a cash basis and occur at the end of the year, except for the initial purchase of machinery, which would take place immediately. No inventory will be held at the end of any year.

Required:

a. Calculate the expected internal rate of return (IRR) associated with the manufacture of VC4. Show all workings to the nearest ₦million. (19 Marks)

b. i. Explain what is meant by an asset beta and how it differs from an equity beta. (2 Marks)
ii. Given the company’s equity beta is 1.2, the market return is 15%, and the risk-free rate is 8%, discuss whether introducing the product is advisable. (4 Marks)

c. The company is concerned about a potential increase in corporate tax rates. Advise the directors by how much that the tax rate would have to change before the project is not financially viable. A discount rate of 17% per year may be assumed for part (c). (5 Marks)

Answer

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Tags: Cost Analysis, Depreciation, Financial strategy, Investment Appraisal, Labour Costs, Material Costs, Overhead Allocation, Product Development, Profitability analysis, Strategic Decision-Making
Level: Level 3

Topic: Strategic Cost Management

FM – Nov 2020 – L3 – Q6 – Dividend Policy

Evaluates the dividend payout and investment appraisal for Binko Industrial Services based on Modigliani and Miller's dividend policy, considering four potential projects.

Question

Binko Industrial Services plc is an all-equity financed and Stock Exchange-listed company. Recently, there have been changes at the board level, prompting a shift from conservative profit distribution to seeking new investment opportunities. In the financial year just ended, the company reported a profit of ₦50 million, similar to previous years. The company’s cost of equity is 15% per annum, and four investment projects have been identified, each with the same risk class as existing projects.

Required:

a. Calculate the dividend Binko Industrial Services plc should pay to shareholders in the financial year just ended, based on Modigliani and Miller’s 1961 proposition, ignoring taxation. (5 Marks)

b. Prepare notes for the board meeting, explaining Modigliani and Miller’s dividend policy proposition and reasons why the company may decide against the calculated dividend in (a). Your comments should address Binko’s circumstances. Work to the nearest ₦1,000. (15 Marks)

Answer

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Tags: Cash Flow Analysis, Cost of Equity, Dividend Policy, investment projects, Modigliani and Miller
Level: Level 3

Topic: Dividend Policy

FM – Nov 2020 – L3 – Q5 – Financial Strategy Formulation

Examines financial proposals affecting Yinko plc's capital structure, including debt-financed share buyback, asset expansion, and asset sale with debt reduction.

Question

Yinko plc operates in the hospitality and leisure industry. The board of directors met recently to discuss several financial proposals:

Proposal 1: Increase the company’s debt by borrowing an additional N100 million and use the funds raised to buy back its shares.
Proposal 2: Increase the company’s debt by borrowing an additional N100 million to invest in expanding available rooms in one of its hotels.
Proposal 3: Sell excess non-current assets in another hotel with a net book value of ₦100 million for N135 million. The funds from the sale will be used to reduce the company’s debt.

Yinko plc Financial Information:

	Amount (N Million)
Non-current assets	1,410
Current assets	330
Total assets	1,740
Equity and liabilities
Share capital (40 kobo per share par value)	240
Retained earnings	615
Total equity	855
Non-current liabilities	700
Current liabilities	185
Total liabilities	885
Total liabilities and capital	1,740

Additional Information:

Yinko’s forecasted after-tax profit for the coming year, without implementing the proposals, is N130 million.
Current share price: N3.20 per share.
Non-current liabilities include a 6% medium-term loan redeemable in seven years. Any increase in borrowing raises the coupon rate by 25 basis points on the total amount borrowed, while a reduction lowers it by 15 basis points.
Effective tax rate: 20%
Expected after-tax return on investment: 15% for new or reduced investments.

Required:

a. Estimate the impact of each proposal on the forecast statement of financial position, earnings per share, and financial gearing (Total Debt/Total Assets) of Yinko Plc. Show all calculations. (16 Marks)

b. Discuss your results. (4 Marks)

Answer

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Tags: Asset sale, debt level, EPS, Financial Gearing, Financial restructuring, Non-current Assets, share buyback
Level: Level 3

Topic: Financial strategy formulation

Subject: FINANCIAL MANAGEMENT

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Advise on financial synergies from KP's acquisition of TE and evaluate cash vs. share-for-share offers.

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Acquisition Information:

Additional Financial Information:

Required:

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Analyze costs and investment requirements for Femi Appliances Ltd's new motor vehicle vacuum cleaner product line.

Direct Costs (per unit):

Indirect Costs:

Required:

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Evaluates the dividend payout and investment appraisal for Binko Industrial Services based on Modigliani and Miller's dividend policy, considering four potential projects.

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Examines financial proposals affecting Yinko plc's capital structure, including debt-financed share buyback, asset expansion, and asset sale with debt reduction.

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