- 15 Marks
SFM – May 2024 – PL – SC – Q7 – Mergers and Acquisitions
Discuss manager-shareholder conflicts with examples; explain reasons for synergy in mergers/takeovers.
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Subject: STRATEGIC FINANCIAL MANAGEMENT
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- 15 Marks
May 2024 – PL – SC – Q6 – Foreign Exchange Risk Management
Explain economic exposure and management; estimate impact on Linko Plc's value from expected USD strengthening vs GBP.
Question
a. With respect to foreign currency risk management, explain economic exposure and discuss generally, how a company can manage economic exposure. (8 Marks)
b. Linko Plc is a Uk-based company. It supplies medical equipment to the USA and Europe. It also buys some basic raw materials from USA.
In a typical financial year Linko has net imports of 8 million dollars from USA. This is expected to continue for the next six years.
The company’s cost of capital is 10% per year. Assume that cash flows occur at the year end. Ignore taxation.
Required:
Assuming that there is no change in the physical volume or dollar price of imports, estimate the impact on the expected market value of Linko Plc, if the market expects the dollar to strengthen by 4% per year against the pounds. The current spot rate exchange rate (US$ per £1) is 1.9156 – 1.9210. (7 Marks)
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- 15 Marks
SFM – May 2024 – PL – SC – Q5 – Financial Distress and Bankruptcy
Explain problems/costs of financial distress; describe impacts of high gearing on stakeholders and protective measures.
Question
a. Explain the main problems and costs which might arise for a company experiencing a period of severe financial difficulties. (7 Marks)
b. Describe how interested parties, other than bondholders, will be affected by high financial gearing levels, and describe what protective measures they can take. (8 Marks)
(Total 15 Marks)
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- 20 Marks
SFM – May 2024 – PL – SB – Q4 – Cost of Capital
Calculate forward rates from default-free bonds; price 9% bond, YTM, price change expectation, modified duration and limitations.
Question
The following information is on 3 default free bonds.
| Bonds | Price ₦ | Coupon % | Redemption value ₦ | Maturity Years |
|---|---|---|---|---|
| A | 105 | 10 | 100 | 1 |
| B | 96 | 4 | 100 | 2 |
| C | 98 | 6 | 100 | 3 |
Required:
a. Estimate the two-year forward rate at the end of year 1 and the one-year forward rate at the end of year 2. (5 Marks)
b. You are considering buying a three – year 9% annual-coupon paying bond with
face value of ₦1,000. The bond is default free bond.
i. Calculate the price of the bond and its yield to maturity. Clearly explain why you may not realise the calculated yield. (6 Marks)
ii. One-year after purchasing the bond at the price you have calculated and if there are no changes in market interest rates, do you expect the price of the bond to increase, fall or remain constant? Explain. (2 Marks)
iii. Estimate and interpret the modified duration of the bond. Identify the key limitations of modified duration in bond analysis. (7 Marks)
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- Tags: Bond pricing, Bond Risks, Duration, Forward Rates, Interest rates, Modified Duration, Yield to Maturity
- Level: Level 3
- Topic: Cost of capital
- Series: MAY 2024
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- 20 Marks
SFM – May 2024 – PL – SB – Q3 – Capital Structure Decisions
Analyze Tope's financing options (equity/debt) for expansion: forecast P&L, EPS, gearing; indifference point; evaluate for shareholders; discuss debt/equity factors.
Question
Tope operates a chain of cellular telephone stores in the country. An abbreviated profit or loss account and statement of financial position of the business for the year that has just ended is as follows:
Abbreviated profit or loss account for the year ended 31 May 2023
| ₦‟000 | |
|---|---|
| Sales | 6,450 |
| Operating profit for the year | 800 |
| Interest payable | (160) |
| Net profit before taxation | 640 |
| Tax (20%) | (128) |
| Net profit after taxation | 512 |
| Dividends proposed | (256) |
| Retained profit for the year | 256 |
Abbreviated statement of financial position as at 31 May 2023
| ₦‟000 | ₦‟000 | |
|---|---|---|
| Non-current assets at written down values | 3,500 | |
| Current assets | 1,800 | |
| Less: Current liabilities | (1,100) | 700 |
| 4,200 | ||
| Less: long-term liabilities | (2,000) | |
| 2,200 | ||
| Capital and reserves | ||
| ₦0.50 ordinary shares | 600 | |
| Retained profit | 1,600 | |
| 2,200 |
The company is expecting a surge in sales following advances in cellular telephone technology that should translate into additional operating profits of ₦180,000 per year for the foreseeable future. However, the company will need to invest ₦1,200,000 immediately in expanding the asset base of the business, if it is to achieve these additional profits.
The business has approached a large supplier that already has an equity investment in the business to see whether it would be prepared to provide further funds for the business. The supplier has indicated it would be willing to provide the necessary funds by either:
(i) An issue of ₦0.50 ordinary shares at a premium of ₦1.50 per share; or
(ii) An issue of ₦1,200,000 10% debt at par.
The Board of Directors of Tope has already announced that it will maintain the same dividend payout ratio in future years as in the past and that this policy will be unaffected by the form of finance raised.
Required:
a. For each of the financing options:
i. Prepare a forecast profit or loss account for the forthcoming year.
(5 Marks)
ii. Calculate the forecast earnings per share for the forthcoming year.
(2 Marks)
iii. Calculate the projected level of gearing (D/(D+E)) at the end of the forthcoming year. (2 Marks)
b. Calculate the level of operating profit at which the earnings per share will be the same under each financing option. (3 Marks)
c. Evaluate each of the financing options from the view point of an existing shareholder. (2 Marks)
d. Discuss the factors that will influence a company to finance through debt or equity, and whether to opt for long-term or short-term debt. (6 Marks)
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- 20 Marks
SFM – May 2024 – PL – SB – Q2 – Investment Appraisal Techniques
Identify errors in trainee's NPV appraisal for Keke Plc project; revise NPV calculation; discuss multiple IRR and differing business risk issues.
Question
The following draft appraisal of a proposed investment project has been prepared for the Finance Director of Keke Plc (KP) by a trainee accountant. The project is consistent with the current business operations of KP.
| Year | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|
| Sales (units/yr) | 250,000 | 400,000 | 500,000 | 250,000 | |
| Contribution | 13,300 | 21,280 | 26,600 | 13,300 | – |
| Fixed costs | (5,300) | (5,618) | (5,955) | (6,312) | – |
| Depreciation | (4,375) | (4,375) | (4,375) | (4,375) | – |
| Interest payments | (2,000) | (2,000) | (2,000) | (2,000) | – |
| Taxable profit | 1,625 | 9,287 | 14,270 | 613 | |
| Taxation | – | (488) | (2,786) | (4,281) | (184) |
| Profit after tax | 1,625 | 8,799 | 11,484 | (3,668) | (184) |
| Scrap value | – | – | – | 2,500 | – |
| After-tax cash flows | 1,625 | 8,799 | 11,484 | (1,168) | (184) |
| Discount at 10% | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 |
| Present values | 1,477 | 7,268 | 8,624 | (798) | (114) |
Net present value = (16,457,000 – 20,000,000) = ₦3,543,000 so reject the project. The following information was included with the draft investment appraisal:
(1) The initial investment is ₦20 million.
(2) Selling price: ₦120/unit (current price terms), selling price inflation is 5% per year.
(3) Variable cost: ₦70/unit (current price terms), variable cost inflation is 4% per year.
(4) Fixed overhead costs: ₦5,000,000/year (current price terms), fixed cost inflation is 6% per year.
(5) ₦2,000,000/year of the fixed costs are development costs that have already been incurred and are being recovered by an annual charges to the project.
(6) Investment financing is by a ₦20 million loan at a fixed interest rate of 10% per year.
(7) Keke Plc can claim 25% reducing balance tax allowable depreciation on this investment and pays taxation one year in arrears at a rate of 30% per year.
(8) The scrap value of machinery at the end of the four-year project is ₦2,500,000.
(9) The real weighted average cost of capital of Keke is 7% per year.
(10) The general rate of inflation is expected to be 4.7% per year.
Required:
a. Identify and comment on any errors in the investment appraisal prepared by the trainee accountant. (4 Marks)
b. Prepare a revised calculation of the net present value of the proposed investment project and comment on the project’s acceptability. (12 Marks)
c. Discuss the problems faced when undertaking investment appraisal in the following areas and comment on how these problems can be overcome:
i. an investment project has several internal rates of return;
ii. the business risk of an investment project is significantly different from the business risk of current operations. (4 Marks)
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- 30 Marks
SFM – May 2024 – PL – SA – Q1 – Business Valuation Techniques
Evaluate Kenny Ltd share value using net assets (historic/revalued), P/E, dividend yield, and DCF methods; discuss method pros/cons and merger benefits with Bolade Plc.
Question
You are employed by Bolade Plc ( BP), a very large printing firm with retail outlets across Nigeria. Its board is considering making an offer to buy 100% of the shares of Kenny Ltd (KL), a competitor of Bolade in Aba. KL‟s financial year end is 28 February and its most recent financial statements are summarised below:
KL Income Statement for the year ended 28 February 2023
| ₦m | |
|---|---|
| Revenue | 17.3 |
| Profit before interest and tax | 5.9 |
| Interest | (0.3) |
| Profit before taxation | 5.6 |
| Tax at 21% | (1.2) |
| Profit after taxation | 4.4 |
| Dividends declared | 1.1 |
KL Statement of financial position at 28 February 2023
| ₦m | ₦m | ₦m | |
|---|---|---|---|
| Non-current assets: | |||
| Freehold land and buildings (original cost ₦4.1m) | 3.5 | ||
| Machinery (original cost ₦8.8m) | 5.3 | ||
| 8.8 | |||
| Current assets: | |||
| Inventories | 3.0 | ||
| Receivables | 0.5 | ||
| Cash and bank | 2.8 | ||
| 6.3 | |||
| Current liabilities: | |||
| Trade payables | 3.5 | ||
| Dividends | 1.1 | ||
| Taxation | 1.2 | ||
| (5.8) | |||
| 0.5 | |||
| 9.3 | |||
| Non-current liabilities: | |||
| 10% bonds (redeemable 2031) | (3.0) | ||
| 6.3 | |||
| Equity: | |||
| Ordinary shares of ₦1 each | 2.1 | ||
| Retained earnings | 4.2 | ||
| 6.3 |
Additional Information KL‟s management had some of the company’s assets independently revalued in January 2023. Those values are shown below:
| ₦m | |
|---|---|
| Freehold land and building | 8.3 |
| Machinery | 4.1 |
| Inventories | 3.1 |
The average price/earnings ratio for listed business in the printing industry is 9 and the average dividend yield is 6% p.a.
The cost of equity of business in the printing industry, taking account of the industry average level of capital gearing, is 14% p.a.
KL’s finance department has estimated that the company’s pre-tax net cash inflows (after interest) for the next four trading years ending 28 February, before taking account of capital allowances, will be:
| ₦m | |
|---|---|
| Year to 2024 | 4.6 |
| Year to 2025 | 4.3 |
| Year to 2026 | 5.2 |
| Year to 2027 | 5.7 |
KL’s existing equipment has tax written-down value of ₦3.6 million at 28 February 2023. The equipment attracts 18% (reducing balance) tax allowances in every year of ownership by the company, except the final year.
You should assume that KL will not be purchasing or disposing of any machinery in the years 2024-2027 and that it would dispose of the existing equipment on 28 February 2027 at its tax written-down value.
Bolade’s board estimates that in four years‟ time, i.e. 28 February 2027, it could, if necessary, dispose of KL for an amount equal to four times its after-tax cash flow (ignoring the effects of capital allowances and the disposal value of the equipment) for the year to 28 February 2027.
Assume that the company income rate is 21% p.a.
Required: Using the information provided, prepare a report for Bolade’s board by:
a. Calculating the value of one share in KL based on each of the following
methods:
i. Net asset basis (historic cost)
ii. Net asset basis (revalued)
iii. Price/earnings ratio
iv. Dividend yield
v. Present value of future cash flows
(16 Marks)
b. Explain the advantages and disadvantages of using each of the five valuation methods in (a). (8 Marks)
c. What are the possible benefits from the merger between Bolade Plc (BP) and Kenny Limited (KL). (6 Marks)
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- Tags: Acquisitions, Business Valuation, Discounted Cash Flow, Dividend Yield, Mergers, Net Asset Value, P/E Ratio, Synergies
- Level: Level 3
- Topic: Business Valuation Techniques
- Series: MAY 2024
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- 15 Marks
SFM – Nov 2022 – L1 – Q7 – Financial Strategy Formulation
Assess Chairman's proposals to increase EPS by delaying payments, postponing capex, freezing pay, ending sponsorship, and discuss ways to encourage managers to achieve stakeholder objectives.
Question
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2022
STRATEGIC FINANCIAL MANAGEMENT
The Chairman of Opeyemi plc, a company listed on the Alternative Investment Market, has circulated a memorandum to the company’s directors and senior managers which contains the following statements: ‘Looking to the year ahead, there are a number of measures which I propose to increase the company’s earnings per share (EPS). Payments to trade creditors should be made as late as possible, even if this means extending our credit beyond the terms allowed by our suppliers. The company currently runs a substantial overdraft, and this measure will cut the level of bank interest and charges. Relatively high capital expenditure in recent years has resulted in substantial depreciation charges in the profit or loss account. All capital spending, including that on the Oloro II project – designed to reduce toxic emissions from the manufacturing plant – should be postponed except where such spending can be shown to be essential to current operations. Staff pay should be frozen at this year’s level for the forthcoming year. The company’s sponsorship of the local charity events run by the Staff Social Club should also, regrettably be ended. By boosting profits and therefore EPS, these measures will help us to achieve the highest possible stock market capitalization.’
Required: a. Prepare a response to the Chairman’s proposals which examines the possible consequences of the proposals for the price of the company’s shares and for the company’s stakeholders. b. Discuss FOUR ways that encourage managers to achieve stakeholder objectives.
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- 15 Marks
SFM – Nov 2022 – Q6 – Business Valuation Techniques
Explain P/E ratio with data from food retailers, calculate and discuss dividend cover for companies B and C.
Question
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2022
STRATEGIC FINANCIAL MANAGEMENT
Companies A, B and C are in the food retailing sector of the stock market. The following key stock market statistics are provided.
Food Retailers: Ordinary Shares, Key Stock Market Statistics
Company Current Share price (kobo) 52 week high 52 week low Dividend Yield (%) P/E ratio
A 63 112 54 1.8 14.2 B 291 317 187 2.1 13.0 C 187 201 151 2.3 21.1
Required:
a. Illustrating your answer by use of data from the table above, define and explain the term P/E ratio, and comment on the way it may be used by an investor to appraise a possible share purchase.
b. Using data in the above table, calculate the dividend cover for C and B, and explain the meaning and significance of the measure from the point of view of equity investors.
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- 15 Marks
SFM – Nov 2022 – Q5 – Business Valuation Techniques
Calculate APL's equity value using SVA with given drivers and outline three methods for funding a management buy-out.
Question
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2022
STRATEGIC FINANCIAL MANAGEMENT
SECTION C: OPEN-ENDED QUESTIONS (30 MARKS)
INSTRUCTION: YOU ARE REQUIRED TO ATTEMPT ANY TWO OUT OF THE THREE QUESTIONS IN THIS SECTION
QUESTION 5
ADERUPOKO PLC
Aderupoko Plc (ADP), a large, listed media group, has been the holding company of Adamu Publishers Limited. (APL) since 2015. The publishing company (APL) is 100% owned by ADP since inception.
Recently the directors of APL informed ADP’s board of their readiness to make a management buy-out (MBO) of APL. Accordingly, ADP’s board decided to value APL using the shareholder value analysis method (SVA). ADP’s board estimates that APL has a four-year competitive advantage over its competitors (to 30 September 2024) and the following data regarding APL’s value drivers and additional financial information has been collected.
Sales for the current year to 30 September 2020 N80 Million Annual depreciation (equal to annual replacement of non-current asset expenditure N2.0 million Par value of 6% debentures in issue (current market value N95.00) nominal value N100 N10.0Million Short-term investments held N0.8Million Company tax rate 20% Current WACC 10%
Year to 30 September budgeted 2021 2022 2023 2024 2025+ Sales growth 5% 4% 3% 2% 0% Operating profit margin 8% 9% 10% 10% 10% Incremental non-current asset Investment (as a % of sales increase) 5% 6% 3% 2% 0% Incremental working capital Investment (as a % of sales increase) 6% 5% 4% 4% 0%
Required:
a. Calculate the value of APL’s equity using SVA b. Outline THREE methods by which APL’s directors might raise the funds necessary for the proposed MBO of the company
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- 30 Marks
SFM – May 2025 – PL – SA – Q1 – Corporate Restructuring
Evaluate demerger and acquisition options for Kola Plc's restaurant business, including valuations, gains, and factors for shareholders.
Question
Kola Plc. is a large listed company involved in two business sectors. Its main business is in the production of food and drink for supermarkets and other large traders. It also owns a chain of restaurants nationwide. Kola’s Board of Directors (BoD) think that the company is undervalued and is of the opinion that it should focus on the rapid innovation taking place in the food and drink production sector.
Therefore, Kola’s BoD has decided to unbundle the restaurant business into a company called ZK Ltd and Kola Plc can either spin-off or sell ZK Ltd after the demerger so that Kola Plc can focus on its remaining business of food and drink production. Initially, Kola Plc’s shareholders will own ZK Ltd on the basis of owning one ZK Ltd share for every Kola Plc share owned by them.
MK Ltd is a large unlisted company controlled by 20 shareholders who all have a significant stake in the business. MK Ltd owns a number of hotels around the country and is looking to diversify into the restaurant business. MK Ltd has approached Kola Plc about the possibility of purchasing ZK Ltd. MK Ltd will finance the purchase either through a cash-only offer or a share-for-share offer.
If ZK Ltd is demerged, it will be listed on the stock exchange as an independent company. Kola Plc is unsure whether to sell ZK Ltd to MK Ltd or demerge it into an independent company.
Extracts from Kola Plc’s financial statements are as follows:
| NM | |
|---|---|
| Assets less current liabilities | 5,010 |
| Financed by: | |
| Share capital (nominal value N0,50 per share) | 1,000 |
| Reserves | 1,180 |
| Non-current liabilities: Loan notes A (nominal value N100 per loan note) | 2,470 |
| Non-current liabilities: Loan notes B (nominal value N100 per loan note) | 360 |
Kola Plc’s shares are trading at N2.45 each and have an equity beta of 1.3. The part of the business which will become ZK Ltd accounts for 24.5% of Kola Plc’s total equity value.
Kola Plc’s loan notes A currently have a total market value of N2,100m. Loan notes B currently have a total market value of N400m. The pre-tax cost of debt has been determined at 4.3% for loan notes A and 4.1% for loan notes B. After the unbundling, loan notes B will be serviced by ZK Ltd and loan notes A will remain with Kola Plc. but the pre-tax cost of debt for both will increase by 0.3%. It is expected that ZK Ltd will maintain its capital structure after the unbundling.
MK Ltd’s debt to equity ratio is estimated to be 40:60 in equivalent market value terms and it has 1,200 million shares in issue.
The restaurant industry is dominated by Yani Plc, a large listed company which owns many restaurants around the country. The average equity beta for the restaurant industry is estimated at 1.38.
The average debt equity ratio in the restaurant industry is 20:80.
All companies pay corporate tax at a rate of 20% per year and tax is payable in the same year as the profits it is based on. The risk-free rate of return is estimated at 3% and the market risk premium at 7.2%.
The following estimated information will be applicable to ZK Ltd if it is demerged. Kola Plc’s sales revenue is N4,500m currently, of which 20% is attributable to ZK Ltd. It is estimated that after ZK Ltd is demerged, its annual sales revenue growth rate will be 6% and the profit margin before interest and tax will be 21% of sales revenue, for each of the next four years. It can be assumed that the current tax allowable depreciation will remain equivalent to the amount of investment needed to maintain the current level of operations, but that ZK Ltd will require an additional investment in assets of N0.25 for every N1 increase in sales revenue.
After the initial four years, the annual growth rate of the company’s free cash flow is expected to be 2.5% for the foreseeable future.
The following estimated information applies to the acquisition of ZK Ltd by MK Ltd, if ZK Ltd is acquired.
The average price earnings (PE) ratio for the hotel industry is 15.61, however, MK Ltd’S PE ratio is estimated to be 10% lower than this.
Extracts from the current statements of profit or loss applicable to MK Ltd and ZK Ltd are as follows:
| MK Ltd N’M | ZK Ltd N’M | |
|---|---|---|
| Profit before Interest and tax | 305.0 | 161.2 |
| Interest | (91.2) | (14.8) |
| Tax (20%) | (42,8) | (29.3) |
| Profit after tax | 171.0 | 117.1 |
After the acquisition, it is expected that the PE ratio of the combined company will be midpoint between the two individual companies‟ PE ratios. The annual after-tax profits will increase by N62m due to combination of the two companies.
MK Ltd has proposed to pay for acquiring ZK Ltd either through a cash offer of N0.66 for a ZK Ltd share, or one MK Ltd share for every three ZK Ltd shares. MK Ltd will borrow the money needed to pay for the acquisition.
Required:
a. Estimate the value of each ZK Ltd share if it is demerged and listed as an independent company. Note: (Calculate to nearest N1 million except per share data that should be done to two decimal places). (12 Marks)
b. Estimate:
i. the additional equity value created when combining MK Ltd and ZK Ltd. (4 Marks)
ii. the percentage gain to each of MK Ltd’s and ZK Ltd’s shareholder group under each payment method. (4 Marks)
iii. the impact of MK Ltd’s capital structure under each payment method (5 Marks)
c. Evaluate the financial and other factors that both MK Ltd’s shareholders and ZK Ltd’s shareholders would consider prior to agreeing to the acquisition, and the impact of MK Ltd’s capital structure under each payment method. (5 Marks)
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- Tags: Acquisition, Beta, Cost of Capital, Demerger, FCFF Valuation, Gearing, P/E Ratio, Shareholder Value, Spin-off, Synergy, WACC
- Level: Level 3
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