STRATEGIC FINANCIAL MANAGEMENT

Transcription

1 STARRYGOLD ACADEMY MID DIET MOCK QUESTIONS ON STRATEGIC FINANCIAL MANAGEMENT FOR 2016 NOVEMBER DIET PROFESSI0NAL LEVEL STARRY GOLD ACADEMY , , Page 1

2 PREPARED BY: JOHNSON J.O , STARRY GOLD ACADEMY , , Page 2

3 STARRYGOLD ACADEMY LIMITED PROFESSIONAL LEVEL EXAMINATION NOVEMBER 2016 STRATEGIC FINANCIAL MANAGEMENT MID-DIET MOCK QUESTION Time allowed 3 hours SECTION 1 COMPULSORY QUESTION 30marks QUESTION1 Kabira-Kabiru Plc is a large company which is listed on the Nigeria Stock Exchange. It was founded 45 years ago as a manufacturer of car engine parts, but in recent years it has diversified into the aviation sector and now approximately one quarter of the company s revenue and profits are generated by the aircraft engine parts manufacturing business. The company has been quite successful in recent years. Despite the global recession which has had a major impact on the car industry, Kabira- Kabiru Plc has seen its profits grow slightly year by year. Over the last 12 months, the company s share price has stayed fairly constant at approximately N3.29 per share. The company has 40 million N0.50 nominal value shares in issue. Kabira-Kabiru Plc also has N50 million corporate bonds (at nominal value) in issue, which were issued 3 years ago and are redeemable in 5 years time. The bonds are trading at N per N100 nominal value. Kabira-Kabiru Plc is an AA rated company according to the Nigerian credit rating agency. The agency is currently displaying the following summary of credit spreads on its website: Credit spreads in basis points: 1 Year 3 years 5 years 8 years AA rating The risk free rate of interest in Nigeria is currently 3.75% per annum. The company is considering its future options. The directors are keen to expand the business further by investing in new projects, so they want to compute a cost of capital to be used in the investment appraisal process and for the purpose of valuing the company. In a recent newspaper article, a market analyst commented that the equity beta for Kabira-Kabiru Plc is approximately However, the directors of Kabira-Kabiru Plc want to independently verify this figure using their own calculations based on proxy companies. STARRY GOLD ACADEMY , , info@starrygoldacademy.com, Page 3

4 Therefore, two suitable proxy companies have been identified: Black-Friday Plc, a manufacturer of car engine parts, and Esther-Sunday Plc, a manufacturer of aircraft engine parts. Key financial information for these two companies is as follows: Black-friday Plc Esther-Sunday Plc Gearing (debt to equity at market value) 20:80 50:50 Equity beta 1.60 Not available Cost of equity Not available 9.48% Pre tax cost of debt Not available 4.38% The debt beta for both proxy companies, and for Kabira-Kabiru Plc, is The market risk premium on the stock market was 6.25% last year, and the corporation tax rate is 30%. You are to assume that the proportion of Kabira-Kabiru Plc asset beta to the proxy company is in the ratio 75:25 for car and aircraft respectively. Required: (a) Using the given proxy company information, estimate the current equity beta of Kabira-Kabiru Plc. (20 Marks) (b) Calculate the current weighted average cost of capital (WACC) for Kabira-Kabiru Plc. (10marks) QUESTION 2 Banden Ltd is a highly geared company that wishes to expand its operations. Six possible capital investments have been identified, but the company only has access to a total of N620,000. The projects are not divisible and may not be postponed until a future period. After the projects end, it is unlikely that similar investment opportunities will occur. Expected net cash inflows (including salvage value) Initial Project Year outlay A 70,000 70,000 70,000 70,000 70, ,000 B 75,000 87,000 64, ,000 C 48,000 48,000 63,000 73, ,000 D 62,000 62,000 62,000 62, ,000 E 40,000 50,000 60,000 70,000 40, ,000 F 35,000 82,000 82, ,000 Projects A and E are mutually exclusive. All projects are believed to be of similar risk to the company s existing capital investments. Any surplus funds may be invested in the money market to earn a return of 9% per year. The money market may be assumed to be an efficient market. Banden s cost of capital is 12% per year. Required: STARRY GOLD ACADEMY , , info@starrygoldacademy.com, Page 4

5 (a) Calculate: (i) The expected net present value; (ii) The expected profitability index associated with each of the six projects. (b) Give reasoned advice to Banden Ltd recommending which projects should be selected. QUESTION 3 Hotalot plc produces domestic electric heaters. The company is considering diversifying into the production of freezers. Data on four listed companies in the freezer industry and for Hotalot are shown below: Freeze-up Glow-cold Shiver-all Top-ice Hot-alot N 000 N 000 N 000 N 000 N 000 Fixed assets 14,800 24,600 28,100 12,500 20,600 Working capital 9,600 7,200 11,100 9,600 12,700 24,400 31,800 39,200 22,100 33,300 Financed by: Bank loans 5,300 12,600 18,200 4,000 17,400 Ordinary shares* 4,000 9,000 3,500 5,300 4,000 Reserves 15,100 10,200 17,500 12,800 11,900 24,400 31,800 39,200 22,100 33,300 Turnover 35,200 42,700 46,300 28,400 45,000 EPS(K) DPS(K) Price/earnings ratio Beta equity *The par value per ordinary share is 25k for Freeze-up and Shiver-all, 50k for Top-ice and N1 for Glow-cold and Hot-alot. Corporate debt may be assumed to be almost risk-free, and is available to Hot-alot at 0.5% above the Treasury Bill rate, which is currently 9% per year. Corporate taxes are payable at a rate of 35%. The market return is estimated to be 16% per year. Hot-alot does not expect its financial gearing to change significantly if the company diversifies into the production of freezers. Required: a. Estimate what discount rate Hotalot should use in the appraisal of its proposed diversification into freezer production. STARRY GOLD ACADEMY , , info@starrygoldacademy.com, Page 5

6 b. Corporate debt is often assumed to be risk-free. Explain whether this is a realistic assumption and calculate how important this assumption is likely to be to Hotalot s estimate of a discount rate in (a) above. For this purpose assume that Hotalot and the four freezer companies all have a debt beta of 0.3. c. Discuss whether systematic risk is the only risk that Hotalot s shareholders should be concerned with. QUESTION 4 Starry Gold ltd is a medium-sized manufacturing company which is considering a 1 for 5 rights issue at a 15% discount to the current market price of N4.00 per share. Issue costs are expected to be N220,000 and these costs will be paid out of the funds raised. It is proposed that the rights issue funds raised will be used to redeem some of the existing loan stock at par. Financial information relating to Starry Gold ltd is as follows: Current statement of financial position N'000 N'000 Non-current assets 6,550 Current assets Inventory 2,000 Receivables 1,500 Cash 300 3,800 10,350 Ordinary shares (par value 50K) 2,000 Reserves 1,500 12% loan notes ,500 Current liabilities Trade payables 1,100 Overdraft 1,250 2,350 10,350 STARRY GOLD ACADEMY , , info@starrygoldacademy.com, Page 6

7 Other information: Price/earnings ratio of Starrygold ltd: Overdraft interest rate: 7% Tax rate: 30% Sector averages: debt/equity ratio (book value): 100% interest cover: 6 times Required (a) Ignoring issue costs and any use that may be made 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. (b) What alternative actions are open to the owner of 1,000 shares in Starry gold ltd as regards the rights issue? Determine the effect of each of these actions on the wealth of the investor. (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 loan notes. (d) Evaluate whether the proposal to redeem some of the loan notes would increase the wealth of the shareholders of Starry gold ltd. Assume that the price/earnings ratio of Starry Gold remains constant. (e) Discuss the reasons why a rights issue could be an attractive source of finance for Starry gold ltd. Your discussion should include an evaluation of the effect of the rights issue on the debt/equity ratio and interest cover. STARRY GOLD ACADEMY , , info@starrygoldacademy.com, Page 7

8 QUESTION 5 Pathfinder LTD is a software development company, which was established few years ago by three computer programmers. The company has been very successful with the development of custom-written software solutions. Recently, the founder shareholders who are also the directors have identified the current year as an ideal opportunity to launch a new range of software products. This new range will require considerable investment in human resources and involve relocation to a more modern office. At a recent board meeting, it was suggested that the company consider either a launch onto a recognized stock exchange, or raising long term debt finance. Required: a) Identify and briefly explain THREE key considerations when deciding between raising debt and equity finance. ( 4 ½ marks) b) Briefly discuss THREE factors which will limit the amount of loan capital Pathfinder LTD is able to raise (4 ½ marks) c) State the regulatory institutions within the financial system in your country and Give any 2 functions each of any two of them (6marks) d) Identify and briefly discuss THREE reasons why Bugs Ltd might wish to obtain a stock exchange listing (5marks) 20marks STARRY GOLD ACADEMY , , info@starrygoldacademy.com, Page 8