SECTION A CASE QUESTIONS (Total: 50 marks)

Transcription

1 SECTION A CASE QUESTIONS (Total: 50 marks) Answer ALL of the following questions. Marks will be awarded for logical argumentation and appropriate presentation of the answers. CASE Wellgas Oil & Gas Limited ( Wellgas ) refines automobile petrol and distributes it through its own Wellgas petrol stations in Hong Kong. It has been a publicly listed firm on the Growth Enterprise Market of the HK Stock Exchange since As the competition became keen amid new players such as those coming from China, Wellgas decided to spend millions of dollars to conduct market research in It was told by the consulting firm that 65% of the overall petrol market in Hong Kong consists of service-oriented customers, medium to high earning individuals who do not mind paying a higher price for petrol if they have a quality experience when they visit the petrol station. Quality is further defined as top class customer service, a tidy and clean environment, friendly staff, a convenience store and relatively short turnaround time. The other 35% of the market are those who only have the time and interest to visit a petrol station with the bargain petrol price. After lengthy discussion by the management team, Wellgas strategy was to stay focused on that 65% of service-oriented customers beginning in The balanced scorecard for the year 2015 is given below. Objectives Measures Target performance Actual performance Financial: Increase shareholder value Operating profit change from price recovery HK$380m HK$385m Operating profit change from growth HK$325m HK$327m Customer: Increase market share Market share of overall petrol market in HK 20% 18.8% Internal business process: Improve service delivery Quality index 184 points 185 points Learning and growth: Increase refinery process capability Percentage of refinery processes with advanced controls 89% 95% Module B (December 2016 Session) Page 1 of 9

2 The success of the new strategy has pushed the major shareholder, Herman Cai, to consider expanding the business further in Shenzhen, near the border with China. The Shenzhen government has recently proposed a build-operate-transfer arrangement where the vendor of a petrol station will have to transfer the business to the Shenzhen government after four years of operation. According to the due diligence, this Shenzhen project would require an initial cash outlay for hardware equipment costing HKD593 million. The hardware equipment would be depreciated to a zero book value over the four-year life of the project, based on a government tax incentive programme. At the end of the project, the Shenzhen government will pay for the equipment to the vendor at a price of HKD299 million. The project is likely to produce cash inflows of HKD126 million annually for the first two years and HKD158 million annually for the following two years. The risk premium of this project is expected to be 3% higher than Wellgas existing overall firm risk in Hong Kong. Not only will the financial required rate of return be higher, the China project is also likely to mean that the firm has to deal with some new environmental and ethical responsibilities and challenges. For instance, the Shenzhen government currently requires firms to report on environmental performance. Besides, business unit managers in China not adhering to ethical accounting policies and procedures are quite common indeed. Wellgas has 80 million shares of common stock outstanding at a price of HKD64 per share and the required rate of return is 15%. Also, it has 20 million shares of preferred shares outstanding at a price of HKD54 per share and paying a HKD6 dividend. The outstanding debt has a total face value of HKD1 billion and a market price equal to 102% of the face value. The yield to maturity on the debt is 6.33%. The marginal tax rate of Wellgas is 15%. While business seems to be going in the right direction, the Chief Executive Officer ( CEO ) of Wellgas has just submitted his resignation to the board of directors to pursue other personal interests. The firm has no choice, but to kick start an executive search. An executive search firm has recommended that the board could consider Kester Lee (current CEO of Kowloon Gas Limited) or Issac Chan (current CEO of Island Gas Limited). The information below highlights the financial information of Kowloon Gas Limited ( Kowloon Gas ) and Island Gas Limited ( Island Gas ) for 2014 and 2015 respectively. Module B (December 2016 Session) Page 2 of 9

3 Kowloon Gas Island Gas HK$ m HK$ m HK$ m HK$ m Total assets 2,453 2,460 1, Current liabilities Revenue 2,120 2,800 2,350 1,400 Cost R&D Design Production Marketing Distribution Customer service Total costs 1,805 1,920 1,847 1,096 Operating profit In early 2016, a marketing research company gave Island Gas five stars (its highest rating on a five-point scale). Kowloon Gas was given three stars, down from four stars a year ago due to a poor customer feedback survey. Question 1 (20 marks approximately 36 minutes) (a) Explain whether you would consider Wellgas to have been successful in (6 marks) (d) Describe the other measures that could be included in the learning and growth area to improve its quality. Evaluate the customer factor of Wellgas performance. Compare and contrast the customer factor with the financial factor with explanations. Explain what is likely to be the causation linkage between the customer-related factors and the internal business process factor. Recommend some additional measures on either factor to assist the management team to better understand the relationship. (6 marks) Module B (December 2016 Session) Page 3 of 9

4 Question 2 (15 marks approximately 27 minutes) (a) Calculate the weighted average cost of capital of Wellgas. Explain if Wellgas should go ahead with the Shenzhen project based on financial well-being. (4 marks) If Mr Cai is very determined to make sure of a good start in Shenzhen, suggest operational arrangements which will enhance compliance of environmental and ethical responsibilities (three operational arrangements for environmental responsibilities and three operational arrangements for ethical responsibilities). (6 marks) Question 3 (15 marks approximately 27 minutes) (a) Use the DuPont method to analyse the Return-on-Investment ( ROI ) of Kowloon Gas and Island Gas in 2014 and Interpret the results. (4 marks) Rank Kester and Issac as potential candidates for CEO of Wellgas and give explanations. During the job interview, Kester emphasised that the profit number in 2015 was attributed by cost decided by head office and reinvestment in new non-current assets. Explain if Kester makes a good point. (6 marks) * * * * * * * * Module B (December 2016 Session) Page 4 of 9

5 End of Section A

6 SECTION B ESSAY / SHORT QUESTIONS (Total: 50 marks) Answer ALL of the following questions. Marks will be awarded for logical argumentation and appropriate presentation of the answers. Question 4 (15 marks approximately 27 minutes) It is now June Mr Chow, CEO of TTT Limited ( TTT ), is puzzled as to what to do about managing the company s foreign currency risks. TTT is a Hong Kong based trading company established more than 10 years ago. It sources products from the PRC and sells them to Japan, where it has a sales and marketing office in Tokyo. The office is under a lease which will expire by the end of this year, The functional currency is USD. TTT pays RMB to its suppliers in China and bills its customers in Japan in Yen. Annual sales from Japan are about USD20.5 million. Since the later part of November 2015, the RMB has been depreciating, which is supposed to be good news. However, despite the market consensus that the RMB will head downwards in the long term, increasing short term volatility is unavoidable. TTT s sales and marketing office in Japan has 10 staff. All expenses of about USD0.5 million are settled in Japanese Yen. In order to save on rental expenses, the company also plans to acquire its own office, estimated at USD40 million, payable in Yen. The Board will only be able to decide on this investment at the next board meeting scheduled in December of It is expected a suitable property will be located in early 2017 so the Yen will be required in 2017 s first quarter to pay for it. Recently, Mr Chow was given two Yen forecasts for the average in All exchange rates are in USD/Yen. Assume the current rate is 115 (i.e. 1 USD to 115 Yen) and TTT would like to hedge its Yen currency risk within 110 and 120 and capture any gain beyond this range if possible. Forecast 1: Forecast 2: Mr Chow was completely puzzled as to how to handle the foreign exchange exposure starting 2017 and onwards. He came to Mr Leo Li, the Financial Controller, for a consultation. Module B (December 2016 Session) Page 6 of 9

7 Required: Assuming the only tools that TTT feels comfortable using to hedge its Yen exchange rate risks are a currency option and natural hedge. For RMB exposure, TTT plans to only consider a currency future. Assume hedging is done quarterly and that you are the Financial Controller, Mr Leo Li, write a memo to advise Mr Chow on the following: (a) Describe the general mechanisms of EACH of the three foreign currency risk management tools preferred by the company. Explain how the company should employ the relevant tools for Yen currency risk management in The assessment should be under the scenarios of: (i) not investing in property; and (ii) investing in property. (7 marks) Explain what TTT can do if the company does not want to do hedging and does not want to be exposed to any currency risk. (2 marks) [Mark(s) to be awarded for proper memorandum format with logical presentation.] Module B (December 2016 Session) Page 7 of 9

8 Question 5 (15 marks approximately 27 minutes) Mr A is a 60% shareholder of a Hong Kong listed company AB Limited with 1,000,000 shares issued and outstanding. The remaining 40% of shares are held by independent third parties. AB Limited plans to raise HKD12 million financing an investment via a rights issue. The share price at time of the rights issue is HKD100 per share. The subscription price is HKD50 per share. One share will be entitled to one right. Mr A said, the exercise price looks attractive as it is a 50% discount from the current value of a share. Ms C, a prospective investor, is interested in becoming a shareholder of AB Limited by buying and exercising all the rights unsubscribed. Required: (a) Calculate how much money will Mr A need if he will fully subscribe. (2 marks) Comment on Mr A s impression that a big discount in the issue price is beneficial to shareholders. Support your argument with calculation and base on the theoretical ex-rights price, indicate the wealth of the existing shareholders before the issue, after the issue and sell the rights, and after the issue and exercise to subscribe. Given your answer in Question 5(a), unfortunately Mr A does not have enough money to take up all rights. He understands that he may lose control of the company if he is diluted to below 51% after the issue if he does not subscribe at all since any unsubscribed shares will be taken up by Ms C. This is unacceptable to him as AB Limited was established by his father. Advise Mr A, with the support of calculation (ignoring transaction costs) regarding the following: (i) the implication of him not subscribing at all (i.e. will he lose control?); (2 marks) (ii) (iii) the number of additional shares that are needed to be taken up by him to maintain 51% ownership; and how he should finance the acquisiton of the shares calculated in Question 5(ii) with minimum cash to obtain this 51% ownership. Assume he can sell any rights received without any restriction. Module B (December 2016 Session) Page 8 of 9

9 Question 6 (20 marks approximately 36 minutes) CS Limited ( CS ) is a company listed in Hong Kong. Its management plans to acquire 100% of its competitor QM Limited ( QM ) via a cash and new share offer at a total consideration of HKD1.0 per share, of which the cash component is HKD0.5 per share. The share prices of CS and QM are HKD2.5 and HKD1.0 respectively. The exchange ratio is therefore equal to 5 (2.5/0.5). The acquisition will not generate any significant and immediate tangible synergy. In deciding the purchase consideration, the Board of CS decided to offer a reasonable premium to QM shareholders to complete the deal. In other words, the cash and total value of the combined group transferred to QM shareholders via the share component of the consideration should not be too excessive compared to QM s market value before acquisition. The following data was gathered by CS mergers and acquisitions team: CS Limited QM Limited No. of shares 100, ,000 Price per share HK$2.50 HK$1.00 Profit after tax HK$10,000 HK$10,000 Earnings per share ( EPS ) HK$0.1 HK$0.1 Price-earnings ( PE ) ratio Market value HK$250,000 HK$100,000 Required: (a) (i) Calculate the total value of the combined group transferred to QM s shareholders via the share component of the purchase consideration. (ii) Calculate the premium paid to QM s shareholders. (2 marks) (i) Calculate the EPS of the combined group after the acquisition. (ii) Assume the EPS of the combined group calculated in Question 6(i) is higher than that before acquisiton and therefore should drive CS s share price up. But right after the announcement, CS s share price falls instead. Explain the possible reason(s) why this may happen. Support your explanations by appropriate calculations. (7 marks) Discuss with explanations, three possible types of synergies that may arise from an acquisition. * * * END OF EXAMINATION PAPER * * * Module B (December 2016 Session) Page 9 of 9