EXCEL 2.4 FM
ICAG PROFESSIONAL EXAMSFINALMOCK EXAMS- NOV2017
COURSE / 2.1 FINANCIAL MANAGEMENTTIME / 3 HOURS
Instructions: Attempt all questions. Show all workings in the answer booklet provided.
Cheating in the exams is unethical, and will be least tolerated
QUESTION 1
(a) Entity M is reviewing its credit policy. It is estimated that if the period of credit allowed to customers is reduced to 60 days, there will be a 25% reduction in annual sales, but bad debts would be reduced by GHS30,000 each year. It would also benecessary to spend an extra GHS20,000 each year on credit control. Entity M has cashflow difficulties and relies on overdraft finance, for which the interest rate is 9%.
Required
Calculate the effect of these changes on the annual profit. Base your answer on the level of sales in Year 3, and assume that purchases and inventory would be reduced in the same proportion as the reduction in sales.
Entity M ‐ Extracts from annual accounts Year 3
Inventory GHS
Raw materials 180,000
Work in progress 93,360
Finished goods 142,875
Purchases 720,000
Cost of goods sold 1,098,360
Sales 1,188,000
Trade receivables 297,000
Trade payables 126,000(10 marks)
(b) Smeaton Furniture wishes to increase its production capacity by purchasing additional plant and equipment at a cost of GHS3.8 million. The abridged profit and loss account for the year ended 30th November 2016 is as follows:
GHSm
Sales turnover 140.6
Profit before interest and taxation 8.4
Interest 6.8
Profit before tax 1.6
Tax 0.4
Profit after taxation 1.2
Earnings per share 15 pesewas
In order to finance the purchase of the new plant and equipment, the directors of the company have decided to make a rights issue equal to the cost of the equipment.
The shares are currently quoted on the Stock Exchange at GHS2.70 per share and the new shares will be offered to shareholders at GHS1.90 per share.
Required
Calculate:
(i) the theoretical ex-rights price per share(3 marks)
(ii) the value of the rights on each existing share(1 mark)
(iii) assuming the increase in production capacity will lead to an increase in profit after tax of GHS600,000 per annum and the P/E ratio of the company will remain unchanged after the rights issue, calculate the market value per share after the rights issue. (2 marks)
(b) What are the options available to a shareholder who receives a rights offer from a company?
(4 marks)
QUESTION 2
(a) Misteri Company is considering whether to purchase a machine for the manufacture of a new product, Product X. It has been estimated that Product X would have a life of four years and at a selling price of GHS8 per unit, annual sales demand would be 400,000 units in Year 1, 600,000 units in Year 2 and 800,000 in each of Years 3 and 4.
Variable production and selling costs would be GHS6per unit. Incremental annual fixed cost expenditures (all cash cost items) would be GHS500,000 in Year 1, rising by GHS20,000 each year.
The machine, which has an annual output capacity of 700,000 units of Product X, would cost GHS1,200,000 and would have a resale value of GHS200,000 at the end of Year 4. Capital allowances would be available on a 25% annual reducing balance basis, with a balancing charge or allowance in the year of disposal. Tax at 25% is payable one year in arrears of the profits to which it relates.
Misteri Company is financed 70% by equity capital and 30% by debt capital. The equity has a cost of 10% and the debt has a cost of 8.9%.
Required
Calculate the net present value of the proposed project and recommend whether the investment in the machine should be undertaken. (10 marks)
(b) Minicorp is a mining company. Its mission is to ‘maximise profits for shareholders whilst recognising its responsibilities to society’. It is considering a mining opportunity abroad in a remote country area where there is widespread poverty. The mining work will destroy local vegetation and may pollute the immediate water supply for some years to come. The company directors believe that permission for the mining work is likely to be granted by the government as there are few people or animals living in the area and the company will be providing much-needed jobs.
Required:
Identify the likely stakeholders in the company’s decision. Consider their possible objectives and describe three likely conflicts in those objectives. (10 marks)
QUESTION 3
(a). Grudem Co makes toys aimed at pre-school children. It was set up two years ago and has already achieved revenue in excess of GHS500,000 per annum.
It's business model is based around the following:
• Designing a range of toys throughout the year based on focus groups
• In the three months before Christmas extensive research is undertaken to identifying trends in consumer preferences, resulting in production for the top four toys being boosted.
Grudem sells 80% of its output via leading high street stores and 20% via online channels.
Based on latest sales projections for the next year, Grudem Co expects to have cash shortages during November and December, with a peak deficit of GHS100,000 and large inflows in February and March, resulting in a peak surplus of GHS300,000.
Required:
(i) Explain why Grudem is experiencing the cash deficit and surplus described. (2 marks)
(ii) Discuss the factors to be considered by Grudem Co when planning ways to invest any cash surplus forecast by its cash budgets. (4 marks)
(iii) Discuss the advantages and disadvantages to Grudem Co of using overdraft finance to fund any cash shortages forecast by its cash (4 marks)
(b) A company’s board of directors makes a decision on 1st May to invest in a newproject that will have an NPV of + GHS4,000,000. The decision is announced to the stock market on 12th May.
The company has 50 million shares in issue and at close of trading on 30th April these had a market value of GHS4 each.
Required
State what would happen to the share price of the company if the stock market:
(i) has weak form efficiency(2 marks)
(ii) has semi-strong form efficiency(2 marks)
(iii) has strong-form efficiency.(2 marks)
(c) Explain the following terms:
(i) Placing
(ii) Initial public Offer
(iii) Introduction
(iv) Underwriting(4 marks)
QUESTION 4
(a). FRQ Co is a UK based company which has just begun to make export sales to the Eurozone and is considering starting to purchase from a supplier in Germany. The managing director is aware that the company is likely to face foreign exchange rate risk but is unsure how this could be managed. Additionally the managing director is keen to understand how she could forecast future exchange rates as this would be of assistance when budgeting for the company.
FRQ Co can borrow in euros at 4% and in pounds sterling at 3%. Deposits in pounds earn just 1%. All rates are annual rates. The current Euro/£ exchange rate is 1.200 +/– 0.005. A 12 month forward contract with a spread of +/– 0.010 will be available.
The company has just won a tender which will result in a receipt of €280,000 in one year’s time.
Required
(i) Briefly explain the methods that could be used to forecast future exchange rates and using the available information calculate a one year forward rate. (5 marks)
(ii) Discuss simple techniques the company could use to minimise the foreign exchange rate risk that it is exposed to and hence reduce the need for hedging. (3 marks)
(iii) Show how the receipt expected in one year’s time could be hedged using a forward market hedge or a money market hedge and recommend which hedge should be used. (7 marks)
(b) Discuss the main factors which should be taken into account when choosing between long-term loan capital and ordinary share capital. (5 marks)
QUESTION 5
(a) The directors of M Co are considering opening a new factory to manufacture a new product at a cost of GHS3.0 million. During the last 5 years, the company has had 3 million shares in issue. The current market price of these shares (at 31 December 20X8) is GHS1.45 ex-dividend.
The company pays only one dividend each year (on 31 December) and dividends for the last five years have been as follows:
Year Dividend per share (pesewas)
20X8 14.1
20X7 14.1
20X6 12.1
20X5 11.6
20X4 11.0
M Co currently has in issue GHS1 million 7% debentures redeemable on 31
December 20Y2 at par. The current market price of these debentures is GHS83.60 ex-interest, and the interest is payable in one amount each year on 31 December. The company also has outstanding a GHS500,000 bank loan repayable on 31 December 20Y7. The rate of interest on this loan is variable, being fixed at 3% above the bank’s base rate which is currently 5%.
Required:
(a) Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 20X8. (12 marks)
(b) Briefly advise the directors of M Co on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project. (3 marks)
Note: Ignore taxation
(b) A company has just paid an annual dividend of 38. The board of directors has a target of increasing the share price to 800, and is considering policies for investment and growth.
Shareholders expect a return on their investment of 10% per year.
Required
Calculate the annual expected growth rate in dividends that would be required to raise the share price to 800. Use the dividend growth model to make your estimate. (5 marks)
*END OF PAPER*
Page 1 of 8