Question Tag: CAPM

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FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

Question

The expected return on the market portfolio (estimated from past data) is 12% p.a. with a standard deviation of 15% and the risk-free rate of 4% p.a. The actual prices, last year dividends, and the covariances from three securities (A, B, C) with the market are given in the table below:

Security	Actual Price (N)	Last Year Dividend (N)	Covariance with Market
A	107	1.30	0.025650
B	618	18.00	0.018675
C	1,350	22.00	0.029025

You are required to:

i.

Calculate the betas and the required rates of return of securities A, B, and C. (3 Marks)

ii.

In the table below, you have the market consensus forecast of 12-month price targets, ex-dividends, and the expected dividend growth rate of the securities.

Security	12-month price target (N)	Dividend growth rate (%)
A	122.50	12
B	740.00	10
C	1,500.00	11

Assuming the dividends are paid in 12 months exactly, compute the required stock price for the 3 stocks and state your conclusion. (4 Marks)

iii.

Considering the results in (ii) above, explain briefly what will be your strategy? (1 Mark)

Answer

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Tags: Beta, CAPM, Dividends, Market Portfolio, Required Return, Stock valuation
Level: Level 3

Topic: Investment Appraisal Techniques

FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

Question

a. Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.
What are the basic assumptions on which this model is based? (6 Marks)

b. Currently, the rate of return on the Federal Government Bond redeemable at par in the year 2018 is 5%. The securities of four companies, Akira Plc., Bombadia Plc., Courage Plc., and Divine Plc., have expected returns of 12%, 9.5%, 10.5%, and 13%, respectively. The average expected return on the market portfolio is 10%, subject to a 6% risk (standard deviation). Other relevant information relating to the four securities of the companies is as stated below:

Company	Standard Deviation	Correlation Coefficient
Akira Plc	0.080	0.975
Bombadia Plc	0.075	0.640
Courage Plc	0.090	0.740
Divine Plc	0.150	0.680

You are required to show which of the companies is/are overvalued. (9 Marks)

Answer

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Tags: Assumptions, CAPM, Market Portfolio, Portfolio analysis, Risk-Return Trade-Off, Valuation
Level: Level 3

Topic: Portfolio Management
Series: NOV 2016

FM – May 2017 – L3 – Q7 – Investment Appraisal Techniques

Provide background on the Capital Asset Pricing Model (CAPM) and its use in project evaluation.

Question

ou were recently appointed by a major manufacturing company as the senior accountant at one of the divisions of the company, which is located in Makurdi. You have received the following memorandum from the divisional manager:

“I tried to see you today, but you were busy with the auditors.
I have to go to a meeting at the head office on Friday about the new project. We sent to the head office its projected cash flow figures before you arrived. Apparently, one of the head office finance people has discounted our figures, using a rate which was calculated from the Capital Asset Pricing Model. I do not know why they are discounting the figures, because inflation is predicted to be negligible over the next few years. I think that this is all a ploy to stop us from going ahead with the project and let another division have the cash.
I looked up Capital Asset Pricing Model in a finance book which was lying in your office, but I could not make a head or tail of it, and anyway it all seemed to be about buying shares and nothing about our project.
We always use payback for the smaller projects which we do not have to refer to head office. I am going to argue for it now because the project has a payback of less than five years, which is our normal yardstick.
I am very keen to go ahead with the project because I feel that it will secure the medium-term future of our division.
I will be tied up all day tomorrow, so again I will not be able to see you. Could you please make a few notes for me which I can read on the way on Friday morning? I want to know how the Capital Asset Pricing Model is supposed to work, plus any other things which you feel I ought to know for the meeting. I do not want to look like a fool or lose the project because they blind me with science.
As you have probably discovered, I do not know much about finance, so please do not use any technical jargon or complicated maths.”

Required:
Prepare notes for the divisional manager which provide helpful background for the meeting.

Answer

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Tags: CAPM, Investment Appraisal, Project evaluation
Level: Level 3

Topic: Investment Appraisal Techniques

FM – May 2019 – L3 – Q4 – Portfolio Management

Evaluate abnormal returns for shares and bonds, calculate required returns for a pension fund portfolio, and assess its active management strategy.

Question

The managers of a pension fund follow an active portfolio management strategy. They try to purchase shares and bonds that show a positive abnormal return (positive alpha factor in the case of shares). The pension fund is required by law to hold at least 40% of its investments in bonds. N100million is currently available for
investment. Three shares and three bonds are being considered for purchase. The required return on bonds may be measured using a model similar to the capital asset pricing model, where beta is replaced by the relative duration of the individual bond (Di) and the bond market portfolio (Dm) i.e. Di/Dm.

Note: Assume the risk-free rate is 4 percent per year.

Required:

a. Evaluate whether or not any of the shares or bonds is expected to offer a positive abnormal return. (10 Marks)

b. The pension fund currently has the maximum permitted investment in shares and wishes to continue this strategy. It has a market value of N1,000 million and a beta of 0.62.

Required:
Calculate the required return from the pension fund if any shares and bonds with positive abnormal returns are purchased. State clearly any assumptions that you make. (4 Marks)

c. Discuss possible problems with the pension fund’s investment strategy. (6 Marks)

Answer

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Tags: Abnormal Returns, CAPM, Investment strategy, Portfolio Management
Level: Level 3

Topic: Portfolio Management

FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

Question

Tico Plc is comprised of only four major investment projects, details of which are as follows:

Project	% of Company Market Value	Annual % Return During Last 5 Years	Risk % Standard Deviation	Correlation with the Market
1	28	10	15	0.55
2	17	18	20	0.75
3	31	15	14	0.84
4	24	13	18	0.62

The risk-free rate is expected to be 5% per year, the market return 14% per year, and the standard deviation of market returns 13%.

Required:

a. Assume that Tico Plc’s shares are currently priced based upon the assumption that the last five years’ experience of returns will continue for the foreseeable future. Evaluate whether or not the share price of Tico Plc is undervalued or overvalued. (8 Marks)

b. Discuss why your results in (a) above might not correctly identify whether or not the share price of Tico Plc is undervalued or overvalued. (6 Marks)

c. Briefly discuss the key limitations of portfolio theory in the analysis of physical investment decisions in practice. (6 Marks)

Answer

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Tags: CAPM, Market Valuation, Portfolio Theory, Risk-Return Tradeoff
Level: Level 3

Topic: Portfolio Management

FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for Gap Plc, including rights issue and debt issue, using CAPM, market dynamics, and strategic implications.

Question

You should assume that the current date is 31 December 2019.
You work for Eko Corporate Finance (ECF). One of the clients for whom you are responsible is Gap Plc (GP).

Gap Plc is a listed company and is seeking to raise ₦560 million to invest in new projects during 2020. Currently, Gap Plc is financed by equity. However, at a recent board meeting, the finance director stated that, since other companies in Gap Plc’s industry have average gearing ratios (measured by debt/equity by market value) of 30% (with a maximum of 40%) and an average interest cover of 6 times (with a minimum of 5 times), perhaps the company should access the debt markets. The finance director presented to the board two alternative sources of finance to raise the ₦560 million.

Equity Issue:
The ₦560 million would be raised by a 1 for 2 rights issue, priced at a discount on the current market value of GP’s shares.

Debt Issue:
The ₦560 million would be raised by an issue of 7% coupon bonds, redeemable on 31 December 2029. The yield to maturity (YTM) of the bonds would be equal to the YTM of the bonds of Eko Ventures (EV), another listed company in Gap Plc’s market sector. Eko Ventures has a similar risk profile to Gap Plc and has recently issued its bonds. Eko Ventures’ bonds have a coupon of 7%, will be redeemed in four years at par, and their current market price is ₦110 per ₦100 nominal value.

There were concerns expressed by a number of board members regarding the debt issue since it has been the long-standing policy of the company not to borrow. Their concerns were how Gap Plc’s shareholders and the stock market would react. The company’s cost of capital would increase as a result of the borrowing, leading to a fall in the company’s value.

An extract from Gap Plc’s most recent management accounts is shown below:

₦m
Operating profit	200
Taxation at 20%	(40)
Profit after tax	160

Additional Information:

Gap Plc has an equity beta of 1.1
The risk-free rate is expected to be 3% p.a.
The market return is expected to be 8% p.a.
Gap Plc’s current share price is ₦5 per share ex-dividend.
Gap Plc has 320 million ordinary shares in issue.

Required:

a. Calculate, using the CAPM, Gap Plc’s cost of capital on 31 December 2019. (1 Mark)

b. Assuming a 1 for 2 rights issue is made on 1 January 2020:
i. Calculate the discount the rights issue represents on Gap Plc’s current share price. (1 Mark)
ii. Calculate the theoretical ex-rights price per share. (1 Mark)
iii. Discuss whether the actual share price is likely to be equal to the theoretical ex-rights price. (4 Marks)

c. Alternatively, assuming debt is issued on 1 January 2020:
i. Calculate the issue price and total nominal value of the bonds that will have to be issued to give a YTM equal to that of Eko Ventures’ bonds in the above calculation. (5 Marks)
ii. Discuss the validity of the use of the YTM of Eko Ventures’ bonds in the above calculations. (3 Marks)

d. Outline the advantages and disadvantages of the two alternative sources for raising the ₦560 million, discuss the concerns of the board regarding the bond issue (using the gearing and interest cover information provided by the finance director), and advise Gap Plc’s board on which source of finance should be used. (5 Marks)

Answer

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Tags: CAPM, Debt Financing, Gearing Ratio, Interest Cover, Rights Issue
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – May 2022 – L3 – Q1 – Business Valuation Techniques

Estimate VT's valuation using FCFE, CAPM, and terminal value assumptions for three-year cash flow forecasts.

Question

Vico Tony (VT) is a software design company established six years ago. The company is owned by five directors. Since establishment, the company has developed rapidly. VT finds it difficult to obtain bank finance and relies on a long-term strategy of using internally generated funds to finance expansion. The directors are therefore giving consideration to the possibility of floating the company on the stock market. As a first step, you have been appointed by the directors to advise on the current value of the business under their ownership.

The company’s most recent statement of profit or loss and the extracted balances from the latest statement of financial position are as follows:

During the current year:

Depreciation is charged at 10% per annum on the year-end non-current assets balance before accumulated depreciation, and is included in other operating costs in the statement of profit or loss.
The investment in net working capital is expected to increase in line with the growth in gross profit.
Other operating costs consisted of:

Sales and variable costs are projected to grow at 9% per annum and fixed costs are projected to grow at 6% per annum.
The company pays interest on its outstanding loan of 7.5% per annum and incurs tax on its profits at 30%, payable in the following year. The company does not currently pay dividends.

One of your first tasks is to prepare for the directors a forward cash flow projection for three years and to value the firm on the basis of its expected free cash flow to equity. In discussion with them, you note the following:

The company will not dispose of any of its non-current assets but will increase its investment in new non-current assets by 20% per annum. The company’s depreciation policy matches the currently available tax allowable depreciation. This straight-line write-off policy is not likely to change;
The directors will not take a dividend for the next three years but will then review the position taking into account the company’s sustainable cash flow at that time;
The level of loan will be maintained at ₦1.98 billion and interest rates are not expected to change.
For estimating the appropriate required return on equity, it is decided to make use of the capital asset pricing model (CAPM). The challenge, however, is that since the company is not quoted, an appropriate beta factor does not exist. You have found a listed company, Konputer Limited (KL) that is into software development. KL is also into computer hardware retailing. It has the following financial statistics:

About 60% of the market value of KL is attributed to the software development division, while 40% of the value is attributed to computer hardware retailing. The computer hardware retailing division has an equity beta of 0.8.
Risk-free rate is 4% and the market risk premium is 8%.
VT has maintained a long-term debt/(debt+equity) ratio of 20%.

Required:

a. Provide an estimate of the appropriate rate of return to be used for the valuation of VT. Round your answer to the nearest whole number. (7 Marks)
b. Prepare a three-year cash flow forecast for the business on the basis described above highlighting the free cash flow to equity in each year. (14 Marks)
c. Estimate the value of the business based on the expected free cash flow to equity and a terminal value based on a sustainable growth rate of 4% per annum thereafter. (Note: Irrespective of your answer in (a), assume required return of 17%). (5 Marks)
d. Advise the directors on the assumptions and the uncertainties within your valuation. (4 Marks)

Answer

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Tags: Business Valuation, CAPM, Financial Projections, Free Cash Flow to Equity
Level: Level 3

Topic: Business Valuation Techniques

FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

Question

You are a Financial Analyst at Tayo Research Group (TRG). You begin valuing Aba Hotels Plc (AHP), a thinly and infrequently traded stock currently selling at 217 kobo, cum 2021 dividend.

For estimating AHP’s required return on equity, TRG uses the capital asset pricing model (CAPM) approach, but you think its equity beta of 1.20 is not reliable because of the stock’s extremely thin trading volume. You have therefore obtained the beta and other pertinent data for Eko Hotel Plc (EHP) – (See Table 1), a midsized company in the same industry with high liquidity trading on the Nigerian Stock Exchange.

Table 1: Valuation Data for EHP

Parameter	Value
Asset beta	0.763
Debt beta	0.150
Debt ratio (D/D+E)	0.60
Effective tax rate (%)	30%

Summarised financial data for AHP is shown below:

Statement of Profit or Loss Account

Year	2019	2020	2021*
Sales (₦’000)	305,500	357,600	409,200
Taxable income (₦’000)	40,500	49,000	56,700
Taxation (₦’000)	(14,175)	(17,150)	(19,845)
Post-tax income (₦’000)	26,325	31,850	36,855
Dividend (₦’000)	(9,340)	(10,228)	(11,200)
Retained earnings (₦’000)	16,985	21,622	25,655

Statement of Financial Position

Year	2021*
Non-current assets (₦’000)	216,800
Current assets (₦’000)	158,000
Current liabilities (₦’000)	(104,800)
Net assets (₦’000)	270,000
Ordinary shares (₦0.50 par value)	80,000
Reserves (₦’000)	130,000
15% Bond 2026 (₦100 par value)	60,000

(*2021 figures are unaudited)

Other Relevant Information:

It has been estimated that the debt/equity ratio of AHP is 0.16 and the beta of its debt is 0.2.
The risk-free rate is 12% and the market risk premium is 5%.
AHP has an effective tax rate of 35%.
As a result of recent capital investment, stock market analysts expect post-tax earnings and dividends to increase by 25% for two years and then revert to the company’s existing growth rates.

Required:

a. Stock market analysts sometimes use fundamental analysis and sometimes technical analysis to forecast future share prices.
What are fundamental analysis and technical analysis? (4 Marks)

b. Using the dividend valuation model, estimate what a fundamental analyst might consider to be the intrinsic (or realistic) value of the company’s shares.
Comment upon the significance of your estimate for the fundamental analyst. (12 Marks)

c. Explain whether your answer to (b) above is consistent with the semi-strong and strong forms of the efficient markets hypothesis (EMH), and comment upon whether financial analysts serve any useful purpose in an efficient market. (4 Marks)

Answer

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Tags: CAPM, Dividend valuation, Efficient Markets, Fundamental Analysis, Technical Analysis
Level: Level 3

Topic: Business Valuation Techniques

FM – Nov 2016 – L3 – Q5a – Portfolio Management

Explanation of the basic assumptions of the Capital Asset Pricing Model (CAPM).

Question

(a) Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.

What are the basic assumptions on which this model is based?

Answer

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Tags: CAPM, Portfolio Theory, Risk and Return
Level: Level 3

Topic: Portfolio Management

FM – Nov 2023 – L1 – SC – Q7 – Corporate Governance and Financial Strategy

Analyze FP’s dividend payout impact on stock price using forward P/E ratio, ROE, and sustainable growth rate.

Question

Ope plc has N10m 5 percent convertible bonds in issue. The option to convert into 40 N1 ordinary shares is open only for one more year; they must be either converted in one year’s time or left as ordinary bonds until nine years’ time when they will be redeemed at par. The current share price is ₦1.60, and the annual growth rate in the share price is 15 percent per annum. The current required return on Ope’s equity is 25 percent, its business being relatively risky.

The current yield on ordinary non-convertible bonds in similar companies is 11 percent. These interest rates are expected to remain constant.

Ife plc has 100,000 warrants outstanding, each entitling the holder to subscribe for one N1 ordinary share at 90 kobo any time during the next 3 years. The current share price is 57 kobo, and the capital growth is expected to be constant at 12 percent p.a. in the future. The current price of the warrant is 10 kobo.

Required:

a. Calculate the current value of Ope’s convertibles as straight debt, i.e., ignoring the option to convert and the value if conversion were to take place today. Would you expect the market value of the convertible to be above or below each of these amounts and why? (5 Marks)

b. By how much should the share price of Ope Plc rise before holders would be induced to convert, on the last possible date for conversion? (4 Marks)

c. Explain why the market value of a convertible bond is likely to be affected by the dividend policy of the issuing company. (4 Marks)

d. Based on the projected capital growth for Ife Plc, would you expect holders of the warrants to exercise them before expiry? What is the minimum annual growth rate of the share price necessary to induce holders to exercise their warrants? (2 Marks)

(Total 15 Marks)

Answer

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Tags: CAPM, Dividend Payout, DuPont Analysis, Forward P/E, Return on Equity, Sustainable Growth Rate
Level: Level 3

Topic: Corporate Governance and Financial Strategy
Series: NOV 2023

FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

Question

Security	Actual Price (N)	Last Year Dividend (N)	Covariance with Market
A	107	1.30	0.025650
B	618	18.00	0.018675
C	1,350	22.00	0.029025

You are required to:

i.

Calculate the betas and the required rates of return of securities A, B, and C. (3 Marks)

ii.

In the table below, you have the market consensus forecast of 12-month price targets, ex-dividends, and the expected dividend growth rate of the securities.

Security	12-month price target (N)	Dividend growth rate (%)
A	122.50	12
B	740.00	10
C	1,500.00	11

Assuming the dividends are paid in 12 months exactly, compute the required stock price for the 3 stocks and state your conclusion. (4 Marks)

iii.

Considering the results in (ii) above, explain briefly what will be your strategy? (1 Mark)

Answer

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Tags: Beta, CAPM, Dividends, Market Portfolio, Required Return, Stock valuation
Level: Level 3

Topic: Investment Appraisal Techniques

FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

Question

Company	Standard Deviation	Correlation Coefficient
Akira Plc	0.080	0.975
Bombadia Plc	0.075	0.640
Courage Plc	0.090	0.740
Divine Plc	0.150	0.680

You are required to show which of the companies is/are overvalued. (9 Marks)

Answer

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Tags: Assumptions, CAPM, Market Portfolio, Portfolio analysis, Risk-Return Trade-Off, Valuation
Level: Level 3

Topic: Portfolio Management
Series: NOV 2016

FM – May 2017 – L3 – Q7 – Investment Appraisal Techniques

Provide background on the Capital Asset Pricing Model (CAPM) and its use in project evaluation.

Question

Required:
Prepare notes for the divisional manager which provide helpful background for the meeting.

Answer

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Tags: CAPM, Investment Appraisal, Project evaluation
Level: Level 3

Topic: Investment Appraisal Techniques

FM – May 2019 – L3 – Q4 – Portfolio Management

Evaluate abnormal returns for shares and bonds, calculate required returns for a pension fund portfolio, and assess its active management strategy.

Question

Note: Assume the risk-free rate is 4 percent per year.

Required:

a. Evaluate whether or not any of the shares or bonds is expected to offer a positive abnormal return. (10 Marks)

b. The pension fund currently has the maximum permitted investment in shares and wishes to continue this strategy. It has a market value of N1,000 million and a beta of 0.62.

Required:
Calculate the required return from the pension fund if any shares and bonds with positive abnormal returns are purchased. State clearly any assumptions that you make. (4 Marks)

c. Discuss possible problems with the pension fund’s investment strategy. (6 Marks)

Answer

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Tags: Abnormal Returns, CAPM, Investment strategy, Portfolio Management
Level: Level 3

Topic: Portfolio Management

FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

Question

Tico Plc is comprised of only four major investment projects, details of which are as follows:

Project	% of Company Market Value	Annual % Return During Last 5 Years	Risk % Standard Deviation	Correlation with the Market
1	28	10	15	0.55
2	17	18	20	0.75
3	31	15	14	0.84
4	24	13	18	0.62

The risk-free rate is expected to be 5% per year, the market return 14% per year, and the standard deviation of market returns 13%.

Required:

b. Discuss why your results in (a) above might not correctly identify whether or not the share price of Tico Plc is undervalued or overvalued. (6 Marks)

c. Briefly discuss the key limitations of portfolio theory in the analysis of physical investment decisions in practice. (6 Marks)

Answer

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Tags: CAPM, Market Valuation, Portfolio Theory, Risk-Return Tradeoff
Level: Level 3

Topic: Portfolio Management

FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for Gap Plc, including rights issue and debt issue, using CAPM, market dynamics, and strategic implications.

Question

You should assume that the current date is 31 December 2019.
You work for Eko Corporate Finance (ECF). One of the clients for whom you are responsible is Gap Plc (GP).

Equity Issue:
The ₦560 million would be raised by a 1 for 2 rights issue, priced at a discount on the current market value of GP’s shares.

An extract from Gap Plc’s most recent management accounts is shown below:

₦m
Operating profit	200
Taxation at 20%	(40)
Profit after tax	160

Additional Information:

Gap Plc has an equity beta of 1.1
The risk-free rate is expected to be 3% p.a.
The market return is expected to be 8% p.a.
Gap Plc’s current share price is ₦5 per share ex-dividend.
Gap Plc has 320 million ordinary shares in issue.

Required:

a. Calculate, using the CAPM, Gap Plc’s cost of capital on 31 December 2019. (1 Mark)

Answer

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Tags: CAPM, Debt Financing, Gearing Ratio, Interest Cover, Rights Issue
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – May 2022 – L3 – Q1 – Business Valuation Techniques

Estimate VT's valuation using FCFE, CAPM, and terminal value assumptions for three-year cash flow forecasts.

Question

The company’s most recent statement of profit or loss and the extracted balances from the latest statement of financial position are as follows:

During the current year:

Depreciation is charged at 10% per annum on the year-end non-current assets balance before accumulated depreciation, and is included in other operating costs in the statement of profit or loss.
The investment in net working capital is expected to increase in line with the growth in gross profit.
Other operating costs consisted of:

Sales and variable costs are projected to grow at 9% per annum and fixed costs are projected to grow at 6% per annum.
The company pays interest on its outstanding loan of 7.5% per annum and incurs tax on its profits at 30%, payable in the following year. The company does not currently pay dividends.

The company will not dispose of any of its non-current assets but will increase its investment in new non-current assets by 20% per annum. The company’s depreciation policy matches the currently available tax allowable depreciation. This straight-line write-off policy is not likely to change;
The directors will not take a dividend for the next three years but will then review the position taking into account the company’s sustainable cash flow at that time;
The level of loan will be maintained at ₦1.98 billion and interest rates are not expected to change.
For estimating the appropriate required return on equity, it is decided to make use of the capital asset pricing model (CAPM). The challenge, however, is that since the company is not quoted, an appropriate beta factor does not exist. You have found a listed company, Konputer Limited (KL) that is into software development. KL is also into computer hardware retailing. It has the following financial statistics:

About 60% of the market value of KL is attributed to the software development division, while 40% of the value is attributed to computer hardware retailing. The computer hardware retailing division has an equity beta of 0.8.
Risk-free rate is 4% and the market risk premium is 8%.
VT has maintained a long-term debt/(debt+equity) ratio of 20%.

Required:

Answer

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Tags: Business Valuation, CAPM, Financial Projections, Free Cash Flow to Equity
Level: Level 3

Topic: Business Valuation Techniques

FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

Question

You are a Financial Analyst at Tayo Research Group (TRG). You begin valuing Aba Hotels Plc (AHP), a thinly and infrequently traded stock currently selling at 217 kobo, cum 2021 dividend.

Table 1: Valuation Data for EHP

Parameter	Value
Asset beta	0.763
Debt beta	0.150
Debt ratio (D/D+E)	0.60
Effective tax rate (%)	30%

Summarised financial data for AHP is shown below:

Statement of Profit or Loss Account

Year	2019	2020	2021*
Sales (₦’000)	305,500	357,600	409,200
Taxable income (₦’000)	40,500	49,000	56,700
Taxation (₦’000)	(14,175)	(17,150)	(19,845)
Post-tax income (₦’000)	26,325	31,850	36,855
Dividend (₦’000)	(9,340)	(10,228)	(11,200)
Retained earnings (₦’000)	16,985	21,622	25,655

Statement of Financial Position

Year	2021*
Non-current assets (₦’000)	216,800
Current assets (₦’000)	158,000
Current liabilities (₦’000)	(104,800)
Net assets (₦’000)	270,000
Ordinary shares (₦0.50 par value)	80,000
Reserves (₦’000)	130,000
15% Bond 2026 (₦100 par value)	60,000

(*2021 figures are unaudited)

Other Relevant Information:

It has been estimated that the debt/equity ratio of AHP is 0.16 and the beta of its debt is 0.2.
The risk-free rate is 12% and the market risk premium is 5%.
AHP has an effective tax rate of 35%.
As a result of recent capital investment, stock market analysts expect post-tax earnings and dividends to increase by 25% for two years and then revert to the company’s existing growth rates.

Required:

a. Stock market analysts sometimes use fundamental analysis and sometimes technical analysis to forecast future share prices.
What are fundamental analysis and technical analysis? (4 Marks)

Answer

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Tags: CAPM, Dividend valuation, Efficient Markets, Fundamental Analysis, Technical Analysis
Level: Level 3

Topic: Business Valuation Techniques

FM – Nov 2016 – L3 – Q5a – Portfolio Management

Explanation of the basic assumptions of the Capital Asset Pricing Model (CAPM).

Question

(a) Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.

What are the basic assumptions on which this model is based?

Answer

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Tags: CAPM, Portfolio Theory, Risk and Return
Level: Level 3

Topic: Portfolio Management

FM – Nov 2023 – L1 – SC – Q7 – Corporate Governance and Financial Strategy

Analyze FP’s dividend payout impact on stock price using forward P/E ratio, ROE, and sustainable growth rate.

Question

The current yield on ordinary non-convertible bonds in similar companies is 11 percent. These interest rates are expected to remain constant.

Required:

b. By how much should the share price of Ope Plc rise before holders would be induced to convert, on the last possible date for conversion? (4 Marks)

c. Explain why the market value of a convertible bond is likely to be affected by the dividend policy of the issuing company. (4 Marks)

(Total 15 Marks)

Answer

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Tags: CAPM, Dividend Payout, DuPont Analysis, Forward P/E, Return on Equity, Sustainable Growth Rate
Level: Level 3

Topic: Corporate Governance and Financial Strategy
Series: NOV 2023

Question Tag: CAPM

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FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

i.

ii.

iii.

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FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

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FM – May 2017 – L3 – Q7 – Investment Appraisal Techniques

Provide background on the Capital Asset Pricing Model (CAPM) and its use in project evaluation.

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FM – May 2019 – L3 – Q4 – Portfolio Management

Evaluate abnormal returns for shares and bonds, calculate required returns for a pension fund portfolio, and assess its active management strategy.

Required:

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FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

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FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for Gap Plc, including rights issue and debt issue, using CAPM, market dynamics, and strategic implications.

Additional Information:

Required:

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FM – May 2022 – L3 – Q1 – Business Valuation Techniques

Estimate VT's valuation using FCFE, CAPM, and terminal value assumptions for three-year cash flow forecasts.

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FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

Table 1: Valuation Data for EHP

Statement of Profit or Loss Account

Statement of Financial Position

Other Relevant Information:

Required:

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FM – Nov 2016 – L3 – Q5a – Portfolio Management

Explanation of the basic assumptions of the Capital Asset Pricing Model (CAPM).

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FM – Nov 2023 – L1 – SC – Q7 – Corporate Governance and Financial Strategy

Analyze FP’s dividend payout impact on stock price using forward P/E ratio, ROE, and sustainable growth rate.

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FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

i.

ii.

iii.

You're reporting an error for "FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques"

FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

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FM – May 2017 – L3 – Q7 – Investment Appraisal Techniques

Provide background on the Capital Asset Pricing Model (CAPM) and its use in project evaluation.

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FM – May 2019 – L3 – Q4 – Portfolio Management

Evaluate abnormal returns for shares and bonds, calculate required returns for a pension fund portfolio, and assess its active management strategy.

Required:

You're reporting an error for "FM – May 2019 – L3 – Q4 – Portfolio Management"

FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

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FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for Gap Plc, including rights issue and debt issue, using CAPM, market dynamics, and strategic implications.

Additional Information:

Required:

You're reporting an error for "FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets"

FM – May 2022 – L3 – Q1 – Business Valuation Techniques

Estimate VT's valuation using FCFE, CAPM, and terminal value assumptions for three-year cash flow forecasts.

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FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

Table 1: Valuation Data for EHP

Statement of Profit or Loss Account

Statement of Financial Position

Other Relevant Information: