Question Tag: Debt Financing

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  • 14 Marks

FM – Nov 2024 – L2 – Q1a – Sources of Finance

Compare equity and debt financing for business expansion using rights issue and loan notes.

GoodLife Innovations is planning to expand its operations, which will boost its profit before interest and tax by 20%. The company is evaluating whether to fund the GH¢4,000,000 needed for this expansion through equity or debt financing.

If equity financing is chosen, the company will offer a 1-for-5 rights issue to existing shareholders at a 20% discount to the current ex-dividend share price of GH¢5 per share. The par value of the ordinary shares is GH¢1 per share. Alternatively, if debt financing is selected, GoodLife Innovations will issue 20,000 8% loan notes, each with a par value of GH¢200.

The following information was extracted from the financial statement prior to raising new finance:

GH¢’000 Amount
Profit before interest and tax 3,194
Finance costs (interest) (630)
Taxation (564)
Profit after tax 2,000
Equity & Liability:
Ordinary shares 5,000
Retained earnings 10,976
Long-term liabilities: 7% loan notes 9,000
Total equity & liabilities 24,976

GoodLife Innovations currently has a price/earnings ratio of 12.5 times. Corporate tax is payable at a rate of 22%.

Required:
i) Calculate the theoretical ex-rights price per share. 
ii) Calculate the revised earnings per share after the business expansion:

  • assuming equity finance is adopted.
  • assuming debt finance is adopted. 
    iii) Determine the revised share prices under both financing methods after the business expansion. 
    iv) Determine which financing method should be used for the planned business expansion using computations for interest cover and share price changes.

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  • 20 Marks

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.

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:

  1. Gap Plc has an equity beta of 1.1
  2. The risk-free rate is expected to be 3% p.a.
  3. The market return is expected to be 8% p.a.
  4. Gap Plc’s current share price is ₦5 per share ex-dividend.
  5. 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)

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  • 20 Marks

ATAX – Nov 2021 – L3 – Q3 – Tax Planning and Management

Analysis of tax planning, avoidance, thin capitalisation concepts, and strategies for Dragbat Limited to improve tax efficiency.

The board of directors of Dragbat Limited, Lagos, a medium-sized company, at its last meeting, deliberated on the company’s tax-related issues vis-à-vis one of its major competitors in the same line of business. The Managing Director presented the audited accounts of the two companies for the previous three years. He affirmed that their company has been paying more corporate and tertiary education taxes than their competitors, while returning lower profit before tax in each of the years under review. The board has since directed the Managing Director to do a thorough investigation on how competitors, according to the Chairman of the board, are having it easy with the tax authorities.

With the assistance of a former course-mate in the university, who works in the Finance unit of a competitor’s organisation, the Managing Director was informed that the competitor was involved in tax planning and tax avoidance activities, which have helped in reducing the company’s tax liabilities over the years.

Being an engineer with sparse knowledge of accounting and taxation, the Managing Director has contacted you as the company’s tax consultant to help explain some fundamental issues in tax planning and tax avoidance. To assist with this assignment, the Managing Director of Dragbat Limited provided you with the audited financial statements of the two competing companies for the last three years. He also informed you that the major difference between the two companies is that Dragbat Limited is servicing a loan facility of ₦120 million obtained five years ago, and the company is not finding it comfortable in implementing the terms of the loan, despite its increased profitability over the last three years.

The board will be meeting in a fortnight to consider the report on the preliminary investigation, and the Managing Director expects you to submit your report to him next week.

Required:

As the company’s tax consultant, you are expected to address and advise on the following issues in your report:

a. The concepts of tax planning, tax avoidance, and thin capitalisation. (9 Marks)
b. Tax planning activities and strategies. (6 Marks)
c. Tax implications for companies that practice tax planning, tax avoidance, and thin capitalisation. (5 Marks)

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  • 20 Marks

FM – May 2024 – L3 – SB – Q3 – Financial Planning and Forecasting

Evaluate financing options for Tope's Cellular Stores, including impact on profit, EPS, gearing, and shareholder perspective.

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

Item Amount (₦’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

Item Amount (₦’000)
Non-current assets at written down values 3,500
Current assets 1,800
Less: Current liabilities (1,100)
Net Current Assets 700
Total Assets 4,200
Less: Long-term liabilities (2,000)
Net Assets 2,200
Capital and Reserves
₦0.50 ordinary shares 600
Retained profit 1,600
Total Capital and Reserves 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 viewpoint 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)

(Total: 20 Marks)

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  • 20 Marks

FM – Nov 2023 – L3 – SB – Q4 – Financial Risk Management

Assess whether debt or equity financing is more suitable for a business expansion and discuss related financial concepts.

Xeco is considering a N15 million expansion to increase profit before interest and tax by 20%. Financial details for Xeco are as follows:

Item Amount (N’000)
Profit before interest 13,040
Finance charges (interest) (240)
Profit before tax 12,800
Taxation (3,840)
Profit for the year 8,960

Financing Options:

  1. Debt: Issue N15m in 8% loan notes, with each note at a nominal value of N100.
  2. Equity: 1-for-4 rights issue at a 20% discount to current share price (N6.25/share). Xeco has 12 million shares outstanding.
  3. Corporate tax rate: 30%.

Required:

  • a. Evaluate whether Xeco should finance the expansion with debt or equity. (10 Marks)
  • b. Explain the relationship between systematic and unsystematic risk. (5 Marks)
  • c. Discuss the assumptions made by the Capital Asset Pricing Model (CAPM). (5 Marks)

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  • 10 Marks

PSA&F – Nov 2019 – L2 – Q4b – Fiscal Policy and Public Finance

Discusses circumstances under which debt financing is appropriate and identifies four documents needed for the issuance of bonds.

Public projects can be financed through debt, taxation, and other related revenue. The choice of any one method depends on the objective and the overall long-term implications for the economy.

Required:

  • Discuss TWO circumstances under which debt financing is appropriate.
  • Identify FOUR documents required for the issuance of bonds to a state or local government.

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Has Case Study
  • 9 Marks

SCS – Nov 2023 – L3 – Q5b – Sources of Finance

Explaining three advantages of issuing convertible bonds for NSL and investors/bondholders.

To defer dilution of the Martinsons’ shareholding of NSL, they have agreed to issue a 10-year convertible bond to new investors/bondholders.

Required:
Explain THREE (3) advantages of issuing convertible bonds to NSL and to investors/bondholders, respectively.
(9 marks)

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  • 1 Marks

BMF – Nov 2021 – L1 – SA – Q19 – Basics of Business Finance and Financial Markets

Question on identifying the key role of banks as financial intermediaries.

Banks are important financial intermediaries because they:

A. Create new debt
B. Are the only source of debt finance
C. Are the only source of long-term finance
D. Operate between investors and borrowers
E. Take deposits from all their customers

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  • 12 Marks

AFM – May 2019 – L3 – Q4b – Dividend policy in multinationals and capital structure decisions

Evaluate the financing options for Asana Ltd’s expansion, calculate the value of a right, dividend capacity, and debt-to-equity ratio under different methods.

Asana Ltd (Asana) is a manufacturing company based in Ghana. It is listed on Ghana’s stock exchange with a total market capitalization of GH¢400 million and 50 million shares outstanding. Its debt stock is made up of 10,000 18% bonds with a face value of GH¢100 each. Per the bond indenture, Asana is required to maintain a maximum debt-to-equity ratio of 80% and is prohibited from paying a dividend in any year unless its dividend capacity for that year is at least 45% of net income for that year. For the past three years, the company has not been able to pay dividends to its shareholders because it has not been able to meet the minimum dividend capacity requirement.

Presently, the company is planning an expansion project that could enhance its dividend capacity for the coming years. The expansion project is expected to increase profit before interest and tax by 15% above the recent figure of GH¢35 million. The directors are considering whether to use equity or debt finance to raise the GH¢50 million required by the expansion project. The amount required for the business expansion will be invested in additional property and equipment. Details of the two financing methods under consideration follow:

Method 1: Equity Finance
If equity finance is used, Asana will offer 1 new share for every 4 existing shares in a rights offer at a discount of 10% off the current market price.

Method 2: Debt Finance
If debt finance is used, Asana will raise the required GH¢50 million through a syndicated loan arrangement. The interest rate on this syndicated loan is expected to be 20%. It is assumed that the entire principal will be drawn immediately and paid back in a lump sum in 5 years’ time.

Additional information:

  1. Presently, the book value of equity is GH¢200 million, while the debt level is GH¢100 million.
  2. The recent profit before interest and tax is reported after charging depreciation of GH¢10 million and profit on disposal of non-current assets of GH¢2 million. The aggregate cost of the non-current assets sold is GH¢10 million, and their aggregate accumulated depreciation is GH¢8 million.
  3. In addition to the business expansion expenditure, GH¢2 million will be invested to maintain existing productive capacity in the coming year. This will be financed from retained earnings.
  4. Additional investment in net working capital will be 20% of the current net working capital balance of GH¢100 million.
  5. Asana pays corporate income tax at 22%.

Required:

i) Supposing equity finance is used, compute the value of a right.
(2 marks)

ii) Forecast the dividend capacity of Asana under both financing methods after the business expansion. Conclude whether Asana would be able to pay dividends to its shareholders in the coming year.
(5 marks)

iii) Compute the revised debt-to-equity ratio of Asana under both financing methods after the business expansion.
(3 marks)

iv) Use the results of the calculations above to evaluate whether equity or debt finance should be used for the planned business expansion.
(2 marks)

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  • 5 Marks

AFM – May 2018 – L3 – Q1c – Theories of capital structure

Calculating the WACC for different financing options and determining the optimal capital structure.

Paisley Brothers Ltd, a company producing loud paisley shirts, has a net operating income of GH¢20,000 and is faced with the following three options for how to structure its debt and equity:

i) Take no debt and pay shareholders a return of 9%.
ii) Borrow GH¢50,000 at 3% and pay shareholders an increased return of 10%.
iii) Borrow GH¢90,000 at 6% and pay a 13% return to shareholders.

Assuming no taxation and a 100% payout ratio:

Required:
Calculate the Weighted Average Cost of Capital (WACC) for each of the options and determine which method is optimal. (5 marks)

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  • 14 Marks

FM – Nov 2024 – L2 – Q1a – Sources of Finance

Compare equity and debt financing for business expansion using rights issue and loan notes.

GoodLife Innovations is planning to expand its operations, which will boost its profit before interest and tax by 20%. The company is evaluating whether to fund the GH¢4,000,000 needed for this expansion through equity or debt financing.

If equity financing is chosen, the company will offer a 1-for-5 rights issue to existing shareholders at a 20% discount to the current ex-dividend share price of GH¢5 per share. The par value of the ordinary shares is GH¢1 per share. Alternatively, if debt financing is selected, GoodLife Innovations will issue 20,000 8% loan notes, each with a par value of GH¢200.

The following information was extracted from the financial statement prior to raising new finance:

GH¢’000 Amount
Profit before interest and tax 3,194
Finance costs (interest) (630)
Taxation (564)
Profit after tax 2,000
Equity & Liability:
Ordinary shares 5,000
Retained earnings 10,976
Long-term liabilities: 7% loan notes 9,000
Total equity & liabilities 24,976

GoodLife Innovations currently has a price/earnings ratio of 12.5 times. Corporate tax is payable at a rate of 22%.

Required:
i) Calculate the theoretical ex-rights price per share. 
ii) Calculate the revised earnings per share after the business expansion:

  • assuming equity finance is adopted.
  • assuming debt finance is adopted. 
    iii) Determine the revised share prices under both financing methods after the business expansion. 
    iv) Determine which financing method should be used for the planned business expansion using computations for interest cover and share price changes.

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  • 20 Marks

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.

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:

  1. Gap Plc has an equity beta of 1.1
  2. The risk-free rate is expected to be 3% p.a.
  3. The market return is expected to be 8% p.a.
  4. Gap Plc’s current share price is ₦5 per share ex-dividend.
  5. 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)

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  • 20 Marks

ATAX – Nov 2021 – L3 – Q3 – Tax Planning and Management

Analysis of tax planning, avoidance, thin capitalisation concepts, and strategies for Dragbat Limited to improve tax efficiency.

The board of directors of Dragbat Limited, Lagos, a medium-sized company, at its last meeting, deliberated on the company’s tax-related issues vis-à-vis one of its major competitors in the same line of business. The Managing Director presented the audited accounts of the two companies for the previous three years. He affirmed that their company has been paying more corporate and tertiary education taxes than their competitors, while returning lower profit before tax in each of the years under review. The board has since directed the Managing Director to do a thorough investigation on how competitors, according to the Chairman of the board, are having it easy with the tax authorities.

With the assistance of a former course-mate in the university, who works in the Finance unit of a competitor’s organisation, the Managing Director was informed that the competitor was involved in tax planning and tax avoidance activities, which have helped in reducing the company’s tax liabilities over the years.

Being an engineer with sparse knowledge of accounting and taxation, the Managing Director has contacted you as the company’s tax consultant to help explain some fundamental issues in tax planning and tax avoidance. To assist with this assignment, the Managing Director of Dragbat Limited provided you with the audited financial statements of the two competing companies for the last three years. He also informed you that the major difference between the two companies is that Dragbat Limited is servicing a loan facility of ₦120 million obtained five years ago, and the company is not finding it comfortable in implementing the terms of the loan, despite its increased profitability over the last three years.

The board will be meeting in a fortnight to consider the report on the preliminary investigation, and the Managing Director expects you to submit your report to him next week.

Required:

As the company’s tax consultant, you are expected to address and advise on the following issues in your report:

a. The concepts of tax planning, tax avoidance, and thin capitalisation. (9 Marks)
b. Tax planning activities and strategies. (6 Marks)
c. Tax implications for companies that practice tax planning, tax avoidance, and thin capitalisation. (5 Marks)

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  • 20 Marks

FM – May 2024 – L3 – SB – Q3 – Financial Planning and Forecasting

Evaluate financing options for Tope's Cellular Stores, including impact on profit, EPS, gearing, and shareholder perspective.

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

Item Amount (₦’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

Item Amount (₦’000)
Non-current assets at written down values 3,500
Current assets 1,800
Less: Current liabilities (1,100)
Net Current Assets 700
Total Assets 4,200
Less: Long-term liabilities (2,000)
Net Assets 2,200
Capital and Reserves
₦0.50 ordinary shares 600
Retained profit 1,600
Total Capital and Reserves 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 viewpoint 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)

(Total: 20 Marks)

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  • 20 Marks

FM – Nov 2023 – L3 – SB – Q4 – Financial Risk Management

Assess whether debt or equity financing is more suitable for a business expansion and discuss related financial concepts.

Xeco is considering a N15 million expansion to increase profit before interest and tax by 20%. Financial details for Xeco are as follows:

Item Amount (N’000)
Profit before interest 13,040
Finance charges (interest) (240)
Profit before tax 12,800
Taxation (3,840)
Profit for the year 8,960

Financing Options:

  1. Debt: Issue N15m in 8% loan notes, with each note at a nominal value of N100.
  2. Equity: 1-for-4 rights issue at a 20% discount to current share price (N6.25/share). Xeco has 12 million shares outstanding.
  3. Corporate tax rate: 30%.

Required:

  • a. Evaluate whether Xeco should finance the expansion with debt or equity. (10 Marks)
  • b. Explain the relationship between systematic and unsystematic risk. (5 Marks)
  • c. Discuss the assumptions made by the Capital Asset Pricing Model (CAPM). (5 Marks)

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  • 10 Marks

PSA&F – Nov 2019 – L2 – Q4b – Fiscal Policy and Public Finance

Discusses circumstances under which debt financing is appropriate and identifies four documents needed for the issuance of bonds.

Public projects can be financed through debt, taxation, and other related revenue. The choice of any one method depends on the objective and the overall long-term implications for the economy.

Required:

  • Discuss TWO circumstances under which debt financing is appropriate.
  • Identify FOUR documents required for the issuance of bonds to a state or local government.

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  • 9 Marks

SCS – Nov 2023 – L3 – Q5b – Sources of Finance

Explaining three advantages of issuing convertible bonds for NSL and investors/bondholders.

To defer dilution of the Martinsons’ shareholding of NSL, they have agreed to issue a 10-year convertible bond to new investors/bondholders.

Required:
Explain THREE (3) advantages of issuing convertible bonds to NSL and to investors/bondholders, respectively.
(9 marks)

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  • 1 Marks

BMF – Nov 2021 – L1 – SA – Q19 – Basics of Business Finance and Financial Markets

Question on identifying the key role of banks as financial intermediaries.

Banks are important financial intermediaries because they:

A. Create new debt
B. Are the only source of debt finance
C. Are the only source of long-term finance
D. Operate between investors and borrowers
E. Take deposits from all their customers

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  • 12 Marks

AFM – May 2019 – L3 – Q4b – Dividend policy in multinationals and capital structure decisions

Evaluate the financing options for Asana Ltd’s expansion, calculate the value of a right, dividend capacity, and debt-to-equity ratio under different methods.

Asana Ltd (Asana) is a manufacturing company based in Ghana. It is listed on Ghana’s stock exchange with a total market capitalization of GH¢400 million and 50 million shares outstanding. Its debt stock is made up of 10,000 18% bonds with a face value of GH¢100 each. Per the bond indenture, Asana is required to maintain a maximum debt-to-equity ratio of 80% and is prohibited from paying a dividend in any year unless its dividend capacity for that year is at least 45% of net income for that year. For the past three years, the company has not been able to pay dividends to its shareholders because it has not been able to meet the minimum dividend capacity requirement.

Presently, the company is planning an expansion project that could enhance its dividend capacity for the coming years. The expansion project is expected to increase profit before interest and tax by 15% above the recent figure of GH¢35 million. The directors are considering whether to use equity or debt finance to raise the GH¢50 million required by the expansion project. The amount required for the business expansion will be invested in additional property and equipment. Details of the two financing methods under consideration follow:

Method 1: Equity Finance
If equity finance is used, Asana will offer 1 new share for every 4 existing shares in a rights offer at a discount of 10% off the current market price.

Method 2: Debt Finance
If debt finance is used, Asana will raise the required GH¢50 million through a syndicated loan arrangement. The interest rate on this syndicated loan is expected to be 20%. It is assumed that the entire principal will be drawn immediately and paid back in a lump sum in 5 years’ time.

Additional information:

  1. Presently, the book value of equity is GH¢200 million, while the debt level is GH¢100 million.
  2. The recent profit before interest and tax is reported after charging depreciation of GH¢10 million and profit on disposal of non-current assets of GH¢2 million. The aggregate cost of the non-current assets sold is GH¢10 million, and their aggregate accumulated depreciation is GH¢8 million.
  3. In addition to the business expansion expenditure, GH¢2 million will be invested to maintain existing productive capacity in the coming year. This will be financed from retained earnings.
  4. Additional investment in net working capital will be 20% of the current net working capital balance of GH¢100 million.
  5. Asana pays corporate income tax at 22%.

Required:

i) Supposing equity finance is used, compute the value of a right.
(2 marks)

ii) Forecast the dividend capacity of Asana under both financing methods after the business expansion. Conclude whether Asana would be able to pay dividends to its shareholders in the coming year.
(5 marks)

iii) Compute the revised debt-to-equity ratio of Asana under both financing methods after the business expansion.
(3 marks)

iv) Use the results of the calculations above to evaluate whether equity or debt finance should be used for the planned business expansion.
(2 marks)

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  • 5 Marks

AFM – May 2018 – L3 – Q1c – Theories of capital structure

Calculating the WACC for different financing options and determining the optimal capital structure.

Paisley Brothers Ltd, a company producing loud paisley shirts, has a net operating income of GH¢20,000 and is faced with the following three options for how to structure its debt and equity:

i) Take no debt and pay shareholders a return of 9%.
ii) Borrow GH¢50,000 at 3% and pay shareholders an increased return of 10%.
iii) Borrow GH¢90,000 at 6% and pay a 13% return to shareholders.

Assuming no taxation and a 100% payout ratio:

Required:
Calculate the Weighted Average Cost of Capital (WACC) for each of the options and determine which method is optimal. (5 marks)

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