Question Tag: Discounted Cash Flow

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  • 11 Marks

FM – Nov 2024 – L2 – Q4a – Business Valuation

Valuing a company using the discounted cash flow model and price multiples.

Djokoto PLC (Djokoto) has 12 million ordinary shares outstanding and no other long-term debt. The Finance Director of Djokoto, Adepa, estimates that Djokoto’s free cash flows at the end of the next three years will be GH¢0.5 million, GH¢0.6 million, and GH¢0.7 million, respectively. After Year 3, the free cash flow will grow at 5% yearly forever. The appropriate discount rate for this free cash flow stream is determined to be 15% annually.

In a separate analysis based on ratios, Adepa estimates that Djokoto will be worth 10 times its Year 3 free cash flow at the end of the third year. Adepa gathered data on two companies comparable to Djokoto: Mesewa and Dunsin. It is believed that these companies’ price-to-earnings, price-to-sales, and price-to-book-value per share should be used to value Djokoto.

The relevant data for the three companies are given in the table below:

Variables Mesewa Dunsin Djokoto
Current Price Per Share 7.20 4.50 2.40
Earnings Per Share 0.20 0.15 0.10
Revenue Per Share 3.20 2.25 1.60
Book Value Per Share 1.80 1.00 0.80

Required:
i) Estimate Djokoto’s fair value based on the discounted cash flows model. (5 marks)
ii) Compute the following ratios for the comparable companies:

  • P/E Ratio (2 marks)
  • Price-to-Sales Ratio (2 marks)
  • Price-to-Book-Value Ratio (2 marks)
    iii) Based on the valuation results, discuss whether an investor should buy, sell, or hold Djokoto shares. Justify your recommendation. (4 marks)
    iii) Identify two advantages and two disadvantages of business combinations.

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  • 20 Marks

FM – Nov 2024 – L2 – Q2 – Investment Appraisal

Calculate the NPV of launching two new products, Agbui and Loloi, and advise on the investment decision.

Santrofi PLC is a publisher that wants to expand its market share in magazine publications. The company plans to launch two new products, Agbui and Loloi, at the start of January 2025, which it believes will each have a 4-year life span. The sales mix is assumed to be fixed. The information below is relevant:

  1. Expected sales volumes (units) for Agbui:
Year 1 2 3 4
Volume 30,000 55,000 50,000 15,000

  1. The first year’s selling price and direct material costs for each Agbui unit will be GH¢31 and GH¢12, respectively. On the other hand, the company expects to sell 25% more Loloi units than Agbui. Both selling price and direct material cost of Loloi are expected to be 25% less than Agbui’s.

  2. Incremental fixed production costs are expected to be GH¢500,000 in the first year of operation, apportioned based on revenue. Advertising costs will be GH¢250,000 in the first year of operation and then GH¢125,000 per year for the following two years.

  3. To produce the two products, an investment of GH¢1 million in machinery and GH¢500,000 in working capital will be needed, payable at the start of the period. Santrofi PLC expects to recover GH¢600,000 from the sale of machinery at the end of the project life. Investment in machinery attracts a 100% first-year tax-allowable depreciation. The company has sufficient profit to take full advantage of the allowance in Year 1. For the purpose of reporting accounting profit, the company depreciates machinery on a four-year straight-line basis.

  4. Revenue and costs are expected to be affected by inflation after the first year as follows:

    • Selling price: 3% a year
    • Direct material cost: 3% a year
    • Fixed production cost: 5% a year

  5. The company’s real discount rate is 10% for investment appraisal. Average inflation is deemed to be 3%. The applicable corporate tax rate is 25%.

Required:
Calculate the Net Present Value (NPV) of the proposed investment in the two products and advise the company on its investment appraisal.

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  • 20 Marks

FM – Nov 2014 – L3 – SB – Q3 – Mergers and Acquisitions

Appraise Syntax Plc.'s proposed acquisition of Synapse Chemical Company based on forecast profits and provide a recommendation.

Syntax Plc., a fertilizer company, is concerned about fluctuating sales and earnings. This caused the management of the company to consider acquisition of another company in the same line of business.

In order to boost its sales and stabilize its earnings, Syntax Plc.’s management has identified Synapse Chemical Company Plc. as a possible target. Syntax proposed to acquire Synapse for a consideration of N20 million, which was agreed to by both companies.

Synapse’s expected future profits, as projected from its past financial records, are as follows:

Forecast Profits

Year Revenue (N’m) Cost of Sales (N’m) Other Expenses (N’m) Depreciation (N’m) Total Expenses (N’m) Profit Before Tax (N’m)
2015 60 30 15 5 50 10
2016 70 35 15 4 54 16
2017 78 39 15 4 58 20
2018 86 43 15 4 62 24
2019 94 47 15 4 66 28

The following information is relevant:

  1. The forecast profits have been limited to five years.
  2. All sales are for cash.
  3. The net book value of Synapse’s assets of N2 million is intended to be sold for N1 million in 2015. The expected loss from the disposal of these assets has been included in the depreciation for 2015. These assets currently have a tax written down value of N3 million. Capital allowances were claimed as at when due.
  4. Synapse currently has a tax liability of N4.5 million due for payment in 2015.
  5. The interest charges of N1 million of Synapse Plc. have been included in other expenses.
  6. In order to maintain the future earnings forecast of Synapse Chemical Company, Syntax Plc. needs to invest in capital expenditure.

7. Company income tax is currently at 30 percent, and the tax delay is one year.

8. The after-tax weighted average cost of capital has been calculated at 22%.

The management of Syntax Plc. has asked you, as a Financial Expert, to appraise the intended acquisition of Synapse Chemical Company Plc. and advise on the reasonableness of the acquisition. Your advice should be in the form of a report to the Board of Directors of Syntax Plc.

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  • 40 Marks

FM – May 2021 – L3 – Q1 – Business Valuation Techniques

Evaluate the value of Zinco Limited using various valuation techniques and estimate the coupon rate for bond financing.

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components.
The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry-recognized techniques.

Summarized financial statements of Zinco Limited for the last two years are shown below:

Statements of Profit or Loss for the years ended 30 June

2020 (N’000) 2019 (N’000)
Sales Revenue 112,400 101,090
Opening Profit before exceptional items 6,510 4,100
Exceptional Items (10,025) –
Interest Paid (Net) (1,400) (890)
Profit/(Loss) before Tax (4,915) 3,210
Taxation (1,050) (890)
Profit/(Loss) after Tax (5,965) 2,320
Note: Dividend 1,000 500

Statement of Financial Position as at 31 March (N’000)

Additional Information Relating to Zinco:

  1. If the acquisition succeeds, there will be revenue synergy leading to an increase in annual sales revenue of Zinco of 25% for three years, and 10% per year thereafter.
  2. Non-cash expenses, including depreciation, were N4,100,000 in 2020.
  3. Income tax rate is 30% p.a.
  4. Capital expenditure was N5 million in 2020 and is expected to grow at approximately the same rate as revenue.
  5. Working capital, interest payments, and non-cash expenses are expected to increase at the same rate as revenue.
  6. Zinco has a patent with a current market value of N50 million. This has not been included in the non-current assets.
  7. Operating profit is expected to be approximately 8% of revenue in 2021 and to remain at the same percentage in future years.
  8. Dividends are expected to grow at the same rate as revenue.
  9. The realizable value of inventory is expected to be 70% of its book value.
  10. The estimated cost of equity is 12%.
  11. The average P/E ratio of listed companies of similar size to Zinco is 30:1.
  12. Average earnings growth in the industry is 6% per year.

Required:

a. Prepare a report that gives an estimate of Zinco using:
(i) Asset-based valuation (8 Marks)
(ii) P/E ratios (6 Marks)
(iii) Dividend-based valuation (6 Marks)
(iv) The present value of expected future cash flows (5 Marks)
(v) Discuss the potential accuracy of each of the methods used and recommend, with reasons, a value or range of values that PT might bid for Zinco. State clearly any assumptions that you make.

b. The directors of PT are considering issuing some ₦100 nominal value ten-year bonds to finance the purchase of Zinco. To make the bonds look attractive to potential investors, the bonds are to be issued at a discount of 10%. Based on PT’s credit rating, investors are expected to require a return of 7% per year from such bonds.

You are required:
To estimate the coupon rate that PT will have to pay on these bonds in order to satisfy the investors. (5 Marks)

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  • 7 Marks

CR – May 2021 – L3 – Q5b – Provisions, Contingent Liabilities, and Discounted Cash Flows (IAS 37)

Calculate provisions and charges for emission modifications in 2015 and 2016 for Gama Plastic Limited.

Gama Plastic Limited owns a number of plastic recycling plants in various parts of the country which supply most of the raw material used by Gama Plastic Limited for its production of household and corporate plastic products.

On December 1, 2015, the directors of Gama Plastic Limited announced publicly that it intends to voluntarily reduce the level of harmful emissions from its recycling plants through modifications of the plants.

The average useful economic life of these plants as of December 31, 2015, was 15 years. Gama Plastic Limited charges depreciation in relation to the recycling plants to cost of sales on a straight-line basis.

The directors believe that while the modifications will be effective from early 2016 onward, the actual cash costs of the modifications will be as follows:

Date Amount (N’000)
December 31, 2016 100,000
December 31, 2017 80,000
December 31, 2018 140,000

No contract was signed until 2016, but Gama Plastic Limited prides itself on its excellent public image and has a well-known reputation for meeting both legal and constructive obligations.

The directors of Gama Plastic Limited believe that it is appropriate to use discounted cash flow techniques and that an appropriate rate would be 10%, with the following discount factors:

Year PV Factor
1 0.909
2 0.826
3 0.751
4 0.683
5 0.620
6 0.564

Required:

Assuming the actual cash cost of the modification is a reliable estimate, calculate the provisions that should be included in the statement of financial position and the charges to the statement of profit or loss of Gama Plastic Limited in respect of the proposal for each of the years 2015 and 2016. (7 Marks)

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  • 15 Marks

CR – Nov 2023 – L3 – SC – Q7 – Provisions, Contingent Liabilities and Contingent Assets (IAS 37)

Evaluate Roman Limited's recognition of provision for emission reduction costs, compute the provision amounts, and explain the profit or loss components.

Roman Limited prepares its financial statements in accordance with International Accounting Standards. On March 16, 2017, Roman Limited made a public announcement of a decision to reduce the level of emission of harmful chemicals from its factories. The average useful life of the factories on March 31, 2017 was 25 years. The depreciation of the factories is computed on a straight-line basis and charged to cost of sales. The directors formulated the proposal for emission reduction following an agreement in principle earlier in the year.

The directors prepared detailed estimates of the costs of their proposals, showing the following expenditures:

  • N60 million on March 31, 2018
  • N60 million on March 31, 2019
  • N80 million on March 31, 2020

All estimates were for actual anticipated cash payments. No contracts were entered into until after April 1, 2017. The estimate proved accurate regarding the expenditure due on March 31, 2018. When the directors decided to proceed with this project, they used discounted cash flow techniques to appraise the proposed investment, with an annual discount rate of 8%. The company has a reputation for fulfilling its financial commitments after it has publicly announced them. Roman Limited has made a provision for the expected costs of its proposal in the financial statements for the year ended March 31, 2017.

In accordance with the provisions of IAS 37 – Provisions, Contingent Liabilities, and Contingent Assets:

Required:
a. Explain the decision of the directors of Roman Limited to recognize the provision in the statement of financial position as at March 31, 2017.
(6 Marks)

b. Compute the appropriate provisions in the statement of financial position in respect of the proposed expenditure at March 31, 2017, and March 31, 2018.
(4 Marks)

Compute the TWO components of the charge to the statement of profit or loss in respect of the proposal for the year ended March 31, 2018. You should explain how each component arises and identify where in the statement of profit or loss each component is reported.
(5 Marks)

(Total 15 Marks)

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  • 1 Marks

BMF – Nov 2014 – L1 – SA – Q9 – Investment Decisions

Identifies which option is not a discounted cash flow investment appraisal technique.

Which of the following is NOT a discounted cash flow investment appraisal technique?
A. Net present value
B. Internal rate of return
C. Profitability index
D. Discounted payback period
E. Payback period

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  • 15 Marks

PSAF – MAY 2019 – L2 – Q7 – Performance Measurement in the Public Sector

Compare NPV and IRR methods, state decision rules, and apply NPV to evaluate two investment projects for selection.

a. Distinguish between net present value (NPV) and internal rate of return (IRR) and state the decision rule under both criteria. (8 Marks)

b. Two projects A and B have initial capital investment of N900,000 each. The cash inflows of the two projects are as follows:

Required:
i. As a financial analyst, calculate the net present value (NPV) of the two projects given a cost of capital of 12%. (6 Marks)
ii. Based on the results obtained in (i), which of the projects should be chosen? (1 Mark)

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  • 15 Marks

CR – Nov 2020 – L3 – Q4a – Business Valuation

Determine share value of Anidaso Ltd using multiple valuation methods including net assets, P/E ratio, dividend yield, and discounted cash flow.

Anidaso Ltd operates in the manufacturing industry in Ghana. The company is in the process of selling some of its shares to the general public to raise funds to expand its operations. Below are the financial statements of the company:

Statement of profit or loss for the year ended 30 September, 2019

GH¢’000
Revenue 122,900
Cost of sales (58,650)
Gross profit 64,250
Selling, general & administration expenses (43,570)
Profit before interest & taxes 20,680
Finance cost (1,680)
Profit before taxation 19,000
Taxation @ 20% (4,750)
Profit after tax 14,250

Statement of changes in equity (extracts) for the year ended 30 September, 2019

GH¢’000
Retained Earnings at October 1, 2018 47,970
Profit for the year 14,250
Dividend paid (6,200)
Retained Earnings at 30 September, 2019 56,020

Statement of Financial Position as at 30 September, 2019

GH¢’000 GH¢’000
Non-current assets
Development expenditure 13,050
Patents 8,200
Property, plant, and equipment 98,750 120,000
Current assets
Inventories 21,700
Trade receivables 12,501
Bank and cash 5,944 40,145
Current liabilities
Trade payables (15,400) 24,745
Net current assets 144,745
Non-current liabilities
10% Debenture loan stock (12,000) 132,745
Equity
Share capital 50,000
Revaluation Surplus 26,725
Retained Earnings 56,020 132,745

Additional relevant information:

  • The share capital of the company is composed of:
    • GH¢000
    • 20% redeemable preference shares 10,000
    • Ordinary shares (issued @GH¢0.20 each) 40,000
    • Total share capital: 50,000
  • A review of the development expenditure indicated that only 50% of it is worthwhile.
  • An independent valuer has placed values on some of the assets of Anidaso Ltd below:
    • Property, plant & equipment: GH¢111,000
    • Inventories: GH¢16,200
    • Trade receivables: GH¢10,000
    • Total value: GH¢137,200
  • Profit forecasts for the next five years of Anidaso Ltd are as follows:
    Year-end 30 September Profit before Tax (GH¢’000) Depreciation Charge (GH¢’000)
    2020 14,900 1,100
    2021 16,000 1,225
    2022 19,250 1,550
    2023 19,800 2,025
    2024 21,550 2,130
  • The patents in the statement of financial position represent a license to produce an improved variety of a product and is expected to generate a pre-tax profit of GH¢10,000 per year for the next five years.
  • Abiola Limited is a competitor company listed on the Ghana Stock Exchange, and data extracted from its recently published financial statements revealed the following details:
    • Market capitalization: GH¢1,000,000
    • Number of ordinary shares: 800,000
    • Earnings per share: GH¢0.20
    • Dividend payout ratio: 80%
  • The cost of capital of Anidaso Ltd is 10%.

Required:
Determine the value to be placed on each share of Anidaso Ltd using the following methods of valuation: i) Net assets
ii) Price-earnings ratio
iii) Dividend yield
iv) Discounted cash flow

 

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  • 14 Marks

BMF – Nov 2021 – L1 – SB – Q5B – Investment Decisions

This question asks candidates to evaluate two investment projects using the Net Present Value (NPV) method.

McPat Investment Limited is considering investing in either of two mutually exclusive projects, namely Axiom and Axis. Each project costs ₦1.5 billion. The cost of capital to the company is 15%. The projected cash flows from the two projects are as stated below:

Year Axiom (₦’000) Axis (₦’000)
1 220,000 200,000
2 220,000 200,000
3 240,000 220,000
4 240,000 220,000
5 300,000 340,000
6 300,000 340,000
7 280,000 280,000

You are required to evaluate the projects using the Net Present Value method to decide which one to accept.

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  • 10 Marks

FM – Nov 2020 – L2 – Q4a – DCF: Specific applications

Determine the optimal replacement cycle length for the machine using the equivalent annual cost method at Rock Beverages Ltd (RBL)

a) Rock Beverages Ltd (RBL) is a producer of fresh fruit juice. RBL operates a fruit juice extracting machine, which costs GH¢150,000 to purchase and GH¢10,000 to install. The efficiency of the machine reduces over time. Consequently, the costs associated with its use increase over time. Two costs that are influenced by the level of efficiency of the machine are operational costs and maintenance costs. Operational costs are estimated to be GH¢30,000 during the first year of the machine’s use; GH¢35,000 during its second year; and GH¢40,000 during its third year. Maintenance costs are estimated to be GH¢11,000 during the first year of the machine’s use; GH¢13,000 during its second year; and GH¢15,000 during its third year. The resale value of the machine is GH¢40,000 at the end of the first year of use; GH¢35,000 at the end of the second year of use; and GH¢28,000 at the end of the third year of use. RBL’s cost of capital is 18%.

Required:

Determine the optimal replacement cycle length for the machine using the equivalent annual cost method. (10 marks)

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  • 10 Marks

FM – Nov 2020 – L2 – Q3a – DCF: Specific applications | Discounted cash flow

Calculate the present value of payments under cash and credit purchase options, and recommend the better option.

The directors of PDS Foods Ltd (PDS) are considering two payment options for the purchase of a new cereal processing plant:

Option 1: Cash purchase option
This option requires immediate payment of the full price of the plant. If PDS chooses this option, it will pay the cash price of GH¢800,379 today. PDS plans to raise the required amount by borrowing from a bank. Conso Bank Ghana has offered to lend the cash price to PDS at an annual interest rate of 15% with monthly compounding. The loan, interest, and other charges are to be amortized by even instalments of GH¢27,952.26 each made at the end of each month over the next three years.

Option 2: Credit purchase plan
Under this option, the vendor requires an immediate down payment followed by a series of even payments. If PDS chooses this option, it will be required to pay GH¢50,000 today. This will be followed by the payment of GH¢116,100 at the end of each quarter over the next two years. The interest rate implicit in this credit purchase plan is 20% per annum.

Required:

i) Find the present value of all the payments under the cash purchase option. (5 marks)
ii) Find the present value of all the payments under the credit purchase option. (4 marks)
iii) Which of the two options do you recommend to the company? Explain. (1 mark)

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  • 20 Marks

FM – DEC 2023 – L2 – Q2 – Business valuations | Mergers and acquisitions

Business valuation techniques applied to a 70% acquisition using P/E ratio, balance sheet valuation, and discounted cash flow.

a) Panpana Ltd is in advanced negotiation with shareholders of Zanu Ltd to acquire 70% shares in that company. The following financial information is provided for Zanu Ltd:

  • Number of ordinary shares = 20 million
  • Net assets per share = GH¢8
  • Earning per share = GH¢15
  • Price Earnings ratio (P/E) = 10

The Finance Director who performed a due diligence review recommended the following:

  1. Fixed assets included in the net assets were overstated by GH¢6 million
  2. A key customer who owes GH¢4 million has gone bankrupt and debt considered irrecoverable
  3. A provision of GH¢10 million is made for a tax liability
  4. Panpana Ltd cost of capital is 16% and risk premium of 4% is added in the valuation of Zanu Ltd to take care of additional operational risk.
  5. The Finance manager provided a statement showing projected cash inflows for the next 5 years as follows:
Year Cash flow (GH¢ million)
1 125
2 60
3 150
4 200
5 110

Required:
Advise shareholders of Panpana Ltd on how much to pay for 70% of the shares of Zanu Ltd using the following valuation methods:
i) Price Earning (P/E) ratio. (4 marks)
ii) Balance sheet valuation basis. (5 marks)
iii) Cash flow valuation. (5 marks)

b) Explain THREE (3) reasons business valuation is undertaken in the corporate environment. (6 marks)

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  • 20 Marks

FM – May 2020 – L2 – Q4 – Discounted cash flow | Introduction to Investment Appraisal

Calculate the NPV and payback periods for a project, and explain concepts related to market volatility and bull/bear markets.

Sabir Company is considering whether to invest in a project whose details are as follows.
The project will involve the purchase of equipment costing GH¢2,000,000. The equipment will be used to produce a range of products for which the following estimates have been made.

Incremental fixed costs are GH¢1,200,000 per annum. The sales prices allow for expected price increases over the period. However, cost estimates are based on current costs and do not allow for expected inflation in costs. Inflation is expected to be 3% per year for variable costs and 4% per year for fixed costs. The incremental fixed costs are all cash expenditure items. Tax on profits is at the rate of 30%, and tax is payable in the same year in which the liability arises.

Sabir Company uses a four-year project appraisal period, but it is expected that the equipment will continue to be operational and in use for several years after the end of the first four-year period.

The company’s cost of capital for investment appraisal purposes is 10%. Capital projects are expected to pay back within two years on a non-discounted basis and within three years on a discounted basis. Tax allowable depreciation will be available on the equipment at the rate of 25% per year on a reducing balance basis. Any balancing allowance or balancing charge is not attributed to a project unless the asset is actually disposed of at the end of the project period.

Required:

a) Calculate the net present value (NPV) of the project.
(11 marks)

b) To the nearest month, calculate the non-discounted payback period and the discounted payback period.
(4 marks)

c) Explain the meaning of market volatility in financial markets.
(3 marks)

d) Explain the difference between a bull and bear market.
(2 marks)

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  • 20 Marks

FM – May 2020 – L2 – Q2 – Business valuations | Mergers and acquisitions

Value Staygood Ltd using the Price/Earnings ratio, Gordon growth model, and Discounted cash flow methods for a potential takeover by Restwell Ltd.

Restwell Ltd (Restwell), a hotel and leisure company, is currently considering taking over a smaller private limited liability company, Staygood Ltd (Staygood). The board of Restwell is in the process of making a bid for Staygood but first needs to place a value on the company. Restwell has gathered the following data:

Restwell:

  • Weighted average cost of capital: 12%
  • P/E ratio: 12
  • Shareholders’ required rate of return: 15%

Staygood:

  • Current dividend payment (GH¢): 0.27
  • Past five years’ dividend payments (GH¢): 0.15, 0.17, 0.18, 0.21, 0.23
  • Current EPS: 0.37
  • Number of ordinary shares issued: 5 million

The required rate of return of the shareholders of Staygood is 20% higher than that of Restwell due to the higher level of risk associated with Staygood. Restwell estimates that cash flows at the end of the first year will be GH¢2.5 million and these will grow at an annual rate of 5%. Restwell also expects to raise GH¢5 million in two years’ time by selling off hotels of Staygood that are surplus to its needs.

Required:

Estimate values for Staygood using the following valuation methods:

i) Price/earnings ratio valuation. (6 marks)

ii) Gordon growth model. (8 marks)

iii) Discounted cash flow valuation. (6 marks)

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  • 20 Marks

FM – MAY 2016 – L2 – Q1 – Capital rationing | Discounted cash flow

Appraise project PA205 using NPV criteria, sensitivity analysis, and capital rationing advice. Discuss ways to address capital constraints.

ABC Ltd is considering five projects for the coming financial year. Four of the projects have undergone financial appraisal (see the table below).

Project Lifespan Initial investment (GH¢) NPV (GH¢) IRR
PA201 Indefinite (50,000) 85,200 11.5%
PA202 Indefinite (75,000) 98,500 12.3%
PA203 Indefinite (48,000) 65,950 10.2%
PA204 Indefinite (85,000) 95,400 11.4%
PA205 Indefinite (150,000) Yet to be appraised Yet to be appraised

Project PA205 entails an immediate capital investment of GH¢150,000 and will produce the following annual net cash flows in real terms:

Year 1 2 3 4 5 Every year after year 5
Cash flow (GH¢) 5,000 10,500 25,000 28,000 30,000 30,000

Expected general rate of inflation is 15% and the company’s money required rate of return is 25%.

Required:

a) Appraise Project PA205 using the NPV criteria. (4 marks)
b) Assess the sensitivity of Project PA205 to the discount rate. (4 marks)

c) Suppose in the coming financial year, only GH¢200,000 of finance will be available for investments but the capital constraint will ease afterwards. Advise the company on which project(s) to implement in the coming year if the projects are –

i) Independent and divisible (3 marks)
ii) Independent and indivisible (3 marks)

d) When management rejects projects with positive net present value because of capital constraints, they lose opportunities to enhance the value of shareholders. Suggest three practical ways of dealing with capital rationing so as not to discard projects with positive net present value. (6 marks)

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  • 10 Marks

FM – March 2023 – L2 – Q1b – Discounted cash flow | Dividend Policy

Calculate the value of a share for Oliso Ghana Ltd using projected dividend growth rates and the total value for an investor holding 1,500 shares.

Oliso Ghana Ltd paid a dividend of GH¢120 per share two years ago. In the previous and current year, dividend grew by 10% per annum. Starting from next year, dividend is projected to grow by 15% for the next three years and then 10% for another three years and finally settling at 12% forever. The investors expect 20% returns.

Required:
i) Calculate the value of a share in cedis for Oliso Ghana Ltd. (8 marks)
ii) If an investor holds 1,500 shares of the company, what will be the total value in cedis? (2 marks)

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  • 12 Marks

FM – April 2022 – L2 – Q2 – Business valuations | Mergers and acquisitions

Evaluate the possible prices for Blanco Ltd to offer for Zinko using three valuation methods, discuss the issues Zinko may have with these methods, and outline benefits to Blanco Ltd from the acquisition.

Blanco Ltd is listed on the Ghana Stock Exchange (GSE) and is also included in the Ghana club 500 companies. In its recently published accounts, the directors indicated that as part of their growth strategy, the company is negotiating to take over the business of Zinko Enterprise (Zinko), a start-up business in the industry.

Blanco Ltd has in issue 2,480,000 ordinary shares with each share earning approximately GH¢0.79 to give a Price-Earnings ratio of 8. Shareholders expected rate of return is 18%.

The books of Zinko also show that the company has in issue 1,456,000 ordinary shares. The Company’s earnings have increased significantly in the last 4 years from GH¢300,000 to GH¢455,000. The dividend pay-out ratio has been consistent at 45% as a strategy to pay enough funds to shareholders and generate internal resources for future expansion projects. Shareholders expected rate of return is 20%.

Blanco Ltd has estimated that upon completion of the acquisition, the Zinko line of business would generate annual cashflow of GH¢682,500 in the first year, and after that grow at an annual rate of 5% into perpetuity. The investment required for the acquisition will be GH¢1,230,000. However, the funds for this investment would be raised at a cost of capital of 20%.

Required:
a) Use the following valuation methods to estimate the possible prices that Blanco Ltd can offer for the acquisition of Zinko:
i) Price-Earnings ratio
ii) Dividend growth model
iii) Discounted Cashflow (12 marks)

b) Discuss TWO (2) key issues that Zinko management may have with each of the valuation methods used above. (6 marks)

c) Discuss FOUR (4) possible benefits that will accrue to Blanco Ltd if it acquires Zinko. (2 marks)

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