Question Tag: Dividend growth model

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  • 15 Marks

FM – May 2023 – L3 – Q7 – Mergers and Acquisitions

Evaluate the share price of Obong plc under different growth scenarios and advise on the takeover bid. Explain EMH and its implications for the market.

Obong plc recently received a takeover bid from Abdul plc. If the bid for Obong plc is successful, it will provide Abdul plc the needed competitive edge in research and development to expand its laboratories into the production of the COVID-19 vaccine.

The shareholders of Obong plc will only accept an offer that meets a required return of 14% on their current shareholdings.

Obong plc recently paid a dividend of N20, and this is expected to grow at a rate of 7% for the foreseeable future.

Required:

a. Estimate the share price of Obong plc today. (2 Marks)

b. If Obong plc accepts the bid from Abdul plc, it is estimated that the new growth rate will rise to 12% for the first 3 years and thereafter stabilize at 7%. Calculate the new share price to the shareholders of Obong plc. (2 Marks)

c. As a financial advisor, recommend to the shareholders of Obong plc whether the offer from Abdul plc should be accepted. (2 Marks)

d. According to Efficient Market Hypothesis (EMH), it is believed that the market would react instantly and accurately to the merger announcement between Obong plc and Abdul plc.
Define briefly the THREE forms of EMH and their implications to the market. (9 Marks)

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  • 10 Marks

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

Rosa Kurablah Ltd (Kurablah) plans to invest in ordinary shares for a period of fifteen years, after which she will sell out, buy a lifetime room and board membership in a retirement home, and retire. She feels that Senchi Ltd (Senchi) is currently, but temporarily, undervalued by the market. Kurablah expects Senchi’s current earnings and dividend to double in the next fifteen years. Senchi’s last dividend was GH¢3, and its stock currently sells for GH¢35 a share.

Required:

i) If Kurablah requires a 12 percent return on her investment, will Senchi be a good buy for her?
(3 marks)

ii) What is the maximum that Kurablah could pay for Senchi and still earn her required 12 percent?
(2 marks)

iii) What might be the cause of such a market undervaluation?
(3 marks)

iv) Given Kurablah’s assumptions, what market capitalization rate for Senchi does the current price imply?

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  • 15 Marks

FM – MAY 2017 – L2 – Q5 – Business valuations

Calculate the value of FCH Bank Ltd. using net asset value, dividend growth model, and earnings yield method, and analyze Kantamanso Ltd's financial ratios.

a) Recent financial information of FCH Bank Ltd., a listed company, is as follows:

Financial analysts have forecasted that the dividends of FCH Bank Ltd. will grow in the future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year. The finance director of FCH Bank Ltd. thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for valuation purposes. FCH Bank Ltd. has a cost of equity of 10% per year and a before-tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time. FCH Bank Ltd. pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is GH¢8.50 per share.

Required:
Calculate the value of FCH Bank Ltd. using the following methods:
i) Net asset value method;
ii) Dividend growth model;
iii) Earnings yield method.
(9 marks)

b) Kantamanso Ltd, which operates in the Distribution sector in Ghana, has provided the following information for the year ended 31 December 2015:

No of Shares Market Value (GH¢)
10% cum preference shares 18,000
Ordinary Shares 15,000

The proposed dividend for the year is GH¢0.3 for the preference shares and GH¢0.45 for ordinary shares each. The company’s chargeable profit was GH¢40,000 and the profit before taxation was GH¢38,000. The tax rate is 25% for both the company and the individual.

Financial Data GH¢m
Profit after tax (earnings) 66.6
Dividends 40.0
Statement of financial position information
Non-current assets 595
Current assets 125
Total assets 720
Current liabilities 70
Equity
Ordinary share (GH¢1 nominal) 80
Reserves 410
Non-current liabilities
6% Bank loan 40
8% Bonds (GH¢100 nominal) 120
Total liabilities 160

Required:
Calculate in respect of ordinary shares:
i) Dividend cover
ii) Earnings per share
iii) Price/earnings ratio
(6 marks)

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  • 20 Marks

FM – NOV 2016 – L2 – Q4 – Foreign exchange risk and currency risk management

Explains types of foreign exchange risks, calculates equity cost using different models, and distinguishes between repos and reverse repos.

a) You have been appointed as the Finance Manager of Jaja Ltd and the expectation of the board is for you to provide education and working solution to their foreign exchange losses problem which your predecessor had no clue.

How will you explain the following? i) Foreign Exchange Risk (2 marks)
ii) Transaction Risk (2 marks)
iii) Translation Risk (2 marks)
iv) Economic Risk (2 marks)

b) Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the following performance. The following information was made available to you:

  • Current market price per share (as at 31/12/15): GH¢ 10
  • Dividend per share 2015: GH¢ 1
  • Expected growth rate of dividend: 20% per annum
  • The average market returns: 27%
  • The risk-free government rate: 24%
  • The beta factor of Kaluu Ltd: 1.4

Required: i) What is the estimated cost of equity using the dividend growth model? (3 marks)
ii) What is the estimated cost of equity using the Capital Assets Pricing model? (3 marks)

c) i) Distinguish between repurchase agreement (repos) and reverse repos. (3 marks)

ii) A company enters into an agreement with a bank and it sells GH¢10 million government bonds with an obligation to buy back the security in 60 days. If the rate is 8.2%, what is the repurchase price of the bond? Assume 365 days in a year. (3 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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  • 6 Marks

FM – MAY 2019 – L2 – Q5b – Business valuations | Dividend Policy

Identify and explain the weaknesses of the dividend growth model as a method for valuing companies.

Question:
The dividend growth model also has its fair share of criticism. While some have hailed it as being indisputable and not subjective, recent academicians and practitioners have come up with arguments that make you believe the exact opposite. Recent studies have unearthed some glaring flaws in what was considered to be a perfect valuation model.

Required:
Identify and explain THREE (3) weaknesses of the dividend growth model as a way of valuing a company with shares. (6 marks)

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  • 15 Marks

FM – May 2023 – L3 – Q7 – Mergers and Acquisitions

Evaluate the share price of Obong plc under different growth scenarios and advise on the takeover bid. Explain EMH and its implications for the market.

Obong plc recently received a takeover bid from Abdul plc. If the bid for Obong plc is successful, it will provide Abdul plc the needed competitive edge in research and development to expand its laboratories into the production of the COVID-19 vaccine.

The shareholders of Obong plc will only accept an offer that meets a required return of 14% on their current shareholdings.

Obong plc recently paid a dividend of N20, and this is expected to grow at a rate of 7% for the foreseeable future.

Required:

a. Estimate the share price of Obong plc today. (2 Marks)

b. If Obong plc accepts the bid from Abdul plc, it is estimated that the new growth rate will rise to 12% for the first 3 years and thereafter stabilize at 7%. Calculate the new share price to the shareholders of Obong plc. (2 Marks)

c. As a financial advisor, recommend to the shareholders of Obong plc whether the offer from Abdul plc should be accepted. (2 Marks)

d. According to Efficient Market Hypothesis (EMH), it is believed that the market would react instantly and accurately to the merger announcement between Obong plc and Abdul plc.
Define briefly the THREE forms of EMH and their implications to the market. (9 Marks)

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  • 10 Marks

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

Rosa Kurablah Ltd (Kurablah) plans to invest in ordinary shares for a period of fifteen years, after which she will sell out, buy a lifetime room and board membership in a retirement home, and retire. She feels that Senchi Ltd (Senchi) is currently, but temporarily, undervalued by the market. Kurablah expects Senchi’s current earnings and dividend to double in the next fifteen years. Senchi’s last dividend was GH¢3, and its stock currently sells for GH¢35 a share.

Required:

i) If Kurablah requires a 12 percent return on her investment, will Senchi be a good buy for her?
(3 marks)

ii) What is the maximum that Kurablah could pay for Senchi and still earn her required 12 percent?
(2 marks)

iii) What might be the cause of such a market undervaluation?
(3 marks)

iv) Given Kurablah’s assumptions, what market capitalization rate for Senchi does the current price imply?

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  • 15 Marks

FM – MAY 2017 – L2 – Q5 – Business valuations

Calculate the value of FCH Bank Ltd. using net asset value, dividend growth model, and earnings yield method, and analyze Kantamanso Ltd's financial ratios.

a) Recent financial information of FCH Bank Ltd., a listed company, is as follows:

Financial analysts have forecasted that the dividends of FCH Bank Ltd. will grow in the future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year. The finance director of FCH Bank Ltd. thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for valuation purposes. FCH Bank Ltd. has a cost of equity of 10% per year and a before-tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time. FCH Bank Ltd. pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is GH¢8.50 per share.

Required:
Calculate the value of FCH Bank Ltd. using the following methods:
i) Net asset value method;
ii) Dividend growth model;
iii) Earnings yield method.
(9 marks)

b) Kantamanso Ltd, which operates in the Distribution sector in Ghana, has provided the following information for the year ended 31 December 2015:

No of Shares Market Value (GH¢)
10% cum preference shares 18,000
Ordinary Shares 15,000

The proposed dividend for the year is GH¢0.3 for the preference shares and GH¢0.45 for ordinary shares each. The company’s chargeable profit was GH¢40,000 and the profit before taxation was GH¢38,000. The tax rate is 25% for both the company and the individual.

Financial Data GH¢m
Profit after tax (earnings) 66.6
Dividends 40.0
Statement of financial position information
Non-current assets 595
Current assets 125
Total assets 720
Current liabilities 70
Equity
Ordinary share (GH¢1 nominal) 80
Reserves 410
Non-current liabilities
6% Bank loan 40
8% Bonds (GH¢100 nominal) 120
Total liabilities 160

Required:
Calculate in respect of ordinary shares:
i) Dividend cover
ii) Earnings per share
iii) Price/earnings ratio
(6 marks)

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  • 20 Marks

FM – NOV 2016 – L2 – Q4 – Foreign exchange risk and currency risk management

Explains types of foreign exchange risks, calculates equity cost using different models, and distinguishes between repos and reverse repos.

a) You have been appointed as the Finance Manager of Jaja Ltd and the expectation of the board is for you to provide education and working solution to their foreign exchange losses problem which your predecessor had no clue.

How will you explain the following? i) Foreign Exchange Risk (2 marks)
ii) Transaction Risk (2 marks)
iii) Translation Risk (2 marks)
iv) Economic Risk (2 marks)

b) Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the following performance. The following information was made available to you:

  • Current market price per share (as at 31/12/15): GH¢ 10
  • Dividend per share 2015: GH¢ 1
  • Expected growth rate of dividend: 20% per annum
  • The average market returns: 27%
  • The risk-free government rate: 24%
  • The beta factor of Kaluu Ltd: 1.4

Required: i) What is the estimated cost of equity using the dividend growth model? (3 marks)
ii) What is the estimated cost of equity using the Capital Assets Pricing model? (3 marks)

c) i) Distinguish between repurchase agreement (repos) and reverse repos. (3 marks)

ii) A company enters into an agreement with a bank and it sells GH¢10 million government bonds with an obligation to buy back the security in 60 days. If the rate is 8.2%, what is the repurchase price of the bond? Assume 365 days in a year. (3 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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  • 6 Marks

FM – MAY 2019 – L2 – Q5b – Business valuations | Dividend Policy

Identify and explain the weaknesses of the dividend growth model as a method for valuing companies.

Question:
The dividend growth model also has its fair share of criticism. While some have hailed it as being indisputable and not subjective, recent academicians and practitioners have come up with arguments that make you believe the exact opposite. Recent studies have unearthed some glaring flaws in what was considered to be a perfect valuation model.

Required:
Identify and explain THREE (3) weaknesses of the dividend growth model as a way of valuing a company with shares. (6 marks)

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