Question Tag: Equity Valuation

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FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

Question

Tinko Plc (TP) repairs and maintains heavy-duty trucks, with workshops in Nigeria and several other African countries. TP is considering an expansion project in response to the government’s recent policy aimed at encouraging mechanized farming through the “Graduates Back To Land (GBTL)” program, which will likely increase demand for heavy-duty machinery.

Below are extracts from the most recent Statement of Financial Position of TP:

Item	₦’million
Share capital	200
Reserves	320
Non-current liabilities	760
Current liabilities	60
Total	1,340

TP’s Free Cash Flows to Equity (FCFE) is currently estimated at ₦153 million, and it is expected to grow at 2.5% per annum indefinitely. The equity shareholders require a return of 11%.

The non-current liabilities consist entirely of bonds redeemable in four years at par with a coupon rate of 5.4%. The debt is rated BB, and the credit spread on BB-rated debt is 80 basis points above the risk-free rate.

In light of the GBTL program, TP is contemplating entry into the mechanized farming support industry through a four-year project, recognizing that after four years, competition may intensify significantly.

The project requires an initial investment of ₦84 million and is expected to generate the following after-tax cash flows:

Additional Information:

Scenario Adjustments:
- There is a 25% probability that the GBTL program will not grow as expected in the first year. If this occurs, the present value of the project’s cash flows over its four-year life will be 50% of the original estimates.
- If the GBTL program grows as expected in the first year, there is still a 20% probability that growth will slow in subsequent years, reducing the present value of cash flows to 40% of the original estimates for those years.
Sale Option: Feedwell Limited (FL) has offered ₦100 million to buy the project from TP at the start of the second year. TP is evaluating if this option adds strategic value to the project.
Abako Plc, a comparable company, operates primarily in non-agricultural services, similar to TP, and has an equity beta of 1.6. Abako derives approximately 80% of its revenues from services outside agriculture, with an asset beta of 0.80. Abako’s capital structure consists of 80 million shares trading at ₦4.50 per share and debt of ₦340 million.
The debt is trading at ₦1,050 per ₦1,000 with a zero debt beta.
Risk-free rate: 4%; Market risk premium: 6%; Corporate tax rate: 20%.

Requirements: a. Calculate TP’s current total market value of:

i. Equity (3 Marks)
ii. Bonds (4 Marks) b. Determine the risk-adjusted cost of capital for the new project (to the nearest percent) (10 Marks) c. Estimate the value of the project:
i. Without factoring in the potential strategic value or synergy from the project (5 Marks)
ii. With FL’s offer, assuming it reflects the market’s view of the project’s value (5 Marks) d. Clearly state the assumptions made in your calculations (3 Marks)

Answer

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Tags: Cost of Capital, Debt Valuation, Equity Valuation, Market Value, Project Valuation, Risk Adjustment
Level: Level 3

Topic: Investment Appraisal Techniques

FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

Question

Companies A, B, and C are in the food retailing sector of the stock market. The following key stock market statistics are provided.

Food Retailers: Ordinary Shares, Key Stock Market Statistics:

Company	A	B	C
Share Price (₦)	2.10	1.80	2.30
Earnings per Share (₦)	0.30	0.25	0.35
Dividend per Share (₦)	0.18	0.15	0.25

Required:

a. Illustrating your answer by using data from the table above, define and explain the term P/E ratio, and comment on the way it may be used by an investor to appraise a possible share purchase. (8 Marks)

b. Using data in the above table, calculate the dividend cover for Companies C and B, and explain the meaning and significance of the measure from the point of view of equity investors. (7 Marks)

(Total 15 Marks)

Answer

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Tags: Dividend Cover, Equity Valuation, Investment decisions, P/E Ratio, Stock Market Analysis
Level: Level 3

Topic: Dividend Policy
Series: NOV 2022

FM – Nov 2022 – L3 – Q3 – Financing Decisions and Capital Markets

Evaluate the financing structure and calculate required return, WACC, and factors influencing beta.

Question

Zakai (ZK) Plc is a listed company that owns and operates a large number of farms throughout the country. A variety of crops are grown.

Financing Structure:
The following is an extract from the statement of financial position of ZK Plc as at 30 September 2021:

The ordinary shares were quoted at ₦3 per share ex div on 30 September 2021. The beta of ZK Plc’s equity shares is 0.8; the annual yield on treasury bills is 5%, and financial markets expect an average annual return of 15% on the market index.

The market price per preference share was ₦0.90 ex div on 30 September 2021. Loan stock interest is paid annually in arrears and is allowable for tax at 30%. The loan stock was priced at ₦100.57 ex interest per ₦100 nominal on 30 September 2021. Loan stock is redeemable on 30 September 2022.

Assume that taxation is payable at the end of the year in which taxable profits arise.

A New Project:
Difficult trading conditions have caused ZK Plc to decide to convert a number of its farms into camping sites with effect from the 2022 holiday season. Providing the necessary facilities for campers will require major investment, and this will be financed by a new issue of loan stock. The returns on the new campsite business are likely to have a very low correlation with those of the existing farming business.

Required:

a. Using the capital asset pricing model, calculate the required rate of return on equity of ZK Plc as at 30 September 2021. Ignore any impact from the new campsite project. (3 Marks)

b. Briefly explain the implications of a beta of less than 1, such as that for ZK Plc. (2 Marks)

c. Calculate the weighted average cost of capital (WACC) of ZK Plc as at 30 September 2021 (use your calculation in answer to requirement (a) above for the cost of equity). Ignore any impact from the new campsite project. (10 Marks)

d. Without further calculations, identify and explain the factors that may change ZK Plc’s equity beta during the year ending 30 September 2022. (5 Marks)

(Total 20 Marks)

Answer

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Tags: Beta Analysis, CAPM, Cost of Capital, Equity Valuation, Financing Structure, Investment decisions
Level: Level 3

Topic: Financing Decisions and Capital Markets
Series: NOV 2022

AFM – May 2018 – L3 – Q4b – Business reorganisation

Estimating equity growth for a management buyout and determining if the growth target is viable.

Question

UTFM Ltd is experiencing financial difficulties, and management is prepared to undertake a buyout. UTFM Ltd is considering selling the business for GH¢50 million. After an analysis, management concluded that the company requires a capital injection of GH¢30 million. A Venture Capitalist has agreed to raise the required funds, providing GH¢8 million at 10% interest and GH¢7 million in equity. Management will provide the remaining funding as equity.

Forecasted Earnings Before Interest and Tax (EBIT) for the next 5 years are as follows:

Corporation tax is charged at 25%, and dividends are expected to be no more than 10% of profits for the first five years. Management forecasts that the value of equity capital is likely to increase by approximately 15% per annum for the next 5 years.

Required:
On the basis of the above forecasts, determine whether management’s estimate that the value of equity will increase by 15% per annum is a viable one.

Answer

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Tags: Buyout, EBIT, Equity Valuation, Growth Estimation, Venture Capital
Level: Level 3

Topic: Business reorganisation
Series: MAY 2018

CR – Nov 2021 – L3 – Q4a – Business valuations

Determine the value of shares of Aboto Ltd using multiple valuation methods including net assets, price-earnings ratio, dividend yield, and discounted cash flow

Question

Aboto Ltd is a private company in the printing industry. It was established by the Aboto family some twenty years ago with Mrs. Aboto as the Managing Director. The business has grown in size over the years, and the directors are now considering listing the company on the Ghana Stock Exchange. The financial statements of the company for the year 2020 are given below:

Additional Information:

The Share Capital of Aboto Ltd consists of ordinary share capital of no par value issued at GH¢100 per share.
An independent valuer estimated the fair value of the Property, Plant & Equipment at GH¢500,000. Valuation charges of 2% have not been accrued for in the above accounts.
The inventory includes obsolete items worth GH¢5,000 being held despite persistent advice by the auditors to have them written off.
Receivables include an amount of GH¢12,000 resulting from the bankruptcy of a major customer. Aboto Ltd is not likely to realize any amount from this, but the directors have refused to make any provision.
The patents represent a right to sell a special product. This product is expected to generate cash flows of GH¢2,000 per annum indefinitely.
The discounted present value of future cash payments in respect of the debentures is GH¢20,000.
Profits after tax of Aboto Ltd over the past four years were as follows:

Year Profits (GH¢)

2019 38,000

2018 36,000

2017 32,000

2016 30,000
A corporate plan prepared by the directors of Aboto Ltd in 2018 included the following positions:
The price-earnings ratio and a dividend yield of quoted companies in the same industry Aboto Ltd operates are 8 and 4%, respectively.
The net assets of Aboto Ltd as at 31 December 2019 were GH¢251,100.
The cost of capital of Aboto Ltd is 20%.
Investing in unlisted securities is about 20% more risky than investing in listed securities.

Year	Profits (GH¢)
2019	38,000
2018	36,000
2017	32,000
2016	30,000

Required:

Determine the value to be placed on each share of Aboto Ltd using the following methods of valuation:

i) Net assets (4 marks)
ii) Price-earnings ratio (4 marks)
iii) Dividend yield (3 marks)
iv) Discounted cash flow (4 marks)

Answer

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Tags: Discounted Cash Flow, Dividend Yield, Equity Valuation, Financial Statements, Net Asset Valuation, Price-Earnings ratio, Share Valuation
Level: Level 3

Topic: Business valuations
Series: NOV 2021

FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

Question

Below are extracts from the most recent Statement of Financial Position of TP:

Item	₦’million
Share capital	200
Reserves	320
Non-current liabilities	760
Current liabilities	60
Total	1,340

TP’s Free Cash Flows to Equity (FCFE) is currently estimated at ₦153 million, and it is expected to grow at 2.5% per annum indefinitely. The equity shareholders require a return of 11%.

The project requires an initial investment of ₦84 million and is expected to generate the following after-tax cash flows:

Additional Information:

Scenario Adjustments:
- There is a 25% probability that the GBTL program will not grow as expected in the first year. If this occurs, the present value of the project’s cash flows over its four-year life will be 50% of the original estimates.
- If the GBTL program grows as expected in the first year, there is still a 20% probability that growth will slow in subsequent years, reducing the present value of cash flows to 40% of the original estimates for those years.
Sale Option: Feedwell Limited (FL) has offered ₦100 million to buy the project from TP at the start of the second year. TP is evaluating if this option adds strategic value to the project.
Abako Plc, a comparable company, operates primarily in non-agricultural services, similar to TP, and has an equity beta of 1.6. Abako derives approximately 80% of its revenues from services outside agriculture, with an asset beta of 0.80. Abako’s capital structure consists of 80 million shares trading at ₦4.50 per share and debt of ₦340 million.
The debt is trading at ₦1,050 per ₦1,000 with a zero debt beta.
Risk-free rate: 4%; Market risk premium: 6%; Corporate tax rate: 20%.

Requirements: a. Calculate TP’s current total market value of:

i. Equity (3 Marks)
ii. Bonds (4 Marks) b. Determine the risk-adjusted cost of capital for the new project (to the nearest percent) (10 Marks) c. Estimate the value of the project:
i. Without factoring in the potential strategic value or synergy from the project (5 Marks)
ii. With FL’s offer, assuming it reflects the market’s view of the project’s value (5 Marks) d. Clearly state the assumptions made in your calculations (3 Marks)

Answer

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Tags: Cost of Capital, Debt Valuation, Equity Valuation, Market Value, Project Valuation, Risk Adjustment
Level: Level 3

Topic: Investment Appraisal Techniques

FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

Question

Companies A, B, and C are in the food retailing sector of the stock market. The following key stock market statistics are provided.

Food Retailers: Ordinary Shares, Key Stock Market Statistics:

Company	A	B	C
Share Price (₦)	2.10	1.80	2.30
Earnings per Share (₦)	0.30	0.25	0.35
Dividend per Share (₦)	0.18	0.15	0.25

Required:

b. Using data in the above table, calculate the dividend cover for Companies C and B, and explain the meaning and significance of the measure from the point of view of equity investors. (7 Marks)

(Total 15 Marks)

Answer

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Tags: Dividend Cover, Equity Valuation, Investment decisions, P/E Ratio, Stock Market Analysis
Level: Level 3

Topic: Dividend Policy
Series: NOV 2022

FM – Nov 2022 – L3 – Q3 – Financing Decisions and Capital Markets

Evaluate the financing structure and calculate required return, WACC, and factors influencing beta.

Question

Zakai (ZK) Plc is a listed company that owns and operates a large number of farms throughout the country. A variety of crops are grown.

Financing Structure:
The following is an extract from the statement of financial position of ZK Plc as at 30 September 2021:

Assume that taxation is payable at the end of the year in which taxable profits arise.

Required:

a. Using the capital asset pricing model, calculate the required rate of return on equity of ZK Plc as at 30 September 2021. Ignore any impact from the new campsite project. (3 Marks)

b. Briefly explain the implications of a beta of less than 1, such as that for ZK Plc. (2 Marks)

d. Without further calculations, identify and explain the factors that may change ZK Plc’s equity beta during the year ending 30 September 2022. (5 Marks)

(Total 20 Marks)

Answer

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Tags: Beta Analysis, CAPM, Cost of Capital, Equity Valuation, Financing Structure, Investment decisions
Level: Level 3

Topic: Financing Decisions and Capital Markets
Series: NOV 2022

AFM – May 2018 – L3 – Q4b – Business reorganisation

Estimating equity growth for a management buyout and determining if the growth target is viable.

Question

Forecasted Earnings Before Interest and Tax (EBIT) for the next 5 years are as follows:

Required:
On the basis of the above forecasts, determine whether management’s estimate that the value of equity will increase by 15% per annum is a viable one.

Answer

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Tags: Buyout, EBIT, Equity Valuation, Growth Estimation, Venture Capital
Level: Level 3

Topic: Business reorganisation
Series: MAY 2018

CR – Nov 2021 – L3 – Q4a – Business valuations

Determine the value of shares of Aboto Ltd using multiple valuation methods including net assets, price-earnings ratio, dividend yield, and discounted cash flow

Question

Additional Information:

The Share Capital of Aboto Ltd consists of ordinary share capital of no par value issued at GH¢100 per share.
An independent valuer estimated the fair value of the Property, Plant & Equipment at GH¢500,000. Valuation charges of 2% have not been accrued for in the above accounts.
The inventory includes obsolete items worth GH¢5,000 being held despite persistent advice by the auditors to have them written off.
Receivables include an amount of GH¢12,000 resulting from the bankruptcy of a major customer. Aboto Ltd is not likely to realize any amount from this, but the directors have refused to make any provision.
The patents represent a right to sell a special product. This product is expected to generate cash flows of GH¢2,000 per annum indefinitely.
The discounted present value of future cash payments in respect of the debentures is GH¢20,000.
Profits after tax of Aboto Ltd over the past four years were as follows:

Year Profits (GH¢)

2019 38,000

2018 36,000

2017 32,000

2016 30,000
A corporate plan prepared by the directors of Aboto Ltd in 2018 included the following positions:
The price-earnings ratio and a dividend yield of quoted companies in the same industry Aboto Ltd operates are 8 and 4%, respectively.
The net assets of Aboto Ltd as at 31 December 2019 were GH¢251,100.
The cost of capital of Aboto Ltd is 20%.
Investing in unlisted securities is about 20% more risky than investing in listed securities.

Year	Profits (GH¢)
2019	38,000
2018	36,000
2017	32,000
2016	30,000

Required:

Determine the value to be placed on each share of Aboto Ltd using the following methods of valuation:

i) Net assets (4 marks)
ii) Price-earnings ratio (4 marks)
iii) Dividend yield (3 marks)
iv) Discounted cash flow (4 marks)

Answer

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Tags: Discounted Cash Flow, Dividend Yield, Equity Valuation, Financial Statements, Net Asset Valuation, Price-Earnings ratio, Share Valuation
Level: Level 3

Topic: Business valuations
Series: NOV 2021

Question Tag: Equity Valuation

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FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

FM – Nov 2022 – L3 – Q3 – Financing Decisions and Capital Markets

Evaluate the financing structure and calculate required return, WACC, and factors influencing beta.

AFM – May 2018 – L3 – Q4b – Business reorganisation

Estimating equity growth for a management buyout and determining if the growth target is viable.

CR – Nov 2021 – L3 – Q4a – Business valuations

Determine the value of shares of Aboto Ltd using multiple valuation methods including net assets, price-earnings ratio, dividend yield, and discounted cash flow

Additional Information:

FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

FM – Nov 2022 – L3 – Q3 – Financing Decisions and Capital Markets

Evaluate the financing structure and calculate required return, WACC, and factors influencing beta.

AFM – May 2018 – L3 – Q4b – Business reorganisation

Estimating equity growth for a management buyout and determining if the growth target is viable.

CR – Nov 2021 – L3 – Q4a – Business valuations

Determine the value of shares of Aboto Ltd using multiple valuation methods including net assets, price-earnings ratio, dividend yield, and discounted cash flow

Additional Information:

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FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

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FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

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FM – Nov 2022 – L3 – Q3 – Financing Decisions and Capital Markets

Evaluate the financing structure and calculate required return, WACC, and factors influencing beta.

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AFM – May 2018 – L3 – Q4b – Business reorganisation

Estimating equity growth for a management buyout and determining if the growth target is viable.

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CR – Nov 2021 – L3 – Q4a – Business valuations

Determine the value of shares of Aboto Ltd using multiple valuation methods including net assets, price-earnings ratio, dividend yield, and discounted cash flow

Additional Information:

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FM – Nov 2016 – L3 – Q1 – Investment Appraisal Techniques

Evaluate TP’s project considering current market values and assess the risk-adjusted cost of capital.

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FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

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FM – Nov 2022 – L3 – Q3 – Financing Decisions and Capital Markets

Evaluate the financing structure and calculate required return, WACC, and factors influencing beta.

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AFM – May 2018 – L3 – Q4b – Business reorganisation

Estimating equity growth for a management buyout and determining if the growth target is viable.

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CR – Nov 2021 – L3 – Q4a – Business valuations

Determine the value of shares of Aboto Ltd using multiple valuation methods including net assets, price-earnings ratio, dividend yield, and discounted cash flow

Additional Information:

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