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ABC Manufacturing Ltd (ABC) is an indigenous Ghanaian company that manufactures components used in air conditioners. The company now wants to manufacture air conditioners for sale in Ghana. Though the manufacture of air conditioners will be a completely new business, directors of ABC plan to integrate it into the company’s core business.
ABC has premises it considers suitable for the project. This premises was acquired two years ago at the cost of GHS50,000. ABC will acquire and install the needed machinery immediately, so production and sales can commence during the first year. The directors of ABC intend to develop the project for five years and then sell it to a suitable investor for an after-tax consideration of GHS20 million.
The following data are available for the project:
ABC Ltd pays tax at 25% on taxable profits. Tax is payable in the same year the profit is earned. ABC Ltd uses 25% as its discount rate for new projects but the directors feel that this rate may not be appropriate for this new venture.
Currently, ABC can borrow at 500 basis points above the five-year Treasury note yield rate. Ghana’s government is enthused by the venture and has offered ABC a subsidized loan of up to 60% of the investment funds required at an interest rate of 200 basis points above the five-year Treasury note yield rate. ABC plans to use debt capital to finance the project by taking advantage of the government’s subsidized loan and raising the balance through a fresh issue of 5-year debentures. Issues costs, which can be assumed to be tax-deductible expenses, will be 5% of the gross proceeds from the debenture offer. The financing strategy for the project is not expected to affect the company’s borrowing capacity in any way.
ABC Ltd will be the first indigenous Ghanaian company to manufacture air conditioners in Ghana. However, it will be competing with XYZ Ltd, a listed company with majority shares held by foreign investors. The cost of equity of XYZ Ltd is estimated to be 20% and it pays tax at 22%. XYZ has 10 million shares in issue that are trading at GHS5.5 each, and bonds with total market value of GHS40 million.
The five-year Treasury note yield rate is currently 10% and the return on the market portfolio is 18%.
Required:
Evaluate, on financial grounds, whether ABC should implement the project or not. (20 marks)
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Ahomka Fruity Ltd (Ahomka), a listed company based in Ghana, produces fresh pineapple juice packaged in bottles and cans. The company has been exporting to Nigeria for many years, earning an annual after-tax contribution of NGN5 million. The company wants to establish a wholly-owned subsidiary in Nigeria to produce and sell its pineapple juice products over there. If a subsidiary is established and operated in Nigeria, Ahomka will cease exporting pineapple juice products to Nigeria. However, Ahomka plans to sell some raw materials and services to the subsidiary for cash.
Acquiring a suitable premise, required plant, and equipment, and installing the machinery will take the next two years to complete. Production and sales will commence in the third year and indefinitely.
Capital expenditure is estimated to be NGN10 million at the start of the first year and NGN5 million at the start of the second year. Ahomka will have to make working capital of NGN2 million available at the start of the third year, and this is expected to increase to NGN2.5 million at the start of the fifth year.
The proposed Nigerian subsidiary will produce the following pre-tax operating cash flows at the end of each of the first three years of production and sales:
| Production/sales year | Pre-tax operating cash flows (NGN ‘000) |
|---|---|
| 1 | 2,800 |
| 2 | 4,500 |
| 3 | 5,200 |
The tax rate in Nigeria is 30%, and tax is paid in the same year the profit is earned. Capital allowance is granted on capital expenditure at the end of each year of production/sale at the rate of 30% on a reducing balance basis.
After the first three years of production and sales, post-tax incremental net operating cash flows will grow at a rate of 4% every year to perpetuity.
Ahomka plans to finance the project entirely with loans raised from Ghana at an after-tax cost of 18%. The maximum post-tax operating cash flows possible will be remitted to the parent company at the end of each year to help pay off the loans. Nigeria does not restrict fund remittance to a parent company outside of Nigeria, and there are no taxes on funds remittance.
The Naira-Ghana Cedi exchange rate is currently NGN55.40/GHS. Annual inflation is expected to be 18% in Ghana and 20% in Nigeria.
Required:
(a) Perform a financial appraisal of the project using the net present value and the modified internal rate of return (MIRR) methods, and recommend whether Ahomka should proceed with the project. (10 marks)
(b) Present a paper to the Board of Directors of Ahomka, which advises on potential risks the company might be exposed to if it proceeds with the Nigerian subsidiary project, and strategies the company could employ to avoid or manage the risks.
(Note: Professional marks will be awarded for presentation) (10 marks)
Find Related Questions by Tags, levels, etc.
Find Related Questions by Tags, levels, etc.
ABC Manufacturing Ltd (ABC) is an indigenous Ghanaian company that manufactures components used in air conditioners. The company now wants to manufacture air conditioners for sale in Ghana. Though the manufacture of air conditioners will be a completely new business, directors of ABC plan to integrate it into the company’s core business.
ABC has premises it considers suitable for the project. This premises was acquired two years ago at the cost of GHS50,000. ABC will acquire and install the needed machinery immediately, so production and sales can commence during the first year. The directors of ABC intend to develop the project for five years and then sell it to a suitable investor for an after-tax consideration of GHS20 million.
The following data are available for the project:
ABC Ltd pays tax at 25% on taxable profits. Tax is payable in the same year the profit is earned. ABC Ltd uses 25% as its discount rate for new projects but the directors feel that this rate may not be appropriate for this new venture.
Currently, ABC can borrow at 500 basis points above the five-year Treasury note yield rate. Ghana’s government is enthused by the venture and has offered ABC a subsidized loan of up to 60% of the investment funds required at an interest rate of 200 basis points above the five-year Treasury note yield rate. ABC plans to use debt capital to finance the project by taking advantage of the government’s subsidized loan and raising the balance through a fresh issue of 5-year debentures. Issues costs, which can be assumed to be tax-deductible expenses, will be 5% of the gross proceeds from the debenture offer. The financing strategy for the project is not expected to affect the company’s borrowing capacity in any way.
ABC Ltd will be the first indigenous Ghanaian company to manufacture air conditioners in Ghana. However, it will be competing with XYZ Ltd, a listed company with majority shares held by foreign investors. The cost of equity of XYZ Ltd is estimated to be 20% and it pays tax at 22%. XYZ has 10 million shares in issue that are trading at GHS5.5 each, and bonds with total market value of GHS40 million.
The five-year Treasury note yield rate is currently 10% and the return on the market portfolio is 18%.
Required:
Evaluate, on financial grounds, whether ABC should implement the project or not. (20 marks)
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Ahomka Fruity Ltd (Ahomka), a listed company based in Ghana, produces fresh pineapple juice packaged in bottles and cans. The company has been exporting to Nigeria for many years, earning an annual after-tax contribution of NGN5 million. The company wants to establish a wholly-owned subsidiary in Nigeria to produce and sell its pineapple juice products over there. If a subsidiary is established and operated in Nigeria, Ahomka will cease exporting pineapple juice products to Nigeria. However, Ahomka plans to sell some raw materials and services to the subsidiary for cash.
Acquiring a suitable premise, required plant, and equipment, and installing the machinery will take the next two years to complete. Production and sales will commence in the third year and indefinitely.
Capital expenditure is estimated to be NGN10 million at the start of the first year and NGN5 million at the start of the second year. Ahomka will have to make working capital of NGN2 million available at the start of the third year, and this is expected to increase to NGN2.5 million at the start of the fifth year.
The proposed Nigerian subsidiary will produce the following pre-tax operating cash flows at the end of each of the first three years of production and sales:
| Production/sales year | Pre-tax operating cash flows (NGN ‘000) |
|---|---|
| 1 | 2,800 |
| 2 | 4,500 |
| 3 | 5,200 |
The tax rate in Nigeria is 30%, and tax is paid in the same year the profit is earned. Capital allowance is granted on capital expenditure at the end of each year of production/sale at the rate of 30% on a reducing balance basis.
After the first three years of production and sales, post-tax incremental net operating cash flows will grow at a rate of 4% every year to perpetuity.
Ahomka plans to finance the project entirely with loans raised from Ghana at an after-tax cost of 18%. The maximum post-tax operating cash flows possible will be remitted to the parent company at the end of each year to help pay off the loans. Nigeria does not restrict fund remittance to a parent company outside of Nigeria, and there are no taxes on funds remittance.
The Naira-Ghana Cedi exchange rate is currently NGN55.40/GHS. Annual inflation is expected to be 18% in Ghana and 20% in Nigeria.
Required:
(a) Perform a financial appraisal of the project using the net present value and the modified internal rate of return (MIRR) methods, and recommend whether Ahomka should proceed with the project. (10 marks)
(b) Present a paper to the Board of Directors of Ahomka, which advises on potential risks the company might be exposed to if it proceeds with the Nigerian subsidiary project, and strategies the company could employ to avoid or manage the risks.
(Note: Professional marks will be awarded for presentation) (10 marks)
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