Question Tag: Investment Decision

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  • 6 Marks

CR – Nov 2024 – L3 – Q5a – Financial Analysis and Investment Evaluation

Compute financial ratios for Nsawkaw PLC to evaluate its financial performance for investment recommendation.

Nsawkaw PLC (NK), a gold processing and trading company, has been identified by Djaraye Private Equity Fund (DPEF) as a target for long-term equity investment. As a financial consultant of DPEF, you have been tasked to evaluate the integrated financial condition of NK and make an investment recommendation.

Below are the summarised versions of NK’s Consolidated Financial Statements for the year ended June 30, 2024 (together with its comparative period):

Summarised Consolidated Statement of Profit or Loss for the year ended 30 June 2024

2024 (GH¢000) 2023 (GH¢000)
Revenue 2,538,000 2,125,000
Operational expenses (1,909,100) (1,592,900)
Interest costs (186,700) (157,250)
Taxation (234,000) (198,500)
Profit after tax 208,200 176,350
Other comprehensive income 17,900 10,550
Total comprehensive income 226,100 186,900

Summarised Consolidated Statement of Changes in Equity for the year ended 30 June 2024

Equity Holders of the Parent (GH¢000) Non-controlling Interests’ Equity (GH¢000) Total Equity (GH¢000)
2024
Balances b/d 457,200 65,600 522,800
Total comprehensive income 190,800 35,300 226,100
Dividends (110,000) (8,700) (118,700)
Balances c/d 538,000 92,200 630,200
2023
Balances b/d 355,000 46,650 401,650
Total comprehensive income 160,500 26,400 186,900
Dividends (58,300) (7,450) (65,750)
Balances c/d 457,200 65,600 522,800

Summarised Statement of Financial Position as at 30 June 2024

2024 (GH¢000) 2023 (GH¢000)
Non-current assets
Property, plant, and equipment 718,000 657,000
Others 156,000 99,000
Total Non-current assets 874,000 756,000
Current assets
Trade receivables 140,000 121,000
Others 236,500 123,050
Total Current assets 376,500 244,050
Total Assets 1,250,500 1,000,050
Total Equity and Liability 1,250,500 1,000,050

Additional information:

  1. The total number of equity shares outstanding was 1.2 million and 1.4 million at 30 June 2023 and 30 June 2024 respectively.
  2. Other comprehensive income attributable to non-controlling interests for the years ended 30 June 2023 and 2024 amounted to GH¢8.05 million and GH¢9.6 million respectively.
  3. Non-current liabilities at 30 June 2023 and 30 June 2024 amounted to GH¢250,800 and GH¢308,510 respectively.
  4. The following metrics have been gleaned from NK’s published sustainability reports across the two years:
Metric 2024 2023
Scope 1 & 2 carbon emissions (tonnes of CO2) 650 780
Scope 3 carbon emissions (tonnes of CO2) 2,400 2,380
Women in senior management (%) 21 16
Total recordable injury frequency rate (TRIFR) per 100 full-time workers 3.3 4.1

The scope and definitions of the above sustainability measures have remained materially unchanged across the two years.

Required:

Compute the following ratios for the years ended 2024 & 2023:

  1. Operating profit margin
  2. Return on parent’s equity
  3. Earnings per share
  4. Current ratio
  5. Trade receivables days
  6. Total liabilities to total assets %

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  • 10 Marks

FR – Nov 2024 – L2 – Q4b – Financial Performance Assessment of Acquisition Targets

Assessment of financial performance and position of Suah LTD and Nagbe LTD to assist Dukuly LTD in an acquisition decision.

Dukuly LTD, a public entity, has been expanding through acquisitions. It is assessing two potential acquisition targets, Suah LTD and Nagbe LTD, both operating in the same industry.

The financial statements of Suah LTD and Nagbe LTD for the year ended 30 September 2024 have been provided, along with a set of financial ratios calculated for Suah LTD.

Required:
Using the calculated ratios for Nagbe LTD from Question 4a, assess the relative financial performance and financial position of Suah LTD and Nagbe LTD, to assist the directors of Dukuly LTD in making an acquisition decision.

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  • 10 Marks

FR – Nov 2024 – L2 – Q4a – Financial Ratios and Performance Evaluation

Calculation of key financial ratios for Nagbe LTD to compare with Suah LTD and evaluate financial performance.

Dukuly LTD, a public entity, has been expanding through acquisitions. It is assessing two potential acquisition targets, Suah LTD and Nagbe LTD, which operate in the same industry. The indicative price for acquiring either entity is GH¢12 million.

The financial statements for Suah LTD and Nagbe LTD are provided as follows:

Statement of Profit or Loss for the year ended 30 September 2024

Item Suah LTD (GH¢’000) Nagbe LTD (GH¢’000)
Revenue 25,000 40,000
Cost of Sales (19,000) (32,800)
Gross Profit 6,000 7,200
Distribution & Admin Expenses (1,250) (2,300)
Finance Costs (250) (900)
Profit Before Tax 4,500 4,000
Income Tax Expense (900) (1,000)
Profit for the Year 3,600 3,000

Statement of Financial Position as at 30 September 2024

Item Suah LTD (GH¢’000) Nagbe LTD (GH¢’000)
Non-Current Assets 4,800 10,300
Current Assets 4,800 8,700
Total Assets 9,600 19,000
Equity 2,600 5,600
Non-Current Liabilities 5,000 9,200
Current Liabilities 2,000 4,200
Total Equity & Liabilities 9,600 19,000

Additional Information:

  1. Carrying Amount of Plant Assets:

    • Suah LTD: GH¢4,800,000
    • Nagbe LTD: GH¢2,000,000

  2. The following ratios for Suah LTD are provided:

    Ratio Suah LTD
    Return on Capital Employed (ROCE) 62.5%
    Net Asset Turnover 3.3 times
    Gross Profit Margin 24.0%
    Profit Margin (Before Interest & Tax) 19.0%
    Current Ratio 2.4:1
    Inventory Holding Period 31 days
    Trade Receivables Collection Period 31 days
    Trade Payables Payment Period 24 days
    Gearing Ratio 65.80%
    Acid Test Ratio 1.6:1

Required:
Using the financial statements provided, calculate the corresponding ratios for Nagbe LTD to compare with Suah LTD.

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  • 20 Marks

FM – Nov 2016 – L3 – SB – Q2 – Investment Appraisal Techniques

Calculate the value of the convertible loan stock, expected growth rate in equity price, and provide recommendations on whether to hold or sell the security.

Honey Comb Plc has issued 10% convertible loan stock, which is due for redemption in 10 years’ time (i.e., December 31, 2025). The option to convert is open only for another two years. If conversion does not take place by December 31, 2017, the option will lapse. The issue was sold to the public at a price of N920 for N1000 of convertible loan stock. The conversion rate at January 1, 2016 was 250 equity shares for N1000 of stock. Non-convertible loan stock in a similar risk class is presently yielding 12%. The market price of Honey Comb Plc equity shares has been increasing steadily over time, reflecting the performance of the company. The shares currently pay a dividend of N0.30 per share. The current price of the convertible security is N960, and each share is currently valued at N3.00. A holder of the convertible loan stock is considering whether to sell his holdings or continue to hold the stock. Ignore taxation while answering the questions.

Required:
a. What is the value of the security as simple unconvertible loan stock? (5 Marks)

b. What is the expected minimum annual rate of growth in the equity share price that is required to justify the holder of convertible loan stock holding on to the security before the option expires? (12 Marks)

c. What recommendation would you make to the holder of the security and why? (3 Marks)

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  • 1 Marks

AAA – Nov 2013 – L3 – A – Q10 – Assurance Engagements

This question assesses which elements are typically excluded from investigations related to investment decisions.

Investigation under investment decision will NOT include:
A. Loan facility decision
B. Purchase of shares
C. Purchase of business
D. Reporting on profit forecast
E. Partnership participation

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  • 20 Marks

CR – May 2024 – L3 – SB – Q2 -Consolidated Financial Statements (IFRS 10)

Memo advising on acquisition decision based on financial analysis of Betta and Gamma Ltd.

Alpha PLC is an entity which has grown in recent years by acquiring established businesses. Alpha PLC is contemplating acquiring Betta Limited and Gamma Limited, both operating in the same industry as Alpha PLC. The management of Alpha PLC has indicated a total acquisition price of N12 million for each company. The following financial statements provide insight into the performance and financial position of both Betta Limited and Gamma Limited as at September 30, 2020:

  1. Statement of Profit or Loss (for the year ended September 30, 2020):
    Betta Ltd (N’000) Gamma Ltd (N’000)
    Revenue 25,000 40,000
    Cost of sales (19,000) (32,800)
    Gross profit 6,000 7,200
    Distribution costs (800) (1,400)
    Administrative expenses (450) (900)
    Finance costs (250) (900)
    Profit before tax 4,500 4,000
    Income tax expense (900) (1,000)
    Profit for the year 3,600 3,000
  2. Statement of Financial Position (as at September 30, 2020):
    Betta Ltd (N’000) Gamma Ltd (N’000)
    Non-current assets
    Property, plant and equipment
    – Property – 3,000
    – Owned plant and equipment 4,800 2,000
    – Leased plant and equipment – 5,300
    Total non-current assets 4,800 10,300
    Current assets
    Cash at bank and in hand 1,600 200
    Trade receivables 1,600 5,100
    Inventories 1,600 3,400
    Total current assets 4,800 8,700
    Total assets 9,600 19,000
    Equity and liabilities
    Ordinary shares (N1.00 each) 1,000 2,000
    Revaluation surplus on property – 900
    Retained earnings 1,600 2,700
    Total equity 2,600 5,600
    Non-current liabilities
    Finance lease obligation – 4,200
    5% loan notes (Dec 2026) 5,000 –
    10% loan notes (Dec 2026) – 5,000
    Total non-current liabilities 5,000 9,200
    Current liabilities
    Trade payables 1,250 2,100
    Finance lease obligation – 1,000
    Tax payable 750 1,100
    Total current liabilities 2,000 4,200
    Total equity and liabilities 9,600 19,000
  3. Additional Ratios Calculated:
    • Gross profit margin: Betta 24.0%, Gamma 18.0%
    • Profit margin (before interest and tax): Betta 19.0%, Gamma 12.3%
    • Return on capital employed (ROCE): Betta 62.5%, Gamma 31.0%
    • Current ratio: Betta 2.4:1, Gamma 2.1:1
    • Acid test ratio: Betta 1.6:1, Gamma 1.26:1
    • Net assets turnover: Betta 3.3 times, Gamma 2.5 times
    • Gearing: Betta 65.8%, Gamma 64.6%

Required:

a. Write a memo to the Director of Alpha PLC advising him on how to make the investment decision considering the performance and financial position of Betta Limited and Gamma Limited for the year ended September 30, 2020. (14 Marks)

b. What other qualitative factors should the management of Alpha PLC take into consideration assuming Gamma Limited is a foreign subsidiary? (6 Marks)

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  • 20 Marks

FM – May 2018 – L3 – SB – Q4 – Portfolio Management

Analyze SF Plc.'s portfolio beta and assess whether the short-term investment strategy is optimal.

Sunmola Funds (SF) Plc. has a portfolio of short-term investments in the shares of four quoted companies.

Company Holding
Tomiwa (T) 100,000 shares
Pascal (P) 155,000 shares
Binta (B) 260,000 shares
Yetunde (Y) 420,000 shares

You have the following additional information:

Company Beta Market Value Per Share (Kobo) Expected Total Return on Investment p.a (%)
T 1.55 280 21.0
P 0.65 340 12.5
B 1.26 150 18.0
Y 1.14 9.5 18.5

The market risk premium is 10% per year, and the risk-free rate is 6% per year.

Required:

a. Estimate the Beta of SF Plc.’s short-term investment portfolio. (4 Marks)

b. Recommend, giving your reasons, whether the composition of SF Plc.’s short-term investment portfolio should be changed using relevant calculations. (10 Marks)
Hint: Consider the alpha values of the shares and the propriety of investing short-term funds in equity.

c. Explain THREE factors that a financial manager should take into account when investing in marketable securities. (6 Marks)

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  • 10 Marks

PSAF – May 2021 – L2 – Q3b – Fiscal Policy and Public Finance

NPV-based investment recommendation for Omidan Local Government among three projects and a risk-free security alternative.

Omidan Local Government Council has N20,000,000 to invest, if there is an assurance that the investment will earn at least 12% p.a. In view of this, the following projects are being considered:

  • Project A will earn N21,800,000 at the end of year one with a residual value of N1,500,000;
  • Project B will earn N24,000,000 at the end of year two with a residual value of N500,000; and
  • Project C will earn N14,000,000 at the end of year one and another N10,000,000 at the end of year two with no residual value.

If none of the projects is undertaken, Omidan Local Government Council will invest the N20,000,000 in a risk-free security that will earn interest of 12% p.a.

Required:

Assess and advise Omidan Local Government Council on which of the projects to be undertaken using Net Present Value (NPV) method.

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  • 16 Marks

QT – May 2019 – L1 – Q2b – Mathematics of Business Finance

Calculate NPV and IRR for two machines and determine which machine yields a better return.

BonBone Company Ltd wants to make a decision on which of the two machines to purchase. Each will involve a GH¢10,000 investment. The expected net incremental cash flows are given by the table below:

Year Machine I (GH¢) Machine II (GH¢)
1 5,000.00 2,000.00
2 4,000.00 3,000.00
3 2,000.00 5,000.00
4 2,000.00 4,000.00

Required:

i) If the company’s cost of capital is 10%, calculate the Net Present Value (NPV) of Machine I and Machine II and determine which machine should be purchased for higher returns. (8 marks)

ii) If the initial investment for Machine I is changed to GH¢4,000 and Machine II is changed to GH¢2,000, calculate the Internal Rate of Return (IRR) for Machine I and Machine II. (6 marks)

iii) If the IRRs in (ii) above are to be used as the basis of selection, determine which machine should be purchased for higher returns. (2 marks)

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  • 4 Marks

QT – May 2019 – L1 – Q2a – Mathematics of Business Finance

Distinguish between IRR and NPV, and evaluate investment decisions using NPV and IRR.

Distinguish between Internal Rate of Return and Net Present Value. (4 marks)

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  • 14 Marks

QT – May 2018 – L1 – Q1a – Mathematics of Business Finance

Compare returns from a bank account and savings fund with different compounding rates and calculate the effective interest rate.

You have received a prize amount of GH¢5,000 and you wish to invest it for five years. The two alternatives are to use a bank account where the 14% per annum gross rate is compounded monthly or a savings fund where the 14.5% per annum gross rate is compounded annually.

Required:
i) Calculate the size of each fund at the end of the five years. (Ignore tax considerations). (8 marks)
ii) Calculate the effective annual interest rate of the bank account investment. (4 marks)
iii) Advise your client on the basis of your calculations. (2 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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  • 20 Marks

AFM – Nov 2015 – L3 – Q2 – Discounted Cash Flow Techniques | Sources of Finance and Cost of Capital

Evaluate the financial viability of a proposed air conditioner manufacturing project using APV.

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:

  1. The cost of acquiring and installing plant and machinery needed for the project will be GHS5 million at the start of the first year. Tax-allowable depreciation is available on the plant and machinery at the rate of 30% on reducing balance basis.
  2. Working capital requirement for each year is equal to 10% of the year’s anticipated sales. ABC has to make working capital available at the beginning of the respective year. It is expected that 40% of working capital will be redeployed to other projects at the end of the fifth year when the project is sold.
  3. It is expected that 2,000 units will be manufactured and sold in the first year. Unit sales will grow by 5% each year thereafter.
  4. Unit sales price is estimated at GHS2,200 in the first year. Thereafter, the unit sales price is expected to be increased by 10% each year.
  5. Unit variable cost will be GHS1,100 per unit in the first year. Unit variable cost is expected to increase by 8% each year after the first year.
  6. Fixed overhead costs are estimated at GHS1.5 million in total in each year of production/sale. One-half of the total fixed overhead costs are head office allocated overheads. After the first year of production/sales, fixed overhead costs are expected to increase by 5% per year.

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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  • 20 Marks

CR – Mar 2024 – Q5 – Analysis and interpretation of financial statements

Analyze and compare cash flow statements of two companies to recommend an investment choice between them.

You are the Financial Consultant of Nkoso Funds, a pension fund in Ghana. Your company has identified two companies which you have been asked to evaluate as possible investments. The two companies, Trokaa Plc (Trokaa Plc) and Krokro Plc (Krokro Plc), are both publicly held and similar in size. Assume that all other publicly available information, including all climate, sustainability, and governance disclosures, have already been analysed and the decision concerning which company’s shares to acquire depends on their cash flow data given below:

Statement of cash flows for the years ended December 31, 2023 and 2022 Trokaa Plc Krokro Plc

Required:
a) Conduct a horizontal analysis for each of the two companies. (6 marks)

b) Write a report to the investment manager of Nkoso Funds discussing the relative strengths and weaknesses of each of the two companies. Conclude your report by recommending one company’s share as an investment avenue. (14 marks)

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  • 20 Marks

CR – July 2024 – L3 – Q5 – Analysis and Interpretation of Financial Statements

Analyze Towobo Ltd’s financial health and provide advice on whether ABC Mutual Funds should invest.

Presented below are the common-sized financial statements of Towobo Ltd over the last five years:

Vertical Common-Sized Statements of Profit or Loss for the Years Ended 31 December

% 2022 2021 2020 2019 2018
Revenue 100.00 100.00 100.00 100.00 100.00
Cost of sales (88.58) (85.45) (84.92) (87.36) (92.70)
Gross profit 11.42 14.55 15.08 12.64 7.30
Distribution & marketing costs (1.00) (0.86) (0.83) (1.15) (0.87)
Administrative expenses (0.74) (0.79) (0.88) (0.85) (0.73)
Other operating income 2.06 1.78 0.77 0.58 0.69
Other operating expenses (1.36) (0.86) (1.21) (1.20) (0.94)
Profit from operations 10.38 13.82 12.93 10.02 5.45
Finance cost (0.02) (0.04) (0.02) (0.05) (0.10)
Profit before tax 10.36 13.78 12.92 9.97 5.35
Tax (3.25) (3.98) (4.05) (3.25) (2.61)
Profit after tax 7.11 9.80 8.86 6.72 2.74

Vertical Common-Sized Statements of Financial Position as at 31 December

% 2022 2021 2020 2019 2018
Non-current assets
Property, plant & equipment 8.49 8.55 15.50 20.27 23.33
Intangible assets 0.52 0.72 0.44 0.51 0.70
Capital work-in-progress 0.13 0.39 7.39 0.28 0.66
Long-term loans & advances 0.33 0.22 0.52 3.20 3.65
Total non-current assets 9.47 9.88 23.85 24.26 28.31
Current assets
Inventories 14.20 13.19 25.51 40.61 32.25
Receivables 0.16 0.09 0.53 0.32 –
Prepayments, advances, & other receivables 22.33 17.65 6.21 10.69 20.33
Short-term investments 35.15 40.67 7.10 – –
Cash and bank balances 18.69 18.52 36.80 24.12 19.11
Total current assets 90.53 90.12 76.15 75.74 71.69
Total assets 100.00 100.00 100.00 100.00 100.00
Equity
Issued, subscribed & paid-up capital 2.43 2.77 8.81 10.25 11.59
Retained earnings 16.50 10.69 18.24 3.78 0.62
Other reserves 10.10 11.91 21.95 22.74 7.20
Total equity 29.03 25.37 49.00 36.77 19.41
Non-current liabilities
Pensions liabilities 0.16 0.12 0.51 0.38 0.36
Deferred tax 0.74 0.71 0.83 – –
Deferred revenue 0.02 0.02 0.06 0.08 0.10
Total non-current liabilities 0.92 0.85 1.40 0.46 0.46
Current liabilities
Trade, dividend & other payables 70.04 73.15 49.60 62.73 80.02
Current portion of deferred revenue 0.01 0.01 0.04 0.03 –
Income tax – 0.62 – 0.01 0.11
Total current liabilities 70.05 73.78 49.60 62.77 80.13
Total equity & liabilities 100.00 100.00 100.00 100.00 100.00

Required:
As the Financial Advisor to ABC Mutual Funds, report on the financial health or otherwise of Towobo Ltd based on the vertically analysed financial statements and advise ABC Mutual Funds on whether to invest in Towobo Ltd. Your report should focus on the profitability and cost control analysis, asset structure, capital structure, and working capital structure.

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  • 6 Marks

AT – Nov 2020 – L3 – Q4b – Business income – Corporate income tax

Evaluate the tax implications of financing a vehicle through a finance lease arrangement versus an outright purchase for a mining company.

A mining company in Ghana intends to buy a vehicle (Pajero) for official use under a finance lease arrangement or an outright purchase. The cost profile of the vehicle is as follows:

i) Outright Purchase: Cost at GH¢80,000.

ii) Finance Lease Arrangement: Cost inclusive of interest is GH¢105,000, to be paid over three years. The interest component is GH¢30,000 to be spread over the three years.

Required:
Determine which of the options you would advise to be adopted.

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  • 6 Marks

AT – Nov 2019 – L3 – Q2d – Business income – Corporate income tax

Advise on which company, Tiika or Taaka, a Ghanaian investor should invest in, considering tax benefits and future growth potential.

The following is the extract of financial statements – Financial position as at 31 December 2018 of the following companies:

Item Tiika (GH¢) Taaka (GH¢)
Stated Capital 1,000,000 1,000,000
Retained Earnings 600,000 600,000
Share Deals 30,000 30,000
Total Equity 1,630,000 1,630,000

Tiika is a Free Zone company, resident in Ghana. Taaka is also a company resident in Ghana, and both companies are engaged in the sale of tiles.

A Ghanaian who was living in the United States for a very long time has relocated to Ghana and has sought your opinion as a student of taxation to advise on the company to buy shares in. Your background checks indicate that the two companies have huge prospects.

Required:

Which of the companies will you advise this Ghanaian to invest in and why?

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  • 12 Marks

MA – May 2019 – L2 – Q1b – Divisional Performance

Evaluate divisional performance using ROI and RI and assess the impact of investment decisions on these metrics.

Ayittey Ltd is an organization with two divisions: A and B, each with its own cost and revenue streams. Each of the two divisions is classified as an Investment center. The company’s cost of capital is 12%. Historically, investment decisions have been made by calculating the return on investment (ROI). A new manager who has recently been appointed in Division A has argued that using residual income (RI) to make investment decisions would result in ‘better goal congruence’ throughout the company. The data below shows the current position of the division as at the end of 31 December, 2016:

Details of Projects Project A Project B
Capital required GH¢ 82.8 million GH¢ 40.6 million
Sales generated GH¢ 44.6 million GH¢ 21.8 million
Net Profit margin 28% 33%

The company is seeking to maximize shareholders’ wealth. Assuming that Division A acquires a more efficient asset at GH¢15 million and Division B sold one of its assets with a written down value of GH¢24 million, and profits are expected to increase and decrease by GH¢11 million and GH¢5 million for Division A and B respectively.

Required:
i) Calculate both the current Return on Investment (ROI) and Residual Income (RI) for each of the divisions. (5 marks)
ii) Calculate and comment on the effect of the decision to invest in the new asset and disposal of some assets on the current ROI and RI. (7 marks)

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  • 15 Marks

FM – May 2021 – L2 – Q4a – Introduction to investment appraisal

Evaluate the financial viability of an investment using NPV, IRR, and explain the concept of sensitivity analysis.

CVD Ghana Ltd, which is into the production and sale of COVID-19 vaccine in Ghana and abroad, plans to buy a new machine to expand the scope of its operations due to increased demand in both the local and the international markets.

The cost of the machine is GH¢24,000,000 and has a useful life of five years. The machine will require additional investment in working capital of GH¢2,700,000 at the beginning of the first year of operations. At the end of year five, the machine will be sold for scrap, with the scrap value expected to be 5% of the machine’s initial purchase cost. The company has no intention to replace the machine. Production and sales from the new machine are expected to be 1,000,000 packs per year.

The selling price per pack and variable cost per pack are as follows:

Year Selling Price per Pack (GH¢) Variable Cost per Pack (GH¢)
1 48 33
2 48 33
3 55 38
4 55 38
5 60 42

It is also estimated that incremental fixed costs arising from the machine’s operations will be GH¢4,800,000 per year. CVD Ghana Ltd has an after-tax cost of capital of 20%, which it uses as a discount rate in its investment appraisal. The company pays corporate tax at an annual rate of 25% per year. Capital allowance should be ignored.

Required:

i) Compute the Net Present Value of this project and advise CVD Ghana Ltd whether the investment is financially viable. (8 marks)

ii) Calculate the Internal Rate of Return of investing in the machine and advise whether it is financially viable. (5 marks)

iii) Explain the meaning of the term “sensitivity analysis” in the context of investment. (2 marks)

 

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  • 20 Marks

FM – DEC 2023 – L2 – Q4 – Capital rationing | Introduction to Investment Appraisal | Sources of finance: debt

Explanation of capital rationing concepts, NPV and profitability index calculations, and factors influencing debt finance decisions.

a) In periods of difficult global financial environment, raising of capital is a challenge necessitating the need for prudent and best use of scarce capital for projects.

Required:
i) Explain the term capital rationing. (2 marks)
ii) Distinguish between soft capital rationing and hard capital rationing giving an example each. (3 marks)

b) Akonta Ghana Ltd has excess funds of GH¢200 million and is looking for attractive investment opportunities that will yield a return of 15% per annum or better to deploy the funds. An extract from a Feasibility report submitted by a team of investment and project experts is as follows:

Project Initial Investment Required (GH¢) Constant Annual Cash Inflow (GH¢) Project Life (Years)
A 80,000,000 36,000,000 4
B 40,000,000 23,000,000 3
C 78,000,000 30,000,000 5
D 40,000,000 20,000,000 4
E 40,000,000 22,000,000 3

The cash flows per project are constant for the life span of each project and each project is divisible for the purpose of capital allocation.

Required:
i) Calculate the Net Present Values (NPVs) of each project. (7 marks)
ii) Rank the projects using Profitability Index and allocate the GH¢200 million among the projects. (3 marks)

c) There are many sources of debt finance available to a company which has viable and profitable investment opportunities to utilise the funds. It is, however, very important for the Finance Manager to do a thorough work before deciding the type and source of debt finance to tap into.

Required:
Explain THREE (3) factors a Finance Manager should consider when deciding the type of debt finance to raise. (5 marks)

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