Question Tag: Loan financing

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

You are the head of the treasury group of Top Flight Aviation (TFA), a Nigerian company. The company operates chartered international flights for the elites in the country.

It is now December 31, and TFA needs to borrow £60 million from a UK bank to finance a new air jet. The borrowing and the purchase will be in three months’ time, and the borrowing will be for a period of six months.

You have decided to hedge the relevant interest rate risk using interest rate futures. Your expectation is that interest rates will increase from 13% by 2% over the next three months.

In the month of March, the current price of Sterling 3-month futures is 87.25. The standard contract size is £500,000.

Required:

a. Set out calculations of the effect of using the futures market to hedge against movements in the interest rate if:
(i) Interest rates increase from 13% by 2% and the futures market price moves by 2%;
(ii) Interest rates increase from 13% by 2% and the futures market price moves by 1.75%;
(iii) Interest rates fall from 13% by 1.5% and the futures market price moves by 1.25%;

In each case, show the hedge efficiency. The time value of money, taxation, and margin requirements should be ignored.

b. Show, for the situations in (a) above, whether the total cost of the loan after hedging would have been lower with the futures hedge chosen by the treasurer or with an interest rate guarantee which the treasurer could have purchased at 13% for a premium of 0.25% of the size of the loan to be guaranteed.

The time value of money, taxation, and margin requirements should be ignored.

(Total: 15 Marks)

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FM – Nov 2022 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluating financing options (rights issue vs convertible loans) for Balama Plc's expansion.

Balama Plc. (Balama) is a listed manufacturer of dairy products. In recent years, the company has experienced only a modest level of growth, but following the recent retirement of the chief executive, his replacement is keen to expand Balama’s operations.

The board of directors has recently agreed to support a proposal by the new chief executive that the company purchase new manufacturing equipment to enable it to expand its range of dairy products. The new equipment will cost N50 million, and the company is seeking to raise new finance to fund the expenditure in full. However, the board of directors is undecided as to how the new finance is to be raised. The directors are considering either a 1 for 5 rights issue at a price of N2.50 per share with a theoretical ex-rights price of N2.92 or a convertible loan of N50 million.

The loan will be secured against the company’s freehold land and buildings. The company’s share is presently quoted at a price of N3.00 per share.

Required:

a. Explain the terms ‘rights issue’ and ‘convertible loans’. (3 Marks)

b. Explain how the ‘theoretical ex-rights’ price of N2.92 is calculated and why the actual price might be different. Show your workings. (4 Marks)

c. Prepare a report for the board of directors that fully evaluates the two potential methods of financing the company’s expansion plans. (13 Marks)

(Total 20 Marks)

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AT – Mar 2024 – L3 – Q3a – Business income – Corporate income tax

Discussing the tax implications of providing an asset to a company as capital or loan contribution.

Agogo Ghana Ltd is a manufacturing entity in Ghana. Mr. Konto, a citizen and resident of Malaysia, owns 80% of the company’s shares. Mrs. Konto, a citizen and resident of Malaysia and wife of Mr. Konto, also owns 15% of the shares of the company. Mr. Bawa, the son of Mr. Konto, holds the remaining 5% of the shares in the company. As of 1st June 2023, the company had a share capital of GH¢400,000. A report submitted by the management to the Board of Directors indicated that the company needs to acquire a plant valued at GH¢1,000,000 to enable the company to increase its production capacity. Mr. Konto, who is the majority shareholder, has offered to finance the purchase of the plant for the company but is unsure whether to provide the plant as a loan or as capital.

Required:
Advise Mr. Konto on the income tax treatment of providing the asset to the company as capital or loan contribution.

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AT – July 2023 – L3 – Q3a – Tax planning

Analyzing the tax implications of providing assets as equity or loan and determining the best option for tax purposes

Kinky Ltd is a manufacturing entity resident in Ghana. Mr. Andre Camil, a citizen and resident of France, owns 90% of the company’s shares. Mrs. Claude Camil, a citizen and resident of France and wife of Mr. Andre Camil, also owns 5% of the shares of the company. Mr. Francois Camil, the son of Mr. Andre Camil, holds the remaining 5% of the shares in the company.

As at 1 June, 2021, the company had a share capital of GH¢400,000. A report submitted by the management to the Board of Directors indicated that the company needs to acquire a plant valued at GH¢1,000,000 to enable the company to increase its production capacity. Mr. Andre Camil, the majority shareholder, has offered to finance the purchase of the plant for the company but his challenge is whether to provide the asset to the company as a loan or as equity.

Required:
Advise Mr. Andre Camil on:

  1. The income tax treatment of providing the asset to the company as equity contribution.
  2. The income tax treatment of providing the asset to the company as a loan.
  3. The preferable option for providing the asset to the company in order to derive the maximum tax benefits.

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

You are the head of the treasury group of Top Flight Aviation (TFA), a Nigerian company. The company operates chartered international flights for the elites in the country.

It is now December 31, and TFA needs to borrow £60 million from a UK bank to finance a new air jet. The borrowing and the purchase will be in three months’ time, and the borrowing will be for a period of six months.

You have decided to hedge the relevant interest rate risk using interest rate futures. Your expectation is that interest rates will increase from 13% by 2% over the next three months.

In the month of March, the current price of Sterling 3-month futures is 87.25. The standard contract size is £500,000.

Required:

a. Set out calculations of the effect of using the futures market to hedge against movements in the interest rate if:
(i) Interest rates increase from 13% by 2% and the futures market price moves by 2%;
(ii) Interest rates increase from 13% by 2% and the futures market price moves by 1.75%;
(iii) Interest rates fall from 13% by 1.5% and the futures market price moves by 1.25%;

In each case, show the hedge efficiency. The time value of money, taxation, and margin requirements should be ignored.

b. Show, for the situations in (a) above, whether the total cost of the loan after hedging would have been lower with the futures hedge chosen by the treasurer or with an interest rate guarantee which the treasurer could have purchased at 13% for a premium of 0.25% of the size of the loan to be guaranteed.

The time value of money, taxation, and margin requirements should be ignored.

(Total: 15 Marks)

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FM – Nov 2022 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluating financing options (rights issue vs convertible loans) for Balama Plc's expansion.

Balama Plc. (Balama) is a listed manufacturer of dairy products. In recent years, the company has experienced only a modest level of growth, but following the recent retirement of the chief executive, his replacement is keen to expand Balama’s operations.

The board of directors has recently agreed to support a proposal by the new chief executive that the company purchase new manufacturing equipment to enable it to expand its range of dairy products. The new equipment will cost N50 million, and the company is seeking to raise new finance to fund the expenditure in full. However, the board of directors is undecided as to how the new finance is to be raised. The directors are considering either a 1 for 5 rights issue at a price of N2.50 per share with a theoretical ex-rights price of N2.92 or a convertible loan of N50 million.

The loan will be secured against the company’s freehold land and buildings. The company’s share is presently quoted at a price of N3.00 per share.

Required:

a. Explain the terms ‘rights issue’ and ‘convertible loans’. (3 Marks)

b. Explain how the ‘theoretical ex-rights’ price of N2.92 is calculated and why the actual price might be different. Show your workings. (4 Marks)

c. Prepare a report for the board of directors that fully evaluates the two potential methods of financing the company’s expansion plans. (13 Marks)

(Total 20 Marks)

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AT – Mar 2024 – L3 – Q3a – Business income – Corporate income tax

Discussing the tax implications of providing an asset to a company as capital or loan contribution.

Agogo Ghana Ltd is a manufacturing entity in Ghana. Mr. Konto, a citizen and resident of Malaysia, owns 80% of the company’s shares. Mrs. Konto, a citizen and resident of Malaysia and wife of Mr. Konto, also owns 15% of the shares of the company. Mr. Bawa, the son of Mr. Konto, holds the remaining 5% of the shares in the company. As of 1st June 2023, the company had a share capital of GH¢400,000. A report submitted by the management to the Board of Directors indicated that the company needs to acquire a plant valued at GH¢1,000,000 to enable the company to increase its production capacity. Mr. Konto, who is the majority shareholder, has offered to finance the purchase of the plant for the company but is unsure whether to provide the plant as a loan or as capital.

Required:
Advise Mr. Konto on the income tax treatment of providing the asset to the company as capital or loan contribution.

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AT – July 2023 – L3 – Q3a – Tax planning

Analyzing the tax implications of providing assets as equity or loan and determining the best option for tax purposes

Kinky Ltd is a manufacturing entity resident in Ghana. Mr. Andre Camil, a citizen and resident of France, owns 90% of the company’s shares. Mrs. Claude Camil, a citizen and resident of France and wife of Mr. Andre Camil, also owns 5% of the shares of the company. Mr. Francois Camil, the son of Mr. Andre Camil, holds the remaining 5% of the shares in the company.

As at 1 June, 2021, the company had a share capital of GH¢400,000. A report submitted by the management to the Board of Directors indicated that the company needs to acquire a plant valued at GH¢1,000,000 to enable the company to increase its production capacity. Mr. Andre Camil, the majority shareholder, has offered to finance the purchase of the plant for the company but his challenge is whether to provide the asset to the company as a loan or as equity.

Required:
Advise Mr. Andre Camil on:

  1. The income tax treatment of providing the asset to the company as equity contribution.
  2. The income tax treatment of providing the asset to the company as a loan.
  3. The preferable option for providing the asset to the company in order to derive the maximum tax benefits.

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