Question Tag: Market capitalization

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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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  • 6 Marks

CR – Apr 2022 – L3 – Q2a – Impairment of assets, IAS 36

Discuss the significance of three factors affecting impairment testing under IAS 36, including market capitalization and allocation of goodwill.

An assessment of accounting practices for asset impairments is important in the context of financial reporting quality, especially during periods of economic uncertainty. The exercise of management judgment in impairment accounting is crucial. There are several factors that can influence the quality of impairment accounting and disclosures, including changes in circumstances, market capitalization, and the allocation of goodwill to cash-generating units.

Required:
Discuss the significance of the THREE (3) factors above when conducting an impairment test under IAS 36: Impairment of Assets.

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  • 14 Marks

FM – MAY 2019 – L2 – Q2a – Capital structure

Calculate the current market capitalization of M&E Ltd and the Weighted Average Cost of Capital (WACC) prior to financing a new project.

Question:
M&E Ltd, recognized as the leader in steel manufacturing, has received an invitation to supply steel for the construction of rail lines to connect the ECOWAS countries, starting from Nigeria. The contract will be for 10 years, and management is considering appraising the investment to enable them to present their proposals for the contract. The following information was extracted from the recently published accounts of M&E Ltd:

GH¢ ‘000
Equity Shares (1,000,000 shares) 70,000
15% Preference shares 50,000
10% (Bonds irredeemable) 30,000
Total 150,000

The Treasury unit of M&E Ltd has estimated that it will require GH¢ 10 million to finance the new project. The total amount would be raised through 10% Irredeemable bonds at the current market price. The cost of Preference shares and Bonds will not change, but equity shareholders will demand an increase of 20% on the current cost of equity.

M&E Ltd has a beta of 0.8, the market risk premium for the steel industry is 6.25%, and the Government of Ghana Bond rate is 20%. The current market price for Irredeemable Bonds of GH¢1,000 nominal value is GH¢850.

M&E Ltd’s dividend policy is to pay constant dividends, and this policy will not change in the foreseeable future. The recent dividend paid was GH¢20 per share. M&E Ltd is a Free Zones Company and therefore pays tax at a rate of 8%.

Required:

i) Calculate the current market capitalization of M&E Ltd. (5 marks)

ii) Calculate the Weighted Average Cost of Capital (WACC) prior to the consideration of the finance for the proposed project. (9 marks)

(Total: 14 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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  • 6 Marks

CR – Apr 2022 – L3 – Q2a – Impairment of assets, IAS 36

Discuss the significance of three factors affecting impairment testing under IAS 36, including market capitalization and allocation of goodwill.

An assessment of accounting practices for asset impairments is important in the context of financial reporting quality, especially during periods of economic uncertainty. The exercise of management judgment in impairment accounting is crucial. There are several factors that can influence the quality of impairment accounting and disclosures, including changes in circumstances, market capitalization, and the allocation of goodwill to cash-generating units.

Required:
Discuss the significance of the THREE (3) factors above when conducting an impairment test under IAS 36: Impairment of Assets.

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  • 14 Marks

FM – MAY 2019 – L2 – Q2a – Capital structure

Calculate the current market capitalization of M&E Ltd and the Weighted Average Cost of Capital (WACC) prior to financing a new project.

Question:
M&E Ltd, recognized as the leader in steel manufacturing, has received an invitation to supply steel for the construction of rail lines to connect the ECOWAS countries, starting from Nigeria. The contract will be for 10 years, and management is considering appraising the investment to enable them to present their proposals for the contract. The following information was extracted from the recently published accounts of M&E Ltd:

GH¢ ‘000
Equity Shares (1,000,000 shares) 70,000
15% Preference shares 50,000
10% (Bonds irredeemable) 30,000
Total 150,000

The Treasury unit of M&E Ltd has estimated that it will require GH¢ 10 million to finance the new project. The total amount would be raised through 10% Irredeemable bonds at the current market price. The cost of Preference shares and Bonds will not change, but equity shareholders will demand an increase of 20% on the current cost of equity.

M&E Ltd has a beta of 0.8, the market risk premium for the steel industry is 6.25%, and the Government of Ghana Bond rate is 20%. The current market price for Irredeemable Bonds of GH¢1,000 nominal value is GH¢850.

M&E Ltd’s dividend policy is to pay constant dividends, and this policy will not change in the foreseeable future. The recent dividend paid was GH¢20 per share. M&E Ltd is a Free Zones Company and therefore pays tax at a rate of 8%.

Required:

i) Calculate the current market capitalization of M&E Ltd. (5 marks)

ii) Calculate the Weighted Average Cost of Capital (WACC) prior to the consideration of the finance for the proposed project. (9 marks)

(Total: 14 marks)

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