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FM – May 2017 – L3 – Q2 – Financing Decisions and Capital Markets

Calculate gearing ratio, rights issue impacts, and shareholder implications.

LL Plc. is a large engineering company. Its ordinary shares are quoted on the Stock Exchange.

LL Plc.’s Board is concerned that the company’s gearing level is too high and that this is having a detrimental impact on its market capitalisation. As a result, the Board is considering a restructuring of LL Plc.’s long-term funds, details of which are shown here as at 28 February, 2017:

Funding Source Total Par Value (₦m) Market Value
Ordinary Share Capital (50k) 67.5 ₦2.65/share ex-div
7% Preference Share Capital (₦1) 60.0 ₦1.44/share ex-div
4% Redeemable Debentures (₦100) 45.0 90% ex-int

The debentures are redeemable in 2022. LL Plc.’s earnings for the year to 28 February, 2017 were ₦32.4 million and are expected to remain at this level for the foreseeable future. Retained earnings, as at 28 February, 2017 were ₦73.2 million.

The Board is considering a 1 for 9 rights issue of ordinary shares, and this additional funding would be used to redeem 60% of LL Plc.’s redeemable debentures at par. However, some of LL Plc.’s directors are concerned that this issue of extra ordinary shares will cause the company’s ordinary share price and its earnings per share (EPS) to fall by an excessive amount, to the detriment of LL Plc.’s shareholders. Accordingly, they are arguing that the rights issue should be designed so that the EPS is not diluted by more than 5%.

The Directors wish to assume that the income tax rate will be 21% for the foreseeable future and the tax will be payable in the same year as the cash flows to which it relates.

Required:
a. i. Calculate LL Plc.’s gearing ratio using both book and market values. (5 Marks)

ii. Discuss, with reference to relevant theories, why LL Plc.’s Board might have concerns over the level of gearing and its impact on LL Plc.’s market capitalisation. (6 Marks)

b. Assuming that a 1 for 9 rights issue goes ahead, calculate the theoretical ex-rights price of LL Plc.’s ordinary share and the value of a right. (3 Marks)

c. Discuss the Directors’ view that the rights issue will cause the share price and the EPS to fall by an excessive amount, to the detriment of LL Plc.’s ordinary shareholders. Your discussion should be supported by relevant calculations. (6 Marks)

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AFM – May 2018 – L3 – Q5a – Dividend policy in multinationals and transfer pricing

Discussing why share prices plunge when multinational companies suspend paying dividends and outlining theories of dividend policy.

Recently, some multinational companies have suspended paying dividends. If, as some say, dividends are irrelevant, why have share prices plunged in most of these companies?

Required:
In your answer, outline both dividend policy theory and relevant examples.

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AFM – May 2018 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluating the favourability of a takeover and its impact on EPS and share price.

Okumkom Ltd has a current price of GH¢2.20 per share and a price/earnings ratio of 15. At present, it has 10 million, GH¢1.00 ordinary shares issued. Okumkom Ltd is considering the takeover of Dasco Ltd. The current price of each of Dasco’s 4 million issued shares is 330 pesewas. Dasco’s price/earnings ratio is 10. Okumkom Ltd expects to be able to purchase the shares at their current price and will pay for them with an issue of its own shares valued at their current price.

Okumkom Ltd wishes to know how many shares to offer for each of Dasco Ltd’s shares, and the effect of the takeover on Okumkom Ltd’s reported earnings per share and share price.

Required:
Evaluate the favourability of this takeover and comment on your computations. (12 marks)

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AFM – May 2018 – L3 – Q1d – Theories of capital structure

Determining the required rate of return for Lime Spider Ltd’s shares using CAPM.

The market is currently yielding a return of 16% while Treasury bills are yielding 10%. Shares of Lime Spider Ltd have a covariance of 7.5 with the market, while the market has a variance of 4.5.

Required:
Determine the required rate of return for Lime Spider Ltd’s shares

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AFM – May 2018 – L3 – Q1b – Sources of finance and cost of capital

Calculating the share price at which public and rights issues should be made and the share price expected after the rights issue.

Mbo Ltd needs to raise GH¢500,000 to finance a large-scale project which would produce earnings of GH¢90,000 in perpetuity but is undecided as to the manner in which the money should be raised.

The company has an issued capital of 2 million equity shares of GH¢1 each with a current market price of GH¢1.38 cum div. The annual dividend (which has been constant for many years) of GH¢360,000 is about to be paid.

Two methods of raising capital are being considered, a public issue, and a right issue at GH¢1.

Required:
i) Calculate the price at which the public issue should be made. (5 marks)
ii) Calculate the price at which you would expect shares to be valued immediately after the rights issue. (5 marks)

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FM – May 2017 – L3 – Q2 – Financing Decisions and Capital Markets

Calculate gearing ratio, rights issue impacts, and shareholder implications.

LL Plc. is a large engineering company. Its ordinary shares are quoted on the Stock Exchange.

LL Plc.’s Board is concerned that the company’s gearing level is too high and that this is having a detrimental impact on its market capitalisation. As a result, the Board is considering a restructuring of LL Plc.’s long-term funds, details of which are shown here as at 28 February, 2017:

Funding Source Total Par Value (₦m) Market Value
Ordinary Share Capital (50k) 67.5 ₦2.65/share ex-div
7% Preference Share Capital (₦1) 60.0 ₦1.44/share ex-div
4% Redeemable Debentures (₦100) 45.0 90% ex-int

The debentures are redeemable in 2022. LL Plc.’s earnings for the year to 28 February, 2017 were ₦32.4 million and are expected to remain at this level for the foreseeable future. Retained earnings, as at 28 February, 2017 were ₦73.2 million.

The Board is considering a 1 for 9 rights issue of ordinary shares, and this additional funding would be used to redeem 60% of LL Plc.’s redeemable debentures at par. However, some of LL Plc.’s directors are concerned that this issue of extra ordinary shares will cause the company’s ordinary share price and its earnings per share (EPS) to fall by an excessive amount, to the detriment of LL Plc.’s shareholders. Accordingly, they are arguing that the rights issue should be designed so that the EPS is not diluted by more than 5%.

The Directors wish to assume that the income tax rate will be 21% for the foreseeable future and the tax will be payable in the same year as the cash flows to which it relates.

Required:
a. i. Calculate LL Plc.’s gearing ratio using both book and market values. (5 Marks)

ii. Discuss, with reference to relevant theories, why LL Plc.’s Board might have concerns over the level of gearing and its impact on LL Plc.’s market capitalisation. (6 Marks)

b. Assuming that a 1 for 9 rights issue goes ahead, calculate the theoretical ex-rights price of LL Plc.’s ordinary share and the value of a right. (3 Marks)

c. Discuss the Directors’ view that the rights issue will cause the share price and the EPS to fall by an excessive amount, to the detriment of LL Plc.’s ordinary shareholders. Your discussion should be supported by relevant calculations. (6 Marks)

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AFM – May 2018 – L3 – Q5a – Dividend policy in multinationals and transfer pricing

Discussing why share prices plunge when multinational companies suspend paying dividends and outlining theories of dividend policy.

Recently, some multinational companies have suspended paying dividends. If, as some say, dividends are irrelevant, why have share prices plunged in most of these companies?

Required:
In your answer, outline both dividend policy theory and relevant examples.

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You're reporting an error for "AFM – May 2018 – L3 – Q5a – Dividend policy in multinationals and transfer pricing"

AFM – May 2018 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluating the favourability of a takeover and its impact on EPS and share price.

Okumkom Ltd has a current price of GH¢2.20 per share and a price/earnings ratio of 15. At present, it has 10 million, GH¢1.00 ordinary shares issued. Okumkom Ltd is considering the takeover of Dasco Ltd. The current price of each of Dasco’s 4 million issued shares is 330 pesewas. Dasco’s price/earnings ratio is 10. Okumkom Ltd expects to be able to purchase the shares at their current price and will pay for them with an issue of its own shares valued at their current price.

Okumkom Ltd wishes to know how many shares to offer for each of Dasco Ltd’s shares, and the effect of the takeover on Okumkom Ltd’s reported earnings per share and share price.

Required:
Evaluate the favourability of this takeover and comment on your computations. (12 marks)

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AFM – May 2018 – L3 – Q1d – Theories of capital structure

Determining the required rate of return for Lime Spider Ltd’s shares using CAPM.

The market is currently yielding a return of 16% while Treasury bills are yielding 10%. Shares of Lime Spider Ltd have a covariance of 7.5 with the market, while the market has a variance of 4.5.

Required:
Determine the required rate of return for Lime Spider Ltd’s shares

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AFM – May 2018 – L3 – Q1b – Sources of finance and cost of capital

Calculating the share price at which public and rights issues should be made and the share price expected after the rights issue.

Mbo Ltd needs to raise GH¢500,000 to finance a large-scale project which would produce earnings of GH¢90,000 in perpetuity but is undecided as to the manner in which the money should be raised.

The company has an issued capital of 2 million equity shares of GH¢1 each with a current market price of GH¢1.38 cum div. The annual dividend (which has been constant for many years) of GH¢360,000 is about to be paid.

Two methods of raising capital are being considered, a public issue, and a right issue at GH¢1.

Required:
i) Calculate the price at which the public issue should be made. (5 marks)
ii) Calculate the price at which you would expect shares to be valued immediately after the rights issue. (5 marks)

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