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- 15 Marks
FM – Nov 2023 – L1 – SC – Q5 – Business Valuation Techniques
Calculate convertible bonds' value as debt, assess market expectations, and analyze conversion inducements and dividend policy effects on convertible bonds.
Question
Ope plc has N10m 5 percent convertible bonds in issue. The option to convert into 40 N1 ordinary shares is open only for one more year; they must be either converted in one year’s time or left as ordinary bonds until nine years’ time when they will be redeemed at par. The current share price is ₦1.60, and the annual growth rate in share price is 15 percent per annum. The current required return on Ope’s equity is 25 percent, as its business is relatively risky.
The current yield on ordinary non-convertible bonds in similar companies is 11 percent. These interest rates are expected to remain constant.
Ife plc has 100,000 warrants outstanding, each entitling the holder to subscribe for one N1 ordinary share at 90 kobo anytime during the next 3 years. The current share price is 57 kobo, and capital growth is expected to be constant at 12 percent per annum in the future. The current price of the warrant is 10 kobo.
Required:
a. Calculate the current value of Ope’s convertibles as straight debt, i.e., ignoring the option to convert, and the value if conversion were to take place today. Would you expect the market value of the convertible to be above or below each of these amounts, and why? (5 Marks)
b. By how much should the share price of Ope Plc rise before holders would be induced to convert on the last possible date for conversion? (4 Marks)
c. Explain why the market value of a convertible bond is likely to be affected by the dividend policy of the issuing company. (4 Marks)
d. Based on the projected capital growth for Ife Plc, would you expect holders of
the warrants to exercise them before expiry? What is the minimum annual
growth -rate of the share price necessary to induce holders to exercise their
warrants?
(2 Marks)
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- Tags: Convertible Bonds, Convertible Securities, Debt and Equity, Market Value, Valuation, Warrants
- Level: Level 3
- Topic: Business Valuation Techniques
- Series: NOV 2023
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- 30 Marks
FM – Nov 2023 – L1 – SA – Q1 – Mergers and Acquisitions
Evaluate Finkex Plc's acquisition strategy of Toba Plc, focusing on share-for-share impact, valuation methods, and shareholder implications.
Question
Finkex Plc (FP) is a listed company that operates in the pharmaceutical sector, manufacturing a broad range of drugs under license in a number of countries along the ECOWAS sub-region. For a number of years, the company has grown organically.
Three years ago, the company acquired 20% of the issued share capital of Toba Plc (TP) for N110 million, as a route to both expansion and diversification. The acquisition was by private negotiation in exchange for an issue of its own shares.
Toba Plc is involved in a different area of the pharmaceutical sector from FP as it is primarily a research-driven company involved in the development of new drugs.
To expedite the realization of its diversification strategy, the directors of FP have now decided to acquire the remaining 80% of Toba’s share capital.
Extracts from the financial statements of Finkex Plc are given below:
Finkex Plc – Extracts from financial statements for the last two years
| Year | 2023 | 2022 |
|---|---|---|
| N’m | N’m | |
| Non-current assets (including investment in Toba plc) | 602.8 | 499.4 |
| Current assets | 265.0 | 180.4 |
| Total Assets | 867.8 | 679.8 |
| Current liabilities | 199.2 | 136.8 |
| Total assets less current liabilities | 668.6 | 543.0 |
| Non-current liabilities | 149.5 | 159.4 |
| Net assets | 519.1 | 383.6 |
| Issued share capital (ordinary shares of ₦1 each) | 100.0 | 73.6 |
| Share premium | 84.0 | 12.4 |
| Profit or loss account | 335.1 | 297.6 |
| Total Equity | 519.1 | 383.6 |
| Sales revenue | 1320.6 | 496.0 |
| Earnings after tax | 51.50 | 37.60 |
| Dividend | 14.0 | 14.0 |
| Retained profits | 37.5 | 23.6 |
All that is known about Toba Plc is that it has 114 million shares in issue; total share capital and reserves are N684 million; earnings after tax in the most recent year were ₦85.2 million on sales of N1,252.0 million, which were double those of the previous year; and that it has an investment valued at N80 million (book and market) in a type of enterprise which might not be of interest to Finkex Plc.
The current stock market prices per share are: Finkex Plc 300k; Toba plc 341k. Both companies pay tax at 50%.
Required:
a. At the above market prices, how many shares of Finkex Plc would have to be issued to buy the rest of Toba Plc on a share-for-share offer? (4 Marks)
b. With regard to earnings and also the book value of assets per share, how would the above share-for-share offer affect the position of:
i. Existing shareholders in Finkex Plc; (6 Marks)
ii. The 80% shareholders in Toba Plc whose shares were to be acquired? (4 Marks)
c. Assuming that the 80% shareholders in Toba Plc were prepared to accept ₦80 million 10% Loan Stock as part of the consideration:
i. What advantages might there be for Finkex Plc in this arrangement? (2 Marks)
ii. What total price could Finkex Plc afford to pay without diluting the earnings per share of its existing shareholders, as calculated in (b) (i) above? (6 Marks)
d. If the board of Toba Plc decided to advise its shareholders not to accept an offer from Finkex Plc, what arguments might they use – including any derived from the financial information available about Finkex Plc?
(8 Marks)
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- 20 Marks
CR – Nov 2018 – L3 – SB – Q3 – Business Combinations (IFRS 3)
Evaluation of Abana and Doha as potential acquisition targets using adjusted financial ratios.
Question
Banny Plc. (Banny) is a diversified company that has achieved its present size through vertical and horizontal acquisition. The directors have identified two potential target entities for acquisition. The first is Abana Limited (Abana), which operates a cement business near Offa, Kwara State. The second is Doha Limited (Doha), also in the cement industry, located near Oturukpo, Benue State. Banny has obtained copies of their audited financial statements, along with additional information notes.
Statement of Profit or Loss for the Year Ended December 31, 2017
| Item | Abana (₦’m) | Doha (₦’m) |
|---|---|---|
| Revenue | 136,000 | 132,000 |
| Cost of sales | (84,000) | (91,900) |
| Gross profit | 52,000 | 40,100 |
| Other operating expenses | (36,000) | (28,000) |
| Profit from operations | 16,000 | 12,100 |
| Finance costs | (6,000) | (8,000) |
| Profit before tax | 10,000 | 4,100 |
| Income tax expense | (3,000) | (2,000) |
| Net profit for the period | 7,000 | 2,100 |
Statement of changes in equity for the year ended December 31, 2017
Statement of financial position as at December 31, 2017
Additional Notes:
- Doha revalued its non-current assets for the first time following IFRS adoption on January 1, 2017. Abana maintains its non-current assets at historical cost.
- Banny uses the following ratios to evaluate acquisition targets: Return on Capital Employed (ROCE), Gross Profit Margin, Turnover on Capital Employed, and Leverage.
Required:
a. Compute adjustments for the revaluation of property, plant, and equipment, making Abana and Doha comparable for analysis. (14 Marks)
b. Calculate the four ratios (ROCE, Gross Profit Margin, Turnover on Capital Employed, and Leverage) after adjustments. (4 Marks)
c. Advise Banny on the better acquisition target based on adjusted ratios. (2 Marks)
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- 15 Marks
FM – Nov 2022 – L3 – Q5 – Business Valuation Techniques
Calculate the equity value of APL using SVA and outline three methods for funding the MBO.
Question
Aderupoko Plc (ADP), a large listed media group, has been the holding company of Adamu Publishers Limited (APL) since 2015. The publishing company (APL) is 100% owned by ADP since inception.
Recently, the directors of APL informed ADP’s board of their readiness to make a management buy-out (MBO) of APL. Accordingly, ADP’s board decided to value APL using the shareholder value analysis method (SVA). ADP’s board estimates that APL has a four-year competitive advantage over its competitors (to 30 September 2024) and the following data regarding APL’s value drivers and additional financial information has been collected:
| Year to 30 September | 2021 | 2022 | 2023 | 2024 | 2025+ |
|---|---|---|---|---|---|
| Sales growth (%) | 5% | 4% | 3% | 2% | 0% |
| Operating profit margin | 8% | 9% | 10% | 10% | 10% |
| Incremental non-current asset investment (% of sales increase) | 5% | 6% | 3% | 2% | 0% |
| Incremental working capital investment (% of sales increase) | 6% | 5% | 4% | 4% | 0% |
Financial Information:
- Sales for the current year to 30 September 2020: ₦80 million
- Annual depreciation (equal to annual replacement of non-current asset expenditure): ₦2.0 million
- Par value of 6% debentures in issue (current market value ₦95.00, nominal value ₦100): ₦10.0 million
- Short-term investments held: ₦0.8 million
- Company tax rate: 20%
- Current WACC: 10%
Required:
a. Calculate the value of APL’s equity using SVA.
(12 Marks)
b. Outline three methods by which APL’s directors might raise the funds necessary for the proposed MBO of the company. (3 Marks)
(Total 15 Marks)
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- Tags: Competitive Advantage, Equity, Funding Methods, MBO, SVA, Valuation
- Level: Level 3
- Topic: Business Valuation Techniques
- Series: NOV 2022
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- 20 Marks
FM – Nov 2017 – L3 – Q2 – Mergers and Acquisitions
Calculate Raymond Plc.'s valuation, analyze Harold Limited's acquisition value, and assess the offer price from shareholders' perspectives.
Question
Raymond Plc. is a successful IT services company incorporated 10 years ago. It was listed on the Stock Exchange 3 years ago. The company has a broad customer base mainly consisting of small and medium-sized companies. Raymond Plc. has achieved rapid growth in recent years by obtaining regular business from satisfied customers and also by acquiring other IT services companies.
The Directors of Raymond Plc. have identified Harold Limited, an unlisted company, as a possible acquisition target. Harold Limited has a number of large multinational clients, and, in general, its clients tend to be larger than those of Raymond Plc. If successful, the acquisition would go ahead on January 1, 2018.
Forecast financial data for Raymond Plc. and Harold Limited as of December 31, 2017, are summarized below:
| Financial Item | Raymond Plc. | Harold Limited |
|---|---|---|
| Share capital (Ordinary ₦1 shares) | ₦150m | ₦40m |
| Market share price | ₦4.90 | N/A |
N/A: Not applicable (not listed).
Additional information:
- If Harold Limited were to remain an independent company, its Directors estimate that reported Profit After Tax would be ₦15 million for 2018 and then grow by 2% yearly in perpetuity;
- If the acquisition were to go ahead, Raymond Plc.’s Directors estimate that Harold Limited’s profit after tax would be 5% higher for 2018 than if the company remains an independent company, and that profit after tax would then grow by 3% yearly in perpetuity;
- The average ungeared Cost of Equity for the industry is 8%;
- Both Raymond Plc. and Harold Limited are wholly equity financed; and
- Profit after tax can be assumed to be a good approximation of free cash flow attributable to investors.
The Directors of Raymond Plc. are considering offering to purchase Harold Limited at a price of ₦7.00 per share. It is estimated that transaction costs of ₦8 million would be payable on the acquisition and that ₦2 million would be required in the first year to cover the costs of integrating the two companies.
Required:
- (a) Calculate:
- i. The value of Raymond Plc. as at December 31, 2017.
- ii. The value of Harold Limited as at December 31, 2017 before taking the possible acquisition of the company by Raymond Plc. into account.
- iii. The overall increase in value created by the acquisition of Harold Limited by Raymond Plc. (8 Marks)
- (b)
- i. Explain how value might be created by the proposed acquisition. (2 Marks)
- ii. Comment on the difficulties which Raymond Plc. is likely to face in realizing the potential added-value, after the acquisition. (2 Marks)
- (c) Evaluate the proposed offer price of ₦7.00 per share for Harold Limited from the point of view of:
- i. Harold Limited’s shareholders.
- ii. Raymond Plc.’s shareholders. (8 Marks)
(Total 20 Marks)
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- 15 Marks
AA – May 2017 – L2 – SC – Q5 – Internal Control Systems
Examination of internal control meaning, examples, and sources of audit evidence for completeness, ownership, and valuation.
Question
You are the Auditor of Bistro Bottling Limited (BBL), a major manufacturer and distributor of fruit juice drinks based in Lagos. A review of the previous year’s audit working papers revealed some weaknesses in internal controls with regard to safeguarding the company’s non-current assets.
The company uses a combination of both owned and leased motor vehicles for operational activities, including deliveries to customers. It has recently sold some old vehicles and bought new ones in a bid to lower motor vehicle running expenses.
During the planning of the audit, you have decided that motor vehicles will be a key area because of the likelihood of weaknesses in the company’s system of internal control over non-current assets.
You are required to:
- (a) Explain with suitable illustration the meaning of Internal Control. (4 Marks)
- (b) List FIVE examples of internal controls. (5 Marks)
- (c) Identify TWO sources of audit evidence you will obtain for each of the following: completeness, ownership, and valuation, to provide reasonable assurance with regard to the company’s assets and liabilities. (6 Marks)
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- Tags: Audit evidence, Completeness, Dividend valuation, Internal Control, Non-current Assets, Ownership, Valuation
- Level: Level 2
- Topic: Internal Control Systems
- Series: MAY 2017
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- 10 Marks
FR – Nov 2015 – L2 – Q7b – Fair Value Measurement (IFRS 13)
Explaining accounting treatment for investment property and calculating values for the financial statements.
Question
KOLA NITDA Nigeria Plc is a company engaged in the manufacturing of hand sanitizer to prevent Ebola disease. The following information relates to property owned by the company:
| N’000 |
|---|
| Land – Plot 404 Apapa Industrial Area |
| Building therein (acquired June 30, 2013) |
| Improvement to the building to extend rented floor capacity |
| Repairs and maintenance to investment property for the year |
| Rental received for the year |
Approximately six percent of the property floor space is used as the administrative head office of the company. The property can be sold only as a complete unit. The remainder of the building is leased out under operating leases. The company provides lessees with security services.
The company values investment property using the fair value model on December 31, 2014, which is the company’s year-end. Tewogbade & Co. (an independent valuer) valued the property at N144,000,000 on that date.
Required:
i. Advise the Directors of KOLA NITDA Nigeria Plc on how the property should be treated in the financial statements of the company as at December 31, 2014 in order to ensure strict compliance with provisions of IAS 40. (5 Marks)
ii. Calculate the value of investment property that should be disclosed in the statement of financial position as at December 31, 2014 and the amount that should be charged to the statement of profit or loss and other comprehensive income for the period then ended. (5 Marks)
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- Tags: Fair Value, IAS 40, Investment Property, Property Accounting, Revaluation Model, Valuation
- Level: Level 2
- Topic: Fair Value Measurement (IFRS 13)
- Series: NOV 2015
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- 1 Marks
FA – Nov 2012 – L1 – SA – Q6 – Financial Statements Preparation
Identifying the price for returnable containers after allowing for wear and tear.
Question
Returnable containers are charged out to the customers’ accounts when containers are sent to them. The amount placed on each container for financial statement purposes after allowing for wear and tear is …… price.
A. Charge-out
B. Return
C. Cost
D. Valuation
E. Replacement
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- Tags: Containers, Valuation, Wear and Tear
- Level: Level 1
- Topic: Financial Statements Preparation
- Series: NOV 2012
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- 20 Marks
AA – Nov 2018 – L2 – Q3a, b & c – Audit and Assurance Risk Environment
Identifies audit risks at International Training Center and outlines appropriate auditor responses.
Question
International Training Center (ITC) is a large company limited by shares that operates a network of teaching centers in countries across West Africa. The Company was incorporated under the requirements of the Companies Act, 1963 (Act 179), on 19 January 1990 and domiciled in Ghana. Students who register with the Center pay 30% during initial registration and the remaining 70% over the course period. You are the senior Associate of Add Consult. ITC is a new client, and you are currently planning the audit with the audit manager to audit the company for the year ended 31 December 2017.
You have been provided with the following planning notes from the audit partner following his meeting with the Finance Director.
- ITC purchases stationery from a supplier in China, and these goods are shipped to the company’s central warehouse. The goods are usually in transit for a fortnight, and the company correctly records the goods when received. ITC does not undertake a year-end inventory count but carries out monthly continuous (perpetual) inventory counts, and any errors identified are adjusted in the inventory system for that month.
- During the year, the directors of the Company have each been paid a significant bonus, and they have included this in wages and salaries expenses. Separate disclosure of the bonus is required by the Companies Act.
- ITC has a policy of revaluing its land and buildings, and this year has updated the valuations of all land and buildings.
- During the year, the company introduced a bonus-based scheme on sales for its salespersons. The bonus target was based on increasing the number of students signing up for 6-month courses by the school for individuals running accountancy examinations. This has been successful, and revenue has increased by 25%, especially in the last few months of the year. The level of receivables is considerably higher than last year, and there are concerns about the creditworthiness of some students.
Required:
a. Describe FIVE (5) audit risks, and explain the auditor’s response to each risk, in planning the audit of International Training Center. (10 marks)
b. Identify FIVE (5) audit procedures Add Consult should perform in order to place reliance on the continuous (perpetual) counts for year-end inventory. (5 marks)
c. Describe substantive procedures Add Consult should perform to confirm the directors’ bonus payments included in the financial statements. (5 marks)
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- Tags: Audit risks, Directors' Bonus, Inventory, Revenue Recognition, Valuation
- Level: Level 2
- Topic: Audit and Assurance Risk Environment
- Series: NOV 2018
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- 16 Marks
AFM – May 2017 – L3 – Q3a & b – Valuation of acquisitions and mergers
Calculating the maximum and minimum prices for Jacobs Ltd's acquisition of Idowu Co Ltd based on future revenue and cost synergies.
Question
Jacobs Limited and Idowu Company Limited both manufacture and sell auto parts. The summarised profit and loss accounts of the two companies for 2014 are as follows:
| Jacobs Ltd (GH¢’000) | Idowu Co Ltd (GH¢’000) | |
|---|---|---|
| Sale Revenue | 1,500 | 800 |
| Operating Expenses | (800) | (620) |
| Profit | 700 | 180 |
Each company has earned a constant level of profit for a number of years, and both are expected to continue to do so. The policy of both companies is to distribute all profits as dividends to ordinary shareholders as they are earned. Neither company has any fixed interest capital. Details of the ordinary share capital of the two companies are as follows:
| Jacobs Ltd (GH¢’000) | Idowu Co Ltd (GH¢’000) | |
|---|---|---|
| Authorised Ordinary Shares | 2,500 | 2,000 |
| Issued Ordinary Shares | 2,000 | 1,000 |
| Market Value per Share (Ex Div) | 3.50 | 1.50 |
The directors of Jacobs Limited are considering submitting a bid for the entire share capital of Idowu Co Limited. They believe that, if the bid succeeds, the combined sales revenue of the two companies will increase by GH¢60,000 per annum, and savings in operating expenses, amounting to GH¢50,000 per annum, will be possible. Part of the machinery at present owned by Idowu Co Limited would no longer be required and could be sold for GH¢100,000. Furthermore, the directors of Jacobs Limited believe that the takeover would result in a reduction to 9% in the annual return required by the ordinary shareholders of Idowu Co Limited.
Required:
i) On the basis of the above information, calculate the maximum price that Jacobs Ltd should be willing to pay for the entire share capital of Idowu Co Limited. (6 marks)
ii) Calculate the minimum price that the ordinary shareholders in Idowu Co Ltd should be willing to accept for their shares. (4 marks)
Assume that the takeover price is agreed at the figure calculated in part (ii) above, and that the purchase consideration will be settled by an exchange of ordinary shares in Idowu Co Ltd for the ordinary shares of Jacobs Ltd. Show how the entire benefit from the takeover will accrue to all the present shareholders of Jacobs Ltd. (6 marks)
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- Tags: Investment, Mergers and Acquisitions, Shareholders, Synergies, Valuation
- Level: Level 3
- Topic: Valuation of acquisitions and mergers
- Series: MAY 2017
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- 14 Marks
AFM – Nov 2016 – L3 – Q1b – Business reorganisation | Valuation of acquisitions and mergers
Calculate and analyze the effects of a proposed spin-off on shareholder wealth and discuss reasons and disadvantages of a spin-off.
Question
Last Chance Limited operates various manufacturing and retail operations throughout Ghana and has 400 million GH¢0.25 ordinary shares in issue. For the year that has just ended, the directors reported total after-tax profits of GH¢300 million and the P/E ratio of the company is 11.4 times.
The company has developed sophisticated computer software over the years and now considers ‘spinning-off’ its subsidiary, Ananse Systems Limited. Ananse Systems Limited has contributed GH¢40 million of the total after-tax profits of Last Chance Limited. After the spin-off, Last Chance Limited’s P/E ratio is expected to reduce to 11.0 times, while Ananse Systems Limited is expected to attract a P/E ratio of either 17 or 18 times.
Required:
i) Suggest THREE reasons why Last Chance Limited may wish to ‘spin-off’ part of its operations. (3 marks)
ii) Discuss THREE possible disadvantages of a ‘spin-off’ for the shareholders of Last Chance Limited. (3 marks)
iii) Calculate the likely effect of the proposed ‘spin-off’ on the wealth of a shareholder holding 10,000 ordinary shares in Last Chance, assuming that Ananse Systems Limited trades at a P/E ratio of 17 times and 18 times. (8 marks)
(Ignore taxation)
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- Tags: Corporate finance, P/E Ratio, Shareholder Wealth, Spin-off, Stock Market, Valuation
- Level: Level 3
- Topic: Business reorganisation, Valuation of acquisitions and mergers
- Series: NOV 2016
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- 15 Marks
AFM – May 2019 – L3 – Q3a – Valuation of acquisitions and mergers
Use comparative analysis to value Alpha Ltd based on data from Beta Ltd and Gamma Ltd, and discuss factors for private company valuation.
Question
At a meeting of the Directors of the Alpha Company Limited – a privately owned company – in May 1975, the recurrent question is raised as to how the company is going to finance its future growth and at the same time enable the founders of the company to withdraw a substantial part of their investment. A public quotation was discussed in 1974 but because of the depressed nature of the stock market at that time, consideration was deferred. Although the matter is not of immediate urgency, the Chairman of the company – one of the founders – produces the following information which he has recently obtained from a firm of financial analysts in respect of two publicly quoted companies, Beta Limited and Gamma Limited, which are similar to Alpha Limited in respect to size, asset composition, financial structure, and product mix.
The only information you have available at the meeting in respect of Alpha Limited is the final accounts for 1974, which disclose the following:
Alpha Limited
Share Capital (no variation for 8 years) 100,000 Ordinary GH¢1 Share
Post-Tax Earnings GH¢400,000
Gross Dividends GH¢100,000
Book Value GH¢3,500,000
From memory, you are of the view that the post-tax earnings and gross dividends for 1974 were at least one-third higher than the average of the previous five years.
Required:
i) Use the information provided to answer the Chairman’s question on what Alpha Ltd was worth in 1974.
ii) Discuss FOUR (4) factors to be taken into account in trying to assess the potential market value of shares in a private company when they are first offered for public subscription.
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- 20 Marks
AFM – Nov 2017 – L3 – Q3 – Valuation of acquisitions and mergers
Calculating the valuation per share for minority and complete takeover of Fasco and Boscan, and discussing limitations of the approach.
Question
Zed Ltd is considering the immediate purchase of some, or all, of the share capital of one of two firms—Fasco Ltd and Boscan Ltd. Both Fasco Ltd and Boscan Ltd have one million ordinary shares issued, and neither company has any debt capital outstanding.
Both firms are expected to pay a dividend in one year’s time—Fasco’s expected dividend amounting to 30p per share, and Boscan’s being 27p per share. Dividends will be paid annually and are expected to increase over time. Fasco’s dividends are expected to display perpetual growth at a compound rate of 6% per annum. Boscan’s dividend will grow at the high annual compound rate of 33⅓% until a dividend of 64p per share is reached in year 4. Thereafter, Boscan’s dividend will remain constant.
If Zed is able to purchase all the equity capital of either firm, then the reduced competition would enable Zed to save some advertising and administrative costs, which would amount to GH¢225,000 per annum indefinitely, and, in year 2, to sell some office space for GH¢800,000. These benefits and savings will only occur if a complete takeover is carried out. Zed would change some operations of any company completely taken over, the details are:
- Fasco – No dividend would be paid until year 3. Year 3 dividend would be 25p per share, and dividends would then grow at 10% per annum indefinitely.
- Boscan – No change in total dividends in years 1 to 4, but after year 4, dividend growth would be 25% per annum compound until year 7. Thereafter, annual dividends would remain constant at the year 7 amount per share.
An appropriate discount rate for the risk inherent in all the cash flows mentioned is 15%.
Required:
a) Calculate the valuation per share for a minority investment in each of the firms, Fasco and Boscan, which would provide the investor with a 15% rate of return. (6 marks)
b) Calculate the maximum amount per share which Zed should consider paying for each company in the event of a complete takeover. (8 marks)
c) Comment on any limitation of the approach used in part (a), and specify the other major factors which would be important to consider if the proposed valuations were being undertaken as a practical exercise. (6 marks)
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- Tags: Acquisition, Discount rate, Dividend Growth, Synergies, Valuation
- Level: Level 3
- Topic: Valuation of acquisitions and mergers
- Series: NOV 2017
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- 20 Marks
AFM – Nov 2015 – L3 – Q5 – Valuation of acquisitions and mergers
Evaluate the acquisition of Anas-Expo Clothing Ltd by Two-Pack Fashion Ltd, analyzing its effect on EPS, shareholders' wealth, and sources of conflict.
Question
You are the Finance Manager of a growing clothing company, Two-Pack Fashion Ltd (Two-Pack). Two-Pack has enjoyed significant growth in recent years using an internal growth strategy. Two-Pack is now seeking to acquire other companies to speed up its growth drive. It has identified Anas-Expo Clothing Ltd (Anas-Expo) as a suitable candidate for takeover. Both companies have the same level of risk.
Anas-Expo produces high-quality handmade clothes, with which it has earned several awards. The company has recorded considerable profits in the past, but its output has dwindled over the past two years due to increasing labour costs. Labour unions have pressured policymakers into amending labour regulations, particularly those relating to pensions and minimum wages, to provide more benefits and protection for workers. Directors of Two-Pack believe that production and profitability of Anas-Expo will be enhanced if its production process is mechanized.
Below are summarized financial data for the two companies immediately before acquisition:
| Two-Pack (GHS’m) | Anas-Expo (GHS’m) |
|---|---|
| Sales revenue | 285.8 |
| Net operating income | 85.8 |
| Interest charges | 14.2 |
| Net income before tax | 71.6 |
| Corporate tax | 15.8 |
| Net income after tax | 55.8 |
| Dividends | 22.3 |
| Addition to retained earnings | 33.5 |
Two-Pack has 40 million shares and a P/E ratio of 18, while Anas-Expo has 25 million shares and a P/E ratio of 12. Directors of Two-Pack have decided that Two-Pack takes up all the equity shares in Anas-Expo by offering to its shareholders one new share for every share they hold. They have also decided that Two-Pack mechanizes Anas-Expo’s production process immediately at the cost of GHS18 million, replacing work currently done by hand. It is estimated that operational efficiency arising from the acquisition and integration of the two companies would yield after-tax benefits of GHS25 million per year to perpetuity. The cost of capital of Two-Pack is 25%.
Required:
(a) Evaluate the acquisition proposal, and recommend whether the acquisition should go ahead.
(b) Analyze the effect of the acquisition on the earnings per share (EPS) of Two-Pack following the successful acquisition of Anas-Expo.
(c) Analyze the effect of the acquisition on the wealth of the shareholders of each company.
(d) Advise the directors of Two-Pack on three likely sources of conflict in relation to the acquisition of Anas-Expo and the mechanization of its production process, and suggest ways through which the conflict could be avoided or resolved.
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- 12 Marks
AFM – Nov 2018 – L3 – Q3b -Valuation and use of free cash flows
Estimate the value of the firm and its equity using the FCFF and FCFE valuation approaches and calculate the value per share.
Question
DoGood Ltd is evaluating Phinex Ltd using the Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE) valuation approaches.
DoGood Ltd has gathered the following information (in current Ghana Cedis terms):
- Phinex Ltd has net income of GH¢250 million, depreciation of GH¢90 million, capital expenditures of GH¢170 million, and an increase in working capital of GH¢40 million.
- Phinex Ltd will finance 40% of the increase in net fixed assets (capital expenditures less depreciation) and 40% of the increase in working capital with debt financing.
- Interest expenses are GH¢150 million. The current market value of Phinex’s outstanding debt is GH¢1,800 million.
- FCFF is expected to grow at 6.0% indefinitely, and FCFE is expected to grow at 7.0%.
- The tax rate is 30%.
- Phinex Ltd is financed with 40% debt and 60% equity. The before-tax cost of debt is 9% and the before-tax cost of equity is 13%.
- Phinex Ltd has 10 million outstanding shares.
Required:
i) Using the FCFF valuation approach, estimate the total value of the firm, the total market value of equity, and the value per share.
(6 marks)
ii) Using the FCFE valuation approach, estimate the total market value of equity and the value per share.
(6 marks)
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- Tags: Cost of Capital, FCFE, FCFF, Free Cash Flow, Valuation, Value per Share
- Level: Level 3
- Topic: Valuation and use of free cash flows
- Series: NOV 2018
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- 10 Marks
AFM – May 2016 – L3 – Q3a – Valuation of acquisitions and mergers, Acquisitions and mergers versus other growth strategies
Calculate pre-acquisition market values of two companies and determine the maximum price for an acquisition.
Question
a) Plainview Farms Limited is considering acquiring Cottage Industries Limited. The extracts of the financial statements of the two companies are as follows:
Statement of Financial Position
| Plainview Farms Ltd (GH¢’m) | Cottage Industries Ltd (GH¢’m) | |
|---|---|---|
| Net Assets | 6,300 | 1,892 |
| Equity Capital | 2,000 | 1,000 |
| Income Surplus | 4,300 | 892 |
Income Statement
| Plainview Farms Ltd (GH¢’m) | Cottage Industries Ltd (GH¢’m) | |
|---|---|---|
| Profit after tax | 800 | 300 |
| Dividend | (600) | (100) |
| Retained earnings | 200 | 200 |
The two companies retain the same proportion of profits each year, and this is expected to continue in the future. Plainview Farms Limited’s return on investment is 16%, while Cottage Industries Limited’s is 21%. One year after the post-acquisition period, Plainview Farms will retain 60% of its earnings and expects to earn a return of 20% on new investment.
The dividends of both companies have been paid. The required rate of return for ordinary shareholders of Plainview Farms Limited is 12%, and for Cottage Industries Limited it is 18%. After the acquisition, the required rate of return will become 16%.
Required:
i) Calculate the pre-acquisition market values of both companies. (5 marks)
ii) Calculate the maximum price Plainview Farms Limited will pay for Cottage Industries Limited. (5 marks)
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- 15 Marks
CR – Nov 2018 – L3 – Q3 – Business valuations
Identify valuation factors, determine share value using the net assets approach, and prepare the consolidated financial statement for GCC Bank Ltd after the takeover of Wunam Bank Ltd.
Question
The shareholders of Wunam Bank (Ghana) Limited have decided to sell the company to GCC Bank (Ghana) Limited following their inability to recapitalize the company as demanded by the Bank of Ghana. The statement of financial positions of the two banks as at 31 March 2018 are given below.
Additional Information:
- Wunam Bank Ltd carries a huge non-performing loan portfolio. It is estimated that only 40% of the outstanding loans are recoverable.
- Investments represent 91-Day Treasury Bills held as secondary reserves. An audit has shown that the investments were overstated in 2017, as interest on investments for that year amounts to GH¢4.15 million.
- Other assets include long outstanding debits amounting to GH¢3.6 million, which are not represented by tangible assets.
- Deposits amounting to GH¢3.75 million could not be accounted for. This phenomenon has prevailed since 2014 but has not been provided for in the accounts.
- Property, Plant & Equipment includes an old banking software amounting to GH¢1.25 million, considered worthless. The remaining tangible fixed assets have been revalued at GH¢15.3 million.
- Cash and balances with other banks include GH¢2.4 million due from Sakara Rural Bank Ltd, which was liquidated in 2016.
- Other liabilities include interest earned on investments amounting to GH¢3.15 million.
- Goodwill was assessed at 2.5% of adjusted deposits and current accounts.
- Wunam Bank Ltd has invested in Government bonds worth GH¢12.6 million as at 31 March 2018 to fund new ATMs and branches.
Required: a) Identify FOUR (4) factors you would consider in determining the value to be placed on assets when using the net assets approach to valuation of Wunam Bank Ltd.
(4 marks)
b) Determine the value to be placed on the shares of Wunam Bank Ltd using the net assets approach to valuation.
(5 marks)
c) Prepare the statement of financial position of GCC Bank Ltd after the takeover using your answer in (b). Assume the following:
- The purchase consideration was duly settled.
- GCC Bank Ltd took over all assets and liabilities.
- Goodwill was written off.
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- Tags: Bank Valuation, Consolidation, Financial Reporting, Takeover, Valuation
- Level: Level 3
- Topic: Business valuations
- Series: NOV 2018
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- 15 Marks
CR – Mar 2024 – Q4a – Business valuation
Apply various valuation methods to determine the value of Meddy Ltd's shares in a potential merger scenario with Flossybeats Ltd.
Question
Flossybeats Ltd is a major competitor of Meddy Ltd in the telecommunication industry. Flossybeats Ltd is listed on the Ghana Stock Exchange with a P/E ratio of 11 and a dividend yield of 7.2%. Directors of Flossybeats Ltd have been presented with a proposal to merge with Meddy Ltd which owns 45% of the market share but not yet listed. The summarized financial statements of Meddy Ltd for the year 2023 are given below:
Statement of Financial Position as at 31 December 2023
Additional information: i) An existing property included in property, plant and equipment with a carrying value of GH¢675,000 could be developed as a site for residential use at a cost of GH¢75,000 and would then be worth GH¢975,000. The remaining property, plant and equipment can be used to generate a net cashflow of GH¢300,000 each year for the foreseeable future.
ii) The worth of the Investment Property is difficult to value, as there is no active market. A normal sale in the present condition could be reasonably expected to yield GH¢600,000 based on an analysis of transactions in similar assets.
iii) The trademark represents a license to produce and sell a special product which is expected to generate an after-tax profit of GH¢1,500,000 over the next four years. The expected after-tax profit projection was made without the consideration of amortisation of the book value of the trademark over the same period.
iv) The discounted present value of future cash payments in respect of long-term loan is GH¢975,000. The discount rate of Meddy Ltd is 25% per annum but the financial controller asserts that beta of the company is 1.5. The Treasury bill rate and the return on the market are estimated to be 16% and 23% respectively.
v) Dividend payments of Meddy Ltd in 2022 was GH¢112,500. The dividend growth achieved in 2023 is expected to be sustained in the foreseeable future.
Required: Advise the directors of Meddy Ltd on the value to be placed on the ordinary shares using:
- Net Assets Method
- Constant Dividend Method
- Dividend Growth Method
- Earning based (P/E) Method
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- Tags: Asset-Based Method, Dividend Method, Earning Method, Gordon's Growth Model, Valuation
- Level: Level 3
- Topic: Business valuations
- Series: MAR 2024
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