Subject: FINANCIAL MANAGEMENT

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  • 5 Marks

FM – Nov 2024 – L2 – Q5c – Public-Private Partnerships (PPP)

Discuss types of PPP arrangements and their suitability for a highway project.

Public-Private Partnerships (PPP) involve collaboration between government and a private sector company that can be used to finance, build and operate projects. Financing a project (for example, a highway) through PPP can allow a project to be completed sooner or make it a possibility in the first place.

Required:
Given the following types of PPP arrangements, discuss each of them and how they can be suitable for a highway project:

i) Build-Operate-Transfer (BOT) 
ii) Design-Build-Finance-Operate (DBFO) 
iii) Service Concession

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  • 5 Marks

FM – Nov 2024 – L2 – Q5b – Overdue Debt Collection

Steps to collect overdue debts in financial management.

Outline the steps to be followed to collect overdue debts.

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  • 10 Marks

FM – Nov 2024 – L2 – Q5a – Management of Receivables

Evaluate the financial implications of different strategies for managing Abaa LTD's accounts receivable.

Abaa LTD, a company that manufactures and sells electronic appliances, has been facing challenges with its accounts receivable management. Currently, the company allows its customers 60 days of credit. Due to the highly competitive market, Abaa LTD has been experiencing an increasing amount of bad debts and delayed payments, which has adversely affected its cash flow and profitability. To address these issues, the company’s Finance Manager is considering several strategic changes:

  1. Reduction in Credit Period: Reducing the credit period from 60 days to 45 days. It is estimated that this change could reduce sales by 5% due to the stricter credit terms, but it would also decrease the bad debt ratio from 4% to 2% of sales.
  2. Offering Early Payment Discounts: Introducing a 2% discount for customers who pay within 30 days. The company anticipates that 30% of its customers will take advantage of this discount, which would improve cash flow and reduce the average collection period by 15 days.
  3. Engagement of a Factor: The company is also considering engaging a factoring company to manage its receivables. The factor would advance 80% of the invoice value upon the sale of goods at 200 basis points below the company’s cost of capital and charge a 3% fee on all sales. The factor is expected to reduce the bad debt ratio to 1% of sales and further reduce the average collection period by 20 days. Engaging the factor will lead to annual administrative savings of GH¢90,000.

Abaa LTD’s current annual sales are GH¢20 million, and the variable cost of sales is 60% of sales. The company’s cost of capital is 12% per annum.

Required:
Evaluate the financial implications of the following:
i) Reduction in Credit Period
ii) Offering Early Payment Discounts
iii) Engagement of a Factor
iv) Recommend the appropriate method to manage the credit sales

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  • 5 Marks

FM – Nov 2024 – L2 – Q4b – Procurement and Tendering Procedures

Discuss circumstances under which single-source procurement is appropriate and functions of the Entity Tender Committee.

The Farms and Gardens Authority (FGA), a public entity, wants to buy 100 computers and 20 printers for its administrative offices. The Chief Executive Officer (CEO) is considering using the single-source procurement method to procure the computers and printers while pushing back on the recommendations of the Entity Tender Committee.

Required:

i) State TWO circumstances under which single-source procurement would be appropriate for the goods the FGA wants to procure.

ii) Advise the CEO on TWO functions the Entity Tender Committee is expected to perform in the FGA’s procurements.

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  • 11 Marks

FM – Nov 2024 – L2 – Q4a – Business Valuation

Valuing a company using the discounted cash flow model and price multiples.

Djokoto PLC (Djokoto) has 12 million ordinary shares outstanding and no other long-term debt. The Finance Director of Djokoto, Adepa, estimates that Djokoto’s free cash flows at the end of the next three years will be GH¢0.5 million, GH¢0.6 million, and GH¢0.7 million, respectively. After Year 3, the free cash flow will grow at 5% yearly forever. The appropriate discount rate for this free cash flow stream is determined to be 15% annually.

In a separate analysis based on ratios, Adepa estimates that Djokoto will be worth 10 times its Year 3 free cash flow at the end of the third year. Adepa gathered data on two companies comparable to Djokoto: Mesewa and Dunsin. It is believed that these companies’ price-to-earnings, price-to-sales, and price-to-book-value per share should be used to value Djokoto.

The relevant data for the three companies are given in the table below:

Variables Mesewa Dunsin Djokoto
Current Price Per Share 7.20 4.50 2.40
Earnings Per Share 0.20 0.15 0.10
Revenue Per Share 3.20 2.25 1.60
Book Value Per Share 1.80 1.00 0.80

Required:
i) Estimate Djokoto’s fair value based on the discounted cash flows model. (5 marks)
ii) Compute the following ratios for the comparable companies:

  • P/E Ratio (2 marks)
  • Price-to-Sales Ratio (2 marks)
  • Price-to-Book-Value Ratio (2 marks)
    iii) Based on the valuation results, discuss whether an investor should buy, sell, or hold Djokoto shares. Justify your recommendation. (4 marks)
    iii) Identify two advantages and two disadvantages of business combinations.

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  • 5 Marks

FM – Nov 2024 – L2 – Q3b – Mobile Money vs Traditional Banking

Discuss the disadvantages of mobile money compared to traditional banking services.

The development of mobile money in Ghana has provided a section of the population with banking services that were previously not accessed. This expansion in financial inclusion is seen as a positive step towards boosting economic activity and alleviating poverty. However, there are some disadvantages to mobile money compared to a traditional bank account.

Required:
Explain FOUR disadvantages of mobile money compared to a traditional bank account.

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  • 12 Marks

FM -NOV 2024 – L2 – Q3a – Foreign Exchange Risk Management

Explaining foreign exchange risk types and calculating the impact of forward contract hedging.

a) Dadisen PLC manufactures and sells pharmaceutical products in Ghana. It imports a significant portion of its pharmaceutical inputs from the USA. However, it only sells its products in Ghana. The company is considering establishing its foothold in The Gambia, Liberia, and Sierra Leone markets.

i) Dadisen PLC reports its results in its home currency. It pays for its purchases from the USA in US dollars but receives payments for its sales in Ghana cedis. All sales from Gambia, Liberia, and Sierra Leone are expected to be transferred into US dollar accounts each week. On average, the company generally takes 90 days to pay its suppliers and receives payment from its debtors within 60 days. In paying its suppliers, the company relies on bank overdrafts at an annual rate of 10%.

Over the last few years, the company has found that sales have been quite predictable, and it has been possible to plan sales levels and purchases of goods in advance. However, the company does not have adequate management skills for its foreign currency exposure. As a result, the company has reported exchange rate losses since 2020. The company is currently considering whether the forex exposure could be better managed.

Required:

Describe the following types of foreign currency exposure, giving examples of how they could impact the financial statements of Dadisen PLC:

  • Transaction risk
  • Translation risk
  • Economic risk

ii) The company estimates that it will need to borrow $1 million in three months’ time for a period of six months but is concerned about expected fluctuations in the exchange rate. The company is considering hedging this exposure using a currency forward contract. The company’s banker, GCB, has agreed to sell the US dollar forward for 9 months at GH¢17 to the dollar.

Required:
Compute the effect of the currency forward transaction on profitability if the spot exchange rate in 9 months is:

  • GH¢22
  • GH¢15

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  • 20 Marks

FM – Nov 2024 – L2 – Q2 – Investment Appraisal

Calculate the NPV of launching two new products, Agbui and Loloi, and advise on the investment decision.

Santrofi PLC is a publisher that wants to expand its market share in magazine publications. The company plans to launch two new products, Agbui and Loloi, at the start of January 2025, which it believes will each have a 4-year life span. The sales mix is assumed to be fixed. The information below is relevant:

  1. Expected sales volumes (units) for Agbui:
Year 1 2 3 4
Volume 30,000 55,000 50,000 15,000

  1. The first year’s selling price and direct material costs for each Agbui unit will be GH¢31 and GH¢12, respectively. On the other hand, the company expects to sell 25% more Loloi units than Agbui. Both selling price and direct material cost of Loloi are expected to be 25% less than Agbui’s.

  2. Incremental fixed production costs are expected to be GH¢500,000 in the first year of operation, apportioned based on revenue. Advertising costs will be GH¢250,000 in the first year of operation and then GH¢125,000 per year for the following two years.

  3. To produce the two products, an investment of GH¢1 million in machinery and GH¢500,000 in working capital will be needed, payable at the start of the period. Santrofi PLC expects to recover GH¢600,000 from the sale of machinery at the end of the project life. Investment in machinery attracts a 100% first-year tax-allowable depreciation. The company has sufficient profit to take full advantage of the allowance in Year 1. For the purpose of reporting accounting profit, the company depreciates machinery on a four-year straight-line basis.

  4. Revenue and costs are expected to be affected by inflation after the first year as follows:

    • Selling price: 3% a year
    • Direct material cost: 3% a year
    • Fixed production cost: 5% a year

  5. The company’s real discount rate is 10% for investment appraisal. Average inflation is deemed to be 3%. The applicable corporate tax rate is 25%.

Required:
Calculate the Net Present Value (NPV) of the proposed investment in the two products and advise the company on its investment appraisal.

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  • 15 Marks

FM – May 2016 – L3 – Q7 – Financing Decisions and Capital Markets

Comparing the cost of financing equipment replacement through an outright purchase funded by a loan versus a finance lease.

MK Plc is considering the best way to finance the replacement for a particular high specification piece of equipment that has become too costly to maintain. The replacement equipment is estimated to have a useful life of 4 years with no residual value after that time.

Two alternative financing schemes are being evaluated:

  • Scheme A: Buy the equipment outright funded by a bank loan
  • Scheme B: Enter into a four-year finance lease

Scheme A: Buy outright, funded by a bank loan
MK Plc could purchase the equipment outright at a cost of N200 million on July 1, 2016. MK Plc can normally borrow at an annual interest rate of 13% per year.

Scheme B: Four-year finance lease
The equipment would be delivered on July 1, 2016, and MK Plc would pay a fixed amount of N58,790,000 each year in advance, starting on July 1, 2016, for four years. At the end of four years, ownership of the equipment will pass to MK Plc without further payment.

Other Information:

  • MK Plc has a cost of equity of 20% and WACC of 16%
  • MK Plc is liable to company tax at a marginal rate of 30%, which is settled at the end of the year in which it arises
  • Tax depreciation allowances on the full capital cost are available in equal instalments over the first four years of operation

You are required to:

a.

Calculate which payment method is expected to be cheaper for MK Plc and recommend which should be chosen solely on the present value of the two alternatives as at July 1, 2016. (13 Marks)

b.

Discuss the appropriateness of the discount rate used in (a). (2 Marks)

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  • 8 Marks

FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

The expected return on the market portfolio (estimated from past data) is 12% p.a. with a standard deviation of 15% and the risk-free rate of 4% p.a. The actual prices, last year dividends, and the covariances from three securities (A, B, C) with the market are given in the table below:

Security Actual Price (N) Last Year Dividend (N) Covariance with Market
A 107 1.30 0.025650
B 618 18.00 0.018675
C 1,350 22.00 0.029025

You are required to:

i.

Calculate the betas and the required rates of return of securities A, B, and C. (3 Marks)

ii.

In the table below, you have the market consensus forecast of 12-month price targets, ex-dividends, and the expected dividend growth rate of the securities.

Security 12-month price target (N) Dividend growth rate (%)
A 122.50 12
B 740.00 10
C 1,500.00 11

Assuming the dividends are paid in 12 months exactly, compute the required stock price for the 3 stocks and state your conclusion. (4 Marks)

iii.

Considering the results in (ii) above, explain briefly what will be your strategy? (1 Mark)

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  • 7 Marks

FM – May 2016 – L3 – Q6a – Financial Risk Management

Calculating the number of call options needed to delta-hedge the position of a bank's investment in shares.

You work in the corporate finance department of a major bank. The bank has invested in 20,000,000 shares of Ode Oil Plc. You are concerned about the recent volatility in Ode Oil Plc’s share price due to the recent instability in the global oil market. You plan to protect the bank’s investment from a possible fall in Ode Oil Plc’s share price for the next three months and do not plan to sell the shares at present.

You have the following additional information:

  • Ode Oil Plc’s current share price: N10
  • Call option’s current share price: N11
  • Option expiry: 3 months
  • Interest rate (annual): 8%
  • Ode Oil Plc’s share annual standard deviation: 64%

You are required to calculate:
How many call options you need to buy or sell in order to delta-hedge the bank’s position. Please be specific.

Note: Delta may be estimated using N(d1).

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  • 15 Marks

FM – May 2016 – L3 – Q5 – Financing Decisions and Capital Markets

Preparation of a report identifying factors in choosing the appropriate debt finance mix and restrictions on debt raising for a company.

BADEJO Limited, a small company, is currently considering a major capital investment project for which additional finance will be required. It is not currently feasible to raise additional equity finance, consequently debt finance is being considered. The decision has not yet been finalized whether this debt finance will be short or long term and whether it will be at fixed or variable rates. The financial controller has asked you, as the company’s Accountant, to prepare a report for the forthcoming meeting of the board of directors.

You are required to:

a.

Prepare a draft report to the board of directors which identifies and briefly explains:
The main factors to be considered when deciding on the appropriate mix of short, medium, or long-term finance for BADEJO Limited. (8 Marks)

b.

The practical considerations which could be factors in restricting the amount of debt BADEJO Limited could raise. (7 Marks)

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  • 20 Marks

FM – May 2016 – L3 – Q4 – Mergers and Acquisitions

Estimating the additional equity value created by combining two companies and analyzing the impact of premium increases on shareholders.

Eko Product Plc (EP Plc) is a producer of a variety of vegetable oil and other household products in Lagos. The company presently faces significant competition in the market for one of its major raw materials – palm oil. To secure a regular flow of the raw material, the Directors of EP Plc are now considering making an offer for the entire share capital of Benin Oil Plc (BO Plc), a palm oil producing company in Benin.

The following financial information is provided for the two companies:

Parameter EP Plc BO Plc
Equity beta 1.2 1.2
Asset beta 0.9 1.2
Number of shares (million) 210 200
Current share price N29 N12

It is thought that combining the two companies will result in several benefits. It is estimated that combining the two companies will generate free cash flow to the firm (FCFF) of N1,080 million in current value terms, but these will increase by an annual growth rate of 5% for the next four years before reverting to an annual growth rate of 2.25% in perpetuity. In addition to this, combining the companies will result in cash synergy benefits of N100 million per year for the next four years. These synergy benefits are not subject to any inflationary increase, and no synergy benefits will occur after the fourth year.

The debt-to-equity ratio of the combined company will be 40:60 in market value terms and it is expected that the combined company’s cost of debt will be 4.55% before tax.

The income tax rate is 20%, the current risk-free rate of return is 2%, and the market risk premium is 7%. It can be assumed that the combined company’s asset beta is the weighted average of EP Plc’s and BO Plc’s asset betas weighted by their current market values.

EP Plc has offered to acquire BO Plc through a mixed offer of one of its shares for two BO Plc shares, plus a cash payment, such that a 30% premium is paid for the acquisition. Shareholders of BO Plc feel that a 50% premium would be more acceptable. EP Plc has sufficient cash reserves if the premium is 30%, but not if it is 50%.

You are required to:

(a) Estimate the additional equity value created by combining EP Plc and BO Plc based on the free cash flow to firm method. Comment on the results obtained and discuss briefly the assumptions made. (11 Marks)

(b) Estimate the impact on EP Plc’s equity holders if the premium paid is increased to 50% from 30%. (5 Marks)

c. Estimate the additional funds required if a premium of 50% is paid instead of 30% and discuss how this premium could be financed. (4 Marks)

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  • 20 Marks

FM – May 2016 – L3 – Q3 – Financing Decisions and Capital Markets

Calculation of bond issue price, yield to maturity, and duration, and discussion of conflicts between shareholders and bondholders.

(a)

Skylet Limited is a major player in the aviation industry with a credit rating of AA. The company plans to raise ₦5 billion from the bond market. The features of the bond are:

  • Maturity: 4 years
  • Coupon payment: Annual
  • Coupon rate: 5%
  • Redemption value: Par

The current annual spot yield curve for government bonds is as follows:

Term Spot Rate
One-year 3.3%
Two-year 3.8%
Three-year 4.5%
Four-year 5.3%

The following table of spreads (in basis points) is given for the aviation industry:

Rating 1 Year 2 Year 3 Year 4 Year
AAA 12 23 36 50
AA 27 40 51 60
A 43 55 67 80

You are required to calculate:
i. The issue price of the bond. (6 Marks)
ii. The yield to maturity. (3 Marks)
iii. The duration. (6 Marks)

(b)

Discuss why conflicts of interest might exist between shareholders and bondholders. (5 Marks)

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  • 20 Marks

FM – May 2016 – L3 – Q2 – Financing Decisions and Capital Markets

Analysis of the impact of a rights issue on shareholder wealth, financial ratios, and evaluation of its appropriateness.

BeeJay Plc is a medium-sized manufacturing company which is considering a 1-for-5 rights issue at a 15% discount to the current market price of ₦4.00 per share. Issue costs are expected to be ₦220,000, and these costs will be paid out of the funds raised. It is proposed that the funds raised from the rights issue will be used to redeem some of the existing debentures at par.

(a)

Ignoring issue costs and any use that may be made of the funds raised by the rights issue, calculate:
i. the theoretical ex-rights price per share.
ii. the value of the rights per existing share. (3 Marks)

(b)

Calculate the current earnings per share and the revised earnings per share if the proceeds of the rights issue are used to redeem some of the existing debentures. (4 Marks)

(c)

Evaluate whether the proposal to redeem some of the debentures would increase the wealth of the shareholders of BeeJay Plc. Assume that the price/earnings ratio of BeeJay Plc remains constant. (2 Marks)

(d)

Discuss the reason why a rights issue could be an attractive source of finance for BeeJay Plc. Your discussion should include an evaluation of the effect of the rights issue on the debt/equity ratio and interest cover. (11 Marks)

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  • 30 Marks

FM – May 2016 – L3 – Q1 – Investment Appraisal Techniques

Calculation of Adjusted Present Value (APV) for a proposed project and analysis of its application in investment appraisal.

Katam Pie has adopted a strategy of diversification into many different industries in order to reduce risk for the company’s shareholders. This has resulted in frequent changes in the company’s gearing level and widely fluctuating risks of individual investments. Presently, the company has a target debt-to-asset ratio i.e., D/(E + D) of 25%, an equity beta of 2.25, and a pre-tax cost of debt of 5%.

On January 1, 2016, Katam Plc with a year-end of December 31, is considering the purchase of a new machine costing N750million, which would enable it to diversify into a new line of business. The new business will generate sales of N522.50million in the first year, growing at 4.5% p.a. A constant contribution margin ratio of 40% can be expected throughout the 15-year life of the project. Incremental fixed cash costs will be N84.32million in the first year, growing by 5.4% p.a.

A regional development bank has offered a 10-year loan of 3% interest to finance 40% of the cost of the machine. The balance of 60% will be financed equally by a 10-year commercial loan (with annual interest of 5%) and a fresh round of equity. The issue cost on the commercial loan will be 1%, and the new equity will incur an issue cost of 3%. All issue costs are on the gross amount raised for the respective capital. Issue costs on debt are allowed for tax purposes.

A firm that is already in the business of the new project has a gearing ratio of 20% (debt to asset) and a cost of equity of 18.1%. Its corporate debt is risk-free.

The tax rate is 30% payable in the year the profit is made. Tax depreciation of 20% on cost is available on the new machine. Katam Pie has a weighted average cost of capital of 14% and a cost of equity of 17.5%. The risk-free rate is 4%, and the market risk premium is 7%.

You are required to:

  1. Estimate the Adjusted Present Value (APV) and advise whether the project should be accepted? (21 Marks)
  2. Explain:
    i. The circumstances under which the use of APV is appropriate. (5 Marks)
    ii. The major advantages and limitations of the use of the APV method. (4 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – SC – Q7 – Mergers and Acquisitions

Advise on the benefits, drawbacks, alternatives, and target selection criteria for expansion through mergers or acquisitions.

One of the means by which companies expand is through mergers and acquisitions. However, there are other means of expansion aside from these methods.

Inkline Plc. is one of your client companies intending to expand its business by means of merger or acquisition. Your firm of management consultants has been asked to advise the management of the company on what steps to take while considering the merger and acquisition methods, and whether it should go ahead with the expansion programme or otherwise.

Required:

a. (i) FOUR benefits derivable from its proposed means of expansion. (4 Marks)
(ii) THREE probable demerits of employing its proposed method of expansion. (3 Marks)

b. TWO alternatives to merger and acquisition in your report. (2 Marks)

c. Where the company decides to go ahead with either of these methods, indicate THREE criteria the company may consider in choosing its target company. (6 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – SC – Q6 – Strategic Performance Measurement

Evaluate Osamco Limited’s financial performance compared to industry benchmarks and discuss reasons for considering stock exchange listing.

Osamco Limited, manufacturer of wire and cables, was bought from its conglomerate parent company in a management buyout deal in August 2010. Six years later, the managers are considering the possibility of listing the company’s shares on the Nigerian Stock Exchange.

The following information is made available:

OSAMCO LIMITED
INCOME STATEMENT FOR THE YEAR ENDED JUNE 30, 2016

N’million Amount
Turnover 91.25
Cost of sales (79.00)
Profit before interest and taxation 12.25
Interest (3.25)
Profit before taxation 9.00
Taxation (1.25)
Profit attributable to ordinary shareholders 7.75
Dividend (0.75)
Retained profit 7.00

STATEMENT OF FINANCIAL POSITION AS AT JUNE 30, 2016

N’million Amount
Non-current assets (at cost less accumulated depreciation)
Land and buildings 9.00
Plant and machinery 24.75
Total non-current assets 33.75
Current assets
Inventories 11.00
Accounts receivable 11.75
Cash at bank 2.50
Total current assets 25.25
Total assets 59.00
Equity
Ordinary shares of N1 each 6.75
Reserves 24.25
Total equity 31.00
Non-current liabilities
Accounts payable due after more than one year: 12% Debenture 2018 5.50
Current liabilities
Trade accounts payable 17.50
Bank overdraft 5.00
Total current liabilities 22.50
Total equity and liabilities 59.00

Industry sector ratios:

Metric Industry Average
Return before interest and tax on long-term capital employed 24%
Return after tax on equity 16%
Operating profit as percentage of sales 11%
Current ratio 1.6:1
Quick (acid test) ratio 1.0:1
Total debt: equity (gearing) 24%
Dividend cover 4.0
Interest cover 4.5

Required:
a. Evaluate the financial state and performance of Osamco Limited by comparing it with that of its industry sector. (10 Marks)

b. Discuss FOUR probable reasons why the management of Osamco Limited is considering Stock Exchange listing. (5 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

a. Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.
What are the basic assumptions on which this model is based? (6 Marks)

b. Currently, the rate of return on the Federal Government Bond redeemable at par in the year 2018 is 5%. The securities of four companies, Akira Plc., Bombadia Plc., Courage Plc., and Divine Plc., have expected returns of 12%, 9.5%, 10.5%, and 13%, respectively. The average expected return on the market portfolio is 10%, subject to a 6% risk (standard deviation). Other relevant information relating to the four securities of the companies is as stated below:

Company Standard Deviation Correlation Coefficient
Akira Plc 0.080 0.975
Bombadia Plc 0.075 0.640
Courage Plc 0.090 0.740
Divine Plc 0.150 0.680

You are required to show which of the companies is/are overvalued. (9 Marks)

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  • 20 Marks

FM – Nov 2016 – L3 – SB – Q4 – Investment Appraisal Techniques

Evaluate Gugi Plc.'s proposed investment in a foreign factory, considering costs, revenues, tax, and exchange rate impacts.

Gugi Plc. is a highly successful manufacturing company operating in Nigeria. In addition to sales within Nigeria, the company also exports to a foreign country (with currency F$) along the ECOWAS sub-region. The export sales generate annual net cash inflow of ₦50,000,000. Gugi Plc. is now considering whether to establish a factory in the foreign country and stop exporting from Nigeria to the country. The project is expected to cost F$1 billion, including F$200million for working capital.

A suitable existing factory has been located, and production could commence immediately. A payment of F$950million would be required immediately, with the remainder payable at the end of year one. The following additional information is available:

  • Annual production and sales in units: 110,000
  • Unit selling price: F$5,000
  • Unit variable cost: F$2,000
  • Unit royalty payable to Gugi Plc: ₦300
  • Incremental annual cash fixed costs: F$50million

Assume that the above cash items will remain constant throughout the expected life of the project of 4 years. At the end of year 4, it is estimated that the net realisable value of the non-current assets will be F$1.40billion.

It is the policy of the company to remit the maximum funds possible to the parent (i.e., Gugi Plc.) at the end of each year. Assume that there are no legal complications to prevent this.

If the new factory is set up and export to the foreign country is stopped, it is expected that new export markets of a similar worth in North Africa could replace the existing exports.

Production in Nigeria is at full capacity, and there are no plans for further capacity expansion.

Tax on the company’s profits is at a rate of 40% in both countries, payable one year in arrears. A double taxation agreement exists between Nigeria and the foreign country, and no double taxation is expected to arise. No withholding tax is levied on royalties payable from the foreign country to Nigeria.

Tax allowable “depreciation” is at a rate of 25% on a straight-line basis on all non-current assets.

The Directors of Gugi Plc. believe that the appropriate risk-adjusted cost of capital for the project is 13%.

Annual inflation rates in Nigeria and the foreign country are currently 5.6% and 10%, respectively. These rates are expected to remain constant in the foreseeable future. The current spot exchange rate is F$1.60 = N1. You may assume that the exchange rate reflects the purchasing power parity theorem.

Required:
a. Evaluate the proposed investment from the viewpoint of Gugi Plc.
Notes:
i. Show all workings and calculations to the nearest million.
ii. State all reasonable assumptions. (18 Marks)

b. State TWO further information and analysis that might be useful in the evaluation of this project?

(2 Marks)

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