SFM Question Bank 2019
SFM Question Bank 2019
SFM Question Bank 2019
QUESTIONS
CAPITAL STRUCTURE
QUESTION 1: A Limited and B Limited are two companies in the sports promotion
industry. The companies have the same business risk and are identical in all respects
except for their capital structures and total market values.
The companies’ capital structures are summarized below:
A Limited N’000
Ordinary share (25k par value) 50,000
Share premium 112,500
Retained Earnings 90,000
Equity attributable to owners 252,500
B Limited’s ordinary shares are trading at 400k per share and loan Notes at N100.
Annual Earnings before interest and Tax (EBIT for both companies is N62.5m. company
income tax rate is 30% .
Required:
( a ) if Mr. Ronalmessi holds 4% of the ordinary shares of company B, what action
should he take to improve his financial position without increasing his risk assuming:
i. Additional income is desired?
ii. His existing income is to be maintained?
In each case, calculate by how much his financial position is expected to improve.
(show all workings)
i. Calculate the effect this would have on the company’s cost of capital according to
Modigliani and Miller
ii. What implications would this suggest for the company’s choice of capital
structure?
(show all workings) ICAN
QUESTION 2 Company A and Company B are in the same risk class and are identical in
every respect except that company A is geared while Company B is not. Company A has
in issue 10% N9,000,000 debt capital. Both firms earn 20% operating profit on their
assets of N15,000,000 each.
Assume:
(1). Perfect capital markets and Rational Investors ( as enunciated by Modigliani and
Miller – revised after – tax version)
(11). A tax rate of 30%
(111). Capitalization rate of 15%
QUESTION 3: Ade plc and Oba plc have the same business risk and the same Earnings
Before interest and Tax (EBIT) which is N10m. Ade plc is not leveraged but Oba plc has
N40m 8% debenture in its capital structure. The equity capitalization rate for the firms is
10%.
You are required to:
a. Determined and evaluate the implied overall capitalization rates and the values of
the firms using the Net Income (NI) approach.
b. Assess and advise an investor who owns 5% of Oba plc’s shares how he can
increase his return through the process of arbitrage assuming the Modigliani and
Miller (M &M) hypothesis. ICAN
QUESTION 4 : NES plc and CAD plc are two companies quoted on the stock market in
the food Beverages and Tobacco Sector. Both companies are similar in all respect except
that NES plc is geared while CAD plc is ungeared. NES plc has a paid –up equity share
capital having a market value of N1.2m while CAD plc has an equity capital with a
market value of N1.5m. NES plc also has a debt capital of N600,000 with coupon rate of
12 percent which is equal to the market interest rate. Each of the two companies earns
an operating profit of N300,000.
Required:
Assuming John holds 15% of NES plc shares would you advice him to carry out an
arbitrage activity? ICAN
QUESTION 1: Saulson plc is a fully equity financed company. The directors are considering
investment in one of two projects which are mutually exclusive. The cash flows of the two
projects are as follows:
Project A project B
(Hire purchase Finance) (Mortgage Finance)
Initial outlay N10 Million N24 Million
Cash flow:
Years 1 – 3 N4.8 million p.a N7.8 Million p.a
Years 4 – 5 N5.6 Million p.a N8.9 million p.a
Residual value N1 Million N1 million
( c ) Explain Three factors that must be estimated for any valuation model ICAN
QUESTION 2. Kee plc and Jee plc are quoted companies. The following is the extract of the
Statement of financial postions of the two companies.
Kee plc Jee plc
N’000 N’000
Ord. share capital
Authorised – 2,000,000 shares of 50k each 1,000 1,000
Issued & fully paid 1,000,000 shares of 50k each 500 500
Reserves 1,750 150
Shareholders funds 2,250 650
6% irredeemable debenture - 2,500
2,250 3,150
Each of the two companies has operating profits of N500,000 and these are expected to remain
unchanged for an indefinite future. The profits of each of the companies are generally regarded
as identical in terms of risk. It is the policy of each company to distribute all available profits as
dividend, at the end of the year. The current market value of kee plc ord. shares is N3 per share
cum div. an annual dividend is due to be paid in the very near future.
Jee plc has just made annual dividend and interest payments both on its ordinary share and its
debentures respectively. The current market value per share of the ord. share is N1.40 ex div.
each debenture stock (Nominal N100) is worth N50 in the market.
Required: Calculate the cost of equity capital for Kee plc and the Weighted average cost of
capital (WACC) for Jee plc. ICAN
QUESTION 3. Silogar Limited and Lowood Limited are two companies in the same chemical
industry. While Silogar has automated its operations, Lowood is just in the process of doing so.
Both however use good quality materials in their production processes and their products are
well accepted in the market. For the year ended 31 December, 2011 each company had net
turnover of N4,800,000. The actual keys of chemical sold were : Siogar 320,000 and Lowood
300,000.
Other operating statistics for the companies for 2011 are as follows:
Silogar LoWood
N N
Cost of material consumed 1,800,000 1,950,000
Direct labour cost 1,200,000 450,000
Production overheads 400,000 1,000,000
The two companies summarized statement of financial position as at 31 December 2011 are as
follows:
Silogar LOwood
N N
Capital: N1.00 ord. shares 1,000,000 -
N0.25 ord. share - 1,000,000
400,000 10% preference shares 400,000 -
General reserves 1,500,000 1,600,000
Debentures 800,000 1,200,000
Accounts payable and accruals 1,300,000 1,200,000
5,000,000 5,000,000
Other assets 2,000,000 3,200,000
Current assets 3,000,000 1,800,000
5,000,000 5,000,000
Required:
Assuming the market values of preference shares and debentures are the same as their book
values, you are required to advise the management of the two companies on the appropriate
cost of capital for purposes of project evaluation.
(note: Use earnings method for equity cost of capital) ICAN
QUESTION 4; Karim Plc and Roshan Plc are companies quoted on the Nigeria stock Exchange.
The following are extracts from their statement of financial position as at 31 December, 2006:
Karim Plc Roshan Plc
N ‘000 N ‘000
Ordinary Share Capital:
Authorized: 4,000,000 shares of 50k each 2,000 2,000
Issued: 2,000,000 shares of 50k each 1,000 1,000
Reserves 3,500 300
Shareholders’ fund 4,500 1,300
6% irredeemable debentures 5,000
Annual profits of each of the companies before charging debenture interest were N1,000,000.
These are expected to remain constant in each case for an indefinite future period. The profits
of each of these companies before charging debenture interest are generally regarded as being
subject to identical levels of risk. Both companies have, respectively, policies of distributing all
available profits as dividends at the end of each year.
The current market value of Karim Plc’s ordinary shares is N3.000 per share cum div. annual
dividend is due to be paid in the very near future.
Roshan Plc has just paid annual dividend and interest on its ordinary shares and debentures
respectively. The current market value of the ordinary shares is N1.40 per share while that of
the debenture is N50
You are required to:
Estimate the cost of ordinary share capital and weighted average cost of capital of Karim Plc and
Roshan Plc respectively. ICAN
( d ). Use your calculation in ‘C’ to state the effect of a drop in the beta of the share of the
Company on its required return and price. ICAN
The investment in Hotel and Tourism would cost N300 million while that in food and Beverages
would cost N400 million.
The Directors have discovered have discovered that industry beta for Hotel & Tourism and Food
and Beverages sectors are 1.2 and 2.2 respectively. They believe the investments being
considered are typical of projects in the relevant industries.
Dede Plc industries beta is 1.6, treasury bill rate is 9% and the average return on companies
quoted on the stock exchange is 14%.
Question 7: AMH Co wishes to calculate its current cost of capital for use as a discount
rate in investment appraisal. The following financial information relates to AMH Co:
Financial position statement extracts as at 31 December 2012
$000 $000
Equity Ordinary shares (nominal value 50 cents) 4,000
Reserves 18,000 22,000
–––––––
Long-term liabilities
4% Preference shares (nominal value $1) 3,000
7% Bonds redeemable after six years 3,000
Long-term bank loan 1,000 7,000
29,000
The ordinary shares of AMH Co have an ex div market value of $4·70 per share
and an ordinary dividend of 36·3 cents per share has just been paid. Historic
dividend payments have been as follows: Year 2008 2009 2010 2011 Dividends
per share (cents) 30·9 32·2 33·6 35·0 The preference shares of AMH Co are not
redeemable and have an ex div market value of 40 cents per share. The 7%
bonds are redeemable at a 5% premium to their nominal value of $100 per bond
and have an ex interest market value of $104·50 per bond. The bank loan has a
variable interest rate that has averaged 4% per year in recent years. AMH Co
pays profit tax at an annual rate of 30% per year.
Required:
(a) Calculate the market value weighted average cost of capital of AMH Co.
(b) Discuss how the capital asset pricing model can be used to calculate a
project-specific cost of capital for AMH Co, referring in your discussion to the key
concepts of systematic risk, business risk and financial risk.
(c) Discuss why the cost of equity is greater than the cost of debt.
ACCA
$m $m
Reserves 15 40
Non-current liabilities
Current liabilities
Trade payables 10
Overdraft 15 25
Total liabilities 95
BKB Co has an equity beta of 1·2 and the ex-dividend market value of the
company’s equity is $125 million. The ex-interest market value of the convertible
bonds is $21 million and the ex-dividend market value of the preference shares is
$6·25 million. The convertible bonds of BKB Co have a conversion ratio of 19
ordinary shares per bond. The conversion date and redemption date are both on
the same date in five years’ time. The current ordinary share price of BKB Co is
expected to increase by 4% per year for the foreseeable future. The overdraft has
a variable interest rate which is currently 6% per year and BKB Co expects this to
increase in the near future. The overdraft has not changed in size over the last
financial year, although one year ago the overdraft interest rate was 4% per year.
The company’s bank will not allow the overdraft to increase from its current level.
The equity risk premium is 5% per year and the risk-free rate of return is 4% per
year. BKB Co pays profit tax at an annual rate of 30% per year.
Required: (a) Calculate the market value after-tax weighted average cost of
capital of BKB Co, explaining clearly any assumptions you make.
(b) Discuss why market value weighted average cost of capital is preferred to
book value weighted average cost of capital when making investment decisions.
(c) Comment on the interest rate risk faced by BKB Co and discuss briefly how
this risk can be managed. ACCA
Question 9: KFP Co, a company listed on a major stock market, is looking at its cost of
capital as it prepares to make a bid to buy a rival unlisted company, NGN. Both
companies are in the same business sector. Financial information on KFP Co and NGN
is as follows:
KFP Co NGN
$m $m $m $m
Non-current assets 36 25
Current assets 7 7
Current liabilities 3 4
Net current assets 4 3
Total assets less current liabilities 40 28
Ordinary shares, par value 50c 15 5
Retained earnings 10 3
Total equity 25 8
PORTFOLIO MANAGEMENT
Example 1: Odeade has just won N200,000 from Pop lottery Limited and has decided in the
interim to invest the money in two securities, X and Y, for a period of one year. N120,000 is to
be invested in security X and the balance in security Y. He has estimated returns ( that is, cash
inflow at the end of the year) and their probabilities as follows:
State of the Economy Returns probabilities
X Y
1 150,000 91,200 0.25
11 146,400 94,400 0.30
111 134,400 96,000 0.45
You are required to:
(a ). Calculate the expected return of each security
(b ) Calculate the standard deviation of each security
(c ) State ( with relevant calculations) the security with the risk given its expected return.
ICAN
Example 2: An investment analyst has provided the following data in respect of securities X and
Y:
Expected Return Risk
N N
X 2150 381
Y 2250 637
A prospective investor believes that by combining securities X and Y in the proportion 60% and
40% respectively, he could improves his position.
Required:
Calculate the portfolio return and risk where the correlation coefficient is +1, -1, and 0.
Example 3:
( a ). List the THREE forms of Capital Market Efficiency
( b ). A valued client of your stock broking firm has asked for your advice on his investment
portfolio. Details of his securities in the stock market ( which is regarded as efficient) with the
associated risk characteristics are given below:
Securities
X Y Z
Standards deviation (%) 5 15 14
Correlation coefficient (%) 80 40 60
Proportion of amount invested (%) 30 30 40
The expected return on shares in general and on the basis of past return and inflationary
expectation was estimated to be 20%. It is expected that the risk premium will be about 5%.
The risk of the market as measured by its standard deviation is 8%. All the three securities lie on
the same securities Market Line (SML).
You are required to prepare the following computations for a discussion with your client, as a
prelude to your advise.
(i ). The expected portfolio return
( ii). The risk of the portfolio
ICAN
Example 4: Your investment firm is a major player in the Nigeria Capital Market. Following
recent positive signs in the capital market, your firm has recruited a number of young
graduates. An in-house training programme is being planned for the young trainees and you are
to facilitate on subject areas such as portfolio concepts, capital assets pricing model, etc.
( a. ) your managing Director requires you to explain, without the use of graphs, Capital
Market Line (CML) and the Security Market Line (SML). You are to also consider the difference
between the two.
( b. ) consider a client having a portfolio of three stocks. The various expectations and the
current market situations are tabulated below ( all annualized values). The current risk free
interest rate is 6% per annum.
i. Calculate the expected returns from the three stocks if the stocks are correctly priced in
accordance with Capital Asset Pricing Model (CAPM).
ii. Are there any discrepancies between the return based on the CAPM theory and your
own expectations? If yes, advice on how to reshuffle the portfolio within these three
stocks in order to profit from them. If No, explain why. ICAN
Example 5: Chief Alagbala has the following portfolio of shares in five listed companies
in Nigeria:
Companies Black Blue Yellow Purple White
Shares held (units) 15,000 18,000 10,000 12,000 20,000
Price per unit N0.50 N0.60 N0.40 N0.25 N0.35
(a..) calculate
i. The Beta Factor
ii. The required return on the portfolio
(b..) explain the relevance of Portfolio Theory to chief Alagbala ICAN
Example 7: Badimi Limited is considering two mutually exclusive projects whose annual
possible net cash flows have the following distributions:
Initial investment of N1.1 million and N1.0 million will be required for projects A and B
respectively. The two projects will last for a period of five years.
½
2
m
SD = ∑ Aj – E(A)
P(Aj)
j=1
½
2
m
SD = ∑ Bj – E(B)
P(Bj)
j=1
Where :
Aj and Bj = the cash attached to each outcome
P = probability attached to the cash flow
E = the expected value of all the outcomes
c. Compute the coefficient of variation (CVAR for both projects and indicate the
project to select with reasons.
d. Explain the term “stand alone total risk” with reference to a project. Explain ONE
technique of measuring this type of risk.
ICAN
DIVIDEND POLICY
Exercise 1: Borkinni Plc. had prepared its capital expenditure budget for the next five years. It
expects that funds will be available to achieve the expenditure programme. The target net
income for each year is expected to be met.
Below is the summary of the capital expenditure and net income budget.
Year capital expenditure Net income
N’000 N’000
1 10,000 20,000
2 15,000 15,000
3 20,000 25,000
4 15,000 23,000
5 20,000 18,000
The company adopts active dividend policy and pays annual dividend of N1 per share. It had
issued 10 million ordinary shares of N1 each out of its 20 million authorized shares.
Required:
(a). Calculate the dividend per share and external financing in each year assuming the
company decides to treat dividend payment as a residual dividend policy.
(b). Calculate the amount of external financing that will be necessary in each year if the
present annual dividend per share is maintained.
(c). Calculate the dividend per share and the amounts of external financing that will be
necessary if a dividend payment ratio of 50% is adopted.
(d). under which of the three dividend policies (a, b, and c above) are aggregate dividends
over the five years maximized?
(e). which policy minimized required external financing over the five years? ICAN
Exercise 2: The management of Ballserve Plc. disagreed with the financial controller of the
company for using Walter’s model in estimating its share value. One director was of the opinion
that Gordon’s model would have presented a better position because of the company’s
dividend policy of 40% payout ratio. The cost of capital is 7.5% and the earnings per share is 285
kobo.
Required:
(a). Explain the importance of Walter’s dividend model and state THREE assumptions of the
model.
(b). Discuss THREE limitations of walter’s model
(c). (i). Calculate the share value at the payout ratios of 40% and 60% respectively and an
internal rate of return of 7.5% on each occasion.
(ii). Calculate the share values at the payout ratios of 40% and 60% respectively and an
internal rate of return of 12% on each occasion.
ICAN
Exercise 4: Timberland Plc has just made earnings of N450, 000. Its directors are trying
to decide a dividend policy. If they retain 20% of earnings, they think they can achieve
an annual growth rate in earnings and dividend of 5%. If they retain only 10% of
earnings, the growth rate would be only 2%. Shareholders would expect a return of 14%.
(b..) Mainland Plc has just made earnings of N2,250,000.its Directors are trying to
decide on a dividend policy. If they retain 20% of earnings, they believe they can achieve
an annual growth rate of 5% in earnings and dividend. If they retain only 10% of earrings
the growth rate would be 2% and shareholders would expect a return of 14%.
You are required to determine which retention policy would maximize the value of the
company’s shares.
(c..) State THREE advantages of retained earnings to a company. ICAN
EXERCISE 2
Company XEE Plc is planning to buy company YEE Plc. The financial
information on the proposed purchase is shown below:
Company YEE Plc has accepted the offer of N20.00 per share, to be received in shares of
company XEE Plc.
Determine the financial effect of this acquisition on the shareholders of both company X EE Plc
and company YEE Plc regarding their earnings per share. ICAN PILOT
EXERCISE 3
Victory Plc is considering making an offer for Valentine Plc. The offer is in the form of merger
where the shares in both companies will be swapped for shares in Victory plc. Extract of the
latest accounts of the two companies are as follows:
The two companies have the culture of retaining the same proportion of profits each year and this
is expected to continue indefinitely. Victory plc earns a return of 21% on new investments while
Valentine plc earns 16%. After Merger, Victory plc is expected to retain 60% of its earnings and
earn a return of 20% on investment.
The dividends of both companies have been paid. Ordinary shareholders of Victory plc required
18% rate of return and those of Valentine plc expect 12%. This will rise to 16% after the merger.
You are required to determine the:
a. market Value of each of the TWO companies before the Merger
b. maximum Price Victory should pay for Valentine Plc
ICAN
Exercise 4
Vita Plc. is a manufacturing company quoted on the stock Exchange. The company is doing very
well in view of the quality of its products and the effectiveness and efficiency of its management.
The company procures one of its major materials from Ponil Plc, a medium – size organization,
the shares of which are also quoted in the Exchange.
In order to quarantee smooth and continuous supply of its raw materials from Ponil plc Vital plc
plans to acquire ponil plc by issuing ordinary shares to its shareholders. The acquisition will, in
addition, focus on increasing earnings per share so as to provide necessary synergy for the
shareholders of both companies. The shareholders and management of Ponil plc are however
skeptical of the Merger because of the ‘side effects’ it may produce.
Ponil plc has agreed to an offer of N2.00 per share in exchange for Vital Shares.
You are required to:
( a ). State two likely side effects of the acquisition as envisaged by the shareholders and
management of Ponil plc from the standpoint of :
i. Control
ii. The managements of the company
Exercise 5
Adam plc is considering acquiring Eve plc. The summary of their most recent accounts is
presented below:
Both companies retain the same proportion of profits each year and are expected to do so in the
future. Adam plc’s return on investment is 16% while that of Eve plc is 21%. After the
acquisition in one year’s time, Adam plc 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 of ordinary
shareholders of Adam plc is 12% and Eve plc 18%. After the acquisition, this will become 16%.
Required:
( a ). If the acquisition is to proceed immediately, calculate the:
i. Pre – merger market values of the two companies
ii. Maximum price Adam plc will pay for Eve plc
( b ). Briefly explain the following actions a target company might take tp prevent a hostile
Takeover bid:
i. White Knight
ii. Shark repellants
iii. Pac – Man Defence
iv. Poison pill
v. Golden Parachute ICAN
Exercise 6
The Directors of Actuarial Plc, a conglomerate, is targeting Minororia Plc, an engineering
machinery manufacturer, for possible acquisition of its entire share capital. The directors were
interested in the acquisition because of the similarity in the two companies’ capital structure.
They believe that the takeover will not affect their business risks. The statement of financial
position of Minororia as at 31st December, 2014 is expected to be as follows;
Minororia Plc
Projected Statement of Financial Position
N’000 N’000
Non-current asset (Net of depreciation) 651,600
Current assets: inventory and W.I.P 515,900
Receivable 745,000
Bank balance 158,100 1,419,000
2,070,600
Current liabilities:
Payables 753,600
Bank 862,900 1,616,500
Bank overdraft 454,100
Representing:
Capital and Reserves:
Issued ordinary shares of N1 each 50,000
Distributable Reserves 404,100
454,100
The summarized financial records of Minororia plc for five years to 31st December 2014 is as
follows:
Minororia Plc
Additional information:
i. There have been no changes in the issued share capital of Minororia plc during the past
five years.
ii. The estimated values of Minororia Plc’s non-currents, inventory and work-in-progress for
the year ended 31st December 2014 will be as follows:
Companies within the industry having similar profit woth those of Minororia plc have P/E
ratio of approximately 10, although these companies tend to be large than Minororia plc.
Exercise 7
KING PLC and QUEEN PLC both ,manufacture and sell household equipment. The summarized
Income Statements of the two companies for the year 2012 are as follows:
KING PLC QUEEN PLC
N’000 N’000
Revenue 37,500 20,000
Operating expenses (20,000) (15,500)
17,500 4,500
Each company has earned a constant level of profit for a number of years and both are expected
to continue to do so for the nearest future. The policy of both companies is to distribute all profits
as dividend to ordinary shareholders as they are earned. None of the companies has any fixed
interest capital.
The ordinary shares of KINGS plc have a current market value of N3.50 each ex –div, and those
of QUEEN plc a current market value of N1.50 ex – div.
The directors shares of KING plc are considering submitting a bid for the entire share capital of
QUEEN plc. They believe that if the bid succeeds, the combined sales revenue of the two
companies will increase by N1,500,000 per annum and savings in operating expenses amounting
to N1,250,000 per annum will be possible. Part of the machinery presently owned by KING plc
would no longer be required and could be sold for N2,500,000.
Furthermore, the directors of KING plc believe that the takeover would result in a reduction of
the returns required by the ordinary shareholders to 10%.
Required:
a. As a financial consultant to KING plc, advise on the maximum price that the company
should be willing to pay for the entire share capital of QUEEN plc, showing clearing the
basis of your advice. (
b. Show how the entire benefits from the takeover will accrue to all the present shareholders
of KING plc assuming that the takeover is agreed at half of the figure you advised, and
that the purchase consideration will be settled by an exchange of ordinary shares in
QUEEN plc.
c. Discuss briefly any other factors that the directors and shareholders of both companies
might consider in assessing the acceptability of the proposed takeover.
d. List any FIVE defence tactics that could be used by QUEEN plc to frustrate the take-over
bid of KINGs plc. ICAN
Exercise 8
Gazoline Plc., a public limited company with a market value of N7 billion , is a major supplier of
gas to both business and domestic customers. The company also provides maintenance contracts
for both gas and central heating customers using the well-known brand name “Gas For All”.
Customers can call emergency lines for assistance for any gas-related incident, such as a
suspected leakage. Gasoline Plc. Employs its own highly trained work force to deal with all such
situations quickly and effectively. The company also operates a major new credit card scheme,
which has been extensively marked and is designed to give users concessions such as reductions
in their gas bills.
The company has recently bid N1.1 billion for Smooth car, a long established mutual
organization (i.e., it is owned by its members) that is the country’s leading motoring
organization. Smooth car is financed primarily by an annual subscription of its 4.4 million
members. In addition, the organization obtains income from a range of other activities such as a
high profile car insurance brokerage, a travel agency and assistance with all types of travel
arrangements. Its main service to members is the provision of a roadside break-down service
which is now an extremely competitive market with many other companies involved. Although
many of its competitors use local garages to deal with break-downs. Smooth Car uses its own
road patrols.
Smooth Car members have to approve the takeover which once completed would provide them
each with a windfall of around N300 each.
Gazoline plc. Intend to preserve the Smooth Car name which is well-known by customers.
Required:
a. Examine the possible reasons why Gazoline plc. is seeking to buy Smooth Car.
b. Discuss how the various stakeholders of Smooth Car might react to the takeover.
c. Explain the potential problems that Gazoline plc. may face in running Smooth Car now
that the takeover has been achieved. ICAN
Exercise 9
Corporate failure is never the result of a random set of events. It is normally a reflection of deep-
seated corporate shortcomings.
a. Identify and discuss the financial symptoms of a corporate failure in Nigeria.
b. Discuss SEVEN general causes of corporate failure in Nigeria.
ICAN
Exercise 10
The entire share capital of WAZOBIA Limited, an unlisted company, is held by the three
directors of the company – Chief Oyomesi, Alhaji Katagun and High Chief Agbor. They have
decided to sell their shares in order to complete a divestment proposal agreed with management
and, as such, wish to know the likely value of the shares before approaching prospective buyers.
Should they fail to get buyers for the shares, the company will go into liquidation.
b.. Extracts from the published statement of Profit or Loss and other comprehensive income for
the last three years are
It was discovered that inventories were over-valued at the end of 2008 by N600,000. The
directors have increased their remuneration in order to reduce the company’s tax liability. A
realistic charge for services rendered would be N1,875,000. The equipment is old and it is in
need of replacement. The annual depreciation, based on current replacement cost is in the region
of N3,000,000
c.. Each of the directors expressed different opinion on the valuation method to be adopted . to
Chief Oyomesi, it is most appropriate to value the shares on the basis of price/earnings ratio. For
this purpose, he argues that earnings should be defined as the average reported profits for the last
three years, after making proper charges for depreciation and directors’ remuneration and
correcting the error made on inventories in 2008.
In his own opinion, Alhaji Katagun recommends break – up basis using liquidation values as
provided by experts. High Chief Agbor, on the other hand, believes that dividend yield basis be
used, with available data obtained from two similar but listed companies where he is a
shareholder.
d.. The relevant data of the two listed companies engaged in similar line of business as
WOZOBIA Limited are as follows:
e.. Figures obtained from experts for items appearing in the Statement of Financial position of
WAZOBIA Limited as at 31 December 2011 are as stated below:
N’000 N’000
Freehold properties 15,000 15,000
Equipment 8,650 5,400
Inventories 4,350 8,000
Note: Assume you are making the valuation as at 31 December, 2011. Ignore taxation and
liquidation costs. (show all workings)
(b. Identify any TWO limitations associated with each of the methods above.
ICAN
Exercise 11
Chelsy Plc has two manufacturing divisions, Bolts and Nuts. The Bolts division is profitable
whereas the Nuts division is not. The company’s share price has consequently decline to 50k per
share from a price of N2.83 per share three years ago.
Loss (77,000)
If the company’s assets are sold, the estimated realizable values are as follows
N’000
Non-current assets 550,000
Current assets 605,000
Required:
a. Discuss, briefly, the possible benefits of divesting Bolts division through a management
buyout.
b. Estimate the return the creditors and the shareholders will receive in the event that Chelsy
Plc is closed and all its assets sold.
c. Estimate the additional amount of finance needed and the value of the new company, if
only the assets of Nuts division are sold and Bolts division is divested through a
management buyout.
d. Discuss the issues that should be taken into consideration in relation to:
i. Seeking potential buyers and negotiating the price
ii. Due diligence
(Assume that the Nuts division is to be sold as a going concern) ICAN
Exercise 12 : Razer Bank Plc is a commercial bank incorporated in Nigeria in the early 90’s. The
Head office of the bank is situated in Lagos and it has a network of branches in all the states of
the Federation. The objectives of Razer bank plc are maximization of shareholders’ wealth and
provision of efficient retail and corporate banking services to its individual and corporate
customers. These have been achieved over the past years.
Recently the Federal Government, through the CBN, revised the minimum capital of banks. This
conditions was to be met by all banks latest 31 December 2015. This forced all the banks to
offer to members of the public their ordinary shares for subscription. Razer bank plc, in line
with this directive offered its shares to the public. However, it only succeeded in increasing its
capital bas substantially although this still falls below the required amount. The only option that
is open to Razer bank plc if it wants to remain in business is to amalgamate with another bank
with good track record. The bank which come to mind is Help Bank plc, which incidentally
managed to increase its capital base to N10m. the board of Razer bank plc, is considering
making an offer to Help bank plc. The offer is to take the form of a merger on a share exchange
basis. The new bank to be formed is to be called Ralp bank plc.
Extracts from the most recent accounts of the two banks are given below:
RAZER HELP
N’m N’m
19,460 12,150
RAZER HELP
N’m N’m
Both companies retain the same proportion of profits each year and are expected to do so in
the future. While Razer bank’s dividends are expected to grow by 12%, those of Help bank are
expected to grow by 4% per annum.
After the merger ( i.e. in one year’s time), Ralp plc will retain 60% of its earnings and post
merger dividends growth rate is expected to be 10%. The dividends of both companies have
been paid. The required rate of return of the ordinary shareholders of Razer Bank plc is 15% and
that of Help Bank plc is 12%. After merger this will alter to 14%.
Required:
( a ). What is the required minimum capital for Nigerian banks under the current
dispensation?
( b ). What is the type of integration anticipated by Razer Bank plc called?
( c ). If the merger is to take place immediately, calculate;
( i ). Market values of the two banks before merger
( ii ). Maximum price Razer Bank plc will pay Help bank plc. ICAN
VALUATION OF SECURITIES
Example 1: You are given the following information about Affairs Plc, which is an all equity-
financed company. The number of shares in issue is 150,000 of N1 each.
Current Dividend N6,158
Cost of capital 24%
Current Earnings N62,858
Net Assets N315,000
Dividend – 5 years ago N2,473
You are required to estimate the market value per share for the company, using
a. Dividend growth valuation method
b. Gordon’s growth model
Example 2
Dopemu Plc and Demurin Plc are subsidiary companies of Ketu investments Plc. The companies
have in issue 4 million ordinary shares of 50k each.
Other information relating to the two subsidiary companies are:
Dopemu Plc has 250,000 units of convertible Debenture each with a nominal value of N100 and
a coupon interest rate of 12% payable annually. Each N100 unit may be converted into 40
ordinary shares at anytime until the expiry date and any Debentures remaining unconverted
will be redeemed that day at N105.
Demurin plc has 5,000,000 warrants, each of which provides the holder with an option to
subscribe for 2 ordinary shares at a price of N2.50 per share. Each warrant holder can exercise e
his option before the expiry date.
NOTE
Ordinary shares, convertibles and the warrants of the companies, are all actively traded in the
stock market.
Required:
( a ). Give FOUR factors which influence the value of warrants and convertibles
( b ). Determine the value of each N100 unit of convertible Debentures and each Warrant on
the day of expiry and advise Ketu Investments Plc whether or not to exercise its conversion and
option rights if the share prices of each company immediately prior to the latest time for
conversion and exercise were to be: (i) N2.20 (ii) N2.60 (iii) N3.00 (iv) N3.40
( c ). Determine the likely current market price, or likely range of current market price of each
N100 unit of convertible Debentures, if they have a further 5 years before expiry and if the
current price for each share is : (i) N2.20 (ii) N2.60 (iii) N3.00 (iv) N3.40
The appropriate pre – tax rate of interest on a five – year debt security is 8%
(ICAN Pilot)
Example 3. You are a financial consultant to a major company based in Kano. The company
plans to build a major warehouse in Abuja. You plan to convince the company’s manager to
raise the needed funds through a convertible bond issue. Based on the company’s current
rating of BBB, you have projected the following offer terms:
Maturity: 6 years
Annual coupon: 1%
Conversion ratio: 50 shares
Par value per bond: N1,000
Issue price: 98% of par value
Current stock price: N16
Risk-free-rate: 0.5%
Coupon on straight bonds: 2% (trading at par)
The proposal suggests raising up to N20, 000,000. However, with key financial ratios close to
the boundaries of the rating category, offering the full amount could threaten the BBB rating.
Given an average business risk profile, the following rating guidelines apply:
Required:
a. i. Determine the value of the convertible bond offer (5 mks)
ii. Discuss why the convertible bond cannot generally be considered as ‘cheap
debt’ despite its low coupon, given its financial advantage quantified in economic
terms. (3 mks)
b. i. compute the company’s current interest coverage ratio. (1 mk)
ii. How much money should be raised with the convertible bond issue (in thousands
of naira in order to avoid the threat of a rating downgrade, based on the quoted
rating guidelines? (4 mks)
c. Advise the company on the advantages of convertible bond for companies on one hand
and for the investors on the other hand. (7 mks)
(Total 20 marks)
ICAN MAY 2017
Example 4
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. long term funds, details of which are
shown here as at 28 February, 2017:
Total par value Market value
Nm
Ordinary share capital (50k) 67.5 N2.65/share ex-div
7% Preference share capital (N1) 60.0 N1.44/share ex div
4% Redeemable debentures (N100) 45.0 N90% ex-int
The debentures are redeemable in 2022. LL Plc.‟s earnings for the year to 28
February, 2017 were N32.4 million and are expected to remain at this level for the
foreseeable future. Retained earnings, as at 28 February, 2017 was N73.2 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)
(Total 20 Marks)
ICAN MAY 2017
Example 5
LA Ltd., a food packaging company, has operated as a private company for the past 10
years. The company has been growing rapidly over the last few years. The Directors are
now considering listing the company on the stock market. Preparatory to this, the Directors
are interested in determining a fair price per share for the company. Assume today is
November 1, 2016.
The following information has been extracted from the most recent audited financial
statements of LA Ltd:
The Directors believe that the free cash flow to equity model should provide
appropriate valuation for the company‟s shares.
Required
a. Calculate the free cash flow available to equity for the year ended October 31,
2016. (7 Marks)
b. Use Free Cash Flow to Equity model to calculate the current value per share.
(5 Marks)
c. What are the key advantages and disadvantages of stock exchange listing
(8 Marks)
(Total 20 Marks)
ICAN MAY 2017