financial management strategy nov 2007

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QUESTION 1

(a) You have just been employed as the new Chief Executive Officer of a medium-sizedcompany that is listed on the Ghana Stock Exchange. At the maiden Board Meeting, thechairman advised you and your management team to avoid what he termed as Agency

problem.

Explain the term Agency Problem, and identify four (4) ways by which shareholders can dealwith it.

(8 marks)

(b) Renicard Company Ltd, a consulting firm, has decided to acquire computer/datahandling equipment. The company should choose one of two ways of financing theacquisition.

Option 1: Renicard Company Limited to lease the equipment on a six-year contract

for a lease payment of GH18,000 per year, with payments to be made at the beginningof each year. The lease payment will include maintenance.

Option 2: Renicard company Limited could purchase the equipment outright for GH90,000, financing the purchase by a bank loan for the net purchasing price andamortizing the loan over a six-year period. Under the borrow-to-purchase arrangement,the company would have to maintain the equipment at GH3,000 per year, payable atthe end of each year. The equipment will be depreciated on a reducing balance methodat 40 percent per annum. The equipment would be disposed of and would have aresidual value of GH4,199, which is expected to be the market value after six years,when the construction company plans to replace the asset irrespective of whether itleases or buys the asset. Renicard company Limited falls within the 25% tax bracket.The rate of interest is 10% per annum.

Should the company lease or buy the computer/data handling equipment?(12 marks)

(Total: 20 marks)

QUESTION 2

You find yourself in a situation commonly faced by Financial Managers. Your ManagingDirector thinks business will improve if you change your current policy of cash sales only toallow for credit sales. Currently your annual sales are GH6,000. If you offer 30 days credit,you will need to set up a credit department. You expect that it will cost you GH2 to run thisdepartment monthly. Naturally, you expect all customers to buy on credit for 30 days. You

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anticipate that 1.5% of credit sales will not be collected. You must also make additionalinvestments in debtors but not in fixed machinery or other overheads by drawing on your creditline with a bank on which you expect to pay 12% per annum interest on amounts drawn. Yourcost of sales has been 60% of sales. Additionally, marketing expenses are 25% of sales. If yourtax rate is 25% by how much must your sales increase to make this change worthwhile?

(20 marks)

QUESTION 3

The Government of Ghana intends to borrow to finance a nuclear plant in order to increase theenergy generating capacity of the country.

The Ghanaian government has a choice of two possible $100 million, five year Eurodollarloans. The first loan is offered at Prime Rate + 1% with 2.5% syndication fee whereas thesecond loan is priced at Prime rate + 1.5% and a 0.75% syndication fee. The cost of capital is10%.

You are required:

(a) To calculate the cost of the two loans and advise the Finance Minister on the loan whichis preferable. (10 marks)

(b) Identify four (4) benefits the Government of Ghana will obtain from centralising itsinternational cash management and foreign exchange management.

(10 marks)(Total: 20 marks)

QUESTION 4

(a) Company XX has a market value of GH50 million. Company YY has a market valueof GH200 million. YY has determined that if it combines resources with XX, costsavings will be worth GH25 million today. On this basis YY makes an offer to buyXX.

(i) If YY makes a cash offer of GH65 million for all the shares of XX, what is the costof this purchase to YY? (3marks)

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(ii) What are the gains of this transaction? (1 mark)

(iii) Suppose YY has issued 100 of its shares to its shareholders, and is consideringissuing 30 shares to the shareholders of XX, what is the cost of the share offer?

(6 marks)

(iv) What is the net present value of the transaction under the cash offer to YY?(2 marks)

(v) What is the net present value under the share offer? (2 marks)

(b) Explain clearly but briefly, three (3) ways by which synergies might be realized inbusiness combinations. (6 marks)

(Total: 20 marks)

QUESTION 5

(a) Identify and briefly explain the implications of efficient market hypothesis (EMH)for investors and firms. (5marks)

(b) Explain the differences between using currency futures versus currency options tohedge exchange risk.

(5 marks)

(c) Asaba Ltd, a low rated firm desires a fixed rate, long term loan. It currently hasaccess to floating interest rate funds at a margin of 1.5% over the Prime Rate. Its directborrowing cost is 13% in the fixed rate bond market. Bezec Ltd which prefers a floatingrate loan has access to fixed rate funds in cedi-bond market at 11% and floating ratefunds at Prime Rate + %.

You are required:

(i) To explain how Asaba Ltd and Bezec Ltd can use swap to their advantage.(8 marks)

(ii) Calculate how much Asaba Ltd would pay for its fixed rate funds.(2 marks)

(Total: 20 marks)

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financial management strategy nov 2007

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