UNIVERSITY OF PROFESSIONAL STUDIES, ACCRA

SCHOOL OF GRADUATE STUDIES

MBA ACCOUNTING AND FINANCE
FINANCIAL MANAGEMENT
PRACTICE SET
Question 1
a. As the Head of Business Development of Fidelity Venture Capital, a client has presented a
business plan that has the following projected returns for your consideration;

Stock A Stock B

State of the Economy Returns Prob Returns Prob

Excellent 32% 0.4 40% 0.2

Worse -5% 0.4 8% 0.3

Normal 21. % 0.2 25% 0.5

Required:
i. Calculate the expected return for each stock
ii. Calculate the total risk of the client’s business for each stock
iii. If your client plans investing equally in each stock, with a correlation coefficient of -0.8,
what is the portfolio return and portfolio risk?
iv. If the beta of the client’s business is 0.9 and the risk-free rate is 22%, calculate the required
rate of investment if the market risk premium is 4%.

Question 2
Shiloh Ltd is buying a piece of equipment for GH¢100,000. The company intends to finance the
purchase using debt and equity. A loan (debt) of GH¢30,000 is to be sourced from GCB at an
interest rate of 16% per annum. The remaining GH¢70,000 will be financed using equity. The
firm is listed on the GSE with an equity beta of 2.5. The risk free rate of interest is 10% and the
market risk premium is 10%%. The marginal tax rate of the firm is 25%. The equipment is
expected to generate the following cash flows:

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Year Cash Flows (GH¢)
1 25,000
2 39,000
3 42,000
4 35,000
5 25,000
6 30,000
i. Advise whether the company should buy the equipment or not using the NPV and
profitability index
ii. Why would you prefer the NPV method to other methods of project evaluation?

Question 3
a. Mr. Kiwat borrowed GH¢200,000 from his bankers to buy his dream house. Repayment is
over 4 years and first payment is due one year from hence. He will make equal payments to
amortize both the principal and interest, which is calculated on a reducing balance basis. The
bank will charge 5% above its current base rate of 20% per annum.

Required:
i. Calculate Mr Bruce’s annual payments
ii. Show a table on how the annual payment will liquidate the loan and interest.

b. Cross Ltd has bought an asset with a life span of 4 years. At the end of the 4 years,
replacement of the asset will cost GH¢12,000. In this direction, the company has decided to
provide for the future commitment by setting up a sinking fund account into which equal
annual investment will be made at the end of each year. Interest rate on the investment will
be 12% per annum.

Required:
i. Calculate the annual instalments
ii. Draw up the sinking fund schedule to show the growth fund
iii. Assuming the first payments will be made now and 12 months thereafter, what are the annual
payments?
iv. Draw up the sinking fund schedule under (c)

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Question 4
A father is planning a savings program to put his daughter through university. His daughter is
now 13-year-old. She plans to enroll at the university in 5 years, and it should take her 4 years to
complete her education. Currently, the cost per year (for everything – her food, clothing, tuition,
books, transportation, and so forth) is GH¢ 12,000 per year. This cost is expected to remain
constant throughout the four-year university education. The daughter recently received GH¢
7,500 from her grandfathers, estate; this money will be invested at a rate of 8% to help meet the
costs of the daughter’s education. The rest of the costs will be met by money the father will
deposit in a savings account which also earns 8 percent compound interest per year. He will
make 5 equal deposits into the account, one deposit per annum starting one year from now until
his daughter starts university. These deposits will begin one year from now. (Assume that school
fees are paid at the beginning of the year)
i) What will be the present value of the cost of 4 years of education at the time the daughter
turns 18?
ii) What will be value of the GH¢ 7,500 that the daughter received from her grandfather’s
estate when she starts college at 18?
iii) If the father is planning to make the first of 5 deposits one year from now, how large
must each deposit be for him to able to put his daughter through college?

Question 5
The earnings, dividends and stock price of Carpetto Technologies Inc. are expected to grow at
7% per year in the future. Carpetto’s common stock sells for GH¢ 23 per share, its last dividend
was GH¢ 2, and the company will pay a dividend of GH¢ 2.14 at the end of the current year.
a) Using the discounted cash flow approach, what is its cost of common equity?
b) If the firm’s beta is 1.6, the risk-free rate is 9%, and the average return on the market is
13%, what is the firm’s cost of common equity using CAPM approach?
c) If the firm’s bond earns a return of 12%, what will the cost of equity be using the bond-
yield-plus-risk-premium approach? Use a risk premium of 4%
d) On the basis of the results of parts a through c, what would you estimate Capetto’s cost
of cost of common equity to be?

Question 6
God is King Ltd has been printing all its magazines from Dubai due to the comparative cost
advantage. The company is considering establishing its own printing department, and the R&D
team have identified a printing machine which will meet the quality and cost specifications of
God is King Ltd. The machine also has the capacity to print to meet the market needs of the

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company. The machine, which has a useful life of 5 years, will cost GHȼ800,000 and immediate
installation cost will be GH¢ 50,000. Fixed cost for maintaining the machine will be GH
¢170,000 per annum over the machine’s useful life and additional working capital of GH¢
30,000 will be introduced in year 2. The use of this machine will generate a contribution of GH¢
500,000 per annum for five (5) years. Corporate income tax rate, payable in areas, is 25% and
the companies after tax cost of capital is 20%. No capital allowance is permitted.
Required:
Calculate the NPV for the project and advise management on whether to accept or reject the
project.

Question 7
Alpha Corporation and Beta Corporation are identical in every way except their capital
structures. Alpha Corporation, an all equity firm, has 15,000 shares of stock outstanding,
currently worth GH¢ 30 per share. Beta Corporation uses leverage in its capital structure. The
market value of Beta’s debt is GH¢ 65, 000, and its cost of debt is 9 percent. Each firm is
expected to have earnings before interest of GH¢ 75,000 in perpetuity. Neither firm pays taxes.
Assume that every investor can borrow at 9 percent per year.
a. What is the value of Alpha Corporation?
b. What is the value of Beta Corporation?
c. What is the market value of Beta Corporation’s equity?

Question 8
a. Given the following information for Huntington Power Co., find the WACC. Assume the
company’s tax rate is 35 percent.

Debt: 5,000 6 percent coupon bonds outstanding, GH¢ 1,000 par value, 25 years to maturity,
selling for 105 percent of par; the bonds make annual payments.

Common stock: 175,000 shares outstanding, selling for GH¢ 58 per share; the beta is 1.10.
Market: 7 percent market risk premium and 5 percent risk-free rate.

b. The Saunders Investment Bank has the following financing outstanding. What is the WACC
for the company?
Debt: 60,000 bonds with a coupon rate of 6 percent and a current price quote of 109.5; the bonds
have 20 years to maturity. 230,000 zero coupon bonds with a price quote of 17.5 and 30 years
until maturity.

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Preferred stock: 150,000 shares of 4 percent preferred stock with a current price of GH¢ 79, and
a par value of GH¢ 100.
Common stock: 2,600,000 shares of common stock; the current price is GH¢ 65, and the beta of
the stock is 1.15.
Market: The corporate tax rate is 40 percent, the market risk premium is 7 percent, and the risk-
free rate is 4 percent.

Question 9
Howell Petroleum is considering a new project that complements its existing business. The
machine required for the project costs GH¢3.8 million. The marketing department predicts that
sales related to the project will be GH¢2.5 million per year for the next four years, after which
the market will cease to exist. The machine will be depreciated down to zero over its four-year
economic life using the straight-line method. Cost of goods sold and operating expenses related
to the project are predicted to be 25 percent of sales. Howell also needs to add net working
capital of GH¢ 150,000 immediately. The additional net working capital will be recovered in full
at the end of the project’s life. The corporate tax rate is 35 percent. The required rate of return for
Howell is 16 percent. Should Howell proceed with the project?

Question 10
With the growing popularity of casual surf print clothing, two recent MBA graduates decided to
broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited
capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They
projected unit sales of these lamps to be 7,000 in the first year, with growth of 8 percent each
year for the next five years. Production of these lamps will require GH¢35,000 in net working
capital to start. Total fixed costs are GH¢ 95,000 per year, variable production costs are GH¢ 20
per unit, and the units are priced at GH¢48 each. The equipment needed to begin production will
cost GH¢175,000. The equipment will be depreciated using the straight-line method over a five-
year life and is not expected to have a salvage value. The effective tax rate is 34 percent, and the
required rate of return is 25 percent. Evaluate the project using NPV.

Question 11
Pilot Plus Pens is deciding when to replace its old machine. The machine’s current salvage value
is GH¢ 2.2 million. Its current book value is GH¢ 1.4 million. If not sold, the old machine will
require maintenance costs of GH¢ 845,000 at the end of the year for the next five years.
Depreciation on the old machine is GH¢ 280,000 per year. At the end of five years, it will have a
salvage value of GH¢ 120,000 and a book value of GH¢ 0. A replacement machine costs GH¢
4.3 million now and requires maintenance costs of GH¢ 330,000 at the end of each year during

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its economic life of five years. At the end of the five years, the new machine will have a salvage
value of GH¢ 800,000. It will be fully depreciated by the straight-line method. In five years a
replacement machine will cost GH¢ 3,200,000. Pilot will need to purchase this machine
regardless of what choice it makes today. The corporate tax rate is 40 percent and the appropriate
discount rate is 8 percent. The company is assumed to earn sufficient revenues to generate tax
shields from depreciation. Should Pilot Plus Pens replace the old machine now or at the end of
five years?

Question 12
Aguilera Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation
implant as follows:
Year Unit Sales
1 83,000
2 92,000
3 104,000
4 98,000
5 84,000

Production of the implants will require GH¢ 1,500,000 in net working capital to start and
additional net working capital investments each year equal to 15 percent of the projected sales
increase for the following year. Total fixed costs are GH¢ 2,400,000 per year, variable
production costs are GH¢ 190 per unit, and the units are priced at GH¢ 345 each. The equipment
needed to begin production has an installed cost of GH¢ 23,000,000. Because the implants are
intended for professional singers, this equipment depreciated using the straight-line basis. In five
years, this equipment can be sold for about 20 percent of its acquisition cost. AAI is in the 35
percent marginal tax bracket and has a required return on all its projects of 18 percent. Based on
these preliminary project estimates, what is the NPV of the project? What is the IRR?

Question 13
Consider the following information about three stocks:

Returns
State of Economy Prob A B
Boom 0.3 0.2 0.25
Normal 0.45 0.15 0.11
Bust 0.25 0.01 -0.15

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a. If your portfolio is invested 70 percent in A and 30 percent in B, what is the portfolio
expected return? The variance? The standard deviation?
b. If the expected T-bill rate is 3.80 percent, what is the expected risk premium on the portfolio?
c. If the expected inflation rate is 3.50 percent, what are the approximate and exact expected
real returns on the portfolio? What are the approximate and exact expected real risk
premiums on the portfolio?

Question 14
Security F has an expected return of 10 percent and a standard deviation of 43 percent per year.
Security G has an expected return of 15 percent and a standard deviation of 62 percent per year.
a. What is the expected return on a portfolio composed of 30 percent of Security F and 70
percent of Security G?
b. If the correlation between the returns of Security F and Security G is .25, what is the standard
deviation of the portfolio described in part (a)?

Question 15
You own all the equity of R.G.C. I Ltd. The company has no debt. The company’s annual cash
flow is GH¢900,000 before interest and taxes. The company tax rate is 35%. You have the
option to exchange 1/2 of your equity position for 5% bonds with a face value of GH¢2,000,000.
i. What is the value of the unlevered firm?
ii. What is the value of the levered firm?
iii. Assuming a bankruptcy cost of GH¢8000, what is the value of the levered firm after
considering bankruptcy cost?

Question 16
a. Based on the following information, calculate the expected return and standard deviation for
each of the following stocks. What are the covariance and correlation between the returns of
the two stocks? Calculate the portfolio return and portfolio standard deviation if you invest
equally in each asset.

Returns
State of Economy Prob J K
Recession 0.25 -0.02 0.034
Normal 0.6 0.138 0.062
Boom 0.15 0.218 0.092

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b. A portfolio that combines the risk-free asset and the market portfolio has an expected return
of 7 percent and a standard deviation of 10 percent. The risk-free rate is 4 percent, and the
expected return on the market portfolio is 12 percent. Assume the capital asset pricing model
holds. What expected rate of return would a security earn if it had a .45 correlation with the
market portfolio and a standard deviation of 55 percent?
c. Suppose the risk-free rate is 4.2 percent and the market portfolio has an expected return of
10.9 percent. The market portfolio has a variance of .0382. Portfolio Z has a correlation
coefficient with the market of .28 and a variance of .3285. According to the capital asset
pricing model, what is the expected return on Portfolio Z?

Question 17
a. Consider the following information about Stocks A and B:

Returns
State of Economy Prob A B
Recession 0.15 0.11 -0.25
Normal 0.55 0.18 0.11
Irrational Exuberance 0.3 0.08 0.31

The market risk premium is 7.5 percent, and the risk-free rate is 4 percent. Which stock has the
most systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”?
Explain.

b. There are two stocks in the market, Stock A and Stock B . The price of Stock A today is GH¢
75. The price of Stock A next year will be GH¢64 if the economy is in a recession, GH¢ 87 if
the economy is normal, and GH¢97 if the economy is expanding. The probabilities of
recession, normal times, and expansion are 0.2, 0.6, and 0.2, respectively. Stock A pays no
dividends and has a correlation of 0.7 with the market portfolio. Stock B has an expected
return of 14 percent, a standard deviation of 34 percent, a correlation with the market
portfolio of 0.24, and a correlation with Stock A of 0.36. The market portfolio has a standard
deviation of 18 percent. Assume the CAPM holds.
i. If you are a typical, risk-averse investor with a well-diversified portfolio, which stock
would you prefer? Why?
ii. What are the expected return and standard deviation of a portfolio consisting of 70
percent of Stock A and 30 percent of Stock B ?
iii. What is the beta of the portfolio in part (b)?

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Question 18
a. Weston Industries has a debt–equity ratio of 1.5. Its WACC is 11 percent, and its cost of debt
is 7 percent. The corporate tax rate is 35 percent.
i. What is Weston’s cost of equity capital?
ii. What is Weston’s unlevered cost of equity capital?
iii. What would the cost of equity be if the debt–equity ratio was 2? What if it were 1.0?
What if it were zero?

b. Shadow Corp. has no debt but can borrow at 8 percent. The firm’s WACC is currently 11
percent, and the tax rate is 35 percent.
i. What is Shadow’s cost of equity?
ii. If the firm converts to 25 percent debt, what will its cost of equity be?
iii. If the firm converts to 50 percent debt, what will its cost of equity be?
iv. What is Shadow’s WACC in part (b)? In part (c)?

c. The Dongomi Corp. buys a part that costs GHȼ 500. The carrying cost of inventory is
approximately 20% of the part’s cedi value per year. It costs GHȼ 5000 to place, process and
receive an order. The firm uses 90,000 of the GHȼ 500 parts per year. What ordering
quantity minimizes inventory costs? What inventory costs are incurred for the part with this
ordering quantity?

Question 19
a. Your company will generate GH¢ 55,000 in annual revenue each year for the next eight years
from a new information database. The computer system needed to set up the database costs
GH¢ 250,000. If you can borrow the money to buy the computer system at 7.5 percent annual
interest, can you afford the new system?
b. An investment offers GH¢ 2,250 per year for 15 years, with the first payment occurring one
year from now. If the required return is 10 percent, what is the value of the investment? What
would the value be if the payments occurred for 40 years? For 75 years? Forever?
c. You want to have GH¢ 50,000 in your savings account five years from now, and you’re
prepared to make equal annual deposits into the account at the end of each year. If the
account pays 9.5 percent interest, what amount must you deposit each year?
d. First National Bank charges 7.5 percent compounded quarterly on its business loans. First
United Bank charges 7.5 percent compounded semi-annually. As a potential borrower, which
bank would you go to for a new loan?

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Question 20
The Baldwin Company, originally established 16 years ago to make footballs, is now a leading
producer of tennis balls, baseballs, footballs, and golf balls. Nine years ago, the company
introduced “High Flite,” its first line of high-performance golf balls. Baldwin management has
sought opportunities in whatever businesses seem to have some potential for cash flow. Recently
W. C. Meadows, vice president of the Baldwin Company, identified another segment of the
sports ball market that looked promising and that he felt was not adequately served by larger
manufacturers.
As a result, the Baldwin Company investigated the marketing potential of brightly colored
bowling balls. Baldwin sent a questionnaire to consumers in three markets: Philadelphia, Los
Angeles, and New Haven. The results of the three questionnaires were much better than expected
and supported the conclusion that the brightly colored bowling balls could achieve a 10 to 15
percent share of the market. Of course, some people at Baldwin complained about the cost of the
test marketing, which was GH¢ 250,000.
In any case, the Baldwin Company is now considering investing in a machine to produce
bowling balls. The bowling balls would be manufactured in a building owned by the firm and
located near Los Angeles. This building, which is vacant, and the land can be sold for GH¢
150,000 after taxes.
Working with his staff, Meadows is preparing an analysis of the proposed new product. He
summarizes his assumptions as follows: The cost of the bowling ball machine is GH¢100,000
and it is expected to last five years. At the end of five years, the machine will be sold at a price
estimated to be GH¢ 30,000. The machine is depreciated on straight line basis. The company is
exempt from capital gains tax. Production by year during the five-year life of the machine is
expected to be as follows: 5,000 units, 8,000 units, 12,000 units, 10,000 units, and 6,000 units.
The price of bowling balls in the first year will be GH¢20. The bowling ball market is highly
competitive, so Meadows believes that the price of bowling balls will increase at only 2 percent
per year, as compared to the anticipated general inflation rate of 5 percent.
Conversely, the plastic used to produce bowling balls is rapidly becoming more expensive.
Because of this, production cash outflows are expected to grow at 10 percent per year. First-year
production costs will be GH¢10 per unit. Meadows has determined, based on Baldwin’s taxable
income, that the appropriate incremental corporate tax rate in the bowling ball project is 34
percent.
Like any other manufacturing firm, Baldwin finds that it must maintain an investment in working
capital. It will purchase raw materials before production and sale, giving rise to an investment in

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inventory. It will maintain cash as a buffer against unforeseen expenditures. And, its credit sales
will not generate cash until payment is made at a later date. Management determines that an
initial investment (at Year 0) in net working capital of GH¢10,000 is required. Subsequently, net
working capital at the end of each year will be equal to 10 percent of sales for that year. In the
final year of the project, net working capital will decline to zero as the project is wound down. In
other words, the investment in working capital is to be completely recovered by the end of the
project’s life.
Evaluate the project using NPV

Question 21
You have just been employed as the new Chief Executive Officer of a medium-sized company
that is listed on the Ghana Stock Exchange. At the maiden Board Meeting, the chairman advised
you and your management team to avoid what he termed as “Agency problem”. Explain the
term “Agency Problem” in corporate governance, and briefly explain four (4) ways by which
the shareholders of company can encourage its managers to act in ways which are consistent
with the objective of value maximization.

Question 22
a. Kako Ltd has a revolving credit agreement with a bank. It can borrow up to GHȼ 1 million at
12 percent interest but is required to maintain a 10 percent compensating balance on any
funds borrowed under the agreement. In addition, it must pay a 0.5 percent commitment fee
on the unused portion of the formal credit line. If the firm borrows GHȼ 400,000 for an entire
year under this agreement, makes all payments at note maturity, and would not otherwise
maintain cash deposits at this particular bank, what is the effective cost of borrowing?

b. Ama is considering the following investments. The current rate on T-bill is 5.5%, and the
expected return for the market is 11%. Using CAPM, what rates of return should Ama
require for each individual security?
Stock Beta
A 0.75
B 1.4
C 0.95
D 1.25
c. Suppose you invest 60% of your portfolio in Exxon Mobil and 40% in Coca Cola. The
expected dollar return on your Exxon Mobil stock is 10% and on Coca Cola is 15%. The

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standard deviation of their annualized daily returns are 18.2% and 27.3%, respectively.
Assume a correlation coefficient of 1.0 and calculate the portfolio variance.

Question 23
Following the seminal paper of Modigliani and Miller (1958) on the relevance of capital
structure decision of firms a number of theories have emerged, discuss five (5) of these theories
explaining capital structure decisions of firms and five (5) factors that influence the capital
structure decisions of firms.

Question 24
CPC is considering introducing a new product unto the market. This will require the injection of
huge capital to the tune of GH¢20,000 for the purchase of the equipment for production. The
firm will put GH¢6,000 down and finance the remaining GH¢14,000 from a loan. The firm’s
opportunity cost is 12% for the GH¢6,000 and 8% for the GH¢14,000 loan. The successful
implementation of this will generate additional cash flows into the business. The Production and
Marketing department has presented the information in the table below:

2015

Variable cost per unit of the product GH¢2

Selling price per unit GH¢6

Quantity 4000units per annum

Again the following information should be taken not of:

 Feasibility studies cost the company GH¢2000
 Variable cost will increase by 5% per annum
 Selling price will increase by 10% per annum
 Marketing expense will be 5% of sales revenue per year
 Overhead cost will be fixed at GH¢6000 per year
 The project will last for five years (2016-2020) and the machines will be sold for a
scrap value of GH¢4000
 Charge depreciation using the straight-line method
 CPC falls within the 25% tax bracket
 The project will be financed with debt and equity

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Required:
Using incremental cash flows, calculate;
c. The gross profits for 2016-2020
d. The Net Profits after tax
e. The free cash flow
f. Calculate the WACC for the project
g. Evaluate the project using NPV

Question 25
A firm is considering a new project which would be similar in terms of risk to its existing
projects. The firm needs a discount rate for evaluation purposes. The firm has enough cash on
hand to provide the necessary equity financing for the project. Also, the firm has 1,000,000
common shares outstanding with a current market price of GH¢11 per share. Next year’s
dividend is expected to be GH¢1 per share and the firm estimates dividends will grow at 5% per
year for the next several years. The firm also has 150,000 preferred shares outstanding with a
current market price of GH¢10 per share. Dividend of GH¢0.9 per share is paid on preferred
stock. The firm has a total of GH¢10,000,000 in debt outstanding. The debt stock is currently
valued at of GH¢9,500,000. The yield on the debt is 8%. The firm’s tax rate is 20%. The project
requires an initial capital investment of GH¢500,000. However, the project is expected to
generate GH¢100,000 annually in perpetuity.
Required:

i. Calculate the WACC for this project?

ii. Evaluate the project using NPV

Question 26
a) Joana’s Dad is looking to deposit a sum of money immediately into an account that pays an
annual interest rate of 9% so that her first-year college tuition costs are provided for. Currently,
the average college tuition cost is ¢15,000 and is expected to increase by 4% (the average annual
inflation rate). Joanna just turned 5, and is expected to start college when she turns 18. How
much money will Joanna’s Dad have to deposit into the account?

b) ADB offers to pay you a lump sum of ¢20,000 after 5 years if you deposit ¢9,500 with them
today. UT Bank, on the other hand, says that they will pay you a lump sum of ¢22,000 after 5
years if you deposit ¢10,700 with them today. Which offer should you accept, and why?

c) Accra Hearts of Oak FC Ltd wants to invest in two projects, namely, X & Y. The expected
return on projects X & Y are 12% and 20% respectively while the risk associated with project X
is 3% and that of Y is 7%. Accra Hearts of Oak FC Ltd planned to invest 80% of its available
funds in project X and the remaining in project Y. The correlation coefficient between the returns
of the projects is 0.10.

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Question 27
Robert and Mabel are using the CAPM for making recommendations to their clients. Their
research department has developed the information shown in the following table.
Forecasted returns, Standard deviations and Betas
Stock Forecasted Return Standard Deviation Betas
X 14% 36% 0.8
Y 17% 25% 1.5
Market Index 14% 15% 1.0
Risk Free rate 5%
a) Calculate the expected return using the CAPM for each stock.
b) Estimate the alpha (difference between expected return and market actual return) for each
stock.
c) Identify and justify which stock would be more appropriate for an investor.

Question 28

a) Sandra wants to borrow ¢40,000 for a period of 5 years.

The lender offers her a choice of three payment structures:
i) Pay all of the interest (10% per year) and principal in one lump sum at the end of 5
years
ii) Pay interest at the rate of 10% per year for 4 years and then a final payment of
interest and principal at the end of the 5th year;

iii) Pay 5 equal payments at the end of each year inclusive of interest and part of the
principal
Under which of the three options will Sandra pay the least interest and why? Calculate the
total amount of the payments and the amount of interest paid under each alternative
c. The New Performance Studio is looking to put on a new opera. The manager figures that the
set-up and publicity will cost ¢400,000. The show will go on for 3 years and bring in after-
tax net cash flows of ¢200,000 in Year 1; ¢350,000 in Year 2; -¢50,000 in Year 3. If the firm
has a required rate of return of 9% on its investments, evaluate whether the show should go
on using the MIRR approach and advise the manger
Question 29
a) Corbett and Sullivan Enterprises (CSE) use the Modified Internal Rate of
Return (MIRR) when evaluating projects. CSE's cost of capital is 9.5%. What
is the MIRR of a project if the initial costs are GH¢10,200,000 and the project
lasts seven years, with each year producing the same after-tax cash inflows
of GH¢1,900,000?
b) Assume that both Apple and Yahoo plot on the SML. Apple has a beta of

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2.6 and an expected return of 21.2%. Yahoo has a beta of 0.90 and an
expected return of 9.3%. The expected return on the market portfolio is
10% and the risk-free rate is 3%. See table below. If you wish to hold a
portfolio consisting of Apple and Yahoo and have a portfolio beta equal to
1.5,
i) What proportion of the portfolio must be in Apple?
ii) What is the expected return on the portfolio?

Market Risk-free
Apple Yahoo Portfolio Asset
Beta 2.6 0.9 1.0 0.0
Expected
Return 21.2% 9.3% 10.0% 3.0%

Question 30
a) Assume that you are 23 years old and that you place GH¢3,000 year-end deposits each year
into a stock index fund that earns an average of 9.5% per year for the next 17 years. Attempt the
following:
ii) How much money will be in the account at the end of 17 years? How much money will you
have in the account 15 years later at age 55 if the account continues to earn 9.5% per year but
you discontinue making new contributions?
iii) How much money would you have at the end of 17 years if you had made the same number
of deposits but at the beginning of the year instead of at the end of the year?
iv) How much money will you have in the account 15 years later at age 55 if the account
continues to earn 9.5% per year but you discontinued making new contributions?

b) You are considering buying a share of stock in a firm that has the following two possible
payoffs with the corresponding probability of occurring. The stock has a purchase price of GH
¢50.00. You forecast that there is a 40% chance that the stock will sell for GH¢70.00 at the end of
one year. The alternative expectation is that there is a 60% chance that the stock will sell for GH
¢30.00 at the end of one year.
i) What is the expected percentage return on this stock, and what is the return variance? (

Question 32
Cronox Industries and Zealous Incorporated share prices and dividends are shown below for the
period 1995 – 2000.
Cronox Industries Zealous Incorporated
Year Stock price Dividend (GH¢) Stock price Dividend (GH
¢)
2005 7.62 0.85 55.75 2.00
2006 12 0.90 60.00 2.25
2007 10.75 0.95 57.25 2.50

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2008 17 1.00 48.75 2.75
2009 15.75 1.06 52.30 2.90
2010 17.25 1.15 48.75 3.00

i. Use the data given to calculate annual returns for Cronox, and Zealous.
ii. Compute average return (Arithmetic Average) over the five-year period (2006-2010)
iii. Calculate the risk (standard deviation of returns) for both Cronox and Zealous.
iv. Calculate the coefficient of variation for both companies
v. Compare the two companies in terms of risk and returns.
vi. Calculate the correlation coefficient between the two stock
vii. Calculate the portfolio risk and return assuming the assets are equally weighted.
viii. Assuming Kweku invested GH¢20,000 in the stocks of Cronox Industries and GH
¢30,000 in that of Zealous Incorporated with a correlation coefficient between the two
firms of 0.8, what is the portfolio risk and return?

Question 33
a. Kako Ltd has a revolving credit agreement with a bank. It can borrow up to GHȼ 2 million at
24 percent interest but is required to maintain a 10 percent compensating balance on any
funds borrowed under the agreement. In addition, it must pay a 0.5 percent commitment fee
on the unused portion of the formal credit line. If the firm borrows GHȼ 800,000 for an entire
year under this agreement, makes all payments at note maturity, and would not otherwise
maintain cash deposits at this particular bank, what is the effective cost of borrowing?

b. The Dongomi Corp. buys a part that costs GHȼ 50,000. The carrying cost of inventory is
approximately 20% of the part’s cedi value per year. It costs GHȼ 500,000 to place, process
and receive an order. The firm uses 9,000,000 of the GHȼ 50,000 parts per year. What
ordering quantity minimizes inventory costs? What inventory costs are incurred for the part
with this ordering quantity?

c. Kari-Kidd Corporation currently gives credit terms of “net 30 days.” It has GHȼ 60 million in
credit sales, and its average collection period is 45 days. To stimulate demand, the company
may give credit terms of “net 60 days.” If it does instigate these terms, sales are expected to
increase by 15 percent. After the change, the average collection period is expected to be 75
days, with no difference in payment habits between old and new customers. Variable costs
are GHȼ 0.80 for every GHȼ 1.00 of sales, and the company’s before-tax required rate of
return on investment in receivables is 20 percent. Should the company extend its credit
period? (Assume a 360-day year.)

Question 34
a. On the basis of an analysis of past returns and of inflationary expectations, Marta Gomez
feels that the expected return on stocks in general is 12 percent. The risk-free rate on short-
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term Treasury securities is now 7 percent. Gomez is particularly interested in the return
prospects for Kessler Electronics Corporation. Based on monthly data for the past five years,
she has fitted a characteristic line to the responsiveness of excess returns of the stock to
excess returns of the S&P 500 Index and has found the slope of the line to be 1.67. If
financial markets are believed to be efficient, what return can she expect from investing in
Kessler Electronics Corporation?

b. Salt Lake City Services, Inc., provides maintenance services for commercial buildings.
Currently, the beta on its common stock is 1.08. The risk-free rate is now 10 percent, and the
expected return on the market portfolio is 15 percent. It is January 1, and the company is
expected to pay a GH¢2 per share dividend at the end of the year, and the dividend is
expected to grow at a compound annual rate of 11 percent for many years to come. Based on
the CAPM and other assumptions you might make, what dollar value would you place on one
share of this common stock?

c. Schmendiman, Inc., is the sole manufacturer of schmedimite (an inflexible, brittle building
material made of radium and asbestos). Assume that the company’s common stock can be
valued using the constant dividend growth model (also sometimes known as the “Gordon
Dividend Growth Model”). You expect that the return on the market will be 14 percent and
the risk-free rate is 6 percent. You have estimated that the dividend one year from now will
be GH¢3.40, the dividend will grow at a constant 6 percent, and the stock’s beta is 1.50. The
common stock is currently selling for GH¢30.00 per share in the marketplace.
i. What value would you place on one share of this company’s common stock?
ii. Is the company’s common stock overpriced, underpriced, or fairly priced? Why?

Question 35
a. The Sprouts-N-Steel Company has two divisions: health foods and specialty metals. Each
division employs debt equal to 30 percent and preferred stock equal to 10 percent of its total
requirements, with equity capital used for the remainder. The current borrowing rate is 15
percent, and the company’s tax rate is 40 percent. At present, preferred stock can be sold
yielding 13 percent.
Sprouts-N-Steel wishes to establish a minimum return standard for each division based on
the risk of that division. This standard then would serve as the transfer price of capital to the
division. The company has thought about using the capital-asset pricing model in this regard.
It has identified two samples of companies, with modal value betas of 0.90 for health foods
and 1.30 for specialty metals. (Assume that the sample companies had similar capital
structures to that of Sprouts-N-Steel.) The risk-free rate is currently 12 percent and the
expected return on the market portfolio 17 percent. Using the CAPM approach, what
weighted average required returns on investment would you recommend for these two
divisions?
b. The R-Bar-M Ranch in Montana would like a new mechanized barn, which will require a GH
¢600,000 initial cash outlay. The barn is expected to provide after-tax annual cash savings of
GH¢90,000 indefinitely (for practical purposes of computation, forever). The ranch, which is

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incorporated and has a public market for its stock, has a weighted average cost of capital of
14.5 percent. For this project, Mark O. Witz, the president, intends to provide GH¢200,000
from a new debt issue and another GH¢200,000 from a new issue of common stock. The
balance of the financing would be provided internally by retaining earnings. The present
value of the after-tax flotation costs on the debt issue amount to 2 percent of the total debt
raised, whereas flotation costs on the new common stock issue come to 15 percent of the
issue. What is the net present value of the project after allowance for flotation costs? Should
the ranch invest in the new barn?

Question 36
a. Cohn and Sitwell, Inc., is considering manufacturing special drill bits and other equipment
for oil rigs. The proposed project is currently regarded as complementary to its other lines of
business, and the company has certain expertise by virtue of its having a large mechanical
engineering staff. Because of the large outlays required to get into the business, management
is concerned that Cohn and Sitwell earn a proper return. Since the new venture is believed to
be sufficiently different from the company’s existing operations, management feels that a
required rate of return other than the company’s present one should be employed.

The financial manager’s staff has identified several companies (with capital structures similar
to that of Cohn and Sitwell) engaged solely in the manufacture and sale of oil drilling
equipment whose common stocks are publicly traded. Over the last five years, the median
average beta for these companies has been 1.28. The staff believes that 18 percent is a
reasonable estimate of the average return on stocks “in general” for the foreseeable future
and that the risk-free rate will be around 12 percent. In financing projects, Cohn and Sitwell
uses 40 percent debt and 60 percent equity. The after-tax cost of debt is 8 percent.

i. On the basis of this information, determine a required rate of return for the project, using
the CAPM approach.
ii. Is the figure obtained likely to be a realistic estimate of the required rate of return on the
project?

Question 37
a. A firm is currently employing an “aggressive” working capital policy with regard to the level
of current assets it maintains (relatively low levels of current assets for each possible level of
output). The firm has decided to switch to a more “conservative” working capital policy.
What effect will this decision probably have on the firm’s profitability and risk?

b. The Acme Aglet Corporation has a 12 percent opportunity cost of funds and currently sells
on terms of “net/10, EOM.” (This means that goods shipped before the end of the month
must be paid for by the tenth of the following month.) The firm has sales of GH¢10 million a
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year, which are 80 percent on credit and spread evenly over the year. The average collection
period is currently 60 days. If Acme offered terms of “2/10, net 30,” customers representing
60 percent of its credit sales would take the discount, and the average collection period would
be reduced to 40 days. Should Acme change its terms from “net/10, EOM” to “2/10, net 30”?
Why?

c. To reduce production start-up costs, Bodden Truck Company may manufacture longer runs
of the same truck. Estimated savings from the increase in efficiency are GH¢260,000 per
year. However, inventory turnover will decrease from eight times a year to six times a year.
Cost of goods sold is GH¢48 million on an annual basis. If the required before-tax rate of
return on investment in inventories is 15 percent, should the company instigate the new
production plan?

d. Porras Pottery Products, Inc., spends GH¢220,000 per annum on its collection department.
The company has GH¢12 million in credit sales, its average collection period is 2.5 months,
and the percentage of bad-debt losses is 4 percent. The company believes that, if it were to
double its collection personnel, it could bring down the average collection period to 2 months
and bad-debt losses to 3 percent. The added cost is GH¢180,000, bringing total collection
expenditures to GH¢400,000 annually. Is the increased effort worthwhile if the before-tax
opportunity cost of funds is 20 percent? If it is 10 percent?

Question 38
a. The Barnes Corporation has just acquired a large account. As a result, it will soon need an
additional $95,000 in working capital. It has been determined that there are three feasible
sources of funds:
i. Trade credit: The Barnes company buys about GH¢50,000 of materials per month on
terms of “3/30, net 90.” Discounts currently are taken.
ii. Bank loan: The firm’s bank will loan GH¢106,000 at 13 percent. A 10 percent
compensating balance will be required.
iii. Factoring: A factor will buy the company’s receivables ( GH¢150,000 per month),
which have an average collection period of 30 days. The factor will advance up to 75
percent of the face value of the receivables at 12 percent on an annual basis. The
factor also will charge a 2 percent fee on all receivables purchased. It has been
estimated that the factor’s services will save the company GH¢2,500 per month –
consisting of both credit department expenses and bad-debts expenses.
Which alternative should Barnes select on the basis of annualized percentage cost?
b. Hayleigh Mills Company has a GH¢5 million revolving credit agreement with First State
Bank of Arkansas. Being a favored customer, the rate is set at 1 percent over the bank’s cost
of funds, where the cost of funds is approximated as the rate on negotiable certificates of
deposit (CDs). In addition, there is a 1⁄2 percent commitment fee on the unused portion of the
revolving credit. If the CD rate is expected to average 9 percent for the coming year and if
the company expects to utilize, on average, 60 percent of the total commitment, what is the
expected annual dollar cost of this credit arrangement? What is the percentage cost when
both the interest rate and the commitment fee paid are considered? What happens to the
percentage cost if, on average, only 20 percent of the total commitment is utilized?

Page 19 of 34
Question 39
The Shelby Gaming Manufacturing Company has experienced a severe cash squeeze and needs
GH¢200,000 over the next 90 days. The company has already pledged its receivables in support
of a loan. However, it does have GH¢570,000 in unencumbered inventories. Determine the best
financing alternative from the following two that are available.
a. The Cody National Bank of Reno will lend against finished goods provided that they are
placed in a public warehouse under its control. As the finished goods are released for sale,
the loan will be reduced by the proceeds of the sale. The company currently has GH¢300,000
in finished-goods inventory and would expect to replace finished goods that are sold out of
the warehouse with new finished goods, so that it could borrow the full GH¢200,000 for 90
days. The interest rate will be 10 percent, and the company will pay quarterly warehousing
costs of GH¢3,000. Finally, it will experience a reduction in efficiency as a result of this
arrangement. Management estimates that the lower efficiency will reduce quarterly before-
tax profits by GH¢4,000.
b. The Vigorish Finance Company will lend the company the money under a floating lien on all
of its inventories. The rate will be 23 percent, but no additional expenses will be incurred.

Question 40
Mawuko Investment Limited is assessing a business opportunity of Project Y with the following
estimated cashflows:
¢’000
Investment (Cash Outlay) as at January 2012 250.00
Net annual cash inflow (arising at year end):
2012 160.00
2013 160.00
2014 100.00
Cash inflow from residual value 31st December, 2014 50.00
All of the above figures are expressed at 1 st January 2012 prices. Inflation is expected to be at 5%
p.a throughout the project’s life. The real cost of finance is given as 10% p.a. Corporate tax is
charged on profit at a rate of 30%, payable during the year in which the profit is earned
(assuming taxable profit equals the net operating cash flow). Estimate (using money cash flows),
the NPV of project Y.

Question 41
Page 20 of 34
b. Your company expects to pay dividend of GH¢1 per share, GH¢2.4 per share and GH¢3 per
share over the next 3years. Thereafter, dividends are expected to grow at 15 % per annum
from 2 years, then 10% definitely. If your cost of capital is 24%, what price will investors be
willing to pay for a share of the stock today
c. The company has paid dividend of GH¢300 per share, which is expected to grow at 15% per
annum. Investors required return is 30%. What is the expected market value?
d. The Government is in the process of issuing a 6-year bond which has a coupon rate of 15%.
The face value is GH¢10,000 per bond. The government pays interest, annually. You are the
Finance Director of ABC Ltd a medium-sized company which is interested in buying the
bond issued by the Government. The company’s cost of capital is 20% p.a.
i. Advice the company on how much should be paid for the bond.
ii. If the bonds were issued by a private company, would you be prepared to pay the same
amount as in (a). Justify your position.

e. Suppose you invest 60% of your portfolio in ABC and 40% in KDS. The expected dollar
return on your ABC stock is 20% and on KDS is 30%. The standard deviations of their
annualized daily returns are 36% and 47%, respectively. Assume a correlation coefficient of
0.8 and calculate the portfolio standard deviation and portfolio expected return.
f. Glory Ltd is a stock listed on the Ghana Stock exchange which has a beta of 1.8. The rate on
Government of Ghana traded treasury bills is 11% and the market risk premium for the
Ghana Stock Exchange is 20%. Calculate the expected return on the stock.

Question 42
a. Von Corp. is experiencing rapid growth. Dividends are expected to grow at 30% per year
during the next three years, 18 % over the following year, and then 8% per year indefinitely.
The last dividend paid by the company was GH¢20. The required return on this stock is
13%. What is current price of the stock?
b. Moon Co just paid a dividend of GH¢190 per share on its stocks. The dividends are expected
to grow at a constant rate of 5% per year, indefinitely. If investors require a 12% return on
the stock, what is the current price?
c. Bank of Africa just issued some new preferred stock. The issue will pay a GH¢7 annual
dividend in perpetuity. If the market required a 6 % return on this investment, how much
does a share of preferred stock cost today?

Question 43

a. The Blue Dog Company has common stock outstanding that has a current price of GH¢20
per share and a GH¢0.5 dividend. Blue Dog’s dividends are expected to grow at a rate of 3%
per year, forever. The expected risk-free rate of interest is 2.5%, whereas the expected market
premium is 5%. The beta on Blue Dog’s stock is 1.2.

Page 21 of 34
i. What is the cost of equity for Blue Dog using the dividend valuation model?

ii. What is the cost of equity for Blue Dog using the capital asset pricing model?
b. A GH¢1000 Eurobond expires in 8 years. It pays a coupon rate of 12%. If the market price of
this bond is GH¢850.70, what is the yield to maturity of this bond?

c. Hydepark Ltd’s last dividend payment was GH¢8. The growth rate in dividends over the
following three years is forecast at 15%. After that, Hydepark’s growth rate is expected to
equal the industry average of 5%. If the required rate of return is 18%, what is the current
value of the stock?

Question 44
a. Bond X is a premium bond making annual payments. The bond pays an 8 percent coupon,
has a YTM of 6 percent, and has 13 years to maturity. Bond Yis a discount bond making
annual payments. This bond pays a 6 percent coupon, has a YTM of 8 percent, and also has
13 years to maturity. If interest rates remain unchanged, what do you expect the price of
these bonds to be one year from now? In three years? In eight years? In 12 years? In 13
years? What’s going on here? Illustrate your answers by graphing bond prices versus time to
maturity.
b. Both Bond Twain and Bond Brooks have 6 percent coupons, make semiannual payments,
and are priced at par value. Bond Twain has 2 years to maturity, whereas Bond Brooks has
15 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage
change in the price of Bond Twain? Of Bond Brooks? If rates were to suddenly fall by 2
percent instead, what would the percentage change in the price of Bond Twain be then? Of
Bond Brooks? Illustrate your answers by graphing bond prices versus YTM. What does this
problem tell you about the interest rate risk of longer-term bonds?
c.
i. What is the relationship between the price of a bond and its YTM?
ii. Explain why some bonds sell at a premium over par value while other bonds sell at a
discount. What do you know about the relationship between the coupon rate and the YTM
for premium bonds? What about for discount bonds? For bonds selling at par value?
iii. What is the relationship between the current yield and YTM for premium bonds? For
discount bonds? For bonds selling at par value?
d. The Back Street Girls Corporation has two different bonds currently outstanding. Bond M
has a face value of GH¢20,000 and matures in 20 years. The bond makes no payments for the
first six years, then pays GH¢1,000 every six months over the subsequent eight years, and
finally pays GH¢1,750 every six months over the last six years. Bond N also has a face value
of GH¢20,000 and a maturity of 20 years; it makes no coupon payments over the life of the

Page 22 of 34
bond. If the required return on both these bonds is 14 percent compounded semi-annually,
what is the current price of Bond M? Of Bond N?

Question 45
a. Suppose you know that a company’s stock currently sells for GH¢60 per share and the
required return on the stock is 16 percent. You also know that the total return on the stock is
evenly divided between a capital gains yield and a dividend yield. If it’s the company’s
policy to always maintain a constant growth rate in its dividends, what is the current dividend
per share?
b. Shaq, Inc., has an issue of preferred stock outstanding that pays a GH¢9.50 dividend every
year, in perpetuity. If this issue currently sells for GH¢85 per share, what is the required
return?
c. Smashed Pumpkin Farms (SPF) just paid a dividend of GH¢4.50 on its stock. The growth rate
in dividends is expected to be a constant 7.5 percent per year, indefinitely. Investors require a
20 percent return on the stock for the first three years, an 11 percent return for the next three
years, and then a 12 percent return, thereafter. What is the current share price for SPF stock?
d. Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock
over the next five years, because the firm needs to plough back its earnings to fuel growth.
The company will pay a GH¢6 per share dividend in six years and will increase the dividend
by 5 percent per year, thereafter. If the required return on this stock is 21 percent, what is the
current share price?
e. South Park Corporation is expected to pay the following dividends over the next four years:
GH¢4.75, GH¢3, GH¢2, and GH¢1. Afterwards, the company pledges to maintain a constant 9
percent growth rate in dividends, forever. If the required return on the stock is 16 percent,
what is the current share price?
f. Mega Growth Co. is growing quickly. Dividends are expected to grow at a 30 percent rate for
the next three years, with the growth rate falling off to a constant 7 percent, thereafter. If the
required return is 21 percent and the company just paid a GH¢1.50 dividend, what is the
current share price?
g. Janicek Corp. is experiencing rapid growth. Dividends are expected to grow at 20 percent per
year during the next three years, 15 percent over the following year, and then 10 percent per
year, indefinitely. The required return on this stock is 15 percent, and the stock currently sells
for GH¢50.00 per share. What is the projected dividend for the coming year?

Question 46
a. The directors of Sunland Company, a company which has 75% of its operations in the retail
sector and 25% in manufacturing, are trying to derive the firm's cost of equity. However,

Page 23 of 34
since the company is not listed, it has been difficult to determine an appropriate beta factor.
The following information was researched:
 Retail industry – quoted retailers have an average equity beta of 1.20, and an average
gearing ratio of 20:80 (debt: equity).
 Manufacturing industry – quoted manufacturers have an average equity beta of 1.45
and an average gearing ratio of 45:55 (debt: equity).
 The risk-free rate is 3% and the equity risk premium is 6%.
 Tax on corporate profits is 30%.  Sunland Co has gearing ratio of 50% debt and 50%
equity by market values. Assume that the risk on corporate debt is negligible.

Required:
Calculate the cost of equity of Sunland Company using the Capital Asset Pricing Model.
b. When determining the financial objectives of a company, it is necessary to take three types of
policy decision into account: investment policy, financing policy and dividend policy.
Required:
Discuss the nature of these THREE types of decisions, commenting on how they are
interrelated and how they might affect the value of the firm (that is the present value of
projected cash flows).

Question 47
A company plans to invest GH¢7million in a new product. Net contribution over the next
five years is expected to be GH¢4.2million per annum in real terms. Marketing expenditure
of GH¢1.4m per annum will also be needed. Expenditure of GH¢1.3m per annum will be
required to replace existing assets which will now be used on the project but are getting to
the end of their useful lives. This expenditure will be incurred at the beginning of each year.
Additional investment in working capital equivalent to 10% of contribution will need to be
in place at the start of each year. Working capital will be released at the end of the project.
The following forecasts are made of the rates of inflation each year for the next five years:

Contribution 8%

Marketing 3%

Assets 4%

General Prices 4.7%

The real cost of capital of the company is 6%. All cash flows are in real terms. Ignore tax.
Required:
Calculate the Net Present Value (NPV) of the project and appraise whether it is a worthwhile
project.

Page 24 of 34
Question 48
a. Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the
following performance. The following information was made available to you:

Current market price per share (as at 31/12/15) GH¢ 10

Dividend per share 2015 GH¢ 1
Expected growth rate of dividend 20% per annum
The average market returns 27%
The risk-free government rate 24%
The beta factor of Kaluu Ltd 1.4
Required:
i. What is the estimated cost of equity using the dividend growth model?
ii. What is the estimated cost of equity using the Capital Assets Pricing model?

b. The annual demand for Praise Limited’s inventory is 10,500 units. The item costs GH¢400 a
unit to purchase. The holding cost for one unit for one year is 12% of the unit cost and
ordering costs are GH¢450 per order. The supplier offers a 2% discount for orders of 700
units or more and a discount of 3% for orders of 950 units or more.
Required:
Determine the cost minimising order size of the company.
c. Five years ago, Gasoto Ltd. issued 12 per cent irredeemable debentures at their par value of
GH¢100. The current market price of these debentures is GH¢94. The company pays
corporation tax at a rate of 30 per cent. Required: Calculate the company’s current cost of
debenture.

Question 49
One of your clients has seen many references to the “Cost of Capital” in the Business and
Financial Times and has asked you to give him some guidance on what would be an appropriate
figure for his organization-Zaytuna Ltd. The following information are available for Zaytuna
Ltd.
Existing capital structure
Issued ordinary shares - 12,000,000 12,000
Retained earnings 4,000

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6% Preference shares 2,000
9% Debenture repayable 2018 6,000
24, 000
i. 9% Debenture

Issued in 2008 at par

Current price GH¢ 92
A similar issue if made now would require to be at GH¢ 90
ii. Preference Shares

Preference shares have a par value of GH¢1 and were originally issued at 92p per share
Current price 43p
A similar issue if made now would require to be 40p per share
iii. Ordinary Share

The market price of an ordinary share is GH¢7.00

GH¢ 6 million in dividends were paid this year which represented 75% of earnings
Earnings are expected to grow at an annual rate of 5%
If new ordinary shares were issued now, costs incurred would represent 25p per share and a
reduction below market value of 50p per share would also be made.
iv. Corporate tax rate is 25%

Required:
Calculate Zaytuna Ltd Weighted Average cost of capital.

Question 50
a. Asuo Ltd manufactures only one product, planks. The single raw material used in making
planks is the dint. For each plank manufactured, twelve dints are required. The company
manufactures 150,000 planks per year and that demand for planks is perfectly steady
throughout the year. It costs GH¢ 200 each time dints are ordered, and that carrying costs are
GH¢8 per dint per year

Required:
i. Determine the economic order quantity of dints.

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ii. What are total inventory costs for Asuo (carrying costs plus ordering costs)?
iii. How many times per year would inventory be ordered?

b. Abbot Ltd needs to increase its working capital by GH¢100,000. It has decided that there are
essentially three alternatives of financing available.
They are:
i. Borrow from bank at 8%. This alternative would necessitate maintaining a 25%
compensation balance.
ii. Issue promissory notes at 7.5%. The cost of placing the issue would be GH¢500
each six months.
iii. Forego cash discount, granted on the basis of 3/10, net 30.

The firm prefers the flexibility of bank financing, and has provided an additional cost of this
flexibility to be 1%.
Required:
Assess which alternative financing method should be selected.

Question 51
a. Your Uncle has won lotteries and has decided to invest the funds in various Securities. His
financial advisor advised him to invest 40% of the proceeds into Government Securities
(Treasury Bills) and the balance invested in the Stock Market, with funds spread equally
among the Securities listed on the market.

Required:
Advise your Uncle’s Portfolio risk (beta coefficient).
b.. One of the important sustainability requisite for the accelerated development of an economy
is the existence of a dynamic financial market. Financial markets can be found in nearly every
nation in the world. Some are very small, with only a few participants, while others, like the New
York Stock Exchange (NYSE) and the forex markets, trade trillions of dollars daily.
Required:
What is a financial market?
c. Explain the difference between the following financial markets;
i) Debt market and Equity market.
ii) Money market and Capital market
iii) Forex market and Interbank market

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d. SAFOO Ltd has in issue 5 million shares with a market value of GH¢ 3.81 per share. The
equity beta of the company is 1.2. The yield on short- term government debt is 23% per year
and equity risk premium is 5% per year. The debt finance of SAFOO Ltd consists of bonds
with a total book value of GH¢2 million. These bonds pay annual interest before tax of 25%.
The par value and market value of each bond is GH¢100. The Company pays tax at 25%.
Required:
Calculate SAFOO Ltd Weighted Average cost of Capital.
e. Factoring and Invoice Discounting are both financial services that can release the funds tied
up in your unpaid invoices, involving a provider who agrees to advance money against
outstanding debtor balances. However, factoring is not the same as invoice discounting.
Required:
Differentiate between factoring and invoice discounting.

Question 52
The financial management team of T Ltd is discussing how the company should appraise new
investments.
There is a difference of opinion between two managers.
Manager A believes that net present value should be used as positive NPV investments are
quickly reflected in increases in the company's share price. It is also simpler to calculate than
MIRR and APV.
Manager B states that NPV is not good enough as it is only valid in potentially restrictive
conditions, and should be replaced by APV (adjusted present value).
T Ltd has produced estimates of relevant cash flows and other financial information associated
with a new investment. These are shown below:
Year 1 2 3 4
GHȼ’000 GHȼ’000 GHȼ’000 GHȼ’000
Investment pre-tax 1,250 1,400 1,600 1,800
operating cash flows

Notes
1. The investment will cost GHȼ 5,400,000 payable immediately, including GHȼ 600,000 for
working capital and GHȼ 400,000 for issue costs. GHȼ 300,000 of issue costs is for equity,
and GHȼ 100,000 for debt. Issue costs are not tax allowable.
2. The investment will be financed 50% equity, 50% debt which is believed to reflect its debt
capacity.
3. Expected company gearing after the investment will change to 60% equity, 40% debt by
market values.
4. The investment equity beta is 1.5.
5. Debt finance for the investment will be an 8% fixed rate debenture.

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6. Capital allowances are at 25% per year on a reducing balance basis.
7. The corporate tax rate is 30%. Tax is payable in the year that the taxable cash flow arises.
8. The risk-free rate is 4% and the market return 10%.
9. The after-tax realisable value of the investment as a continuing operation is estimated to be
GHȼ 1.5m (including working capital) at the end of year 4.
10. Working capital may be assumed to be constant during the four years.
Required
a. Calculate the expected NPV, MIRR and APV of the proposed investment.
b. Discuss briefly the validity of the views of the two managers. Use your calculations in (a) to
illustrate and support the discussion.

Question 53
Argnil Co is appraising the purchase of a new machine, costing GHȼ 1·5 million, to replace an
existing machine which is becoming out of date and which has no resale value. The forecast
levels of production and sales for the goods produced by the new machine, which has a
maximum capacity of 400,000 units per year, are as follows:
Year 1 2 3 4
Sales volume (units/year) 350,000 380,000 400,000 400,000

The new machine will incur fixed annual maintenance costs of GHȼ145,000 per year. Variable
costs are expected to be GHȼ3·00 per unit and selling price is expected to be GHȼ5·65 per unit.
These costs and selling price estimates are in current price terms and do not take account of
general inflation, which is forecast to be 4·7% per year.
It is expected that the new machine will need replacing in four years’ time due to advances in
technology. The resale value of the new machine is expected to be GHȼ200,000 at that time, in
future value terms.
The purchase price of the new machine is payable at the start of the first year of the four-year life
of the machine.
Working capital investment of GHȼ150,000 will already exist at the start of the four-year period,
due to the operation of the existing machine. This investment in working capital is expected to
increase in nominal terms in line with the general rate of inflation.
Argnil Co pays corporation tax one year in arrears at an annual rate of 27% and can claim 25%
reducing balance tax-allowable depreciation on the purchase price of the new machine. The
company has a real after-tax weighted average cost of capital of 6% and a nominal after-tax
weighted average cost of capital of 11%.

Required:
a. Using a nominal terms net present value approach, evaluate whether purchasing the new
machine is financially acceptable.
b. Discuss the reasons why investment finance may be limited, even when a company has
attractive investment opportunities available to it.

Question 54

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The Board of Peartek Ltd is considering the company’s capital investment options for the
coming year, and also evaluating the following potential investments:

Investment A
This investment is similar to its current investments and requires an investment of GH¢60,000
now, GH¢40,000 for new capital equipment and GH¢20,000 for increases in working capital.
This will be financed from Shareholders Funds. Sales next year would be 10,000 units, variable
costs would be GH¢6 and the product would be sold for GH¢10. But due to entry of new
competitors and technological improvements, the sales price would decline by 20% per annum
thereafter, sales volume would fall by 10% and variable costs would fall by 20% per annum.
Overheads attributed to the project would be GH¢15,000 per annum.
In year three the project would be wound up, working capital investment would be recovered and
capital equipment sold off for 25% of its purchase costs the following year. Fixed costs include
an annual charge of GH¢4,000 for depreciation.

Investment B
This is a long–term project in a totally new area, involving an immediate outlay of GH¢90,000,
which they intend to borrow from their lenders at 6%. They expect net profits of GH¢12,000
next year, rising thereafter by 3% per annum in perpetuity.

Investment C
This is another long-term investment in a totally new area, involving an immediate outlay of GH
¢25,000 which they intend financing by retained profits.
Expected annual net cash profits are as follows:
Years 1 to 4: GH¢3,000
Years 5 to 7: GH¢5,000
Year 8 onwards forever: GH¢7,000
The company discounts all projects lasting ten years duration or less at a cost of capital of 10%
and all other projects at a cost of 13%. You may ignore taxation.

Required:
a. As a financial management analyst, you have been asked to advise the board of Peartek Ltd
(in the form of a briefing report) which investment should be undertaken. In your report you
are to make use of the NPV method, as the members of the board believe this is the best to
use and have asked you to use it.
b. Minority of board members feel that the Internal Rate of Return (IRR) should also be used as
either an alternative or a complementary method of investment appraisal. Calculate the IRR
of investments A and B (you may use 25% as the upper limit if you wish) and comment
accordingly.

Question 55
From the perspective of a corporate financial manager, explain and write short notes on the
following:
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i. The relationship between working capital and profitability.
ii. Overtrading. Identify THREE of its symptoms and explain how it can be resolved.
iii. Describe the main features of and explain the main attractions to the investor and to the
issuer of convertible bonds.

Question 56
UTFM Ltd is experiencing considerable financial difficulties. The management is prepared to
undertake a buyout, and UTFM Ltd is considering selling the business for GH¢50 million. After an
analysis of the company’s performance, the management concluded that the company required a
capital injection of GH¢30 million.
The management has agreed with a Venture Capitalist to raise the amount required for the buyout.
The Venture Capitalist will provide GH¢8 million of the required funds at 10% interest, and provide
equity of GH¢7 million. The fixed rate loan principal is repayable in 10 years’ time.

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The management will provide the remaining required funding by way of equity.
Forecasts of Earnings before Interest and Tax (EBIT) for the next 5 years following the buyout are as
follows:

Year 1 2 3 4 5
GH¢'000 GH¢'000 GH¢'000 GH¢'000 GH¢'000
EBIT 4,400 6,300 7,800 8,400 9,000

Corporation tax is charged at 25%. Dividends are expected not to be more than 10 % of profits for
the first five years. Management has forecast that the value of equity capital is likely to increase by
approximately 15 % per annum for the next 5 years

Required:
On the basis of the above forecasts, determine whether management’s estimate that the value of
equity will increase by 15% per annum is a viable one.

Question 57
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
GH¢'000 GH¢'000
Equity
Ordinary shares (nominal value 50 pesewas) 4,000
Reserves 18,000 22,000
Long-term liabilities
4% Preference shares (nominal value GH¢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 (pesewas) 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
pesewas per share. The 7% bonds are redeemable at a 5% premium to their nominal value of GH
¢100 per bond and have an ex interest market value of GH¢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.

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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.

Question 58
a. Discuss how invoice discounting and factoring can aid the management of trade receivables.
b. Identify the objectives of working capital management and discuss the central role of
working capital management in financial management.
c. Discuss briefly the reasons why interest rates may differ between loans of different maturity.
d. Explain the difference between systematic and unsystematic risk in relation to portfolio
theory and the capital asset pricing model.
e. Discuss the differences between weak form, semi-strong form and strong form capital market
efficiency, and discuss the significance of the efficient market hypothesis (EMH) for the
financial manager
f. Critically discuss FOUR reasons why NPV is regarded as superior to IRR as an investment
appraisal technique.

Question 59
The finance director of Widnor Co has been looking to improve the company’s working capital
management. Widnor Co has revenue from credit sales of GH¢26,750,000 per year and although
its terms of trade require all credit customers to settle outstanding invoices within 40 days, on
average customers have been taking longer. Approximately 1% of credit sales turn into bad debts
which are not recovered.
Trade receivables currently stand at GH¢4,458,000 and Widnor Co has a cost of short-term
finance of 5% per year.
The finance director is considering a proposal from a factoring company, Nokfe Co, which was
invited to tender to manage the sales ledger of Widnor Co on a with-recourse basis. Nokfe Co
believes that it can use its expertise to reduce average trade receivables days to 35 days, while
cutting bad debts by 70% and reducing administration costs by GH¢50,000 per year. A condition
of the factoring agreement is that the company would also advance Widnor Co 80% of the value
of invoices raised at an interest rate of 7% per year. Nokfe Co would charge an annual fee of
0·75% of credit sales.
Assume that there are 360 days in each year.
Required:
a. Advise whether the factor’s offer is financially acceptable to Widnor Co.
b. Briefly discuss how the creditworthiness of potential customers can be assessed.

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Question 60
The Directors of Moore Plastics Ltd have been deliberating on the company’s capital structure
with a view to identifying an optimal financing mix. Opening the deliberation, the Board Chair
remarked “For the past 10 years, we have deployed a financing strategy of reinvesting as much
profit as available. When profit is inadequate, we go for borrowing. New equity offers have been
a last resort”.
Required:
i. Explain with THREE reasons why most managers tend to use financing strategies that
follow the pecking order.
ii. Identify and explain TWO factors the directors of Moore Plastics Ltd should consider in
redesigning the company’s capital structure.

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