Ican 2023 Strategic Financial Management Question 1

KK, a company quoted on the Stock Exchange, has cash balance of ₦230 million which are currently invested in short-term money market deposits. The cash is intended to be used primarily for strategic acquisitions, and the company has formed an acquisition committee with a remit to identify possible acquisition targets. The committee has suggested the purchase of ZL, a company in a different industry that is quoted on the AIM (Alternative Investment Market). Although ZL is quoted, approximately 50% of its shares are still owned by three directors. These directors have stated that they might be prepared to recommend the sale of ZL, but they consider that its shares are worth ₦220 million in total. Summarised financial data KK ZL ₦’000 ₦’000 Revenue 4,800,000 380,000 Pre tax operating cash flow 510,000 53,000 Taxation (33%) (168,300) (17,490) Post tax operating cash flow 341,700 35,510 Dividend 110,000 8,420 Non-current assets 1,680,000 84,000 Current assets 1,350,000 47,000 Current liabilities (996,800) (39,000) 2,033,200 92,000 KK ZL Long-term finance Ordinary shares (25 kobo par) 100,000 (ZL 10 kobo par) 5,000 Reserves 1,583,200 52,000 12% Bond 200,000 - 10% Bank term loan 150,000 Recent 11% bank loan 35,000 2,033,200 92,000 KK ZL ₦‟000 ₦‟000 Current share price 785 kobo 370 kobo Earnings yield 10.9% 19.2% Average dividend growth during the last five years 7% pa 8% pa Equity beta 0.95 0.8 Industry data: Average P/E ratio 10:1 6:1 Average P/E of companies recently taken over, based upon the offer price 12:1 7:1 The risk free rate of return is 6% per annum and the market return is 14% per annum. The rate of inflation is 2.4% per annum and is expected to remain at approximately this level. Expected effects of the acquisition: (i) 50 employees of ZL would immediately be made redundant at an after tax cost of ₦12 million. Pre-tax annual wage savings are expected to be ₦7.50 million (at current prices) for the foreseeable future. (ii) Some land and buildings of ZL would be sold for ₦8 million (after tax). (iii) Pre-tax advertising and distribution savings of ₦1.50 million per year (at current prices) would be possible. (iv) The three existing directors of ZL would each be paid ₦1 million per year for three years for consultancy services. This amount would not increase with inflation.