ICAN 2023 Strategic Financial Management | Mixed

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.

You are a Financial Analyst at Tayo Research Group (TRG). You begin valuing Aba Hotels Plc (AHP), a thinly and infrequently traded stock currently selling at 217 kobo, cum 2021 dividend. For estimating AHP’s required return on equity, TRG uses the capital asset pricing model (CAPM) approach, but you think its equity beta of 1.20 is not reliable because of the stock’s extremely thin trading volume. You have therefore obtained the beta and other pertinent data for Eko Hotel Plc (EHP) – (See Table 1), a midsized company in the same industry with high liquidity trading on the Nigerian Stock Exchange. Table 1: Valuation Data for EHP Asset beta 0.763 Debt beta 0.150 Debt ratio (D/D+E) 0.60 Effective tax rate 30% Summarised financial data for AHP is shown below: Statement of profit or loss account 2019 2020 2021* Sales 305,500 357,600 409,200 Taxable income 40,500 49,000 56,700 Taxation (14,175) (17,150) (19,845) 26,325 31,850 36,855 Dividend (9,340) (10,228) (11,200) Retails earnings 16,985 21,622 25,655 Statement of Financial Position (₦’000) 2021* Non-current assets 216,800 Current assets 158,000 Current liabilities (104,800) 270,000 Ordinary Shares (50 kobo par value) 80,000 Reserves 130,000 15% bond 2026(₦100 par value) 60,000 270,000 (*2021 figures are unaudited) Other relevant information (i) It has been estimated that the debt/equity ratio of AHP is 0.16 and beta of its debt is 0.2 (ii) The risk free rate is 12% and the market risk premium is 5%. (iii) AHP has effective tax rate of 35%. (iv) As a result of recent capital investment, stock market analysts expect post-tax earnings and dividends to increase by 25% for two years and then to revert to the company’s existing growth rates.

Tinco Limited (TL) is considering an expansion project. The project will involve the acquisition of an automated production machine costing ₦11,000,000 and payable now. The machine is expected to have a disposal value at the end of 5 years, which is equal to 10% of the initial expenditure. The following schedule reflects a recent market survey regarding the estimated annual sales revenue from the expansion project over the Project’s five-year life: Level of demand ₦’000 Probability High 16,000 0.25 Medium 12,000 0.50 Low 8,000 0.25 It is expected that the contribution to sales ratio will be 50%. Additional expenditure on fixed overheads is expected to be ₦1,800,000 per annum. TL incurs a 20% tax rate on corporate profits. Corporate tax is paid one year in arrears. TL’s after-tax nominal (money) discount rate is 15.5% per annum. A uniform inflation rate of 5% per annum will apply to all costs and revenues during the life of the project. All of the values above have been expressed in terms of current prices. You can assume that all cash flows occur at the end of each year and that the initial investment does not qualify for capital allowances.

The directors of Kenny plc wish to make an equity issue to finance an ₦800 million expansion scheme, with an expected net present value of ₦110 million. It is also to re-finance an existing 15% term loan of N500m and pay off penalty of N35m for early redemption of the loan. Kenny has obtained approval from its shareholders to suspend their pre-emptive rights and for the company to make a ₦1,500 million placement of shares which will be at the price of 185 kobo per share. Issue costs are estimated to be 4 per cent of gross proceeds. Any surplus funds from the issue will be invested in commercial paper, which is currently yielding 9 per cent per year. Kenny’s current capital structure is summarised below: Ordinary shares (25 kobo per share) ₦800 million Share premium ₦1,120 million Revenue reserves ₦2,310 million ₦4,230 million 15% term loan ₦500 million 11% bond ₦900 million ₦5,630 million The company’s current share price is 190 kobo, and bond price ₦102. Kenny can raise bond or medium-term bank finance at 10 per cent per year. The stock market may be assumed to be semi-strong form efficient and no information about the proposed uses of funds from the issue has been made available to the public. Taxation may be ignored.

The following financial information relates to TAXIM Plc, a listed company: Year Profit before interest and tax (₦m) 18.3 Profit after tax (₦m) 12.8 Dividends (₦m) 5.1 Equity market value (₦m) 56.4 TAXIM Plc has 12 million ordinary shares in issue and has not issued any new shares in the period under review. The company is financed entirely by equity. The annual report of TAXIM Plc states that the company has three financial objectives: Objective 1: To achieve growth in profit before interest and tax of 4% per year Objective 2: To achieve growth in earnings per share of 3.5% per year Objective 3: To achieve total shareholder return of 5% per year TAXIM Plc has a cost of equity of 12% per year.

Neko Plc has issued the following statement as part of its annual report: "This company aims at all times to serve its shareholders by paying a high level of dividends and adopting strategies that will increase the company’s share price. Satisfying our shareholders will ensure our success. The company will reduce costs by manufacturing overseas wherever possible, and will attempt to minimise the company’s global tax bill by using tax haven facilities."

Obong plc recently received a takeover bid from Abdul plc. If the bid for Obong plc is successful, it will provide Abdul plc the needed competitive edge in research and development to expand its laboratories into the production of the covid-19 vaccine. The shareholders of Obong plc will only accept an offer that meets a required return of 14% on their current shareholdings. Obong plc recently paid a dividend of N20 and this is expected to grow at a rate of 7% for the foreseeable future.