SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

SOLUTION 1

(a) E(R) = 4% + 1.3 (16% - 4%) = 20%

- Given the expected return of Newco’s shares using CAPM is 20% and the investor
anticipates a 20% return, the security could be properly valued.

- If the expected return using the CAPM is higher than the investor’s required return, the
security is undervalued and the investor should buy it.

- If the expected return using the CAPM is lower than the investor’s required return, the
security is overvalued and should be sold.

(b) Re = 0.13 + (0.13 – 0.08) x 0.75 x (1- 0.25)

= 0.158125 = 15.81%

(c) [𝐺𝐻¢ 2100 𝑥 (1 − 0.25)] ÷ 0.14 = GH¢11,250

Vu = GH¢11,250 + (0.25 x 2800) = 11950

SOLUTION 2 (a)

Present Terms New Terms

Credit sales 8,000,000 8,000,000

Average collection period 60days 40days
Average receivables 1,333,333 888,889
Reduction in receivables
from present level 444,444
Return on reduction (12%) = 53,333

Cost of discount being taken = 8,000,000 x 60% x 2% = GH¢96,000

(b) A temporary surplus implies a need for funds in the near future. As such, the qualities looked
for is an investment are the following:

1. Easy marketability
2. Low risk of price changes
3. Low risk of default

The firms want a high degree of liquidity and are prepared to forgo the possibility of a high
return in exchange for a relatively high degree of safety. The higher the possibility of return, the
higher the risk of an investment.

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 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

SOLUTION 3

(a) Maxy Ltd

(i) Gain = 700,000

0.10
= ¢7,000.000

(ii) Cost of cash offer = cash paid – PVBafsco

= ¢15,000,000 - ¢10,000,000
= ¢5,000,000

(iii) Cost of stock offer = xPVAB - PVB

= 0.5 (30m + 10m + 7m) – 10,000,000

= ¢23,500,000 - ¢10,000,000

= ¢13,500,000

(iv) NPV = Gain – cost

= 7,000,000 – 5,000,000
= ¢2,000,000

(v) NPV = Gain – cost

= 7,000,000 – 13,500,000
= -6,500,000

Year Dividend Growth in

Per share dividend
𝑑𝑖
(Pesewas) 𝑔 = (𝑑𝑜 )1/𝑛 − 1

1 19.86 -

2 21.45 8%

3 23.17 8%

4 25.02 8%

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 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

With a constant growth in dividend of 8%, using the dividend valuation model, the price of the
company should be:

Price = D = 25.02 (1.08) = GH¢6.00

Ke – g 0.125 – 0.08

Over valuation is 6.45 – 6 = 0.45

SOLUTION 4

(a) (i) Expected Return

Stock A = (0.35 x 0.20) + (0.40 x 0.15) + (0.25 x 0.01)

= 0.07 + 0.06 + 0.0025 = 0.1325

Stock B = (0.35 x 0.35) + (0.40 x 0.21) + (0.25 x -0.25)

= 0.1225 + 0.0480 – 0.0625 = 0.1080

Stock C = (0.35 x 0.60) + (0.40 x 0.05) + (0.25 x -0.50)

= 0.21 + 0.02 – 0.1250 = 0.150

Portfolio Return = (0.40 x 0.1325) + (0.4 x 0.1080) + (0.2 x 0.1050)

= 0.0530 + 0.0432 + 0.0210
= 0.1172

(ii) The expected risk premium for the portfolio

= 0.1172 – 0.0380
= 0.0792

𝐸 𝐷
(iii) WACC = [𝑘𝑒 𝑥 𝐸𝑥𝐷] + [𝑘𝑑 (1 − 𝑡)𝑥 ]
𝐸𝑥𝐷

Ke = Rf + B (Rm – Rf)
8% + 0.85 (14-8) = 13.1%

Kd = 8%
E=3
D=2
3 2
[13.1 𝑥 3+2] + [8% (1 − .25)𝑥 3+2 ]

7.86 + 2.4 = 10.26%

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 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

SOLUTION 5

(a) Call Option: A right to buy foreign currencies at a strike price at a price premium at a
given time.

Put Option: A right to sell foreign currencies at a strike price at a price premium at a
given time.

(b) (i) pv = GH¢60

(ii) pv 1-1
(1.10)10 x 12 = GH¢73.73
.10

(iii) pv (perpetuity) = GH¢10 = GH¢100

.10

(iv) pv = 1
(1.10)10 x 150 = GH¢57.83

*Choose option (iii)

(c) Advantages of Overdraft facility

(i) A bank overdraft facility is quick and cheap to arrange as the borrower does not
need to undergo the stringent scrutiny subjected to borrowers of long term longs.

(ii) The company only pays interest on a bank overdraft facility only when it has a
debit balance in its bank account.

(iii) An overdraft is flexible as the borrower only borrows what they need to use at the
time and this makes it cheaper than loans.

(iv) There are no penalties or charges for paying off the overdraft earlier as the
borrower can repay the overdraft at any time.

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 SOLUTION: FINANCIAL MANAGEMENT, MAY 2014

Disadvantages of Overdraft

(i) A bank overdraft is usually a privilege offered to customers for banking with a certain
bank.

(ii) A bank overdraft facility poses a risk to the availability of working capital support to
a business if the bank decides not to renew it.

(iii) Bank overdrafts are repayable on demand and the lender may call them anytime. The
withdrawal of the overdraft facility may put pressure on the cash needs or day to day
financing needs of the business.

(iv) Overdraft are usually secured against business assets and the lender can take control
of the business assets if it defaults in its repayment.

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SOLUTION: FINANCIAL MANAGEMENT, MAY 2014