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AMA811S-ADVANCED MANAGEMENT ACCOUNTING-2ND OPP-JULY 2022 |
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nAm I Bl A un IVERS ITY
OF SCIEnCE Ano TECHnOLOGY
FACULTY OF COMMERCE, HUMAN SCIENCESAND EDUCATION
DEPARTMENT OF ACCOUNTING, ECONOMICS & FINANCE
QUALIFICATION: BACHELOR OF ACCOUNTING (HONOURS)
QUALIFICATION CODE: 08BOAH
COURSE CODE: AMA811S
LEVEL: 8
COURSE NAME: ADVANCED MANAGEMENT
ACCOUNTING
SESSION: JUNE 2022
DURATION: 3 HOURS
PAPER: PRACTICAL AND THEORY
MARKS: 100
SECOND OPPORTUNITY EXAMINATION QUESTION PAPER
EXAMINERS:
Kuhepa Tjondu
MODERATOR: Mr. L. Shinkeva
INSTRUCTIONS
• This question paper is made up of THREE(3) questions.
• Answer All the questions and in blue or black ink.
• Show all your working in the answer sheet.
• Start each question on a new page in your answer booklet and show all your workings.
• Questions relating to this paper may be raised in the initial 30 minutes after the start of
the paper. Thereafter, candidates must use their initiative to deal with any perceived error
or ambiguities and any assumption made by the candidate should be clearly stated.
PERMISSIBLE MATERIALS
Non-programmable calculator/financial calculator
THIS QUESTION PAPER CONSISTS OF 7 PAGES (Including this front page)
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QUESTION 1
[40 MARKS]
It is now May 2022. Okandjira Co is a listed company which produces a range of
branded products all of which are well-established in their respective markets,
although overall sales have grown by an average of only 2% per annum over the past
decade. The board of directors is currently concerned about the company's level of
financial gearing, which although not high by industry standards, is near to breaching
the covenants attaching to its 15% debenture issue, made in 2009 at a time of high
market interest rates. Issued in order to finance the acquisition of the premises on
which it is secured, the debenture is repayable at par value of N$100 per unit at any
time during the period 2022 - 2025.
There are two covenants attaching to the debenture, which state:
'At no time shall the ratio of debt capital to shareholders' fund exceed 50%. The
company shall also maintain a prudent level of liquidity, defined as a current ratio at
no time outside the range of the industry average (as published by the corporate credit
rating agency, Creditrate), plus or minus 20%.'
Okandjira's most recent set of accounts is shown in summarised form below. The
buildings have been depreciated since 2009 at 4% per annum, and most of the
machinery is only two or three years old, having been purchased mainly via a bank
overdraft. The interest rate payable on the bank overdraft is currently 9%. The finance
director argues that Okandjira should take advantage of historically low interest rates
on the European money markets by issuing a medium-term Eurodollar bond at 5%.
The dollar is currently selling at a premium of about 1% on the three-month forward
market.
Okandjira's ordinary shares currently sell at a P/E ratio of 14, and look unattractive
compared to comparable companies in the sector which exhibit an average P/E ratio
of 18. According to the latest published credit assessment by Creditrate, the average
current ratio for the industry is 1.35. The loan stock currently sells in the market at
N$15 above par.
Summarised financial accounts for Okandjira Co for the year ended 31
December 2021:
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2021
N$m
N$m
Assets employed
Non-current (net):
Land
5.0
Premises
4.0
Machinery and vehicles
11.0
20.0
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Current
Inventory
Receivables
Cash and cash equivalents
Total assets
2.5
4.0
0.5
7.0
27.0
Equity
Ordinary shares (25 cents par value)
Reserves
Long-term payables
15% Loan notes 2022 to 2025
5.0
10.0
5.0
Current liabilities
Payables
4.0
Bank overdraft (interest bearing)
3.0
7.0
Total equity and liabilities
27.0
STATEMENT OF PROFIT OR LOSS EXTRACTS FOR THE YEAR ENDED 31
DECEMBER 2021
N$m
Sales
28.00
Profit before interest and tax
3.00
Interest payable
-1.00
Profit before tax
2.00
Taxation
-0.66
PAT
1.34
Dividend
-0.70
Retained profit
0.64
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REQUIRED:
(a) Calculate appropriate gearing (debt/equity) ratios for Okandjira Co
using:
(i) Book values; and
(3)
(ii) The market values of debt and equity.
(4)
(b)
Assess how close Okandjira Co is to breaching the debenture
covenants.
(4)
(c) Discuss whether Okandjira Co's gearing is in any sense 'dangerous'
based on debt levels, Interest coverage and the entity's Non-current (10)
assets.
(d) Discuss what financial policies Okandjira Co might adopt:
(i) In order to lower its capital gearing; and
(8)
(ii)
To improve its interest cover. (show the relevant calculations to support
your suaaestions)
(6)
(e) Explain why a company might prefer raising capital in the form of
convertible debt as distinct from raising straight debt or straight equity (5)
and the associated benefits of such a strategy.
TOTAL
(40)
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QUESTION 2
[35 MARKS]
The directors of Otjunda Co are considering a planned investment project costing
N$25m, payable at the start of the first year of operation. The following information
relates to the investment project:
Years
1
2
3
4
Sales volume (units/year)
520,000
624,000 717,000 788,000
Selling price (N$/unit)
30.00
30.00
30.00
30.00
Variable costs (N$/unit)
10.00
10.20
10.61
10.93
Fixed costs (N$/year)
700,000
735,000 779,000 841,000
This information needs adjusting to take account of selling price inflation of 4% per
year and variable cost inflation of 3% per year. The fixed costs, which are incremental
and related to the investment project, are in nominal terms. The year 4 sales volume
is expected to continue for the foreseeable future.
Otjunda Co pays corporation tax of 30% one year in arrears. The company can claim
tax-allowable depreciation on a 25% reducing balance basis.
The views of the directors of Otjunda Co are that all investment projects must be
evaluated over four years of operations, with an assumed terminal value at the end of
the fourth year of 5% of the initial investment cost. Both net present value and
discounted payback must be used, with a maximum discounted payback period of two
years. The real after-tax cost of capital of Otjunda Co is 7% and its nominal after-tax
cost of capital is 12%.
The Chief Operating Officer (COO) Mr. Hunga attended a 1 day training workshop on
capital budgeting and investment appraisal last year. During the workshop they were
taught about the basic principles of capital budgeting which are very similar to relevant
costing principles. Unfortunately the COO cannot remember the principles but he is of
the opinion that they can be useful when looking at a project like this one.
REQUIRED:
(a) Calculate the net present value of the planned investment project.
(20)
(b) Calculate the discounted payback period of the planned investment project. (2)
(c) Discuss the financial acceptability of the investment project.
(2)
(d)
Critically discuss the views of the directors on Otjunda Co's investment
appraisal
(6)
(e)
Briefly explain the principles (assumptions) of Capital Budgeting and the
treatment of financinq costs.
(5)
TOTAL
(35)
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QUESTION 3
[25 MARKS]
OMBU Co, a company listed on a major stock market, is looking at its cost of capital
as it prepares to make a bid to buy a rival unlisted company, IMBII. Both companies
are in the same business sector. Financial information on OMBU Co and IMBII is as
follows:
OMBU Co
IMBII
N$m N$m N$m N$m
Non-current assets
36
25
Current assets
7
7
Total assets
43
32
Ordinary shares, par value 50 cents
15
5
Retained earnings
10
3
Total equity
25
8
Current liabilities
3
4
?%bonds, redeemable at par in seven years'
15
time
9% bonds, redeemable at par in two years'
20
time
Total equity and liabilities
43
32
Other relevant financial information:
Risk-free rate of return
Average return on the market
Taxation rate
4%
10.5%
30%
IMBII has a cost of equity of 12% per year and has maintained a dividend payout ratio
of 45% for several years. The current earnings per share of the company is 80c per
share and its earnings have grown at an average rate of 4.5% per year in recent years.
The ex div share price of OMBU Co is N$4.20 per share and it has an equity beta of
1.2. The 7% bonds of the company are trading on an ex interest basis at N$94.74 per
$100 bond. The price/earnings ratio of OMBU Co is eight times.
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The directors of OMBU Co believe a cash offer for the shares of IMBII would have the
best chance of success. It has been suggested that a cash offer could be financed by
debt.
REQUIRED:
{a)
Calculate the weighted average cost of capital of OMBU Co on a market
value weighted basis
(9)
{b) Calculate the total value of the target company, IMBII, using the following
valuation methods:
{i) Price/earnings ratio method, using the price/earnings ratio of OMBU Co; and (4)
{ii) Dividend growth model.
(4)
{c) Discuss the relationship between capital structure and weighted average
cost of capital, and comment on the suggestion that debt could be used to (8)
finance a cash offer for IMBII.
TOTAL
(25)
TOTALASSESSMENTMARKS
[100]
THE END
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