Question Tag: Shareholder Value

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  • 6 Marks

AT – Nov 2023 – L3 – Q1c – Tax planning

Advise on tax strategies to reduce advertising and marketing costs while creating value for shareholders.

Zantem Ltd has equity of GH¢10,000,000 while Bonty Ltd has equity of GH¢12,000,000. The two companies are in competition for the same market space. This has increased their advertising and marketing costs. The Ghana Revenue Authority (GRA) has threatened to disallow a portion of their advertising and marketing costs, which appear astronomically high.

The Management of the two companies have invited you, a tax expert, to be part of a discussion to look at the possible ways the two companies can eliminate or reduce any tax exposure to their shareholders with the potential threat from the GRA.

Required:
Advise the Management on the tax strategy(ies) to adopt to reduce their cost while creating value for their shareholders. (6 marks)

  • Merger or Amalgamation: Under section 47 of Act 896, gains arising from a merger, amalgamation, or reorganization are exempt from tax if there is 50% or more continuity in the underlying ownership of the new assets. The two companies should consider merging or amalgamating, provided they will achieve at least 50% in the underlying ownership. Zantem Ltd must increase its capitalization to be at par with Bonty Ltd to avoid tax liabilities on gains.
  • Joint Advertising: The companies could consider joint advertising to share costs, thereby reducing the overall expenditure on marketing. This strategy would keep costs down and reduce the potential for GRA disallowing the expenses.
  • Reduction or Elimination of Advertising Costs: If feasible, the companies might reduce or eliminate advertising and marketing costs entirely. This could involve leveraging other cost-effective marketing strategies that do not attract the scrutiny of the GRA.
  • 20 Marks

FM – DEC 2023 – L2 – Q1 – Introduction to Financial Management

Explanation of profit maximization vs. wealth maximization, disadvantages and advantages as performance measures, calculation related to rights issue.

a) Shareholders generally look forward to acceleration of the growth rate of their business. They therefore, prefer management report on wealth maximization to profit maximization.
Required:
i) In the light of this, explain the following:

  • Profit maximization. (2 marks)
  • Wealth maximization. (2 marks)

b) Explain to a shareholder THREE (3) inherent disadvantages of using profit as a performance measure and TWO (2) advantages of using wealth maximization as a performance measure. (8 marks)

c) Sobolo Ghana Ltd has taken a strategic decision to expand its scope of operations to enhance revenue growth. A new venture has been identified and requires funding to execute. Management in the light of the above has agreed to raise funding through a rights issue. The rights issue will be done at GH¢6 per share and existing shareholders will receive 2 rights for each 3 shares currently held. The company has 600,000 shares outstanding and they are currently trading at GH¢8 per share.
Required:
i) Calculate the number of new shares to be issued. (3 marks)
ii) Calculate the amount of money raised from the rights issue and the total value of the company after the rights issue. (5 marks)

a)
i) Profit maximization refers to good financial performance which focuses more on short term thinking of quick wins or high profits irrespective of the long-term implications or consequences of this short-term profits on a company and its shareholders. It focuses more on a narrow, short-term performance parameters like return on equity, return on investment, return on assets etc. (2 marks)

ii) Shareholder wealth maximization relates to long term approach to sustainably grow the value of shareholder interest which translates to sustainable share price growth and good dividend payments and focuses more on long term value and decisions made based on long term strategic focus rather than short term quick profits. (2 marks)

b)
Inherent Disadvantages of Profit Measure:

  • Profits are short term and might be driven by short term management interest.
  • Creative accounting can be used to produce and boost profits which might not be sustainable.
  • Profits might be book profits with no bearing on the real cash or cash flow of the entity.
  • Profit might not consider time value of money.
  • Profits might ignore the interest of other non-shareholders like the environment which will create long term problem for the company.

(Any 3 points @ 2 marks each = 6 marks)

Advantages of Wealth Maximisation:

  • Time value of money
  • It promotes the economic welfare of shareholders
  • It helps for achieving other objectives
  • It is useful for taking investment decisions
  • Payment of regular dividend

c)
i) Number of new shares:

3 old shares = 2 new shares
600,000 old shares = ?

600,000 shares/3 x 2 = 400,000 new shares under rights issue (3 marks)

ii) Amount of money of new shares issued = Number of new shares x right issue price
= 400,000 x GH¢6 = GH¢2,400,000

Existing value of shares = number of issued shares x currently share price
= 600,000 x GH¢8 = GH¢4,800,000

Total value of the company = Existing value + new shares issued value
= GH¢4,800,000 + GH¢2,400,000
= GH¢7,200,000 (5 marks)

  • 10 Marks

FM – Nov 2020 – L2 – Q1a – Introduction to Financial Management

Advise on non-financial objectives and risks associated with seabed mining.

Demo Gold is a Ghanaian mining company that has been operating on-land deep pit gold mining in Africa since its incorporation. Aiming at increasing the value of shareholders, the directors have signed an agreement with the governments of Tonga and Tuvalu to begin excavating an area of seabed in the Pacific Ocean for ores of copper, gold, and other valuable metals.

The idea of mining mineral deposits in the seabed has for many decades been considered unrealistic because of engineering challenges. However, the recent boom in offshore oil and gas operations has come with it the development of a few advanced deep sea technologies which can be used in mining mineral deposits in the seabed.

Required:

i) It appears that the sole objective of the seabed mining operation is to maximize the value of shareholders. Advise the directors on FOUR (4) non-financial objectives that Demo Gold should pursue to achieve a sustainable increase in shareholder value. (4 marks)

ii) Advise the directors of Demo Gold on THREE (3) likely sources of risk relating to the seabed mining operation. For each point, suggest a way through which the risk could be avoided or minimized. (6 marks)

i) Nonfinancial objectives

The following nonfinancial objectives can help Demo Gold to achieve a sustainable increase in shareholder value:

  • Customer satisfaction: The company should seek to provide minerals of the quality that customers expect for a fair price.
  • Employee satisfaction: The company should seek to maintain a safe working environment and provide job security to employees. Again, the company should seek to provide opportunities for employees to develop their professional knowledge and skills, and grow within the company.
  • Supplier satisfaction: The company should seek to remain loyal to its suppliers and continue to give them business. It should seek to pay them a reasonable price and ensure prompt payment.
  • Market leadership in research and development: The company should show a dominant position and leadership in research and development.
  • Diversification strategy: Seeking to expand and diversify business and product offerings to the market.
  • Market share growth: The company should seek to expand to increase its market share.
  • Reduction in negative environmental footprint: The company should seek to reduce environmental degradation and pollution. It should aim to protect marine life in the area it operates.

(4 nonfinancial objectives @ 1 mark each = 4 marks)

ii) Likely sources of risk relating to the seabed mining operation

Likely sources of conflicts relating to the operation of seabed mining include the following:

  • Potential reduction in shareholders’ value: The directors should manage the risk of the new business failing by hedging against mineral price, buying insurance to cover operational risks, and taking political risk insurance.
  • Exposure of employees to risk: The company should invest in safe machinery, disclose any safety issues to employees, train them on offshore mining, and maintain a compensation scheme for injuries.
  • Destruction to marine life: The company should invest in machinery that would not emit harmful gasses to marine life and carry out refinery operations onshore to avoid discharging untreated waste into the sea.
  • Loss of livelihoods of people living in the area: The company should provide compensation to displaced people and facilitate skill development in fish farming, providing seed capital for such activities.
  • Technology or system malfunction: Procure high-quality, well-tested equipment and systems with proper after-sales service and performance guarantees.
  • Political risk in the foreign environment: Take political risk insurance.
  • Economic risk: Proper economic forecasting and risk management in economic variables.
  • Currency risk: Use currency hedging tools to manage this risk.
  • 10 Marks

FINANCIAL MANAGEMENT – MAY 2021 – L2 – Q1A – Introduction to Financial Management

Discuss the agency problem in modern management, factors contributing to it, and strategies to mitigate it.

Management of a limited liability company is appointed to promote and protect shareholders’ interest in the performance of their functions. The aim is to maximise shareholder value. Management, however, could have interests that might be incompatible and in conflict with shareholders’ interest.

Required:
i) Identify this type of conflict in modern-day management. (2 marks)
ii) Explain THREE (3) different factors that contribute to this conflict in (i) above. (4 marks)
iii) As a Management professional, explain FOUR (4) strategies that can be used to manage or mitigate this conflict to protect shareholders. (4 marks)

i) Type of Conflict:
This type of conflict is known as the Agency Problem, where the interests of management (agents) conflict with the interests of shareholders (principals).

Marks: 2

ii) Factors Contributing to the Agency Problem:

  1. Goal Conflict: Management might pursue goals that maximize their personal benefits rather than those of the shareholders, leading to goal incongruence.
  2. Separation of Ownership and Control: Shareholders own the company but do not manage its day-to-day operations, leading to potential conflicts of interest with management.
  3. Information Asymmetry: Management has more access to the company’s financial and operational information than shareholders, which can lead to manipulation and self-serving decisions.

Marks: 4

iii) Strategies to Mitigate the Agency Problem:

  1. Internal Firings or Dismissals: Management can be fired, dismissed, or warned with layoffs for non-performance, keeping them motivated to act in shareholders’ best interests.
  2. Use of External Analysts and Experts: External consultants can monitor and assess management’s performance to ensure it aligns with shareholder interests.
  3. Performance-Related Incentives: Implementing executive share options or compensation linked to the performance of the share price ensures that management’s interests align with those of shareholders.
  4. Performance-Related Pay: Management’s compensation and bonuses are linked to the company’s performance, such as share price increases, which encourages management to maximize shareholder value.
  5. Use of Market Forces: Institutional investors can exercise strong voting powers to replace non-performing management, ensuring that management prioritizes shareholder interests.
  6. Monitoring: Performance of management can be monitored through schemes set up by shareholders, or by hiring external consultants and auditors to perform this role.

Marks: 4

Total Marks: 10

  • 20 Marks

FM – July 2023 – L2 – Q2 – Mergers and acquisitions

Calculate the value of a combined business after a merger, determine the maximum and minimum acceptable prices for the merger, and evaluate the type of merger.

Amanfi Ltd manufactures cooking oil for the local markets in Ghana. The management of Amanfi Ltd believes that by merging with one of their input suppliers, Aseebu Ltd, the company will be able to control supply, thus giving the Amanfi Group a low-price advantage in the market. Aseebu Ltd is a key supplier of inputs to companies in the cooking oil industry. The financial statements of the two companies are shown below:

Income Statement for the past Five Years (Amanfi Ltd)

Year (Million GH¢) 2018 2019 2020 2021 2022 (current year)
Sales 3,720 4,092 4,500 4,950 5,442
Cost of Sales (1,674) (1,841) (2,025) (2,228) (2,449)
Operating Profit 2,046 2,251 2,475 2,722 2,993
Finance Cost (252) (278) (305) (336) (369)
Earnings Before Tax 1,794 1,973 2,170 2,386 2,624
Tax @ 30% (538) (592) (651) (716) (787)
Earnings After Tax 1,256 1,381 1,519 1,670 1,837

Income Statement for the past Five Years (Aseebu Ltd)

Year (Million GH¢) 2018 2019 2020 2021 2022 (current year)
Sales 1,860 2,046 2,250 2,475 2,496
Cost of Sales (837) (921) (1,013) (1,114) (1,123)
Operating Profit 1,023 1,125 1,237 1,361 1,373
Finance Cost (126) (139) (153) (168) (169)
Earnings Before Tax 897 986 1,084 1,193 1,204
Tax @ 30% (269) (296) (325) (358) (361)
Earnings After Tax 628 690 759 835 843

Additional Information:
Amanfi Ltd and Aseebu Ltd have beta of 1.6 and 1.1 respectively. The government treasury bill rate pays a yield of 8% and risk premium on the market is 17%. If the merger goes through, the combined company’s earnings after tax will grow at the same rate as Amanfi Ltd. The merger will lead to annual cost savings of GH¢850 million in perpetuity.

Required:
a) As a Finance Manager, calculate the value of the combined business based on the present value of expected earnings. (8 marks)
b) What is the maximum amount that Amanfi Ltd should pay for Aseebu Ltd? (4 marks)
c) What is the minimum bid that Aseebu Ltd shareholders should be prepared to accept? (4 marks)
d) Calculate the gain/loss from the merger. (2 marks)
e) Identify and explain the type of merger between Amanfi Ltd and Aseebu Ltd. (2 marks)

a) Calculation of the Value of the Combined Business Based on the Present Value of Expected Earnings
Value of Combined Business (GH¢’million):
(1 mark for each line up to 5, 1 mark each for the growth rate and 2 marks for cost of equity = 8 marks)

b) Maximum Amount that Amanfi Ltd Should Pay for Aseebu Ltd
Value of Amanfi = = GH¢8,081 million
(2 marks each for the maximum price and the value of Amanfi = 4 marks)

c) Minimum Bid that Aseebu Ltd Shareholders Should Be Prepared to Accept

(2 marks for the minimum price and 1 mark each for the growth rate and the cost of equity = 4 marks)

d) Gain/Loss from the Merger
Gain:
Value of Combined business − (Value of Amanfi + Value of Aseebu)
=14,216 − (8,081 + 4,672) = GH¢1,463 million

e) Type of Merger Between Amanfi Ltd and Aseebu Ltd
Backward Vertical Merger/Acquisition:
A merger between firms that operate at different stages of the same production chain, or between firms that produce complementary goods. This type of vertical merger between a supplier and a firm is known as a backward merger. (2 marks)

 

  • 10 Marks

FM – Nov 2019 – L2 – Q2b – Mergers and acquisitions

Determine the extent to which Powell's shareholders will benefit from the proposed merger.

Global companies continuously explore ways to be more efficient and effective to survive the challenging global competition. Some resort to mergers and acquisitions to survive. In the light of this, Carsley Ltd and Powell Ltd are planning to merge to form Stimac Ltd. It has been agreed that Powell’s shareholders will accept three shares in Carsley for every share in Powell they hold. Other details are as follows:

Carsley Ltd Powell Ltd
Number of shares 40m 10m
Annual earnings GH¢10m GH¢5.8m
P/E ratio 8 10

Post-merger annual earnings of the enlarged company are expected to be eight percent higher than the sum of the earnings of each of the companies before the merger, due to economies of scale and other benefits. The market is expected to apply a P/E ratio of 9 to Stimac Plc.

Required:
Determine the extent to which the shareholders of Powell will benefit from the proposed merger. (10 marks)

Market Value of Powell Ltd:
Powell’s market value, using its P/E ratio and earnings, is calculated as:
Market Value = Earnings× P/E Ratio
Market Value = GH¢5.8m × 10 = GH¢58m
(2 marks)

Post-Merger Annual Earnings of Stimac Ltd:
The earnings of Stimac Ltd will be:
Post-Merger Earnings = (Carsley Earnings + Powell Earnings) × 1.08
Post-Merger Earnings = (GH¢10m+GH¢5.8m) × 1.08 = GH¢17.06m
(2 marks)

Market Value of Stimac Ltd:
Using a P/E ratio of 9, the value of Stimac Ltd is calculated as:
Market Value of Stimac Ltd = GH¢17.06m × 9 = GH¢153.54m
(2 marks)

Wealth of Powell’s Shareholders Post-Merger:
The 10 million shares of Powell will be swapped for 30 million Carsley shares, making 70 million shares in the new company in total. Therefore, the wealth of Powell’s shareholders will now be:
(2 marks)

(2 marks)

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