Thursday 6 December 2007
Reading and planning:
ALL FOUR questions are compulsory and MUST be attempted.
Formulae Sheet, Present Value and Annuity Tables are on
pages 6, 7 and 8.
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.
This question paper must not be removed from the examination hall.
The Association of Chartered Certified Accountants
Fundamentals Level – Skills Module
ALL FOUR questions are compulsory and MUST be attempted
(a) Phobis Co is considering a bid for Danoca Co. Both companies are stock-market listed and are in the same business sector. Financial information on Danoca Co, which is shortly to pay its annual dividend, is as follows: Number of ordinary shares
Ordinary share price (ex div basis)
Earnings per share
Proposed payout ratio
Dividend per share one year ago
Dividend per share two years ago
Other relevant financial information
Average sector price/earnings ratio
Risk-free rate of return
Return on the market
Calculate the value of Danoca Co using the following methods: (i) price/earnings ratio method;
(ii) dividend growth model;
and discuss the significance, to Phobis Co, of the values you have calculated, in comparison to the current market value of Danoca Co.
(b) Phobis Co has in issue 9% bonds which are redeemable at their par value of $100 in five years’ time. Alternatively, each bond may be converted on that date into 20 ordinary shares of the company. The current ordinary share price of Phobis Co is $4·45 and this is expected to grow at a rate of 6·5% per year for the foreseeable future. Phobis Co has a cost of debt of 7% per year. Required:
Calculate the following current values for each $100 convertible bond: (i) market value;
(ii) floor value;
(iii) conversion premium.
(c) Distinguish between weak form, semi-strong form and strong form stock market efficiency, and discuss the significance to a listed company if the stock market on which its shares are traded is shown to be semi-strong form efficient.
Duo Co needs to increase production capacity to meet increasing demand for an existing product, ‘Quago’, which is used in food processing. A new machine, with a useful life of four years and a maximum output of 600,000 kg of Quago per year, could be bought for $800,000, payable immediately. The scrap value of the machine after four years would be $30,000. Forecast demand and production of Quago over the next four years is as follows: Year
Existing production capacity for Quago is limited to one million kilograms per year and the new machine would only be used for demand additional to this.
The current selling price of Quago is $8·00 per kilogram and the variable cost of materials is $5·00 per kilogram. Other variable costs of production are $1·90 per kilogram. Fixed costs of production associated with the new machine would be $240,000 in the first year of production, increasing by $20,000 per year in each subsequent year of operation.
Duo Co pays tax one year in arrears at an annual rate of 30% and can claim capital allowances (tax-allowable depreciation) on a 25% reducing balance basis. A balancing allowance is claimed in the final year of operation. Duo Co uses its after-tax weighted average cost of capital when appraising investment projects. It has a cost of equity of 11% and a before-tax cost of debt of 8·6%. The long-term finance of the company, on a market-value basis, consists of 80% equity and 20% debt.
(a) Calculate the net present value of...
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