CPA 8-FINANCIAL MANAGEMENT

Solution 1

(a) MUL’s Weighted Average Cost of Capital (WACC) for the existing capital structure;
Cost of equity (Ke) = Div0 (1 + g) + g
P0
Dividends paid = 40% x 5,160 million = Shs 2,064 million
Dividend per share = Total dividends / No. of shares
But No. of shares = 7,500 million / 10,000 = 750,000 shares
Dividend per share = 2,064 million / 750,000 shares = Shs 2,752
Market price per share = Par value + premium
= 10,000 + (50% x 10,000) = Shs 15,000
Therefore, cost of equity (Ke) = Div0 (1 + g) + g
P0
Ke = 2,752 (1 + 5%) + 5% = 24.26%
15,000
𝑑
Cost of preference shares (Kp) = 𝑝𝑓
No. of Preference shares = 2,500 million/ 20,000 = 125,000 shares
Dividend per share = 10% x 2,500 million = Shs 2,000
125,000 shares
Kp =2,000 x 100 = 9.1%
22,000

Cost of redeemable debentures = IRR

Interest payable = 16% x 1,000 = Shs160 per debenture stock
Redemption value = 1,000 x 1.1 = Shs 1,100 per debenture stock
Market price per debenture stock = 1,000 – (10% x 1,000) = Shs 900

Years Cash flow DCFs at 16% PVs DCFs at 24% PVs

0 (900) 1.000 (900) 1.000 (900.0)
1-4 160 2.798 447.7 2.404 384.64
4 1,100 0.552 607.2 0.4230 465.30
NPVs = 154.9 (50.06)
Cost of debentures = 16% + [(154.9 / (154.9 + 50.06)) x (24% - 16%)]
= 22.1 %( 1 – 0.3)
= 15.47%

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 Market value
Capital structure No. of stocks Unit price (Shs 000) % proportions
Ordinary share capital 750,000 15,000 11,250,000 70%
Preference share capital 125,000 22,000 2,750,000 17%
Debentures 2,250,000 900 2,025,000 13%
16,025,000 100%

WACC = 24.26% x 70% + 9.1% x 17% + 15.47% x 13% = 21%

= 0.16982+0.01547+0.0201= 20.5%

(b) Evaluation of the financial viability of the proposed expansion using the Net Present
Value (NPV) technique;

Evaluation;

The proposed expansion is financially viable since it results in positive NPV of

Shs.563 million, implying that if undertaken, it will add value to the wealth of
existing shareholders. Therefore, it should be undertaken. Detailed analysis is
provided in the Appendix .

Appendix;

Cost of capital for evaluating the proposed expansion;

 The cost of capital will be the cost of equity since the expansion will be financed
using proceeds from a rights issue.
Therefore, cost of equity (Ke) = Div0 (1 + g) +g
P0
Ke = 2,752 (1 + 5%) + 5% = 25%
14,500
Number of shares in right issue = 2/3 x 750,000 = 500,000 shares
Proceeds from rights issue = 500,000 shares x offer price
= 500,000 shares x 14,500
= 7,250 million
Required capital = 80% x 7,250 million
= Shs 5,800 million

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Output levels
Years No. of cartons
1 75,000 5,000
2 75,000 x 1.1 82,500
3 82,500 x 1.1 90,750
4 90,750 x 1.1 99,825
5 99,825 x 80% 79,860

Years 1 2 3 5
Sales / output 75,000 82,500 90,750 79,860
Unit contribution 35,000 35,000 35,000 35,000
Total contribution 2,625,000 2,887,500 3,176,250 2,795,100
Years Cum. W.C Incremental W.C
0 = 25% x 5,800 = 1,450 1,450
1 = 1,450 x 1.05 = 1,523 73
2 = 1,523 x 1.05 = 1,599 76
3 = 1,599 x 1.05 = 1,679 80
4 = 1,679 x 1.05 = 1,762 84
5 Recovery 1,762
Capital allowances (Shs. Millions)
Years Allowances Tax savings at 30%
1 = 4,350 x 20% 870 261
2 = 3,480 x 20% 696 209
3 = 2,784 x 20% 557 167
4 = 2,227 x 20% 445 134
5 = 1,782 x 20% 356 107

Balancing allowance / charge (Shs Millions)

WDV in year 5 1,426
Disposal proceeds 1,200
Balancing allowance 226
Tax savings at 30% 68

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Determining NPV (Shs. Millions);
Years 0 1 2 3 4 5
Contribution
(w2) 2,625 2,888 3,176.3 3,493.9 2,795.1
Fixed costs (240) (259) (280) (302) (327)
Taxable profits 2,385 2,628 2,896 3,192 2,469
Tax at 30% (716) (788) (869) (957) (741)
After tax profits 1,670 1,840 2,027 2,234 1,728
Initial outlay (4,350)
Working capital (1,450) (73) (76) (80) (84) 1,762
Tax savings
(W4 & 5) 261 209 167 134 175
Scrap proceeds 1,200
Net cash flows (5,800) 1,858 1,973 2,114 2,284 4,865
PVIFs at 25% 1.000 0.800 0.640 0.512 0.410 0.328
PVs (5,800) 1,486 1,262 1,083 936 1,596
NPV 563

(c) Validity of using payback period technique;

Arguments for;
 Payback period is simple to calculate and the concept of can easily be understood
by even non-financial managers;
 The technique is useful in periods of rapid technological changes as it helps an
investor or entity to know whether the project will have paid back before
obsolescence sets in;
 The technique uses cash flow information which is less susceptible to creative
accounting as it is the case with ARR technique that uses accounting information.
Arguments against;
 It does not take into consideration time value of money.
 It does not take into consideration the cash flows occurring after payback period.
 The technique does not consider the total return from an investment, hence it is
not an appropriate method in measuring the profitability of an investment.
 There is definite measure of what constitutes an appropriate payback period and
there is no criteria for setting a minimum payback period.

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(d) Advantages of using equity capital;
 There is fixed obligation to pay. If a firm has insufficient cash, it can suspend
payment of equity dividends without legal consequences.
 Equity capital has no maturity date hence the firm has no obligation to pay out the
principal invested.
 Equity capital cushions an entity against financial risk that is associated with
excessive gearing.

Disadvantages of using equity capital;

 Sale of shares to outsiders dilutes control and ownership of the existing
shareholders.
 Equity dividends are paid out of profits after tax while interest payments are tax
deductible expenses. This makes the relative cost of equity more expensive.
 The cost of issuing equity shares is generally higher than the cost of issuing other
types of capital such as raising debt capital.
Solution 2
(a) Evaluation of the viability of the proposed extension of the credit period;

Shs. Million
Incremental sales revenue = 25% x Shs.54,000 13,500
Incremental contribution = 35% x 13,500 4,725
Increase in provision for bad debts = 8% x 13,500 (1,080)
Net contribution = 4,725 - 1,080 3,645
Less: Income tax (30% x 3,645) (1,093.5)
Net contribution after tax 2,551.5
Incremental investment in receivables
= 67,500m x 60 days – 54,000m x 30 days
365 days
= 6,657.5 million
Marginal rate of return = Incremental net contribution after tax x 100
Incremental investment in receivables
= 2,551.5 million x 100 = 38.3%
6,657.5 million

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Evaluation;
The proposed extension of the credit period from 30 days to 60 days is financially viable
because it results in a marginal rate of return of 38.3% which is higher than the minimum
required return of 25%. Hence, PTL should revise its credit period as proposed.
Drawbacks of the strategy
 It increases administrative costs through follow up of credit customers
 May lead to increase in bad debts
 It increases the financing costs like borrowing costs
(b) Goals of credit management to an organization like PTL:
 To obtain optimum volume of sales. Through efficient and effective credit
management, a firm can expand its sales. It helps in retaining old customers and
wining new ones.
 To control the cost of credit and keep it at its maximum. Credit management
involves costs which include administration, bad debts, losses and opportunity cost
of funds locked up in receivables. The aim of credit management is to control these
costs.
 To maintain investment in receivables at optimum level. By extending liberal credit
period, the firm can increase its sales and thereby increase its profitability.
Increasing sales also increase costs and therefore there is a need to have
investment in receivables maintained at optimum level by trading off between
costs and benefits.
 To reduce the number of late payments by detecting them earlier and preventing
bad debts consequently reducing the possibility that a default will adversely impact
on business.
 To enhance cash flows protection. Credit management ensures that the timing of
cash inflows is fairly matched with cash outflows to avoid liquidity crisis.
(c) Role of the financial controller to an organization like PTL:
 Stewardship – The financial controller protects and conserves business resources
and accurately reports on its financial performance and position;
 The financial controller provides right information at the right time to support
business execution.
 The financial controller supports decision making in an organization through
providing timely financial information and analysis to those charged with decision
making in the organization.

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 The financial controller implements the financial strategies of the organization
including risk management and control, financial and opportunity forecasting.

Solution 3

To: Board Chairman of MTL

From: Finance Director
Date: Exam date
Subject: Financing of Investment in South Sudan

I submit this paper for discussion at the upcoming board meeting in fulfillment of my
employment terms as the finance director of the company. The paper contains the validity
of using Eurobond market, discussion Islamic financing structures and the role of
international banks in international trade.
(a) Validity of using Eurobond markets for capital mobilization:
Arguments for;
 The issue costs are relatively low - Issuers of Eurobonds can raise cash and lower
borrowing costs by borrowing in international markets.
 Interest rate and currency conversion risks in overseas countries can be mitigated
by issuers.
 Eurobonds provide investors a unique way to diversify their investments because
their market is offshore and it is not subjected to national regulations and controls.
 Eurobonds also provide tax advantages to investors and involve less
documentation from the issuers, which lowers the tax liability for investors.
 Eurobonds are issued on international exchanges, hence they are extremely liquid
debt products.
Arguments against;
 Issuers of Eurobonds may be exposed to currency risk while investors may be
exposed to regulatory risks when purchasing these bonds. This tends to scare
away such investors, hence limiting the funding.
 Companies with poor or average credit ratings are not able to issue Eurobonds
which limits the source of funding for such entities.
 Investors of such bonds tend to buy several different currency Eurobonds in order
to ensure diversification. This in turn exposes the issuer to foreign exchange risks.

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(b) Role of international banks in international trade.
 Accepting deposits and advancing loans and facilitating borrowing and lending in
euro currencies.
 Financing export and import trade.
 Underwriting issuance of euro bonds, euro notes and foreign bonds.
 Providing capital for capital projects.
 Setting or joining syndicated loan schemes.
 Facilitating international fund management and rapid transfer of funds.
 Accepting local currency deposits and advancing local currency loans
(c) Discussion of Islamic financing structures appropriate to MTL:
 Istisna – This is the most appropriate financing structure for funding large, long-
term construction projects. The Islamic bank funds construction of the masts and
other infrastructures, with MTL paying an initial deposit, followed by instalments
during the course of construction. Upon completion of the construction, the masts
and other infrastructures are handed over to MT.
 Murabaha – This is a deferred payment sale of instalment credit sale used to
purchase assets for immediate delivery. In this arrangement, the Islamic bank can
purchase the required equipment and sells them to MTL on deferred payment
terms.
 Musharaka – In this structure, MTL and the financing institution operate as
partners who bring a share of capital and expertise to the business but do not
have to provide equal amounts of capital or expertise.
All profits made are shared based on the ratios agreed in the original contract however,
losses made by the financed business are shared in the proportions of capital
contribution.
 Mudaraba – This financial instrument is a partnership transaction in which the
Islamic bank contributes capital and MTL contributes skill and expertise. Profits are
shared according to a pre-agreed contract but all losses are solely attributable to
the provider of capital (Islamic bank).
 Ijara – Ijara is the Islamic equivalent of a lease where one party (lessor) allows
another party (lessee) to use his asset in return for a rental fee.
Therefore, under this financial instrument, the Islamic bank purchases the required
equipment and leases it out to MTL in return for rental payments for a specified period

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of time but the Islamic bank bears and incurs the risk of ownership including being
responsible for major maintenance and insurance of the infrastructure / equipment.

Solution 4
(a) Evaluation of the viability of acquiring PCL using Net assets valuation method;
 The planned acquisition at Shs 30,000 per share if financially viable since the
quoted price is less than the value per share of Shs 30,259.2 determined using net
assets valuation method. Refer to the workings below.
Share valuation using net assets method;
(Shs.000)
Assets:
Non-current assets:
Property, plant and equipment (w1) 23,538,630
Goodwill Nil
Equity investment (w2) 3,000,000
Current assets (w3) 9,833,700
Total assets 36,372,330
Less: Liabilities:
18% term loan (w4) 9,257,100
15% debentures 6,276,000
Trade and other payables (4,427,400 + 270,000) 4,697,400
Current tax (987,250 + 25,000) 1,012,250
Total liabilities 21,242,750
Net assets (36,372,330 - 21,242,750) 15,129,580

No. of ordinary shares = 7,500 million / 15,000 500,000

Value per share = 15,129,580,000 / 500,000 30,259.2

Workings:

W1 - Property, plant and equipment (Shs 000)

Carrying value Realisable value
Grading machine 360,000 324,000
Land 1,200,000 1,350,000
Other PPE items 23,015,400 21,864,630
24,575,400 23,538,630

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 W2 - Equity investment (Shs.000)

Realisable value = 200,000 shares x 15,000 = 3,000 million

Carrying value
Trade & other receivables 7,400,000
Inventory 1,400,000
Cash & cash equivalents 1,325,700
10,125,700

W4 - 18% Term loan (Shs.000)

Reported carrying amount 7,845,000
Add: Omitted interest (18% x 7,845,000) 1,412,100
9,257,100

(b) Importance of investing in corporate social responsibility:

 It encourages customer loyalty - Customer feels like they are living out their values
by supporting a certain business, they are more likely to stick with the brand.
 It gives businesses a competitive edge – Organizations that engage in social
responsibility have a competitive edge over companies that do not as such entities
are considered more appealing to the customers.
 Investing in corporate social responsibility makes an organization more attractive
to investors because such an entity guarantees sustainability, customer loyalty,
and competitiveness.
 Corporate responsibility attracts better talent and helps an entity to retain such
talented employees which ensures its future growth.
Solution 5

(a) Evaluation of the financial performance and position of CPL for the year ended 31
December 2022.
 The production cost accounted for 66.27% of revenue in 2021 decreasing to
63.06% in 2022, resulting into an increase in contribution from 33.73% in 2021 to
36.94% in 2022.

 Administrative costs accounted for 15.88% of the total revenue up from 13.83%
registered in 2021. In contrast, distribution and finance costs decreased from
17.35% and 2.05% of revenue in 2021 to 16.82% and 1.74% in 2022,
respectively.

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 Consequently, the net profit before and after tax increased from 0.51% and 0.35%
in 2021 to 2.49% and 1.75% in 2022, respectively, an indication of improvement
in the earnings performance of the company.

 Property, plant & equipment (PPE) and inventory accounted for 57.6% and 24.5%
of the total assets in 2022 down from 61.5% and 26% in 2021. The decline in PPE
may be attributable to impairment and periodic depreciation of these assets while
the decrease in inventory levels may be due to increased stock turnover in CPL.

 Trade and other receivables accounted for 10.5% of the total assets in 2022 up
from 3.8% registered in 2021. This significant increase in receivables may pose
adverse effects to the liquidity position of CPL since much of the current assets are
held in inventory (24.5%) which is considered less liquid compared to the holding
in cash and cash equivalents of 7.4%.

 Current liabilities accounted for 17.4% of the total assets in 2022 down from
19.8% in 2021 while current assets accounted for 42.4% in 2022 from 38.6% in
2021. Consequently, the company’s net working capital position improved from
18.8% (38.6% - 19.8%) in 2021 to 25% (42.4% - 17.4%) in 2022. This
improvement in net working capital position results in improved liquidity position
of CPL.

 28.8% of the assets in 2022 were financed by long term liabilities compared to
31.5% in 2021. Whereas this may indicate declining gearing levels, it may also be
attributable to the decline in the total assets which are used as base values in the
analysis.

 Total assets financed by equity in 2022 were 53.8% up from 48.8% in 2021. This
is an indicator of increased capital maintenance in the entity and continuous
decline in gearing levels at its associated risks. Please refer to the Appendix for
detailed analysis.

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 Appendix:
Common size statement of financial performance;
Common size analysis
2022 2021 2022 2021
(Shs.000) (Shs.000)
Revenue 42,500,000 41,500,000 100% 100%
Production cost (26,800,000) (27,500,000) -63.06% -66.27%
Contribution 15,700,000 14,000,000 36.94% 33.73%
Administrative costs (6,750,000) (5,740,000) -15.88% -13.83%
Selling & distribution costs (7,150,000) (7,200,000) -16.82% -17.35%
Finance costs (740,000) (850,400) -1.74% -2.05%
Profit before tax 1,060,000 209,600 2.49% 0.51%
Income tax (318,000) (62,880) -0.75% -0.15%
Profits for the year 742,000 146,720 1.75% 0.35%

Common size statement of financial position;

Common size analysis
2022 2021 2022 2021
Assets: (Shs.000) (Shs.000)
Non-current assets:
Property, plant & equipment 17,500,000 19,254,000 57.6% 61.5%
Current assets:
Inventory 7,450,000 8,125,000 24.5% 26%
Trade and other receivables 3,175,000 1,177,680 10.5% 3.8%
Cash and cash equivalents 2,240,000 2,750,400 7.4% 8.8%
Total assets 30,365,000 31,307,080 100% 100%
Equity and liabilities:
Ordinary share capital 5,500,000 5,000,000 18.1% 16%
Retained earnings 6,259,500 5,517,500 20.6% 17.6%
Preference share capital 4,570,000 4,754,500 15.1% 15.2%
Non-current liabilities:
Long term loans 8,750,000 9,847,200 28.8% 31.5%
Current liabilities:
Trade and other payables 4,967,500 6,125,000 16.4% 19.6%
Current tax payable 318,000 62,880 1.0% 0.2%
Total equity and liabilities 30,365,000 31,307,080 100% 100%
(b) Requirements for listing on the Fixed Income Securities Market Segment (FISMS):
FISMS is one of the market segments of the Uganda Securities Exchange that aims at
providing a separate independent market for companies wishing to raise financing
through issuance and listing of fixed income securities. Such securities include; treasury
bonds, preference shares and debenture stocks as well as short-term financial
instruments such as treasury bills and commercial papers.
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Requirements;

 The issuer shall be a company, government, local government or any other body
corporate.

 The issuer shall have net assets of Shs. 2billion before the public offering of
securities. In the event that the issuer does not meet these net assets
requirements, the issuer shall obtain a guarantee from a bank or other financial
institution acceptable to the exchange.

 The issuer shall have published audited financial statements for a period of three
years complying with International Accounting standards for an accounting period
ending on a date note more than 6months prior to the proposed dates of the offer.

 The issuer shall have prepared financial statements for the latest accounting period
on going concern basis and audit report shall not contain any emphasis of matter
or qualification of in this regard.

 At the date of the publication, the issuer shall not be in breach of any of its loan
covenant.

 The issuer should have made profits in at least two of the last three years
preceding the issue of the commercial paper of the corporate bond. In the event
that the issuer cannot meet this requirement, the issuer shall obtain a guarantee
from a bank or other financial institution acceptable to the exchange.

 An issuer wishing to issue all its debt securities shall not be insolvent within the
meaning of the Companies Act 2012 and any other amendments thereto.

 Commercial paper or corporate bond shall not exceed 400% of the issuer’s net
worth (or a gearing ratio of 4:1) as at the date of the latest balance sheet.

 Where there is a guarantor and in the event that the guarantor is a bank or an
insurance company licensed to operate in Uganda, the consent of the relevant
regulatory authority shall be required. The ratio of funds generated from the
operations to total debt for the three trading periods preceding the issue shall be
maintained at the weighted average of 40% or more.

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