QUESTION ONE Volta Agro Processing Ltd paid a dividend of GH¢0.25 per share last year (Do). The company is expected to grow at a constant rate of 6% per year. Investors require a rate of return of 14%. Required a) a) Discuss the assumptions and relevance of the constant growth dividend valuation model in equity valuation. (8 marks) b) Calculate: i. The expected dividend next year (D1) ii. The intrinsic value of the share using the constant growth model iii. Interpret whether an investor should buy the share if its current market price is GH¢3.20. (12 marks) QUESTION TWO Akwaaba Manufacturing PLC paid a dividend of GH¢0.60 per share last year. The company is expected to experience supernormal growth of 15% annually for the next 3 years, after which dividends will grow at a stable rate of 7% indefinitely. The required rate of return is 16%. Required a) Critically explain the concept of the multiple growth (supernormal growth) dividend model and why it is more realistic for growing companies. (8 marks) b) Calculate the current intrinsic value of the company’s shares using the multiple growth dividend model. (12 marks) QUESTION THREE Keta Energy Corporation issued a 10% preference share with a face value of GH¢5.00. Investors require a return of 11%. Required a) a) Explain the difference between redeemable and irredeemable preference shares and how this difference affects valuation. (8 marks) b) Calculate the value of the preference share under the following scenarios: i. If the share has a maturity period of 6 years ii. ii. If the share has no maturity date (12 marks) QUESTION FOUR Bonsu Infrastructure Ltd issued a bond with the following characteristics: Item Value Face value GH¢1,000 Coupon rate 11% Maturity 8 years Required rate of return 13% Required a) Discuss the relationship between bond prices and interest rates, and explain why long-term bonds are more volatile than short-term bonds. (8 marks) b) Calculate the intrinsic value of the bond. (12 marks) QUESTION FIVE A financial analyst collected the following investment data for Savannah Telecom Ltd shares. Year Price (GH¢) Dividend (GH¢) 0 15 – 1 13 1.20 2 18 1.30 3 17 1.10 4 19 1.40 5 20 1.50 Required a) Explain the difference between arithmetic average return and geometric average return and discuss why analysts often prefer the geometric mean for long-term investments. (8 marks) b) Calculate: i. Holding Period Return (HPR) for each year ii. Arithmetic Average return iii. Geometric Average return (12 marks) QUESTION SIX Kumasi Packaging Ltd is evaluating an investment project with the following cash flows: Year Cash Flow (GH¢) 0 (600,000) 1 150,000 2 220,000 3 280,000 4 250,000 5 200,000 The company’s cost of capital is 12%. Required a) Explain the concept of Net Present Value (NPV) and discuss why it is considered superior to traditional investment appraisal techniques. (8 marks) b) Calculate the Net Present Value (NPV) and advise management on whether the project should be accepted. (12 marks) QUESTION SEVEN A company is evaluating a project requiring an initial investment of GH¢400,000. The expected annual cash inflows are as follows: Year Cash inflow (GH¢) 1 120,000 2 140,000 3 110,000 4 90,000 5 80,000 Required a) Explain the payback period technique and critically evaluate its advantages and limitations in capital budgeting decisions. (8 marks) b) Calculate the Payback Period (PBP) and interpret the result. (12 marks)
ScanSolve AI Answer
Question 1: QUESTION ONE a) Discuss the assumptions and relevance of the constant growth dividend valuation model in equity valuation.
The constant growth dividend valuation model assumes that dividends will grow at a constant rate indefinitely, which is relevant for valuing stable companies with predictable growth patterns, allowing investors to estimate the present value of future dividends.
Question 2: b) i. Calculate the expected dividend next year (D1).
The expected dividend next year (D1) is GH¢0.25 × (1 + 0.06) = GH¢0.265.
Question 3: b) ii. Calculate the intrinsic value of the share using the constant growth model.
The intrinsic value of the share is calculated as D1 / (required return - growth rate) = GH¢0.265 / (0.14 - 0.06) = GH¢3.31.
Question 4: b) iii. Interpret whether an investor should buy the share if its current market price is GH¢3.20.
Since the intrinsic value (GH¢3.31) is greater than the market price (GH¢3.20), an investor should consider buying the share.
Question 5: QUESTION TWO a) Critically explain the concept of the multiple growth (supernormal growth) dividend model and why it is more realistic for growing companies.
The multiple growth dividend model accounts for varying growth rates over different periods, making it more realistic for companies experiencing fluctuating growth phases before stabilizing, reflecting real-world scenarios better than constant growth models.
Question 6: b) Calculate the current intrinsic value of the company’s shares using the multiple growth dividend model.
The intrinsic value is calculated by discounting the dividends during the supernormal growth phase and the stable growth phase, resulting in an intrinsic value of approximately GH¢7.14.
Question 7: QUESTION THREE a) Explain the difference between redeemable and irredeemable preference shares and how this difference affects valuation.
Redeemable preference shares can be bought back by the issuing company at a predetermined price, providing a fixed return, while irredeemable shares do not have a maturity date, making their valuation dependent on perpetual cash flows.
Question 8: b) i. Calculate the value of the preference share if the share has a maturity period of 6 years.
The value of the redeemable preference share is calculated as the present value of future cash flows, resulting in approximately GH¢4.50.
Question 9: b) ii. Calculate the value of the preference share if the share has no maturity date.
The value of the irredeemable preference share is calculated as the dividend divided by the required return, resulting in GH¢4.55.
Question 10: QUESTION FOUR a) Discuss the relationship between bond prices and interest rates, and explain why long-term bonds are more volatile than short-term bonds.
Bond prices inversely relate to interest rates; as rates rise, bond prices fall, and long-term bonds are more volatile due to their extended duration, which amplifies the impact of interest rate changes on their present value.
Question 11: b) Calculate the intrinsic value of the bond.
The intrinsic value of the bond is calculated as the present value of future cash flows, resulting in approximately GH¢925.12.
Question 12: QUESTION FIVE a) Explain the difference between arithmetic average return and geometric average return and discuss why analysts often prefer the geometric mean for long-term investments.
The arithmetic average return is the simple average of returns, while the geometric average accounts for compounding, making it more suitable for long-term investments as it reflects the actual growth rate over time.
Question 13: b) i. Calculate Holding Period Return (HPR) for each year.
The HPR for each year is calculated as follows: Year 1: -13.33%, Year 2: 38.46%, Year 3: -5.56%, Year 4: 11.76%, Year 5: 5.26%.
Question 14: b) ii. Calculate Arithmetic Average return.
The arithmetic average return is (−13.33% + 38.46% − 5.56% + 11.76% + 5.26%) / 5 = 7.12%.
Question 15: b) iii. Calculate Geometric Average return.
The geometric average return is calculated as [(1 - 0.1333) × (1 + 0.3846) × (1 - 0.0556) × (1 + 0.1176) × (1 + 0.0526)]^(1/5) - 1 = 7.12%.
Question 16: QUESTION SIX a) Explain the concept of Net Present Value (NPV) and discuss why it is considered superior to traditional investment appraisal techniques.
NPV is the difference between the present value of cash inflows and outflows, and it is superior because it accounts for the time value of money, providing a clearer picture of an investment's profitability.
Question 17: b) Calculate the Net Present Value (NPV) and advise management on whether the project should be accepted.
The NPV is calculated to be approximately GH¢-18,000, indicating that the project should not be accepted as it does not meet the required return.
Question 18: QUESTION SEVEN a) Explain the payback period technique and critically evaluate its advantages and limitations in capital budgeting decisions.
The payback period measures the time required to recover an investment, offering simplicity and liquidity focus, but it ignores cash flows beyond the payback period and does not account for the time value of money.
Question 19: b) Calculate the Payback Period (PBP) and interpret the result.
The payback period is approximately 3.5 years, indicating that the investment will be recovered in a reasonable timeframe, but further analysis is needed for long-term profitability.
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