Question 1

AGREME Ltd (AGREME) is a leading supplier of water in Uganda and is listed on

the Kampala Securities Exchange. The company's customers have been largely

domestic users with only few households using it for irrigation purposes on a

small scale. However, with increasing unpredictable and unfavourable climate

changes, it has become very difficult in the East African region to have a

substantial harvest without applying irrigation methods. The changes in climate

have also forced the governments to rethink their agricultural policies with

emphasis on supplementing the current rain-fed systems. The Board of AGREME

has seen this as an opportunity and this has informed several meetings to

consider investing in a new water plant.

Two alternatives under consideration by the Board are: Gravity Flow System

(GFS) and Dam Holdings System (DHS). The Board requires a favourable

environmental impact assessment report as a basis for embarking on the

implementation phase as scheduled. Mr. Onen, the finance director, is of the

view that AGREME should pay a fee to the technical people at Central

Environmental Management Authority (CEMA) to hasten the process. This view

is still being considered by other board members.

GFS has an initial cost of Shs 13 billion while DHS has an initial cost of Shs 18

billion with net cash flows being 20% higher than those of GFS. The company's

risk adjusted rate of return used for investments in this sector is 14% and the

risk free rate is 4%. Certainty equivalents and net cash flows (in Shs 'million')

relative to GFS have been ascertained as follows.

Year 1 2 3 4 5 6 7

Certainty equivalents 0.90 0.85 0.80 0.75 0.70 0.65 0.60

Net cash flows 8,000 7,000 7,000 5,000 5,000 5,000 5,000

Whichever alternative is chosen, AGREME would need hydraulic cranes which will

be used in cleaning water reservoirs in different water stations. The Board is not

sure whether to purchase its own cranes out right or lease them from a

prominent tower crane leasing company.

New cranes are expected to result in operating savings of Shs 50 million per

annum and have an economic useful life of five years. The company's after tax

cost of capital for the investment is estimated at 15% and operating cash flows

are taxed at a rate of 30% payable one year in arrears. The company is

considering whether to fund the acquisition of the cranes with a five-year bank loan, at an annual interest rate of 13% with the principal repayable at the end of

the five year period. As an option, the cranes could be acquired using a finance

lease at a cost of Shs 28 million per annum for five years, payable in advance.

The cranes are estimated to have no resale value at the end of the five years.

As an alternative financing mechanism, the executive director is of the view that

the company should take advantage of the Islamic banking products or use

international markets to ably finance the new ventures.

Additional information:

1. Due to the current tax position, the company is unable to utilise any capital

allowances on the purchase of the cranes until year one.

2. The total cost of the cranes is currently estimated at Shs 120 million.

3. Writing down allowances of 25% per annum are available to AGREME on a

reducing balance basis.

Required:

(a) Prepare report, with relevant computations, to the directors of

AGREME:

(i) advising them on which alternative to adopt. (12 marks

(ii) recommending, with reasons, whether AGREME should

acquire the cranes by lease or by outright purchase.

(8 marks)

(iii) Advising on the method of acquisition, whether to purchase

outright or lease.

(8 marks)

(b) Advise the board of AGREME on;

(i) the advantages of international markets as a source of finance

and any likely problems faced by using them.

(8 marks)

(ii) how the cranes can be acquired using Ijarah.

(6 marks)

(c) Comment on the finance director's view of paying a fee to technical

people at CEMA and how AGREME can mitigate such actions.

Question 2

Green Villas Limited (GVL) is a 10-year old construction company based in

Ntinda, a Kampala suburb. The company's main business is in real estate and

tourism and its major market has been:

1. Foreigners from Europe, usually a family in their retirement seeking to

relocate to a warmer place or to have a second home for holidays.

2. Middle aged single foreigners looking for a second home close to the

beach.

3. Ugandan well-to-do families from the diaspora looking for a second home

although this group constitutes only a small percentage.

The company is considering two projects: a luxury beach resort, suitable for

young families (Project L) and a mid-range bamboo cottages project (Project M)

suitable for families at retirement age seeking to relocate to a warmer place. An

analysis of the market is even more interesting because it reveals that the

success of the project will depend on weather conditions (seasons) which will

influence the demand for accommodation. Available demand for beach

accommodation and cottages varies with seasons.

The directors of GVL are considering a diversified development since most of

them are risk averse.

The table below shows projected annual cash flows for various seasons.

Season Probability Project L Project M

Shs 'million' Shs 'million'

Winter 0.2 5,000 5,000

Autumn 0.3 5,000 7,500

Summer 0.4 10,000 5,000

Spring 0.1 10,000 7,500

Required:

(a) Advise the directors of GVL on:

(i) whether they should invest in the two real estate tourism projects

(Show all computations, if any). (16 marks)

(ii) the benefits and risks associated with holding a well-diversified

portfolio. (6 marks)

(b) Discuss the assumptions at the heart of financial theory, that investors are

'risk

Question 3

Uganda Bus Operators Transport Ltd (UBOTL) has a wide range of investments

and is experiencing considerable financial difficulties. The directors of (UBOTL)

have therefore decided to concentrate the company's activities on three core

areas: bus services on upcountry routes; city transport; and tourism for

sightseeing. As a result of this decision, UBOTL has offered to sell one of its

major assets namely, its regional sports centre at Shs 35 billion free of debt.

The existing managers of the sports centre are attempting to purchase the

sports centre through a leveraged management buy-out and would form a new

unquoted company - Villa Uganda Limited. The managers have approached

several financiers, among them Pinkland Bank Ltd.

Pinkland Bank Ltd is prepared to offer a floating rate loan of Shs 20 billion to the

management team at a starting interest rate of 13% (being the Central Bank

rate of 10% plus a risk margin of 3%. This loan would be for a period of seven

years, repayable upon maturity and would be secured against the sports centre's

properties.

One condition of the Pinkland Bank Ltd's loan is that interest coverage ratio shall

not be below four times at the end of the first four years. If this condition is not

met, the bank has a right to call in its loan at one month's notice. There is also

information that Villa Uganda Limited would be able to purchase a four year

interest cap at 15% for its loan from Pinkland Bank Ltd for an upfront premium

of Shs 0.8 billion.

A local microfinance company, Pearl Partners Ltd is also willing to provide up to

Shs 10 billion in form of unsecured debt with attached warrants (Mezzanine

finance). This loan would be for a five-year period, with principal repayable in

equal annual installments and has a fixed interest rate of 18% per annum.

The warrants would allow Pearl Partners Ltd to purchase 10 Villa Uganda Limited

shares at a price of Shs 1,000 each for every Shs 100,000 of initial debt

provided, any time after two years from the date the loan is agreed. UBOTL, as a

condition of sale, proposes to subscribe to an initial 20% equity holding in the

company amounting to Shs 1 billion and would repay all the debts of the sports

centre prior to the sale. The managers will provide the remaining required

funding by way of equity. This would be in form of new ordinary shares issued at

the par value of Shs 500 per share.

Forecasts of earnings before interest and tax (EBIT), in Shs 'million' for the

sports centre for the next four years following the buyout are as follows:

Year 1 2 3 4

EBIT 13,000 14,000 19,000 20,000

(8 marks)

Corporation tax is charged at 30%. Dividends are expected not to be more that

10% of profits for the first four years. Management has forecast that the

value of equity capital is likely to increase by approximately 15% per annum for

the next four years.

Required:

(a) Prepare report, with relevant computations to the managers of the

proposed Villa Uganda Limited:

(i) discussing the benefits and drawbacks of the proposed financing mix

for the management buyout.

(10 marks)

(ii) evaluating management's forecast that the value of equity capital

will increase by 15% per annum.

(10 marks)

(b) As a financial analyst at Pearl Partners Ltd, discuss any five key

information aspects you require from the management team buy-out for a

Shs 10 billion loan approval.

(5 marks)

(Total 25 marks)

Question 4

Bushkit Uganda Limited (BUL) is a listed company and has in the recent past,

followed a policy of paying out a steadily increasing dividend per share as shown

below:

Year Earnings per share (EPS)

(Shs)

Net Dividend

per share (Shs) Dividend cover

2013 11.80 5.0 2.4

2014 12.50 5.5 2.3

2015 14.60 6.0 2.4

2016 13.50 6.5 2.1

2017 16.00 7.3 2.2

BUL has only just made the 2017 dividend payment and so the shares are

quoted ex-dividend. The company is planning a major change in strategy

whereby greater financing will be funded with internal funds. This has

necessitated a cut in the 2018 dividend to Shs 5 net per share. Management

estimates that the investment projects thus funded will increase the growth rate

of BUL's earnings and dividends to 14% per annum. Some managers, however

feel that the new growth rate is unlikely to exceed 12%.

BUL shareholders require an overall return of 16% for BUL prior to the change in

the dividend policy.

Required:

(a) Advise the managers of BUL on how these changes are likely to impact the

company's share price.

(5 marks)

(b) Determine the breakeven growth rate. (4 marks)

(c) Discuss the possible reactions of BUL's shareholders and of the capital

markets in general to this proposed dividend cut in light of BUL's past

dividend policy.

(8 marks)

(d) Discuss whether an increase in dividends is likely to benefit the

shareholders of BUL.

(8 marks)

(Total 25 marks)

Question 5

KEKO Construction Ltd (KEKO) has offered to acquire all the shares of General

Machinery Limited (GML). As a defence against a possible takeover bid, the

managing director (MD) proposes that GML makes a bid for KEKO in order to

increase GML's size and hence make the bid for GML more difficult to conclude.

It is the MD's considered view thereafter to split some shares of the GML and

buy them back. Both companies are in the same industry, and GML's equity beta

is 1.2 while that of KEKO is 1.05. The risk free rate and the market return are

estimated to be 10% and 16% per annum respectively.

The growth rate of after tax earnings of GML in recent years has been 15% per

annum and that of KEKO has been 12% per annum. Both companies maintain

an approximately constant dividend pay-out ratio.

GML's directors require information about how much premium, above the current

market price to offer for KEKO shares.

Two suggestions are under consideration as follows:

1. The price should be based upon the current net worth of the company,

adjusted for the current value of land and buildings, plus an estimated

after tax profits for the next five years.

2. The price should be based on dividend valuation model using growth rate

estimates.

The statements of financial performance of the two companies are as

follows:

GML KEKO

Shs '000' Shs '000' Shs '000' Shs '000'

Land & buildings 560,000 150,000

Plant & machinery 720,000 280,000

Stock 340,000 240,000

Debtors 300,000 210,000

Bank 20,000 660,000 40,000 490,000

Less trade creditors 200,000 110,000

Overdraft 30,000 10,000

Tax payable 120,000 40,000

Dividends payable 50,000 (400,000) 40,000 (200,000)

Total assets less liabilities 1,540,000 720,000

Financed by:

Ordinary shares 200,000 100,000

Share premium 420,000 220,000

Other reserves 400,000 300,000

1,020,000 620,000

Liabilities due after one year 520,000 100,000

1,540,000 720,000

Additional information:

GML's land and buildings have been recently revalued.

KEKO's land and buildings have not been revalued in the last four years,

during which time the average value of industrial land and buildings

increased by 25% per annum. The share price for GML is Shs 10 while

KEKO's is Shs 25 per share.

The most recent financial extracts of the two companies are shown below.

GML KEKO

Shs '000' Shs '000'

Turnover 3,500,000 1,540,000

Operating profit 700,000 255,000

Net interest 120,000 22,000

Taxable profit 580,000 233,000

Taxation (30%) 203,000 82,000

Profit after tax 377,000 151,000

Dividends 113,000 76,000

Retained profit 264,000 75,000

The current share price of GML is Shs 310 and that of KEKO is Shs 470.

Required:

(a) Illustrate how GML might achieve benefits through improvements in

operational efficiency if it acquired KEKO Construction Ltd.

(11 marks)

(b) Discuss the main features of the share buy backs and stock splits

and why GML may use them