FINANCIAL STRATEGY
PART A - Question 1
Answer both questions in this section.
Advanced Mobile Phones (AMP) is a UK company which specialises in the construction and operation of low cost mobile phone franchises in developing countries. It is currently considering a new project in an African country. You are responsible for the department which was asked to assess the attractiveness of this project. The project will involve an upfront payment to the government for the franchise. Then, the construction and installation of the mobile phone network infrastructure, which will be outsourced to a major Chinese telecommunications equipment and services company. This work is planned to start this year (i.e. at the start of Year 0) and will last for three years (i.e. to be finished at the end of Year 3) when the network will be available for use. It will then be operated by AMP which will handle ongoing operations.
The projected cost of the franchise is £500 million and the construction cost is an additional £200 million, both of which need to be paid in full at the beginning of the construction period. AMP has also invested £100 million in market research to help make the decision as to whether to bid on this franchise. The analyst has conducted demographic and historical research in order to estimate the expected numbers of subscribers to the service. The findings from this research are presented in Exhibit 1. He has made a number of assumptions about the market penetration ratios (share of AMP subscribers to total mobile phone subscribers in the country) and the number of calls, texts and downloads per subscriber. These assumptions are based on historical studies from other countries that AMP and its competitors have entered into in earlier periods.
In Exhibit 1, the analyst has also estimated the projected pre-tax cash flows for the project. These cash flows will stem from four different revenue streams: monthly subscription fees, charges for ‘pay-as-you go' calls and revenues from texts and data downloads as these are not included in the basic monthly plans that the company plans to offer in this country. These cash flows are shown in GBP but will actually be collected in the local currency. The analyst has also made assumptions above future prevailing currency exchange rates in order to conduct the analysis in a single currency. Taxes are payable one year in arrears. No capital allowances are available for construction cost or franchise payment. The capital structure of the project is presented in Exhibit 2. The bank loan is a 20-year fixed-rate loan with the principal paid back at the end of the loan period.
The interest rate on this loan is 7% per annum. After Year 7, the project's free cash flows are expected to grow at a constant rate of 3% per annum. You have also conducted some research and collected some market data which is presented in Exhibit 3. Note that all cash flows are in nominal terms.
Exhibit 1: Projected subscribers (in ‘000s) and cash flows (£'000)
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Year Year 3 Year 4
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Year 5
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Year 6
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Year 7
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Subscribers 100 200
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400
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600
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800
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Cash Flows 6,000 12,000
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24,000
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36,000
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48,000
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Exhibit 2: Capital Structure (£ million)
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Source of Finance
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Amount
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Debt (bank loan)
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420
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Equity
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280
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Total
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700
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Exhibit 3: Market Data
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Risk-Free Rate of Interest
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3%
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Tax Rate
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25%
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Equity Beta for projects with similar risk
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0.7
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Equity Market Return
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9.0%
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Required:
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Required:
(a) Calculate the NPV for this project as at the start of Year 0.
(b) Make a recommendation to AMP about whether or not to undertake the project, and briefly comment on any risks it should take into account in making its final decision
Question 2
Both conventional and Islamic financial institutions face ethical challenges. Discuss the nature of these ethical challenges in both types of financial institutions and critically appraise the extent of their uniqueness in each with reference to relevant literature.
PART B
Question 3
The following information has been taken from a UK company's annual report for the year end 31st December 20X1:
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Income statement for year ended 31st December 20X1
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£ (million)
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Revenue
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62,000
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Cost of sales
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55,800
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Gross profit
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6,200
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Expenses
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1,700
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Operating profit
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4,500
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Interest cost
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520
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Profit before tax
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3,980
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Taxation
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1,114
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Profit for the year
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2,866
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Dividends
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1,800
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Retained earnings
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1,066
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Balance Sheet extracts at the year-end of
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£ (million)
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20X1
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20X0
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Long-term debt
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8,700
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10,800
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Short-term debt
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1,400
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1,620
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Total debt
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10,100
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12,420
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Total equity
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16,623
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N/A
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P/E ratio
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14
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Price-to-cash flow
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7.5
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Corporate tax
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28%
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Number of ordinary shares of
£1 (in million)
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1400
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Required:
1. Calculate the value of each share as at 31st December 20X1.
2. (a)Calculate dividend yield as at 31st December 20X1.
(b) Calculate the price-to-book ratio as at 31st December 20X1.
(c) Explain the four market multiples which were identified in this question and comment on the value of this company.
3. Critically discuss whether book value is a good estimate of economic value of assets? Briefly outline how we can arrive at economic value by giving two examples of balance sheet items.
Question 4
1. Describe three motives of firms to acquire or merge with another firm. Explain the economic reasons underlying mergers and acquisitions in each of these motives.
2. Explain two methods that a bidder can use to estimate the price it would be willing to pay when to target shareholders when acquiring another firm.
3. Explain an empirical method to estimate the short-term wealth effects of acquisitions on target shareholder wealth. Specify the data that would be needed and outline the process to estimate such wealth effects.
Question 5
How can corporate governance address company failure?
Question 6
‘When comparing conventional and Islamic banks, controlling for time-variant country- fixed effects, we find few significant differences in business orientation.' (Beck, Demirg-Kunt and Merrouche, 2013) With reference to relevant literature, critically discuss how different Islamic banks are from conventional banks.