Geometric average dividend growth rate = (21·8/19·38)0.25 – 1 = 0·0298 or 3%
Using the dividend growth model, ke = 0·03 + ((21·8 x 1·03)/2.5) = 0·03 + 8.9816= 9.0116 x 100% = 901.16%

Market values of equity and debt.
Market value of equity = Ve = 100m x 2·50 = GH¢250 million
Market value of bonds = Vd = 60m x (104/100) = GH¢62·4 million
Total market value = Ve + Vd = 250 + 62·4 = GH¢312·4 million

• It serves the interests of owners, (shareholders) as well as other stakeholders in the firm; i.e. suppliers of loaned capital, employees, creditors and society.
• It is consistent with the objective of owners’ economic welfare.
• The objective of wealth maximization implies long-run survival and growth of the firm.
• It takes into consideration the risk factor and the time value of money as the current present value of any particular course of action is measured.
• The effect of dividend policy on market price of shares is also considered as the decisions are taken to increase the market value of the shares.
• The goal of wealth maximization leads towards maximizing stockholder’s utility or value maximization of equity shareholders through increase in stock price per share.

The agency problem is a conflict of interest inherent in any relationship where one party is expected to act in another’s best interests. Within the context of limited liability company, the agency problem usually refers to a conflict of interest between a company’s management and the company’s stockholders. The manager, acting as the agent for the shareholders, or principals, is supposed to make decisions that will maximize shareholder wealth even though it is in the manager’s best interest to maximize his own wealth.

• Managers prefer greater levels of consumption and less intensive work, as these factors do not decrease their remuneration and the value of the company’s shares that they own;
• Managers prefer less risky investments and lower financial leverage, because in this way they may decrease the danger of bankruptcy, and avoid losses on their managerial capital and portfolios;
• Managers prefer short-term investment horizon;
• Managers avoid problems stemming from reductions in employment levels, which increase with the changes in control of a company.
• Managers also fear rocking the boat to deliver shareholder value and will rather choose operating in their comfort zones.

• Managerial Compensation:
  Managerial compensation refers to the incentive mechanism for the good performance of the management. Their objectives are to attract and retain able managers and to harmonize managerial actions with the interest of shareholders. Several measures are used to evaluate managers’ performance. Some of the most common are sales, profit, current value of expected cash flows and value added.
• Shareholder control and interference:
  Shareholders can influence the company’s management in two ways. Firstly, they can influence management directly as to how the company should be managed. Secondly, any shareholder can make a proposal which is voted on at the annual general meeting (AGM).
• Threat of dismissal:
  In the past it seldom happened that a senior manager or chief executive officer was dismissed by shareholders. The reason for this was possibly that the ownership of a great number of companies was dispersed, as well as the fact that the agency problem was only brought to the attention of shareholders (and management) over the past two decades.
• Threat of take-overs:
  The threat of a take-over serves to monitor the actions of management. If the actions or decisions of management decrease the future earnings or value of shareholders, the share price usually decreases as well. In some instances, the company can become a take-over target. If the management of such a company is replaced, the move can benefit the shareholders. The threat of take-overs can thus serves as an external control mechanism which ensures that the decisions and actions of management maximize shareholders’ wealth.

• Changes in interest rates affect the public’s demand for goods and services and, thus, aggregate investment spending.
• A decrease in interest rates lowers the cost of borrowing, which encourages businesses to increase investment spending.
• Lower interest rates also give banks more incentive to lend to businesses and households, allowing them to spend more.
• Higher interest rates may make the corporate sector pessimistic about future business prospects and confidence in the economy. This ay further reduce investment in the economy.
• Higher interest rates will increase mortgage payments and will thus reduce the amount of disposable income in the hands of home buyers for discretionary spending.
• Higher interest rates encourage savers to save as more interest will be earned from their savings or investments

In the absence of any information about realisable values and replacement costs, net asset value is on a book value basis. It is the sum of non-current assets and net current assets, less long-term debt, i.e. 595 + 125 – 70 – 160 = GH¢490 million.

Total dividends of GH¢40 million are expected to grow at 4% per year and FCH Bank Ltd. has a cost of equity of 10%. Value of company = (40m x 1.04)/(0.1 – 0.04) = GH¢693 million.

Profit after tax (earnings) is GH¢66.6 million and the finance director of FCH Bank Ltd. thinks that an earnings yield of 11% per year can be used for valuation purposes.
Ignoring growth, value of company = 66.6m/0.11 = GH¢606 million
Alternatively, profit after tax (earnings) is expected to grow at an annual rate of 5% per year and earnings growth can be incorporated into the earnings yield method using the growth model. Value of company = (66·6m x 1.05)/ (0.11 – 0.05) = GH¢1,166 million.

Earnings / Dividend
= 24,600/6,750 = 3.64

Earnings available to equity holders/no of ordinary shares
24,600/15000 = 1.64
= 0.0484

Price per share/earning per share

= 45/2.18   = 20.64

• The essential difference between Factoring and Invoice Discounting lies in who takes control of the sales ledger and responsibility for collecting payment:
  With Factoring, the provider takes the role of managing the sales ledger, credit control and chasing customers for settlement of their invoices whilst with Invoice Discounting, your business retains control of its own sales ledger and chases payment in the usual way.
• Another difference between Factoring and Invoice Discounting is in the area of confidentiality: With Factoring, the customer settles their invoice directly with the Factoring Company; so customers are more likely to be aware of your Factoring arrangement. With Invoice Discounting, your customers still pay you directly; there is no need for them to know that a third party is involved.
  

Present Position:                      GH¢
Sales                                     24,000,000
30% contribution                 7,200,000

Cost:
Bad debts 1% x 24,000,000 x 70% = 168,000

Cost of Debtors:
Variable cost of debtors:
24,000,000/12 x 1 = 2,000,000 x 70% = 1,400,000
Hence cost of debtors = 20% x 1,400,000 = 280,000
NB// Debtors could also be valued at selling price.

Proposed policy:
Sales 30,000,000
30% contribution 9,000,000
Cost:
Bad debts 1.5% x 30,000,000 x 70% = 315,000
Cost of Debtors
Variable cost of debtors:
30,000,000/12 X 2 = 5,000,000 X 70% = 3,500,000
Hence cost of Debtors 20% = 3,500,000 x 20% = 700,000

Decision: The company should pursue the policy of taking in the new customers.

ALTERNATIVE SOLUTION:

Decision: The company should pursue the policy of taking in the new customers.

The original expectation would have been that the amount to payback would be $280,000 x GH¢4.2 = GH¢1,176,000. However, during the time that it was exposed to the currency risk, the exchange rate has moved in an adverse direction, and the actual payments are $280,000 x GH¢4.6 = GH¢1,288,000. The ‘FX loss’ has been GH¢112,000.

Currency risk arises from exposure to the consequences of a rise or fall in an exchange rate. Here, the Ghanaian company was exposed to the risk of a fall in the value of the cedi.
Currency risk is a two-way risk, and exposure to risk can lead to either losses or gain from movements in an exchange rate. In this example, the exchange rate could have moved the other way. For example, if the exchange rate after three months had been $1= GH¢4.0, the Ghanaian company would have paid GH¢1,120,000 instead of GH¢1,288,000.

Transaction risk arises only when the settlement of the transaction (and receipt/payment) will occur at a future date. An exposure lasts for a period of time. Here, the exposure lasts from when the goods were sold on credit until the time that the customer eventually pays.

Trading profits for companies engaged in foreign trade can be significantly affected by currency movements. When exchange rates are volatile and unpredictable, the gain or loss on currency exchange could possibly be even bigger than the expected gross profit from the transaction.

The decision is to recommend that the project be undertaking based on the positive NPV results. This will add value to share holders’ wealth.

ALTERNATIVE SOLUTION:  USING YEAR 0 (ZERO) AS THE CURRENT YEAR

The decision is to recommend that the project be undertaken based on the positive NPV results. This will add value to share holders’ wealth.

Advantages:

• Simple and easy to use.
• It gives indication of the liquidity. The earlier the payback period the better the liquidity.
• It broadly measures the risk of the project. The earlier the payback period the better the risk.
• Is faster to compute

Disadvantages:

• It ignores the time value of money.
• Ignores the cash flows after the payback period and may discriminate against projects that have significant cash flows after the payback period.
• It ignores the residual value and total economic life of the project.
• Determination of the payback period upfront could be subjective and discretionary.
• It measures mainly recovery of capital and not profitability of the project.

In theory, the holder of five shares in the company in the previous example could buy two new shares in the rights issue for GH¢3 each, and these two shares will be expected to rise in value to GH¢3.50, a gain of GH¢0.50 for each new share or GH¢1.00 in total for the five existing shares.

We can therefore say that the theoretical value of the rights is:
GH¢0.50 for each new share issued, or
GH¢0.20 (GH¢1.00/5 shares) for each current share held.