Financial Strategy: Siyaya Ltd and Photo Limited - Assignment Example

Question 2 (A) a) The most prominent approach of reducing risks is through diversification. It spreads the risk of one unit to two or more units thuscreating lowered level of riskiness for one unit. In the case of Siyaya Ltd., the company should go ahead for the approach of diversification as it will reduce risks related to business, economy and competition. By diversifying and setting up a new unit in food sector, there are substantial chances of growth for Siyaya Ltd., as it will have two streams of income and reduced level of risk. b) The biggest advantage for the cash consideration to the shareholders of the target company is that they make use of that cash elsewhere as per their own preferences. However, for the acquiring company, cash deficit may occur which is a disadvantage for the company. In case of share-for-share exchange, the shareholders of the target company feel reluctant to acquire the shares of the acquiring company and they feel the risk of falling down of the share price of the acquiring company after the merger or acquisition which is a disadvantage to them. The acquiring company welcomes share-for-share exchange such that it does not have to pay the cash to the shareholders of the target company and they obtain the control without cash payment. Question 2 (B) a) i) On the basis of Price/Earning multiple, the share price of Dancer would be: P/E = 10 EPS = 40c or $0.4 Price = 10 x 0.4 = $4 Value of the company = Share Price x No. of shares outstanding = 4 x 5,000,000 = $20,000,000 ii) On the basis of Dividend Growth Model, the share price of Dancer would be: Beta 1.4 Rf 4.60% Rm 10.60% Ke = Rf + Beta x (Rm – Rf) Ke = 4.6% + 1.4 x (10.6 – 4.6) Ke 13.00% g = (23.3-22) / 22 g = 5.91% D0 = 0.6 D1 = D0 (1+g) D1 = 0.6(1+5.91%) D1 = 0.64 Price = D1/Ke – g Price = 0.64 / (13%-5.91%) Price = $8.96 Value of the company = Share Price x No. of shares outstanding = 8.96 x 5,000,000 = $44,807,692 b) For Photo Limited, it would be quite necessary to assess the market value of the Dancer Limited, so that it can place a proper bid price to purchase the Dancer Limited. With having different techniques, it gives an overall judgment as to whether the target company is over-priced or under-prices. In this way, a better purchase price can be set. Question 3(A) a) 8% Coupon Rate Par value = $10,000 Coupon rate = 8% Annual payments R = 10% Maturity = 5 years Time Cash Flow PV of CF PV of CF x t 1 $800 $727.27 $727.27 2 $800 $661.16 $1,322.31 3 $800 $601.16 $1,803.16 4 $800 $546.41 $2,185.64 5 $10,800 $6,705.95 $33,529.75 $9,241.84 $39,568.14 Duration = $39,568.14/9,241.84 = 4.2814 10% Coupon Rate Par value = $10,000 Coupon rate = 10% Annual payments R = 10% Maturity = 5 years Time Cash Flow PV of CF PV of CF x t 1 $1,000 $909.09 $909.09 2 $1,000 $826.45 $1,652.89 3 $1,000 $751.31 $2,253.94 4 $1,000 $683.01 $2,732.05 5 $11,000 $6,830.13 $34,150.67 $10,000.00 $41,698.65 Duration = $41.698.65/10,000.00 = 4.1699 12% Coupon Rate Par value = $10,000 Coupon rate = 12% Annual payments R = 10% Maturity = 5 years Time Cash Flow PV of CF PV of CF x t 1 $1,200 $1,090.91 $1,090.91 2 $1,200 $991.74 $1,983.47 3 $1,200 $901.58 $2,704.73 4 $1,200 $819.62 $3,278.46 5 $11,200 $6,954.32 $34,771.59 $10,758.16 $43,829.17 Duration = $43,829.17/10,758.16 = 4.0740 b) Duration decreases as the amount of coupon interest increases which shows an inverse relation. Duration Coupon Change in Duration 4.2814 8% 4.1699 10% -0.1115 4.0740 12% -0.0959 c) Diagram Question 3(B) a) The swap agreement between the two contracting parties will have the following structure: High-rated borrower > borrows > long-term > 9% Low-rated borrower > borrows > short-term > prime +1.50% High-rated borrower > pays > prime > -0.50% Low-rated borrower > pays > 9% fixed +0.25% b) Assuming that prime rate is prevailing at 10%, the high-rated borrower will owe 9.50% (10%-0.50%) and the low-rated borrower will have to pay 9% (assumption of separate payment of underwriting cost). As a result, the high-rated borrower would be indebted more than the low-rated owner, will be paying the difference of the rates which is 0.50% (9.50%-9.00%). c) This swap agreement is advantageous to both the parties. High-rated party would be saving 0.5% as would be effectively paying the 0.5% less of prime rate. On the other hand the low-rated borrower would also be saving 0.5% as after swap it has to pay 11.25% and without swat it had to pay 11.75% inclusive of underwriting cost. Question 4 a) i) Forward Exchange Contract The forward rate is: $ Spot rate 1·5852 Premium (0·0072) –––––––– 1·5780 –––––––– The sterling amount is: $150,000,000/1·5780 = £95,057,034 ii) Currency Options The results for each of the spot rates in six months time are as follows: (i) (ii) Exchange rate $1·65 $1·50 Exercise price $1·60 $1·60 Option Exercise Lapse £ £ £ sterling receipts $150,000,000/1·60 93,750,000 $150,000,000/1·50 100,000,000 Option premium [($150m/$100) x £1·10] (1,650,000) (1,650,000) ––––––––––– –––––––––––– 92,100,000 98,350,000 ––––––––––– –––––––––––– iii) To do nothing Sterling receipts for each of the spot rates in six months time are as follows: Spot rate $1·65 $1·50 £ £ $150,000,000/1·65 90,909,091 ––––––––––– $150,000,000/$1·50 100,000,000 –––––––––––– b) In case if spot rate is 1£ = $1.5, then the best option would be “do nothing”, as the forward exchange contract will end up with lower level of receipts and options would not be exercised, and their premium cost would have to be incurred. However, if the spot rate approaches to 1£ = 1.65, the simply “do nothing” would not be favorable to the company. In that case options will be provide benefits over simply “do nothing”. Forward exchange contract, on the other hand will result in the highest benefit. c) Currency futures are a type forward exchange contract. They are traded on standardized term with specified number of contracts such that each contract has the same number of currency units. Normally a specific time period is allotted to a particular period i.e. three months and after which the contracts are “closed out”. In case if Giza Limited is interested in hedging its upcoming receipts, it should buy the appropriate currency future contracts against US$ and then sell those contracts after three months to close out its position. Read More