Question

a. Pasuman is establishing an endowment fund to finance a scholarship scheme to provide funding for the education of her children. She plans to make an initial deposit of GH¢1,000,000 into the fund now. The initial deposit will be invested for five years before any disbursements will be

made from the fund. The effective annual rate of return on the fund is expected to be 14% in the first and second year, 15% in the third and forth year, and 16.5% in the five year.

Required:

Compute the balance of the fund at the end of five years.

b. Yientieobiaa Ltd is offering 10 million units of 15-year bonds with a face value of GH¢1000 each. Though the bonds are being offered at a price of GH¢950 each, the bonds will be redeemed at a premium of 15%. The annual coupon rate of the bonds is 20%. Interest is payable at the end of every six months.

A provision in the bond indenture requires that Yientieobiaa Ltd establishes a sinking fund to accumulate enough money to pay the total redemption value of the bonds upon maturity. To comply with this provision, Yientieobiaa Ltd plans to set aside an even amount at the end of each quarter over the next 15 years. Each of the even amounts that will be set aside will be invested at an annual interest rate of 24% with quarterly compounding.

Required:

Calculate the even amount that should be put into the sinking fund at the end of each quarter to raise enough money to pay the total redemption value of the bonds.

c. Ten years ago, God’sway Ltd issued GH¢2.5 million of 6% discounted debenture at GH¢98 per GH¢100 nominal. The debentures are redeemable in 6 years from now at a GH¢2 premium over nominal value. They are currently quoted at GH¢79 per debenture, ex interest. The company pays tax at the rate of 30%. Required: Estimate the after tax cost of the debenture.

QUESTION FOUR

a. Choosing an appropriate source of business finance can be a difficult and time-consuming task.

This is due to the sheer amount of funding options available. Financing can come in the form of

debt or investment, and finance terms can vary significantly.

(Total: 15 marks)

Answer 1

a.

Initial Investment in the fund = GHC 1000000

Time (t) = 5 year

Interest rates

Year 1	14%
Year 2	14%
Year 3	15%
Year 4	15%
Year 5	16.5%

FV = PV (1+r)^t

Fv = Future value

PV= present value

r= rate of interest

t= time

FV = GHC 1000000*(1+14%)*(1+14%)*(1+15%)*(1+15%)*(1+16.5%)

.=> FV = GHC 1000000(1.14) *(1.14)*(1.15)*(1.15)*(1.165)

=> FV = GHC 2002310

Alternatively

Year	Opening GHC(A)	Interest(B)	Closing(A+B)
1	1000000	=1000000*14% =140000	1140000
2	1140000	=1140000*14% =159600	1299600
3	1299600	=1299600*15% =194940	1494540
4	1494540	=1494540*15% =224181	1718721
5	1718721	=1718721*16.5% =283589	2002310

---------------------------------------------------------------------------------------------------------------------------------

b.

Face Value of the bond =GHC 1000

Redemption value per bond = GHC 1000+15% premium= GHC 1150

Number of units = 10 Millions

Total amount to be paid on redemption after 15 year = 10000000 UNITS * GHC 1150/ UNIT= GHC 11500000000

Amount to be deposited in each quarter which pays interest @24% pa compounding per quarter, so that at the end of 15 year the total amount will be GHC11500000000

FV of annunity = A * ((1+r)^n -1)/ r

where FV annunity = FV of annunity =GHC 11500000000

A = Amount to be deposited quarterly

r= rate per quarter = 24%/4 = 6%

n= number of period = 15 year * 4 quarter per year = 60

hence

GHC 11500000000 = A * ((1+0.06)^60-1)/0.06

=> GHC 11500000000= A *(32.987691-1 )/ 0.06

=>GHC 11500000000 = A* (533.1282)

=>A or Deposite per quarter = GHC 11500000000 / 533.1282 = GHC 21570797

---------------------------------------------------------------------------------------------------------------------------------

c.

After tax cost of the debenture is the interest cost less income tax savings on the interest

(i) After tax cost of debenture (in %) = Interest rate (1- tax rate)

=>After tax cost of debenture (in %)= 6% * (1-30%) = 6%*0.7 =4.2%

(ii)After tax cost of debenture (in amount) = Interest expenses (1- tax rate)

=>After tax cost of debenture (in amount) = GHC 2.5 million *6% (1-30%)

=>After tax cost of debenture (in amount) = GHC 0.15 Million*0.7 =GHC 0.105 Million.

---------------------------------------------------------------------------------------------------------

Question-4

-

Choosing an appropriate source of business finance can be a difficult and time-consuming task. This is due to the sheer amount of funding options available. Financing can come in the form of debt or investment, and finance terms can vary significantly.

-The criteria and implications of each source require critical analysis before proceeding, and it is essential to weight the cost versus benefits of each source before making a decision.

-Below are some of the factors that we should consider before deciding on a source that most suits our business needs -

1) Risk

Risk is an important element to consider. We must consider what will happen if we are unable to meet the financial commitments relating to that particular source of finance. If we borrow from friends and family, for example, we will need to take into account what would happen to our relationship with them should the business fail and we are unable to repay them.When it comes to choosing suitable funding, we must strive to minimise the overall risk.

-Deciding the appropriate balance of equity and debt will be an important decision when deciding the appropriate funding or capital structure for our business. Our overall aim will be to find the mix of finance that minimises our overall capital structure, thereby increasing the net present value of future cash inflows.

2) Cost

The cost of finance and its effect on income will play a fundamental role in our financing decision. Our overall aim is to minimise the cost of finance and maximise owners wealth. Therefore, it is essential to consider the implications of choosing one source of funding over another.

3) Control

Control is another factor that plays an important role when choosing a source of finance. Issuing additional shares (equity) will result in a dilution of control among existing shareholders/owners. You are effectively giving each investor a piece of ownership in your business and thereby are accountable to those shareholders.

Investors will require input into the operations such as sitting on the board of directors and receiving performance and operation reports. You will have to provide them with information that you may have wished to keep hidden from your competition, as well as detailed explanations for your business decisions.

Owners who do not want to lose control of their business, preferring to keep major decision-making in their own hands, will only consider equity financing up to a certain level or may prefer loan capital.

4) Long term versus short term borrowing

When sourcing finance, we also need to consider whether we should obtain long term or short term funding. In many cases, it may be appropriate to match the type of funding to the nature of the asset.

-Long term finance will be repaid over a longer period and include bank loans, hire purchase, debentures and retained profits for example.

-Short-term financing can often appeal more as they often come with no additional penalty for early payment, which is not the case with some sources of long-term finance.