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ACADEMIC YEAR 2018/2019


ACC40700
Strategic Corporate Finance

Professor Anthony Brabazon
Professor Eamonn Walsh
Mr Jack Massey*


Time Allowed: 2 Hours


Instructions for Candidates

Answer QUESTION 1 (compulsory) AND two of the remaining three questions (2, 3 AND 4).



Instructions for Invigilators

Closed book examination

Use of non-programmable calculators permitted













SEMESTER
I
I EXAMINATIONS
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Question 1

You are the Chief Financial Officer at Kicker, an Irish listed company specialising in
fitness technology. The company has expanded rapidly since its flotation in 2013, but with its
organic growth now slowing, the company is interested in value-creating acquisitions.

Kicker is assessing the possible purchase of a small listed business in Germany, Power Zone
AG (‘PZ’), which has developed an innovative bicycle power meter integrated into a cyclist’s
shoes (‘Powfoot’). PZ’s business is broadly similar to Kicker’s and both companies are entirely
equity financed with an estimated cost of capital of 8.0%.

PZ’s share price had been performing steadily over the last year. Recently however some
research notes have highlighted the attractiveness of PZ as an acquisition target (even
mentioning Kicker as a possible suitor), and PZ’s share priced subsequently jumped 8% to
€6.48 giving it a market capitalisation of €71.28 million.

The consensus market forecast for PZ is set out below. Consensus for growth post the forecast
period is 2.5% per annum. Your finance team have carefully reviewed these projections and
believe they are a reasonable forecast for PZ on a standalone basis.

€000 2019
Forecast
2020
Forecast
2021
Forecast
Depreciation 420 400 394
Profit Before Tax 4,650 5,051 5,360
Corporation Tax at 30% (1,395) (1,515) (1,608)
Profit after Tax 3,255 3,536 3,752
EPS (€) 0.296 0.321 0.341
Capex 315 360 345
(2019 cashflows are assumed to arise in exactly one year’s time and so on for 2020 and 2021)

Kicker is confident it could substantially enhance the distribution and further development of
Powfoot, adding €2 million to PZ’s annual sales in 2020, with these additional sales
increasing at 2.5% per annum thereafter. These sales would be at an Operating Profit margin
of 40%. In addition, Kicker anticipates that a fixed amount of €0.5 million could be removed
from operating costs from 2019 onwards by eliminating duplicated functions.

The Board of Kicker recently discussed the potential acquisition and one of the non-
executive directors, Brody Grace, raised some concerns:







…Question 1 continues over the page.
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Question 1 (continued)

• Firstly, Brody indicated he was conscious of the Efficient Market Hypothesis and the
danger of acquisitions gaining hard-to-stop momentum, hence he wondered if Kicker
should set the current elevated PZ share price as an upper limit on the acquisition price?

• Secondly, Brody highlighted that at its current share price, Kicker would be acquiring PZ
at a P/E ratio of 21.9x based on forecasted 2019 earnings, which is higher than Kicker’s
equivalent multiple of 18.0x. Accordingly, he wonders if PZ might be too expensive?


Required:

(a) Prepare a valuation of PZ on a standalone basis using a discounted cashflow model.
(13 marks)

(b) Calculate a minimum and a maximum consideration that Kicker might consider paying
for PZ.
(12 marks)

(c) Explain the likely reason for any difference between your discounted cashflow
valuation and the current share price of PZ.
(5 marks)

(d) Critically evaluate each of the two concerns raised by Brody Grace.
(Calculations are not required)
(10 marks)

(TOTAL: 40 MARKS)


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Question 2

You are an investment advisor at Honest Stock Brokers. You have been approached by a new
client, Hugo Elliot, who has accumulated total savings of €100,000 working as a musician in
Dublin. He now wishes to invest this amount securely in bonds to cover expenses that his
children will incur when they begin post graduate courses in U.C.D. in Autumn 2021.

Hugo presents you with the list of bonds below that he is considering for his investment. He
is inclined to purchase the bond with the highest ‘interest coupon’, but is also tempted by the
bonds currently being offered at a ‘discount’? A colleague of his mentioned inflation risk, so
he has also considering a US Treasury Inflation Protected Securities (US TIPS)?


Each bond pays annual interest at its maturity date, and on that same day and month each year
prior to its maturity. Hugo will hold any interest and capital payments he receives in a secure
non-interest bearing bank account. The current euro to USD spot exchange rate is 1.15.

Required:

(a) Given Hugo’s specific circumstances, you are required to, select one bond from the
shortlist which you consider as the most suitable investment, explaining all relevant
features of the other bonds which make them less suitable.
(All other possible investments and investment advice should be ignored)
(18 marks)

(b) Calculate the amount of funds that the bond investment you are recommending will
provide Hugo with on 1 September 2021.
(Taxation and transaction costs should be ignored)
(6 marks)

(c) Explain the benefits of financing a business with debt. (6 marks)

(TOTAL: 30 MARKS)


Issuer Interest
Coupon
Maturity
Date
Currency Price Callable
Fedex Corporation 2.5% 15 Aug 2021 USD $96.675 No
French Government 0.5% 31 Aug 2021 Euro €101.11 No
CRH plc 3.0% 1 Sep 2021 Euro €114.09 Yes, at par
US TIPS 0.75% 1 Aug 2021 USD $98.33 No
Irish Government 0.9% 15 Aug 2031 Euro €98.63 No
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Question 3

Snapit plc, an online photography retailer, has been retaining surplus cash to fund its growth
and, unlike many of its peer companies, has never paid a dividend. Given its growing Profit
After Tax and free cashflow (both €70m in 2018), its surplus cash has grown to €159m as at
December 2018. This represents 10% of Snapit’s market capitalisation.

The Board expects to complete acquisitions over the next five years, investing up to €150m.
Snapit plc has no debt currently but the Board has decided it would be comfortable taking on
debt of up to 1x EBITDA for a suitable acquisition(s). The company’s internal forecasts for
the next five years are set out below:
€m 2019 2020 2021 2022 2023
EBITDA 96 101 108 112 115
Depreciation 8 7 7 6 6
Profit Before Tax 88 94 101 106 109
Profit After Tax 75 82 89 93 96
Capex and other organic investment 8 8 7 5 5

Snapit equity has generally traded at price levels consistent with the Board’s view of the
Company’s prospects. The stock is however associated with luxury goods and American-
Chinese trade, and the Board consider that the share price has a tendency to over-react to
news regarding any possible economic slowdown or trade tensions.

Required:
(a) Briefly explain why shareholders in Snapit plc might have some concerns about its high
level of surplus cash, yet may not have been particularly outspoken about it to date?
(6 marks)

(b) Would you advise the Board of Snapit to retain or return surplus cash to shareholders
over the coming few months? If returning surplus cash, how much would you recommend
returning and via what mechanism(s).
(14 marks)

(c) Set out and explain the likely share price reaction to your proposal(s) at (b) above, and
note any related point(s) Kicker should consider including in its announcement.
(10 marks)

(TOTAL: 30 MARKS)

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Question 4

Answer both parts of this question.

Part (a)

“It is easier to make shareholders wealthier through investment decisions than financing
decisions.”

Required:

Critically evaluate the above statement. (15 marks)


Part (b)

Instant Production Limited (‘IPL’) operates hundreds of 3D printers to offer immediate
product manufacturing capacity to designers. The cost of each printer is €10,000 and each has
a maximum 3 year useful life in IPL’s 3D printer farms. Studies of each printer’s performance
indicate the following:

€ Printer Running Costs Printer Resale Value
End of Year 1 1,200 6,500
End of Year 2 1,700 3,200
End of Year 3 2,500 1,000

IPL has a cost of capital of 14%.

Required:

Calculate the optimum replacement cycle of a printer. (15 marks)

(TOTAL: 30 MARKS)










- oOo -

GENERAL FINANCE FORMULAE

Present value of a perpetuity PV0 = CF1 / r

Terminal Value TV0 = CF1 / (r – g)

Equivalent annual annuity = present value of cashflows / annuity factor for relevant number of years

WACC = Ke x (E / D+E) + [Kd * (1-t)] x (D/ D+E)

PRESENT VALUE DISCOUNT FACTORS


Discount Rate
Time 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15%
0 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
1 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696
2 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.7972 0.7831 0.7695 0.7561
3 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.7118 0.6931 0.6750 0.6575
4 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.6355 0.6133 0.5921 0.5718
5 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.5674 0.5428 0.5194 0.4972
6 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.5066 0.4803 0.4556 0.4323
7 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.4523 0.4251 0.3996 0.3759
8 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.4039 0.3762 0.3506 0.3269
9 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606 0.3329 0.3075 0.2843
10 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.3220 0.2946 0.2697 0.2472

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