ACCA AFM — Advanced Financial Management Practice Exam 2

SECTION A: STRATEGIC CASE STUDY

Verdant Horizon Plc (VH) is a UK-based multinational agricultural technology (AgriTech) company. VH specializes in drought-resistant crop genetics and automated vertical farming systems. The Board of Directors is evaluating the acquisition of Ceres BioSystems (Ceres), a private company located in the rapidly developing nation of Zamboria. Zamboria's local currency is the Z-Dollar (ZD).

Ceres has developed a revolutionary soil microbiome treatment that VH believes could be scaled globally. The acquisition would be VH's first entry into the Zamborian market, which is characterized by high growth but significant political and currency volatility.

Financial Information:

1. Base Case NPV: The present value of Ceres's projected free cash flows, discounted at VH's all-equity rate of 11%, is ZD 4,500 million. The initial acquisition cost is ZD 3,800 million.
2. Financing: VH intends to finance the acquisition by raising £150 million in debt in the UK at a pre-tax cost of 6%. The debt will be structured as an interest-only bond for 5 years. Issue costs for the debt will be 2% of the gross amount raised.
3. Exchange Rates: The current spot rate is ZD 25.00 / £. Zamborian inflation is expected to be 8% per year, while UK inflation is expected to be 2% per year.
4. Taxation: The UK corporate tax rate is 25%. Zamboria has a corporate tax rate of 15%. A bilateral tax treaty exists preventing double taxation, but VH will pay the higher of the two rates on remitted earnings.

Real Option to Expand:
If the soil microbiome treatment is successful in Zamboria, VH has the exclusive option to roll out the technology across South America in three years' time. The estimated present value of the cash flows from this expansion, if undertaken today, is £80 million. The cost of the expansion in three years is estimated at £100 million. The volatility of the cash flows is estimated at 30%, and the UK risk-free rate is 4%.

REQUIREMENTS:

Write a report to the Board of Directors of Verdant Horizon Plc that covers the following:

(a) Calculate the Adjusted Present Value (APV) of the Ceres acquisition in GBP (£), and advise whether the base acquisition is financially viable. (16 marks)

(b) Using the Black-Scholes Option Pricing (BSOP) model, estimate the value of the real option to expand into South America. Discuss how this impacts the overall acquisition decision. (14 marks)

(c) Evaluate the strategic rationale for acquiring Ceres BioSystems, specifically addressing the risks associated with cross-border acquisitions in emerging markets and how VH might mitigate them. (12 marks)

(d) Discuss the post-acquisition integration challenges VH may face, focusing on cultural, operational, and financial alignment between a UK listed multinational and a private emerging-market entity. (4 marks)

Professional Marks will be awarded for the format, structure, and presentation of the report. (4 marks)

SECTION B: ADVISORY REPORT

AeroTurbine Inc (AT) is a US-based developer of offshore wind farms. The company's base currency is the US Dollar ($). AT has recently signed a contract to purchase specialized turbine blades from a European manufacturer. The payment of €50 million is due in exactly six months.

AT's Treasury department is concerned about the volatility of the EUR/USD exchange rate and is considering hedging the exposure. The treasury is currently operated as a cost center, but the CFO is considering transitioning it to a profit center.

Foreign Exchange Data:
Current Spot Rate ($/€): 1.1520 - 1.1540
Six-month Forward Rate ($/€): 1.1610 - 1.1635

Currency Options (Over-the-Counter):
AT's bank has offered a six-month European call option to buy Euros at a strike price of $1.1600/€ for a premium of $0.025 per Euro. The premium is payable immediately.

Interest Rates (Annualized):
US Dollar: Borrowing 4.5%, Investing 2.5%
Euro: Borrowing 3.0%, Investing 1.0%

REQUIREMENTS:

(a) Calculate the expected US Dollar ($) cost of the €50 million payable in six months using:
(i) A Forward Exchange Contract.
(ii) A Money Market Hedge.
(iii) The Over-the-Counter (OTC) Currency Option (assume the option is exercised if the spot rate in six months is $1.1800/€, and calculate the total cost including the future value of the premium). (12 marks)

(b) Based on your calculations in part (a), recommend the most appropriate hedging strategy for AeroTurbine Inc, discussing the advantages and disadvantages of the currency option compared to the forward contract. (6 marks)

(c) Discuss the implications, benefits, and risks of transitioning AeroTurbine's treasury function from a cost center to a profit center. (7 marks)

SECTION B: ADVISORY REPORT

OmniRetail Group (ORG) operates a large chain of traditional brick-and-mortar department stores. Due to changing consumer habits, ORG has suffered declining revenues and is currently facing a severe liquidity crisis. The Board wishes to pivot the business model entirely to an e-commerce platform, which requires an immediate capital injection of $40 million.

ORG is currently in breach of its debt covenants. The current capital structure is as follows:

• Equity: 20 million ordinary shares trading at $1.50 per share.
• Debt: $80 million of 8% unsecured bonds, currently trading at $60 per $100 nominal value.

Current Annual Earnings Before Interest and Tax (EBIT) is $10 million. The corporate tax rate is 20%.

The Board has proposed the following Capital Reconstruction Scheme:

1. Debt-for-Equity Swap: Bondholders will be asked to exchange 50% of their nominal bond holdings ($40 million) for 25 million newly issued ordinary shares.
2. Rights Issue: Following the swap, a rights issue will be launched to raise the required $40 million for the e-commerce pivot. The rights issue will be offered at a 20% discount to the theoretical ex-swap share price.

The Board estimates that the $40 million investment in e-commerce will increase annual EBIT by $6 million immediately.

REQUIREMENTS:

(a) Calculate the current Earnings Per Share (EPS) and the current gearing ratio (Debt / (Debt + Equity)) using market values. (4 marks)

(b) Assuming the reconstruction scheme is fully implemented:
(i) Calculate the theoretical share price immediately after the debt-for-equity swap.
(ii) Calculate the issue price of the rights shares and the number of shares to be issued.
(iii) Calculate the revised EPS and the revised market value gearing ratio. (12 marks)

(c) Evaluate the acceptability of the proposed reconstruction scheme from the perspective of:
(i) The existing bondholders.
(ii) The existing shareholders. (9 marks)