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Question 1 Victoria is a publicly listed company that would like to acquire 100% of a private company to expand its operations. It has obtained the following draft financial statements for two companies, Grappa and Merlot. They operate in the same industry and their managements have indicated that they would be receptive to a takeover. Statement of income for the year ended 30 September 20X3 Revenue Cost of sales Gross profit Operating expenses Finance costs - loan Finance costs - overdraft Finance costs - lease Profit before tax Income tax expense Profit for the year Note: Dividends paid during the year Grappa $'000 12,000 (10,500) 1,500 (240) Merlot $'000 20,500 (18,000) 2,500 (500) (210) 0 0 1,050 (150) 900 250 (300) (10) (290) 1,400 (400) 1,000 700 Statement of financial position as at 30 September 20X3 Grappa $'000 4,400 5,000 0 Merlot $'000 0 2,200 5,300 Non-current assets Current assets Inventory 9,400 7,500 2,000 3,600 Trade receivable Bank Current assets Total assets Equity and liabilities Equity shares of $1 each Property revaluation reserve Retained earnings Equity 2,400 600 5,000 14,400 3,700 0 7,300 14,800 2,000 900 2,600 5500 2,000 0 800 2800 Non-current assets Freehold factory [Note (i)] Owned plant [Note (ii)] Leased plant [Note (iii)] Page 3 of 10 Examination - January Semester 2016 Non-current liabilities Finance lease obligations [Note (iii)] 7% loan notes 10% loan notes Deferred tax Government grants Non-current liabilities Current liabilities Bank overdraft Trade payables Government grants Finance lease obligations [Note(iii)] Taxation Current liabilities Total equity and liabilities 0 3,200 3,000 0 600 1,200 4,800 0 3,000 100 0 6,300 0 3,100 400 0 1,200 3,800 0 500 600 4,100 14,400 200 5,700 14,800 Note: (i) Both companies operate from similar premises. (ii) Additional details of the two companies' plant are: Owned plant - cost Leased plant - original fair value Grappa $'000 8,000 0 Merlot $'000 10,000 7,500 There were no disposals of plant during the year by either company. (iii) The interest rate implicit within Merlot's finance lease is 7.5% per annum. For purpose of calculating ROCE and gearing, all finance lease obligations are treated as long-term interest bearing borrowings. (iv) The following ratios have been calculated for Grappa and can be taken as correct for comparison with Merlot: Return on year end capital employed (ROCE) Capital employed taken as shareholders' funds plus Long-term interest bearing, see Note (iii) above Pre-tax return on equity (ROE) Net assets (total assets less current liabilities) turnover Gross profit margin Operating profit margin Current ratio Closing inventory holding period 14.8% 19.1% 1.2 times 12.5% 10.5% 1.2:1 70 days Trade receivables' collection period Trade payables' payment period (using Cost of sales) Gearing [see Note (iii) above)] Interest cover Dividend cover 73 days 108 days 35.3% 6 times 3.6 times Page 4 of 10 Semester 2016 Required: (a) Calculate for Merlot the ratios equivalents to all those given for Grappa above in (iv). (12 marks) (b) Assess the relative performance and financial position of Grappa and Merlot for the year ended 30 September 20X3 to inform the directors of Victoria in their acquisition decision. (8 marks) (c) Explain the limitation of ratio analysis. Analyse and identify any further information that may be useful to the directors of Victoria when making an acquisition decision. (5 marks) Question 2 This question consists of two parts (Part I and II). You are required to answer both parts. Part I Alpha Ltd was incorporated in 20X1, with a paid-up capital of 5,000,000 ordinary shares. Its accounting year end is 31 December each year. On 1 October 20X4, Alpha Ltd issued 1,000,000 convertible preference shares (CPS). The CPS carries a net dividend rate of 7 cents per share (which are payable quarterly) and are convertible into ordinary shares at a rate of 1:1 as from 1 January 20X5 onwards. Alpha Ltd profits after tax were $1,000,000 for each of the years ended 31 December 20X4 and 20X5. Required: To explain the effects of the above events, (a) Compute the basic earnings per share for the year 20X4. (4 marks) (b) Compute the diluted earnings per share for the year 20X4. (4 marks) (c) Compute the basic earnings per share for the year 20X5. (4 marks) Page 5 of 10 2016 (d) Compute the diluted earnings per share for the year 20X5. (4 marks) Part II In some cases, exercises of options or conversion of securities to shares would lead to an increased EPS. Explain briefly a procedure used for an anti-dilution test. (9 marks) Question 3 This question consists of two parts (Part I and II). You are required to answer both parts. Part I On 1 January 20X0, UVC Limited issued $100,000, 9%, 5 year bonds at a premium of $4,100. It pays interest semi-annually on 1 January and 1 July. The market interest rate was 8%. Required: (a) Write the journal entry to issue the bond on 1 January 20X0. (3 marks) (b) Construct the amortization schedule assuming that the effective interest rate is used to amortize the premium for the years from 1 January 20X0 to 1 January 20X2. (16 marks) (c) Write the journal entry for the first interest payment using the effective-interest method to amortize the premium. (3 marks) Part II Describe with an example the circumstances which affect whether bonds are issued at a premium or at a discount. Name one reason why issuance of bond at a premium is rare in practical world. (3 marks) Page 6 of 10 2016 Question 4 (a) Three factors that are potential sources of noise and bias that may affect the quality of accounting are (i) manager's accounting choices; (ii) rigidity in accounting rules; and (iii) random forecast errors. Comment on how accounting regulation can affect each of those factors and the quality of accounting. (9 marks) (b) List and describe four (4) red flags that would alert an analyst conducting financial statement analysis. For each red flag, discuss what are some questions that need to be answered by a more detailed analysis of the company. (16 marks) ----- END OF PAPER