ACCA AFM Exam 1

Report to the board of directors of Asantewaa Cocoa Co — proposed San-Pédro grinding plant

Introduction: this report evaluates the proposed grinding plant in Côte d'Ivoire, discusses the reliability of the forecasts, values the financing package offered and reviews the ESG issues. Detailed workings are in Appendix 1. Figures are in XOF m and GHS m, rounded to the nearest million, so small rounding differences arise.

Appendix 1 — NPV workings

Contribution inflated at 3% a year (specific price increase), years 1 to 4: 66950, 84872, 98345, 101296. Fixed costs inflated at 2% a year: 16320, 16646, 16979, 17319.

Tax allowable depreciation at 25% reducing balance, years 1 to 3: 50000, 37500, 28125. The tax written-down value at the end of year 3 is 84375 against sale proceeds of 70000, so year 4 has a balancing allowance of 14375.

Taxable profit, years 1 to 4: 630, 30726, 53241, 69602. Ivorian tax at 25%: 158, 7681, 13310, 17400. No further Ghanaian tax arises, because Ghana credits the Ivorian tax and the rates are equal.

Working capital: 20000 at time 0, then increments of 400, 408 and 416 at the start of years 2 to 4; the full balance of 21224 is released at the end of year 4.

Net XOF cash flows: time 0 = −220000; years 1 to 4: 50072, 60136, 67640, 157801 (year 4 includes the 70000 sale proceeds and the working capital release).

Exchange rates forecast by purchasing power parity, XOF per GHS = 50.00 × (1.02 ÷ 1.09) for each year: 46.79, 43.78, 40.97, 38.34. The cedi is expected to weaken, so each XOF flow is worth more cedis over time.

GHS value of the XOF flows: time 0 = −4400; years 1 to 4: 1070, 1374, 1651, 4116.

Head office costs inflated at 9% (163.5, 178.2, 194.3, 211.7) less 25% Ghanaian tax relief, years 1 to 4: 123, 134, 146, 159. The GHS 60m feasibility study is a sunk cost and is excluded.

Net GHS flows: −4400; then 948, 1240, 1505, 3957. Present values at 22%: 777, 833, 829, 1785; total present value of inflows 4224.

Base-case NPV = 4224 − 4400 = GHS −176m.

Assessment: discounted at the 22% ungeared cost of equity, the operating cash flows do not recover the investment, so on its own the plant would reduce shareholder wealth by about GHS 176m. The result is also fragile: the year 4 flow, including the residual sale value, supplies 1785 of the 4224 present value of inflows (about 42%).

📋 Objective: 2.5 (International investment and financing decisions (B5))

Recommendation on the base case

On its operating cash flows alone the plant is not worthwhile: the base-case NPV is GHS −176m, so it destroys value at the 22% required return, and I advise the board not to approve it on these figures alone (Part 3 shows how the financing changes this).

Sensitivity

Present value of after-tax contribution in cedis = sum of (contribution × 0.75 ÷ forecast rate × discount factor) = 3743. Contribution would need to rise by 176 ÷ 3743 = 4.7% for the NPV to reach zero, so the decision is finely balanced and depends on small forecasting errors.

Reliability of the key assumptions

Exchange rates: the forecast assumes purchasing power parity, under which the cedi weakens from XOF 50.00 to 38.34. The XOF has a fixed euro peg, while the cedi has at times depreciated much faster or more slowly than inflation differentials imply. If the rate stayed at XOF 50.00 the NPV would fall to about GHS −944m, so the result depends heavily on the cedi's path.

Prices and volumes: 3% annual growth in cocoa product prices may be optimistic, because grinding margins are volatile and cocoa bean prices have swung sharply. The forecast also assumes the plant reaches full volumes quickly and keeps the European buyer.

Residual value: the XOF 70000m sale value supplies a large share of the value and is a guess four years ahead; a forced sale could raise much less, while ignoring flows after year 4 may understate value.

Tax and remittance: equal 25% tax rates, full credit in Ghana and free remittance with no withholding tax are assumed to continue. These estimates may be unreliable, so the board should test them with scenario analysis or simulation before deciding.

📋 Objective: 2.1 (Discounted cash flow techniques (B1))

Adjusted present value (GHS m)

The 22% rate is Asantewaa's ungeared cost of equity, so GHS −176m is the base-case NPV of the project as if it were all-equity financed. The adjusted present value adds the financing side effects, each discounted at a rate that reflects its own risk.

Tax shield on the interest actually paid: 2600 × 10% × 25% = 65 a year; present value at the normal 18% cost of debt = 65 × 2.690 = 175.

Subsidy: interest saved after tax = 2600 × (18% − 10%) × (1 − 0.25) = 156 a year; present value = 156 × 2.690 = 420.

Loan arrangement fee: 2% × 2600 = 52 at time 0, not tax allowable.

Rights issue costs: the issue must be grossed up so that 1800 is received net, gross = 1800 ÷ 0.96 = 1875, so issue costs = 75, not tax allowable.

APV = −176 + 175 + 420 − 52 − 75 = GHS 292m.

Advice: the financing adds GHS 468m of value and turns a negative base case into a positive APV, so the plant is acceptable only because of the subsidised loan, mostly the subsidy itself. The board should recognise that most of the value comes from the Fund's concession rather than from grinding cocoa. The side effects are discounted at the cost of debt because they are about as risky as the debt, while the base case uses the ungeared rate because the project's financing differs from Asantewaa's existing gearing.

Commercial points: the tax shield and subsidy assume Asantewaa has enough Ghanaian taxable profit, which is a tax capacity question if the project disappoints. The dividend restriction of 40% of profit may disappoint shareholders who are also asked to fund the rights issue, and covenant breaches could make the loan repayable early. Borrowing in cedis to fund XOF assets leaves a currency mismatch; part of the debt could be raised in XOF to give a natural hedge.

📋 Objective: 2.3 (Impact of financing on investment decisions and adjusted present values (B3))

ESG concerns and recommended responses

Deforestation and traceability: the European buyer will take 40% of output only if every bean is traced to a mapped plot. With 60% of beans bought through intermediaries who cannot identify farms, Asantewaa risks losing that buyer and access to the European market. It should map supplying farms with geolocation data, buy directly from farmer co-operatives where possible and require traceability as a condition of purchase, so that its cocoa can be certified as deforestation-free.

Child labour: the NGO findings near Soubré expose Asantewaa to serious reputational and legal risk. It should suspend the intermediary until it is investigated, introduce child labour monitoring and remediation systems with community partners, carry out independent supplier audits and support school access. Paying a fair farm-gate premium helps address the poverty that drives child labour.

Environment and energy: heavy fuel oil boilers increase emissions and fuel costs. Burning cocoa shells in biomass boilers turns a waste by-product into energy; the extra XOF 6000m should be appraised as part of the project, since lower fuel costs and lower emissions may justify it and make the plant eligible for green finance.

Social stakeholders: meeting the 70% local hiring target through training programmes builds goodwill in San-Pédro. Ghanaian farmer associations should be reassured through continued purchase commitments, otherwise Asantewaa could lose supply and political support at home.

Governance: combining the roles of chief executive and chair concentrates power. The board should separate the roles, appoint an independent chair and publish a sustainability report using IFRS S1 and S2, giving investors and the Fund the information they need.

Addressing these issues protects Asantewaa's licence to operate and market access, and may earn price premiums from buyers that pay more for certified sustainable cocoa.

Conclusion

The plant has a negative base-case NPV of GHS −176m but a positive APV of GHS 292m because of the subsidised loan. I recommend that the board proceeds only if it accepts that the value depends on the financing, tests the exchange-rate and price assumptions further, and adopts the traceability, child labour, biomass and governance actions above.

📋 Objective: 1.3 (Corporate ESG and ethical issues (A3))

Liquidation (ZMW m)

Realisable value = 1500 + 180 + 220 + 40 = 1940; less liquidation costs of 90 leaves 1850.

The bank's fixed charge on property, plant and equipment (realisable value 1500) covers its loan of 1300, so the bank is repaid in full. Preferential creditors then receive 60. The amount left for unsecured creditors is 1850 − 1300 − 60 = 490.

Unsecured claims are bonds 900 + trade payables 450 = 1350, so each receives 490 ÷ 1350 = 36.3 ngwee per kwacha: bondholders 327 and trade payables 163. Shareholders receive nothing.

Scheme (ZMW m)

Shares after the scheme: 100 (existing holders) + 350 (rights issue) + 270 (bondholders, 900 ÷ 100 × 30) = 720 million shares.

Interest: bank 1300 × 12% = 156; new bonds 405 × 11% = 44.55; total 200.55.

Profit before tax = 360 − 200.55 = 159.45; tax at 30% = 47.84; earnings = 111.6. EPS = 111.6 ÷ 720 = ZMW 0.155. At a P/E of 8 the share price is about ZMW 1.24, and the equity is worth about 893.

Comparison by capital provider

Bondholders: liquidation 327; scheme 405 of new secured bonds plus 270 million shares × 1.24 = 335, a total of 739.8, about 740. They are clearly better off, although part of their claim becomes risky equity.

Shareholders: liquidation nil; scheme 100 million shares worth 124 plus 350 million shares worth 434 for a payment of 350, a net value of about 208. They gain only if they invest new money.

Bank: repaid 1300 in full in liquidation, so it is no better off in amount; it gains a higher rate but keeps its exposure for five more years, so it is worse off in risk terms and may resist.

Trade payables and employees: 163 and 60 in liquidation against full payment under the scheme, so they gain.

Evaluation: every class except the bank gains, so the scheme looks acceptable to most providers, but the bank holds the decisive position because it can recover its loan in full by forcing liquidation.

📋 Objective: 4.1 (Financial reconstruction (D1))

Capital structure after the scheme

Debt = bank 1300 + new bonds 405 = 1705. Equity market value about 893. Gearing (debt ÷ debt plus equity, market values) = 1705 ÷ (1705 + 893) = 65.6%.

Interest cover = 360 ÷ 200.55 = 1.8 times, compared with 150 ÷ 211 = 0.71 times now.

Is the mix appropriate?

Cement is a cyclical business with high fixed costs, so its operating risk is already high. Gearing of 65.6% and interest cover of only 1.8 times leave little headroom: a further fall in road spending could put Kafue back into breach. Under the static trade-off theory, the tax relief on interest is outweighed at this level by expected financial distress costs, such as lost customers and higher supplier terms. The scheme improves the position but probably does not reach an optimal mix; Kafue should aim to reduce debt further, for example by selling surplus land or retaining all earnings and paying no dividends until gearing falls.

Likely responses of capital providers

Bank: it can recover 1300 in full now, so it will want stronger covenants, a security package, perhaps an arrangement fee or a share of the upside before agreeing to wait five more years.

Bondholders: they receive about 740 against 327 in liquidation, and their new bonds have a second charge, so the pension fund is likely to accept, though it may dislike holding 37.5% of the equity.

Shareholders: they must find ZMW 350m to keep any value; some may not subscribe, so the rights issue should be underwritten. The market may view the scheme as a positive signal if the new kiln is credible.

The EBIT forecast rises by 140% to 360, which looks optimistic while road projects remain paused; if it is not met, all the values above fall. On the other hand, the kiln burning alternative fuels cuts imported coal costs and links to renewed infrastructure spending, which support a recovery.

📋 Objective: 1.2 (Financial strategy formulation (A2))

Interest cost of the USD 30 million six-month loan (USD)

Unhedged: at 5.5% the rate is 6.7%, cost 30000000 × 6.7% × 6/12 = 1005000; at 4.0% the rate is 5.2%, cost 780000.

FRA: as a borrower AGM buys the 3–9 FRA at the higher rate of 4.78%. Whatever happens, the effective rate is 4.78% + 1.2% = 5.98%, cost 30000000 × 5.98% × 6/12 = 897000, because the bank pays or receives the difference between the reference rate and 4.78%.

Futures: a borrower is hurt by rising rates, so AGM should sell June futures, which expire after 1 June. Number of contracts = 30000000 ÷ 1000000 × 6/3 = 60 contracts, so sell 60 June futures. Basis now = (100 − 4.60) − 95.30 = 0.10 with four months to expiry; on 1 June one month remains, so unexpired basis = 0.025.

If the rate is 5.5%, the futures price on 1 June = 100 − 5.5 − 0.025 = 94.475; gain = 95.30 − 94.475 = 0.825%, or 82.5 ticks × 25 × 60 = 123750. Net rate = 6.7% − 0.825% = 5.875%, cost 881250.

If the rate is 4.0%, the futures price = 95.975; loss = 0.675%. Net rate = 5.2% + 0.675% = 5.875%, cost 881250. The futures lock in 4.675% + 1.2% = 5.875% in both cases.

Collar: buy 60 June puts at 95.25 (premium 0.30%) and sell 60 June calls at 95.50 (premium 0.15%); net premium 0.15%, which is 22500.

At 5.5%: futures price 94.475, so the puts are exercised with a gain of 0.775%; the calls lapse. Net rate = 6.7% − 0.775% + 0.15% = 6.075%, cost 911250.

At 4.0%: futures price 95.975, so the puts lapse and the calls are exercised against AGM, a loss of 0.475%. Net rate = 5.2% + 0.475% + 0.15% = 5.825%, cost 873750. The collar therefore keeps AGM's cost between 5.825% and 6.075%.

Comparison

Summary of results, rate rises / rate falls: FRA 897000 / 897000; futures 881250 / 881250; collar 911250 / 873750; unhedged 1005000 / 780000.

Recommendation: the futures give the lowest expected cost, but their result depends on the basis behaving as assumed and needs margin payments in dollars. The FRA costs only 15750 more, locks in a certain cost with AGM's own bank, needs no margin and suits a treasury with no experience of exchange-traded contracts. As the treasurer expects rates to rise, the collar's limited benefit from falling rates does not justify its higher cost if rates rise. I recommend the FRA.

📋 Objective: 5.3 (Financial derivatives to hedge interest rate risk (E3))

Why the futures result may differ

Basis risk: the calculation assumes the basis falls linearly from 0.10 to zero at the end of June, so that 0.025 remains on 1 June. In practice the futures price and the cash market rate do not move perfectly together, so the unexpired basis on 1 June may differ and the hedge will be imperfect. Basis risk can be reduced by using the contract that expires soonest after the borrowing date, as here.

Mismatch: the futures are three-month contracts used to hedge a six-month rate, so the hedge assumes that the six-month and three-month rates move together; the yield curve may change shape. Contracts are standardised, so amounts and dates rarely match exactly and only whole contracts can be traded.

Margin: futures need an initial margin and daily variation margin as positions are marked to market. Losses must be paid in dollars at short notice, which is a real problem for AGM given its dollar liquidity constraints in Egypt.

OTC compared with exchange-traded instruments

Over-the-counter instruments such as the FRA are tailored to the exact amount, start date and period of the loan, need no margin and are simple to manage. Their drawbacks are counterparty risk, because AGM depends on the bank honouring the contract, and they are harder to cancel or close out before maturity. Exchange-traded futures and options are standardised and liquid, can be closed out at any time, and the clearing house removes most counterparty risk, but they bring basis risk, margin calls and need expertise AGM lacks.

The board should not assume that the futures figure of 5.875% is certain. Because the exposure is in dollars while AGM earns Egyptian pound revenue, it also faces currency risk on repayment, which none of these interest rate hedges covers; dollar liquidity and foreign currency shortages make simple, tailored bank products more suitable.

📋 Objective: 5.1 (Role of the treasury function in multinationals (E1))