Reference no: EM132625057

AFIN209 Corporate Finance and Financial Modelling - University of Lusaka

QUESTION ONE

Case Study
Litumezi Enterprise is a local private agro business run as a cooperative in Western Province of Zambia. The business was an initiative of the local Member of Parliament (MP) to encourage rice and cashew nut production, so that locals can tap into the economic benefit of the export markets in the region.Litumezi Enterprise is seeking to expand its operations as it has reached a critical stage in its life cycle. Since its initial Loan funding through Citizen Economic Empowerment Commission (CEEC) of K5, 000,000.00 the business has seen positive growth in the last 12 years and the Debt has since been settled.

The business has put together an aggressive investment plan to expand the current project which includes increasing its current output of rice and cashew nuts to 3,000 hectares from 500 hectares as well as diversifying its operations to include Beef and dairy production. The Business plans on purchasing 500 herd of beef cattle and 100 dairy cows. Further there is a plan to add sugarcane production to its portfolio. All these investments will require huge investment in land, labor and equipment and logistics.

Management has been advised by the Finance Manager that the business will need adequate and appropriate finance of about K20, 000,000.00 for both Asset acquisition and working capital. The project is expected to take 2-6 years before it breaks even and becomes profitable.

Currently Management is debating on how to finance this project looking at the nature of operations and risks involved. Currently itsnet profit per year is K600, 000.00 while the K2, 000,000.00 of cash reserves in the bank fixed deposit account and has a finance lease for an equipment that will be fully paid off in the next 6 months freeing up K50, 000.00 of cash flow which is being paid each month. Purchasing the traditional land will cost K 8,000,000.00.

Some of the local villagers however, are not happy giving up ancestral land and are demanding explanations on how this project will benefit them and their children. The K8, 000,000.00 will be used to purchase the livestock, trucks and equipment while the other K4, 000,000.00 is expected to be used as working capital.

At this stage only preliminary studies have been done and many assumption have been used which could change. However, an investment appraisal was conducted and the project is viable even though management is still not very certain regarding climate and economic situation in the country and region.

Required

i. As a Corporate Finance expert discuss how the business could benefits from Financial Markets in the context of this project.

ii. What consideration should management take in choosing between long term Debt and Equity in financing this new project?

iii. In your opinion how best can the above project be best financed. What would be the sources of finance and how much would you be looking to raise internally and externally. You are free to make relevant assumptions.

QUESTION TWO

Case Study

Luangwa Mineral Resources is a State Owned Enterprise (SOE) that was in past managed parastatal before being privatize after liberalization of the Zambia economy. The privatization of the firm was decided because the firm had been run down and was not performing well as expected. Further the firm accrued huge liabilities and was running losses consistently. After being privatized the new owners (majority shareholders 75%) re capitalized the firm by investing $160 million to improve operation and clear outstanding debts. The new Board of Directors brought in goods expertise and knowhow which greatly improved the way the company was managed. The company was turned around within Three years and become profitable and as a result government was able to receive its share of profits.

The company remained profitable until a regime changed policy that now required government to own majority share in a bid to accrue more benefits for the state. The changes in policy meant the minority foreign investors could not control decision making within the company as now government took more control of the affairs. The Government appointed a new board and new management took over. The company in a span of four years since these changes has reached a stage where it is now failing to meet its obligations. It has accrued huge debts and has started making losses due to poor decision making regards operations. Audits reports indicated that miss application of resources to non-value adding activities, poor cash flow management, over employment and abuse of company resources and board members (Chairperson) and management staff. It was reported that in previous quarter the board had spent $1.0 million on workshops, travel allowances and meetings alone much of the money obtained through an overdraft with a local bank. This was done at the expense of procuring a critical component of the production process that only costed $150,000. Consequently production was shut down for six months.

This has led to wide spread uproar in the media and among concerned stakeholders and the company's board and corporate governance system has been questioned. Among the many expectations from stakeholders is the effectiveness of the board through composition of members, integrity and ethical values of board members and ability to critically analyses the company's long term sustainability

Required:

i. Discuss the objective and importance of Corporate Governance in general to the operations of an organization.(6 Marks)

ii. Identify and discuss the Agency Problem issues in this case study that may have led to the current situation how this can be rectified.

iii. Discuss how Corporate Finance can be applied in guaranteeing the company's long term financial sustainability while balancing wealth maximsation.

Attachment:- Corporate Finance and Financial Modelling.rar