SECTION A – CASE QUESTIONS (Total: 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

CASE

Reborn International Limited (“Reborn”) is an innovative biotech company that provides

medical devices for the leg injury rehabilitation business. It aims to help athletes and patients
who suffer from major leg injuries to recover their mobility, endurance and power after leg
operations so that they can make a comeback to join competition and resume working normally.
Reborn has been investing more than HK$10 million, and using three years to work with
different scientists to design and build an innovative robotic leg and rehabilitation training
system (“the System”). The System has received a lot of local and international awards even
though Reborn has been focusing on selling to a few Asian markets only. It is expected that
the product life cycle of the System is about eight years maximum, and it may be even shorter
if other competitors can develop similar products in a short period of time.

Reborn has spent a lot of resources applying for patents to protect the intellectual property of
the System in specific markets because it has to go through a lot of medical checking and
approval to obtain biotech medical device patents. After four successful business years,
Reborn sought financing by listing on the Hong Kong Stock Exchange to further develop
other new robotic rehabilitation products, and to expand globally. Reborn was recently listed
on the Hong Kong Stock Exchange when high technology biotech companies gained
popularity in the stock market. Reborn requires more funding to invest in new innovative
robotic rehabilitation technology and to conduct scientific researches.

In the recent Board of Directors’ meeting, the Sale Director reported that there are similar
robotic rehabilitation systems with lower prices and higher functionalities competing with
Reborn in existing Asian markets. The sales growth has been dropping significantly in the
last two quarters due to strong competition, and some customers find Reborn’s system is not
updated with artificial intelligent training functions offered by other competitors. Both sales
quantities and pricing are under pressure, which have been affecting profitability and
shareholders’ confidence to Reborn. The latest marketing research shows that new
technological breakthroughs and development in robotic rehabilitation technology will shorten
the product life cycle of the System significantly, so Reborn started designing new robotic
rehabilitation systems with new artificial intelligence functions as soon as possible.

Reborn is considering financing from the equity market to finance the purchase of a new
computer system equipped with artificial intelligence functions to develop new innovative
robotic rehabilitation system. Rights issue is being considered based on the advice of
a financial advisor. Currently, Reborn has 100 million ordinary shares in issue valued at
HK$10 each share. Reborn has annual earnings equal to 20% of the market value of
the shares. The Board of Directors proposes a 1-for-2 rights issue at 60% discount to current
market price due to uncertainty of the stock market.

Module B (December 2019 Session) Page 1 of 10

Reborn has a subsidiary called Wise Inc (“Wise”) in America, which is solely engaged in
developing a rehabilitation computer game to provide cognitive and responsive training to
patients who suffer from mild cognitive impairment or disorder that aims to facilitate
their recoveries and rehabilitations. Wise has been set up under a weighted voting rights
structure and it has been investing significant amount of money to develop the rehabilitation
computer game. Wise currently has accumulated losses and negative operating cash flow.
At the financial year ended 2018, Wise had current assets of USD6,000, other non-current
assets of USD10,000 and amortised patents of USD90,000. The replacement cost of other
non-current assets was USD4,000. It incurred operating loss of USD10,000 for the year 2018.
Marketing cost of USD120,000 and amortisation of patents of USD25,000 were charged in
which 25% and 80%, respectively, related to the development of rehabilitation computer game.
The cost of equity is 20% and taxation rate is 30%. Wise was wholly funded by equity.

Even though the rehabilitation computer game has been in final development stage, based on
an unofficial investment bank valuation, Wise will have market capitalisation around
USD20 million, assuming the forward foreign exchange rate of USD to HKD is 1 to 7.75 after
the launch of the rehabilitation computer game. The Board of Directors of Wise has learnt
that the Hong Kong Stock Exchange has announced amendments to the Listing Rules to
encourage and allow biotech companies to list. Mr Lee, Chief Financial Officer (“CFO”) of
Reborn, was requested to explore whether Wise could be listed on the Hong Kong Stock
Exchange.

Reborn has been focusing on the development of new innovative robotic rehabilitation system
for years and has not paid special attention to sustainability issues of its businesses.
Reborn is required by auditors to prepare an environmental, social and governance (“ESG”)
report under the Listing Rules; however, all scientists and directors are not able to provide
sufficient sustainability and ESG information to produce the ESG report. Recently, a work
safety incident happened where a scientist was seriously injured when the scientist was testing
a new robotic rehabilitation system. The testing laboratory had not reported the incident to
the management. The Board of Directors only found out the accident when the scientist sued
Reborn for not providing sufficient protection tools to employees when they were conducting
new product testing.

Module B (December 2019 Session) Page 2 of 10

Question 1 (12 marks – approximately 22 minutes)

(a) Using the Ansoff Matrix, recommend strategies available to Reborn to overcome
existing challenges in business and determine whether Reborn shall adopt these
strategies or not.
(6 marks)

(b) Advise how Reborn can maximise the return of launching a new innovative
robotic rehabilitation system at different stages over the product life cycle.
(6 marks)

Question 2 (10 marks – approximately 18 minutes)

(a) Based on International Integrated Reporting Council’s sustainability model,

explain the six capitals that Reborn is required to preserve and enhance in order
to ensure sustainability in high technology business.
(6 marks)

(b) Based on the ESG specific reporting principles, advise Reborn how to prepare
the ESG report relating to the work safety incident.
(4 marks)

Question 3 (10 marks – approximately 18 minutes)

(a) Calculate the theoretical ex-rights price and the amount of new funds raised.
(4 marks)

(b) Prepare a scenario analysis of the value per share if the new funds are expected
to earn 10%, 20% or 30% of the money raised. Evaluate the implications to
the shareholders when they consider whether to exercise the rights offer.
(6 marks)

Module B (December 2019 Session) Page 3 of 10

Question 4 (18 marks – approximately 32 minutes)

(a) Advise whether Wise should further invest in the rehabilitation computer game
based on the economic value added calculation.
(8 marks)

(b) Evaluate whether Wise shall use the economic value added method to assess
the financial feasibility of the rehabilitation computer game project.
(3 marks)

(c) Acting as Mr Lee, prepare a memo to the Board of Directors and advise based on
the listing requirements whether:

(i) Wise is eligible to be listed on the Main Board and GEM of the Hong Kong
Stock Exchange in terms of financial requirements; and

(ii) Wise, as a biotech company in new economy, is eligible to be listed on the

Hong Kong Stock Exchange.
(7 marks)

* * * * * * * *

Module B (December 2019 Session) Page 4 of 10

End of Section A
SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

Question 5 (15 marks – approximately 27 minutes)

AG Fund (“AG”) is a hedge fund based in Hong Kong with assets under management of
HK$7 billion. AG is planning to expand its business into the software industry by acquiring
60% of a private Fintech company: AI Fintech (the “Target Company”); below are the latest
financial statements of the Target Company.

AI Fintech

Statement of Financial Position

2018
HK$’000

Non-current assets
Goodwill 100,000
Intangible assets 89,226
189,226

Current assets
Other current assets 25,700
Cash and cash equivalents 192,183
217,883

Current liabilities
Other current liabilities 84,229
Net current assets 133,654

Net assets 322,880

Capital and reserves

Share capital 180,522
Retained earnings 142,358
322,880

Module B (December 2019 Session) Page 6 of 10

Statement of Profit or Loss

2018
HK$’000

Revenue 367,000
Cost of sales 88,080
278,920

Expenses
Distribution expenses 27,892
Administrative expenses 41,838

Profit before tax 209,190

Income tax expense 34,516
Profit for the year 174,674

Dividend for the year 69,870

The Target Company so far maintains a steady dividend payout ratio. The Target Company
has maintained a growth rate of 4% p.a. for recent years, and based on the profits forecast of
the company, the Target Company is likely to keep the same growth for the foreseeable future.
The price per earnings (“P/E”) ratio of the software industry and the Target Company
is 15 times, and the management considers 40% discount on the P/E ratio for an unlisted
company. The current return to shareholders of companies of the software industry is 6.5%
and the additional risk premium of the Target Company is 3%. Assume all items stated on
the Target Company’s statement of financial position are at fair value.

Required:

(a) Calculate the possible consideration(s) that AG can consider using three
applicable valuation methods.
(7 marks)

(b) Analyse how each of the above consideration(s) calculated in Question 5(a)
could be challenged by the shareholders of the Target Company, and advise
which valuation method is more appropriate in this case.
(8 marks)

Module B (December 2019 Session) Page 7 of 10

Question 6 (15 marks – approximately 27 minutes)

Georgio Development Limited (“the Company”) is a property developer based in Hong Kong.
The Company purchases old hotels or residential buildings, renovates, refurbishes and
converts them into service apartments or student hostels.

The Company is aware that there is a huge demand for student hostels in the United Kingdom (“UK”),
as there is an increasing number of non-local students every year. Due to the uncertainty of
Brexit, the Great Britain Pound (“GBP”) had weakened, and so properties in the UK have
become more affordable. Therefore, the Company has purchased an old commercial building
in the UK for GBP300 million (the “Investment”), and took a five-year loan for GBP150 million
from a bank in the UK with a floating interest rate at 12-month LIBOR + 2% which is payable
at the end of each year with the principal fully-repayable at the end of the loan-term.

The Company’s policy is to hedge at least 50% for both foreign exchange risk and interest rate
risk, and the minimum period of hedging is one year for this long term project.

Required:

(a) Explain the foreign exchange risk(s) faced by the Company for the Investment at
this moment and how it is dealt with by the Company. Advise whether the
Company has properly hedged such risk(s) accordingly to the Company’s policy.
(5 marks)

(b) The Treasurer of the Company is considering fully hedging the interest rate risk of the
loan by entering into an interest rate swap with a bank (including the spread quoted
by the bank) for a five-year LIBOR swap at 2.34%.

(i) Assuming the average 12-months LIBOR for the first year is 1.05%,
calculate the amount of the accrued interests to be paid by the end of the
first year, and the realised gain / loss of the interest rate swap for the
first year.
(2 marks)

(ii) The Chief Executive Officer (“CEO”) thinks the Company does not need to
do any hedging and believes the Company can always terminate the loan
and take out a new loan instead of doing any hedging with the interest rate
risk. As the CFO of the Company, advise on this suggestion and explain
the interest rate risk faced by the Company for not hedging of the loan as
suggested by the CEO.
(4 marks)

(c) The Company plans to start renovating the building at a cost of GBP20 million,
of which 50% will be paid immediately with the remaining 50% in six months after
the renovation is completed. Since the Company is unable to enter into
a forward contract with a bank / counterparty to hedge the GBP, the Company
decides to set up a money market hedge. Explain the procedures for
the Company (no calculation is needed).
(4 marks)

Module B (December 2019 Session) Page 8 of 10

Question 7 (20 marks – approximately 36 minutes)

Angelina Watches Limited (“AWL”) is a famous luxury watch manufacturer with its headquarter
located in Switzerland. In the past, AWL sold its watches in Asia through distributors,
and recently, AWL tried to set up its direct retail stores in Asia with the first market in Hong Kong.

AWL is not aggressive in their takeover of businesses from their distributors

(the “wholesale business”) in Hong Kong. AWL plans to keep those distributors, and at the
same time to start operating one direct retail store in Tsimshatsui (the “TST store”), in order to
get itself familiar with the retail operation in Hong Kong as well as Asia before further expansion.

AWL set up a Hong Kong legal entity (the “HK Company”) on 1 January 2019, which is
responsible for leasing and renovating the watches store, as well as taking over all the
Hong Kong wholesale business originally handled by Swiss headquarter (the “Headquarter”).
The Headquarter is responsible for collecting all the receivables from its distributors for
the sales in 2018, and starting from 1 January 2019, the HK Company purchases watches
from the Headquarter and sells to the distributors. The HK Company gets 60 days credits for
its purchase from the Headquarter, and the credit policy for AWL as well as the HK Company
is to provide 45 days credits to their distributors.

The HK Company entered into a lease agreement for three years for the TST store starting
from 1 February 2019 at HK$4,000,000 per month payable at the beginning of each month
without any rental-free period. The lease agreement, included a rental deposit equivalent to
three-month’s rent that the HK Company has paid in cash when the lease agreement starts.
The HK Company will start renovation immediately and expects the store can be opened for
business by 1 July 2019. The budget of renovation is HK$12,000,000 including the fee for
the management team from the Headquarter for managing the renovation. Half of the cost
needs to be paid before the start of the renovation and the remaining will be paid when
the renovation is completed on 15 June 2019.

There is no credit sale for the retail shop. Cash received from the store will be deposited on
the next day to bank accounts, and cash in transit will be classified as cash under AWL’s policy.
Credit card receipts will be settled by the merchant acquirer to the HK Company’s bank
account in five days (T+5).

The monthly operating expenses, including salary and sales commission but excluding rental,
are HK$1,500,000 per month starting from 1 May 2019. All the expenses are paid on
the 27th of each month without carrying forward. The marketing budget in Hong Kong for
2019 is HK$7,000,000 to be fully paid by the HK Company in second half of 2019 and before
the end of the year.

The group policy for the HK Company is to keep a one-month inventory for its retail store,
and it is unlikely that the HK Company will have loss and obsolete stock. The inventory is
shipped directly from the Headquarter to distributors so there is no inventory kept by
the HK Company for wholesales business.

Module B (December 2019 Session) Page 9 of 10

 Below is the sales forecast for 2019 with costs:

HK$’000 HK$’000

Wholesales
Sales to distributors from 1 January to 31 December 2019 183,040
Cost for sales to distributors from 1 January to 31 December 2019 109,824

Retail
Sales from the TST store from 1 July to 31 December 2019 109,500
- Cash sales 21,900
- Sales paid by credit card 87,600
Cost for sales from the TST store 54,750

Required:

(a) The Headquarter plans to provide a short-term financing for the HK Company
on 1 January 2019 by an intercompany loan of HK$20,000,000. Advise whether
the loan is enough to cover the operating cash flow by mid of February
(i.e. positive free cash flow). Support your answer with calculations.
(4 marks)

(b) Prepare the cash budget (i.e. cash flow forecast) for the HK Company for 2019
(i.e. from 1 January 2019 to 31 December 2019), and evaluate whether
the HK Company will be short of cash if there is no financing at the end of 2019
(i.e. on 31 December 2019).
(12 marks)

(c) Propose two measures to improve the HK Company’s working capital situation
and explain the concerns (if any) that you may have when implementing those
measures that you suggested.
(4 marks)

* * * END OF EXAMINATION PAPER * * *

Module B (December 2019 Session) Page 10 of 10