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REVISION PARTNER

1

QUESTIONS
TOPIC 1
THE ROLE OF FINANCE IN ORGANISATIONS
QUESTION 1
a) Explain how the objective of wealth maximisation differs from that of profit maximisation for a
company listed at the securities exchange
...

May 2014 Question Three A

QUESTION 3
c) Executive compensation plans hinder value creation in a company
...

December 2013 Question Four C

QUESTION 4
a) Explain three causes of conflict of interest between shareholders and debt holders
...

June 2013 Question Two A

QUESTION 6
a) Citing relevant examples in each case, distinguish between "agency costs" and "financial distress
costs"
...

June 2011Question Four A

Brief notes on:
i)
ii)
iii)
iv)
v)

Role of finance manager
Goals of a firm
Nature of agency conflict
Managerial compensation
Managerial incentives

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TOPIC 2
FINANCE AND CAPITAL STRUCTURE
QUESTION 1
a) Explain three factors that might influence the capital structure decision
...
and Beta Ltd
...
The two firms are similar in
all aspects except for their capital structures
...
Alpha Ltd
...
120 million worth of ordinary shares
...
Beta Ltd
...
70 million in ordinary shares and Sh
...

3
...
10 million for both firms
...

4
...
is 10%
...
The corporate tax rate is 30%
...
and Beta Ltd
...
and Beta Ltd
...

May 2014 Question Four A

QUESTION 3
a) Summarize four reasons that might lead to soft capital rationing in a limited company
...

c) Latex Ltd
...
4,500,000 represented by 6 million shares of
Sh
...
75 each
...
During the last financial year, earnings after tax
were Sh
...
000
...
The company is planning to make a large investment which
will cost Sh
...
8 per share
...

(ii) The theoretical ex-rights price per share
...
The statement of financial position of the company for
the year ended 30 June 2011 is as follows:

FINANCIAL MANAGEMENT

REVISION PARTNER
Net non-current assets
Inventory
Trade receivables
Cash

Financed by:
Ordinary share capital
Retained earnings
12% long term debt
Trade payables
Accrued expenses

3
Sh
...
"000’'
126,000
52,800
30,000
54,000
35,000
298,800

Additional information;1
...
360, 000,000
...

2
...

3
...

4
...

Required:
(i) Determine the amount of external financial requirements for the two years ending 30 June 2013
...

November 2011 Question Four A

QUESTION 7
a)

Outline four motives of leasing an asset from the point of view of a company
...

December 2010 Question Five B

QUESTION 9
a) The following information was extracted from the accounting records of Karibu Ltd
...

Sh
...
Total assets
and accounts payable are proportional to sales and that relationship will be maintained in future
...
150 million by floating new ordinary shares on 1 January 2009
...
60 per cent of the earnings attributable to ordinary
shareholders will be paid out as dividends
...
as at 31 December 2008
...

August 2009 Question Two A

QUESTION 10
a) Explain four reasons that may drive a company to raise equity finance rather than debt finance
...
In order to finance these investment projects the company is considering two
options
...
10 each
...
10 each and obtain the balance through a bank loan
at an interest rate of 15% per annum
...

June 2007 Question Four C

QUESTION 12
b) Explain the factors that influence the type of finance sought by a manufacturing company

QUESTION 13
a) “Since debt capital is cheaper than equity, companies should resort to one hundred percent use of
debt to finance the investment”
...

Malindi Leisure Industries is already highly geared by industry standards, but wishes to raise
external capital to finance the development of a new beach resort
...

Examine the relative merits of leasing versus hire purchase as a means of acquiring capital
assets
...


FINANCIAL MANAGEMENT

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5

TOPIC 3
FINANCIAL MARKETS
QUESTION 1
a) Explain three functions of the central depository system (CDS) in your country
...

May 2014 Question Five A

QUESTION 3
a) Explain the following terms as used in capital markets:
(i)
Best efforts offering
...

(iii)
Green shoe provision
...

November 2011 Question Five A

QUESTION 5
a) Briefly explain why companies list their shares on more than one stock exchange
...

June 2011 Question Two A and B

QUESTION 6
a) Outline the factors that contribute to the slow growth of capital markets in many emerging
economies
...

June 2011 Question Five A and B

QUESTION 7
a)

Differentiate between the following sets of terms
i
...

Capital markets and money markets
iii
...

June 2009 Question One A

QUESTION 9
a) Explain the main factors behind the rapid development of capital markets in your country
...


QUESTION 12
a) Distinguish between primary and secondary securities market
...
This was the
opening remark by the guest speaker in a seminar whose theme was “Developing our capital
market
...

ii) Highlight four factors that may hinder companies from being listed at the stock exchange
...

b) Identify and briefly explain the factors that must be taken into account in the design and
construction of a market index for shares
c) Joseph Kimeu is trying to determine the value of Bidii Ltd’s ordinary shares
...
The ending price earnings (P/E) ration is expected to be 20 and the current
earnings per share are Sh
...
The required rate of return for this share is 15%
...

b) Highlight four factors that may underlie the low rate of listing of companies in a stock exchange
you are familiar with
...

(b) In relation to the stock exchange”
(i) Explain the role of the following members:
•
Floor brokers
•
Market makers
•
Underwriters
(ii) Explain the meaning of the following terms:
•
Bull and bear markets
•
Bid-ask spread
...


QUESTION 16
(a)

(b)

What economic advantages are created by the existence of:
(i)
Primary markets
...

Explain how the Capital Authority can ensure:
(i)
Faster growth and development of the Nairobi Stock Exchange or Stock Exchange in
your country
...


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7

TOPIC 4
THE TIME VALUE OF MONEY
QUESTION 1
a)
(i)

John Matata has just borrowed Sh
...

These payments are to be sufficient to repay the principal amount together with interest
...


(ii)

Explain how a ranking conflict between the net present value (NPV) and the internal rate of
return (IRR) can be resolved
...
80,000 from XYZ commercial bank at an interest rate of 1
...
The loan is to be amortized using the reducing balance method and be
repaid in 12 equal monthly installments payable at the end of each month
...
has constructed a commercial building in an upmarket location in your capital city
which the management intends to sell at Shs
...
However, a prospective tenant has
offered to rent the offices for 8 years at a fixed annual rent of Sh
...
At the end of the
eighth year, the building will be sold
...
The
company's cost of capital is 5%
...
on whether to sell the building now or rent out the offices
...
1,000,000 in an investment account
which earned compound interest at 15% per annum
...
500,000 in the same account
...

December 2012 Question Two D

QUESTION 4
a) Malikia Guyo borrowed Sh
...
The loan was repayable in annual instalments over a period of four
years
...

Required:
A loan amortisation schedule
...
is forecasting a growth rate of 12% per annum for the next 2 years
...
After that, the growth rate is expected to
stabilise at 8% per annum
...
1
...

Required:
The intrinsic value per share of Zedi Ltd
...
issued a new bond five years ago
...

Coupon payments are made semi-annually
...

Required:
(i)
The current price of the bond
...

(iii)
The capital gain on the bond
...
had the following pattern of earnings per share (EPS) over the last five years:
Year
2008
2009
2010
2011
2012
Earnings per share (EPS)
Sh
...
00 Sh
...
20
Sh
...
41
Sh
...
63
Sh
...
86
The company maintained a constant dividend payout ratio of 40%
...

Required:
The company's theoretical value of the share
December 2013 Question Five C

QUESTION 4
b) Mongo Ltd
...
4 per share
...
The required rate of return for the ordinary
share is 18%
...

December 2013 Question Two B

QUESTION 5
b) Richy Ltd
...
50 million to finance a new project through a rights issue
...
The project is expected to generate
annual cash inflows of Sh
...
The company has 10 million issued and fully paid up

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9

ordinary shares
...
35 per share
...

Required:
The cum-rights price of the shares
...
has bonds which currently sell for sh
...
1,000 par value
...
The
company’s tax rate is at 30%
Required:
i
...

The yield to maturity (YTM) of the bond
...

Explain the relationship between the calculated yield to maturity, current yield and coupon
rate of the bond
...
has a current dividend of sh
...
00 per share
...

Required:
The intrinsic value of the ordinary share
...
currently sells bonds at Sh
...
1,000 par value
...

Required:
The bond yield to maturity (YTM)
December 2012 Question Two E

QUESTION 9
c) XYZ Ltd
...
50, 000,000 per annum
...
16
...
“000”
50,000
65,000
40,000
155,000
Sh
...
10 each
Reserves
Current liabilities
Assets
Non-current assets
Current assets

Profits for the years were as follows:
Year
1
2
3
4
5

Sh
...
is quoted at Sh
...
100 par value
...
100
nominal loan stock
...
4
...
Annual interest on the stock has just
been paid
...

(ii) The implicit conversion premium on the stock
...
is experiencing a period of rapid growth
...
The last dividend paid by the company was sh
...
50
...

Required:
i)
The value of the equity shares of the company today
...

c) Pentagon Ltd
...
The bond has a coupon rate of 13% per
annum payable semi- annually
...
102 for every Sh
...


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Required:
The highest amount you can pay to acquire the bond today if the required rate of return is 14%
...
is an all equity financed company with a market capitalisation of Sh720,000,000
...
120, 000,000 through a rights issue to finance a new project
...

The proposed offer price is Sh
...

The new project is expected to generate cash flows of Sh
...
For
the year just ended, the company paid a dividend per share of Sh
...
83
...

Required;
(i) Outline three advantages to a company of raising capital through a right issue
(ii) The cum-right market price per share on announcement of the rights issue but just before the
issue is made
...

June 2010 Question Four A

QUESTION 13
b)

Ushindi Ltd
...
1,000, 9 percent convertible bond
...
The current market price of the
shares of Ushindi Ltd
...
25 per share
...
The investors’ required rate of return is 12%
...


c)

Kawaida Ltd
...
Consequently, the company has
been retaining all its earnings to finance the expansion programme
...
1
per share
...
Thereafter, the
dividends will grow at a constant rate of 8% indefinitely
...

Required:
The current value of the company’s stock
...
intends to declare a rights issue of one ordinary share for every five ordinary shares held
as at 31 December 2007
...
16 but subscribers for the rights issue will be offered a 15%
discount
...
5)
Reserves
12% Bank loans
Total equity loans

5,800
32,000
8,000
6,000
18,000
32,000

Required:
a)
i) The theoretical ex- rights price per share
...

b)
i) List three alternative actions available to the shareholders as regards to the rights issue
...

June 2008 Question Two A and B

QUESTION 15
c) D
...
and sh
...
ABC Ltd
...
20 per share
...
is sh
...

D
...

Similarly, proceeds from the sale of rights issue would be credited to the savings account
...
Magana investment portfolio and hence
advise him on whether to exercise, sell or ignore the rights issue
...

June 2007 Question Two C

QUESTION 16
a)
i)
ii)

Define the term “intrinsic value” with reference to the valuation of ordinary and preference
shares
An investor received a dividend of Sh
...
50 in the current financial year on each of his ordinary
shares
...
20
...
The
current market price per share is Sh1
...


QUESTION 17
a) Jasho Ltd paid an ordinary dividend of Sh3
...

The Management of the company projects that the earnings of the company will increase in the
coming years as follows:

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REVISION PARTNER
Year ending 31 December
2006
2007
2008
2009 and subsequent years

13
Projected earnings growth rate
25%
20%
20%
10% Per annum

The investors’ required rate of return is 18%
Required:
Determine the value of an ordinary share in Jasho Ltd as at 31 March 2005

QUESTION 18
a) Briefly explain the operations of the central depository system (CDS) in facilitating securities
trading
...

c) Mauzo ltd has issued 72,000 ordinary shares as at 31 March 2005
...
180,000 including for the year ended 31 March 2005
On 3 April 2005 the management of the company identified an investment opportunity, which
would cost Sh
...
This cost was expected to be financed through an issue of ordinary shares
at par
...
The cost of capital is
20%
Required:
i) Calculate the value of an ordinary share as at 31 March 2005
...


QUESTION 19
a) Distinguish between the following terms
i)
Cum-dividend and ex-dividend
ii)
Cum-all and ex-all
b) Akili limited has issued a debenture whose par value is Sh
...
The debenture can be redeemed
at par after four years or converted to ordinary shares at a conversion rate of Sh
...

The projected market price of the share after the four-year period could either be Sh
...
120
based on the company’s performance
...

Required:
The value of the debenture based on each of the expected share prices
c) Motor works Limited intends to raise additional capital through an issue of ordinary shares of
Sh
...
The company promises to pay dividend at the rate of Sh
...
120
An investor whose required rate of return is 10% intends to hold the shares for six years
Required;
The intrinsic value of the shares
...
50 per
Share
...
8 million to finance a proposed expansion project
...
40 per share
...
945,000
...

The company paid a dividend of Sh
...
5 in the previous financial year
...

iii) Compute the theoretical value of the rights when the shares are selling rights on
...
8
million 10% debenture at par? (Assume a corporation tax rate of 30%)

QUESTION 21
a) What are the determinants of the price of a bond
b) Identify six ways in which a company could make preference shares more attractive to a potential
investor

A person who never made a mistake
never tried anything new
...


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15

TOPIC 6
COST OF CAPITAL
QUESTION 1
(b) Nice Ltd
...

The company has an issued share capital of ten million ordinary shares of Sh
...
It has
also issued Sh
...

The current market value of the ordinary shares is Sh
...
100 par) is
Sh
...
Dividends and interest are payable annually
...
The next
instalment of interest is payable in the near future
...

An extract from the most recent statement of financial position is as follows

Ordinary share
capital
Reserves
Deferred tax
8% debentures

Sh
...

“million”
Non-current assets
Current assets
Less: current
liabilities

4,166
(1,925)

Sh
...
“million”
200
230
230
260
300

Earnings before tax
Sh
...
“million”
350
452
410
536
606

The tax rate is 30%
Required:
Nice Ltd’s weighted average cost of capital (WACC)
...
100)
Preference share capital (par Sh
...
100)

Sh
...
The shareholders of Ngana Ltd
...
The company has just paid a dividend of Sh4
...

2
...
is Sh
...

3
...
The return on the market is 14%
...
50
...
New preference shares can be sold at Sh
...
12 per share; and
floatation costs of Sh
...

5
...

6
...

7
...
90 per debenture
...
100
...
projects to raise Sh
...
After due consideration,
the financial manager proposed the following three financial plans
...
Issue of 5,000,000 ordinary shares at Sh
...

2
...
10 each and 250,000 debentures of Sh
...

3
...
10 each and 250,000 preference shares at Sh
...

The company's tax rate is 30%
...
l million,
Sh
...
4 million, Sh
...
10 million, under each of the three financial
plans
...
on the best financial plan in (b) (i) above
...
is as follows:
8,000,000 ordinary shares of Sh
...
10 each
16% long-term loan
18% debentures

Sh
...
Ordinary shares are currently quoted at Sh
...

2
...
6
...
The 18% debentures were issued in 2006 at a price of Sh
...
They are due for redemption in
2014 at sh
...
The company incurred Sh
...

5
...


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17

Required:
i) The company's growth in equity
...

December 2013 Question Three A

QUESTION 5
a) The following data show the capital structure of Samma Ltd
...
1,000 debentures
Ordinary share capital
Retained earnings

Sh
...
intends to invest in a project estimated to cost sh
...

The cost of the project will be raised as follows:
• Issue 10% 100 debentures at the current price of sh
...

• Issue 10% sh
...
25
...
45 with floatation cost of 12%
...
45
...

Required:
The weighted marginal cost of capital
...
20
Sh
...
40,000
Sh
...
5,000
30%

Required:
i
...

ii
...

iii
...

iv
...

June 2013 Question Two C

QUESTION 7
a) Differentiate between the following sets of terms:
i) “Real interest rate” and “nominal interest rate”
...

June 2013 Question One A

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18

QUESTION 8
(a)

(b)
(c)

Explain the following terms as used in capital structure of a firm:
i) Operating leverage
...

Highlight three reasons why accounting profit might not be the best measure of a company's
achievement
...

(ii) Mutual funds and hedge funds
...
earnings and dividend per share have been growing at a rate of 18% per annum
...

Thereafter, the growth rate will be 6% in perpetuity
...
2 and the investors' required rate of return is 15%
...

May 2012 Question Three B

QUESTION 10
a) Rock Ltd
...
0
...
1
...
An annual dividend of Sh
...
09 has been proposed
...
O
...
The company
also has 13%
...
100 redeemable debentures with a nominal value of Sh
...

105
...

Assume a corporation tax rate of 30%
...

b) Chairimani Ltd
...
100 par value in three
years' time
...
The current market price per share is Sh
...
30 and this is expected to grow at 5% per
annum into perpetuity
...

Required:
(i) Market value of the bond
...

(iii) Conversion premium per share
...
25 million to finance a new project through a rights issue
...
7, 372,280
...
The cost of
capital is 15% and before the announcement of the rights issue, the market price per share was Sh
...

Required:
The cum-rights market puce per share
November 2011 Question Three C

FINANCIAL MANAGEMENT

REVISION PARTNER

19

QUESTION 12
b) Explain the meaning of the term “enterprise value” in the context of the valuation of a business
entity
...
is as shown below
...
10 million worth of 20 – year 9% bonds with sh
...
The market price of the bond is currently sh
...
Assume a tax rate of 30%
...
100 par value) that are expected to sell
at sh
...
5 per share in floatation costs
...
Sh
...
4 per share
...
8
3
...
47
3
...
12
2
...
3 discount and a floatation cost of sh
...
5 per share
...
300,000 in retained earnings and is considering investing in a project which will
cost sh
...

ii) Retained earnings break point
...

Required:
Explain how the achievement of this objective might be compromised by the conflict which may
arise between the organisations
...


Debt (par @sh
...
100)

Sh
...

The company has just paid a dividend of sh
...
6 per share and its stock currently sells at a price of
sh
...
Treasury bonds yield 11% and the return on the market is 14%
...
51
New preferred stock can be sold at sh
...
11 per share and flotation
costs of sh
...

The company’s tax rate is 30%and it pays out all its earnings as dividend
...
92 per debenture
Required
The weighted average cost of capital (WACC) using market values
December 2010 Question Two C

QUESTION 17
a) The capital structure of Jmaa Ltd
...
“000”
360,000
120,000
120,000
200,000
800,000

Ordinary share capital
Returned earnings
8% preference share capital (sh
...
1,000 each par value)

The company intends to raise additional funds for investing in a new project which is estimated to
cost sh
...

Additional information:
1
...

2
...
5
...
The past and expected future earnings growth rate is 10%
...

4
...
25%
...
The company expects to raise a maximum of sh
...

6
...
80 per share
...
A new 12% debenture can be issued at sh
...

8
...

Required:
i)
The current market price per ordinary share
...

iii) The company’s weighted marginal cost of capital (WMCC)
December 2009 Question Two A

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21

QUESTION 18
b) Karatasi Ltd
...

“sh
...
20 par value)
10,000
Retained earnings
12,000
12% preference share capital (sh
...
1,000 par value)
7,200
34000
Additional information:
1
...
50, sh
...
1,200 respectively
...
For the year ended 31 December 2008, the company paid an ordinary dividend of sh
...
00 per
share
...

3
...

Required;The company’s market weighted average cost of capital
...
a quoted company intends to raise sh
...
The
company is considering issuing the following securities in order to raise the required amount
...

The company’s issued shares are currently trading at sh
...
40 per share cum – div
...

• 40,000 12% debentures at the current market price of sh
...
The par value of
each debenture is sh
...

• 100,000 10% preference shares at the current par value of sh
...

The balance of the capital required would be obtained from retained earnings
...
The company declared ordinary dividends over the past five years as follows:
Year ended 31 December
Dividend declared
Sh
...
Ordinary dividends are expected to grow into future at a rate equivalent to the average annual
growth rate over the past five years
...
The current number of issued ordinary shares is 10 million
...
Corporation rate of tax 30%
...

ii)
Cost of capital for each component of additional finance
...

iv)
Comment on the application of the marginal cost of capital obtained in b(iii) above
...

The following was the capital structure of Fahari Ltd
...


Ordinary share capital
12% preference share capital (sh
...
1,000 par)

Sh
...
0 million
4
...
6 million

Additional information:
1
...
45, and sh
...
1,200 respectively on 31 October 2007
...
The dividend per ordinary share for the year ended 31 October 2006 was sh
...
00
...

3
...

Required:
The weighted average cost of capital (WACC) of fahari Ltd
...


QUESTION 21
a)
b)

Distinguish between the marginal cost of capital and the weighted average cost of capital
...
is in the process of raising additional finance
...

Each of these sources of finance is analyzed below:

Ordinary Share Capital
•
The current market price per share is Sh
...
6 per share in the next financial year
•
The annual rate of growth in dividend per share is 6%
•
Flotation costs amounting to Sh8 per share
11% Preference Share Capital
•
The par value per share is Sh
...
4 per share
10% Debenture Capital
• The per value is Sh1,000 for each debenture stock
• The debenture have ten-year maturity period
• The flotation cost for each debenture stock is Sh
...
225,000 of retained earnings available for the next financial
year
...
The target capital structure is as follows
Source of Capital
Debentures

Weight
40%

FINANCIAL MANAGEMENT

REVISION PARTNER
Preference Shares
Equity

2
...


QUESTION 22
a) Distinguish between compounding and discounting of cash flows
...
is considering the launch of a new product
...
6,000,000 in plant and machinery will be required
...
1,500,000
...
600 per unit with a variable cost of Sh240 per unit
2) Fixed production costs (excluding depreciation) would amount to Sh
...
Calculate the net present value (NPV) of the project and advise the management on the
appropriate course of action
...
Calculate the internal rate of return (IRR) of the project and advise the management on the
appropriate course of action
...
Outline the main drawbacks of the IRR method of investment
...

Sh
...
25)
800,000
8% Preference share capital (par value Sh
...
20)
400,000
400,000
10% Debenture
2,200,000

FINANCIAL MANAGEMENT

REVISION PARTNER

24

Additional Information
1
...
)
Ordinary shares
30
8% Preference Shares
20
10% Preference Shares
25
The market value of the 10% debenture on 31 December 2005 was Sh
...
The corporation tax rate is 30%
3
...
3
...

Required:
i
...

ii
...

iii
...

iv
...

v
...

ii) Weighted average cost of capital and marginal cost of capital
iii) Finance lease and operating lease

QUESTION 25
a) Define the following finance terms
ii)
Term of structure of interest rates
iii)
Script dividends
iv)
Shares splits
b)
Zatex ltd, had the following capital structure as at 31 March 2005
Sh
...
The market price of each of ordinary share as at 31 March 2005 was Sh
...
The company paid a dividend of Sh
...
The annual growth rate in dividends is 7%
4
...

ii) The company intends to issue a 15% Sh
...
The existing debentures will not be affected by this issue
...
3 While the average market price per share
over the same period is estimated to be Sh
...
The average annual growth rate in dividend is
expected to remain at 7%
...


FINANCIAL MANAGEMENT

REVISION PARTNER

25

QUESTION 26
a) Highlight four uses of the cost of capital to Limited Liability Company
...

Ordinary Shares
The company’s equity shares are currently selling at Sh
...
Over the past five years,
the company’s dividend pay-outs which have been approximately 60% of the earnings per share,
were as follows
Year ended 30 September
Dividend per Share
Sh
...
60
2003
6
...
85
2001
5
...
23
The dividend for the year ended 30 September 2004 was recently paid
...
3 per share
and it would cost Sh
...

Debt
The company can raise funds by selling Sh
...

The bonds will be issued at a discount of Sh
...

Capital Structure
The company’s current capital structure, which is considered optimal, is:
Sh
...

Required:
i) The specific cost of each source of financing
...


QUESTION 27
a) Explain the meaning of the term “Cost of capital” and explain why a company should calculate its
cost of capital with care
...

c) Biashara Ltd, has the following capital structure

Long-term debt
Ordinary Share Capital
Retained earning

Sh
...
has a proposal for a project requiring Sh
...
He has
proposed the following method of raising the funds
...

• Issue ordinary share at the current market price
...
100 per share which
is the same as par value
...
1,000 per debenture
Additional Information:
1
...
Pays a dividend of Sh5 per share which is expected to grow at the rate of
6% due to increased returns from the intended project
...
’s
...
8 respectively
...
The ordinary share would be issued at a floatation cost of 10% based on the market price
3
...
1,000 per debenture
4
...
’s weighted average cost of capital (WACC)

QUESTION 28
a) Explain why the weighted average cost of capital of a firm that uses relatively more debt capital is
generally lower than that of a firm that uses relatively less debt capital
...
As at 30 April 2003 was Sh
...
The company wishes to raise additional funds to finance a project within the next
one year in the following manner:
Sh
...
20,000,000 from selling new ordinary shares
The following items make up the equity of the company:
3,000,000 fully paid up ordinary shares
Accumulated retained earning
1,000,000 10% Preference shares
200,000 6% long term debenture

30,000,000
20,000,000
20,000,000
30,000,000

The current market value of the company’s ordinary shares is Sh
...
The expected dividend on
ordinary shares by 30 April 2004 is forecast at Sh
...
20 per share
...
150
...

Assume a tax rate of 30%
Required:
i)
The expected rate of return on ordinary share
ii)
The effective cost to the company of:
• Debt capital
• Preference share capital
iii) The company existing weighted average cost of capital
...
50,000,000 as intended
...

(b) On 1 November 2002, Malaba Limited was in the process of raising funds to undertake four
investment projects
...
20 million
...
million
7
6
5
2

A
B
C
D

Internal Rate of Return
(IRR)
24%
16%
18%
20%

You are provided with the following additional information:
1
...


3
...


5
...


5
...


The company had Sh
...
4 million available from retained earnings as at 1 November 2002
...

The current market price per share on 1 November 2002 was Sh
...
40, ex-dividend information
on Earnings Per Share (EPS) and Dividends Per Share (DPS) over the last 6 years is as follows:
Year ended 31 October

1997 1998

EPS (Sh
...
)

4
...
52

4
...
65

1999
4
...
80

2000
4
...
95

2001
5
...
10

2002
5
...
22

Issue of new ordinary share would attract floatation costs of Sh
...
60 per share
...
1,000) could be sold with net proceeds of 90% due
to a discount on issue of 8% and floatation costs of Sh
...
The maximum
amount available from the 9% debentures would be Sh
...

12% preference shares can be issued at par value Sh
...

The company’s capital structure as at 1 November 2002 which is considered optimum is:
Ordinary share capital (equity) 45%
Preference share capital
30%
Debentures
25%
Tax rate applicable is 30%
...

Required:
(i) The levels of total new financing at which breaks occur in the Weighted Marginal Cost
of Capital (WMCC) curve
...

(iii) Advise Malaba Limited on the projects to undertake assuming that the projects are not
divisible
...

Millennium Investments Ltd
...
10 million to finance a
project in the following manner:

FINANCIAL MANAGEMENT

REVISION PARTNER

28

Sh
...
4 million from floating new ordinary shares
...
10 each
Retained earnings of Sh
...
20 each
...
150 each
...
60 per share
...
2
...
The average growth rate in
both dividends and earnings has been 10% over the past ten years and this growth rate is
expected to be maintained in the foreseeable future
...
100 each
...
The preference shares were issued four years ago and
still change hands at face value
...

(iii) Compute the company’s marginal cost of capital if it raised the additional Sh
...
(Assume a tax rate of 30%)
...
15:
ADVANCED FINANCIAL MANAGEMENT
QUESTION 31
a) Describe the following methods of credit enhancement
...

ii) Overcollateralisation
...

b) The following information relates to Unified Holdings Ltd
...
5%
30
8
...
8%
50
10
...
Risk free rate is 8%
...
Market return is 16%
...
Corporate tax rate is 30%
...
The company's ungeared beta (asset beta) is 0
...

December 2011 Question Five A and B

QUESTION 32
(a) Kitunda Ltd
...
9
9
...
8
8
...
7
7
...
5
0
...
9
29
...
5
6
...
2
0
...
4
20
...
3
6
...
6
0
...
1
13
...
1
6
13
...

(ii) Kitunda Ltd
...

Modigliani and Miller's model with no taxes to determine the equity cost of capital
...

June 2011 Question Two A and C

QUESTION 33
Furnace Ltd wishes to evaluate two plans, leasing and borrowing to purchase an oven
...

Lease option: The company can lease the oven under a 5 year lease requiring annual end-of year
payments of Sh 5,000,000
...
The lessee will exercise its option to purchase the asset for Sh
4,000,000 at termination of the lease
...
Depreciation
charges in the five years will be as follows: Year 1 Sh 4,000,000 Year 2 Sh 6,400,000, Year 3 Sh
3,800,000, Year 4 Sh 2,400,000 and Year 5 Sh 2,400,000
...

The total purchase price will be financed by a 5 year, 15% loan requiring equal annual end of year
payments of Sh 5,967,000
...
Insurance and other costs will be borne by the firm
...

Required;
a) For the leasing option, calculate the following:
i)
The after tax cash outflow each year
...


FINANCIAL MANAGEMENT

REVISION PARTNER

30

b) In respect of the purchase options, calculate the following
...

ii)
The after-tax cash outflow resulting from the purchase for each of the 5 years
iii)
The present value of the cash outflow, using a discount rate of 9%
c) Compare the present value of the cash outflow streams for the two plans and determine which
plan would be preferable
...
Each firm has an operating profit of sh
...
The capital
structures of the firms are as follows:

Equity (market value)
8% debt (Trading at par)

Baba Ltd
Sh
...
“million”
1,000
1000
2,000

The two companies have a 100% dividend payout ratio
...

iii) Advise Alusa, who holds 4% of Toto Ltd’s equity shares, on the arbitrage opportunities
available to him (ignore taxation)
...
STN ltd expects its net
income to be Sh 2,700,000 next year and its current dividend payout ratio is 30%
...

The last divided paid by the company was Sh 1
...
If STN Ltd issues new ordinary shares, a
12% underwriting cost will be incurred
...
STN Ltd is at its optimal capital structure, which is 60% debt and 40% equity and the firm’s
corporation tax rate is 40%
...

Project
A
B
C
D

Cost
Sh
3,200,000
1,300,000
1,750,000
450,000

Internal rate of return (IRR)
%
13
...
7
12
...
2

Required
a) The break points in the marginal cost of capital (MCC) schedule
...


FINANCIAL MANAGEMENT

REVISION PARTNER

31

c) The weighted average cost of capital (WACC) in the interval between each break in the MCC
schedule
...

e) STN Ltd’s optimum capital budget
...
This will require an
expansion of its assets by 50%
...
18 million with annual incremental earnings before interest and taxes (EBIT) of
25% on incremental sales
...

A financial analyst hired by the company has submitted the following proposals of financing the
expansion for consideration:
Plan A

Issue of 10% debentures

Plan B

Issue of 10% debentures for half the required amount and issue of ordinary
shares at 25% premium for the remaining balance of the amount
...
“000” Assets
Ordinary shares capital (sh
...
“000”
64,000
32,000

96,000

Pentel Ltd
...
83

The tax rate is expected to remain constant at 30%
...

b) The earnings per share (EPS) indifference points between:

FINANCIAL MANAGEMENT

REVISION PARTNER

32

i) Plan A and plan B
ii) Plan A and plan C
iii) Plan B and plan C
c) Assume that the price/earnings (P/E) ratio will be 8 if plan C is adopted but will drop to 6 if either
plan A or plan B is used to finance the expansion
...

June 2009 Question Four

QUESTION 37
b) The management of Shujaa Ltd is excited that the government has reduced the corporate tax rate
from 33% to 30%
...
15 million
...
5 par value)
Retained earnings
Share premium
Shareholders’ equity
10% debentures (sh
...
“million”
30
70
40
140
40
180

The company’s shares are currently selling at sh
...
00 ex-div and the debentures are selling at
sh
...

The equity beta is 1
...
The market return is 13%
...

Assume that the cost of debt and the market price of the debentures will not change as a result of
tax cut
...

Determine the expected market price per share of Shujaa Ltd after the tax reduction
...
0
22
...
5
150

Mapema Ltd expects an after tax income of sh
...
The company has a
policy of paying out 30% of its earnings as dividends
...
The dividend last paid by the company was sh
...
40 per share
...
90 per share
...
7
...
7
...
15 million must carry an interest rate of 14% and all long-term debt
over sh
...
The corporate tax rate is 30% and interest on
long-term debt is tax allowable
...
18 million can be raised at sh
...
To issue additional shares
above sh
...
18 per share must be incurred
...
100 can be issued and the dividend rate is 11%
...
11
...
Additional preference shares (above sh
...
25 million) can be raised at a
floatation cost of shs
...

The investment opportunities available to the company are as shown below:
Investment

Outlay

I
II
III
IV
V

15000000
15000000
15000000
30000000
30000000

Annual net cash
flow
3286800
4731630
3255270
5684220
8141760

Life(years)
7
5
8
10
6

Internal rate of return
(IRR) (%)
12
...
4
14
...
0
?

Required:
a) Determine the break points in the marginal cost of capital (MCC) schedule
...

c) Calculate the internal rate of return (IRR) for project V
...

June 2009 Question Two

QUESTION 39
(a) Hisa Ltd
...

Debentures

25%

Preference share capital

15%

Ordinary share capital

60%
100%

Additional information:
1
...
's expected profit after tax for the year ending 31 December 2008 is Sh
...

Hisa Ltd
...
The tax rate for the company is
30%, and investors expect earnings and dividends to grow at a constant rate of 9% per annum in
the future
...
The company paid a dividend of Sh
...
60 per share in the year ended 31 December 2007
...
60 per share
...
The company can obtain new capital as follows:
Ordinary shares:New ordinary share capital can be issued at a floatation cost of 10%
Preference share capital:New preference share capital with a dividend of Sh
...
100 per share
...
5 per share
...

4
...

Required:
i) Calculate the break point in the marginal cost of capital (MCC) schedule
...

iii) Calculate the weighted average cost of capital (WACC) in the intervals between the break point in
the marginal cost of capital (MCC) schedule
...
has the following investment opportunities:
Project
A
B
C
D
E

Cost
0
20,000,000
10,000,000
20,000,000
10,000,000

Internal rate of return (IRR)
17%
16%
14%
14%
12%

Which of these projects should the company accept and why?
December 2008 Question Four B

QUESTION 40
(a)

The following extract of the balance sheet of Mapato Ltd, shows the capital structure of the
company as at 31 December 2007
Sh
...
125)
62
...
500
184,000
Shareholders’ equity
Long-term liability:
14% debenture stock (par value Sh
...
The company’s earnings before interest and tax (EBIT) average sh 75 million per annum
...
the ordinary shares are currently trading at Sh 4oo per share
3
...
The corporate rate of tax is 30 per cent
Required:
Using the net income approach (incorporate taxes), calculate the company’s
(i)
Cost of Equity
(ii)
After tax cost of debt(Market value weighted)
(iii)
Market-weighted average cost of capital

FINANCIAL MANAGEMENT

REVISION PARTNER
(b)

35

The following information relates to Abacus Ltd, an all equity financed company
1
The market value of a company (determine using the net income approach) is sh
...
8 million worth of equity with
debenture of similar value (assume all legal requirement will be fulfilled)
...

(ii) Advise the management of the company on whether to change the capital structure
June 2008 Question Two

QUESTION 41
(a) The following information relates to two firms; Bora Ltd and Beta Ltd:
Firm
Bora Ltd
Beta Ltd

Sales (Sh
...

ii)
Comment on how the operating leverage has impacted on the earnings available to
shareholders of each firm
December 2007 Question Four C

QUESTION 42
b) Dawanox Ltd, an unlevered firm, generates average earnings before interest and tax (EBIT) of
Sh
...
the market value of the company as at 31 October 2007, the company’s
financial year-end, was Sh
...

The management of the company are considering the use of debt finance and have provided the
following additional information:
1
the estimated present value of the future financial distress costs is Sh
...
0
50 million
0
...
0250
100 million
0
...
1250
150 million
0
...
750
3
the corporation tax rate is 30 per cent

FINANCIAL MANAGEMENT

REVISION PARTNER

36

Required:
(i)
The company’s cost of equity and weight average cost of capital(WACC) as at 31
October 2007
(ii)
The company’s optimal level of debt finance using the Modigliani and Miller (MM)
with-tax model (excluding financial distress costs)
(iii)
The company’s optimal level of debt finance using the MM with-tax model
incorporating financial distress costs
...
The selling price of each clock is sh
...
700
...
70,000,000 and
incurs average fixed costs of sh
...

However, the two companies differ in their capital structures as stated below:
Maisha Ltd
...
10 per
value
...
10 per value and a loan of sh
...
Comment on the significance of your results
iv) The earning per share (EPS) at the point of indifference between the earning of the two
companies
June 2007 Question Four B

QUESTION 44
(b) The following balance sheet relates to Mapeo Ltd for the year ending 31 December 2006:
Sh
...
20 par)
Retained earnings
16% debenture (sh
...
16, 000,000 per annum
ii) The current market price per share is sh
...
The company is in the process of determining the
optimal capital structure that will minimize its weight average cost of capital
The cost of debt at various levels of leverage is as follows:
Debt to asset ratio
0
0
...
4
0
...
8

Debt to equity ratio
0
0
...
67
1
...
0

Cost of debt (before tax)
7%
8%
10%
12%
15%

Additional information:
1
...
The risk free rate is 5% and the market premium is 6%
3
...
The unlevered beta is 1
...
A Ltd
...
Operate in the same industry
...

The following additional information is available
...
Is financed using sh
...

ii) B ltd
...
50 million in ordinary share and sh
...

iii) The annual earnings before interest and tax sh
...
These earning are
expected to remain constant indefinitely
...
IS 10%
...

Required:
Using the Modigliani miller (mm) model, determine the following
...
and B ltd
...
And B ltd
...
has a capital structure consisting of sh
...
150
million in ordinary share of sh
...
The company distributes all its net earning as
dividends
...
50 million to financed the
expansion programme and considering the financing options
...

Option two: Issue 13%cumulative preference share
Option three: Issue addition ordinary share of SH
...

Calculate the earning before interest and tax (EBIT) and the earning per share (EPS) at the
point of indifference between the following financing options
...

ii) Option two and option three
...

c) Musa Onyango has invested in a portfolio that comprises two assets as shown below;-

Amount invested
Expected return
Standard deviation

Asset C
Sh
...
6,000,000
25%
20%

Correlation coefficient between the rates of return of asset “C” and asset “S” is 0
...
Portfolio expected return
ii
...

Investment A
Investment B
Probability
Return
Probability
Return
0
...
2
20%
0
...
6
8%
0
...
2
-4%
Required:
The standard deviation of each of the two investments
...

Ordinary share
Beginning price
Ending price
Dividend paid
...

Sh
...

X
30
34
3
...
70
Z
140
146
4
...

ii) Relative return for each of the three ordinary shares
...
Determine the expected return of the portfolio
...

End of period price per share (Sh
...
15
42
0
...
30
55
0
...
25
The current price per share is Sh
...

Required:
(i) Expected return
...

May 2012 Question Five D

QUESTION 6
c) Distinguish between the following terms as used in finance
...
with the following return characteristics'
State if the
Probability
Returns
Returns
economy
Security A (%)
Security B (%)
Recession
0
...
4
15
7
...
3
10
5
Required
Assess the riskiness of securities A and B
...
2
10%
8%
0
...
35
8%
7%
0
...
15
14%
11%
0
...

(ii) Bidii Ltd
...
The plant will cost Sh
...
Annual tax
depreciation of 25% will be allowed in respect of the expenditure
...
7 million per annum for the first two years and Sh
...
Incremental costs will be Sh
...
Bidii Ltd
...
Assume that all cash flows occur at the end of the year to which
they relate
...
on whether to proceed with the investment
...

b) Kiwanda Ltd
...
6
million in plant and machinery will be required
...
1
...

Additional information:
1
...
600 per unit with a variable cost of Sh
...

2
...
600,000 per annum
...
The company applies the straight line method of depreciation
...
The cost of capital is 10% per annum
...
The number of units of "M" expected to be produced and sold per annum for the next five
years is shown below:
Year
1
2
3
4
5

Units expected to be produced and sold
8,000
7,000
7,000
5,000
3,000

6
...

Required:
Advise the management of Kiwanda Ltd
...

(ii) The internal rate of return (IRR) approach
...
has found out that, after two years of using a machine, a more advanced model has
arrived in the market
...
The existing machine
had cost sh
...
The
current market value of the existing machine is sh
...


FINANCIAL MANAGEMENT

REVISION PARTNER

42

Bram Ltd
...
123,500 including
installation costs and has a salvage value of sh
...
The
following data has been provided:

Capacity per annum
Selling price per unit:
Production cost per unit:
Labour
Materials
Fixed overheads (allocated)

Existing machine
200,000 units
Sh
...
95

Advanced model machine
230,000 units
Sh
...
95

0
...
48
0
...
08
0
...
16

The required rate of return is 15%
...

Required:
Compute the following in respect of the new machine:
i
...

ii
...

iii
...

June 2013 Question Four A

QUESTION 4
(a)

Bright Ltd
...

The cost of capital for the project is 10%
...

“000”)
(9,600)
4,000
3,750
3,500

Abandonment values
(Sh
...
when to abandon project X
...
has the following proposed independent projects for the year ending 31 December
2012:
Project
Net investment
Present value of future net cash flow
outlay
A
500
1,000
B
1,000
2,500
C
400
300
D
300
400
E
200
300
Required:
(i)
Assuming that there is no capital rationing, indicate which projects should be selected
...


FINANCIAL MANAGEMENT

REVISION PARTNER
(iii)

43

Assuming a single period internal capital constraint of Sh
...

May 2012 Question Four B

QUESTION 6
d) Tezo Ltd
...
The factory manager has proposed the
replacement of the milling machine with a new fully computerised machine
...
4 million
...
However, a management review has established that the machine has a further useful life of
five years with a zero salvage value
...
1
...

The new machine has a purchase price of Sh
...

1
...
2 million
...
2
...
However, electricity costs will increase by Sh
...
The operation of the new machine will also require an increase of Sh
...
The company uses the straight line method of depreciation
...

Required:
Advise the management of Tezo Ltd
...

May 2012 Question Three D

QUESTION 7
b) Dzitsoni Ltd
...
The existing machine was bought 3 year ago at
a cost of Sh 50 million
...
The machine could be disposed of immediately at Sh
...
The new
machine will cost Sh
...
5 million
...
25
million per annum over the next five years
...
The operation of
the new machine will also require an immediate investment of Sh
...

Installation costs of the new machine will amount to Sh 6 million
...
The company's cost of capital is 12%
...

Required;
(i) The initial investment for the replacement decision
...
on whether to replace the machine
...

b) Differentiate between the term "weighted average cost of capital" and "marginal cost of capital"
...
1,000 per value
8% coupon rate, 20 year bonds on which annual interest payments will be
made
...
30 per bond would be
given
Preference stock
The firm can sell 8% preferred stock at its Sh
...
The cost of
issuing and selling the stock is expected to be Sh
...
An unlimited

FINANCIAL MANAGEMENT

REVISION PARTNER

44

amount of preferred stock can be sold under these terms
...
1,000 per value
8% coupon rate, 20 year bonds on which annual interest payments will be
made
...
30 per bond would be
given

Equity

The firm expects to have Sh
...
New shares can be issued at Sh 62 each with a flotation cost of Sh 2 per
share
...
Expected dividend in the coming
year is Sh
...


The company’s estimate optimal capital structure is given below
...
“000”
Debt
30,000
Preferred stock
20,000
Equity
50,000
The company tax is at 30%
Required
(i) Compute the specific cost of each source of financing
(ii) Determine the breakpoint and the weighted average marginal cost of capital below the
breakpoint
...

b) Three options are available to the investment manager of Maendeleo Ltd
...
20 million with a probability of 0
...
40 million with a probability of 0
...

− Project Leta may earn a return of Sh
...
3 or a return of Sh
...
7
− Project Pato yields a return of Sh
...
5 or Sh
...
5
Required:
By applying the mean-variance rule, advise Maendeleo Ltd investment manager on the best
investment option
...
New equipment will
cost sh
...
To operate the new dock will require additional
dockside employees costing sh
...
There will also be need for additional
administrative staff and other overheads such as extra stationery, insurance and telephone costs
amounting to sh
...
Electricity used on the dock is anticipated to cost sh
...

The head office will allocate sh
...
Other docks
will experience in receipts of about sh
...
Annual
fees expected from the new dock are sh
...


FINANCIAL MANAGEMENT

REVISION PARTNER

45

Additional information
1
...

2
...

3
...

Required;
i)
Show the net annual cash flow calculations and explain the reasons for the calculations
...

June 2011 Question Two C

QUESTION 11
b) Mavoko Ltd
...
While the current production capacity is one million units of
“Fixit”, demand for the component is expected to be as follows:
Year
Demand(units)

1
1
...
5 million

3
1
...
7 million

The company is planning to acquire an additional machine at a cost of sh
...
The scrap value of the machine after
four years will be sh
...

The current selling price of “Fixt” is sh
...
50 per unit
...
19
...
2,400,000 in the first year of production increasing by sh
...

Mavoko Ltd
...
A balancing allowance is claimed in the final year of operation
...
is 10% while it pays an interest of 8
...
Its long term
fiancé is made up 80% equity and 20% debt
...

ii) Calculate the internal rate of return (IRR) of the new machine
...
on whether to buy the new machine
...

The machine will be used to manufacture a product known as “omega”
...
5
million and will incur installation costs amounting to sh
...
The machine is expected to have an
economic useful life of 5 years and a resale value of sh
...

The acquisition of this machine is expected to cause changes in working capital at the beginning of
the expected life of the machine
...
2 million ,accounts
receivable will increase bysh
...
5,accounts payable will increase by sh
...
5,accrued expenses and
prepaid expenses are expected to decrease by sh
...
5 million and sh 0
...
The net
change in working capital will be recovered at the end of the machine’s economic life
...
Each unit of omega is expected to be sold at sh
...
However the price is expected to
increase by 10% annually thereafter
...
The variable cost per unit for omega is estimated at Sh
...
In subsequent years, this
cost will rise at the same rate as the increase in the selling price
...
Fixed costs per annum excluding depreciation are estimated at sh
...
5 million
...
The company applies the straight line method of depreciation for all its fixed assets
...
The company’s cost of capital is 12%
6
...
Corporation tax is paid one year in arrears
...

June 2010 Question One

QUESTION 13
High Tec Electronics Ltd is considering the acquisition a new machine to replace existing machine
currently being used in the production of product “Q”
...
40; 000,000
...
However, following a revaluation of the machine, it is now estimated that the machine can be
used for another 15 years with a salvage value of sh
...
The current disposal value of the
machine is sh
...

The new machine is estimated to cost sh
...
The Company will incur an installation cost of
sh
...
However, the machine will require an overhaul at the end of 10 years
...
20; 000,000
...
30, 000,000 at the end of its
useful life
...
40, 000,000 at the end of 5 years
...

The following information relates to the new machine and the existing machine’s expected output of
product “Q” over the 15 years period
...
The unit selling price and unit variable cost of product “Q” are sh
...
15 respectively
...

2
...
100,000,000 over the 15 years period
...
The company applies a policy of straight line depreciation for all its fixed assets
...
The overhaul cost of the new machine will be amortized separately over the remaining useful
life of the machine on straight line basis
...
The company’s cost of capital is 20%
...
Corporation tax rate is 30%
...

Required;
Using the net present value (NPV) technique, advice the company on whether it should replace the
existing machine with the new machine
...

b) Widespread investment company Ltd
...
Annual
cash flows associated with the project are as follows:

Year
1
2
3
4
5
6
7
8

Cash flows
Sh
...
1 billion at the end of the year 5 to
secure a national market
...
600 million higher in each of the
years 6 to 10
...

Assume the project is successful and all cash flows occur at the end of each year
...

ii) Net present value (NPV) of the project with real option
...


QUESTION 15
c)

Aruna Ltd
...
2,700,000
...


FINANCIAL MANAGEMENT

REVISION PARTNER

48

Additional information:
1
...

Shs
...
The machine is expected to increase the company’s annual cash flows (before tax) as shown
below
...
)

1
1,760,000

2
1,360,000

3
1,050,000

4
900,000

5
840,000

6
750,000

3
...

4
...

5
...

Required:
i)
Payback period of the machine
...

iii) Advise the company on whether to import the machine based on your results in (c)(i) and
(ii) above
...

c) Wanga Ltd
...
1,500,000
...
800, 000
...
The
transaction cost of buying and selling of marketable securities is Sh
...
Assume
that one year has 365 days
...

ii) Average cash balance
...

December 2014 Question Five B and C

QUESTION 2
The board of directors of Rand Mills Limited have requested you to prepare a statement showing the
working capital requirements for a level of activity of 30,000 units of output for the year
...
)
Raw materials
Direct labour
Overheads
Total
Profit
Selling price

(Sh
...
Past experience indicates that raw materials are held in stock on average for 2 months
...
Work in progress (100% complete in regard to materials and 50% for labour and overheads) will
be half a month's production
...
Finished goods are in stock on average for 1 month
...
Credit allowed to suppliers is 1 month
...
Credit allowed to debtors is 2 months
...
A minimum cash balance of Sh
...

Required:
Prepare a statement of working capital requirements
...
are 2/15- net 45 days
...
200 million with an average collection period of 30 days
...
50% of customers take advantage of the current discount
...
This relaxation of
discount terms is expected to increase annual sales by Sh
...
The company's cost of capital is 12%
...

Assume 360 days in a year
...
on whether to relax its discount terms
...
is considering relaxing its debt collection effort
...

Total shares
Average collection period
Variable costs to sales ratio
Cost of capital
Bad debt ratio

Sh
...
80
12%
0
...
5
...
06
...

Assume 360 days in a year
...

June 2013 Question One D

QUESTION 5
The following information relates to the current trading operations of Dindiri Ltd
...
900 Million
Contribution to sales ratio
15%
Debtors recovery period:
Percentage of debtors
Average collection period (days)
25
32
60
50
15
80
Credit sales as a percentage of total sales 60%
Required return on investments 15%
Level of bad debts is 2
...

In an effort to improve the liquidity position of the company, the management proposed the following
strategies aimed at reducing its operating cycle
...
This will have the
following effects:
1
...

2
...

3
...

4
...

5
...


FINANCIAL MANAGEMENT

REVISION PARTNER

51

Strategy B
Contract the services of a factor at a cost of 2% of total credit sales while advancing Dindiri Ltd
...
5% per month
...
No change in the level of annual sales proportion of cred it sales and contribution margin ratio
...
Savings on debt administration expenses of Sh
...

3
...

4
...

Required:
(i) Evaluate the financial benefits and Costs of each strategy (assume a 60 day year)
(ii) Advise the management of Dindiri Ltd
...

December 2012 Question Four B

QUESTION 6
Bahari Ltd
...
68, 250
...
500, 000
...
360 from the
money marker
...
865% per annum
...

Assume 365 days a year
...

(ii) Upper cash limit
...

December 2012 Question Five D

QUESTION 7
a)

The finance manager of Charisma Enterprises Ltd
...
“000”
3,600
306
25% on sales
200
350
150
130

Raw materials are 80% of cost of sales which are all on credit
...

May 2012 Question Three C

QUESTION 8
b) The projected monthly working capital requirements for Chasimba Ltd
...
"000"

January

February

4,500

4,500

Month
Amount of working capital
required Sh
...
Ignore taxation
...

(ii) The average amount of long-term and short-term finance that would be required monthly
...

(iv) The total cost of working capital finance, if the firm adopted a conservative financing strategy
...

May 2012 Question One B

QUESTION 9
b) Baren Ltd projects that cash outlays of Sh
...

The company plans to meet its cash requirements by selling marketable securities from its
portfolio
...
30
...

November 2011 Question Four B

QUESTION 10
c) You are given the following financial statement information for Moto Ltd
...
”000”
Sh
...
“000”
Inventory
17,340
15,960
Accounts receivable
42,240
37,250
Accounts payable
35,510
27,370
Net Sales
120,000
Cost of goods sold
92,000
Required;
The operating and cash conversion cycles assuming that the year has 360 days
...
15,000,000
Cost as a percentage of sales:
%
Direct materials
30
Direct labour
25
Variable overheads
10

FINANCIAL MANAGEMENT

REVISION PARTNER
Fixed overheads
Selling and distribution costs

53
15
5

Additional information;1
...
5 months before payment while raw materials are in stock for three months
...
Work in progress represents one month’s worth of half processed goods
3
...
Credit is taken as follows:
Direct materials
2
Direct labour
1
Variable overheads
1
Fixed overheads
1
Selling and distribution overheads
0
...
Work in progress and finished goods are valued at material, labour and variable expense cost
Assume that the sales have been made on credit
Required;
Assuming a 50-week year compute Stores Ltd
...

June 2011 Question Four C

QUESTION 12
a) The working capital policy of any business entity must address the twin issues of the level of
current assets and the manner in which these current assets are financed
...

December 2010 Question Four A

QUESTION 13
a) Chogoria Ltd
...
The bank's manager has requested for a working capital estimate from the
company
...

Sh
...

Average finished goods in stock (holding period)
2
Average raw materials in stock (holding period)
3
A work in progress (holding period)
4
...

Credit period allowed to debtors
6
...

Time lag in payment of overheads
8
...

9
...
240,000
10
...


FINANCIAL MANAGEMENT

1 ½ Months
...

1Month
...

3 Months
½ Month
...


REVISION PARTNER

54

Required
(i) A statement showing the working capital estimate
...

June 2010 Question Three A

QUESTION 14
b) Mapema Ltd
...
The company sells the product to its
customers on credit terms
...

The following information relates to the company:
• Average number of units sold per year 72,000,000
• Selling price per unit sh
...

• Variable cost per unit is sh
...

• Annual fixed collection expenses sh
...

• Average collection period is 40 day
...
Mapema Ltd
...
40,000,000 per annum in
collection expenses
...
Sales will also increase by 1,000,000
units per annum
...

Required:
Advice Mapema Ltd
...

June 2010 Question Three B

QUESTION 15
a) Name and explain three approaches that could be used by a company to finance its working
capital requirements
...
A retail
company, for the year ended 30 September 2009
...
The company’s gross profit margin is 40%
...
All sales are on credit terms
...
Assume a 360 day year
...
“000”
10,000,000
2,000,000
666,667
800,000

Required:
The company’s cash conversion cycle
...
Manufactures a standard farm implement which it sells to distributors at sh
...
The company intends to relax its credit policy which will result in an increase collection
period from one month to two months
...
Variable costs of production are
sh
...
24,000,000
...
2,000,000 and additional creditors of sh
...


FINANCIAL MANAGEMENT

REVISION PARTNER

55

The company’s required rate of return is 20%
...

ii) Existing customers do not change their payment habits and only the new customers take the full
two months credit
December 2009 Question Three

QUESTION 16
Modern Appliance Ltd
...
The purchase price
per unit of the product is sh
...
The cost of placing each order is sh
...

Required:
i)
Economic order quantity
...

iii)
Assume that the company has received a discount offer of 1% for purchases of at least 4,500
units per order
Using supporting calculations, advise the company on whether to take advantage of the discount
offer
...
a large multi- national company is in the process of determining the optimal cash balance
for the year ending 31 December 2009
...
The company’s annual cash requirements amount to sh
...

2
...
500
...
The opportunity cost of funds is 12%
...

ii)
Total cost of maintaining the cash balance determined in (b) (i) above
...
for the year ending

31 December 2008
...
“000”)
3,500
3,500
5,250
7,000
10,500
15,750
21,000
24,250
15,750
8,750
7,000
5,250

FINANCIAL MANAGEMENT

REVISION PARTNER

56

The expected cost of short term funds is 20% while that of long term funds is 25%
...

Required:
i) A schedule showing the amount of permanent and seasonal working capital requirements for
each month
...

iii) Total cost of working capital finance if the firm adopts an aggressive strategy
...

b) The following information was extracted from the books of Changa Ltd
...


Stock of raw materials
Work in progress
Finished goods stock
Trade debtors
Annual sales
Cost of production
Annual cost of sales
Trade creditors
Annual purchase of
raw materials

2006
Sh “000
40,000
10,000
50,000
140,000
2,000,000
1,000,000
1,200,000
110,000
700,000

2007
Sh “000
60,000
18,000
70,000
180,000
2,200,000
1,050,000
1,250,000
100,000
780,000

Required:
i)
The working capital cycle (in days) of Changa Ltd
...
might reduce its working capital style
...


QUESTION 19
The following information was extracted from the books of Shama Ltd
...

Trade debtors balance (31 December 2006)
Trade debtors balance (31 December 2006)
Sales of the year
Purchases of the year
Gross profit margin
Inventory turnover

Sh
...
3 million
Sh
...
60 million
25%
4
...
Assume a 360 – day year
...
sells merchandise on credit terms of net 50 while the industrial average credit
terms are net 30
...
The average number of days sales in
accounts receivables is 60 days
...
This change of credit
terms is expected to result in the following:
• Sales would reduce to sh
...

• Accounts receivable would drop to 35 days of sales
...
The variable cost ratio is 70%
2
...

3
...

Assume a 360 – day year
...
Its credit terms
to net 30
...


FINANCIAL MANAGEMENT

REVISION PARTNER

58

TOPIC 10
FINANCIAL STATEMENT ANALYSIS
QUESTION 1
b) The following data was extracted from the books of Sky Ltd
...
20 million
2 times
30%
3:1
5 times
18 days
5 limes
25%

Assume 360 days in a year
...
as at 31 December 2012
...
is considering a number of funding options for a new project
...
10 million of equity or debt
...
under each funding
option
...
0
...
par value
Share premium
Reserves

Equity finance
Sh
...
Finance
Sh
...
0

11
...
0
5
...
0

3
...
5
5
...
0

Income statement (extract):
Revenue
Gross Profit
Expenses (excluding finance charge)
Operating profit

Sh
...
Return on capital employed (ROCE) under each of the two funding options
...
Return on equity under each of the two funding options
...
Explain the impact on the performance of Docarex Ltd
...

June 2013 Question Three B

QUESTION 3
The following data was extracted from the financial statements of Madrex Ltd
...
"Million"
Sales
200
Cost of sales (including Sh
...
“million”
Sh
...
has made the following projections for the year ending 30 November 2013:
1
...

2
...
12 million
3
...
Receivable days
75
5
...
Depreciation
Sh
...

Required:
Cash flow projection for the year ending 30 November 2013
...
for the year ended 30 November
2012:
Current ratio
Debt/Equity ratio
Interest cover
Current liabilities
Total asset turnover
Fixed asset turnover
Gross profit margin
Earnings before interest and tax (EBIT)/sales 5%

1
...
5
3
...
600,000
1
...
6 times
30%
5%

Required:
(i) Income statement for the year ended 30 November 2012
...

December 2012 Question Three A

QUESTION 5
(a) The following data was obtained from the summarised statement of financial position of
Ngamani Ltd
...
0
...
1 par value)
Share premium account
Retained earnings

Additional information:
1
...
1
...

2
...
0
...
The expected growth rate is 9% per
annum
...
The current price of the preference shares is Sh
...
77 and the dividend has recently been paid
...
The loan notes interest has also been paid recently and the loan notes are currently trading at
Sh
...
100 nominal value
...

5
...

(ii)
Gearing ratio using market values
...

December 2012 Question Four A

QUESTION 6
a) The following statement of financial position was extracted from the books of XYZ Ltd
...


FINANCIAL MANAGEMENT

REVISION PARTNER

61
2011
Sh
...
(Million)

Assets
Current assets
Cash
Accounts receivable
Inventory
Total

84
165
393
642

98
188
422
708

Non-current assets
Plant and equipment
Total assets

2
...

(ii) The equity multiplier ratio for the years 2011 and 2012
...


May 2012 Question Four A

QUESTION 7
a) Highlight three problems that could be faced by a firm with a high gearing level
...

December 2010 Question Five E

QUESTION 9
a) The following statement of financial position relates to Mageuzi Ltd
...

Mageuzi Ltd
...
“million” Sh
...

Ordinary share capital
Retained earnings
Long term debt

1
12
4
6
2
12

Additional information:
1
...
20 million
...
4 million
...
The net profit margin and retention ratio for the year ended 31 December 2009 were 8 % and 30%
respectively
...

3
...

Required:
i) The amount of external financial requirements for the year ending 31 December 2010
...

June 2010 Question Two

QUESTION 10
b) The following information relating to Kawaida Ltd
...


Ordinary share capital (sh
...
“000”
80,000
12,000
12,000

Additional information:
1
...
72 per share
...
Corporation tax rate is 30%
...

ii) Price earning P/E ratio
...
has an issued share capital of sh
...
25 par value
...

Sh
...
”000”
Gross profit
190,000
Deduct: variable costs
70,000
Fixed costs(including depreciation)
40,000
(110,000)
Earnings before interest and tax
80,000
Interest on debentures
(20,000)
Earnings before tax
60,000

FINANCIAL MANAGEMENT

REVISION PARTNER
Taxation
Earnings after tax
Dividend
Retained earnings

63
(18,000)
42,000
(16,000)
26,000

The company is planning on introducing a new production process that is expected to improve
operational efficiency
...
1,500 per unit of output
...
15 million per
annum partly due to additional depreciation on the fixed assets purchased for the production process
...
Variable costs for the year ended 31 December 2008 related to a production and sales level of
20,000 units
...
Capital requirements for the new production process will be met through an issue of sh
...

3
...

4
...
This ratio is expected to be maintained in the year ending 31 December 2009
...
The corporation rate of tax is 30%
...

ii)
Expected EPS and MPS for the year ending 31 December 2009
...

Compute the expected EPS for the year ending 31 December 2009
...

Sh
...

Sales
9
...

Sh
...

Required:
i)
ii)
iii)
iv)
v)
vi)

Operating cash style
Quick ratio
Current ratio
Debt to equity ratio
Operating margin ratio
Debt turnover ratio
June 2009 Question Four B

QUESTION 13
The following summarized financial statements relate to Jasmine Ltd
...

Income statement
Sh
...

Additional information:
1
...
1
...
1
...

2
...
1
...
0
...

3
...

4
...

Required:
i)
External finance (if any ) required in year 2009 assuming that the sales for the year increase
by 20%
ii)
Expected maximum growth in sales in year 2009 assuming that the company only utilizes
internal funds
...

December 2008 Question Four B

QUESTION 14
The following balance sheet was prepared by the management of Mambo Ltd
...

Sh “000”
Non-current assets
Current assets
Inventory
Trade receivables

Sh”000”
13,000

3,000
2,000
5000

Current liabilities:
Trade and other payables
Working capital
Net assets
Financed by:
Ordinary share capital
Retained earnings
Long term debt
Total equity and long term liabilities

6,000
(1,000)
12,000
4,000
6,000
2,000
12,000

The management of the company is evaluating the expected financial requirements for the year
ending 31 December 2008 and has sought your advice as a financial consultant
...
Sales revenue for the year ended 31 December 2007 was sh
...
24 million
...
Total assets and current liabilities for year 2008 are expected to increase in the same proportion
as the increase in sales revenue
...
The average after tax net profit margin of 8% per annum is expected to be maintained in year
2008
...
The current dividend payout ratio of 70% is also expected to be maintained in the year 2008
...
Any additional finance required in year 2008 would be obtained through bank loans
...

ii) Projected balance sheet of the company as at 31 December 2008
...
is 20% and the current market price per ordinary share is Sh100
...
50
...

Required:
i)
The earnings per share
ii)
The dividend cover
iii) The price earnings ratio

QUESTION 16
a)

The following is an extract of the balance sheet of Shauri Moyo limited as at 31 December 2005
Sh ‘000’
Capital and Liabilities
Ordinary Share capital: 1 million ordinary
10,000
Shares of Sh
...
The profit before interest and tax for the year ended 31 December 2005 was Sh
...
The dividend payout ratio for the year 2005 was 40%
3
...
36
4
...
And Vyumba ltd are medium-sized companies dealing in the sale of new residential
houses
...

Sh
...
5 par)
14,400,000
3,600,000
7% Preference Share Capital (Sh
...
75
135
Retained profits balance: 1 January 2005
18,000,000
25,000,000
The corporation tax rate is 30%

FINANCIAL MANAGEMENT

REVISION PARTNER

67

Required:
i)
Gearing ratio for each company
ii) Earnings per share for each company
iii) Price earnings ratio for each company
iv) Interpret your result obtained in (i) and (ii) above

QUESTION 18
Ushindi Limited presented the following financial statements on 30 June 2004
Income statement for the year ended 30 June 2004
Sh
...


Sh
...

480,000
800,000
200,000
200,000
1,680,000

1,000,000
400,000
120,000
1,520,000
238,400
878,400
176,000
107,200

(1,400,000)

Financed by:
Authorised share capital: 800,000 Sh
...
1 ordinary
shares
Capital reserve
Revenue reserve
Loan capital: 400,000 Sh
...
An analysis of the industry in which the company operates reveals the following industrial
average
Current Ratio
1:5:1
Quick Ratio
0:8:1
2
...
2,160,000 while the cost of sales was Sh
...


FINANCIAL MANAGEMENT

REVISION PARTNER

68

3
...
5
Required:
a) Compute the following ratios for Ushindi Limited
i)
Return on capital employed
ii)
Turnover of capital
iii) Operating expenses ratio
iv) Accounts receivable turnover in days
v)
Dividend yield
vi) Price earnings ration
vii) Market value to book value ration
viii) Current ratio
b) Compare the company’s liquidity performance with that of the industry
...
started operations on 1 September 2002
...
65million and debt at an annual rate of interest of 18% before
commencing business
...
‘000’
75,000
39,150
4,220
3,125

Eighty percent (80%) of the sales were on credit
...
Taxation was provided
for at the rate of 30%
...

Fixed Assets turnover
Gross profit margin
Stock turnover
Interest cover
Average debt collection period (based on 360 days of the year)
Current ratio

1
...
4 times
4 Times
84 days
2
...
2:1
Return on equity
21%
Capital gearing ratio
36%
Required:
Comment on the performance of the company relative to these industry statistics

FINANCIAL MANAGEMENT

REVISION PARTNER

69

QUESTION 20
a) Outline four limitations of the use of ratios as a basis of financial analysis
b) The following information represents the financial position and financial results of AMETEX
limited for the year ended 31 December 2002
...
‘000’
Sh ‘000’
Sales - Cash
300,000
- Credit
600,000
900,000
Less Cost of Sales
Opening stock
210,000
Purchases
660,000
870,000
Closing stock
720,000
(150,000)
Gross Profit
180,000
Less expenses:
Depreciation
13,100
Directors’ emoluments
15,000
General expenses
20,900
4,000
Interest on loan
(53,000)
Net profit before tax
127,000
Corporation tax at 30%
(38,100)
Net Profit after tax
88,900
4,800
Preference dividend
10,000
Ordinary dividend
14,800
Retained Profit for the year
74,100
AMTEX Limited
Balance Sheet as at 31 December 2002
Sh ‘000’
Sh ‘000’
Sh ‘000’
213,000
Fixed Assets
Current Assets
Stock
150,000
Debtors
35,900
Cash
20,000
205,900
Current Liabilities
Trade Creditors
Corporation tax payable
Proposed dividend

60,000
63,500
14,800

Financed By
Ordinary shares capital (Sh
...
The company’ ordinary shares are selling at sh
...
The company has a constant dividend payout of 10%

FINANCIAL MANAGEMENT

REVISION PARTNER

70

Required:
i) Acid test ratio
ii) Operating Ratio
iii) Return on total capital employed
iv) Price earnings ratio
v) Interest coverage ratio
vi) Total assets turnover
c) Determine the working capital cycle for the company
...
is in the process of forecasting its financial needs for the coming year ending
31 October 2003
...
300 million for the current year ended 31
October 2002
...
“million’
Turnover
300
Profit before tax
54
18
Taxation
36
Profit after tax
9
Dividend
Retained profit
27
Balance Sheet
Sh
...
“million’
190

146
103

43
233
50
90
140
93
233

From past experience, it has been disclosed that each additional Sh
...
1
...
The Sh
...

The net profit margin after tax and the dividends payout ratio which apply for the year ended 31
October 2002 will also be relevant into the foreseeable future
...

The maximum expected sales growth that can be achieved in the year ending 31
October 2003 if only internally generated funds are used
...

Briefly comment upon the weaknesses of the method of forecasting used above
...
want to establish the amount of financial needs for the next two
years
...
’000’
Net fixed assets
124,800
Stock
38,400
Debtors
28,800
7,200
Cash
Total assets
199,200
Financed by:
Ordinary share capital
84,000
Retained earnings
35,200
12% long-term debt
20,000
Trade creditors
36,000
24,000
Accrued expenses
199,200
For the year ended 31 December 2001, sales amounted to Sh
...
The firm projects that the
sales will increase by 15% in year 2002 and 20% in year 2003
...

The firm intends to maintain its dividend pay out ratio of 80%
...

Any external financing will be effected through the use of commercial paper
...

(b)
(i)
A proforma balance sheet as at 31 December 2003
...


QUESTION 23
Three years ago, Mrs
...
She invested
substantially all her terminal benefits in the shares of ABC Ltd
...
The dividend payments from this investment makes up a significant position of Mrs
Waziri’s income
...
dropped its year 2001 dividend to Sh
...
25 per
share from Sh
...
75 per share which it had paid in the previous two years
...
and the finance sector as a whole
...
Balance Sheets as at 31 October

Cash
Accounts receivable
Inventory
Total current assets

1999
Sh
...
’000’
14,400
87,800
158,800
261,000

FINANCIAL MANAGEMENT

2001
Sh
...
Income Statements for the year ending 31 October

Sales (all on credit)
Cost of sales
Gross profit
General administrative and selling expenses
Other operating expenses
Earnings before interest and tax (EBIT)
Interest expense
Net income before taxes
Taxes
Net income

1999
Sh
...
’000’
858,000
(710,000)
148,000
(47,264)
(31,800)
68,936
(26,800)
42,136
(16,854)
25,282

2001
Sh
...
8
...
1
...
48
...
5
...
1
...
25
...
3
...
1
...
13
...
0
2
...
0 times
2
...
8%
3
...

Industry ratios have been roughly constant for the past four years
...

Inventory turnover, total assets turnover and fixed assets turnover are based on the year-end
balance sheet figures
...

(b) Arrange the ratios calculated in (a) above in columnar form and summarise the
strengths and weaknesses revealed by these ratios based on:
(i) Trends in the firm’s ratios
(ii) Comparison with industry averages
...


QUESTION 24
Rafiki Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30
...
’000’
Sh
...
’000’
Cash
30,000
20,000
5,000
Accounts receivable
200,000
260,000
290,000
Inventory
400,000
480,000
600,000
Net fixed assets
800,000
800,000
800,000
1,430,000
1,560,000
1,695,000
Accounts payable
Accruals
Bank loan, short term
Long term debt
Common stock
Retained earnings

Additional information:
Sales
Cost of goods sold
Net profit

230,000
200,000
100,000
300,000
100,000
500,000
1,430,000

300,000
210,000
100,000
300,000
100,000
550,000
1,560,000

380,000
225,000
140,000
300,000
100,000
550,000
1,695,000

4,000,000
3,200,000
300,000

4,300,000
3,600,000
200,000

3,800,000
3,300,000
100,000

Required:
(a)
For each of the three years, calculate the following ratios:
Acid test ratio, Average collection period, inventory turnover, Total debt/equity, Net profit
margin and return on assets
...


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74

TOPIC 11
DIVIDEND POLICY
QUESTION 1
c) Describe two types of dividends which a corporate entity could pay its shareholders
...

(c) Baraka Ltd
...
Currently, the company has 250,000 shares which are
quoted at the securities exchange at Sh
...
The company's earnings per share is Sh
...

The expected net income for the current year is Sh
...
6 million
...

May 2014 Question Three B and C

QUESTION 3
a)

The following data was obtained from the financial statements of Nemax Ltd
...
3
Dividend per share (DPS) for 2012
Sh
...
20
Target payout ratio
0
...
for the year ended
30 September 2013
...

c) Outline four advantages of paying scrip dividends
June 2013 Question Five B and C

QUESTION 5
b) Davirex Ltd’s share has a nominal value of sh
...
The company pays 10% of the nominal value of
the share as dividend for the year
...
160 with 15%
earnings yield
...

Earnings per share
...

Dividend cover
...

Price – earnings ratio
...
has current earnings per share of sh
...
00
...
1
...
60
...


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Required:
The dividend per share for the current year
...

December 2012 Question Five C

QUESTION 7
b) Enumerate four ways in which the dividend decision affects the wealth maximization goal of a
company quoted in the securities exchange of your country
...

November 2011 Question Two B

QUESTION 9
b)

MCC Enterprises Ltd
...
You are advised that the earnings distribution is
expected to continue in perpetuity
...
The company pays all its earnings in dividends and shareholders require a
12% return
...

Economic Environment
Bad
Fair
Good
Very good
Probability
0
...
25
0
...
25
EBIT (Sh
...
20
3
...
80
6
...
20
3
...
80
6
...
35
6
...
86%
13
...
14%
Required
i
...
The market value of MCC Enterprises Ltd
December 2010 Question Four B

QUESTION 10
b)

Explain the arguments in favour of a stable dividend policy
...
The company’s year-end is 31
December
...

Year ended 31 December
2009
2008
2007
2006
2005
EPS (Sh
...
0
13
...
1
12
...
2
DPS (Sh
...
2
8
...
9
7
...
7
If the current dividend policy is maintained, the directors of PDS Ltd
...

PDS Ltd
...
The company is therefore considering a change in its dividend policy where 50% of its

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earnings will be retained to finance identified projects which are estimated to have an average post-tax
return of 15%
...

Required;The share price of the company which might be expected by the market
(i) If the company does not announce the change of dividend policy
...

June 2010 Question Four B

QUESTION 12
a) Outline the reasons that may constrain a company from paying dividends to its shareholders at the
end of a financial year
...
Has followed a policy of paying out a gradually increasing dividend per share
over the past five years as shown below:
Year
2001
2002
2003
2004
2005

Earnings per share
Sh
...
00
125
...
00
135
...
00

Dividend per share
Sh
...
00
5
...
00
6
...
30

Additional information
1
...
The shares are therefore quoted ex-dividend
...
Management is considered a change in the financing policy whereby greater financing will be
provided from internally generated funds
...
5
...

3
...

4
...

Required:
i) Using the dividend growth model, calculate the market price per share as at 31 December 2005
prior to the change in the financial policy
...

iii) Determine the break-even growth rate in dividend per share using the market price calculated in
i) above

QUESTION 15
The following is the summarized Balance sheet of Kaka Kuona Ltd
...


Fixed Assets
Land and buildings
Furniture and fittings
Current Assets
Stock
Prepaid expenses
Debtors
Cash in hand

60,000,000
8,000,000
35,000,000
5,000,000
30,000,000
10,000,000
148,000,000

Financed by:
Capital:
Ordinary share of Sh
...
In the past Kaka Kuona ltd
...
6 and the dividend payout
rate was 50% or Sh
...
For the year ended 30 November 2003, the EPS declined to
Sh
...
50
...
3 per share
was maintained for the financial year ended 30 November 2003
...
Recent projections however have caused management to revise downwards the expected EPS
...
2 per share
and for the financial year ending 30 November 2004, the forecast of EPS has been reduced to
Sh
...
20
3
...
‘s ordinary shares are currently selling in the market at Ss
...
is considering whether or not to retain the cash dividend of
Sh
...
3 Per share
for the next two financial years
b) Determine whether the company should replace the cash dividend with a bonus issue of one share
for every four ordinary shares
c) Explain the course of action that the management of Kaka Kuona Ltd should take in the light of
the declining projections in dividend payouts
...

(ii) Zero-coupon bonds
...

(ii)
The dividend per share of Mavazi Limited as at 31 December 2000 was Sh
...
50
...
The analyst has also
projected a required rate of return of 10% for the equity market
...


(a)

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78

Required:
The intrinsic value of shares of Mavazi Ltd
...


QUESTION 17
The financial data given below shows the capital structure of Akabebi Company Limited
...
1,000 debenture
Ordinary share capital (Sh
...

Akabebi Company Limited intends to invest in a new project which is estimated to cost
Sh
...
3,000,000 per annum for 10 years
...

2
...

4
...
5,000 per debenture
...

Issue 10% Sh
...
25 per share
Issue ordinary shares at the current market price of Sh
...
Floatation cost per share
is estimated to be 12% of the share value
...

Corporation tax rate is 30%
...

iv) Determine the number of ordinary shares to be issued
...

vi) Evaluate whether it is viable to invest in the proposed project (Round off your answer for cost of
capital to the nearest 1)
vii) Explain clearly the sense in which depreciation is said to be a source of funds to business firms
...

Identify 6 factors a firm must consider when designing dividend policies
...

(ii) Discuss three forms of corporate restructuring that may be adopted by public enterprises
...

(ii) Highlight any six functions of the Controller of Budget
...

b) Explain six disadvantages of using foreign debt as a source of finance to the government of your
country
...

(b) Performance evaluation in the public sector has encountered some resistance from the
employees
...

December 2012 Question Five A and B

QUESTION 5
c)

Financial management practices in government departments are different from financial
management practices in industrial or commercial companies
...

May 2012 Question Five C

QUESTION 6
b) Explain four arguments against a balanced budget in public finance
...

December 2010 Question Five C

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80

QUESTION 8
a) In the context of public finance:
(i) Distinguish between a deficit budget and a surplus budget
...

(ii) National budget
(iii) Direct taxes
...

c) Name and briefly describe three functions of public finance in a country's economy
...

ii
...

Genesis 48

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81

SOLUTIONS
TOPIC 1
THE ROLE OF FINANCE IN ORGANISATIONS
QUESTION 1
a) Difference between goals of profit maximisation and wealth maximisation
...
It enables the firm to pay rent, employees’ salaries etc
...

Wealth maximisation, on the other hand, focuses on the market price of capital invested by
shareholders
...
It must also manage the information relayed to
and relations with investors in order to enhance the market value
...

Hence the agency problem arises whenever there is a divergence of interest between the
principal and the agent
...

• Linkages between size and pay since big companies evidently have a higher pay, most
executive strive for “bigness” irrespective of whether it leaders to value creation or not
...
Usually short term performance such as increase in
sales or growth in earnings is given considerable weight which leads to myopic orientation
and distract executives from value creation
...

• Required current recognition of income
• Although the income tax liability on the growth realized in the cash value is deferred, the
executive is required to recognize current income equal to the bonuses premium payment
each year
...
Since the executive is the policy owner, the employer’s control is limited to the
payment
• Inability to provide for employment loss recovery
...

December 2013 Question Four C

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QUESTION 4
a) Causes of conflict between shareholders and debt holders
...
The amount advanced by the debt holders
may be at risk
...

• Managers may try to undermine the position of debt holders by seeking further loan capital
committing the company to an increased interest burden and hence greater financial risk of
insolvency
...

• Incur bonding expenditures
Firms may seek protection against dishonest acts of managers by obtaining a fidelity bond
from a third party bonding company which agrees to compensate the firm up to a certain
amount if a certain manager’s dishonest acts entail financial losses to the firm
...

• Incurring opportunity costs
The structures of a company are arranged in a manner that decision making is slower and
therefore firms may not be able to seize profitable opportunities because of bureaucratic
procedures and control mechanisms that stifle managerial initiatives
...
The shareholders appoint the directors to run the
company on their behalf
...

Costs of the incentives given to the management
ii
...
Costs of installing systems of internal control
iv
...
Examples of
financial distress costs are:i
...
Lawyers’ fees, court costs and huge administrative expenses
iii
...
High borrowing costs
May 2012 Question One A

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83

QUESTION 7
a
...
Shareholders will want
the managers to engage in policies that will result in the maximum profits
...
This is
contrasted with optimal decision-making, an approach that specifically attempts to find the best
option available
...

June 2011 Question Four A

NOTES
SCOPE OF FINANCE FUNCTIONS
The functions of Financial Manager can broadly be divided into two: The Routine functions and the
Managerial Functions
...

managerial finance functions
...
They refer to the firm's decision to commit current funds to the purchase of fixed
assets in expectation of future cash inflows from these projects
...

Investment decisions also relates to recommitting funds when an old asset becomes less productive
...

(b) Financing decisions
Financing decision refers to the decision on the sources of funds to finance investment projects
...
The mix of debt and equity affects the
firm's cost of financing as well as the financial risk
...

(c) Division of earnings decision
The finance manager must decide whether the firm should distribute all profits to the shareholder, retain
them, or distribute a portion and retain a portion
...
The firm's divided policy may influence the determination of the value
of the firm and therefore the finance manager must decide the optimum dividend - payout ratio so as to
maximize the value of the firm
...
It can
also be referred as current assets management
...
The more current assets a firm has, the more liquid it is
...
The converse will hold true
...

Routine functions
For the effective execution of the managerial finance functions, routine functions have to be performed
...
In most
cases these decisions are delegated to junior staff in the organization
...
He must however, supervise the activities of these junior staff
...
The major goals of a firm
are:
•
•
•
•
•

Profit maximization
Shareholders' wealth maximization
Social responsibility
Business Ethics
Growth

(a) Profit maximization
Traditionally, this was considered to be the major goal of the firm
...
This could be achieved by either increasing sales
revenue or by reducing expenses
...
It should
be noted however, that maximizing sales revenue may at the same time result to increasing the firm's
expenses
...

The profit maximization goal has been criticized because of the following:
a) It ignores time value of money
b) It ignores risk and uncertainties
c) it is vague
d) it ignores other participants in the firm rather than the shareholders
(b)
Shareholders' wealth maximization
Shareholders' wealth maximization refers to maximization of the net present value of every decision
made in the firm
...
(Note this will be discussed
further in Lesson 2)
...
Under this goal, a
firm will only take those decisions that result in a positive net present value
...
This is
because, the goal:
i) Considers time value of money by discounting the expected future cashflows to the present
...

(c) Social responsibility
The firm must decide whether to operate strictly in their shareholders' best interests or be responsible to
their employers, their customers, and the community in which they operate
...
This has a long term advantage to the firm and therefore in the long term the shareholders
wealth may be maximized
...
Ethics are defined as the
"standards of conduct or moral behaviour"
...
High standards of ethical behaviour demand that a firm treat each of these constituents in
a fair and honest manner
...

AGENCY THEORY
An agency relationship may be defined as a contract under which one or more people (the principals)
hire another person (the agent) to perform some services on their behalf, and delegate some decision
making authority to that agent
...
This is because:
i) There are very many shareholders who cannot effectively manage the firm all at the same time
...

iii) Shareholders may lack the required time
...

Managers may award themselves huge salaries and other benefits more than what a shareholder
would consider reasonable
Managers may maximize leisure time at the expense of working hard
...

Manager may undertake projects that improve their image at the expense of profitability
...
‘Management buyout’ occurs where management of
companies buy the shares not owned by them and therefore make the company a private one
...
(This is the cost of internal control)
Opportunity cost associated with loss of profitable opportunities resulting from structure not
permit manager to take action on a timely basis as would be the case if manager were also
owners
...


iii)

(b)

The Shareholder may offer the management profit-based remuneration
...

ii) Share options: (Option to buy shares at a fixed price at a future date)
...
g
...
The threat of firing therefore motivates
managers to make good decisions
...

Debt holders versus Shareholders
A second agency problem arises because of potential conflict between stockholders and creditors
...


These are the factors that determine the riskiness of the firm's cashflows and hence the safety of its debt
issue
...
This will affect the value of debt
...

This will reduce the value of old debt because it increases the risk of the firm
...
Insisting on restrictive covenants to be incorporated in the debt contract
...

The management ability to make future decision (control related covenants)

b
...

It therefore follows that shareholders wealth maximization require fair play with creditors
...


The meaning of earthly existence
lies, not as we have grown used
to thinking, in prospering, but in
the development of the soul
...

• Finance flexibility - This refers to the ability to raise capital in different economic conditions
...

• Industrial norms - A firm will adopt a capital structure similar to other firms in the same
industry
...

b)
(i) Market value of Alpha Ltd and Beta Ltd
...
=
Value of Beta Ltd = Value of Alpha + TD
V L = V u + TD

𝐸𝐴𝑇
𝐾𝑒𝑢

= 10,000,000

(1−0
...
1

= Sh
...
3× 50,000,000
= Sh
...
3)
= 12%

35

Kd = 1 (1-T)
= 8(1 – 0
...
6%
WACC = (12 ×35/ 85 ) + (5
...
24%
December 2014 Question One A and B

QUESTION 2
(a) Factors to consider when choosing between debt and equity:
- Gearing and Financial risk
The company needs to consider what level of financial risk is desirable from both corporate and
stakeholder perspective
...

- Availability of security
Debt will usually need to be secured by either fixed charge on specific assets or floating charge on

FINANCIAL MANAGEMENT

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89

specific class of assets
...

- Control issues
The extent to which the source of finance will affect the existing patterns of ownership and the
restrictive covenants usually written on debt documents
...

• Management might be unwilling to issue additional share capital if it will lead to dilution of
earnings per share (EPS)
• Management might not want to issue shares to avoid large fixed interest payments
• Desire to limit investment to a level that can be financed solely from retained earnings
...

June 2013 Question Five A

QUESTION 4
a) Meaning of deep-discounted rights issue
In deep discounted rights issue, the new shares are priced at a large discount to the current market
price per share (MPS)
...

The disadvantage is that a large number of shares will need to be issued in order to raise the
required finance, and this will lead to a large dilution of earnings per share (EPS) and dividend
per share (DPS)
...
0
...
6 = Shs
...
5 million at Sh 8
10,500,000
=
= 1,312,500 Shares
8
Existing shares
= 6,000,000
Total shares in issues
7,312,500
Total value of the company = (6 million× Shs
...
8
...

New funds may be easily obtained from the stock exchange
ii
...
Transfer of ownership of shares is made easier
iv
...

vi
...


90

Wide ownership of the company in enhanced
There is reduction in risk as perceived by the inventors
The greater prominence and status given to listed companies create good will for the
company
May 2012 Question Five A

QUESTION 6
(a)
(i) External financial requirements for the two years ending 30 June 2013
Sh
...
5

80

Dividends proposed �
𝑥 39,744�
100
External financial requirement-issue of commercial paper
ii)

S Were Ltd
A proforma statement of financial position as at 30th June 2013
Sh
...
“000”
258,336
Non-Current Assets
Total fixed assets (NBV)
Current assets
16
79,488
Inventory �
𝑥 496,800�
100

Trade receivables �
3

12

100

𝑥 496,800�

Cash �
𝑥 496,800�
100
Total assets
Financed by: Equity and liabilities
Ordinary share capital
Retained earnings (52,800 + 6,624 + 7,948
...
80
193,372
...
‘000’
113,544

74,520
49,680
64,771
...
20
412,344
...
8
64,771
...
‘000’
360,000

100
120

414,000
496,000
136,800

Sales (2013) - �
𝑥 414,000�
100
Incremental sales: (496,800 – 360,000)
2
...
Current liabilities expressed as % of sales
𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
54,200
=
𝑥 100 =
𝑥 100
=

𝑆𝑎𝑙𝑒𝑠

𝐴𝑐𝑐𝑢𝑟𝑒𝑑 𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠

𝑥 100 =

360,000

43,200

𝑥 100 = 52%

360,000

𝑥 100

= 16%
= 12%

= 3%

83%

= 15%

= 10%
25%

November 2011 Question Four A

QUESTION 7
d) The motives of leasing an asset from the point of view of management
• Agency costs- large and high growth companies are likely to lease their own assets
...

• Debt capacity- leasing promotes preservation of existing ways of credit
...
The transaction is generally done for fixed assets, notably real estate and planes, trains and
automobiles, and the purposes are varied, including financing, accounting, and taxing
...
210,000,000
Total debt=long term debt+Accounts payables=210,000,000+750,000,000
=sh
...
25) -5,000,000
1,250,000
Increase in total assets 48% × 1,250,000
Increase in accounts payable (15% ×1,250,000)
Retained earnings (5,000,000) (0
...
4) (1
...

It is provided without condition
ii
...

Not secured
iv
...
68

= 2
...

- Such a company will be forced to rely on other sources of finance
...
g
...
g
...

iv) Nature of the assets of the firm:
- E
...
a firm with valuable assets such as land and buildings can use these assets as collateral or
security for new debt capital
...


QUESTION 13
a) Disadvantages of using 100% debt to finance investment
1
...

2
...

3
...

4
...

5
...

6
...
There may be restrictions on further borrowing contained in the debenture trust deed
...
The Treasury bill market is very active and the transaction costs are small in the sale
of Treasury bill in secondary market
...
Treasury bonds are coupon issued and there is an active market for the treasury bonds
...


FINANCIAL MANAGEMENT

REVISION PARTNER
QUESTION 14
c) Difference between operating lease and finance lease
...

(i)
The purpose for which the money is required (matching)
In general its is preferable that the life of the project under review should not
exceed the period for which the money is borrowed
...

(ii) Relative cost of different forms of finance
This is a question that has to be considered in each case
...

(iii) Flexibility – Short term loans are more flexible since a firm can react to changes in
interest rates unlike long term loans
...

(v)
Availability of collateral – a security is required for long term debt unlike short
term debt
...

(vii) Availability – the question of what is available will influence whether the borrow
short or long term debt
...

o If the issue is successful it will not significantly change the voting structure
...
(Lower
floatation costs)
o Less administrative procedures e
...

Drawbacks of rights issue
o The issue will need to be priced at a discount to the current share price in
order to make it attractive to investors
...

o If the issue is not successful, a significant number of shares may be taken by
underwriters thus changing the voting structure

FINANCIAL MANAGEMENT

94

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95

o Administration and underwriting costs are high
o Shareholders may be unable or unwilling to increase their investment in
Malindi Leisure Industries

QUESTION 16
Matching
The traditional view is that fixed assets should be financed by term sources of finance
and current assets by a mixture of long-term and short-term sources
(ii)
Cost – he company may find it easier to raise short term finance with low security
than long term finance
(i)
Security –The company may find it easier to raise short term finance with low
security than long term finance
(ii)
Risk –In opting for short-term debt, the company faces the risk that it may not be able
to renegotiate the loan on such good terms
...

b) Advantages of convertible securities
- Provide lower cost of debt
- No immediate dilution of ownership and EPS
- Provides equity finance on conversion
- Interest charges are tax allowable hence tax shield
...
(No heavy initial capital outlay required)
o Lease finance can be arranged relatively, cheaply, quickly and easily
o Operating leases are off-balance sheet financing
Advantages of hire purchase
o Unlike leasing, hire purchase allows the user of the asset to obtain ownership at the
end of the agreement period
o The interest element of the payments is allowable against tax
o Tax shield on salvage value at the end of economic life of asset

(a)

(i)

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96

TOPIC 3
FINANCIAL MARKETS
QUESTION 1
a) Functions of central depository system (CDS)
• Immobilisation of securities, that is, elimination of physical movement of securities
...

• Effective delivery and payment, that is, simultaneous, exchanging or transferring securities
...

December 2014 Question Five A

QUESTION 2
(a) Functions of a capital markets regulator
- To remove bottlenecks and create awareness for investment in long term securities
...

- Create environment which will encourage local companies to go public
...

- To operate a compensation fund to protect investors from financial losses should licensed
brokers fail to meet their contractual obligations
...

- Removal of barriers on security transfer
...

- Provide adequate information to players in the market in order to prevent insider trading
...

May 2014 Question Five A

QUESTION 3
a)
i) Best efforts offering
This is a system used by investment bankers where they agree to sell as many securities as they
can at an established price
...

ii) Pre-emptive right
Existing common stockholders have the right to preserve their proportionate ownership in
corporation
...
g
...

Underwrites often obtain the option to purchase additional stock at the offering price
...

December 2013 Question Two A

QUESTION 4
a
...

•

Creation of awareness
This can be done through conferences, seminars so as to create awareness about the functioning
and operations of the stock markets
...
This facilitates taping both institutional
and retail investors, regionally and globally
...

Automate the stock markets
November 2011 Question Five A

QUESTION 5
a) Why companies list their shares on more than one stock exchange
• To raise funds for development purposes
• To enhance or promote growth and development of stock markets
• To improve relations between local and other investors regionally and globally
...

• It attracts overseas investors and consumers and thus improving product awareness in other
potential markets
...

b) Distinction between untraded debt and floating rate debt
Untraded debt-refers to debt instruments that are not usually traded or tradable in organized and
other financial markets
...
e
...
This means that when market
rates of interest on loans also increases and vice versa
...

- Lack of sound policies
- Failure to automate stock markets which are largely manual
...
g
...

b) Distinction between “financial gearing” and “operating gearing”
...
It
shows the percentage change in the EPS as a result of the changes in the EBIT
...

Operating gearing is the use of the operating costs in order to improve the profitability of the
company
...
It’s calculated using the degree of operating leverage (DOL)
...
Primary markets and secondary markets
Primary marketsAre those financial markets in which the financial securities are issued for the first time in
the stock exchange
...


FINANCIAL MANAGEMENT

REVISION PARTNER

98

Secondary marketsAre those markets for subsequent selling and purchase of the financial securities i
...
a
company which is already listed in the stock exchange will sell its securities in secondary
financial markets
...
Capital markets and money markets
Capital marketsAre those markets for long term sources of finance
...
The major roles of the capital
markets include;
• It provides long term sources of finance which is important for development purposes
• It provides permanent finance which is necessary for strong financial base for going
concern
...

Money marketsIt’s a market concerned with short term financial securities
...

• It offers advice to the concerned parties as to which appropriate finance will meet
their financial requirements
...

• It is a channel through which government investment such as treasury bills and
government bonds are offered to the general public
...
Brokers and jobbers
A broker is an agent who buys and sells securities on behalf of his clients on a commission
basis
...

He gives advice to the client and sometimes manages the clients’ portfolio
...
Since jobbers are
experts in the market they are not allowed to deal with the general public and can therefore
deal with the brokers or other jobbers
...

Ex-dividend –means the buyer of the shares will not be entitled the next dividend payable on
shares
The market price of shares therefore will not include the value of dividend
June 2009 Question One A

QUESTION 9
a) Factors leading to rapid development of capital market
...
As a result investors make informed decisions leading to development of capital
markets
...
g
...

4) Introduction of wider range of financial instruments in the market e
...
futures, warrants,
options e
...
c
...
This has led to investor confidence in the capital market
...

December 2006 Question Six A

QUESTION 10
d) The role of a capital markets authority in the development of a country’s financial markets:
i) It provides long term sources of finance which is important
ii) It provides permanent finance which is necessary for a strong financial base for a going
concern
...


QUESTION 11
a) Benefits to a country for integrating its financial markets with those of other countries
i)
It leads to capital mobility thereby reducing investment risk
...

iii) This can lead to increase in the company’s trading volume of its securities
iv) It can lead to mutual understanding between countries
...


QUESTION 12
a) Distinction between Primary and secondary securities market
...
e
...

The secondary financial markets on the other hand are those markets for the subsequent selling
and purchase of the financial securities i
...
a company which is already listed in the stock
exchange will sell its securities in the secondary financial market
...
e
...

2) A listed company can be able to obtain the under writing facilities because it can negotiate
with the possible underwriters to purchase its securities which are not subscribed for by the
general public
...

4) A listed company can obtain feedback information from the stock exchange concerning its
performance over time
...

6) A listed company is likely to obtain privileges from the Government i
...

7) The determination of the value of the firm i
...
the value of the shares of the company is
determined by the forces of the market and hence there is no uncertainty
...
e
...


FINANCIAL MANAGEMENT

REVISION PARTNER

100

ii) Factors that may hinder companies from being listed
1) The company will loose confidential information to the public more so to its competitors
2) There are strict rules, regulation and requirements for the company to be listed
...

4) A company whose profit records are not good may be deregistered from the stock exchange
and their will have a negative impact on the company
...

6) Listing involves several formalities i
...
getting permission from the capital market and the
stock exchange council
...
Bull markets are
where prices move in an upward manner for several years whereas in bear markets prices
move in a down ward manner row several years or several months
...

iii)
Daily movements: These are random daily fluctuations in stock prices
...

b) Factors to be taken into account in the design and construction of a market index for shares
1
...
The selection of representatives securities / firms
3
...
Use of suitable weight to be attached to the securities depending on their relative importance
c)
If the market is efficient the price of the share will be equal to the present value of all the expected
future benefits to be obtained from the share
...
The capital gains are normally obtained at the end when
the investor sells the share
...

P/E Ratio = MPS
EPS
P/ E ratio Yr 6 = MPS 6
EPS 6

DPS = EPS x Dividend payout Ratio
= EPS x 60%

Therefore MPS 6 = P/E Ratio Yr6 x EPS 6
Year

EPS

1
2
3
4
5
6

4x1
...
4
4
...
1= 4
...
84 x1
...
324
5
...
1 = 5
...
856 x1
...
4420
6
...
1 = 7
...
64
2
...
1944
3
...
8652
4
...
086 = 141
...
64
0
...
904
0
...
1944
0
...
5136
0
...
8652
0
...
72 145
...
4323
Total Pv of Benefits (MPS of Bidii Ltd)

FINANCIAL MANAGEMENT

PV

2
...
1957
2
...
0091
1
...
1035
73,623

REVISION PARTNER

101

QUESTION 14
a)

b)

Three forms of capital market efficiency
The forms of efficiency are defined by the type of information that is released to the market
...
Weak form efficiency
This is where the share prices fully and instantaneous reflect the past/ historical information
that has been released in the market
2
...
Strong form of efficiency
This is where the share price fully and instantaneously reflect both past, present and future
information that has been released in the market
...

v) High cost of obtaining quotation
...

Disadvantages
• Cost of floating
• Stringent stock exchange regulation
• Agency problem due to divorce of management and ownership
• Dilution of control from wider holding of shares
• Increased chances of forced take over
...

• Market makers may act as shareholders too, dealing directly with individual
investors
...


FINANCIAL MANAGEMENT

REVISION PARTNER
(ii)

Market makers are dealers in the shares of the selected companies whose
responsibility is to “make a market” in the shares of those companies
...

• Must decide the share price
• Brings “new” companies to the market
...


(iii)

•
•
•

(c)

102

Underwriter is an investment banker who performs the insurance function of
bearing the risk of adverse price fluctuating during the period in which a new
issue of security is being distributed
...

He ensures that the company gets the targeted funds sometimes having to take
up the shortfall in demand
...

A bear market is characterized by falling prices encouraging bears to sell now in
order to avoid future losses when prices would have fallen
...


(iii)

Short selling
Is the act of selling a share which one does not already possess
...

- Barometer for Healthy of economy and companies ( as whole)
- Privatization of parastatals and giving local citizens a chance for ownership of
multi-national companies
...

- Improves corporate governance
- Diversification of investments hence reduction of risk
- Liquidity of securities improved
...


(i) Protects investors from financial losses
(ii) Establishes Rules & Regulations for private placement of securities
(iii) Removal for impendment and creation of incentives for long term investment
...

(iv) Facilitate National wide system of Brokerage services
(v) Creation maintenance and regulation market for securities
...

(vii) Removal of Barriers to security transfers
(viii) Encourage Development of International Investors - eg insurance and premium
co’s
(ix) Introduces wider range of Investments in the market
(x) Decentralize operations of market to Rural Areas
...


If you want to feel
rich, just count all the
things you have that
money can’t buy
...


FINANCIAL MANAGEMENT

REVISION PARTNER

104

TOPIC 4
THE TIME VALUE OF MONEY
QUESTION 1
a)
(i) The loan amortisation schedule
Present value of an annuity is given by:
PVIFA12%, 6 =
=

1− (1+0
...
12

1− (1+𝑟)−𝑛
𝑟

= 4
...
1114

= Sh
...
This is
because the net present value (NPV) method ties more directly with the primary financial goal of
the firm; i
...
to maximise firm value
...
25%

=1-

= 11
...
0125
0
...
0793

A=

80,000

11
...
66

FINANCIAL MANAGEMENT

REVISION PARTNER
Month
1
2
3
4
5
6
7
8
9
10
11
12

Beginning
amount
80,000
...
34
67,480
...
76
54,646
...
31
41,490
...
97
28,002
...
52
14,175
...
52

Interest
1
...
00
922
...
51
763
...
09
601
...
63
434
...
03
264
...
19
89
...
00
74,701
...
42
61,867
...
98
48,710
...
64
35,222
...
18
21,395
...
19
7,220
...
66
7,220
...
66
7,220
...
66
7,220
...
66
7,220
...
66
7,220
...
66
7,220
...
34
67,480
...
76
54,646
...
31
41,490
...
97
28,002
...
52
14,175
...
51
0
...
e
...
038 = 10,640,000
PV=

10,640,868
1
...
7,202,158

Selling the building is delayed for 8 years
...
1, 197,842
The present value of the 8 annual rental payments that should be received at least be equal to the cost
...
05 × 1
...
05

Minimum acceptable rent × 6
...
463

= shs
...
038 = shs
...
10,640,868 ÷1
...

=160,000 × PVIFA5% 8 YEARS
= 160,000 × 6
...
8,236,270 to the sales proceeds of sh
...

Advice:
Sell the office building today as it has a higher proceed than the present value of renting out the
offices
...
15 = Sh 1,150,000
A2
= (1,150,000 + 500,000) × 1
...
15 = Shs 2,757,125
A4
= (2,757,125 + 500,000) x 1
...
75
= (3,745,693
...
15 = Sh 4,882,547
...
1, 000,000 + (4 ×500,000)
= Sh 3,000,000

Total amount after 5 years = Shs
...
813
Percentage interest (%) =

4,882,547
...
813
3,000,000

×100%

×100

= 62
...

1,000,000 =A × PVIAF 4,14%
A=

1,000,000

𝑃𝑉𝐼𝐹𝐴 4,14%

1,000,000

=

2
...
343,206

Year

Installment

Interest

Principal Repayment

0
1
2
3
4

343,206
343,206
343,206
343,206
343,206

140,000
111,551
79,120
42,147

203,206
231,655
264,087
301,059

Loan Balance at end

1,000,000
796,794
565,139
301,052
November 2011 Question Three A

FINANCIAL MANAGEMENT

REVISION PARTNER

107

TOPIC 5
VALUATION OF FINANCIAL ASSETS
QUESTION 1
b) The intrinsic value per share
Dividend streams
Year:
1
1
...
12)
2
1
...
12)2
3
1
...
12)2 (1
...
50 (1
...
1)2

1
...
8816
2
...
28

The value of the share at the end of year 4 is = V 4 =
=
Cash flow for year 4 = 30
...
28 = 33
...
68
1
...
07
2
...
78

1
2
3
4
4

𝐷𝑠

𝐾𝑒 −𝑔

2
...
08)
0
...
08

Factor (16%)
0
...
7432
0
...
5523
0
...
78

Sh
...
4483
1
...
3262
1
...
0
22
...
22
...

December 2014 Question Two B

QUESTION 2
(b)
(i) The current price of the bond
V O = present value of interest + present value of par value
VO = I (

𝟏−(𝟏+𝒓)−𝒕
𝒓

) + 1,000 (

𝟏

(𝟏+𝒓)𝒕

)

T is the number of periods i
...
25 years×2=50
r is the interest rate per period 10%÷2 = 5%
I is the interest per period (12/2 %) × 1,000 = 60

60 (

𝟏−(𝟏+𝟎
...
𝟎𝟓

) + 1,000 (

𝟏

(𝟏+𝟎
...
2559) + 1,000(0
...
35 + 87
...
1, 182
...
1015

𝟏,𝟏𝟖𝟐
...
15%

(iii) Capital gain on the bond
Capital gain = Total yield – current yield
10% - 10
...
15%
May 2014 Question Two B

QUESTION 3
c) Theoretical value of the share
𝐸𝑃𝑆𝑜

𝑛

g= �

𝑉𝑒

– 1 where,

g
Ve
EPSo
n

4

4
...
00

= growth rate
= initial EPS
= last paid EPS
= number of years

– 1 = 0
...
05 =5%

Using earnings growth model
1+𝑔

Ve = DPS(

𝑟−𝑔

1
...
05]
0
...
05

)=

= shs
...
15)
4(1
...
15)3
6
...
1)
6
...
1)2
6
...
1)3

Dividend
4
...
29
6
...
688
7
...
09248

Discount rate
@18%
0
...
71818
0
...
515579
0
...
37043

FINANCIAL MANAGEMENT

Present value
dividends @18%
3
...
799
3
...
449
3
...
998
21
...
09248 × (1
...
497

0
...
05

= 8
...
497�0
...
36

PV = 65
...
37043 = 24
...
211 + 21
...
27
December 2013 Question Two B

QUESTION 5
b) The cum rights price
Option I
Cum right price = market price per share before rights + net present value per share
...
14 million × PVIFA 14%, 10 yrs – 50 million
=14 × 5
...
0254 – 50 = Shs
...
0254 million

NPV per share =

𝑠ℎ 23
...
30254

Cum rights price = 35 + 2
...
37
...
0254

Cum-Right Price

373
...
0254

10 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

= Shs
...
3

QUESTION 6
d)
(i) Current yield of the bond
B o = 1,150
Interest = 0
...
57%

(I – T)

FINANCIAL MANAGEMENT

REVISION PARTNER

110

B 0 = Market value
M = par value
t = tax rate
n = number of years
=

1,000− 1,150
18
1,150+1,000
2

110+

(1-0
...
6%

(iii) The relationship between the calculated yield to maturity, current yield and coupon rate
bond
The calculated yield to maturity of 6
...
Whenever a bond's market value is
above the par value (sells at a premium) its yield to maturity and current yield will be below the
coupon
...

June 2013 Question Five D

QUESTION 7
b) MNM Ltd
...
00(1
...
25)3
2(1
...
20)
2(1
...
20)2
2(1
...
20)3
2(1
...
20)3 (1
...
25)3(1
...
15)2
2(1
...
20)3 (1
...
25)3 (1
...
15)3 (1
...
10 - 0
...
5
3
...
906
4
...
625
6
...
763
8
...
266
1118
...
2728
2
...
9348
3
...
4926
3
...
9837
4
...
3538
474
...
201 + (1,000 x 0
...
11
Since 1,082
...
756 + (1,000 x 0
...
212) = 1,175
Since 1,175 < 1,200 let us try 8%
1,200 (110 x 9
...
25025) = 1,281
...
16

FINANCIAL MANAGEMENT

REVISION PARTNER

111

Through interpolation
y2 =

(𝑥2 − 𝑥1 ) (𝑦3 − 𝑦1 )

1,200 =

𝑥3 − 𝑥1

+ y1

(𝑥2 − 0
...
08−0
...
10) 199 +108

1,200 =

0
...
10) 199 − 21
...
9 – 21
...
52

199x 2 = 17
...
088
kd = x 2 = 0
...
9%
Alternatively
YTM = C +

Where

𝐹−𝑃
𝑛
𝐹+𝑃
2

C = Coupon / Interest payment
F = Face value
P = Price
n = years to maturity
YTM =

110+1,000
18

– 1,200

1,000 +1,200
2

= 8
...
12,000,000

�

FINANCIAL MANAGEMENT

REVISION PARTNER

112

ii) Asset method
Total assets – total liabilities
Details
Non-current assets
Current assets

Sh
...
15 (1+
142= (10 x PVIAF

𝑔

)4

100

)+ 30×4
...
0373) + 30×4
...
373= 30×4
...
627= 79
...
4109 = (1+
4

𝑔

100

)4

= √1
...
635

)4 ×0
...
15×30) =17
...
5�124
...
1%
June 2011 Question Five C

FINANCIAL MANAGEMENT

REVISION PARTNER

113

QUESTION 11
b) i)Value of equity shares of the company
End year
11
...
15)1
11
...
15)2
15
...
13)1
P3 =
P=

Expected dividend
13
...
2088
17
...
8929
0
...
7118

𝐷4

𝐾𝑒−𝑔

𝐷3 (1+𝑔)
𝐾𝑒−𝑔

=

17
...
06)
0
...
06

Present value
11
...
1245
12
...
1928

= 𝑠ℎ𝑠
...
6175

Present value = 303
...
711812%, 3 years = sh
...
1150
Value of shares = 216
...
1928 = shs
...
30
(ii) The dividend yield and capital gains
Dividend yield =
Year 1

𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒

Expected market value of the shares at the end of year 1
Year
1
2

P2 =

Expected dividend
15
...
1859

17
...
06)
0
...
06

= 303
...
62 x PVIF1 2years,

Discount rate 12%
0
...
7972

Present value
13
...
7006
27
...
62 x 0
...
242
...
05 + 27
...
269
...
225
269
...
9% ≈ 5%

Capital gain = shs
...
33 – 252
...
17
...
04

269
...
3%

Total return = dividend yield + capital gain
= 13
...
04 = sh
...
265
Year 2
End year
15,2088 (1
...
1859 (1
...
12−0
...
1859

Discount rate 12%
0
...
62

Present value = 303
...
8929 = 271
...
34

REVISION PARTNER

114

Market value = 271
...
34 = shs
...
44
Dividend yield =

17
...
44

× 100 = 17
...
44 – 269
...
17
...
11

286
...
19 + 17
...
34
...
6
...
50 x PVIFA
7% x 16 periods + 102 x PVIF 16 periods, 7%
Highest amount to acquire the bond (B0) = 6
...
4466 + 102 x 0
...
Shs
...
9503
December 2010 Question One B and C

QUESTION 12
(a)
(i) Advantages of raising capital through a rights issue;
• It is less costly i
...
a company incurs less floatation costs
• There are minimal legal and administrative compliant measures
• Does not subject a company to financial risks
• There are no restrictive covenants, no collateral is required
...
The
projects Net Present Value:
1
� − 𝐼0
NPV = �𝐴 ×
𝑟%−𝑔%

R% = WACC thus assumed that K s = r% (WACC
Ke =

𝑑0 (1+𝑔)
𝑃0

+ 𝑔

2
...
30

� − 120,000,000

FINANCIAL MANAGEMENT

REVISION PARTNER

115

Therefore Sh
...
32
Option 2
Alternative to question 4(a) (ii)
Shs
720,000,000
48,000,000
768,000,000

The current market capitalization
Add net present value
Firms total market value after investing in project
Cum rights market price per share MPS = �

(iii) Theoretical ex-rights MPS
Method 1
PX =

(𝑃0 𝑥 𝑆0 )+ (𝑃𝑠 𝑥 𝑆)

=

𝑆0 + 𝑆

(32 𝑥 24𝑀)+ �25 𝑥
24𝑀+4
...
32�

120𝑚
�
25

= Sh
...
83

Where;
Po =cum right market price
So = number of ordinary shares
Ps= offer price
S =number of rights issued
Method 2
P X = P S + (P 0 – P S )

𝑁

𝑁+1

= 25 + (32 – 25)

5

5+1

= 25 + 7 (5/6) = 25 + 5
...
30
...
8 Million
N =5 Thus = 1 for 5 rights issue
i
...
1 for 5 rights issue requires a minimum of 5 existing shares to acquire 1 new share
Method 3
5 existing shares at 32 = Sh
...
25
6 Shares = Sh
...
185
185
Therefore 1 share
=1×
=Sh
...
83
6
Value of each right(R)
R = P 0 -P X =32-30
...
l
...
17

=

30
...
1
...

Conversion value: Expected benefits
9
Interest = 100 ×
= 𝑠ℎ
...

Conversion value = 0 ordinary shares
Value of shares in 5 years’ time = 25 (1
...
402
...
63 × PVIF

5 years, 12%

B0 = 90 × 3
...
63 × 0
...
552
...
00
4
1
...
25
P5 =
P=

Discount rate 15%
0
...
7561
0
...
5718
0
...
25 (1
...
15−0
...
6575
0
...
1187
2
...
34
...
71 x 0
...
17
...
6339 + 17
...
19
...


Theoretical ex-rights price per share
Subscription price
= 15% discount
100 – 15 = 85%
85%×16 = kshs
...
6
1,600,000+ (320,000 ×13
...


1,600,000+320,000

= sh
...
6

Value of right per existing share
Cum – right price
16
Less ex-right price
15
...
0
...

He exercises her rights
Existing shares / number of old shares 1,000
1000
� = 200
Additional �
200

Total value 1200 × 15
...
6 × 200)
Same as before

ii
...
of new shares

1,000
NIL
1,000

Total share value
Add value of right
Same as before
iii
...
6
(1,000 ×0
...
6
× 15
...
6 ×100)
(1360)
1
Add value of right 1000 × × 0
...


Value of each share
= Cum right price
Ex – right price 32
...
5

=

32
...
2
...


Effect on shareholders wealth (exercise his rights)
Number of shares
490
490
New shares
98
5
588
Total value of share 588 x 32
...
Savings account
17,150
Savings a/c balance same as before
37,150

FINANCIAL MANAGEMENT

June 2008 Question Two

REVISION PARTNER
If he sells his rights
Number of old shares
New shares
Total value of share 490 x 32
...
Saving counts
Less = 37,150 – 35925

118
490
NIL
15,925
20,000
35,925
1,225

D Magana can exercise his right or sell his right because if he ignores his rights or al to sell
his rights then he will have a loss of 125/=
June 2007 Question Two C

QUESTION 16
a) i) Intrinsic value: The valuation of a security is determined by a financial analyst using financial
data
...

ii) Theoretical intrinsic value
Po =
=

𝐷1

𝐾𝑒−𝑔

=

1
...
08)
0
...
08

𝐷𝑜 ( 1+𝑔)
𝐾𝑒−𝑔

= Shs
...
5

QUESTION 17
c)
Non-Constant growth period
Period
DPS
PVIF10%; n
2006
3
...
25 = 4
...
8475
2007
4
...
25 = 5
...
7182
2008
5
...
2 = 6
...
6086
Total PV during non-constant growth period

PV
3
...
8783
3
...
6358

Constant growth Period
P 3 = D4 = D3 (1 + g) = 6
...
1)
Ke-g Ke- g
0
...
1
Discounting P3 to Period Zero
= P 3 x PVIF 18% ; 3 = 89
...
6086 = Sh54
...
6358 + 54
...
8621

QUESTION 18
a) CDS is a computerized system which enables the transfer of securities without the need for
physical movement
...

Example:
If X and Y are shareholders of ABC ltd then ABC ltd does not need to deliver the share
certificate to either of them but a ledger account for both the shareholders will be maintained
...
If investors Y sells shares to

FINANCIAL MANAGEMENT

REVISION PARTNER

119

investor X the ledger a/c of investor Y will be debited with the ledger a/c for investor X will be
credited
...

Central bank is the sole currency –issuing authority in a country
...
It prints and
mints coins and is required to keep it as secret as possible
...

ii) Banker to the Government
...
It receives deposits on behalf of the government from various
sources, e
...
income tax, custom duties, proceeds of the sale of government securities, etc
...
All civil servants
receive their salaries by means of cheques drawn on the central bank of their country
...

The central bank provides the government with necessary funds against securities
...

The central bank also manages the public debt, which is the money due by a government to its
people
...

The central bank being a specialized institution is well fitted to give advice on issues of
economic nature
...

v) Banker to commercial Banks
The central bank provides banking facilities to commercial banks in the country
...
They instruct the central bank to make an appropriate entry in the
accounts, thereby eliminating the need for actual transfer of money
...
a in ∞
DPS
=
Total dividend
No
...
50 p
...
50 × =shs
...
50
0
...
V
...
2

180,000 × PVAF, 20%,n
180,000 ×PVAF, 20%, 4
180,000×2
...
Cum dividend and ex dividend: The word cum means inclusive while ex means exclusive
...

ii
...
e
...
and ex-all means exclusive of all the benefits
...
100 per share
No
...
120 ×10

Total Value
Sh
...
1, 200

If MPS is Sh900
A ×PVIFA 10%, 4yrs = 100 ×3
...
6830
Total Value of the Debentures
If MPS is Sh
...
1699
1200 × PVIFA 10%, 4yrs = 1200 ×
0
...
99
614
...
69

316
...
6
1,136
...
8424
A × PVIFA 10%, 6 = 8 × 4
...
74
120 × PVIF 10%, 6 = 120 × 0
...
5824

QUESTION 20
a)
i)

Advantages of a rights issue to the
Issuing company
- It increases the equity, capital of the firm and if the firm was geared, its gearing level will
decrease leading to decrease in financial risk of the company
...
g
...

ii)
The Shareholder
- With increased number of shares the shareholders will receive higher dividends in the
future
...

- It enables the existing shareholders to enjoy the discounts offered by purchasing the shares
at a price below the existing MPS
...
5 (1
...
05
50

=

14
...
1445
= 65,397,992
(8,000,000)
(1,460,208)

PVC0F
NPV
NPV Per share

Therefore
Cum rights
MPS

=-

1,460,208
1,000,000

=

-1
...
50

= Current MPS – NPV per share
= 50 + -1
...
50

ii) Theoretical value = Pe x
Pe x

=

=
=
≈

Total current market value of existing shares + New shares to be raised
Existing shares + New shares issued
(1,000,000 ×Sh 50) + Sh 8,000,000
1,000,000 + 2000,000 shares
Sh 48
...
30

iii) Theoretical value of rights when shares are selling
rights on
Vr

=
=

Vr
MPS – Issue price
No
...
67
Sh 1
...
33
Sh 1
...
70

iv) If the debentures are redeemed the company will lose the interest tax shield benefit
The interest tax
=
Interest expense x tax rate
shield
=
(10% x 8,000,000) x 30%
=
Sh 240,000 p
...

PV of Interest tax Shield =

𝐴

𝑅

=

240,000
0
...
1
...
70

FINANCIAL MANAGEMENT

REVISION PARTNER
Cum rights
MPS

=

Current MPS -PV interest tax shield lost

=
=

Sh 50 – 1
...
30

QUESTION 21
a) Determinants of the price of a bond
1
...
The required rate of return on the bond
3
...
The terminal or maturity value of the bond
b) Ways to make preference shares attractive
1
...
Making the preference shares to be cumulative preference shares
3
...
Giving the preference shareholders the voting rights by allowing them to appoint a
director in the company’s board of Directors
5
...
Giving the preference shareholder the option to redeem them at their own will

FINANCIAL MANAGEMENT

122

REVISION PARTNER

123

TOPIC 6
COST OF CAPITAL
QUESTION 1
a) The weighted average cost of capital (WACC)
WACC= KeWe + KdWe
Net dividend has increased 1
...

4

∴ g = √1
...
1067 or 10
...
1067)

Kd =

𝐶𝑡+

476

𝑀− 𝑃𝑏
𝑁

(𝑀− 𝑃𝑏 )/2

Where:

𝑆ℎ
...
30

+ 0
...
17645 = 17
...
3) = 7
...
6%
7
...
Million
10m ×476
4,760
(8m × 77)
616
5,376

Weights(W)
0
...
1145

WACC
0
...
0086
0
...
1644 =16
...
𝟎𝟓)
×100 +5 =10
...
526%

Cost of Debentures (redeemable) (Kd)
𝟏
𝟏𝟎
𝑴+𝑩𝑶
(
)
𝟐

𝒊(𝟏−𝒕)+ (𝑴−𝑩𝑶 )

Kd =

i is the interest
t is the tax rate
M is the face value
Bo is the par value
n is the number of years to maturity
=

𝟖
...
𝟑)+ (𝟏𝟎𝟎−𝟗𝟎)

𝟗𝟓

×100% = 9
...

64,000,000
42,000,000
24,300,000
130,300,000

Proportion

0
...
32
0
...
00

Component
Cost
%
10
...
53
9
...
02
3
...
88
10
...
27%
May 2014 Question Four B

QUESTION 3
b)
...

EPS =

Earnings per share
𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐵𝐼𝑇)− 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 (1−𝑡)− 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑛𝑑𝑒𝑑
𝑁𝑜 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑙𝑙𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑛 𝑖𝑠𝑠𝑢𝑒

Option 1
The company issue 5 million ordinary shares
EPS =

(𝐸𝐵𝐼𝑇−𝑂)(1−𝑇)− 𝐷𝑃
5 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

FINANCIAL MANAGEMENT

REVISION PARTNER
Expected EPS
EBIT( shs)
EPS

1,000,000
0
...
28

4,000
...
56

6,000,000
0
...
4

6,000,000
1
...
24

Option II
If the company issues 2
...

EPS =
EPS =

(𝐸𝐵𝐼𝑇 𝐼𝑁𝑇) (1−𝑇)

𝑛𝑜 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑙𝑙𝑦 𝑠ℎ𝑎𝑟𝑒𝑠

(𝐸𝐵𝐼𝑇 −0) (1−𝑇)−𝑃𝐷𝑖𝑣
2
...
28

2,000,000
0

4,000
...
56

Option III
EPS =

(𝐸𝐵𝐼𝑇−𝐼𝑁𝑇) (1−𝑇)− 𝑃𝐷𝑖𝑣

EPS =

(𝐸𝐵𝐼𝑇−0) (1−𝑇)− 2,000,000

𝑛𝑜 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑙𝑙𝑦 𝑠ℎ𝑎𝑟𝑒𝑠
2
...
000
6,000,000
EPS
-0
...
24
0
...
88
If EBIT is 1 m or 2m →plan 1; 4m →either plan 1 or 2, 6m → plan 3; 10m → plan 2
...
0

December 2013 Question Four B

QUESTION 4
a)
Market value weights
Ordinary share capital
Preference share capital
Loan(5,000)
Debentures

Ksh
112,000,000
40,000,000
5,000,000
3,000,000
160,000,000

iii) The company’s growth equity
Growth in equity =

𝑟𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠

𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝐸𝑃𝑆

× 100

6

Divided cover =
= =3
𝐷𝑃𝑆 𝑥
Retained earnings = EPS – DPS = 6 -2 = Sh
...
4)
14

×100 + 40% = 60%

Cost of preferences shares = 12%
Cost of loan = 16(1-0
...
2%
𝐼(𝐼−𝑇)

kd =

𝑚𝑣𝑑−𝐹

16(1−0
...
17%

Cost of redeemable debentures
Kd =

(1−𝑡)𝑅+

𝑓+𝑝
2

(1 – 0
...
2%

𝑘𝑑 = cost of debentures
𝑅 = interest rate of debentures
𝐹 = Redeemable value
𝑃 = face value
𝑛 = number 0f periods

Weighted average cost of finance
𝑝
WACC = ks (𝑠⁄𝑣) + kp ( �𝑣 ) + kdt (𝐵�𝑣

= 60% (0
...
25) + 12
...
03125) +9
...
01875)
= 45
...
7
0
...
03125
0
...
6
0
...
122
0
...
42
0
...
0038125
0
...
456

December 2013 Question Three A

QUESTION 5
a) Weighted marginal cost of capital
Debt
𝐼𝑛𝑡 (1−𝑡)
where V d = face value
Kd =
𝑉𝑑

K d = cost of debt
Int = interest
t = tax rate

=

100 (1−0
...
4%

FINANCIAL MANAGEMENT

REVISION PARTNER
Equity
𝐷𝑃𝑆
DY =
where

127

DY = dividend yield
DPS = divided per share
MPS = market price per share

𝑀𝑃𝑆

DPS = DY x MPS
= 0
...
2
...
25

45(1−0
...
25
45

= 5%

= 5
...
00
25

= 8%

100 × 5,000
60% × 6,000,000
16,800,000

𝑉

𝑉

Shs
500,000
3,600,000
10,464,000
2,2236,000
16,800,000

𝑉𝑝

𝑉

WMCC = Kd � 𝑑 � = 𝐾𝑟 � 𝑑 � + 𝐾𝑒 � 𝑒 � 𝐾𝑝 � �
𝑆

= 1
...
5

16
...
6

16
...
68 �

10
...
8

𝑆

� + 8�

2
...
8

� = 5
...
67

[𝑄 (𝑝−𝑣)− 𝑓]

DFL = [𝑄(𝑃−𝑉)−

𝑓−𝑐] (1−𝑡)

[20,000 (20−15)−40,000]

[20,000 (20−15)− 40,000−10,000]5000/ (1−0
...
143

128

= 1
...
143

= 2
...
3

OR

D
...
L= (D
...
L×D
...
L)
1
...
4 = 2
...

Real interest rate - This is the money rate of interest minus the expected rate of inflation
...

ii
...

Also called current return, current yield or yield to maturity while flat yield is the annual
coupon payment divided by the current price of a bond
...

Measured using a degree of operating leverage
...

ii) Financial leverage
Refers to the ratio of profit before interest and tax (PBIT) to profit after tax
...
It is the degree to which an investor is utilizing borrowed money
...
Shows the
sensitivity of the firms earning per share to changes in operating income
...

- Risk-profit does not take into account risk
- Short-term performance – profits focus on the short-term
- Manipulation – accounting profits can be manipulated
- Volume of investment – profits on their own do not take into account the volume of
investment
...

c) (i) Disintermediation is a pattern of funds flow where investors withdraw funds from financial
intermediaries such as banks and invest the funds directly in the market place, because they can
obtain a higher yield
...
The flow of funds through financial intermediaries
...

Hedge fund is an investment fund that can undertake a wider range of investment and trading
activities than other funds which are generally only open to certain types of investors specified by
regulations
...

15%
1 -2 (1
...
36
0
...
18)2 = 2
...
7561
3
3-2(1
...
29
0
...
5718
4-2 (1
...
88
5-3
...
12)1 = 4
...
4972
6-3
...
12)2 = 4
...
4323
7-3
...
12)3 = 5
...
3759
8-3
...
12)4 = 6
...
3269

Sh
...
05
2
...
16
2
...
16
2
...
05
1
...
83

Value of the shares at the end of year 8 (P 8 )
P8 =

𝐷8 (1+𝑔)
𝐾𝑒−𝑔

=

6
...
06)
0
...
06

= sh
...
84

Present value =sh
...
84 × 0
...
23
...
16
...
48 = sh
...
31
May 2012 Question Three B

QUESTION 10
a)
i
...
09
Ke = + 𝑔=
+ 0
...
06 + 0
...
10 x 100 = 10%
𝑃0

ii
...
46

D1 = expected
Cost of redeemable debt (after tax)

=

𝑖𝑛𝑡
...
30) =

= 0
...
Common equity capital
10,000,000 shares × 1
...
14,600,000
ii
...

× 105= sh
...
5

(0
...
70
0
...
10
0
...
07
0
...
094

WACC = 0
...
4%
b)
i
...
100 x
= 8
...
100
- Conversion value = sh
...
30 (1
...
114
...
8 x PV 1 FA 3 years 6% + sh
...
60 × PV 1 F 3 yaers, 6%
= sh
...
00 x2
...
114
...
8396
= sh
...
38 + 96
...
117
...


Floor value of the bond – This is the price of a straight bond with the same corpon rate of
interest
Floor values = sh
...
00 × PV 1 FA 3 years 6% × sh
...
8 × 2
...
100 ×0
...
21
...
83
...
105
...


Conversion premium = current market value of the Bond –curent conversion value
- Current market value = sh
...
60
- Current conversion value =sh
...
30 ×30 shares
= 99
...
117
...
99
= sh
...
60 per share
Or 18
...
79%
May 2012 Question Two

QUESTION 11
(c) The cum-right MPS
Cum-right MPS= current MPS + NPV per share
NPV = [ A × PVIAF n ,

r% ]

– I0

= [7,372,280 × PVIAF 10, 15% ] – 25,000,000
= 11,999,999 ≈ Sh
...
3

Cum-right MPS = (18 + 3) = Sh
...
‘000’
72,000
12,000
84,000

Total market capitalisation of ordinary shares (4,000 x 18)
Add: NPV of Project
Cum-right MPS =

84,000,000

=Sh
...
Enterprise value is calculated as market cap plus debt, minority interest and
preferred shares, minus total cash and cash equivalents
...


The marginal cost of capital
Cost of external equity (ke) =

𝐷𝐼

𝑃0−𝐹

+ 𝑔= sh
...
97 (1+g)5 = 3
...
2795
1+g = 1
...
0505 = 5%
Cost of retained earnings (Kre) =
Cost of preference capital =
Cost of debt =

𝑖𝑛𝑡+

1
(𝐹−𝐵0)
𝑛

1
(𝐹−𝐵0)
2

Source
Capital equity capital
Preference share capital
Long –term debt

ii
...
50
0
...
40

4

50−(2
...
2%

90+

+ 0
...
05 = 13%

1
(1000−980)
20
1
(𝐹−980)
2

(1 − 0
...
43%

Cost
0
...
122
0
...
07
0
...
0257
0
...
79%

Retained earnings break point
0
...
5

= 𝑠ℎ
...
The objective of financial management is to maximize the value of the firm
...

Managers prefer low risk- low return investment since they have a personal fear of losing their
jobs if the projects collapse
...
This difference in risk profile is

FINANCIAL MANAGEMENT

REVISION PARTNER

132

a source of conflict of interest since shareholders will fore go some profits when low return
projects are undertaken
...
Retained
earnings are an internal source of finance
...

Managers might undertake projects which are profitable in the short run
...
The conflict will therefore occur where management pursue short term
profitability while shareholders prefer long term profitability
...
This will constitute directors remuneration which
will reduce dividends paid to the ordinary shareholders
...

December 2010 Question Five D

QUESTION 15
(a) Meaning of the Opportunity cost of capital
This is the minimum required rate of return by providers of long term capital; ordinary
shareholders, preference shareholders and debenture holders
...
It is the discounting rate
...

Ke =
+ 𝑔
Ke =

𝑃𝑜−𝐹

3
...
09)

+ 0
...
54%

60
𝑃𝑟𝑒𝑓
...


Kp =

iii
...
+ (𝐹−𝐵𝑜)
1
(𝐹+𝐵0)
2

= 11
...
30) = 9
...

Cost of debts =
× 92 = 230000000
ii
...


Ke =

600000

100

100

100

× 100 = 150000000

× 60 = 360000000

FINANCIAL MANAGEMENT

REVISION PARTNER
Source

Amount (mkt
value)
230,000,000
150,000,000
360,000,000
740,000,000

Cost of debt
Preferred stock
Common stock

133
Weight

Cost

Weight x cost

0
...
2027
0
...
0933
0
...
1554

0
...
0235
0
...
1281 x 100
WACC 12
...


Current market price per ordinary share
Dividend yield =
Market price =
Market price =

ii
...
5

0
...
80

Number of ordinary shares to be issued to finance the project
Floatation cost = 12% x 80 = sh
...
6
Ke =

𝐷1

𝑃0−𝐹

+𝑔

Ordinary shares % 360,000 + 120000 = 480,000
480,000
× 100 = 60%
800000
60% x 240000 = 144000

Funds to be raised from external equity = sh
...
6 = 70
...


108,000
70
...
10)
Ke =
+ 𝑔=
+ 0
...
81%
𝑃0−𝐹)

80−9
...
10)
Kre =
+ 𝑔=
+ 0
...
88%
𝑃0

80

Cost of preference shares
Kp =
=

8

80

𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑝𝑎𝑟 𝑣𝑎𝑙𝑢𝑒

𝑥100% = 10%

FINANCIAL MANAGEMENT

REVISION PARTNER

134

Cost of debt
𝑖𝑛𝑡
(1 − 𝑇)
Cost of debt = Kd (1 –T) =
=

Source
Ke
Kp
Long-term debt

𝐵0

120
960

(1 − 0
...
75%
Weight
0
...
15
0
...
1781
0
...
0875

WACC

Weight × cost
0
...
015
0
...
1438 x 100
14
...
6
WMCC if the firm is to raise 60,000,000
Source
Weight
Ordinary Share Capital
0
...
15
Long term debt
0
...
1688
0
...
0875

Weight x cost
0
...
015
0
...
1382 x 100
WACC
13
...
Like the assumptions that proportion of debt and equity remain unchanged, the opening risk
of the firm is unchanged and the finance is not project specific
...

ii) The weighted average marginal cost of capital
10,000,000
Ke =
× 50 = 25,000,000
KP =

20

4,800,000

× 24 = 11,520,000

10

Cost of debt =

7200000
1000

× 1,200 = 8,640,000

Cost of specific sources of
Ke =

Kp =

𝐷1

𝑃0−𝐹

+ 𝑔=

𝐷0 (1+𝑔)
𝑃0

𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑉𝑃

Cost of debt =

𝑖𝑛𝑡

𝐵0

+𝑔 =
=

1
...
15)
50

+ 0
...
288 = 28
...
30) = 5
...
55
0
...
19

Cost
0
...
05
0
...
1584
0
...
011

1
...
1825 ×100
18
...
14,000,000 will be raised as follows
1
...
30 (0
...
5,400,000
Cum – dividend market price = 32
...
40
(2
...
40

2
...
Preference share capital 100000 pref
...
2000000
4
...
3200000
ii) Cost of capital for each component
𝐷1
Kre =
+ 𝑔
Ke =
Ke =

𝑃0−𝐹
𝐷1

𝑃0−𝐹

+𝑔

𝐷0 (1+𝑔)
𝑃0−𝐹

+ 𝑔

Computation of growth
1
...
4
(1+g) 4 =
4

2
...
831

(1+g) = √1
...
069992477-1 =0
...
9992477% =7%
Ke =

2
...
07)+ 0
...
4 (1
...
07
30

= 16
...
56%

FINANCIAL MANAGEMENT

REVISION PARTNER
Cost of debt =

𝑖𝑛𝑡

𝐵0

136

(1 − 𝑇) =

Cost of preference capital =

12

80

(0
...
6286
0
...
2286

0
...
10
0
...
1038
0
...
0240
0
...
21%

WACC

iii) Ways that Jasma Limited in (b) above could be used to issue additional ordinary shares
• Public issue by prospectus
• Private placing
• Stock exchange placing
• Stock exchange introduction
• Offer for sale
June 2009 Question One B

QUESTION 20
a) Distinguish between weighted average cost and marginal cost of capital
•
•

WACC-The overall or composite cost of existing capital from various sources based on
% cost and market value weights
...


b)

i)

The weighted average cost of capital
Source

Amount (market
value) sh
...
7962
0
...
01764
1
...
3191
0
...
0583

Weight x
cost
0
...
0102
0
...
2688
26
...

× 45 = 𝑠ℎ𝑠
...

× 30 = 𝑠ℎ𝑠
...

× 1200 = 𝑠ℎ𝑠
...
7962
56520000

Debenture =

2) Preference share capital =
Ke =
Kp =
Kd =

7,200,000

56,520,000

8(1
...
12= 0
...
9%

𝑃𝑜

30

𝐷

45

0
...
1274

3
...
0764

=0
...
3) = 5
...

Weighted average cost of capital on the other hand is the cost of the already raised capital to
finance the firms existing projects
...


b) i)
Cost of ordinary shares
Ke = D 1 + g
6 + 0
...
33%
Po –f = 80 – 8

Workings

Cost of preference shares
Kp = D x 100 = 11 = 11
...
54%

Vd –f = 1000 – 50 = 950
n = 10Yrs

(1- 0
...
06 = 13
...
45
0
...
4
1
...
5%
11
...
54%
MCC

Weighted
Cost
6
...
719%
3
...
81%

Comment: The MCC reflect the average cost of acquiring new funds in order to finance
new project
...

Discounting on the other hand refers to the process of determining the present value of amount of
money to be received at some future date
...
of units sold)
Variable costs (VC x No
...
9091
0
...
7513
0
...
6209
0
...
6
1,333,809
...
2
758,130
298,032
931,350
6,230,300
...
4

Advise: Invest in project because it has a positive NPV
...
8475
0
...
6086
0
...
4371
0
...
8
982,280
...
2
(6,000,000)
(839,113
...
4
230,000+ 839,113
...
72%
Advise: Invest in the new project because the internal rate of return is higher than the cost of capital
of 10%
iii) Main draws backs of the IRR method:
- It is tedious and time consuming to compute
- In some instances it gives conflicting results with the NPV technique when ranking mutually
exclusive projects
- In some cases there might be more than one internal rate of return for the same project
- Some managers confuse the IRR with the ARR

QUESTION 23
a) Advantages of using the market value weights
i)
Investments are rated by investors using their returns which are ascertained using the market
values of such investment
...

iii) Historical book values may not represent the true valuation of capital employed as shown in
the balance sheet
...

v)
The assets used by capital providers as security are valued at market price for collateral
purposes
...
92 ×100
20

= 9
...


= 12
...
8 x 100
30 –0

D x 100
Po

= 2 ×100
25

= 8%

Cost of 10% debentures

K d = Int (1 -t)
Vd

Kd = 40,000 (1-0
...
6%

Int = 10% x 400,000 = 40,000
Vd = Sh
...
3

FINANCIAL MANAGEMENT

REVISION PARTNER
3
...
40

After Tax Cost %
12
...
068%

0
...
6%

1
...
20

8%

1
...
20
1
...
6%
Market WACC

1
...
708%

QUESTION 24
b)

i) Difference between WACC and MCC
WACC
1
...

2
...
e
...

3
...

4
...

5
...


MCC
1
...

It is used in evaluating the company’s
2
...
e
...

Since it is the cost of new funds to be
3
...

It uses the optimal capital structure using
4
...

It considers the cost of retained earnings
since it is not included in the book value
5
...


ii) Finance lease and operating lease
Finance lease
- Long term (at least 90% of asset life)
...

- Option to buy asset at end of lease period
...

- No option
...
These are free shares
issued from retained earnings to ordinary shareholders
...

b) WACC
i)
Interest = 10% × 1000 = 100
Conversion rate = Sh
...
of Shares to be acquired = Sh1,000 = 10 Ord
...
100

FINANCIAL MANAGEMENT

REVISION PARTNER

141

Ke = Do (1 + g) + g = 2 (1
...
07 = 17
...
3) = 9
...
5
0
...
375

17
...
8%
Wacc as at
31 March 2005

8,000

ii)
Ke = D1 + g =
Po

After Tax Cost

Weighted Cost

17
...
5 = 8
...
125 = 1
...
8 × 0
...
675
13
...
07) + 0
...
4%
Po
15

New Kd = Int (1-t) = Before Tax Cost (1-t) = 15% (1-0
...
5%
vd
Source
Equity
10% Per Share
14% Pref Shares
15% Debentures

Total Mkt Value
Sh ‘000’
0
...
33
0
...
33
0
...
0

After Tax Cost
28
...
8%
10
...
3
...
4×0
...
372%
10×0
...
1%
9
...
33 = 3
...
5 x 0
...
415%
16
...

i) Capital budgeting/investment decision
...

- When using IRR the cost of capital is compared with the IRR to determine whether to accept
or reject the project
...
g
...

iii) Evaluation of performance
- A higher cost of capital is an indicator of high riskiness of the firm due to poor performance
...

iv) Inference on dividend policies of the firm e
...
If the cost of retained earring is low the firm
will pay less dividend and retain more to finance future investment opportunities
...
6
...
100 –3 =Sh
...
60 (1+ 0
...
06
97-5
= 0
...
6%
Cost of retained earnings Kr = Do (1+g) +g
Po
= 6
...
06) + 0
...
2%
Cost of preference shares, Kp = dp x 100
Po-fc
=
8% ×10
10 – (5%×10)
=0
...
42%
Cost of debt, kd == Interest + (Maturity Value – Market Value) 1/ n (1- tax)
(Maturity Value + Market Value) 1/ 2
8 + (100-94) 1/ 20 (1-0
...
9%
= 6%

=

ii) Break-even point
=Amount of source with lowest cost
Weight of source with lowest cost
Long-term debt in the source with the lowest cost of 6 %
Weight of the source = 30,000,000 = 0
...
3
= Sh100, 000,000

QUESTION 27
a) The cost of capital is the required rate of return by all the investors who have provided funds to
the company
...
The average cost of capital to the company is
known as the overall cost of capital or the composite cost of capital of weighted average cost of
capital
...
To determine the companies cost of borrowing
...
As a discounting rate for the company’s existing projects
...
For comparison with other similar companies in the same industry
...
To determine the general risk level of the company
...
Calculate the component cost of each source of finance already employed by the company
...
Determine the values to be used in calculating WACC
...
e
...

3
...

c) Biashara Ltd weighted average cost of capital (WACC)
P/E Ratio

Ke

=

Kd

=

= MPS
EPS

D1 + g
P0

=

Therefore:

D 0 (1 + g)
P0

MPS = P/E Ratio x EPS
= 8x5
= Sh 40

+g

=

5 (1
...
06
40

=

19
...
3)
= 7%
Vd
1,000
Int = 10% Par Value = 10% x 1000 = 100
Vd
Source
Equity
Debt

Total Market Value
Sh‘000’
2,600
3,600
6,200

Workings
6,500,000 ×40
Equity
100

Debt

Proportion
0
...
58

After Tax Cost
19
...
25 x 0
...
09%
7 x 0
...
06%
12
...
This is because
interest on debenture is a tax allowable expense i
...
it provides the company with an interest
tax shield
...

b)
i) The expected rate of return on ordinary shares
Ke = D1 + g = Shs 1
...
1
Po
Sh 30
= 14%

FINANCIAL MANAGEMENT

REVISION PARTNER

144

ii) The effective cost of company of
Debt capital (Kd)
Kd = Interest + (Maturity Value – Market Value) 1/n (1- tax)
(Maturity Value + Market Value)
2
Kd = 9 + (150 - 100) 1/100(1-0
...
32%
Preference share capital (kp)
Kp = Do ×100%
Po
Market value of the preference share
= 10% ×20 ×100% = 10%
20
iii) Company’s existing weighted average cost of capital (WACC)
Market Value
Sh‘000’

Proportion

90,000
20,000
20,000
130,000

0
...
154
0
...
00

Source

Ordinary Shares (3m × 30)
10% Preference Shares
6% Long Term Debenture

After Tax
Component
Cost
14%
10%
5
...
688%
1
...
8198%
12
...
‘000’
30,000
20,000
50,000

Proportion
0
...
4

After Tax
Cost
5
...
0%
MCC

Weighted
Cost
3
...
60%
8
...
Agency costs are incurred when
management decisions are based on the interests of directors rather than shareholders
...
Expenditure for external audit incurred by the organization
ii
...
Opportunity costs of foregone projects which are perceived by management to be too risky
...
‘Perks” and incentives paid by the organization to make directors act the best interests of
shareholders
...
4m = 12 million
0
...
25
(ii) Weighted marginal cost of capital for each of the ranges of financing:
From 0 to Sh
...
22
2
...
05 or 5%

Do (1
...
22 (1
...
05
22
...
20 or 20%

Cost of preference shares
Kp
12 × 100%
80
15%
Cost of debt
Kd
= 1(1 –1) ×100%
Pd
= 90 × 0
...
45 ×20%) + 0
...
2(7%)

For the range 12m 16m
Only cost of equity changes since extended equity is to be raised
...
22(1
...
05
22
...
6
= 23%

Thus WMCC = (0
...
3 x15%) + (0
...
6%
For the range 16m 20m
Cost of equity (Ke)
Cost of preference shares (Kp)
Cost of debt

= 430 (0
...
45 × 23%) + (0
...
25 ×10%)
= 17
...


25
24
23

A

22

WMCC

D
21

C

20
19

2

4

6

8

10

12

14

16

18

20

QUESTION 30
(a)

At initial stages of debt capital the WACC will be declining upto a point where the
WACC will be minimal
...

(i)
Debt capital provides tax shield to the firm and after tax cost of debt is low
...

Beyond the optimal gearing level, WACC will start increasing as cost of debt increases due to
high financial risk
...
40

Po

=

Sh60

g

=

10%

Ke

=

2
...
10 = 0
...

1
Int(1 - T) + (m - vd)
n
Kd
=
1
(m + vd)
2
m
vd
n
Int
T

=
=
=
=
=

Maturity/per value = sh 150
market value = Sh
...
150 = Sh
...
a
Tax rate = 30%

9(1 - 0
...
8 x 100
125

=

5
...
V of equity = 600,000 shares × sh 60 MPS
M
...
V of preference shares = 200,000 shares × Sh 20

Ke = 14%

Kd = 5
...
44%

4
44

+10%

4
44

12
...
4%
Marginal cost of ordinary share capital = 14%
Therefore marginal cost of capital = 14%

4
10

+ 5
...
86%

FINANCIAL MANAGEMENT

REVISION PARTNER

148

SOLUTIONS TO PAST PAPER QUESTIONS ADOPTED FROM PAPER
NO
...

Credit enhancement is a key part of the securitization transaction and is important to credit rating
agencies when raising a securitization
Methods of credit enhancement
i
...
It is the difference between interests received by
lenders or issuers of asset based securities (such as morgartges) and interest paid to
holders of such securities for example subprime morgartges
...

ii
...
It occurs when the value of the assets held to
support a security is actually greater than the security
...
This gives the holder a cushion in the event of late or non-payment
...

Surety bond
A surety bond is a promise to pay one party (the oblige) a certain amount if a second
party (the principal) fails to meet some obligation, such as fulfilling the terms of a
contract
...

b) Beta of equity of a geared firm B eg
Gearing
20%
30%
40%
50%
60%
70%
80%

Geared beta
1+0
...
7

0
...
8
1+0
...
7

0
...
7

1+0
...
7

0
...
6

1+0
...
7

0
...
5

)=1
...
24
)=1
...
62

1+0
...
7

)=1
...
7×0
...
50

1+0
...
7

)=3
...
95(
0
...
95(

0
...
3
0
...
12=16
...
96×0
...
5(1-0
...
2]=14
...
24=17
...
92×0
...
1(0
...
3]=14
...
39=19
...
2×0
...
8×0
...
4)=13
...
162=20
...
96×0
...
5×0
...
5) =14
...
95=23
...
60×0
...
7×0
...
06

8+(16-8)2
...
00

(28
...
3) +(13×0
...
7)=14
...
61=36
...
88×0
...
7×0
...
34
December 2011 Question Five A and B

QUESTION 32
(a)

(i)
Debt
9
...
9 = 8
...
2 x 0
...
56
7
...
7 = 5
...
1 x 37
...
7
0
...
0 = 7
...
3 x 35
...
65

Total
12
...
76
15
...
9 x 0
...
14
6
...
5 = 3
...
4 x 0
...
56
6
...
3 = 1
...
1 x 0
...
22
6
...
1 = 0
...
4 x 29
...
64
0
...
2 = 12
...
6 x 20
...
24
0
...
6 = 10
...
8 x 13
...
8
0
...
1 = 11
...
0 x 13
...
78
15
...
8
12
...
02
12
...
00

Optimal capital structure rate of return = 12
...
e
...
e
...
9
(ii) Reason: weighted average cost of capital remains constant regardless of the debt to
equity ratio according to Modigliani and Millers no tax capital structure argument
c) The pecking order theory says that firms prefer internal financing (that is, earnings retained and
re invested) over external financing
...
The pecking order theory starts with the observation that managers
know more than outside investors about the firm’s value and prospects
...
Internal financing
avoids problem
...
The pecking order
theory says that the amount of debt a firm issues will depend on its need for external financing
...

June 2011 Question Two A and C

QUESTION 33
a) i) Lease Option (Cost)
Annual lease payment
Less: lease rentals shield
40% x 5m

5,000,000
(2,000,000)
3,000,000

NB: The relevant discounting rate in the case of lease and buy option is always the after tax
interest rate / cost of debt
...
Factor 9%
1–5
3,000,000
3
...
6499
Total cash outflows

b) i)
Period
1
2
3
4
5

Loan repayment schedule
Beginning
Cash paid
bal
...
00
17,033,000
...
00
9,697,092
...
375

5,967,000
...
00
5,967,000
...
00
5,967,000
...

Sh

2,967,000
...
00
3,923,857
...
125
5,189,301
...
00
2,554,950
...
50
1,454,563
...
4563

17,033,000
...
00
9,697,092
...
375

FINANCIAL MANAGEMENT

REVISION PARTNER
ii)
Year
Purchase
Annual maintenance
Tax savings:
40% x 1m
Depn
...
4)

(0
...
4)

(0
...
4)

20m
1
20m

(1
...
9174
(0
...
56)
(0
...
8417
(0
...
52)
(0
...
7722
(0
...
96)
(0
...
7084
(0
...
96)
(0
...
6499
(0
...
24

Lease = Sh 14,268,700
Purchase = Sh 16,240,000
c) Advice: Furnace Ltd will lease the oven since the net cash flow is minimized i
...
Sh 14,268,700
December 2010 Question Two

QUESTION 34
i
...
(unlevered)

Toto Ltd
...
29%

KeL

=

=17%

Int (1 − t )
Vd
8% × pa (1 − 0 )
=
pa

Kd =

= 8%
WACC = WekeL + Wdkd (1 – t)
= (0
...
5 x 8%)
= 12
...
The two companies are identical, practice Arbitrage to restore the 2 companies to equilibrium
...
Therefore
if this happens, then investors will practice the arbitrage process to restore the values of the 2 firms
to equilibrium
...


151

The investor will sell his ownership in the overvalued firm Toto Ltd
...


Step 1 amount to be realized = 4% x 1000m = 40m
Step 2 He will borrow on the personal account an amount of debt equal to ;
4% x 1000m = 40m
The total funds available for investment = 40m + 40m
= sh
...
whose analysis
will be done as follows;
a) If he decides to invest the whole amount then his % of ownership will be;

80m
× 100 = 4
...

Baba
Ltd
...
29% x 70) 10m

Less Int (8% x 40m

Toto Ltd
...
2m
6
...
8

6
...
4

Available
funds (limit)

2700 (1-0
...
6

1800

Kd

0
...
4
1800
0
...
6

= 4,725

Rank
Column

2

Cost of capital

R/e=

𝑏0(1+𝑔)

+ 𝑔

𝑃𝑜
1(1
...
08
= 14
...
6)
= 6
...
6)
= 7
...
6

No limit

No break

Ke

0
...
4

13 (0
...
8%

= 5225

Ke =

3

𝐷0(1+𝑔)
𝑃𝑜 − 𝑓

+ 𝑔

1(1
...
92

= 15
...
4

Ke =

No limit

0
...
75
14
...
67
16
...
77

No break

1(1
...
68

= 16
...
6
6
...
2
7
...
2
7
...
08
0
...
9
10
...
6
11
...
4

Recall: MCC = WeKe + WdKd(I-T)
13
...
912
...
512
...
1-

Optimal Point

11
...
711
...
3-

D

MCC Graph

11
...
9-

B

10
...
510
...
19
...

Therefore accept A, C, D and reject project B
...
e
...
of ordinary shares =

amount raised from equity
issue price per share

Plan B
Amount to raise from equity = 50% x 48m = 24m

125
× 10 = sh12
...
92m
No
...
5

Issue price

Plan C
Amount to raise from Equity = 48m
Share price
12
...
of ordinary shares =

48m
= 3
...
5

Plan A Equity and Debt finance

EPS =

(EBIT − Int )(1 − Tax )

No
...
72
32
= 3
...
of ordinary shares =
10
(EBIT − 6
...
7 )
EPS A =
3
...
7 EBIT − 4
...
2m
Plan B (Equity and Debt finance)

EPS B =

(EBIT − Int )(1 − tax )
No
...
32m
No
...
5
= 5
...
32)(0
...
12
0
...
024
5
...
7 EBIT − 4
...
7 EBIT − 3
...
2
5
...
584 EBIT − 24
...
24 EBIT − 9
...
344 EBIT
= 14
...
344
EBIT = 10
...
7 × 10
...
704
0
...
72 − 3
...
2
5
...
876
= Sh 0
...
876

= 0
...
7 )
No
...
92m
No
...
5

= 7
...
92)(0
...
04
0
...
344
=
7
...
7 EBIT − 4
...
7 EBIT − 1
...
2
7
...
24 EBIT -4
...
928EBIT – 33
...
688 EBIT = 20
...
72
EPS for A

for C

= 0
...
875

0
...
72 − 4
...
2

0
...
344
7
...
7 EBIT − 1
...
04

3
...
88128 = 4
...
28896

14
...
344 EBIT

EBIT =10
...
7 × 10
...
024
5
...
875

The best financing alternative is where the wealth of the shareholders is maximized and hence it will
be where the MPS will be maximized
...
Therefore the EPS will be determined as
follows
...
of ordianry shares
...
5m
28
...
E ratio x EPS

FINANCIAL MANAGEMENT

REVISION PARTNER

156

A
3
...
72m

No
...
12m
4
...
04m
1
...
of ordinary shared
(28
...
72 )(0
...
7644
EPS A
3
...
5 − 4
...
7 ) = 3
...
12
( 28
...
92)(0
...
6429
EPSC =
7
...
5 − 1
...
7 ) = 2
...
04

MPS = EPS x P/E ratio

MPS A = 6 x 4
...
3059

=Sh 28
...
6429

=Sh 19
...
1432

Conclusion – Select option A since this is where the shareholders wealth will be maximized
...
2
= 13
...
33)
135

kd = 4
...
6 ×

192
54(1 − 0
...
6992%
June 2009 Question Three B

FINANCIAL MANAGEMENT

REVISION PARTNER

157

QUESTION 38
a) Break points in the WMCC Schedule
There are 5 break points which will arise in WMCC Schedule
...

Break point =

7,500,000
25%

= Sh 30,000,000

(WK1) Optimal Capital Structure Proportions
Equity Proportion =

90𝑚

150𝑚

× 100 =

Preference Share Capital Proportion =
Long term debt proportion = =

37
...
5𝑚
150𝑚

x 100 =

x 100 =

%
60
15
25
100

b) Extent to which funds obtained from both issue of 12% and 14% debenture will be
utilised (cumulatively)
Break point = =

7,500,000+7,500,000

Financing Ranges

25%

= Sh 60,000,000

Equity – 18m
0 – 7
...
5m
Equity – 18m
0 – 7
...
5m

0 – 30m
30m – 60m

60m – above – 25% - 16% debenture
25% of additional debt finance in excess of Sh 60 million will be raised from issue of 16% debenture,
thereby causing a break point
...

a) Retained earnings break point
Break point =

70
𝑥
100

Financing Range
Sh (0 – 60m)

5,143,000

60%

= Sh 6,000, 167

≃ Sh
...
A break point occurs when a
company issue new ordinary shares to raise additional equity finance
...

Break point =

3,600,000+18,000,000
60%

≃ Sh
...
6m
D – 1
...
9m
E – 1
...
5m
P – 4
...

i)

Preference share capital break point
...
75,000,000
15%
Sh (0 – Sh 75m)
- 15% of additional finance in excess of Sh 75m shall be raised from the second issue of preference
share, thereby causing the break point
...
15
WMCC
Component cost
0
...
25
Kp
Ke
Kdt
0 – 6 WMCC = (15
...
6) + (8
...
25) + (8
...
15) 15
...
4
11
...
2
6-30
16
...
4
11
...
6
30-36
16
...
8
11
...
0
36-60
17
...
8
11
...
5
60-75
17
...
2
11
...
9
75 – above
17
...
2
11
...
0
Workings
1
...
4 (1+9�100)

=�

� x 100 + 9%

90

= 15
...
Cost of the 1st issue of new ordinary shares
Ks = �

5
...
27%

� x 100 + 9%

3
...
4 (1+9�100)
90−18

= 17
...
Cost of 12% Long-term debt
Kdt = �

𝐼 (1−𝑇)

𝑀𝑣𝑑−𝐹

� 𝑥 100

=

�

12
𝑥
100

100� [1−0
...
4%

x 100

Or Kdt = kd (I-T) – if par value = Market value
5
...
3)
= 9
...
Cost of 16% long term debt
Kdt = kd (I-T) = 16% (1 – 0
...
2%
7
...
6%

8
...
2%

c) Internal rate of return for project V
Recall: IRR is discounting rate which equates NPV = O
Io = 30,000,000
A = 8,141,760 Pa for 6 years
r=?
NPV = (A x PVIAfn, r%) – Io
NPV = O

O = AxPVIAfn, r% - Io
𝐼𝑜
𝐴

=

IRA

AxPVIAfn,r%
𝐴

∴ AxPVIAfn, r% =

Payback period
𝐼𝑜
𝐴

FINANCIAL MANAGEMENT

REVISION PARTNER

160

This approach involves use of payback period to determine IRR
...


PVIAf 6 , r% =

30,000,000
8,141,760

PVIAf 6 , r% = 3
...


201918171615-

WMCC CURVE

WMCC

WMCC
WMCC

WMCC
14% 3rd
1413
...
6%
2
13- 13
...
5%

4th

15%

5th Break point

V

36 40 45 50

III

60

70 75 80

I

90

100 105 110
CUMULATIVE FUNDS

Decision Rule:
If IRR ≥ cost of capital (WMCC) → Accept projects II, IV & V
If IRR < cost of capital → Reject projects III and I

Optimal capital budget is Sh 75,000,000

f) Disregarding if capital structure is optimal,
= Sh 80,000,000 – Sh 75,000,000 = Sh 5,000,000
Considering capital structure is optimal
60
E
× 75 = 45m ← Retained, hence dividends to be paid = 80m – 45m = Sh 35m
100

D 25% × 75 =18
...
25

June 2009 Question Two

FINANCIAL MANAGEMENT

REVISION PARTNER

161

QUESTION 39
i)

A break point will occur when retained earnings are used up
...
0 – payout)
= (34,285,714) (0
...
6 = 40,000,000
Equity fraction
ii)

Component costs are as follows:
K re = D 1 +g = D 0 (1 + g) +g
P0
P0
=3
...
09) + 0
...
54%
60
Ordinary shares with floatation cost of 10%
K E = 𝐷1�𝑃0 (1
...
924

60 𝑥 0
...
27%

Preferred shares with a floatation cost of Sh 5
K ps = Pref Div = 11/ 100
...
58%
Pn

Debentures at Kd = 12%
Kd (1 – t) = 12% (0
...
4
iii)

iv)

WACC calculations within indicated capital intervals
Sh 0 – sh 40,000,000
(Debentures 8
...
58%, retained earnings = 15
...
25 (8
...
15 (11
...
60 (15
...
16%
the company should accept projects
A, B, C and D
Project e should be rejected because its IRR is less than the marginal cost of funds to finance it,
as follows:
Project

IRR

A
B
C
D
E

17
...
2%
13
...
6%)
December 2008 Question Four B

FINANCIAL MANAGEMENT

REVISION PARTNER
QUESTION 40
Value of Equity =

KeL =

ii) Kd =

162

(EBIT − Tax )(1 − Int )
Kel

(EBIT − Int )(1 − t )
Value of Equity

Int (1 − t )
Vd

=

(75M − 16
...
3)

 6,250,000
× 400 


 125

= 20
...
3)
525

Kd =

= 9
...
62
324 : 425
124
...
38
Debt
324
...
5
× 400 = 200m
125

11
...
425m
× 525 =
500
324
...
62 × 20
...
38 × 9
...
22%
b)
Unlevered

Vu = 130m
KeU = 16%
WACC = 16%

Levered

VL = VU + debt × tax rate
= 130m + (8,000,000 × 0
...
4m

The search for selffulfillment is endless, and
endlessly frustrating
...
3)
= 16% + (16% − 12%)
124
...
18%
WACC = WeKeL + WdWd (1 − t )
124
...
18 +
× 12 × 0
...
4
132
...
50755
= 15
...
This implies that there
must be an optimal capital structure where the WACC is minimized and the value of the firm is
maximized hence the capital structure decisions are relevant
...


Q × SP = C

1,800,000 − 450,000
(1,800,000 − 450,000)
1,350,000
= 3 times
=
450,000

Beta Ltd
...
3)
120m

=11
...
67%

FINANCIAL MANAGEMENT

REVISION PARTNER

164

i) WACC
When the company is ungeared /unlevered
WACC = KeU

VL = VU + PVITS
= VU + (debt × tax rate)
Value of
debt
25m
50m
75m
100m
125
150m
200m

VL = VU + ( Debt × tax)
= 120 +(25m x 0
...
5
= 120m + (50 x 0
...
3) = 142
...
3) = 150
= 120 +(125 x 0
...
5
= 120 + (150 x 0
...
3) = 180

Value of debt

VL = VU + ( Debt × tax) −

25
50
75
100
125
150
200

127
...
5
=125-(0
...
5
=142
...
0250 x80) = 140
...
0625 x 80) =145
= 157
...
1250 x 80) =147
...
3125 x 80)= 140
= 180 – (0
...
5

December 2007 Question One B

QUESTION 43
Q4B Sales revenue = S
...


DOL =

Q ( SP −VC ) − FC
Q ( SP −VC ) − FC

DFL =

Q ( SP −VC )− FC
Q ( SP −VC )− FC −int r −

DCL DOL × DFL

BEP =Q

BEP =

FC
FC
=
CMU SP −VC

DCL = DOL × DFL

prof Div
1− t

Bora Ltd
...
7 m
70 , 000 (1000−700 ) −1
...
7 m

= 1
...
07 times

70 , 000 (1000−700 ) −1
...
7 m −0

=

70 , 000 (1000−700 )1
...
7 m

= 1
...
088 x 1
...
088 times
1700 , 000
= 1000
−700 = 56667 units

= 1
...
088 × 1
...
0971 times
1700 , 000
1000−700 = 5667 units

= 1
...
0 = 1
...
088 x
1
...
0971

FINANCIAL MANAGEMENT

REVISION PARTNER
i)

EPS m =

165

EBIT (1 − 0
...
7 EBIT
=
40,000
40,000
EBIT − Int )(1 − t )
EPS B =
=
no
...
3) 0
...
7 EBIT = 1
...
4 EBIT − 224,000
0
...
7
0
...
7 × 320,000 − 112,000
EPSm =
=
= shs
...
60
20,000
20,000

EBIT =

June 2007 Question Four B

QUESTION 44
WACC = Wc K e + Wd k d (1 − t )
( EBIT − int erest )(1 − t ) (16m − 3
...
3)
× 100 = 19%
=
45m
ks
( EBIT − int erest )(1 − t )
ks =
value of equity
45m
24
WACC =
× 19 +
× 16(1 − 0
...
65 × 19 + 0
...
3) = 16
...
of shares × mps

=

10m
× 90 = 45m
20

Interest = 16% × 24m = 3
...
0

0
...
8

0
...
6

D/E

Bel =

Bcu + Bcu DE (1 − t )

1
...
2 × 0(1 − 0
...
2
1
...
2 × 0
...
3)
0
...
25
0
...
41
1
...
2 × 0
...
3)
0
...
67
0
...
7628

0
=0
1
...
2
= 12
...
2 + 0 x 7(1 –
0
...
2%
0
...
48 + 0
...
3)
= 11
...
6 x 15
...
4 x
10
(1 – 0
...
1461%

5 + 6 × 1
...
46

5 + 6 × 1
...
5768

FINANCIAL MANAGEMENT

REVISION PARTNER
0
...
46

1
...
2 × 1
...
3)
0
...
50
0
...
46
1
...
2 × 4(1 − 0
...
8
= 4
...
2
= 4
...
4

0
...
2

= 19
...
56
= 32
...
4 x 19
...
6 x
12(1 – 0
...
944%
0
...
36 + 0
...
3)
= 14
...

December 2006 Question Two

QUESTION 46
Firm A is unlevered

EBIT (1 − t )
Value of Equity =
KeU
10m(1 − 0
...
3)
= 85m

KeL = KeU+(KeU-Kd) DE (1 − t )
=10%(10%-7%) 50
35 (1 − 0
...
7 )

WACC =  70m
  70m

= 10%


  50
 35
 × 13%  +  × 7% (0
...
322a + 4
...
24%

b) i
...
of ordinary shares

Interest = 12% × 250m + 11% × 50m = 35
...
of ordinary shares =

EPS1 =

shs 150m
= 15m
shs 10m

( EBIT − 35
...
7 EBIT − 24
...
of ordinary shares

Interest = 12% × 250m = 30m
No
...
3)
20m
0
...
EPS1 = EPS3

0
...
85m 0
...
5 EBIT -315m
3
...
5m

0
...
5m
235m
= 0
...
5m = shs 1
...
5

0
...
7 ×

235m
− 21m = 1
...
5

YU
...
It is due to factors which
systematically impact on most firms, such as general or macroeconomic conditions (e
...
balance
of payments, inflation and interest rates)
...

Unsystematic (or specific) risk can be diversified away by creating a large enough portfolio of
securities: it is also often called diversifiable risk or company-unique risk
...
Factors such as winning a new contract, an industrial
dispute, or the discovery of a new technology or product would contribute to unsystematic risk
...
The total risk diminishes as the number of assets or securities in the portfolio
increases, the unsystematic risk disappears completely and that systematic risk remains unaffected
by portfolio size
...
4
W s = 6,000,000/ 10,000,000 = 0
...
4(0
...
60 (0
...
1940 = 19
...
42 (0
...
62 (0
...
4) (0
...
3) (0
...
15)(0
...
0036 + 0
...
000432 = 0
...
02232 = 0
...
94%

December 2014 Question Three B and C

QUESTION 2
c) Expected return for each investment
E (r A ) =∑(𝑃𝐴𝑟𝐴 )
= 0
...
4(8) + 0
...
2(20) + 0
...
2(-4) = 8%
Risk is represented by standard deviation
...
3 + (8 − 8)2 0
...
3

= √43
...
2
= 9
...
4

= �(8 − 20)2 0
...
6 + (-4- 8) 20
...
8 + 28
...
6 = 7
...
6 %
December 2013 Question Five D

QUESTION 3
a)
i
...


3
...
70+-3
4
...
40
1
...
80

𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟+𝑝𝑟𝑖𝑐𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑜𝑣𝑒𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠𝑡𝑜𝑐𝑘 𝑎𝑡 𝑡ℎ𝑒 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔

FINANCIAL MANAGEMENT

REVISION PARTNER

170

LetRx, Ry, Rz be the relative returns of stocks x, y, z respectively
...


Rx =

3
...
247 = 24
...
7+(69−72)

= 0
...
4%

Rz =

4
...
077 = 7
...
4 x 0
...
2 x 0
...
4 x 0
...
0988 + 0
...
0308
= 13
...
The required return would
be a risk-free rate plus a risk premium to compensate the investors for the opportunity cost of not
invested in the risk free investments such as treasury bills
...

December 2012 Question Two A

QUESTION 5
d)
i
...

Sh
...
15
0
...
30
0,20
0
...
15 + (16) x 0
...
30 + 10 x 0
...
20
= 0
...
15
0
...
30
0
...
25

FINANCIAL MANAGEMENT

R x probability
(4
...
6)
0
2
...
9%
= 0
...
Variance of end of periods returns
X
(30)
(16)
0
10
20

0
...
9
0
...
9
0
...
9)2 x 0
...
9)2 x 0
...
9)2 x 0
...
9)2 x 0
...
9)2 x 0
...
22
28
...
243
16
...
20
279
...
78
May 2012 Question Five D

QUESTION 6
c) Distinguish between the following terms as used in finance
i)
Perfect markets and efficient markets
Perfect markets is a market with the following assumptions;• Rational investors
• Equal access to information by all market participants
• Completely rational economic factors and no transaction costs such as taxes
...
Information can be classified as past information (historical information)
current (published) information and the future ( confidential information)
ii)

Futures and forwards
Futures
A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset),
such as a physical commodity or a financial instrument, at a predetermined future date and
price
...
Some futures contracts may call
for physical delivery of the asset, while others are settled in cash
...

Futures can be used either to hedge or to speculate on the price movement of the
underlying asset
...
On the other hand, anybody could speculate on the price
movement of corn by going long or short using futures
...
For example, firms often enter into
forward agreements with a bank to buy or sell foreign exchange or to fix the interest rate
on loan to be made in the future
...
Business Risk
A company's business risk is the risk of the firm's assets when no debt is used
...
As a result, there are many factors that can affect
business risk: the more volatile these factors, the riskier the company
...

• Input-cost risk - Input-cost risk is the volatility of the inputs into a company's product as
well as the company's ability to change pricing if input costs change
...
Financial Risk
A company's financial risk, however, takes into account a company's leverage
...

November 2011 Question Five C

QUESTION 7
(d) The riskiness of security A and B
...

The standard deviation of returns;
𝑅𝐽 )2 𝑃𝑖
Generally; 𝜎 J = �∑𝑛𝑡=1(𝑅𝐽 – ������
R

Security A
𝜎 A = �∑𝑛𝑡=1(𝑅𝐽 – ������
𝑅𝐽 )2 𝑃𝑖
R

State of economy
Recession
Stable
Expansion

Security B
State of economy
Recession
Stable
Expansion

Prob
...
3
0
...
3

RA%
12
15
10
R A =12
...
6) (0
...
11
(15-12
...
4) =2
...
6)2 (0
...
03
𝜎 J 2 - 4
...
45 = 2
...

0
...
4
0
...
5
5
R A =12
...
6) (0
...
027
(7
...
6)2 (0
...
576
(5-12
...
3) =0
...
45
2

R

𝜎𝐵 = √1
...
054

Security A is riskier than security B because of higher standard deviation
November 2011 Question Two D

QUESTION 8
c) Explanation of the following;i
...
When a
company uses debt financing, its creditors will be repaid before its shareholders if the
company becomes insolvent
...

ii
...
g
...

December 2010 Question Four C

FINANCIAL MANAGEMENT

REVISION PARTNER

173

QUESTION 9
b)
i
...
2
10
0
...
35
8
0
...
15
14
0
...
2
2
...
75
2
...
35
R’ A =10
...
2(10-10
...
1(12-10
...
2(8-10
...
2(15-10
...
2(14-10
...
2(9-10
...
08
0
...
694
1
...
166
0
...
56

∴ Standard deviation of returns (𝛿𝐴 )= √𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = √5
...
36
ii
...
2
0
...
35
0
...
15
0
...
6
1
2
...
6
1
...
5

Variance
(R B -R’ B )2 PL
0
...
5)2 =
0
...
5)2 =
0
...
5)2 =
0
...
5)2 =
0
...
5)2 =
0
...
5)2 =
Variance (r2 B )

0
...
225
0
...
6125
0
...
0375
2
...
655 = 1
...
Relative risk as measured by coefficient of variation
𝐶𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 𝑜𝑓 𝑉𝑎𝑟𝑖𝑎𝑡𝑖𝑜𝑛 (𝐶𝑉) =
𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝐴 (𝐶𝑉𝐴 ) =

𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦 𝐵(𝐶𝑉𝐵 ) =

2
...
2

𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 (𝛿)
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 (𝐸𝑅)

= 0
...
65
= 0
...
5

August 2009 Question Four B

FINANCIAL MANAGEMENT

REVISION PARTNER

174

TOPIC 8
CAPITAL BUDGETING UNDER CERTAINITY
QUESTION 1
c)

(i) Why capital budgeting decisions are important
The long-term investment decision is called capital budgeting
...

• Capital budgeting involves a huge amount of funds for a long period
...

• Capital budgeting decisions affect the returns of a firm as a whole
...

• Capital budgeting decisions, once taken, cannot be reversed without involving heavy losses
...
“000”
Sh
...
25
937
...
5
703
...
938
2,109
...
344
158
...
031
__-__
1,582
...
609

Cost
Year 1 Tax allowance
Year 2 Tax allowance
Year 3 Tax allowance
Year 4 Tax allowance

Balance allowance

Year
Purchase of machine
Tax saving
Net revenues
Tax on net revenues
Discount factors
Present value

0
Sh
...
000
(5,000)

1
Sh
...
909
2,250

2
Sh
...
25
3,000
(900)
2,381
...
826
1,966
...
“000”

632
...
“000”
210
...
938
0
...
114

4
Sh
...
812
1,000
(300)
1,332
...
683
910
...
811,338
The plant should be bought because the NPV is positive
...

• It should consider the time value of money by discounting the expected future cash flows of
the project
...

• It should distinguish between two or more mutually exclusive projects and should rank
them in order of their economic viability
...

• It should be applicable to any conceivable project independent of all other projects
...
Sh
...
6 million
Useful life
5 years
Scrap value
Sh
...
5 million
Contribution per unit
Selling price – variable cost
= Sh
...
360

Depreciation per annum =
=

𝟔𝐦 − 𝟏
...
0
...
9091
1,696
...
8264
1,333
...
7513
1,212
...
683
758
...
6209
1,307
...
6 + 1,333,809
...
2 + 758,130 +1,307,615
...
6, 308,533
...
8 -6,000,000 = Sh
...
80

FINANCIAL MANAGEMENT

REVISION PARTNER

176

Advice
The management should invest to produce "M" because it yields a positive NPV of Sh
...
80
therefore it will lead to maximisation of shareholders wealth
...
000
1,866
1,614
1,614
1,110
2,106

1
2
3
4
5
Total present value
Less initial investment cost

PVIF

Present values
Sh
...
8552
1,241
...
45
657
...
8564
5,719
...
634)

0
...
7695
0
...
5921
0
...
6-6,000,000 = (280,634)
Ke= 10%
NPV = 308
...
e
...
e
...
e
...
308, 533
...
e
...
(280,634)
IRR = 10% +

𝟑𝟎𝟖,𝟓𝟑𝟑
...
𝟖 + 𝟐𝟖𝟎,𝟔𝟑𝟒

(14 - 10) = 12
...
09 %) is greater than the cost of capital 10%
...
123,500 – Sh
...
108,500
Incremental cash flows
New project’s annual cash inflow= 230,000 × (0
...
08 – 0
...
16)
Less; Existing project annual cash inflow= 200,000 × (0
...
12 – 0
...
25)
Incremental cash flows

FINANCIAL MANAGEMENT

Sh
...
20, 500
i)

Payback period (PBP)
Original cost of the investment

PBP
ii)

=

Annual cash returns (Inflows)

=

𝑠ℎ
...
37,500

= 2
...
48732
8
20,500
0
...
)
(108,500)
168,274
...
45
66,475
...
7860
0
...
95 (32%−15%)
66475
...
75

HR

Present value
PV(sh
...
25
(1,800
...
47%
June 2013 Question Four A

QUESTION 4
b) If the project is used over its entire life, the NPV is negative
...
9091) + (3,750 × 0
...
4 + 3,099 + 2,629
...
05 × 1,000
=
-235,050
If the project is abandoned after one year
NPV = (4,000 × 0
...
9091) – 9,600
=
3,636
...
6 – 9,600
=
-509 x 1,000
=
-509,000
NPV = (4,000×0
...
8264) + (3,800×0
...
4 + 3,099 + 3,140
...
72 x 1,000
=
275,720
Advice
Project X should be abandoned after 2 years as its net present value is positive
...
Indicate which projects should be selected
Project
Present value of future cash
flows
Sh
...
‘000’

NPV
Sh
...
‘000’

500
1,000
400
300
200

500
1500
(100)
100
100

Accept
Accept
Reject
Accept
Accept

Projects A, B, C, D, E have a positive NPV and should therefore be accepted
ii
...
‘000’
A
500
B
1500
D
100
100
E
2200
Total NPV
2,200,000
iii
...
0
2
...
33
1
...
2,100,000 will maximize the value of the firm
May 2012 Question Four B

QUESTION 6
b) Advice on whether to replace the machine
...


9800,000−2000000

Old machine
Cost (two years ago)

5

= 𝑠ℎ
...
4,000,000

FINANCIAL MANAGEMENT

REVISION PARTNER

179

Less: depreciation to date
4,000,000−0

=
×2
5
Current book value

= (1,600,000)
2,400,000

Depreciation (each of the next 5 years)
= sh
...
480,000

Annual incremental depreciation (new machine – old machine)
= sh
...
480,000 = sh
...

May 2012 Question Three D

QUESTION 7
i
...
Advice on whether old machine should be replaced
...
‘000’
Incremental resale value:
New machine
Less: foregone-old machine
Working capital recovered
Total terminal cash flows (TC5)

5,000
-

Sh
...
‘000’
Incremental contribution per annum
10,000
Less: Annual fixed costs excluding depreciation
Incremental
10,000
EBDT
86,000−5,000
16,200
Less: Incremental depreciation New machine
=
5
50,000−0

Less: Foregone depreciation on old machine
Incremental depreciation

8

=

FINANCIAL MANAGEMENT

6,250
(9,950)
50

REVISION PARTNER

180

Less: Tax @ 30%

15
35
9,950
9,985

Add back: incremental Depreciation
Incremental EBDT per annum for 5 years
A replacement decision can be made using any of the following methods;
- Net present value
- Profitability index
- Internal rate of return

The Net Present Value:
NPV = [ A x PVIAF n , r % ] + [l e s x PVIAF n , r % ] - I
= [9,985,000 x PV7AF 5, 12% ] + [13,000,000 x PVIAF 5
...
6048] + [13,000,000 x 0
...
6048]+ [13,000,000 𝑥 0
...
74
The PI is less than 1, thus it is not appropriate to replace the machine
Using the Internal Rate of Return (IRR) method:
Since NPV< 0 I
...
-15,629,872 obtain NPV> 0 using a discounting rate lower than cost of capital
Try 6%
NPV = [9,985,000 x 4
...
7473] – 59,000,000
= [48,461,199 + 12,369,500] – 59,000,000
= 1,830,699
Therefore, IRR = A% +
= 1% +

𝑀

(B% - A %)

𝑀+𝑁
1,830,699

17,460
...
2% = 2
...

• The cost of capitalThe cost of each and every source of capital i
...
cost of debenture, preference share capital
and equity capital will influence the capital structure
...

• Ability of the firms earnings to support the capital structureThe earnings of the firm should be considered and assess whether they are able to support
the capital structure
...
Difference between weighted average cost of capital and marginal cost of capital
Weighted average cost of capitalThis is the overall cost of capital on funds utilized
...
It’s based on the weights or proportions of capitals contributed in
the capital structure
...
It’s the cost of raising new capital to
finance new projects
...


iii
...
Langat Ltd
Specific cost of each financing
Cost of retained earnings;
Kr =

𝑑0 (1+𝑔)
𝑃0

+ 𝑔

Where
Kr = cost of retained earnings
d o = initial dividends
g = growth in dividends
P o = initial price
=

𝑑1

+ 𝑔

𝑃0

=6/62 + 6%
9
...
68%
The cost of ordinary share capital (ke);
Ke =

𝑑0 (1+𝑔)
𝑃0 −𝑓

+ 𝑔

Where
Ke= cost of share capital
f = floatation cost
=

𝑑1

𝑃0 − 𝑓
6

=�
=�

+ 𝑔

62−2
6

62

𝑥 100� + 6%

𝑥 100� + 6%

= 16%

The after tax cost of debt capital;

𝐾𝑑 = �

𝑝𝑑 − (𝑝𝑑 − 𝐷)
�
𝑛
� 𝑥 100
𝑝𝑑 + (𝑝𝑑 − 𝐷)
�
�
2

[𝑖 (1 − 𝑇)] + �

FINANCIAL MANAGEMENT

REVISION PARTNER

182

Where
Kd= cost of debt
Pd =par value of debt
D= discount
n = number of years
t= tax rate
i= interest
1,000 − (1,000 − 30)
[8% 𝑥 1,000(1 − 0
...
5
985

� 𝑥 100 = 5
...
6
90

𝑥 100� = 8
...
200,000

50%

WMCC below the break point
𝑆

𝐵

𝑃

WMCC = 𝑘𝑒 � � + 𝑘𝑑 � � + 𝑘𝑝 � �
𝑉

𝑉

𝑉

= 15
...
5) +5
...
3) +8
...
2) = 8%+ 1
...
688%
= 11
...
5

=

60,000 0
...
2
200,000 1

Cost of
each
15
...
85%

6%

1
...
80%
11
...
This technique is used in the
selection of risky investments
...
This will cause maximization of the investor's utility of wealth
...


𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑉𝑎𝑙𝑢𝑒

𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛𝑠

=

����
𝑅𝐽
𝜎𝐽

b) Using the mean variance rule, we shall determine the return per unit of risk for each
investment option
...


An investment option which provides the greatest return per unit of risk will be
recommended
...
Shs ‘million’
Forecasted return (𝑹𝑾 )
Sh
...
3
[20 − 34]2 x 0
...
8
����
0
...
7 = 25
...
9
...
17𝑀

= 3
...
Shs ‘million’

Forecasted return (𝑹𝑳 )
Sh
...
5]2 x 0
...
075
[55 − 44
...
7 = 77
...
25

0
...
7
44
...
25 = Sh
...
039 million
Therefore, return per unit of risk
=

����
𝑅𝐿

𝜎𝐿

=

44𝑀

16
...
774

Forecasted return (𝑹𝑷 )
Sh
...
Shs ‘million’
[𝑅𝑃− ����
𝑅𝑃 ]2 Pi
[30 − 35]2 x 0
...
5
[40 − 35]2 x 0
...
5
Variance 𝜎𝑃 2 = 25

0
...
5
35

Therefore 𝜎𝑃 = √25 = Sh
...

June 2011 Question One A and B

QUESTION 10
i) Annual cash flow calculations;
Internal investment cost = shs
...
‘000’
60,000
(16,000)
(19,000)
(10,000)
(6,000)
9,000

Are irrelevant cost, they are not directly related to this project
...

Reduction in receipts of other docks is directly associated with this preference, it’s therefore
one of the project cost
ii)

NPV of the project
NPV = present value of inflows – the outflows
NPV =

9,000,000
0
...
Workings
Workings
Selling price per unit
Less: Variable cost 50
Other variable cost 19
Contribution margin

80
(69)
11

Year
1
2
3
4

Units manufactured
400000 x 11
500000x 11
600000 x 11
600000 x11

Total contribution
4400 000
5500000
6600000
6600000

2
...
fig Balancing allowance

Capital allowance
2,000,000 x 30%
1,500,000 x 30%
1,125, 000 x 30%
4,625,000
3,075,000 x 30%

Total allowance (800000 - 300000

7,700,000

Year
Cash flows
1
2000000
2
2900000
3
3380 000
4
2797500
4
300000
5
(157500)
Present value of annual cash flow
Less: Initial investment cost
NPV

Discount factor 9%
0
...
8417
0
...
7084
0
...
6499

Tax benefit
600,000
450,000
337,500
922,500

Cost of capital = 10%
After tax of cost of debt – Kd (1-r) = 0
...
30) = 6
...
8 x 0
...
20 x 0
...
092 = 9%
1
...
IRR = 9% + �

977675
...
25

Year of benefit
2
3
4

× 6� % = 14
...
25)
8,977,967
...
75

5

REVISION PARTNER
Year
1
2
3
4
4
5

186

Cash flows
2,000,000
2,900,000
3,380,000
2,797,500
300,000
(157,500)

Discount factor 15%
0
...
7561
0
...
5718
0
...
4972
Present value
Initial investment
NPV

Present value
1,739,200
2,192,690
2,222,350
1,599,610
...
5
(8,000,000
...
5)
December 2010 Question Three B

QUESTION 12
Using net present value technique advice the company
Annual after tax cash flow
Year
1
2
3
Sh
...

Sh
...

1,597,200
(319,440)
(500,000)
777,760
(140,400)
270,000
907,360

5
Sh
...
10
146
...
20
26
...
282

Year

Cash flow

Discount factor 12%

1
2
3

1,100,000
760,000
492,000

0
...
7972
0
...
948
Present value
Shs
982,190
605,872
350,206
...
6355
0
...
5674
0
...
00
667756
...

June 2010 Question One

QUESTION 13
i
...

Year
Sales
Variable cost
Fixed cost
Before tax cash flow
Tax 30%
Tax shield
(30/100 x 5000000)
Overhaul tax shield
(20000000/5 x 30%)
Annual after tax cash
flows
Overhead cost
Working capital

Annual after tax cash flow
1
Sh
...
‘000’
750,000
(450,000)
(100,000)
200000
(60000)
1500

3
Sh
...
‘000’
1500000
(900000)
(100000)
500000
(150000)
1500

5
Sh
...
‘000’
100000
(600000)
(100000)
300000
(90000)
1500

______
141500

35100

______
311500

211500

_______
141500

_______
351500

(40000)
311500

_______
211500

Workings
120,000,000−30,000,000
Depreciation new machine = shs
...
15
Old machine
= shs
...

= 𝑠ℎ𝑠
...
5,000,000
Terminal cash flows
Salvage value of the new machine after 15 years
Less: salvage value of old machine after 15 years
Release working capital

= shs
...
(5,000,000)
25,000,000
40,000,000
65,000,000

FINANCIAL MANAGEMENT

10
Sh
...
‘000’
1000000
(600000)
(100000)
300000
(90000)
1500
1200
_____
212700

(20000)
_______
(20000)

_____
21270

REVISION PARTNER
End of year

Cash flow ‘000’

1
71,500
2
141,300
3
141,500
4
351,500
5
311,500
6 – 10
211,500
10
(20,000)
11-15
212,700
15
65,000
Present value cash flow
Less: Initial investment cost
NPV

188
Discount factor
20%
0
...
6944
0
...
4823
0
...
2019
0
...
483
0
...
100,000,000
Add: installation costs
=
sh
...

The option to vary output
If the condition turns favorable production can be expanded
...
The option to abandon
If the project has abandonment value this effectively represents an option to the project own
...
The option to postpone
...
For some projects ,
there is the option to wait thereby obtaining new
iv
...
Option to vary the mix of output in response to market demand
b)
i
...
8929
(535,740)
2
(600,000)
0
...
7118
71,180
4
200,000
0
...
5674
226,960
6
400,000
0
...
4523
135,690
8
10,000
0
...
NPV of the project with real options
End of year
Cash flow ‘000’
5
(1,000,000)
6-10
600,000

Discount factor 12%
0
...
0454
NPV

FINANCIAL MANAGEMENT

Present value ‘000’
(567,400)
1,227,240
6,598,840

REVISION PARTNER

189

Therefore NPV of the project with real option
Shs
...
449,740
iii
...
The option
value has raised the work of the project and the project with real option is viable since it has a
positive NPV
August 2009 Question One

QUESTION 15
c)
Shs
...
700000
2 ‘000’
1360
(408)
210

3 ‘000’
1050
(315)
210

4 ‘000’
900
(270)
210

5 ‘000’
840
(252)
210

6 ‘000’
750
(225)
210

1162

945

840

798

735

i)
Payback period
Year
1
2
3

ii)

Cash flow
1,442,000
1,162,000
945,000

651000
0
...
8𝑦𝑒𝑎𝑟𝑠

Net present value of the machine

Year
1
2
3
4
5
6

Cash flow
11442000
1162000
945000
840000
798000
735000

Discount factor 12%
0
...
7972
0
...
6355
0
...
5066
Present value
Initial value
NPV

Present value
1,287,561
...
4
672,651
533,820
452,185
...
0
4,245,515
...
0)
(45,515
...
Profitability
supports the shareholder wealth maximisation objective
...

However, funds held in cash do not earn a return, while near-liquid assets such as short-term
investments earn only a small return
...

Good working capital management, therefore, needs to achieve a balance between profitability
and liquidity if shareholders wealth is to be maximised
...
000328
365
3

Optimal cash balance (Z) = �
3

4𝑖

3× 200× (800,000)2

=�

4×

12
365

+1,500,000

= 663,429 + 1,500,000
Return point

= Sh
...
2, 384,572
3

3

(iii) Upper cash limit
(H) = 3Z – 2L
H = 3×2,163, 429 – 2 × 1,500,000
= 3,490,287
December 2014 Question Five B and C

FINANCIAL MANAGEMENT

REVISION PARTNER

191

QUESTION 2
(b) Rand Mills Ltd Statement of working capital requirements
Output per annum
Output per month

30,000 units
12/100 ×30,000 units = 2,500 units

Raw materials per months (Sh
...
50×2,500)
Overheads per months

500,000
125,000
375,000
Sh
...

1,000,000

250,000
31,250
93,750

Stock of finished goods (1 month) (1,000,000 × 1)
Debtors (2 month) (2,500 × 500 × 2)
Cash balance required
Less: Current liability
Creditors (1 month) (500,000 ×1)
Working capital required

375,000
1,000,000
2,500,000
250,000
5,125,000
(500,000)
4,625,000

May 2014 Question Five B

QUESTION 3
c) The effects of relaxing the cash discount on residue income
...

∆RI = incremental revenue after discount
ACP = Average collection period
=0
...
03 – 0
...
02=1,780,000
∆I =
𝑆𝑜

360

=

𝑆𝑜

360

(ACPo – ACPn)

(ACPo – ACPn) –

200,000,000
360

∆𝑆

360

ACPN

(30 -27) – (0
...
3]
= 231, 000
Alternatively;-

Amount of sales
Variable cost
Contribution
Discount allowed
Opportunity cost
Annual pretax profit
Tax
Annual after tax profit

Current policy
Shs ‘m’
200
(160)
40
(2)
(2)
36
10
...
2

Proposed terms
Shs ‘m’
210
(168)
42
(3
...
890)
36
...
899
25
...
78)
0
...
33
0
...
231

Annual after tax profit=shs
...

December 2013 Question One C

QUESTION 4
b) The effect of relaxing the debt collection effort on the net profit of Magas Ltd
Change in net profit =
(Increase in sales(1 − variable cost to sales ratio) − increase in bad debt) (1-tax rate) – cost
of capital × increase in investment in receivables
Increase in bad debt cost (6/100 × 45,000,000 – 5/100 × 40,000,000) = 700,000
Increase in investment in
𝑠𝑎𝑙𝑒𝑠 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑎𝑣𝑒𝑟𝑎𝑔𝑒
𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛
� 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 − 𝑎𝑣𝑒𝑟𝑎𝑔𝑒
�
𝑝𝑒𝑟𝑖𝑜𝑑
360
𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛
𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒
𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑥 𝑐𝑜𝑠𝑡 𝑡𝑜 𝑠𝑎𝑙𝑒𝑠
360
𝑟𝑎𝑡𝑖𝑜
𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛
𝑝𝑒𝑟𝑖𝑜𝑑

Receivables =

+

FINANCIAL MANAGEMENT

REVISION PARTNER
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛

𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡

= [5,000,000 (0
...
12 �

193
45,000,000

= (1,000, 000-700,000-333,333
...
7)
(Sh
...
40)

360

(40) −

150
...
80� (0
...

June 2013 Question One D

QUESTION 5
a)

(i) (0
...
6×50) + (0
...
6 × 900,000,000 × 0
...
5
2% x 40% x 900,000,000

5,400,000
7,200,000

Strategy B
Average current debtors
Average debtors after adoption
20
x 540,000,000

Shs
49,500,000
2,700,000
4,050,000

(12,600,000)
43,650,000
75,000,000
(30,000,000)
_______
45,000,000

360

Decrease in investment (75 -30) = 45 million
Financial effects
Shs
Bad debts saved (2% x 0
...
9 ×1
...

13,500,000
25,200,000
6,750,000
45,450,000

(18,090,000)
27,360,000

Preferred strategy is to introduce cash discount since this strategy has the highest net benefit
...
09865
365

+ 500,000

= Shs 166,950
...
72
(ii)

Upper cash limit

= Lower limit + 3Z
= 500,000 + 3(666,950
...
16
= 2,500,852
...
72)
= Sh 1,000,213
...
700
Gross profit 3600,000 x 25/100 900
Purchase of raw materials = sh
...


Raw materials holding period =

365 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑅
...


Production period

𝑎𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑠𝑙 𝑢𝑠𝑎𝑔𝑒

365 𝑥 150,000
2160000

= 25 days

=

365 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 𝑖𝑛 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠

=

365 𝑥 350,000

𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡

2,700,000

= 47

R

days

FINANCIAL MANAGEMENT

REVISION PARTNER
iii
...


Average collection period =
=

Average payment period =

𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠

365 𝑥 200,000
2700,000

= 27 days

365 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑒𝑏𝑡𝑜𝑟𝑠
𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑒𝑙𝑠

365 𝑥 306000
3600000

= 31 days

365 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠

𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑠𝑙

=
-

365 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝐹
...

Month
Total working capital
Permanent W
...
‘000’
Sh
...
‘000’
January
4,500
4,500
Nil
February
4,500
4,500
Nil
March
6,250
4,500
1,750
April
8,000
4,500
3,500
May
11,500
4,500
7,000
June
16,750
4,500
12,250
July
22,000
4,500
17,500
August
25,250
4,500
20,750
September
16,750
4,500
12,250
October
9,750
4,500
5,250
November
8,000
4,500
3,500
December
6,250
4,500
1,750
54,000
85,500
6
...

= kshs
...
Total amount of short term finance required monthly = Kshs
...
7,125,000

FINANCIAL MANAGEMENT

REVISION PARTNER

196

8
...
25,250,000 x 25/100
= sh
...
500
9
...
25,250,000 x
= Kshs
...
Total cost of working capital finance under the matching policy
- Cost of long-term funds:
30
= kshs
...
1,350,000
100
- Cost of short term finance
25
= Kshs
...
1,781,250
100
Total cost of working capital finance
= sh
...


Optimal cash balance (C)
𝐶=�

2 × 𝑡 × 𝑏
𝐿

=

Where;
C =optimal cash balance
t= is the cash outlay
b= cost per transaction
L= the expected return
2 𝑥 45,000,000 𝑥 30

�
ii
...
183,712
The average cash balance
1
1
1
= (𝐶 + 𝑀) = (183,712 + 0) = (183,712) = Sh
...


2

2

The number of transfers between cash and marketable securities per annum
...
Inventory holding period (000)
= �

(17,340 + 15,960)/2
𝐴𝑉
...
20 𝐷𝑎𝑦𝑠

FINANCIAL MANAGEMENT

REVISION PARTNER

197

2
...
𝐷𝑒𝑏𝑡𝑜𝑟𝑠
� 𝑥 360
𝑥 360� = �
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
120,000
= �

39745

120,000

𝑥 360� = 119
...
2 + 119
...
435 days
3
...
𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
� 𝑥 360
𝑥 360� = �
𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
90,620
= �

31,440
90,620

𝑥 360� = 124
...
435 – 124
...
535 days
Workings:
COS = O
...
S
= 17,340 + P - 15,960
= 92,000
= 1,380 + P = 92,000
Purchases = 92,000 – 1,380
= 90,620

June 2011 Question One C

QUESTION 11
c) Stores limited working capital requirements
Direct material 30% x 15,000,000
Direct labour 25% x 15,000,000
Variable costs 10% x 15,000,000
Fixed costs 15% x 150,000,000
Selling and distribution 5% x 15,000,000

Current assets
4,500,000
1
...
Work in progress
Raw materials�
Labour �

12

Variable OHD �

12

1

× �

2
150000
12

1

× �
2

1

× �
2

3
...
‘000’

12

4,500,000

3750000

= 4,500,000
= 3,750,000
= 1,500,000
= 2,250,000
= 750,000

12

× 1�

Shs
...
Debtors �
× 2
...
5

(1,168,750)
4,300,000
June 2011 Question Four C

QUESTION 12
a) Explain how business entities can adopt aggressive , moderate and conservative working
capital policies
Aggressive approachUnder this approach the firm uses more of short term financing
...

This approach presents an increased risk of liquidity and cash flow problems but there is potential
profitability increase since short term finances are cheaper
...
e
...
Long term funds will be matched with fixed assets and permanent current assets, while
short term funds will be used to finance the fluctuating current assets
...

Conservative approachUnder this approach the firm depends more on long term funds for its financial needs
...
During this period the firm invests extra capital in marketable
securities and profitability levels are low since long term sources are expensive
...
‘000’
[104 x 100] =
[39 x l00] =
[78 x l00] =
[39x100] =

FINANCIAL MANAGEMENT

10,400
3,900
7,800
22,100
3,900
26,000

REVISION PARTNER

199

W2:
Credit sales
Cash sales

[3/4 x 26,000] =
[1/4 x 26,000] =

19,500
6,500
26,000

The estimated annual average working capital is determined as follows:
Shs ‘000’
Average assets per annum
Closing stock balances
Average raw material stock

2

12

×10,400
1

Average work in progress stock ×22,100
12

Average stock of finished goods
3

Debtors ×19,500
12
Cash balance
Total current assets

1
...
333
1,841
...
50
4,875
240
11,452
...
Saving on 2011 expenses
2
...
90,325

𝑠ℎ𝑠
...
The
financing of all the fixed assets, all permanent current assets and part of the temporary current
assets is through long term funds
...

•

Aggressive approachUnder this approach the firm uses more of short term financing
...

This approach presents an increased risk of liquidity and cash flow problems but there is
potential profitability increase since short term finances are cheaper
...
e
...
Long term funds will be matched with fixed assets and permanent current
assets, while short term funds will be used to finance the fluctuating current assets
...


b) The company’s cash conversion cycle
Gross profit margin = 40%
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
GPM =
0
...
667
10,000
360 ×800
8000

= 24 days
= 36 days

FINANCIAL MANAGEMENT

REVISION PARTNER

201

Stock of holiday period
Average collection period
Operating cycle
Less: average payment period
Conversion cycle

120days
24days
144 days
36days
108 days

c)
i
...
cost on stock (200000 x 20%)
Decrease in financing cost (200000 x 20%)
Increase in opport on receivables (3000 x 20%)
Net

Additional
benefit
6,000,000
(5,100,000)
900,000
(400,000)
40,000
(600,000)
(60,000)

Advice
The company should not extend the credit period since there will be net cost of sh
...
Existing customers do not change their payment habits and only the new customers take the
full two months
Investment in policy
Current policy =

24000000
360

x 30 days = 2000000

Proposed policy
6000000
Existing customers =
× 60 = 1000000
360
3000000
Increase in sales
Variable costs 85%
Increase in sales contribution
Increase in opportunity cost on stock
Decrease in financing cost
Increase in opport on receivables (3000 -200 x 20%)

Proposed
policy
30,000,000

Current
policy
24,000,000

Net

Additional
benefit
6,000,000
(5,100,000)
900,000
(400,000)
40,000
(200,000)
(340,000)

Advice
The company should not extend the credit period since there will be net cost of sh
...


Economic order quantity
2𝐷𝑐

EOQ = �

𝑝𝑖

=�

2 𝑥 24000 𝑥 50
2 (0
...


202

Total relevant costs
𝑄
Inventory holding cost = 𝑃𝑖 =
Inventory ordering cost

iii
...
1)

× 50

Total cost

= 346
...
4
692
...
99)
= 47,520
4500
Inventory holding =
× 2 (0
...
10) = 445
...
7
48,232
...
10)
Inventory ordering cost =

2
24000

× 50
Total cost

3464

48,000
= 346
...
4
48,692
...


2𝑇𝐹

Optimal cash balance = �

i
...
12

𝐾

= 𝑠ℎ𝑠
...
12 = 𝑠ℎ𝑠
...
273861

December 2008 Question Three B

QUESTION 18
a)
Month
January
February
March
April
May
June
July
August
September

Working capital
requirement sh
...
‘000’
3,500
3,500
3,500
3,500
3,500
3,500
3,500
3,500
3,500

FINANCIAL MANAGEMENT

Seasonal working
capital sh
...

= 𝑠ℎ𝑠
...

= 𝑠ℎ𝑠
...
5
Cost of long-term funds = shs
...
875,000
Cost of short term funds = 7,125,000 ×

20

100

100

= 𝑠ℎ𝑠
...
2,300,000
Total cost of working capital finance if the firm adopts conservative financing strategy 242,500
25
×
= 𝑠ℎ𝑠
...

Raw material holding period
Production period
Finished goods holding period
Average collection period

24 days
5 days
18 days
27days
74 days
49 days
25 days

Less average payment period
Working capital cycle

Workings
365 ×𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑠𝑙
Raw material holding period =
𝑎𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑢𝑠𝑎𝑔𝑒

Shs
...
Purchase of raw material
Less closing stock
Raw material usage (annual)
1
2

365 × � (40,000+60,000�

Production period =

760,000

= 24 days

365 ×𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 𝑖𝑛 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠
𝐴𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡

Finished goods holding period =

=

1
2

365 × � (10,000+18,000�
1,050,000

365 ×𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠

FINANCIAL MANAGEMENT

= 5 days

REVISION PARTNER

204
=

1
2

365 × � (50,000+70,000�
1,250,000

365 × �

Average collection period=

Average payment period =

1
2

140,000+18,000
�
2

1,200,000

365 × � (110,000+100,000�
780,000

= 18 days
= 26
...

Stock holding period =
Inventory turnover =
ii
...
8

Gross profit margin =
𝑥
25
=
80𝑚
100
𝑥
= 0
...
8 + purchases – closing stock
Purchases = 60,000
Stock of holiday period
Average collection period
Operating cycle
Less: average payment period
Conversion cycle

75 days
45 days
120 days
18 days
102 days
June 2007 Question One B

FINANCIAL MANAGEMENT

REVISION PARTNER

205

QUESTION 20
Sales decrease
Variable cost 70%
Decrease in sales contribution
Decrease I interest cost (500,000-252178) x 11%

Proposed
policy
2,600,000
1,820,000

Current policy
3,000,000
2,100,000

Decrease in tax (92,805 ×30)
Net cost
Accounts receivables
3,000,000
Current policy =
× 60
Proposed policy =

360

2600000
360

500,000 – 25,778 x 11%

× 35

Additional
benefit
(400,000)
280,000
(120,000)
27,194
...
67
(64,963
...
42

Advice
The company should not change its credit terms to net 30 days as this will result to a net cost
...
(million)
2
1
3
6
4
10
3
7
10

Other current assets
Account receivable
Inventory
Current assents
Fixed assets
Total assets
Debt(total debt)
Equity

Workings
Sales to total assets =

𝑆𝑎𝑙𝑒𝑠

𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Total assets =

=

𝑠ℎ 20 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
2

𝑆𝑎𝑙𝑒𝑠

𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛 𝑜𝑣𝑒𝑟

= sh 10 million

Total debt = 30% × 10 million
= shs 3 million
Fixed assets turnover =

𝑆𝑎𝑙𝑒𝑠

𝑓𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠

Fixed assets

= 20𝑚�5 = sh 4 million

Current assets= total assets – fixed assets
= shs 10m – shs 4m = shs 6m

Current ratio =

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Current liabilities = 6 million÷3
= sh
...


Return On Capital Employed
Equity finance
5 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
× 100% = 25%

ii
...
“million”
5
...
0
(1
...
5

Operating profit
Finance charges
Profit before tax
Tax @ 30%
Profit after tax
Return on equity =
iii
...
5
20

2
...
5%

10

Debt finance
Sh
...
0
(1
...
0
(1
...
8
× 100 = 28%

Impact of the performance of Docarex Ltd
− When considering the return on equity (ROE), the-geared option (debt finance) achieves a
higher return than the equity finance option
...

− The excess return on that part funded by debt passes to the shareholder enhancing their
return
...
(million)
200
(100)
100
50%

FINANCIAL MANAGEMENT

REVISION PARTNER

208

Year 2013 financial performance projection
Sh
...
7
= Sh 600,000

Therefore current assets

= 600,000 × 1
...
6

Fixed asset turnover=

𝑆𝑎𝑙𝑒𝑠

𝐹𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠

Therefore assets =
Total assets =

𝑆𝑎𝑙𝑒𝑠 (𝑆)

𝑆𝑎𝑙𝑒 (𝑆)

5
...
4

But, current asset + Fixed asset = Total assets
5
1,020,000 + = Total assets
5
...
6) + s = (5
...
4
5,712,000 + s = 4s
3s = 5,712,000
s = Sh 1,904,000
Sales = Sh 1,904,000

FINANCIAL MANAGEMENT

REVISION PARTNER
1,904,000

Total assets =
Fixed asset =
𝐷𝑒𝑏𝑡

𝐸𝑞𝑢𝑖𝑡𝑦

3

=

2

1,904,000

EBIT =

5
...
4

100

30

100

209

= 1,360,000
= 340,000

=760,000 𝑥 3�5 =456,000
=760,000 𝑥 2�5 =304,000

x 1,904,000

x 1,904,000

= Shs
...
2 = 95,200/3
...
29,750
(i)

Chepe Ltd
Income Statement for the financial year ended 30 November 2012:
Sh
...

Fixed assets
Current assets
1,020,000
Less current liabilities
(600,000)

Sh
...
‘000’
8,000
1,000
9,000
Sh
...
‘000’
Market values
Fixed charges capital
9% loan notes @ Sh 0
...
77
Equity
Ordinary shares @ Sh 1
...
9%

7,170+10,800

Weighted average cost of capital
Cost of equity
𝐾𝑒 =

0
...
09)

=
1
...
1%

𝐷𝑜 (1+𝑔)+𝑔

+ 0
...
07
𝐾𝑝 =
x 100 = 9
...
77

Cost of loan notes
𝑖 (1−𝑡)
𝐾𝑑 =
=

𝑃𝑜
9 (1−0
...
9

17
...
1 𝑥 770
17,970

+

7
...
Total debt =

ii
...
Capital gearing ratio
=

2011
1074 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
=
× 100
3373 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

= 31
...
79%
3588

= 1
...
76%

FINANCIAL MANAGEMENT

2591

= 1
...
The firm find it difficult to raise additional funds or cost
of additional funds would be too high
May 2012 Question Three A

QUESTION 8
a
...

• Ratios help in determining the liquidity levels of the firm
• Necessary for determining the gearing level of the firm
• They determine in determining the performance of the firm in terms of profitability and even
try to make comparisons with other firms in the same industry
...

December 2010 Question Five E

QUESTION 9
i
...
24,000,000
Balance sheet item
% sales
13
Fixed assets
× 100 = 65
Stock

Debtors
Total assets
Creditors

20

3

20
2

20
6

20

× 100 = 15

× 100 = 10
90
× 100 = 30

Increase in total assets = 4,000,000 ×90%
Less increase in liabilities 30% × 4,000,000
Expected retained earnings 24,000,000 (0
...
30)
External financial requirement

= shs
...
(1,200, 000)
= shs
...
1,824,000

ii
...
‘000’
Net fixed assets
15,600
Stock
3,600
24,000
21,600
Debtors
Financed by
4,000
OSC
6,576
Retained earnings
7,200
Creditors
1,824
Commercial paper
Long term debt
2,000
21,600
June 2010 Question Two B

FINANCIAL MANAGEMENT

REVISION PARTNER

212

QUESTION 10
i
...


Price earnings (P/E) ratio

=

12,000
1,200
13,200
5,143
18,343
= 15
...
72
𝑠ℎ
...
5
...
2 × 13

MPS = 68
...
‘000’
190,000

Gross profit
Deduct: variable costs
Fixed cost
Earnings before interest and tax
Interest (20,000 + 2,000)
Earning before tax
Tax
Retained after tax
EPS =

𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑎𝑛𝑑 𝑖𝑛𝑡𝑒𝑟𝑠𝑡

=

𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠

MPS =

EPS =

40,000
55,000

𝑀𝐴𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟𝑐𝑛𝑒𝑡𝑎𝑔𝑒

8000

= 𝑠ℎ
...
5

= 5
...
71
...
500,000

= 8,000 + 1500 = 9500

FINANCIAL MANAGEMENT

June 2009 Question Three B

REVISION PARTNER

213

QUESTION 12
i)

Operating cash cycle
Stock holding =

360 ×2,680,000

= 49 days

6,460,000

Account receivables =
Accounts payable =

360 ×3,260,000
9,040,000

360 ×2,900,000
6,820,000

= 129
...
1 days

Stock holding period
Add collection period
Operating cycle
Less payment period
Conversion cycle
𝐶𝐴−𝑠𝑡𝑜𝑐𝑘

ii)

Quick ratio =

iii)

Current ratio =

iv)

Debt to equity ratio =
=

149 days
130 days
279 days
(153) days
126 days

𝐶𝐿

=

6,120,000−2,860,000
5,700,000

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦

2,400,000
756,000

=

6,120,000
5,700,000

𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡

𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 𝑐𝑎𝑝𝑖𝑡𝑎𝑙

× 100

= 31
...
6: 1
1
...
7%

= 2
...
00, total assets increase by 1
...
5) = 135,000,000
Less increase in creditors (90,000 x 0
...
20) (0
...
15) = (48,600,000)
Net profit margin =

54,000
45,000

Dividend payout ratio =

× 100

= 12%

𝑇𝑜𝑡𝑎𝑙 𝑑𝑖𝑣𝑖𝑑𝑛𝑒𝑑

𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑒𝑡𝑟 𝑡𝑎𝑥

=

Retained = 100 – 25% = 75%
Total assets
Increase in creditors
Retained earnings
External financial requirement

13,500
5400

× 100

= 25%

135,000,000
(54,000,000)
(48,600,000)
32,400,000

b) Let the maximum growth in sales be (g)
Increase in sales = 450,000,000g
Sh
...
5)
Less increase in creditors – total sales
675,000,000 (g) – 450,000,000 (0
...
12) (0
...
11% = g
Current level of gearing =

𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡

𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 𝑐𝑎𝑝𝑖𝑡𝑎𝑙

Let the maximum growth in sales in (g)

=

139,500

210,000

0
...
5) – 450,000,000g (0
...
75) -450,000,000
(1+g) (0
...
75) (2/3) =0
675,000,000g – 270,000,0000g – 27,000,000 – 27,000,0000g -0
375,000,000g = 27,000,000
g =7
...
4,000,000 x 90%
Less: Increase in total liabilities 30% x 4000000 =
Expected retained earnings = 24,000,000 (0
...
3)
External financial requirement (commercial paper)

Shs
3,600,000
(1,200,000)
57,600
1,824,000

ii) Projected balance sheet
Projected balance sheet as at 31st December 2008
Shs
...
S
...
5)

(12% × 1,750)

(7%×350)

(12% x 13,500)

(7% x 10,500)

8,228
...
of ordinary shares

14,400
5

= 2,880

Vyumba ltd
Sh ‘000’
12,000
(1,620)
10,380
(3,114)
7,266
( 735)
6,531

3,600
5

= 720

i)
Ratio
Gearing ratio

Formula
Fixed charge capital x 100
Equity

ii) Earnings per Share
EPS =

6,531
720

Price Earning Ratio =

MPS
EPS

Vyumba (P/E) =

iv)

8,228
...
1%

Earnings attributable to ordinary shareholders
Number of shares

Mjengo (EPS)
=

iii)

Mijengo ltd
350 + 1,750
x 100
14,400 + 12,000 + 18,000
= 4
...
75
2
...
5
9
...
85

= 9
...
88 times

Interpretation of results in (i) & (iii) above
Gearing ratios:
Vyumba Ltd uses more externally borrowed funds in its capital structure as a compared to
Mijengo Ltd
...

Price Earnings Ratio: The P/E ratio indicates the number of years an investor will take to
recover his investment in the firm given the MPS and EPS
...
88 meaning that investors can recover their investors
faster as compared to investors in Mijengo Ltd
...
68 x 100
36
4
...
8%

=
Workings
EBIT
Interest
EBT
Tax
EAT
Dividends
Retained Earnings
DPS

=
=

Sh‘000’
9,000
(3,000)
6,000
1,800
4,200
1,680
2,520

(10% x 30,000)
(30% x 6,000)
(40% x 4,200)
Dividends
No
...
68

QUESTION 18
i)

Ratio
ROCE

Formula
Net profit (EAT) × 100
Capital employed
Sales
Capital employed

ii)

Turnover of capital

iii)

Operating expenses ratio

iv)

Account receivable T/O in
days

v)

Dividend Yield

Operating expenses ×100
Sales
Av
...
of days
Credit Sales
DPS ×100
MPS

FINANCIAL MANAGEMENT

224,000x 100 = 12
...
22 Times
1,800,000
560,000 x 100 = 14%
4,000,000
400,000 x 365 days
4,000,000
=36
...
268
DY = 0
...
36%
EPS = 224,000
400,000 = 0
...
56 = 8
...
5
MV: BV = 5
3
...
09:1
1,520,000 – 100,000
1,400,000
1
...
5:1

0
...

• This can be determined using the current ratio and quick ratio
...

• This might be because the company does not have as many current assets as the other firms
in the industry
...


QUESTION 19
a)
Ratio
1
...
8
FA

2
...
4
Av
...
Stock Turnover
4
...
Av Debtors Collection Period

360days × Av
...
Current Ratio

CA = 2
...

Let 18% Debt = X
Interest Exp = 18% x X
0
...
08
...
P (45%)
Less: Operating expenses excluding interest
Operating Profits (EBIT)
Less: Interest expense (w4)
EBT
Less: Tax 30%
EAT (Net Profit)
Less Pref dividends
Earnings available to ord
...
shares capital
Retained profit
18% debt (Debenture) Refer note 7
b)
This is an industrial analysis relating to liquidity, profitability and gearing
Ratio
Acid Test Ratio

Formular
CA – Stock
CL

Company
45,200 –16,875 = 1
...
340
x 100 =15
...
T Debt x 100
Equity

30,000 x 100
65,000 + 7120

Return on equity

Capital Gearing

FINANCIAL MANAGEMENT

= 41
...

b) Observation: The co
...

d) Implications: This implies that the firms in this industry will be liquid most of the time but their
profitability is likely to decrease because the return of current assets is less than the return of
long term projects
...

Observation: The ratio for the company is less than that of the industry average
...

Implication: This is because the co
...


iii)
a)
b)
c)

Gearing
Classification: This can be observed by using the capital-gearing ratio
...

Reason: This is because the company has used more fixed return capital (Debt) in its capital
structure
...
will be paying more fixed financing charges in the form of
interest compared with the industry average
...

They are historical in nature
ii
...

Differences in accounting policies by firms
iv
...

Different firms in the same industry have different sizes, levels of technology and
diversification of risks
...

It is not possible to carry out a cross-sectional and industrial analysis for monopolistic firms
vii
...
This
impairs the extent to which ratios can be relied upon
...
56%
900,000

iii) ROCE

Net II(EAT)x 100
Capital Employed

88,900 x100
281,500

iv) P/E Ratio

MPS but EPS = Earning to Ord
...
of Ord
...
9M – 4
...
8
...
8
...
404:1

= 31
...
378 Times

REVISION PARTNER

221

v) Interest Cover Ratio

EBIT
Interest Expense

= 127,000 +4,000
4000

vi) Total Assets Turnover

Sales
Total Assets (FA + CA)

= 32
...
1439 Times
213,900 + 205,900

c) Working Capital Cycle = Debtors Collection period + Stock Turn over - Creditors payment Period
Debtors collection period = average debtors x Number of Days in a year
Credit Sales
= 35,900×365 = 21
...
25 days

Creditors payments period = No
...
18 Days

Working capital Cycle = Debtors collection + Stock Turnover – Creditors Payments Period
= 21
...
25 Days - 33
...
91 Days

QUESTION 21
(a)

Increase by 15%
Increased in assets 300 × 0
...
15 ×0
...
15×0
...
75
Additional funds required
For achieve growth of 15%

(b)

18
...
5 300g ×0
...
12) (0
...
4 (1
...
14) (0
...
’m’
67
...
05)

=0
=0

0
...
891 or 8
...

300g x 0
...
4g)(0
...
75) 300(1 + g) (0
...
75) 40 = 0
60
1
...
4g (1+g) (0
...
75) (1+g)(0
...
75) 40
60
g =
0
...
79%
800g x 1
...

• Fixed assets, stocks and debtors are unlikely to increase in direct proportion to sales similarly,
creditors
...
15
27,600,000 x 1
...


QUESTION 23
(a)
Ratios
Current ratio CA:CI
Quick ratio (CA Stock) CI
Inventory Turnover (cost stock)
Average collection period
IA turnover (Sales FA)
Total Assets Turnover
Net income to Networth
Profit margins on sales
P/E ratio
Debt equity ratio

Industry
Average
2
...
0
7
3
...
0
2
...
5%
6
50%

1999

2000

2001

3
...
9
6
...
2
3
...
3%
46%
5
...
8%

2
...
9
4
...
4 days
10
...
5
14
...
9%
4
...
5%

2
...
7
2
...
1 days
12
...
9
82%
17%
4
...
4%

(b) Liquidity
• Is indicated by quick ratio and current ratio
• Trend wise the company liquidity deteriorated
• Compared to industry ratios are below the norm
...

Profitability is indicated by net income to net worth and profit margins on sales
• Trend wise it is clear the company’s profitability has declined over the years
• Cross-section wise the company is performing below the industry norm
...
The average collection period has also
alarmingly increased
...
The company is deteriorating in its use of assets
...
All indications are that a restructuring is
necessary
...

Debtors
collection period

Inventory
Turnover

Debt/Equity

Ratio NP margin

ROI = ROTA

Formulae
CA – Stock
CL

Av
...
a
...
Closing stock

Fixed charge capital
Equity

NP x 100
Sales

NP
Total Assets

1998
30 + 200
230 + 200 +
100

1999
20 + 260
300 + 210 + 100

2000
5 + 290
380 + 225 + 140

= 0
...
396

= 0
...
25

= 22
...
86

3,200
400

3,600
480

3,300
600

=8

= 7
...
5

350
100 + 500

300
100 + 550

300
100 + 550

= 0
...
46

= 0
...
5%

= 4
...
63%

300 x 100
1,430

200 x 100
1,560

100 x 100
1,695

= 20
...
82%

= 5
...
e
...

(ii)
Debtors = Account Receivable while ordinary share capital = common stock
...
g when commenting on deficiency, identify
efficiency or turnover ratios
...
g ratios are declining or increasing in case of trend or
time series analysis
...

(iv)
State the implications of the observation
...

- The ratio is lower than the acceptable level of 1
...

- The firm’s ability to meet its set financial obligations is poor due to a very low quick ratio
...

- Both ratios are declining over time
- This is particularly due to decline in net profits thus decline in the net profit margin and
increase in total accounts as net profit decline thus reduction in ROTA
...
g Sales – Net profit will indicate the total costs
...
5%
95
...
5%

Comment on gearing position:
- This is shown by debt/equity ratio
- This was 50% in 1998 and declined to 46
...
e
current liabilities + long term debt
Example: the total liabilities (long term debt + Current liabilities) as a percentage of total
assets are as follows:
1998

230+ 200 + 100 + 300 x 100
1,430

=

58
...
33%

2000

380 + 225 + 140 + 300 x 100
1,695

=

61
...

This is where shareholders are given dividends in cash form
...

The shares will be given in proportion to the shareholders ownership
...

• Reverse stock split
This involves the consolidation of the shares into bigger units or stocks
...

• Stock or share repurchase
This is where the company buys back some of the shares it had previously issued using the
cash that would have been paid out as dividend
...

 Liquidity
There must be sufficient cash to pay proposed dividend without compromising day to day
cash financing needs
...
Such dividends must
be paid out of accumulated net profits
...

 Need for finance
Investment plans and financing needs of the company should be considered
...

 Level of financial risk
Maintaining a low level of dividend payment can result to high level of retained earnings
which will reduce gearing by increasing the level of reserves
...
If dividend decisions convey new information
to the market, they have a signalling effect concerning the current position of the company
and its future prospects
...
5 = 5
120 =

𝟓+𝑷𝟏
𝟏
...
127
Step II
Amount of retained earnings
Retained earnings = Earnings - Total dividend
= 3,000,000 - (5 × 250,000)
= Shs
...
4, 250,000
Step IV
Amount of ordinary shares to be issued
𝐀𝐦𝐨𝐮𝐧𝐭 𝐭𝐨 𝐛𝐞 𝐫𝐚𝐢𝐬𝐞𝐝 𝐞𝐱𝐭𝐞𝐫𝐧𝐚𝐥𝐥𝐲
No
...
5669 shares

Value of the firm (Po)
Po =

(𝐍 + 𝐌) 𝐏𝟏 − 𝐓𝐨 + 𝐊
𝟏 +𝐑

N is current number of shares
M is the new number of shares
P1 is the market price per share
R is the cost of capital
T O is investment proposal cost
K is expected income

=

𝟏𝟐𝟕(𝟐𝟓𝟎,𝟎𝟎𝟎 + 𝟑𝟑,𝟒𝟔𝟒
...
𝟏

= Sh
...
𝟏

Initial dividends (Do) = 0
120 =

𝑷𝟏

𝟏
...
3, 000,000
Step III
Amount to be raised externally
= Initial Requirement - Retained earnings
= 6,000,000 - 3,000,000
= 3,000,000

Step IV
No amount of new shares to be issued
𝐀𝐦𝐨𝐮𝐧𝐭 𝐭𝐨 𝐛𝐞 𝐫𝐚𝐢𝐬𝐞𝐝 𝐞𝐱𝐭𝐞𝐫𝐧𝐚𝐥𝐥𝐲

M=

𝐌𝐚𝐫𝐤𝐞𝐭 𝐩𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞 (𝐌𝐏𝐒)
𝟑,𝟎𝟎𝟎,𝟎𝟎𝟎
𝟏𝟑𝟐

Step V

= 22, 727
...
𝟐𝟕𝟐𝟕𝟑) 𝟏𝟑𝟐 − 𝟔𝟎𝟎𝟎𝟎𝟎𝟎 + 𝟑,𝟎𝟎𝟎,𝟎𝟎𝟎
𝟏
...
30, 000,000

Payment of dividends is irrelevant since the value of the firm is the same in both cases
...
According to lintner’s model determine the dividends per share
D t =C r [EPS t + (1-c) D t-1 ]
C = C r is dividend per share of year t
R is the target payout ratio
EPS t = is the earnings per share for year t
D t is the dividend per share for year

t–1

D t = [0
...
6 ×3] + (1 – 0
...
2 = Shs
...
62
December 2013 Question Four A

QUESTION 4
b) Assumptions for dividend irrelevance theory to hold
• No transaction costs
...

• Investment decisions are unaffected by its dividend decisions
...

• Managers with large free cash flows do not waste them to invest in bad projects
...

• Unless-significant, a scrip issue will not dilute share price
• More shares reduce the company’s gearing and hence increase its borrowing capacity
...

• Shareholders may get a tax advantage, if dividends are in the form of shares rather than
cash
...
15 × 160 = Sh
...
8
(ii) Dividend covers
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝐸𝑃𝑆
24
Divided cover =
=
= =3
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

𝐷𝑃𝑆

8

(iii) Price earnings ratio
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
160
Price earnings ratio =
=
= 6
...
60 × 4 + (1 - 0
...
5
=Sh
...
95
June 2013 Question One B and C

QUESTION 6
c) (i) Clientele effect
 Assumes that there is a tendency for him to attract investors who like the firm’s dividend
policy
...

 Change in prices after dividend announcement is thus due to demand and supply forces
occasioned by the investors keen on benefiting out of dividend announcement
 The implication of the dividend-clientele effect on dividend policy is that firms establish
dividend policies that they deem would contribute to wealth maximization
...

 On the other hand, because of high switching costs (exit and entry) management is forced
to establish dividend policies that meet investors
...

(ii) Homemade dividend
 Refers to ability of stock holders to liquidate part of their holding hence realize cash
inflow in lieu of dividend income
...

 It is possible for investors to create homemade dividends thus the firm may opt to pay
dividend and let investors to choose their own dividend policy
...

 It ignores the signaling effect that a declared dividend will name
...
High retention enhances future growth and value of the company
ii
...
High retention reduces the firms gearing leading to decrease in cost of capital and an
increase in the value of the company
...
Retained earnings is a cheap source of funds which end up increase the NPV of the
projects undertaken and the value of the firm as a whole
May 2012 Question Five B

FINANCIAL MANAGEMENT

REVISION PARTNER

231

QUESTION 8
Three ways in which a company could pay dividends to its shareholders
• Constant payout ratio policy
The company can pay fixed proportion of earnings attributable to shareholders as dividends
...

• Constant or fixed dividend per share policy
The company may pay a constant amount of dividends per share irrespective of earnings
...

• Fixed/ constant dividends per share plus surplus
Under this policy dividends is fixed and paid each year
...

• Residual dividend policyThis is where dividends are paid out after investment opportunities have been financed
...

i) Expected EPS
E (EPS) = (2
...
25) + (3
...
25) + (4
...
25) + (6
...
25) = Sh 4
...
25
0
...
25
0
...
)
2
...
80
4
...
0

EPS - Mean (EPS)2P i
(2
...
2)2 x 0
...
0
2
(3
...
2) x 0
...
04
=0
...
8-4
...
25
(6
...
2)2 x 0
...
81

Mean EPS = 4
...
94
Thus, 𝜕𝐸𝑃𝑆

ii)

Therefore, 𝜕𝐸𝑃𝑆= √1
...
39

The market value of MCC Ltd

Expected earnings before interest and tax (EBIT)
= (2
...
25) + (3
...
25) + (4
...
25) + (6M×0
...
2 Million
Expected (Return)
= (6
...
25) + (10
...
25) + (13
...
25) + (17
...
25)
= 12% (Discounting rate)
Market value of MCC Ltd
=

[𝐸 (𝐸𝐵𝐼𝑇)− 𝐼][1−𝑇]
𝐾𝑠

=

[4,200,000−0][1−0]
12%

= Shs 35,000,000
December 2010 Question Four B

FINANCIAL MANAGEMENT

REVISION PARTNER

232

QUESTION 10
a
...
desire to get
stable current income to meet their living expenses
...
If they get low dividend, they would be
compelled to sell some of their shares to meet their living expenses
...

(2) Removes Investors' Uncertainty: The stable dividend policy removes uncertainty in
investors' mind about dividend payment
...
Thus, the changes or no
changes in dividends work as a source of information about firm's profitability
...
When the company wants to raise additional
finance, investors would be willing to buy its shares or debentures
...
Even the preference shares and debentures of such companies
would be easily subscribed, as the investors feel that such company would pay regular
interest or dividend
...
It is
not compelled to resort to external financing for expansion purposes
...
Hence, they can
use their retained earnings for future expansion
...
Besides share
prices remain stable over a period of time and do not fluctuate violently as in case of other
speculative shares
...
This would lead to more efficient management
December 2010 Question Five A

QUESTION 11
b) The share price of the company
(i) If the company does not announce the change of dividend policy
P0 =

𝑑0 (1+𝑔)
𝐾𝑆 − 𝑔

=

𝑑1

𝐾𝑆 − 𝑔

D 0 (2009) =8
...
2
7
...
0159-1 = 0
...
586%
If a firm is financed solely by equity, the cost of equity is equal to the overall cost of capital
...
59

8
...
20 (1
...
1041
12%−1
...
5) = 7
...
5

7
...
5%

=

8
...
045

= 𝑆ℎ 167
...
If a firm has no ability to raise funds from other
sources it will pay lower dividends
...

• Legal requirements i
...
insolvent firms are not to pay dividends
...
This will obviously lead to
payment of low dividends
• If the firm profitability is unstable the amount of dividends paid will be lower
...

The net profit rule which states that dividends can only be paid from the
companies available profits
...

Insolvency rule which states that the company cannot pay dividends when its
insolvent i
...
when total assets are less than liabilities
...

Capital requirement rule which prohibits payment of dividends from capital
through sale of assets to raise money to pay dividends
...

• Bond covenants-these are terms and conditions of the loan agreement, the restrictions may
restrict the company from paying dividends, unless earnings exceed a certain amount
...

• Profitability and liquidity position- companies’ ability to pay dividends will be
determined by the ability to generate stable profits
...
3 – 1 = 9
...
0
D 0 (1 +g) =
Ke –g

7
...
1)
0
...
1

=Sh
...
83

FINANCIAL MANAGEMENT

REVISION PARTNER
ii) D 1 = Sh5 Ke = 16%
Po =

Di =
Ke –g

g=14%

Do (1 + g)
Ke –g

iii) Po = Sh133
...
16 – g

234

=

Po = Di
Ke –g

=

5
= Sh 250
0
...
14%

5

133
...
16 – g) =5
0
...
83

= 5

g = 0
...
26%

QUESTION 15
a) Is it feasible to maintain dividends at Sh3 per share for the next two financial years?
The amount required to pay DPS of Sh3 for the next 2 years
= Sh3×2yrs ×6M shares
...

Profits available for distribution as dividend are for the 2 years
...
20 × 6M shares)

Sh‘000’
10,000
12,000
13,200
35,200

It is therefore not possible to maintain a dividend of Sh3 per share because the amount
required to pay the dividends is Sh36m and the total amount available for distribution in
Sh35
...

Bonus shares
Year 2004
¼ x 6000,000
1,500,000
Year 2005
¼ (6000,000 +15,000,000)
1875,000
Total bonus issue
3,375,000
Amount to be spent = No
...


FINANCIAL MANAGEMENT

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235

c) The course of action that the management of Kaka Kama Ltd should take in the light of the
declining projections in dividend payments
...

(ii) Diversification of the operations of the firm that will minimize business risk because the
company will be holding a portfolio
...

(iv) Disposal of non-profitable assets
...
g
...


QUESTION 16
(a)
i)

Debenture with floating interest rate
A debenture whose interest rate is variable and pegged to charges in interest rate on
Treasury bill e
...
a debenture/bond may have a 3% premium above interest rate on
Treasury bill such that: If interest rate on treasury bill is 7%, interest rate on the bond is 7% + 3% =
10%
 If interest rate on Treasury bill rises to 8
...
5% + 3% = 11
...

Such a bond is advantageous when market interest rates are volatile
...

Since the coupon rate is matched to market interest rate, the intrinsic value of the bond is
usually stable and easy to determine
...

They are issued at a discount and mature at par
...

The lender is not locked into low fixed interest rate while the borrower does not have
fixed financial obligations of paying fixed interest charges
...


(b)
i
...
e
...

-

ii
...

It assumes a constant stream of dividends in future, growth rate and cost of equity all
of which are not achievable in real world
...
Expected DPS =
d o (1 + g) n

FINANCIAL MANAGEMENT

REVISION PARTNER
End of year
1
2
3
4
5
6-∞

236

Expected DPS
2
...
2)1 = 3
...
50(1
...
60
2
...
2)3 = 4
...
50(1
...
18
2
...
2)5 = 6
...
909
0
...
751
0
...
621

P
...
73
2
...
24
3
...
86

Ke − g
=
=

16
...
07)
0
...
07

=

Intrinsic value =

221
...
621

Total present value

137
...
11

QUESTION 17
(a)

(b)

Recall DY

=

Given MPS
DPS

=
=
=

DPS
MPS

DPS = DY x MPS

Sh
...
05)
Sh
...
05
Sh
...
25

Since the company is raising new K determine the amount to raise from each source
...

The amount to raise from ordinary shares can be derived from the existing capital structure
...
Shares
x16
...
9
Issue preference is

= 500,000
= 3,600,000
= 10,463,668

0
...
6M
10
...


2
...
8M

The issue price of ordinary shares is the current MPS net of floatation costs
...
00
5
...
60
Number of shares to be issued to raise Sh
...
464M from issue of ordinary shares at 39
...
of shares

=
=

10
...
60

=

0
...
Ret Earnings are now a
source of capital and hence the need to get the cost of Retained Earnings Kr but does not
involve any floatation cost
...

Kd =

(ii)

Int
...
3
0 (not given)
100(1 − 0
...
4%

M Cost of Retained Earnings (Kr)
Retained Earnings should have been paid out as dividends
...
It is therefore based on dividend paid just like Ke
...
No growth rate is given in the question thus use a zero growth
dividend yield model where:

d
Kr = o
P
o
do
Po
Kr =

(iii)

=
=
2
...
2
...
45
x100 =

5%

Marginal Cost of Ordinary Share Capital (Ke)
d
Ke = o x100
P Fc
o
do

=

Sh
...
25

PoFc

=

Sh
...
60

Ke =

2
...
60

x100 =

5
...
00
25

Preference DPS = 10% coupon rate × 20 par value = Sh
...
45
0 (not given)
x100 = 8
...
5M
3
...
464M
2
...
800M

 0
...
6 
 10
...
236 
 + 5
 + 5
...
8   16
...
8   16
...
4 

1
...
03) + 5(0
...
68(0
...
13)
0
...
07 + 3
...
06
5
...
a
Economic life
10 years
Initial capital
16
...
40
5
...
68
8
...
71% = 6%

3 ×PVAF6%10 – 16
...
36 – 16
...
08 – 16
...
28 (positive NPV)
Accept if NPV is positive

Depreciation as a source of finance to the firm in 2 ways:
(i)
It is tax allowable thus will yield a tax shield/saving to the firm since it reduces firms
tax liability
...
This
appropriation is transferred to a sinking fund which becomes a source of capital for
replacing an existing asset
...


QUESTION 18
(a)

The alternative dividend policies are:
(i)
Fixed or constant dividend per share policy:
The firm pays a fixed dividend per share irrespective of how much profit is
available
...
The earnings per share
(EPS) will be fluctuating over time
...
P
...


FINANCIAL MANAGEMENT

REVISION PARTNER

(b)

239

(ii)

Fixed payout ratio policy:
A fixed proportion of equity earnings will be paid out as dividends meaning that
the dividends shall fluctuate over time creating high uncertainty for shareholders
...

The E
...
S and D
...
S will fluctuate over time
...
P
...

This policy maximizes shareholders wealth since projects with positive
N
...
V are first financed from equity earnings
...

Liquidity and profitability
Tax position of shareholders
Restrictions from band covenants
Access to capital markets
...


Human relationships do not always
come first; they never come first in
the bible; it is always man’s
relationship to God first
...


FINANCIAL MANAGEMENT

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240

TOPIC 12
PUBLIC FINANCE
QUESTION 1
a)
(i) Explain what a public enterprise is
Public enterprise restructuring involves turning around public enterprises to convert them from
inefficient loss making and non-competitive enterprise to efficient, profitable and competitive
institutions
...

• Concession - Where a private enterprise is granted some rights to produced goods and services on
behalf of the public enterprise
...

• Lay-offs-introducing voluntary early retirement or terminating all or some of the employees
...
The cycle starts with the budgetary estimates
preparation stage, through the authorisation of estimates into budgets for spending, the processes of
spending such amounts authorised and the final accountability of such spending to Parliament as
confirmed by the audit of the financial reports revealing the spending
...

PES in government financial administration is a process that involves the examination of spending
activities of public sector organisations and how such expenditures have been felt through projects
and developments in the economy
...

(ii) Functions of the Controller of Budget:
- Monitoring of revenue generation and collection by the agencies of government
...

- Implementing the budget through the issuance of authority to incur expenditure papers for both
capital and recurrent expenditure
...

- Rendering reports on the performance of the yearly budget and assessing its impact on the
economy
...

- Establishing and maintaining a data bank in the budget office
...

- Formulating fiscal monetary and economic policies required to develop the economy
...

• Performance contracts have changed the attitude of employees towards work and work ethics
...

• Significant decline in reliance on exchequer funding by public enterprises resulting in the
increase of investments in public and empowerment of public employees through progressive
improvement in terms of services
...

• Has led to creativity resulting in secondary innovations for example recycling reclamations
and organic power
...

• Had led to mandatory for all public institutions to carryout annual customer satisfaction
surveys
...

• If the debt is not properly applied to variable projects, it accumulates to become a drain on the
country’s resources
...

• Excessive government borrowing leads to an increase in local interest rates where financial
institutions increase their lending rates
...

• Sudden capitals in-flight and debt financing can lead to currency crisis, which causes
uncertainty and instability for business and adds to inflationary pressures
...

December 2013 Question Five A and B

QUESTION 4
a) Effect of loss of value on currency against the dollar
 Inflation if the country is imports dependent
 Expensive essential commodities
 Cheap exports making our exports more competitive
 More revenue for exports since they are paid by the dollar
 A dollar fetches more in our currency term
...

December 2012 Question Five A and B

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REVISION PARTNER

242

QUESTION 5
d) Reasons to justify that financial management in government departments are different
from financial management practices in industrial or commercial companies
i
...
The objective of financial management practices in industrial or commercial
companies is to make a profit and maximize shareholders wealth
ii
...
Government departments may end up with surplus funds while commercial companies
will always experience shortage of funds
iv
...

Commercial companies have to pay dividends to the shareholders eventually while in
government departments surplus funds are returned to the treasury
...
Explain four arguments against a balanced budget in public finance
• A balanced budget restricts the freedom of action on the part of the authorities, restricting the
possible use of fiscal policies
...

• A balanced budget cannot help the economy in recovering from depression, since only a
budget deficit will be necessary so as to enhance a balance in the recovery process
...

November 2011 Question Five B

QUESTION 7
a
...
Objective is to maximize profit/
1
...

value of the firm
...
The finances are managed by
2
...

time civil servants
3
...
The government is accountable to
ordinary shareholders
...
Competition is a key factor on the
4
...

of services
...

A surplus budget is one where the firm’s expenditure is less than the revenue
...

Advantages
Deficit;
• Enhances creativity and innovation on the part of the government
...

• It can enhance the investment for the future especially if more funds are
channeled towards key areas such as health, education, infrastructure etc
...

• The government is not constrained to giving a satisfying budget
...

Disadvantages
Deficit;
• Development activities in the country may be slowed down especially if the
government will be unable to finance the deficit
...

Surplus
• It can lead to or enhance corruption if monitoring of public funds is not done
appropriately
...

b) Highlight three ways in which a government could enhance revenue collection in a country
• Carrying out tax reforms that aim towards netting every potential tax payer
...

• Ensuring a fair expenditure so as to instill public confidence in paying taxes
...
Write explanatory notes on the following terms;
i
...
These changes, which include innovations in
technology, risk transfer and credit and equity generation, have increased available credit
for borrowers and given banks new and less costly ways to raise equity capital
...

National budget
This is a financial statement containing an estimate of government revenue and
expenditure during the coming financial year
...

iii
...
They are progressive
in nature i
...
they increase with increase in income
...
How objectives of organizations in the public sector differ with those in the private sector
• Private sector firms are vulnerable to competitive pressure thus they are forced to invest
heavily in marketing of their products so as to maintain their market share
...


FINANCIAL MANAGEMENT

REVISION PARTNER
•

244

Private firms are aimed at maximizing the value of wealth of owners unlike public sector
firms aim at provision of social services (social needs)

c
...

• It’s used to correct unequal distribution of income
...
There is
no scope for red tapism
...
The primary goal of
corporate finance is to maximize shareholder value
...

Public finance is the study of the role of the government in the economy

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