Search for notes by fellow students, in your own course and all over the country.
Browse our notes for titles which look like what you need, you can preview any of the notes via a sample of the contents. After you're happy these are the notes you're after simply pop them into your shopping cart.
Title: BUSINESS FINANCE
Description: it is about business financing and it aims at 2nd years
Description: it is about business financing and it aims at 2nd years
Document Preview
Extracts from the notes are below, to see the PDF you'll receive please use the links above
UNIVERSITY OF ELDORET
SCHOOL OF BUSINESS & MANAGEMENT SCIENCES
DEPARTMENT OF BUSINESS MANAGEMENT
COURSE OUTLINE
Academic Year: 2023/2024
Sem
...
CHERONO Mobile No: 0722 819848
Purpose of the Course
Introduce learners to basic knowledge and skills in banking and finance
...
Course Assessment
CATs
=30%
Final Examination =70%
Total
=100%
Peer review
Observation by head of department and fellow lecturers and evaluation forms
completed by students
...
Gupta, G
...
Financial Management by IM Pandey, Pearson India, 2021,
Pages: 1030, Rs
...
Abhigyan, 40(1), 53
...
Olowe, R
...
(2011)
...
3
...
(2008)
...
Pearson Education
...
Chandra, P
...
Fundamentals of financial management
...
5
...
(2008)
...
6
...
E
...
Financial management and real options (No
...
Wiley
...
Brigham, E
...
, & Houston, J
...
(2019)
...
8
...
, Clacher, I
...
, Westerfield, R
...
(2014)
...
2
9
...
, & Bill, N
...
Corporate Finance and Investment-Decisions &
Strategies
...
10
...
C
...
M
...
Fundamentals of financial
management
...
11
...
C
...
Financial management and policy (No
...
6)
...
12
Van Horne, J
...
, & Wachowicz, J
...
(2009)
...
Pearson
...
Allen, F
...
A
...
C
...
Principles of corporate finance (p
...
McGraw-Hill/Irwin
...
Mannasseh, P
...
(2004)
...
Nairobi
...
Beck, T
...
Structural issues in the Kenyan financial system: Improving
competition and access (Vol
...
World Bank Publications
...
This provision has to be undertaken on the basis of the needs of a
company
...
The allocation of these resources is done through a market pricing system
...
The funds must be allocated within the organisation to projects that
will yield the highest return
...
Needs Consequent on the Operations of a Company (Basic Needs)
These have to be financed in so far as they arise out of the company’s operations e
...
salaries
...
Shortages of Cash Brought About By Unforeseeable Circumstances E
...
g
...
However, the
financial manager must manage his finances using such tools as:
•
•
Cash budget – statement of expected receipts and payments over a projected period of time – a
forecast
...
Variance between actual funds flow with cash budget
...
On the other hand a financial manager has to meet the company’s strategic/long term
needs (long term investment) are useful to the company because:
1
...
3
...
It influences the company size (assets)
It influences its growth (plough back)
Finances incidental needs
...
These investments will call for long term financing in form of owners finance (Ordinary Share Capital
and Revenue reserves)
...
The company will also use
external financing e
...
debts, loans, debentures, mortgages, lease finance etc
...
This implies that the company’s gearing level is kept low i
...
the relationship between owners and creditors finance
...
Even then, when using creditors
finances a company must consider:
1
...
2
...
3
...
Low credit rating
5
...
6
...
e
...
Assessment of the return – at least should be greater than minimum return + risk + inflation
...
Economic life – if uncertain, the return ought to be higher
...
The financial manager must be guided by principles of financial prudence i
...
1
...
2
...
He has to ascertain whether everyone involved in the implementation of the venture has not
been left out either during the planning phase or implementation phase
...
Managerial Finance Functions
Require skilful planning, control and execution of financial activities
...
These are:
a) Investment of Long-term asset-mix decisions
These decisions (also referred to as capital budgeting decisions) relates to the allocation of funds among
investment projects
...
Investment proposals are evaluated in
terms of both risk and expected return
...
This
is referred to as replacement decision
...
The
finance manager must decide the proportion of equity and debt
...
This will further be discussed under the risk return
trade-off
...
The earnings must also be distributed to other
providers of funds such as preference shareholder, and debt providers of funds such as preference
shareholders and debt providers
...
d) Liquidity decision
The firm’s liquidity refers to its ability to meet its current obligations as and when they fall due
...
Investment in current assets affects the firm’s liquidity,
profitability and risk
...
This implies that the firm
has a lower risk of becoming insolvent but since current assets are non-earning assets the profitability of
the firm will be low
...
The finance manager should develop sound techniques of managing current assets to ensure that neither
insufficient nor unnecessary funds are invested in current assets
...
These decisions concern procedures and systems and involve a lot of paper work and time
...
Some of the important routine functions
are:
a)
b)
c)
d)
Supervision of cash receipts and payments
Safeguarding of cash balance
Custody and safeguarding of important documents
Record keeping and reporting
The finance manager will be involved with the managerial functions while the routine functions will be
carried out by junior staff in the firm
...
THE OBJECTIVES/GOALS OF A BUSINESS
1
...
This is so for the
following reasons:
•
•
•
To earn acceptable returns to its owners
...
e
...
2
...
e
...
This is
important because:
•
•
•
•
It influences company’s share prices
...
It boosts the company’s credit rating
...
3
...
This
includes:
•
•
•
•
Reasonable salaries
Transport facilities
Medical facilities for the employee and his family
Recreation facilities (sporting facilities)
...
Interests of customers – the company has to provide quality goods at fair prices and have honest
dealings with customers
...
Welfare of the society – the company has to maintain sound industrial relations with the society:
•
•
Avoid pollution
Contribution to social causes e
...
Harambee contributions, building clinics etc
...
Fair dealing with suppliers
...
7
...
OVERLAPS AND CONFLICTS
• Overlaps – when achieving ONE MEANS achieving the other
• Conflicts – when achieving ONE CANNOT allow the achievement of the other
...
4 & 5 – Some of the customers will be members of the Society
...
1 & 2 – If a company is profitable it will in most cases increase its net worth
...
1 & 6 – if a company maximises its profits, then it will be able to honour its obligations
• Nos
...
• Nos
...
• Nos
...
Society
Conflicts
• Nos
...
Costs
• Nos
...
Costs
• Nos
...
Costs
• Nos
...
3 & 5 – Costs vs
...
4 & 6 – Better credit terms to customers will not enable the company to pay its creditors
7
The Main objectives of a business entity are explained in detail below
Any business firm would have certain objectives, which it aims at achieving
...
Profit maximization refers to
achieving the highest possible profits during the year
...
Note that:
Profit = Revenue – Expenses
The sales revenue can be increased by either increasing the sales volume or the selling price
...
The pricing mechanism will however, help the firm to determine which goods and services to
provide so as to maximize profits of the firm
...
Net present value is equal to the difference between the present value of benefits received
from a decision and the present value of the cost of the decision
...
A financial action with a positive net present value will maximize the wealth of the shareholders, while a
decision with a negative net present value will reduce the wealth of the shareholders
...
Shareholder wealth maximisation helps to solve the problems with profit maximisation
...
It recognizes risk by using a discount rate (which is a measure of risk) to discount the cash flows
to the present
...
The firm may be involved in
activities which do not directly benefit the shareholders, but which will improve the business
environment
...
d) Business Ethics
Related to the issue of social responsibility is the question of business ethics
...
It can be though of as the company’s attitude toward its
8
stakeholders, that is, its employees, customers, suppliers, community in general creditors, and
shareholders
...
A firm’s commitment to business ethics can be measured by
the tendency of the firm and its employees to adhere to laws and regulations relating to:
•
•
•
•
•
•
Product safety and quality
Fair employment practices
Fair marketing and selling practices
The use of confidential information for personal gain
Illegal political involvement
Bribery or illegal payments to obtain business
...
However, they cannot
manage the firm because:
•
•
•
They may be too many to run a single firm
...
Shareholders therefore employ managers who will act on their behalf
...
Shareholders contribute capital which is given to the directors which they utilize and at the end of each
accounting year render an explanation at the annual general meeting of how the financial resources were
utilized
...
•
•
•
In the light of the above shareholders are the principal while the management are the agents
...
The conflict of interest between management and shareholders is called agency problem
in finance
...
2
...
4
...
Shareholders and Management
Shareholders and Creditors
Shareholders and the Government
Shareholders and Auditors
Headquarter office and the Branch/subsidiary
...
Shareholders and Management
There is near separation of ownership and management of the firm
...
Managers might take actions, which are not in the best interest of
shareholders
...
e
...
The actions of the managers will be in conflict with the interest of the owners
...
This is because irrespective of the profits they make,
their reward is fixed
...
ii)
Consumption of “Perquisites”
9
Prerequisites refer to the high salaries and generous fringe benefits which the directors
might award themselves
...
Therefore the consumption of
perquisites is against the interest of shareholders since it reduces their wealth
...
e they have many investments and the collapse of one firm may have
insignificant effects on their overall wealth
...
(Human capital is not
diversifiable)
...
iv)
Different Evaluation Horizons
Managers might undertake projects which are profitable in short-run
...
The conflict will therefore occur where management
pursue short-term profitability while shareholders prefer long term profitability
...
This is
equivalent to the agent buying the firm which belongs to the shareholders
...
vi)
Pursuing power and self esteem goals
This is called “empire building” to enlarge the firm through mergers and acquisitions
hence increase in the rewards of managers
...
g stock valuation
methods, depreciation methods recognizing profits immediately in long term
construction contracts etc
...
Pegging/attaching managerial compensation to performance
This will involve restructuring the remuneration scheme of the firm in order to enhance the
alignments/harmonization of the interest of the shareholders with those of the management e
...
managers may be given commissions, bonus etc
...
2
...
Management of companies have been fired by the shareholders who have the right to hire
and fire the top executive officers e
...
M
...
3
...
Shareholders
can threatened to sell their shares to competitors
...
This threat is adequate to give
incentive to management to avoid conflict of interest
...
Direct Intervention by the Shareholders
10
Shareholders may intervene as follows:
•
•
•
Insist on a more independent board of directors
...
5
...
6
...
The value of an option will increase if the company is successful and its share price goes up
...
However, although share option schemes can contribute to the achievement of goal congruence, there are
a number of reasons why the benefits may not be as great as might be expected, as follows:
Managers are protected from the downside risk that is faced by shareholders
...
Many other factors as well as the quality of the company’s performance influence share price movements
...
If the share price falls, there is a downward stock market adjustment and
the managers will not be rewarded for their efforts in the way that was planned
...
Note
The choice of an appropriate remuneration policy by a company will depend, among other things, on:
•
•
•
•
Cost: the extent to which the package provides value for money
Motivation: the extent to which the package motivates employees both to stay with the company
and to work to their full potential
...
At times of wage
control and high taxation this can act as an incentive to make the ‘perks’ a more significant part
of the package
...
7
...
The
agency costs are broadly classified into 4
...
These are costs incurred in devising the contract between the managers and
shareholders
...
Examples of the costs are:
•
•
Negotiation fees
The legal costs of drawing the contracts fees
...
They are meant to
ensure that both parties live to the spirit of agency contract
...
Examples are:
•
•
•
•
•
•
External audit fees
Legal compliance expenses e
...
Preparation of
Financial statement according to international accounting standards, company law,
capital market authority requirement, stock exchange regulations etc
...
Cost of instituting a tight internal control system (ICS)
...
g
...
d) Restructuring Costs – e
...
new I
...
S
...
2
...
They will usually give debt capital to the
firm on the strength of the following factors:
•
•
•
•
The existing asset structure of the firm
The expected asset structure of the firm
The existing capital structure or gearing level of the firm
The expected capital structure of gearing after borrowing the new
debt
...
• In case of shareholders and bondholders the agent is the shareholder who should ensure that the
debt capital borrowed is effectively utilized without reduction in the wealth of the bondholders
...
• Wealth of bondholders = Market value of bonds x No
...
• An agency problem or conflict of interest between the bondholders (principal) and the shareholders
(agents) will arise when shareholders take action which will reduce the market value of the bond and
by extension, the wealth of the bondholders
...
In this case the bondholder is exposed to more risk because he may not recover the loan extended in case
of liquidation of the firm
...
However, this
project may be substituted with a high risk project whose cash flows have high standard deviation
...
c) Payment of High Dividends
Dividends may be paid from current net profit and the existing retained earnings
...
The payment of high dividends will lead to low level of capital and
investment thus reduction in the market value of the shares and the bonds
...
This will reduce the value of the firm and bond
...
This
will lead to reduction in the value of the firm and subsequently the value of the bonds
...
The value of the old
bond or debt will be reduced if the new debt takes a priority on the collateral in case the firm is liquidated
...
Solutions to agency problem
The bondholders might take the following actions to protect themselves from the actions of the
shareholders which might dilute the value of the bond
...
Restrictive Bond/Debt Covenant
In this case the debenture holders will impose strict terms and conditions on the borrower
...
No payment of dividends from retained earnings
Maintenance of a given level of liquidity indicated by the
amount of current assets in relation to current liabilities
...
The bondholders may recommend the type of project to be
undertaken in relation to the riskness of the project
...
Callability Provisions
These provisions will provide that the borrower will have to pay the debt before the expiry of the
maturity period if there is breach of terms and conditions of the bond covenant
...
Transfer of Asset
• The bondholder or lender may demand the transfer of asset to him on giving debt or loan to the
company
...
• On completion of the repayment of the loan, the asset used as a collateral will be transferred
back to the borrower
...
Representation
The lender or bondholder may demand to have a representative in the board of directors of the borrower
who will oversee the utilization of the debt capital borrowed and safeguard the interests of the lender or
bondholder
...
Refuse to lend
If the borrowing company has been involved in un-ethical practices associated with the debt capital
borrowed, the lender may withhold the debt capital hence the borrowing firm may not meet its
investments needs without adequate capital
...
6
...
3
...
The government will expect the company and by extension its
shareholders to operate the business in a manner which is beneficial to the entire economy and the
society
...
It
becomes an agent when it has to collect tax on behalf of the government especially withholding tax and
PAYE
...
It provides a conducive investment environment for the company and
share in the profits of the company in form of taxes
...
These actions include:
•
•
•
•
•
Tax evasion: This involves the failure to give the accurate picture of the earnings or profits of the
firm to minimize tax liability
...
Lukewarm response to social responsibility calls by the government
...
Avoiding certain types and areas of investment coveted by the government
...
1
...
g
...
Lobbying for directorship (representation)
The government can lobby for directorship in companies which are deemed to be of strategic nature and
importance to the entire economy or society e
...
3
...
4
...
g
...
5
...
4
...
The
auditors are supposed to monitor the performance of the management on behalf of the shareholders
...
Since auditors act on behalf of shareholders they become agents while shareholders are the principal
...
Demanding a very high audit fee (which reduces the profits of the firm) although there is
insignificant audit work due to the strong internal control system existing in the firm
...
Failure to apply professional care and due diligence in performance of their audit work
...
Firing: The auditors may be removed from office by the shareholders at the AGM
...
Legal action: Shareholders can institute legal proceedings against the auditors who issue
misleading reports leading to investment losses
...
Disciplinary Action – ICPAK
...
Such disciplinary actions may involve:
•
•
•
•
4
...
5
...
The HQ acts as the principal and the subsidiary as an agent thus creating an agency relationship
...
This will
lead to sub-optimisation and conflict of interest with the headquarter
...
Performance contracts with managers with commensurate compensation package for the same
...
The alternatives have different returns and
risk
...
The
relationship between Return and Risk can be expressed as follows:
Required Rate of Return = Risk-free rate + Risk premium
...
It
can be seen that the relationship is direct
...
In making financing decisions for
example, the finance manager must decide whether to finance with equity alone or to use debt as well
...
However, since payment of
interest on debt is compulsory, the risk involved is high
...
The risk is also low since payment of ordinary dividend is not compulsory
...
TYPES OF BUSINESS ORGANISATIONS
1
...
Partnerships
3
...
SOLE PROPRIETORSHIP
Characteristics
1
...
It caters for personal attention of customers
3
...
Personal saving
b
...
Short-term loans from banks
...
Trade credit from suppliers
...
Less legal formalities to form
...
Highly flexible (and adaptable)
6
...
Other Advantages
1
...
Profits motivates owners
3
...
Low bureaucracy (less time wasted)
Disadvantages
1
...
2
...
Success depends on ability or judgement of owner
Note
•
•
•
Most sole traders do not employ professional advice which implies less growth and stagnation
...
Limited accounts knowledge
...
”
Formation of a partnership
1
...
Actions of the person concerned
3
...
4
...
e
...
Note
In case the partners want to run their business under a name which does not disclose true surname of all
partners, such a firm must be registered under the registration of Business Names Act
...
General Partners – Unlimited liability and active in participation in partnership activities
...
Limited partners – Limited liability and does not participate in the management of partnerships
...
Sleeping partners – has no active role, nevertheless, such a partner will have contributed to the
capital of the partnership business and will thus share in the profits although at a lower
proportion in most cases
...
The articles of partnerships must
contain eleven clauses
...
2
...
4
...
6
...
8
...
10
...
Nature of business
...
Powers of each partner
...
Determination of Goodwill
Determination of amount payable to outgoing partners
...
The arbitration clause
...
These companies are governed by the Companies Act (Cap
...
Such must be registered with the Registrar of Companies after which it is issued with a certificate of
incorporation which indicates the Birth of the company
...
• Perpetual existence (or going concern) which allows the company to make strategic plans to raise
finance in Capital Markets more easily
...
• Title to share is freely transferable which makes these shares more of an investment
...
• Shares may be used as securities
...
Disadvantages
• Loss of secrecy – poor competition
17
•
•
•
•
•
Many formalities in forming the company
Heavy initial capital outlay
...
Inflexibility and thus low adaptability
...
Differences between a company and a partnership occur under the following factors:
• Governance
• Legal view (entity)
• Title of shares (transferability)
• Agency
• Liability
• Going concern (dissolution)
• Membership number
...
A holding company may be viewed as a “financial institution” in the sense that it uses shareholders capital
to acquire controlling interests in other companies by acquiring up to 51% of the other company’s shares
or even more
...
It will almost be like a sole owner of such a company by virtue of such share holding
...
Such companies are usually quoted on the stock exchange
...
• The company in need of public money will have to obtain permission from the NSE Council
before it can be allowed to have its shares “dealt-in”
...
PRIVATE LIMITED COMPANIES
These are NOT allowed to advertise their shares so as to attract public money and as such they sell their
shares privately (known as private placing) to interested members of the public
...
Differences between the two above lies on:
1
...
3
...
5
...
7
...
18
QUESTION ONE
Outline FOUR main objectives, which conflict and at the same time overlap – explain these overlap and
conflicts
...
QUESTION THREE
Within a business finance context, discuss the problems that might exist in the relationships (sometimes
referred to as agency relationships) between:
a)
b)
Shareholders and managers, and
Shareholders and creditors
...
In country A, electricity supplies are provided by a nationalised industry
...
Required
a)
b)
Explain how the objectives of the nationalised industry in country A might differ from
those of the private sector companies in country B
...
19
1
...
For large
companies equity finance is made of ordinary share capital and reserves; (both revenue and capital
reserves)
...
This finance is available to limited companies
...
It is thus a base on which
other finances are raised
...
These shares carry
voting rights and can influence the company’s decision making process at the AGM
...
However this investment grows through retention
...
Right to vote
a
...
Sales/purchase of assets
2
...
• Its value grows
...
• They influence the company’s decisions
...
Advantages of using ordinary share capital in financing
...
• Its cost is not a legal obligation
...
• Used with flexibility – without preconditions
...
• Owners contribute valuable ideas to the company’s operations (during AGM by professionals)
...
Such reserves are retained for the following reasons:
•
•
•
•
ii)
To make up for the fall in profits so as to sustain acceptable risks
...
To sustain growth through plough backs
...
...
...
Capital Reserves
1
...
(The difference between the market price (less
floatation costs) and par value is credited to the capital reserve)
...
Through revaluation of the company’s assets
...
3
...
c) PREFERENCE SHARE CAPITAL (Quasi-Equity)
It is also called quasi-equity because it combines features of equity and those of debt
...
Unlike ordinary share capital, it has a fixed return
...
It is an unsecured finance
and it increases the company’s gearing ratio
...
(Can sue the
company)
...
Example
Company XYZ Limited has the following capital structure:
Shs
...
10 ordinary shares
10,000 Sh
...
400,000 show how this would be shared under:
i) Paripasu
ii) ½
Share participation taking into account the par value
...
400,000
(200,000)
200,000
(100,000)
100,000
300,000
Asset proceeds
Less preference claims
Less ordinary shareholders claim
Residue
Total share capital =
Participative claim of ordinary shareholders is given by:
200,000
x100,000 = 66,667
300,000
ii) Sharing under
1
2
ratio
Shs
...
33,000
3
Preference share capital claim =
Ordinary share capital claim =
=
1 1 1
x =
3 2 6
1
x100,000
6
= 16,667%
iii) Non-Participative Preference Shares
These do not claim any money over and above their par value, but are usually cumulative and redeemable
...
g
...
20 preference shares and did not pay dividends
for the next two years, then in the third year shareholders will claim:
10% x 20 x 3yrs = Shs 6 less withholding tax:
= Shs 6 less 5% of Shs 0
...
70 net
vi) Non-Cumulative Preference Shares
These cannot claim interest in arrears
...
Conversion ratio = par value of ordinary share/par value of preference shares e
...
10 and that of preference shares is Sh
...
22
10 1
=
20 2
i
...
of ordinary shares to be acquired
...
30 (partly called up) plus 20,000 Shs
...
Compute the total number of ordinary shares after conversion
...
20,000 3
x
1
1
= 30,000 ordinary shares
...
30
3/ 2
Total = 40,000 ordinary shares after conversion
...
These cannot be converted into ordinary shares
...
DEBT FINANCE
Debt finance is a fixed return finance as the cost (interest) is fixed on the par value (face value of debt)
...
It is raised from external sources to qualifying companies
and is available in limited quantities
...
Liquidity situation in a given country
...
Classification of Debt Finance
Loan finance – this is a common type of debt and is available in different terms usually short term
...
Long-term loans vary from 6 years and above
The terms are relative and depend on the borrower
...
e
...
It is prudent to use shortterm loans for short-term ventures i
...
if a venture is to last 4 years generating returns, it is prudent to
raise a loan of 4 years maturity period
...
b) The company’s future cash flows (inflows and their stability) must be assured
...
c) Economic conditions prevailing
...
Boom conditions are ideal for debt
...
e) When the company’s anticipated future expansion programs, justify such borrowing
...
b) Names, ages, and qualifications of the company’s directors
...
e
...
d) Nature of the products and product lines
...
f) Nature of the loan – either secured, floating or unsecured
...
Reasons Why Commercial Banks Prefer To Lend Short Term Loans
a) Long-term forecasts are not only difficult but also vague as uncertainties tend to jeopardise
planning e
...
political and economic factors
...
c) Short-term loans are profitable
...
d) Long term finance loses value with time due to inflation
...
f) Commercial banks do credit analysis that is limited to short term situations
...
Advantages of Using Debt Finance
• Interest on debt is a tax allowable expense and as such it is reduced by the tax allowance
...
30)
= 7%
Consider companies A and B
Company
10% debt
Equity
A
Sh
...
’000’
1,000
1,000
The tax rate is 30% and earnings before interest and tax amount to Ksh
...
All earnings are paid
out as dividends
...
Company
EBIT
Less interest 10% x 1,000
EBT
Less tax @ 30%
Dividends payable
A
Sh
...
’000’
400
400
(120)
280
Company A saves tax equal to Sh
...
•
•
•
The cost of debt is fixed regardless of profits made and as such under conditions of high profits
the cost of debt will be lower
...
e
...
24
•
•
In case of long-term debt, amount of loan declines with time and repayments reduce its burden to
the borrower
...
Disadvantages
It is a conditional finance i
...
it is not invested without the approval of lender
...
e
...
It is dangerous to use in a recession as such a condition may force the company into receivership
through lack of funds to service the loan
...
It is only available for specific ventures and for a short term, which reduces its investment in strategic
ventures
...
It increases financial risk
and required rate of return by shareholders thus reduce the value of shares
...
Similarities between Preference and Equity Finance
a)
b)
c)
d)
e)
f)
Both may be permanent if preference share capital is irredeemable (convertible)
...
Both are traded at the stock exchange
Both are raised by public limited companies only
Both carry residue claims after debt
...
25
Differences between Preference and Equity Finance
Ordinary share capital
a) Has a residue claim both on assets and profit
b) Carries voting rights
c) Reduces the gearing ratio
d) Variable dividends hence grow over time
e) Permanent finance
f)
Easily transferable
...
b)
Both will increase the company’s gearing ratio
...
d)
Both do not have voting rights
...
g)
Both are external finances
...
Differences between Preference Share Capital and Debt
DEBT
PREFERENCE SHARE CAPITAL
a) Interest is tax allowable
a) Dividends are not tax allowable
b) Interest is a legal obligation
b) Dividends are not a legal obligation
c) Debt finance is always secured
c) Preference is not secured finance
d) Debt finance is a pre-conditional
d) Is not conditional finance
e) Has a superior claim
e) Has a residue claim (after debt)
Why It May Be Difficult For Small Companies To Raise Debt Finance In Kenya (Say Jua Kali
Companies)
• Lack of security
• Ignorance of finances available
• Most of them are risky businesses as there are no feasibility studies done (chances of failure have
been put to 80%)
...
e
...
• Cost of finance may be high – their market share may not allow them to secure debt
...
e
...
• Lack of business principles that are sound and difficult in evaluating their performance
...
g
...
• Education of such businessmen on sound business principles
...
• Encourage formation of co-operative societies
...
3
...
A Bill of Exchange is an
unconditional order in writing addressed by one person to another requiring the person to whom it is
addressed to pay to him as his order a specific sum of money
...
For a bill to be a legal document; it must be
26
a)
b)
c)
e)
Drawn by the drawer
...
It is used to raise finance through:
i) Discounting it
...
Advantages of Using a Bill as a Source of Finance
• They are a faster means of raising finance (if drawer is credible)
...
4 Lease Finance
Leasing is a contract between one party called lessor (owner of asset) and another called lessee where the
lessee is given the right to use the asset (without legal ownership) and undertakes to pay the lessor
periodic lease rental charges due to generation of economic benefits from use of the assets
...
Lease finance is ideal under the following conditions:
a)
b)
c)
d)
e)
f)
When the asset depreciates faster
...
Advantage of Leasing an Asset
• It does not tie up the company’s funds in an asset
...
• The company has the option to purchase assets at the expiry of the lease period at which time it
will know the viability of the asset
...
• Lease finance enables the lessee to use the asset to create financial surpluses which may then be
used to buy assets
...
Disadvantage of Leasing an Asset
27
•
•
•
•
•
•
It is a pre-conditional finance (as on the use of asset)
In the long term the lease charges may out-weigh the cost of buying own asset
...
It is useful for financing fixed assets and not working capital
Lease finance may not be renewed leading to loss of business
...
e
...
Reasons Why Lease Finance Is Not Well Developed In Kenya
• Lease charges are usually prohibitive i
...
the cost of finance is excessive
...
• Uncertainty as to returns from such assets i
...
the returns from such assets leased may not
encourage the growth of lease finance
...
• Lack of flexibility i
...
a number of assets which are ideal for leasing are unavailable
...
• After lease service is poor and this leads to loss of revenue
...
Overdraft Finance
This finance is ideal to use as bridging finance in sense that it should be used to solve the company’s
short term liquidity problems in particular those of financing working capital (w
...
It is usually a secured
finance unless otherwise mentioned
...
Advantages of Overdraft Finance
• It is useful in financial crisis which an accountant cannot forecast due to abrupt fall in profits
thus liquidity problems
...
• It does not entail preconditions and is therefore investible in high-risk situations when the firm
would not have finance in normal circumstances
...
g
...
g
...
• If not used for a long period of time – it does not affect the company’s gearing level and
therefore does not relate to company’s liquidation or receivership
...
Disadvantages of Overdraft Finance
• It is expensive as the interest rates of overdrafts are much higher than bank rates
...
• It may be misused by management because it does not carry pre-conditions
• Being a short-term financial arrangement, it can be recalled at short notice leaving the company in
financial crisis
...
Plastic Money (Credit Card Finance)
28
This is finance of a kind whereby a company will make arrangements for the use of the services of a
credit card organisations (through the purchase of credit cards) in return for prompt settlement of bills on
the card and a commission payable on all credit transactions
...
Reasons behind the Fast Development of This Finance (Plastic Money) In Kenya
a)
High incidences of fraud by dishonest employees has been responsible for development of this
finance as it minimises chances of this fraud because it eliminates the use of hard cash in the
execution of transactions
...
c)
Credit cards have boosted the credibility of holder companies which enables them to obtain trade
credits under conditions which would have otherwise been difficult
...
e)
These cards have been used by financial institutions and banks to boost their deposit and attract
long term clienteles e
...
Royal Card Finance, Standard Chartered
...
Limitations of Credit Cards as a Source of Finance
i)
These cards leads to overspending on the part of the holder and as such may disorganise the
organisation’s cash budget and cash planning
...
iii)
They are expensive to obtain and maintain because of associated cost such as ledger fees,
registration, insurance, commission expenses, renewal fees etc
...
v)
Entail a lot of formalities to obtain e
...
guarantees, presentation of bank statements and even
charging assets that are partially pledged to secure expenses that may be incurred using these
cards
...
vii)
Credit card organisation may suspend the use of such cards without notice and this will
inconvenience the holder who may not meet his/her ordinary needs obtained through these
cards
...
Debenture Finance
A form of long term debt raised after a company sells debenture certificates to the holder and raises
finance in return
...
These
debentures usually mature between 10 to 15 years but may be endorsed, negotiated, discounted or given
as securities for loans in which case they will have been liquidated before their maturity date
...
Classification
i) Secured Debentures
29
These are those types of debentures which a company will secure usually in two ways, secured with a
fixed charge or with a floating charge
...
Floating charge – if it can claim from any or all of the assets which have not been pledged as
securities for any other form of debt
...
iii) Redeemable Debentures
These are the type of debentures, which the company can buy back after the minimum redemption period
and before the maximum redemption period (usually 15 years) after which holders can force the company
to receivership to redeem their capital and interest outstanding
...
However, these are rare and are usually sold by company’s with a history of stable ordinary dividend
record
...
Conversion price = par value of a debenture/No
...
Conversion ratio
=
Par value of debenture
Par value of ordinary shares
Example
ABC Company Ltd books:
Shs
...
000, Sh
...
10 8% preference share capital
5,000, Shs
...
Solution
i)
ii)
Conversion price = par value of debenture/No
...
No
...
30
100
= 5
...
of new ordinary shares
=
35,000, Shs
...
10, 8% preference shares
Total capital
5000 x 5 =
25,000
Shs
...
vii) Sub-ordinate debentures
Usually last for as long as 10 years and they are sold by financially strong companies
...
This means that
they are sub-ordinate to senior debt but superior to ordinary and preference share capital
...
ii)
They are in most cases secured debt and as such constrain the selling company in so far as getting
sufficient securities is difficult
...
iv) Kenya’s capital markets are not developed and as such there is no secondary debenture market
where they can be discounted or endorsed
...
vi) Being long term finance there are a few buyers who may be willing to stake their savings for a
long period of time
...
8
...
Venture capitalists are therefore investment specialists who raise
pools of capital to fund new ventures which are likely to become public corporations in return for an
ownership interest
...
Venture capitalists also provide managerial skills to the firm
...
Since the goal of venture capitalists is to make quick profits, they will invest only in firms with a potential
for rapid growth
...
Their publicity material states that successful investments have three common characteristics
...
There is finance, in the right form to turn the idea into a solid business
...
Attributes of venture capital
i)
Equity participation – Venture Capital participate through direct purchase of shares or fixed
return securities (debentures and preference shares)
ii)
Long term investment – venture capital is an investment attitude that necessitates the venture
capitalists to wait for a long time (5 – 10 years) to make large profits (capital gains)
...
This hands – on Management enable them protect their
investment
...
With start-ups, venture capital often prefers to be one of several financial
institutions putting in venture capital
...
Management buyout – A management buyout is the purchase of all or parts of a business from
its owners by its managers
...
The
venture capital may be prepared to buy some of the company’s equity
...
It will need convincing that the company can be successful (management buyouts of companies
which already have a record of successful trading have been increasingly favored by venture
capitalists in recent years
...
The directors of the company then contract venture capital organizations, to try to find one or more
which would be willing to offer finance
...
Reasons for Significant Growth in Venture Capital in the Developed Countries
i)
Public attitude i
...
ii)
Dynamic financial system e
...
iii) Government support – e
...
g tax concessions and
investment allowance taxes
...
g investors in the industry
...
Constraints of Venture Capital in Kenya
1
...
2
...
Prices do not reflect all the available information in the market
...
Infrastructural problems – this limits the growth rate of small firms which need raw materials and
unlimited access to the market factors of production
...
Lack of managerial skills on part of venture capitalists and owners of the firm
...
Nature of small business in Kenya
...
a
...
32
b
...
c
...
6
...
8
...
Focus on low risk ventures e
...
Conservative approach by the venture capitalists
...
g months or more hence entrepreneurs loose interest in the project
...
Summary
In sum, venture capital, by combining risk financing with management and marketing assistance, could
become an effective instrument in fostering developing countries
...
A broad-based (and less family based) entrepreneurial traditional societies and government
encouragement for innovations, creativity and enterprise
...
Existence of disinvestments mechanisms, particularly over-the counter stock exchange catering for
the needs of venture capitalists
...
A more general, business and entrepreneurship oriented education system where scientists and
engineers have knowledge of accounting, finance and economics and accountants understand
engineering or physical sciences
...
A vigorous marketing thrust, promotional efforts and development strategy, employing new
concepts such as venture fair clubs, venture networks, business incubators etc
...
Linkage between universities/technology institutions, R & D
...
Encouragement and funding or R & D by private public sector companies and the government for
ensuring technological competitiveness
...
(10 marks)
QUESTIONTWO
a)
Why do different sources of finance have different costs?
33
(8 marks)
b)
What are the advantages of having a farmers’ bank compared with an ordinary commercial bank
in the provision of services to farmers?
(12 marks)
QUESTION THREE
a)
What is venture capital?
b)
(4 marks)
Why is the market for venture capital not yet well developed in Kenya or your country?
(16 marks)
QUESTION FOUR
a)
Distinguish between debt and equity capital
...
(15 marks)
QUESTION TWO
a)
Outline the functions of a financial manager in a contemporary corporate set-up
...
(10 marks)
b)
Why does Financial management in private (commercial firms) differ from financial management
in government/public sector
...
(10 marks)
c)
Why is operating lease called off-balance sheet financing?
(4 marks)
34
QUESTION FIVE
The Chuma Ngumu Company needs to finance a seasonal rise in inventories of Sh
...
The funds are needed for six months
...
The terms are 18 per cent annualised with an 80%
advance against the value of the inventory
...
350,000 for the sixmonth period
...
4 million less the amount
advanced will need to be financed by forgoing cash discounts on its payables
...
A floating lien arrangement from the supplier of the inventory at an effective interest rate of 24
per cent
...
A bank loan from the company’s bank for Sh
...
The bank can lend at the rate of 22%
...
Establish a one year line of credit
...
The
interest rate is 17% p
...
Required
Explain which is the cheapest option for the company?
35
(20 marks)
36
CAPITAL STRUCTURE
Factors That Affect Capital Structure
1
...
2
...
3
...
4
...
5
...
COST OF FINANCE
Definition
This is the price the company pays to obtain and retail finance
...
These include: Underwriting commission,
Brokerage costs, cost of printing a prospectus, Commission costs, legal fees, audit costs, cost of printing
share certificates, advertising costs etc
...
e
...
) such costs are knocked off from:
i)
ii)
The market value of shares if these have only been sold at a price above par value
...
I
...
if flotation costs are given per share then this will be knocked off or deducted from the market price
per share
...
Cost of Retaining Finance
This will include dividends for share capital and interest for debt finance (tax deducted) or effective cost
of debt
...
Importance of Cost of Finance
The cost of capital is important because of its application in the following areas:
i)
ii)
iii)
iv)
Long-term investment decisions – In capital budgeting decisions, using NPV method, the cost of
capital is used to discount the cash flows
...
Capital structure decisions – The composition/mix of various components of capital is
determined by the cost of each capital component
...
This is usually attributed to poor performance of the firm
...
g if the cost of retained earnings is low compared to the cost
of new ordinary share capital, the firm will retain more and pay less dividend
...
Lease or buy decisions – A firm may finance the acquisition of an asset through leasing or
borrowing long-term debt to buy an asset
...
37
Factors That Influence the Cost of Finance
1
...
2
...
3
...
4
...
5
...
6
...
7
...
8
...
Term Structure of Interest Rates
The term structure of interest rate describes the relationship between interest rates and the term to
maturity and the differences between short term and long term interest rates
...
2
...
It enables them to understand how long term and short term rates are related and what causes
the shift in their relative positions
...
2
...
Liquidity preference theory
Expectation theory
Market segmentation theory
1
...
i)
ii)
Investors generally prefer short term bonds to long-term securities because such securities are
more liquid in the sense that they can be converted to cash with little danger of loss of principal
...
At the same time borrowers react in exactly the opposite way
...
Conditions, accordingly borrowers are willing to pay
higher rate other things held constant for long-term process than short ones
...
Lenders
prefer liquidity (short term hands) while borrowers prefer long term bonds and are willing to pay a
“premium” for long term borrowing
...
Expectation Theory
This theory states that the yield curve depends on the expectation about future inflation rates
...
The
38
expected future interest rates are equal to forward rates computed from the expectations with regard to
future interest rates are
...
The following conditions are necessary for the expectation theory to hold
...
ii) Investors have homogeneous expectations about future interest rates and returns on all
investments
...
3
...
The lenders and borrower thus have a preferred maturity e
...
However a retailer borrowing
to build up stock in readiness for a peak reason would prefer a short term loan
...
g a person saving to pay school fees for next semester would want to lend on in the shortterm market
...
T market
...
An upward sloping curve would occur if there was a large supply of funds relative to
demand in the short term marketing but a relative shortage of funds in the long-term market would
produce an upward sloping curve
...
Supply and demand conditions in the short and long term market
...
Liquidity preferences of lenders and borrowers
3
...
While any of the 3 factors may dominate the market all the 3
effect the term structure of interest rate
...
1
...
3
...
CBK – Monetary policy
The level of government budget deficit
Balance of trade position
Business activity (circle) in the economy
1
...
The level of money supply is controlled by the CBK
...
The initial effect of such an
action is to cause interest rates to decline but this may also lead to increase in expected rate of inflation
which in turn pushes the interest rates up in the long run
...
Note
During periods when CBK is directly interfering with the market, the yield curve will be distorted
...
T
interests will be too high if the banks are tightening their credit and they could be too low if the banks are
easing the credit
...
Government Budget Deficit
If the Government spends more than it takes in from tax revenue, it runs a budget deficit
...
The Kenya Government has
in the past used the two ways of financing its deficit in a balanced manner
...
The
Government would borrow in the S
...
If the Government prints more money this will lead to inflation and the interest rate would eventually
rise
...
3
...
The main source of financing could be debt
...
This causes the interest rates to go up
...
4
...
As the economy moves in the four (4)
business cycles, interest rates will shift as well e
...
T interest rates
...
T Sector (market) and its intervention has a major effect on S
...
ii)
L
...
These expectations do not change generally because L
...
Other Determinants of Market Interest Rates (Required Rate of Return)
5
...
Risk free rate is made up of two components:
•
Real rate of return – interest rate if there was no inflation
40
•
Inflation premium
Therefore risk free rate (RF) = Real rate of return + Inflation premium
...
7
...
9
...
Therefore required
rate of return = real rate + inflation + premium + risk premium = Risk free rate + Risk
premium
...
From point (1) the higher the inflation premium, the higher the market interest rate
...
Usually, its
added if two securities have equal maturity and marketability
...
Maturity Risk Premium – a premium reflecting interest rate risk i
...
INTEREST RATE LEVELS AND STOCK PRICES
Interest rates have two effects on corporate profits:
a)
b)
Because interest rate is a cost, the higher the rate of interest the lower the firm’s profit other
things held constant
...
Interest rates obviously affect stock prices because of the effect on profit but even more importantly they
have an effect due to the competition in the market between shares and bonds
...
Such transfers in response to increase in interest rates reduces demand for shares in the stock exchange
and this obviously depresses the share prices e
...
Accordingly, investors removed (misdirected) their money (funds) from the stock market into Treasury
Bills
...
Accordingly as CBK achieved its
objective of reducing the money supply in the economy the interest rates declined well below 30% and
the immediate effect was a rebuild in demand for shares and the share prices shot up instantaneously
around February 1994
...
Interest rates in a country influence the foreign exchange rate of the country’s currency
...
Interest may be
41
a)
b)
Base lending rates – Banks lend to individual and small firm’s at certain margins above the base
lending rates
...
Inter-Bank Lending rates
For large loans to big firms, banks will set interest rates at a margin below base rates rather than
above base lending rates
...
• Treasury bills are used to raise, short-term funds for the government
...
• Why interest rates differ in different markets segments
Interest rates may differ in different market and market segment because of:
i)
ii)
iii)
iv)
v)
vi)
Size of the loan: Deposits above certain amounts into the bank might attract higher interest rates
than smaller deposits
...
Risks: Higher risk borrowers must pay higher rates on their borrowing to compensate lenders for
greater risks involved
...
g banks borrow for depositors and charge higher
interest (profit margin) when they lend to borrowers
...
T
...
International interest rates: This vary from one country to another due to differing rates of
inflation and government policies on interest rates and foreign currency exchange rates
...
METHODS/MODELS OF COMPUTING COST OF CAPITAL
The following models are used to establish the various costs of capital or required rate of return by the
investors:
•
•
•
•
Risk adjusted discounting rate
Market model/investors expected yield
Capital asset pricing model (CAPM)
Dividend yield/Gordon’s model
...
The cost of capital of the firm will be used as the discounting rate for a given
project if project risk is equal to business risk of the firm
...
e
...
Therefore a high risk project will be evaluated at a higher discounting rate
...
If an investor is holding ordinary shares, he can receive returns in 2 forms:
•
•
Dividends
Capital gains
Capital gain is assumed to constitute the difference between the buying price of a share at the beginning
of the (P0), the selling price of the same share at the end of the period (P1)
...
42
The amount invested to derive the returns is equal to the buying price at the beginning of the period (P0)
therefore percentage return/yield =
Total returns x 100
Investment
=
DPS + P1 – P0 x 100
P0
Illustration:
For the past 5 years, the MPS and DPS for XYZ Ltd were as follows:
1998
Shs
...
45
3
2000
Shs
...
50
3
2002
Shs
...
Solution
iii)
Year
1998
MPS
40
Capital gain
-
DPS
-
% Return
-
1999
45
5
3
8
5+3
x100 =
x100 = 20%
40
40
2000
53
8
4
8 + 4 12
=
x100 = 27%
45
45
2001
50
-3
3
−3 + 3
0
=
x100 = 0%
53
53
2002
52
2
-
2+0
2
=
x100 = 4%
50
50
Capital asset pricing model (CAPM) – CAPM is a technique that is used to establish the
required rate of return of an investment given a particular level of risk
...
This risk cannot be
eliminated/diversified
...
Since it affects all the firms in the market, the
share price and profitability of the firms will be moving in the same direction i
...
systematically
...
Systematic risk is measured by a Beta factor
...
It is therefore
unique to the firm thus unsystematic trend in profitability of the firm relative to the profitability trend of
other firms in the market
...
According to the model, the required rate of return will be
highly influenced by the Beta factor of each investment
...
g cost of equity should be equal to Rf + (Rm – Rf)BE
Cost of debt = Rf + (Rm – Rf)Bd
= rate of return/interest rate on riskless investment e
...
bills
Where: Rf
= Average rate of return for the entire stock as shown by average
Rm
Percentage return of the firms that constitute the stock index
...
Be
Bd
= Beta factor for investment in debentures/long term debt capital
...
2, the interest rate on T
...
5% and
the market rate of return is 14
...
Determine the cost of equity Ke, for the company
...
5%
Rm = 14
...
2
Ke
=
=
=
=
iv)
Dividend yield/Gordon’s Model – This model is used to determine the cost of various capital
components in particular:
•
•
•
Rf + (Rm – Rf)BE
8
...
5% - 8
...
2
8
...
2
15
...
Recall, Value of a debenture (Vd) =
Therefore Kd =
Interest charges p
...
in ∞
Cost of debt Kd
Int
...
The cost of such securities is called
yield to maturity (YTM) or redemption yield (RY)
...
T
M
Vd
n
Int(1 − T ) + (M − Vd )
1
n
1
(M + Vd ) 2
= Interest charges p
...
= Corporate tax rate
= Par or maturity value of a debenture
= Current market value of a debenture
= Number of years to maturity
WEIGHTED AVERAGE COST OF CAPITAL (W
...
C
...
)
This is also called the overall or composite cost of capital
...
This is determined on the basis of percentage cost of each capital component
...
W
...
C
...
NB: Market value = Market price of a security x No
...
V = Total market value of the firm = E + P + D
...
Ordinary share capital Sh
...
20 par value
12% debenture Sh
...
M
400
200
100
200
900
Additional information
1
...
Preference shares were issued 10 years ago and are still selling at par value MPS = Par value
3
...
It is currently selling at Sh
...
4
...
5
...
a
...
The current MPS is Sh
...
Required
a)
Determine the WACC of the firm
...
c)
What are the weaknesses associated with WACC when used as the discounting rate, in project
appraisal
...
d0 = Sh
...
40
g = 5%
d0 (1 + g )
5(1 + 0
...
05 = 0
...
13%
+g =
40
P0
Cost of perpetual preference share capital (Kp) – preference shares are still selling at par thus
MPS = par value
...
MPS = Par value = Sh
...
20 = Sh
...
2
=
=
= 10%
MPS Pp Sh
...
It is thus a redeemable
fixed return security thus the cost of debt is equal to yield to maturity
...
a
...
100 par value
Maturity period (n)
Maturity value (m)
Current market value (Vd)
Corporate tax rate (T)
K d = YTM = RY =
Int(1 − T ) + (M − Vd )
(M + Vd )½
1
n
46
= Sh
...
100
= Sh
...
12(1 − 0
...
9% ≈ 10%
Compute the market value of each capital component
Market value of Equity (E) = MPS x No
...
40 x
Sh
...
10parvalue
=
1,600
Market value of preference share capital (P)
= Par value, since MPS = Par value per share = 100
Market value of debt (D) = Vd x No
...
90 x
Sh
...
100parvalue
E + P + D = V = total Market Value
=
180
=
1,880
iii)
Compute W
...
C
...
13%, Kp = 10%, Kd(1-T) = 10%
a)
Using weighted average cost method,, WACC =
b)
=
D
P
E
K e + K p + K d (1 − T )
V
V
V
=
1,600
100
180
+ 10%
+ 10%
18
...
43 + 0
...
9574
=
0
...
92%
By using percentage method,
WACC =
Total monetary cost
Total market value (V)
Where: Monetary cost
Monetary cost of E
Monetary cost of P
Monetary cost of D
=
=
=
=
% cost x market value of capital
18
...
08
10% x 100
=
10
...
00
318
...
08
x100
1,880
= 16
...
The problems with the use of market values are:
The market value of each security keep on changing on daily basis thus market values can be computed
only at one point in time
...
Book values – This involves the use of the par value of capital as shown in the balance sheet
...
Replacement values – This involves determining the weights or proportions on the basis of amount
that can be paid to replace the existing assets
...
Intrinsic values – In this case the weights are determine on the basis of the real/intrinsic value of a given
security
...
e) Weaknesses of WACC as a discounting rate
WACC/Overall cost of capital has the following problems as a discounting rate:
•
•
•
•
It can only be used as a discounting rate assuming that the risk of the project is equal to the business
risk of the firm
...
It assumes that capital structure is optimal which is not achievable in real world
...
It is based on past information especially when determining the cost of each component e
...
Note
When using market values to determine the weight/proportion in WACC, the cost of retained earnings is
left out since it is already included or reflected in the MPS and thus the market value of equity
...
Marginal cost of finance
This is cost of new finances or additional cost a company has to pay to raise and use additional finance
is given by:
Total cost of marginal finance x 100
Cost of finance (COF)
Cost of finance may be computed using the following information:
i)
ii)
Marginal cost of each capital component
...
48
a)
b)
c)
Investors usually compute their return basing their figures on market values or cost of
investment
...
Investments appreciate in the stock market and as such the cost must be adjusted to reflect such
a movement in the value of an investment
...
Marginal cost of equity
MCE =
D1
x100
Po − f
(for zero growth firm)
Also cost of equity
D1
Po − f
Ke =
(for normal growth firm)
Where: d1 = expected DPS = d0(1+g)
P0 = current MPS
f = floation costs
g = growth rate in equity
2
...
Cost of debenture
Kd =
Int(1 − T)
Vd − f
Where: Kd = Cost of debt
Int = interest
Po = Market price for debenture (at discount)
f = flotation costs
t = Tax rate
4
...
The firm will issue 200,000 ordinary shares
(Sh
...
16 with Sh
...
20 par
value) at Sh
...
150,000 total floatation costs, 50,000 18% debentures (sh
...
80 and
raised a Sh
...
200,000
...
The company paid 28% ordinary dividends which is expected to grow at 4% p
...
49
Required
a)
Determine the total capital to raise net of floatation costs
b)
Compute the marginal cost of capital
Solution
a)
Ordinary shares 200,000 shares @ Sh
...
1
Preference shares 75,000 shares @ Sh
...
80
Floatation costs
Loan
Less floatation costs
Total capital raised
b)
3,200,000
200,000
1,350,000
(150,000)
3,000,000
-____
5,000,000
(200,000)
Sh
...
10 par =
4%
Sh
...
00
Sh
...
2
...
80(1
...
04
16 − 1
= 0
...
4%
Marginal cost of preference share capital Kp
Kp
=
dp
P0-f
dp
P0
f
=
=
=
Kp
=
12% x Sh
...
2
...
18
Floatation cost per share =
Sh
...
40 =
0
...
80
18% x Sh
...
3)
80
=
=
Sh
...
1575 =
Marginal cost of loan Kd
50
15
...
2
...
5 million
Sh
...
2 million
18% x Sh
...
0
...
9 (1-0
...
2
Source
Ordinary shares
Preference shares
Debenture
Loan
=
Amount to
raise before f
...
’000’
3,200
1,350
3,000
5,000
12,550
Weighted marginal cost =
0
...
13%
% marginal
cost
Maturity cost
23
...
0%
15
...
13%
748
...
5
472
...
5
2,080
...
3 x 100
12,550
51
=
Sh
...
58%
QUESTION ONE
The following is the existing capital structure of Company XYZ Ltd
...
1,000,000
800,000
400,000
300,000
2,500,000
Ordinary shares at Shs
...
10 par
16% loan Shs
...
Ordinary shares sells at Shs
...
15
Debentures are selling at par
...
W
...
C
...
(10 marks)
(10 marks)
QUESTION TWO
Distinguish between
•
•
•
•
Capital structure and financial structure
...
What is the effect of introduction of debt capital on weighted average cost of capital
(WACC)
Differentiate between marginal weighted cost of capital (MWCC) and WACC
QUESTION THREE
a)
Define the term weighted average cost of capital
...
is in the Telecommunications Industry
...
1,000 par)
10% preference shares
Ordinary shares (Sh
...
’000’
12,500 Current assets
16,000 Net fixed assets
6,250
12,500
28,125
75,375
Sh
...
950 in the market and will be redeemed 10 years from now
...
5
...
The
dividends are expected to grow at an annual rate of 10% in the foreseeable future
...
38 per share at the local stock exchange
...
Most banks are lending money at an interest of 22% per annum
...
52
Required
i)
Calculate the market weighted cost of capital for this firm
...
Why”
(2 marks)
QUESTION FOUR
Assume that on 31 December 2001 you are provided with the following capital structure of Hatilcure Ltd
which is optimal
...
10 par)
Retained earnings
Sh
...
360 million but this figure is expected to rise to Sh
...
You are also informed that:
1
...
3
...
5
...
7
...
Any new equity shares sold will net 90% after flotation costs
...
3
...
New 16% debt can be raised at par through the stock exchange
...
Assume marginal at rate of 40%
The company’s capital structure is optimal
Required
a)
Company’s net amount to the capital budget to be financial with equity if 85% of the asset
expansion is included in the 2002 capital budget
...
(8 marks)
c)
What is the firm’s marginal cost of capital? Show full workings
...
(10 marks)
(10 marks)
QUESTION TWO
a)
Explain the term ‘gearing’ in relation to the capital structure of a limited liability
company
...
and Bayet Ltd
...
The
following information has been provided for the year ended 30 April 1998:
Ordinary share capital Sh
...
10 par
Retained profits
15% Debentures
Capital employed
Ayet Ltd
...
600,000
600,000
1,200,000
800,000
2,000,000
2,000,000
4,000,000
Bayet Ltd
...
1,800,000
1,800,000
1,200,000
3,000,000
1,000,000
4,000,000
Required
Calculate the gearing ratio of each company and state in each case whether the gearing is high or low
...
(6 marks)
Calculate the maximum percentage dividend on ordinary shares which each company could declare,
without utilizing, or adding to, accumulated retained profits if profits for the year ended 30 April 1998
was:
Net profit (before Interest and
tax)
(Corporation tax rate is 40%)
Ayet Ltd
...
500,000
Bayet Ltd
...
1,000,000
(6 marks)
Comment on the results of b(ii) above
...
1995
Shs
...
500,000
350,000
Cost of goods sold
Stock at 31 December
Debtors at 31 December
Creditors at 31 December
Total assets at 31 December
360,000
100,000
98,000
40,000
300,000
330,000
60,000
102,000
25,000
185,000
Stock and debtors at 1 January 1994 amounted to Sh
...
98,000 respectively
...
(3 marks)
(3 marks)
b)
Calculate the rate of collection of debtors, in days, for each of the years 1994 and 1995
...
(3 marks)
d)
Show the cash operating cycle for each year
...
(6 marks)
QUESTION FOUR
a)
Briefly explain the meaning of a “floating rate” bond
...
(16 marks)
QUESTION FIVE
The Altman formula for prediction of bankruptcy is given as follows:
Z score =
1
...
4X2 + 3
...
6X5
Where: X1
X2
X3
X4
X5
=
=
=
=
=
Working capital/Total assets
Retained earnings/Total assets
Earnings before interest and tax/Total assets
Sales/Total assets
Market value of Equity/Liabilities
In this model, a Z-score of 2
...
8 or less indicates
failure
...
A
Ltd
Working Retained Earnings
capital
earnings before
interest
and tax
Market
value
of
equity
Sh
...
’000’ Sh
...
’000’
60,000
20,000
Sh
...
’000’
120,000
80,000
Sh
...
20,000
200,000
-30,000
30,000
48,000
100,000
100,000
800,000
1,800,000
740,000
1,000,000
120,000
900,000
2,000,000
Required
a)
The Z-Score for each of the companies
...
(10 marks)
b)
It has been suggested that other ratios ought to be incorporated into Altman’s bankruptcy
prediction model
...
(5 marks)
56
INVESTMENT ANALYSIS
Any company will invest finance for the sake of deriving a return which is useful for four main reasons:
1
...
3
...
To reward the shareholders or owners of the business for staking their money and by foregoing
their current purchasing power for the sake of current and future return
...
To be able to retain part of their earnings for plough back purposes which facilitates not only the
companies growth present and the future but also has the implication of increasing the size of the
company in sales and in assets
...
Such a return is necessary to keep the company’s operations moving smoothly and thus allow the
above objective to be achieved
...
Investments are important because:
i)
ii)
iii)
They influence company’s size
Influence growth
Influence company’s risks
In addition, this investment decision making process also known as capital budgeting, involves the
decision to invest the company’s current funds in viable ventures whose returns will be realised for long
term periods in future
...
2
...
Decisions of this nature are long term i
...
extending beyond one year in which case they are also
expected to generate returns of long term in nature
...
These decisions are irreversible and any mistake may cause the company heavy losses
...
b)
They increase the value of the company’s shares and thus its credibility
...
d)
Due to heavy capital outlay, more attention is required to avoid loss of huge sums of money
which in the extreme may lead to the closure of such a company
...
Thus political certainty has to be
analysed before such decisions are made, such factors must be taken into account such that the
company forecasts the inflows and outflows within given
limitations such as the degree of competition, performance of economy, changing tastes etc
...
ii)
Technological factors – These influence the returns of the company because such technology
will affect the company’s ability to utilise its assets to the utmost ability in particular if such assets
become obsolete and cannot generate good returns or the output of such machines may be low
with time and may not meet planned expectations which in most cases will have an impact on
inflows from a venture
...
There are two methods of analyzing the viability of an investment:
a) Traditional methods
•
•
Pay back period method
Accounting rate of return method
b) Modern methods (Discounted cash flow techniques)
•
•
•
NPV – Net present value method
IRR – Internal rate of return method
PI – Profitability index method
For the above two (a & b) methods to be used, they have to meet the following:
i)
ii)
iii)
They should rank ventures available in the investment market according to their viability i
...
they
should identify which method is more viable than others
...
Should rank any other projects as and when it is available in the investment market
...
TRADITIONAL METHODS
Pay back period method
This method gauges the viability of a venture by taking the inflows and outflows over time to ascertain
how soon a venture can payback and for this reason PBP (or payout period or payoff) is that period of time
or duration it will take an investment venture to generate sufficient cash inflows to payback the cost of such investment
...
This method is
usually an important preliminary screening stage of the viability of the venture and it may yield clues to
profitability although in principle it will measure how fast a venture may payback rather than how much a
venture will generate in profits and yet the main objectives of an investment is not to recoup the original
cost but also to earn a profit for the owners or investors
...
Under uniform annual incremental cash inflows – if the venture or an asset generates
uniform cash inflows then the payback period (PBP) will be given by:
PBP
=
Initial cost of the venture
Annual incremental cost
e
...
If a venture costs 37,910/= and promises returns of 10,000/= per annum indefinitely then
the PBP =
37,910
10,000
=
3
...
2
...
Example
Assume a project costs Sh
...
80,000 cost is recovered between year 4 and 5
...
5,000 is
(80,000 – 75,000) is required out the total year 5 cash flows of 30,000
...
17 years
Example
Cedes limited has the following details of two of the future production plans
...
The
Standard model costs £50,000 and the Deluxe cost £88,000 payable immediately
...
Both machines have no expected scrap value at end of their expected working lives of 4 years for
the Standard machine and six years for the Deluxe
...
The company is
proposing the purchase of either machine with a term loan at a fixed rate of interest of 11% per annum,
taxation at 30% is payable on operating cash-flows one year in arrears and capital allowance are available
at 25% per annum on a reducing balance basis
...
Solution
Establish the cash flows as follows:
Pre-tax inflows (EBDT)
Less depreciation = capital allowance
Earnings before tax
Less tax
Earnings after tax
Add back capital allowance/depreciation
Operating cash flows
XX
(XX)
XX
(XX)
XX
XX
XX
Note
Capital allowance/depreciation is a non-cash item thus when deducted for tax purposes, it should be
added back to eliminate the non-cash flow effects
...
300
9,435
24,210
9,844
14,366
(3,831)
10,545
23,410
7,383
16,027
(4,310)
11,717
-
Add back capital allowance
Operating cash flows
Add working capital realised
Total cash flows
17,500
28,500
28,500
13,125
22,560
22,560
9,844
20,389
20,389
7,383
19,100
10,000
29,100
(4,808)
(4,808)
(4,808)
(4,808)
Cash flows for Deluxe machine
Year
1
2
3
4
5
6
7
Pretax inflows
Less (depreciation)
36,030
32,000
4,030
-
30,110
24,000
6,110
(1,209)
28,380
18,000
10,380
(1,833)
25,940
13,500
12,440
(3,114)
38,560
10,125
28,435
(3,732)
35,100
7,594
27,506
(8,531)
(8,252)
4,030
4,901
8,547
9,326
24,703
18,975
(8,252)
Tax @ 30% in
arrears
60
Inflows after tax
Add back capital
Allowance
32,000
36,030
Add back
w/capital
Total cash flows
Cost
Year
1
2
3
4
5
6
7
24,000
28,901
28,599
18,000
26,547
26,547
Standard
70,000
50,000 + 20,000
Cash flows Accumulated
28,500
28,500
22,560
51,060
20,389
71,449
29,100
100,549
(4,808)
95,741
-
13,500
22,826
22,826
10,125
34,828
34,828
88,000 + 40,000
Cash flows
36,030
28,901
26,547
22,826
34,828
36,569
( 8,252)
7,594
26,569
10,000
36,569
(8,252)
(8,252)
Deluxe
128,000
Accumulated
36,030
64,931
91,478
114,304
149,132
185,701
179,449
*
Pay back period for standard: Initial capital of Sh
...
After year 2,
we require 70,000 – 9,060 = 18,940 to recover initial capital out of year 3 cash flows of Sh
...
*
Applying the same concept for Deluxe, payback period would be:
4+
128,000 − 114,304
34,828
=
4
...
The investment would be equal to either the
original investment plus the salvage value divided by two or the initial investment divided by two or
dividing the total of the investment book value after depreciating by the life of the project
...
The rate of return on asset method
or adjusted rate of return method is given by:
ARR
=
Average income x 100 or
Average investment
Average income – Average depreciation
Initial investment
Unlike PBP, this method will ascertain the profitability of an investment and it will give results which are
consistent with those given by return ratios e
...
Shs
...
100,000
120,000
140,000
160,000
200,000
61
Let tax = 50% and depreciation straight line
...
Solution
Depreciation
=
500,000 – 100,000
5 years
Year
Income
Less depreciation
Earnings before tax EBT
Less tax @ 50%
EAT
=
Shs
...
67%
300,000
Note
The best method of depreciation to use should be that which will produce larger depreciation changes in
the 1st few years of the assets life and lesser changes in the later years because this will produce a higher
tax shield to the company with higher value of inflows
...
The salvage value should be treated as follows:
If the asset produces a salvage value at the end of the year, this will increase inflows for payback period
...
Acceptance Rule of Payback Period (Pbp)
Using PBP method a company will accept all those ventures whose payback period is less than that set by
the management and will reject all those ventures whose PBP is more than that set by the management
...
However, in assessing the viability of a venture it is also
important to see which venture brings returns earlier, other things being equal
...
Simple to use and understand and this has made it popular among executives especially
traditional financial managers in ascertaining the viability of a venture
...
Ideal under high-risk investments because it will identify which venture will payback earlier thus
minimising the risks with a venture
...
Advantageous when choosing between mutually exclusive projects because it will give a clue as to
which venture is viable if one considers the shortest PBP and the highest inflow of a venture
...
Does not take into account time value of money and assumes that a shilling received in the 1st
year and in the Nth year have the same value so as to rank them together to ascertain the PBP
which is unrealistic given that a shilling now is valuable than a shilling N years from now
...
3
...
PBP method does not measure the profitability of a venture but rather measures the period of
time a venture takes to pay back the cost
...
PBP method ignores inflows after PBP and as such, it does not accommodate the element of
return to an investment
...
Acceptance Rule of Accounting Rate of Return (Arr)
ARR method will accept those projects whose ARR is higher than that set by management or bank rate
and it will give highest ranking to ventures with highest ARR and vice versa
...
Simple to understand and use
...
Readily computed from accounting data thus much easier to ascertain
...
It is consistent with profitability objectives as it analyses the return from entire inflows and as
such it will give a clue or a hint to the profitability of venture
...
It ignores time value of money
...
It does not consider how soon the investment should recover the cost (it is owner looking than
creditor oriented approach)
...
It uses accounting profits instead of cash inflows some of which may not be realisable
...
e
...
Present Value Concept
This concept acknowledges the fact that a shilling losses value with time and as such if it is to be
compared with a shilling to be received in Nth year then the two must be at the same values
...
He/she should be able to work in the reverse direction i
...
from
future cash flows to their present values
...
Present Value of a Lumpsum
Usually an investor would wish to know how much he/she would give up now to get a given amount in
year 1, 2, … n
...
This implies that if the time preference rate is 10%, the present value of 1/= to e received at the end of
year 1 is:
Pv =
1
= 0
...
1
The present value of inflows to be received in the 2nd year to Nth year, will be equal to:
63
Pv =
A
(1 + K )N
Where: A = annual cash flows
N = Number of years
Also, the present value of a shilling to be received at a given point in time can in addition to using the
above formula, be found using the present value tables
...
Pv =
L
(1 + K )
=
N
=
40,000
(1
...
12)
6
_
100,000
(1
...
107,740
...
7992) + 70,000(0
...
4039)
107,820
3
...
e
...
The present value of an annuity receivable
where the investor time preference is 10% equal to:
Pv ( A ) =
A
(1 + i)
E
...
Pv of 1/= to be received after 1 year if time preference rate is 10%
...
909
1 + 0
...
1)2
= 0
...
9090
0
...
7513
0
...
1697
4
...
+
AN
(1 + K )N
∑ (1 + K )
t
Where: At = Uneven cash inflows at time t
Pv = Present value
K =Cost of finance
A company contemplates to receive Shs
...
12)
1
+
18,000
(1
...
12)
3
+
40,000
(1
...
004
5
...
e the present value method will
involve selection of rate acceptable to the management or equal to the cost of finance and this will be
used to discount inflows and outflows and net present value will be equal to the present value of inflow
minus present value of outflow
...
Pv(inflow) – Pv(outflows) = NPV
Note
Initial outflow is at period zero and their value is their actual present value
...
In this case, a venture will be viable
if it has the lowest outflows
...
+
NPV =
−C
1
2
3
(1 + K )
(1 + K )N
(1 + K ) (1 + K )
Where: A = annual inflow
K = Cost of finance
C = Cost of investment
N = Number of years
65
Examples
Cost of investment = 100,000/=, interest rate = 10%, inflows year 1 = 80,000/= year 2 = 50,000/=
NPV
=
80,000 50,000
+
− 100,000
1
...
1)2
=
14,049 positive hence invest
...
In the 4th year, this machine will call for an overhaul to cost 80,000/=
...
60,000
72,650
35,720
48,510
91,630
83,715
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
This company can raise finance to purchase machine at 12% interest rate
...
Solution
Shs
...
50,841
...
12)4
Total present value of investment =
PV inflows
Therefore:
=
80,000
(1
...
45
60,000 72,650 35,720
48,510 91,630 83,715
+
+
+
+
+
(1
...
12 )2 (1
...
12) 4 (1
...
12 )6
=
262,147
...
28 – 260,841
...
83
The NPV is positive and I would advise the management to invest
...
1,500,000 which will have a residue value
Shs
...
The saving in cost resulting from the use of this machine are:
Shs
...
Solution
Year
Saving
Scrap value
Total amount
NPV
800,000
=
=
1,880,067
...
07
(1
...
14)2
380,067
...
14)4
+
3
-
975,000
(1
...
337% > 12% hence invest
...
Example
A section of a roadway pavement costs £400 per year to maintain
...
Solution
Total present value of maintenance costs under the re-surfacing scheme
...
05
=
Present value of an Annuity for n years is given by the formula:
1
n
1 −
(
1+ K )
PV = A
K
Whereby:
PV is Present value
A is annuity
K is cost of finance
n is number of year
67
Present value of an annuity to perpetuity is given by the formula
Pv
Whereby:
A
=
K
PV is Present value
A is annuity
K is cost of finance
Therefore PV maximum expenditure
=
400
= £8,000
0
...
05)15
PV = 100
0
...
05)
0
...
5
(1
...
5
=
£4,453
NB:
The present value interest factors PVIF =
Annuity factors, PVAF =
1 − (1 + r ) −n
r
1
(1 + r)n
and present value
can be read from tables provided at the point of interseption
between the discounting rate and number of periods
...
P
...
is positive i
...
if present
value of cash outflows exceeds that of cash inflows or at least is equal to zero
...
This will rank
ventures giving the highest rank to that venture with highest NPV because this will give the highest cash
inflow or capital gain to the company
...
• It takes into account the entire inflows or returns and as such it is a realistic gauge of the
profitability of a venture
...
4
...
Disadvantages of NPV
• It is difficult to use
...
• It is ideal for assessing the viability of an investment under certainty because it ignores the
element of risk
...
68
•
It ignores the PBP
...
It is defined as the
rate which equates the present value of cash outflows of an investment to the initial capital
...
It is also called internal rate of return because it depends wholly on the outlay of investment and proceeds
associated with the project and not a rate determined outside the venture
...
+
AN
(1 + r )N
A = inflow for each period
C = Cost of investment
The value r can be found by:
i)
ii)
iii)
Trial and error
By interpolation
By extrapolation
i) Trial and error method
a)
Select any rate of interest at random and use it to compute NPV of cash inflows
...
c)
If the rate chosen in (a) above gives NPV greater than the cost, choose a higher rate
...
Example
A project costs 16,200/= and is expected to generate the following inflows:
Shs
...
Solution
1st choice 10%
8,000
(1
...
1)
2
+
6,000
(1
...
74 > cost, choose a higher rate
...
646
=
16,194
...
14)
1
+
7,000
(1
...
14)3
3rd choice 15%
8,000
(1
...
15)
2
+
6,000
(1
...
69
ii) Interpolation method
PV at rate of 14%
=
16,453
...
000
PV at rate of 15%
=
16,194
...
646
-5
...
98%
= 14
...
646
253
...
375
Acceptance Rule of IRR
IRR will accept a venture if its IRR is higher than or equal to the minimum required rate of return which
is usually the cost of finance also known as the cut off rate or hurdle rate, and in this case IRR will be the
highest rate of interest a firm would be ready to pay to finance a project using borrowed funds and
without being financially worse off by paying back the loan (the principal and accrued interest) out of the
cash flows generated by that project
...
Advantages of IRR
It considers time value of money
It considers cash flows over the entire life of the project
...
Unlike the NPV method, it does not use the cost of finance to discount inflows and for this reason it
will indicate a rate of return of interval to the project against which various ventures can be assessed
as to their viability
...
• Expensive to use because it calls for trained manpower and may use computers especially where
inflows are of large magnitude and extending beyond the normal limits
...
PROFITABILITY INDEX (P
...
)
P
...
(benefit-cost ratio) =
Present value of inflows
Present value of cash outlay
If P
...
is greater than 1
...
If less than 1
...
Example
The following information was from XYZ feasibility studies
...
b)
Initial cost 200,000/= and 80,000/= at the beginning of the 4th year and it will generate the
following inflows:
70
1st – 2nd year -> Shs
...
70,000 per annum
Using the cost of finance of 12% compute the P
...
of these two ventures, advise the company
accordingly
...
12)3
Inflows:
80,000
80,000
+
80,000
+
50,000
+
50,000
+
50,000
(1
...
12)2 (1
...
12)4 (1
...
12)6
P
...
=
P
...
=
1
...
277,626
277,626
213,885
Outflows:
P
...
+
= 100,000 + 113,887 = 213,885
(1
...
12)3
+
100,000
(1
...
12)3 (1
...
12)5 (1
...
338,501
338,501
256,944
1
...
2
...
4
...
Cost
NPV
500,000
100,000
400,000
200,000
160,000
150,000
40,000
40,000
100,000
90,000
P
...
v___
Initial capital
1
...
4
1
...
5
1
...
I Ranking
4
3
5
2
1
This company has 750,000/= available for investment projects, 3 and 4 are mutually exclusive
...
Which group should be selected in order to maximise the NPV
...
Solution
Using P
...
to rank the projects in order of preference 5, 4, 2, 1, 3
...
750,000
(750,000)
NIL
71
NPV
=
90,000 + 100,000 + 40,000 +
290,000
x150,000
500,000
= 317,000
Advantages of profitability index
a)
Simple to use and understand
...
I
...
I
...
It acknowledges time value for money and at the same time the NPV of a venture at its present
value which is consistent with investment appraisal requirements
...
b)
It may be difficult to ascertain if the economic life of a venture is long and it yields large inflows
because their discounting may call for use of computers that are expensive
...
The choice should not be
limited to one method but at least 2 modern methods
...
Where the cash outlay is larger than the other
...
e the cash flows of one project may overtime increase while
those of the other decrease
...
PBP RECIPROCAL
PBP expresses the profitability of a project in terms of years
...
The PBP reciprocal has been utilised to rectify the situation, but it is only of value where the
pattern of cash flow is relatively consistent and where the life of the asset is at least double the payback
period of the asset
...
e
...
Payback period reciprocal
=
1
x100
PBP
REPLACEMENT OF ASSETS
Example
Estate Developers purchased a machine five years ago at a cost of £7,500
...
It is being depreciated on a straight line basis and currently has a book value of £5,000
...
The new machine will expand sales from £10,000 to £11,000 per
annum and will reduce labour and materials usage sufficiently to cut operating cost from £7,000 to
£5,000
...
The current market
value of the old machine is £1,000 and tax is 40%
...
The financial
manager wishes to make a decision on whether to replace the old machine with a new one and he seeks
your held
...
B
...
Compute the NPV of incremental cash flows
...
V
...
Ascertain whether the NPV (net present value) is positive or whether the IRR (internal rate of
return) exceed the cost in which case invest if its positive
...
This NBV will be depreciated over the
remaining 10 years
...
New machine salvage value
2,000
Less old machine salvage value
0
2,000
Compute the NPV @10% cost of capital:
1 − (1
...
145
0
...
386
1
...
V of cash flows = 2000x
P
...
P
...
Two alternative machines, Pesi TZO
and Upesi MO2, which will cost Sh
...
7,000,000 respectively are available in the market
...
Sh
...
b)
(8 marks)
Assuming that each machine represents a project:
Compute the return Kiwanda Limited expects to earn from each of the two projects
...
(4 marks)
(Total: 22 marks)
QUESTIONTHREE
The Weka Company Ltd
...
The screening criteria established by management are as follows:
No project should involve a net commitment of funds for more than four years
...
Present estimates are that cost of capital as 15 percent per annum after tax
...
A proposal to purchase a new lathe machine is to be subjected to these initial screening processes
...
2,200,000 and has an estimated useful life of five years at the end of which the
disposal value will be zero
...
’000’)
75
Additional operating costs are estimated to be Sh
...
Tax rates may be assumed to be
35% payable in the year in which revenue is received
...
The financial accounting statements issued by the company in recent years shows that profits after tax
have averaged 18% on total assets
...
(Total: 19 marks)
QUESTION FOUR
a)
What are the features of a sound appraisal technique?
(6 marks)
b)
What practical problems are faced by finance managers in capital budgeting decisions?
(6 marks)
c)
Describe the features of long term investment decisions
...
’M’
60
15
20
55
30
40
NPV @ 15% cost
of capital
21
9
9
15
20
-2
The firm has Sh
...
Identify which projects should be undertaken
...
I and NPV ranking, comment on your
answer
...
• Savers include individuals, small businesses, family units savings through institutions such as
SACCOs, banks, insurance firms, pension schemes etc
...
Note
Physical or commodity markets deal with real assets such as tea, coffee, wheat, automobile etc
...
Distribution of financial resources to the most productive units
...
(Link between buyers and sellers)
...
Allocation of savings to real investment
...
Achieving real output in the economy by mobilizing capital for investment
...
Enable companies to make short term and long term investments and increase liquidity of shares
...
Provision of investment advice to individuals through financial experts
...
Enables companies to raise short term and long term capital/funds
7
...
g N
...
E
...
8
...
Savers can hold financial instrument for investment made
...
2
...
g
...
Capital markets are sub-divided into 2:
a) Security markets e
...
b) Non-security/instrument market e
...
•
•
Primary market
Secondary market
CAPITAL MARKET
These are markets for long term funds with maturity period of more than one year
...
g of Financial
instruments used here are debentures, terms, loans, bonds, warrants, preference shares, ordinary shares
etc
...
Capital
market financial institution includes:
1
...
Development bank
3
...
Building societies
5
...
b)
Provide advice to investors as to which investments are viable
...
d)
Facilitates the international capital inflow
...
Money/discount markets
• Are discount and acceptance financial institutions
• This is a market for S
...
Money market works through financial
institutions
...
• The transfer can be direct (from saver to investor) and indirectly through an intermediary)
...
• The money market or discount market is the market for short term loans
...
Commercial paper
2
...
Bills of exchange
4
...
Bank overdrafts
6
...
Primary Markets
These are markets that deal with securities that have been issued for the first time
...
They facilitate capital
formation
...
Raising capital for business
...
Mobilising savings
3
...
Open market operation to effect monetary policy of the government i
...
It is a vehicle for direct foreign investment
...
It gives people a chance to buy shares hence distribution of wealth in economy
...
Enable investors realize their investments through disposal of securities
...
Increases diversification of investments
4
...
This
increases higher standards of accounting, resource management and transparency
...
Privatisation of parastatals e
...
Kenya Airways
...
6
...
Provides investment opportunities for companies and small investors
...
Organised Exchange and Over the Counter (OTC) market
This is where the buying and selling of securities is done by buyers and sellers are not present but
only the agents (brokers) internet
...
2
...
They maintain a reasonable balance between demand and supply and observe price movements
to determine profit margins on sale
...
The dealers/participants set the trading rules OTC specialize in securities such as corporate
bonds, equity securities, Treasury bonds etc
...
Features of OTC Markets
1
...
Usually deal with new securities of firms
3
...
FINANCIAL INTERMEDIARIES
These are institutions which mediate/link between the savers and investors:
Examples of financial intermediaries in Kenya
...
Commercial Banks
...
2
...
They provide credit analysis services
...
Credit Unions
These are cooperative associations whose members have a common bond e
...
The savings of the member are loaned only to the members at a very low interest rate e
...
SACCOS charge p
...
interest on outstanding balance of loan
...
Pension Funds
These are retirement schemes or plans funded by firms or government agencies for their workers
...
Examples of pension funds are NSSF, NHIF and other registered pension funds of individual firms
...
Life Insurance Companies
These are firms that take savings in form of annual premium from individuals and them invest, these
funds in securities such as shares, bonds or in real assets
...
79
6
...
They act on
behalf of members of public who are buying and selling shares of quoted companies
...
Investment Bankers
These are institutions that buy new issue of securities for resale to other investors
...
2
...
4
...
Giving advice to the investors
Giving advice to firms which wants to
Valuation of firms which need to merge
Giving defensive tactics incase of forced takeover
Underwriting of securities
...
They are, in effect, a financial institution, which provides the facilities and
regulations needed to carry out such transactions quickly, conveniently and lawfully
...
(No stock
exchanges exist in the communist world outside Hong Kong and Macao – which have special status, and
Taiwan which is also claimed by China)
...
1
...
2
...
The
document will then facilitate the updating of the issuing companies shareholders register
...
Stock exchanges were the result emerging to provide a continuous auction market
for securities, with the laws of supply and demand determining the prices
...
While
this basic function is extremely important and is the engine through which stock exchanges are driven,
there are also other quite important functions
...
2
...
The mobilization of savings for investment in productive enterprises as an alternative to putting
savings in bank deposits, purchase of real estate and outright consumption
...
g
...
The check against flight of capital which takes place because of local inflation and currency
depreciation
...
5
...
7
...
Encouragement of the divorcement of the owners of capital from the managers of capital; a very
important process because owners of capital may not necessarily have the expertise to manage
capital investment efficiently
...
Facilitation of equity financing as opposed to debt financing
...
Improvement of access to finance for new and smaller companies
...
Encouragement of public floatation of private companies which in turn allows greater growth
and increase of the supply of assets available for long term investment
...
Individuals, corporate
organizations and even the government
...
Stock exchanges, especially in developing countries have not always played the full role in economic
development
...
Raising Capital for Businesses
The Stock Exchange provides companies with the facility to raise capital for expansion through selling
shares to the investing public
...
Mobilising Savings for Investment
When people draw their savings and invest in shares, it leads to a more rational allocation of resources
because funds which could have been consumed, or kept in idle deposits with banks are mobilized and
redirected to promote commerce and industry
...
Redistribution of Wealth
By giving a wide spectrum of people a chance to buy shares and therefore become part-owners of
profitable enterprises, the stock market helps to reduce large income inequalities because many people get
a chance to share in the profits of business that were set up by other people
...
Improving Corporate Governance
By having a wide and varied scope of owners, companies generally tend to improve on their management
standards and efficiency in order to satisfy the demands of these shareholder
...
5
...
Therefore the Stock
Exchange provides an extra source of income to small savers
...
Government Raises Capital for Development Projects
The Government and even local authorities like municipalities may decide to borrow money in order to
finance huge infrastructural projects such as sewerage and water treatment works or housing estates by
selling another category of shares known as Bonds
...
When the Government or Municipal Council gets
this alternative source of funds, it no longer has the need to overtax the people in order to finance
development
...
Barometer of the Economy
At the Stock Exchange, share prices rise and fall depending, largely, on market forces
...
Therefore
their movement of share prices can be an indicator of the general trend in the economy
...
Income in form of dividends
When you have shares of a company you become a part-owner of that company and therefore you will be
entitled to get a share of the profit of the company which come in form of dividends
...
2
...
Capital gains are not taxed in Kenya
...
Share Certificate can be used as a Collateral
Share certificate represents a certain amount of assets of the company in which a shareholder has
invested
...
82
4
...
5
...
Positive advise and guidance
could be provided by the stockbrokers and other investment advisors
...
6
...
Shareholders elect the directors at
the Company’s Annual
...
STOCK MARKET TERMINOLOGY
1
...
• He is an agent of investors
• He is the only authorized person to deal with the quoted securities
...
• He doesn’t buy or sell shares in his own right hence he cannot be a market marker
...
2
...
• He can set prices and activate the market through his own buying and selling hence he is a
market maker
...
• He does not deal with members of the public unlike brokers
...
There are 3 types of jobbers
a)
•
•
Bulls
A jobber buy shares when prices are low and hold them in anticipation that the price will rise and
sell them at gain
...
The
share prices are generally rising
...
It signifies investors confidence/optimism in the future of economy
...
The intention is to buy same securities at lower prices in future thereby making a gain
...
•
•
b)
83
•
c)
3,
•
•
•
•
•
•
•
•
•
•
•
•
4
...
•
•
It is characterized by general downward trend in share prices
...
Stags
This is a jobber found in primary markets
He buys new securities offered to the public and believes that they are undervalued
...
Underwriting
This is the assumption of risk relating unsubscribed shares
When new shares are issued, they may be underwritten/unsubscribed
...
They therefore ensure that all new issues are successful
Underwriters are very important in pry markets and play the following roles:
Advice firms on most suitable issue price
Ensure shares are fully subscribed by taking up all unsubscribed shares
Advice the firms on where to source funds to finance floatation costs
...
They have very good dividend record and are highly demanded in the markets
...
•
•
Going short or long on a share
This is the process of selling (going short) or buying (going long) on a share that one does not
have/own
The aim is to make gain from assumed change in the market value of shares
This practice is not allowed in Kenya
•
•
It is aided by brokers in countries where it is practiced
Investors going short or long are required to pay a premium called margin on the transaction
...
An investor approaches a broker who takes his bid/offer to the trading floor
...
At the trading floor, the buying and selling brokers meet and seal the deal
...
The investor is informed of what happened/transpired at the trading floor through a contract
note
...
The note contains details such as:
• Number of shares bought or sold
• Buying/selling price
• Charges/commission payable etc
...
5
...
Old share certificate is cancelled (for selling investor) and a new one is issued in the name of
buying investor
...
2
...
4
...
6
...
Economic conditions of the country and other non-economic factors e
...
unfavourable climatic
conditions and diseases which may lead to low productivity and poor earnings
...
g are the B
...
D
...
Nature of the product dealt in and its market share e
...
e does the company have a variety of operations e
...
Company’s trading partners (local and abroad) and its competitors
...
Note
Stock broker can give all the above advice when buying shares
...
These influences include:
1
...
3
...
5
...
7
...
9
...
11
...
13
...
15
...
The growth prospects of the industry in which the company operates
...
e
...
The general economic conditions situations e
...
g during boom, firms
would have high profits hence rise in prices
...
g entry and exit of prominent corporate personalities
...
g spending, taxes, monetary policy etc
...
Rumour and announcements of impending political changes eg
...
Rumours and announcement of mergers and take-over bids
...
Industrial relations eg strikes and policies of other firms
...
Changes in the rate of interest on Government securities such as Treasury Bills may make
investors switch to them
...
Announcement of good news eg that a major oil field has been struck or a major new investment
has been undertaken
...
The views of experts e
...
Institutional buyers such as insurance companies can influence share prices by their actions
...
STOCK MARKET INDEX
Definition
An index is a numerical figure which measures relative change in variables between two periods
...
25 M and for year 2001 Shs
...
30 M x 100 = 120
Year 2000 sales Shs
...
A stock index therefore measures relative changes in prices or values of shares
...
20 companies constitute the index
...
M) as follows:
Todays stock index
=
(Today’s share price G
...
M
...
M
=
n P xP xP xP x
...
M
...
N = number of companies
•
•
When stock prices are rising, stock market index will rise and vice versa
...
Illustration
The following 6 companies constitute the index of democratic republic of Kusadikika
...
In construction/computation of stock index the following should be considered:
1
...
3
...
5
...
The weights/number of firms in a sector is kept constant over a reasonably long period
...
2
...
4
...
Few Listed companies
Economy is made up of small firms which are family owned or sole proprietorship
...
STOCK EXCHANGE INDEX (SEI)
Stock Exchange Index is a measure of relative changes in prices of stocks from one period to another
indices
...
Uses of Stock Exchange Index
1
...
To assess overall returns in the market portfolio
3
...
4
...
Assist in examining and identifying the factors that underlie the price movements
...
The 20 companies sample whose share prices are used to compute the index are not true
representatives
...
The base year of 1996 is too far in the past
3
...
g
...
4
...
5
...
The weights used and the method of computation of index may not give a truly representative
index
...
• If the price is not consistent with the activities of the firm e
...
• Price is not compatible with the price of other similar shares of firms in the same industry
• If there is insider trading:
This situation arises where individuals within the firm in privileged positions e
...
They may use such information to dispose off share to make capital gains or avoid capital loss
Example – where individuals (insiders) are aware that a firm has made a loss in a year and such
information, if released to the public, would cause a crash on share price, the information may be
leaked to certain people who could sell the shares in advance
...
P
...
P
...
The greatest problem however is that no one
can be sure when the market is at its bottom or at its top (prices are lowest and highest)
...
These systems are Dow theory and Hatch system
...
Dow Theory
This theory depends on profiting of secondary movement of prices of a chart
...
This is determined by the behaviour of secondary movement but tertiary movements are ignored
...
In a bear market the opposite is the case ie the fall is greater than the rise
87
In a bear market, the volume of the business being done at a certain stage can also be used to interpret
the state of the market
...
2
...
This system can be applied to an index of a group of shares or shares of
dividends companies eg Dow Jones and Nasdaq index of America
...
He sells the shares when
prices are 15% less of the top price and buy the shares when prices are 15% less of the top price and buy
the shares when prices are 15% more of the bottom price
...
At the end of the year the share price was Shs
...
i)
ii)
iii)
Determine the buying and selling price of the shareholders
If the shareholder had 10,000 shares, determine the amount of capital gain on these shares
...
P
...
00 at the end of the year
...
Rules for floatation of new shares on NSE
1
...
20 M
...
The company must have made profits during the last 3 years
...
At least 20% of issued capital (capital to be issued) should be offered to the public
4
...
The market price of the companies share must be determined by the market forces of demand
and supply
6
...
486 with registrar of companies
...
It is prepared by directors of the company and submitted to CMA and NSE for approval
The CMA has issued rules relating to the design and contents of the prospectus, in addition to
those contained in the Companies Act
...
Number of shares to be issued
2
...
The dates during which the other is valid or open
4
...
Action report etc
...
Action may be taken against the directors if the prospectus is fraudulent
...
It facilitates the issue of securities to raise new finance, making a company less dependent upon
retained earnings and banks
...
3
...
5
...
7
...
9
...
The transfer of shares becomes easier
...
For this reason the shares are likely to be perceived as a less risky investment and
hence will have a higher value
...
A market-determine price means that shareholders will know the value of their investment at all
times
...
The shares of a quoted company can be used more readily as consideration in takeover bids
...
Obtaining a quotation provides an entrepreneur with the opportunity to realize part of his
holding in a company
...
The cost of obtaining a quotation is high, particularly when a new issue of shares is made and the
company is small
...
Also, the annual cost of maintaining the quotation may be high due to such
things as increased disclosure, maintaining a larger share register, printing more annual reports,
etc
...
The increased disclosure requirements may be disliked by management
...
The market-determined price and the greater accountability to shareholders that comes with its
concerning the company’s performance may not be liked by management
...
Control of a particular group of shareholders may be diluted by allowing a proportion of shares
to be held by the public
...
There will be a greater likelihood of being the subject of a takeover bid and it may be difficult to
defend it with wide share ownership
...
Management conditions, management employees give themselves more salaries due to prosperity
obtained
...
ROLE OF CMA
1
...
To serve as efficient bridge between the public and private sectors
3
...
To grant approvals and licences to brokers
5
...
Act as a watchdog for the entire capital market system
7
...
To implement government programs and policies with respect to the capital markets
...
89
1
...
3
...
5
...
Removal of Barriers on security transfers
Introduce wider range of instruments in the market
Decentralization of its operations
Encourage development of institutional investors such as pension funds, insurance firms etc
...
Role of CMA in determination of share prices
1
...
2
...
However, CMA may:
4
...
Alert the investors if it feels that the issue price of certain securities is not in their interest
6
...
Other Terminologies
1
...
2
...
3
...
As a security measure, this stock is paid for in full
...
BONUS SHARES
Additional shares issued to shareholders at no
additional cost to themselves as a form of extra dividend
...
4
...
CALL-OVER Bargaining and closing deals in a stock
exchange without a formal floor and position dealings, where the secretary reads, calls out each
security to be dealt, one at a time
...
CARRY-OVER When a deal has been arranged but, for some
valid reason, either the buyer cannot pay on time, or the Jobber may not be able to deliver stock
on time
...
7
...
This happens when a client has commissioned his broker to purchase securities but for
some reason, cannot pay on time
...
CUM
...
hese prefixes are written in front of other
words such as capital, rights and dividends to qualify them
...
“Ex” on the other hand is short for excluding, which is the
opposite of including
...
These terms are necessitated
by the fact that shares are bought and sold throughout the year, but companies only declare
dividends after the end of their financial year when profits can be determined, and moreover,
payment of dividends may take place long after they have been declared
...
“Cum Capital” then means he
sells them inclusive of this right
...
Ex and Cum
proceeding it refers to the sale of shares decision, but before the dividend
...
S
...
They are therefore sold at higher prices than “Ex”
shares
...
FLOOR
Loose term referring to the trading area of a
stock exchange
...
10
...
P
...
Similar securities issued by public corporations are called bonds, if they are issued by public
companies they are called debentures
...
D
...
The ownership of security or shares is through a book entry instead of physical
exchange CDS is for security what a bank is for cash transfer between banks
...
XYZ Ltd
...
Their accounts will be credited with the
number of shares
...
Advantages of CDS
1
...
e
...
2
...
3
...
4
...
g instances of fraud will be reduced since there is no physical share certificate which
may be forged
...
There will be improved and timely communication between company and the investors hence
reduced delay in receiving dividends and right issues and improve information dissemination
concerning a company
...
It will lead to an efficient and transparent securities market to adhere to International Standards
for the benefit of all stakeholders
...
2
...
Dematerialisation i
...
Effective Delivery Vs
...
This can be done without delay if CDS is linked to
the central payment clearing system e
...
Provision of detailed listings of investors according to the type of securities they hold e
...
Effective Distribution of Dividends, interests, rights issues and bonus issues
...
3
...
5
...
Parties Involved In CDS
1
...
2
...
3
...
4
...
For faster settlements and ownership transfer
and reduced cost of transfer through reduced paper work and labour intensive activities
...
Brokers
Reduces paper work, forgery and improved efficiency
6
...
Development Banks And Specialised Financial Institutions
There are some sectors in the economy that may not secure adequate funds from commercial banks for
various reasons
...
g Jua Kali etc
...
g agriculture and tourism are essential for a balanced economic growth and
development
...
They include:
1
...
2
...
3
...
4
...
Post Bank – To mobilize rural savings
6
...
7
...
Advantages/Functions/Case for Development Financial Institutions
1
...
They provide facilities for large lending
3
...
4
...
5
...
Case against Specialized Institutions and Development Banks
1
...
2
...
3
...
They are risk capital providers in areas which are not attractive to commercial banks and other
major lenders due to risk involved
...
They increase government spending
...
It is therefore
entrusted with two objectives:
1
...
3
...
5
...
The
bank has therefore to identify gaps in financial markets and to seek
solutions to these gaps
...
It therefore has to operate profitability
when offering services to difference parties
...
Management of the Bank
Management and policy entrusted to a Board of Directors, comprising of seven
members including the Governor, Deputy Governor, and Ps to treasury
...
The Governor
in charge today is Michael Cheserem
...
A copy of the return to be submitted to Finance Minister
...
Fiscal year ends 30th June
...
Banker to the government
2
...
Ensure Economic stability
4
...
Lender of last resort
Tools Used To Control The Level Of Money In Circulation
1
...
g Treasury bills, Treasury bonds, Reserve ratio etc
2
...
g taxation
Commercial Banks
These are financial institutions that accept deposits of money
from the general public, safeguard the deposits and make them available to
their owners when need arises
...
Functions of Commercial Banks
1
...
Collecting money on behalf of customers and credit this money in
customers accounts
3
...
4
...
5
...
6
...
7
...
8
...
9
...
Before advancing loan to a prospective customer,
commercial banks are very careful and strict so as to give loans to invest in viable sector of the
economy
...
Provision of saves for keeping money and other valuables over night
...
Mortgages
An arrangement where the property being purchased provides the security for funding
...
Features
1
...
Financing relates to acquisition of specific asset
3
...
4
...
5
...
Difficulties in mortgage arrangements
1
...
g
...
Estate
...
Potential participants avoid getting tied up in long term loans
4
...
5
...
Housing Finance Company of Kenya
This is the largest mortgage company in Kenya
...
It is registered under the Building Society Act but operates as a
finance company under the Banking Act
...
Kenya Industrial Estate
This is a body established by the government for the purpose of promoting industrial
development
...
The body is concerned with the provision of a base that will be
considered necessary for technology development e
...
through research
...
4
...
It concentrates on projects requiring
financial participation and active extension of services
Funds provided are from the Government and commercial banks
...
Kenya Tourist Development Corporation
This was established by the Government specifically to promote tourism
...
To provide assistance for establishment of tourism projects
2
...
To provide equity finance on joint venture basis in international hotel organizations
...
Merchant Banks
Merchant Banks begun life as merchants and begun to operate in financial firms, within the 19th
Century
...
Merchant banks accept bills of exchange which deal in the leasing of industrial equipment
...
Shs
...
00
75
...
50
43
...
00
4
...
00 102
...
00
90
...
Sh
...
Ord
...
5
ATH Ltd
...
Sh
...
Ord
...
5
Barclays Bank Ltd
...
Sh
...
120
...
130
...
50
Suspended
317
...
00
90
...
00
Required
a)
Why does the price of a share change?
b)
i)
ii)
iii)
iv)
v)
(6 marks)
What does the CD against Kakuzi’s share price mean?
(2 marks)
Under the yesterday’s column for Express Kenya Ltd
...
Explain
...
Explain why a company may be suspended from
the stock exchange
...
(2 marks)
What is the meaning of the Ord
...
10 indicated against the Barclays Bank?
2 marks)
(Total: 20 marks)
QUESTION TWO
a)
In relation to capital markets, differentiate between the terms stock markets and financial markets
...
i)
ii)
c)
What is the Central Depository System (CDS)?
How will it benefit the parties to be affected by it?
(4 marks)
(4 marks)
The shares of Ndege Airways Company Ltd
...
8
...
The existing shareholders argue that such shares are undervalued
...
15 per share
...
ordinary shares is 2
...
is 10 times,
which share is more attractive to a potential investor? Give reasons
...
a)
With reference to capital market, define the following terms:
i)
ii)
iii)
iv)
b)
4
...
Castro uses a 20% hatch system of timing when to invest in a stock market
...
150 and its bottom was Sh
...
During the
year, the company paid an interim DPS of Sh
...
50 and a final DPS of Sh
...
50
...
(4 marks)
a)
Explain how the savings and credit co-operative societies mobilise savings and
investments
...
Require
a)
Briefly explain the meaning of a “floating rate” bond
...
(16 marks)
(Total: 20 marks)
QUESTIONTWO
Swale Ltd
...
15,000,000 in additional funds through a rights offering
...
’000’
Current assets
45,000 Current liabilities
Fixed assets
30,000 Long-term debt (25%)
Ordinary shares (sh
...
’000’
13,500
4,500
9,000
Earnings before interest and taxes
Interest
Earnings before tax
97
Sh
...
The company had a price-earnings ratio of 7
...
Its dividend
payout ratio is 40%
...
The proposed rights offering subscription price per share is Sh
...
3
...
Required
a)
How many rights are required to buy one new share?
b)
Calculate the return on total assets
...
(2 marks)
(2 marks)
d)
e)
Calculate the dividend per share and market price per share one year after the rights of offering
and state whether you would recommend the rights offering
...
(7 marks)
QUESTION THREE
a)
A firm may adopt a conservative policy or an aggressive policy in financing its
working capital needs
...
b)
(3 marks)
(3 marks)
The following information relates to the current trading operations of Maji Mazuri Enterprises
(MME) Ltd:
-
-
Level of annual sales (uniform per month)
Contribution to sales ratio
Debtors recovery period:
Percentage
Average collection
of debtors
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 (2% of credit sales)
Sh
...
600 million
15%
The management of the company is in the process of reviewing the company’s credit management system
with the objectives of reducing the operating cycle and improving the firm’s liquidity
...
50 per cent of the credit customers (and all cash customers) will take advantage of the 2 per cent
cash discount
...
There will be no change in the level of annual sales, the percentage of credit sales and the
contribution of sales ratio
...
There will be savings in collection expenses of Sh
...
4
...
5
...
Alternative B: contracting the services of a factor
The factor would charge a fee of 2% of total credit sales and advance MME Ltd
...
5% per month
...
Savings on debt administration expenses of Sh
...
Required
i)
Evaluate the annual financial benefits and costs of each alternative (Assume 360–day year)
(8 marks)
ii)
Advise MME Ltd
...
above
(4 marks)
(Total: 20 marks)
QUESTION FOUR
Love Ltd is considering acquiring Beautiful Ltd
...
has
been as follows:
Year
Profits
Sh
...
3
...
The current MPS is Sh
...
The growth in dividends
will be matched with the growth in earnings of Beautiful Ltd
...
The future
expected profits p
...
(equal to the average of past profits) will also grow a rate equal to past
profits growth rate
...
Beautiful Ltd has 50 million ordinary shares
...
b)
Using the cost of equity computed in (a) above, determine the maximum
price with Love Ltd should pay for each share of Beautiful Ltd to acquire it
...
99
(6 marks)
(10 marks)
(4 marks)
5
...
manufactures various types of shoes
...
Fixed assets are projected at Sh
...
27 million
...
Prime Shoe Ltd
...
The following information relates to three policies:
Aggressive
Moderate
Sh
...
’000’
Investment in
Current Assets
42,000
45,000
Projected Sales
88,500
90,000
EBIT
8,500
9,000
Conservative
Sh
...
Net working capital
Current ratio
Operating margin
Current assets turnover
Describe the profitability – risk trade offs of these three policies
Title: BUSINESS FINANCE
Description: it is about business financing and it aims at 2nd years
Description: it is about business financing and it aims at 2nd years