BLOCK 3 – ADVANCED FINANCIAL MANAGEMENT REVISION QUESTIONS AND ANSWERS

QUESTIONS AND ANSWERS

Questions
Question 1
Debt crisis in less developed countries (LDCs)
The debt crisis in LDC has risen as governments have taken on levels of debt to fund their development programmes which are beyond their ability to finance. As the levels of debt increases, the ability to pay decreases thus increasing the amount of GDP absorbed in servicing the debt rather than in financing development. Other factors that have caused debt crisis in less development countries are:
Decline in oil prices and revenues to LDCs especially where the oil reserves were used to
borrow loans when World Oil prices were high e.g in case of Nigeria and Venezuela.
Appreciation of currency value of lenders vis-à-vis that of LDCs
Misuse of debt some corrupt governments of LDCs thus no ability to pay when those
debts matures.
Imposed quota system on exports LDCs thus imports exceed exports and there is always need
for funds to finance the deficit.

b)if the debt crisis is temporary due to fall in commodity prices, the country could borrow short term debt to cover the temporary shortfall. Where the problem of debt crisis is long term, the
following measures would be appropriate:
Restructuring and rescheduling of debt. This would allow the government more time in which to repay the loan.
Economic reforms e.g structural adjustment programmes improve balance of trade and
stimulate growth.
Debt refinancing i.e borrow a lower interest loan, pay-off the high interest rate loan and continue paying lower interest charges on new loan.
Increase foreign direct investment, exports and reduce imports.
Debt cancellation i.e write-off of debt lending governments and banks thus reducing interest charges and increasing ability to pay the remaining debts.
Debt-equity swaps i.e. convert debt to equity giving foreign lenders a stake in local industries thus becoming shareholders. This reduces the burden of interest payment and increase the ability to pay.

c) The solutions to the debt crisis in LDC will benefit the MNC as follows:
Improved trading position e.g less debt burden leads to improved economic position, thus reduced controls on capital flows, exchange rates and imports.
Political and economic stability will result thus improved operational environment of MNC.
Increased size of local market for MNC due to increased purchasing power from economic growth.
Reduced foreign exchange exposure – They will be able to match local payments with local
revenues thus reduce/simplify the foreign exchange exposure management.

Question 2

Direct foreign investment involves capital budgeting/long term investment decisions. The main factors to consider would thus be concerned with:
Tax implications of foreign investment
Estimation of initial capital outlay and future cash in
flows Evaluation of various types of risks involved
Methods of financing the project/investment
Choice of appropriate cost of capital or discounting rate
The risks involved in direct foreign investment Multi-National Companies (MNCs)
Exchange risk – it has effects on imports and exports and will usually boarder of translation, transaction and economic risk.
Financial risk – due to uncertain cash flows, incomes and inflationary pressures
Political risk – the possibility that a political event will occur e.g change in governments which will unfavourably affect the business.
Business risk – occurs due to different economic conditions and competition from other local
and Multi-National firms including imports.
Access to capital markets – the capital market may not be well-developed and its access maybe restricted.
Government controls and regulations e.g. labour relations, sale price, product quality, nonrepatriation of profits.
Taxation laws and procedures and cultural risk.
b) Methods of raising capital for small and medium-size enterprises. From private investor groups or institutions e.g I.C.D.C, Kenya Industrial Estate (KIE) etc. From venture capitalists e.g. Acacia Fund Commercial banks credit facilities e.g overdrafts and short term loans From micro-finance institutions e.g. Faulu Kenya, K-Rep, Kenya Women Finance Trust.
Owner‟s past savings
Loans from trade associations and cooperative societies including saccos.
Sale of securities to private individuals and groups i.e issue of equity shares, corporate bonds
etc. Leasing of assets from lease firms e.g African Retail Traders (ART).

Answers

Question 1

  • Debt crisis in less developed countries (LDCs)The debt crisis in LDC has risen as governments have taken on levels of debt to fund their development programmes which are beyond their ability to finance. As the levels of debt increases, the ability to pay decreases thus increasing the amount of GDP absorbed in servicing the debt rather than in financing development. Other factors that have caused debt crisis in less development countries are:Decline in oil prices and revenues to LDCs especially where the oil reserves were used to borrow loans when World Oil prices were high e.g in case of Nigeria and Venezuela.Appreciation of currency value of lenders vis-à-vis that of LDCsMisuse of debt some corrupt governments of LDCs thus no ability to pay when those debts matures.Imposed quota system on exports LDCs thus imports exceed exports and there is always need for funds to finance the deficit.
  • If the debt crisis is temporary due to fall in commodity prices, the country could borrow short term debt to cover the temporary shortfall. Where the problem of debt crisis is long term, the following measures would be appropriate:Restructuring and rescheduling of debt. This would allow the government more time in which to repay the loan.Economic reforms e.g structural adjustment programmes improve balance of trade and stimulate growth.Debt refinancing i.e borrow a lower interest loan, pay-off the high interest rate loan and continue paying lower interest charges on new loan.Increase foreign direct investment, exports and reduce imports.Debt cancellation i.e write-off of debt lending governments and banks thus reducing interest charges and increasing ability to pay the remaining debts.Debt-equity swaps i.e. convert debt to equity giving foreign lenders a stake in local industries thus becoming shareholders. This reduces the burden of interest payment and increase the ability to pay.
  • The solutions to the debt crisis in LDC will benefit the MNC as follows:Improved trading position e.g less debt burden leads to improved economic position, thus reduced controls on capital flows, exchange rates and imports.Political and economic stability will result thus improved operational environment of MNC. Increased size of local market for MNC due to increased purchasing power from economic growth. Reduced foreign exchange exposure – They will be able to match local payments with local revenues thus reduce/simplify the foreign exchange exposure management.

Question 2

  • Direct foreign investment involves capital budgeting/long term investment decisions. The main factors to consider would thus be concerned with:

Tax implications of foreign investment

  • Estimation of initial capital outlay and future cash in flows Evaluation of various types of risks involved Methods of financing the project/investment Choice of appropriate cost of capital or discounting rate
  • Answers53The risks involved in direct foreign investment Multi-National Companies (MNCs)
  • Exchange risk – it has effects on imports and exports and will usually boarder of translation, transaction and economic risk.
  • Financial risk – due to uncertain cash flows, incomes and inflationary pressures
  • Political risk – the possibility that a political event will occur e.g change in governments which will unfavourably affect the business.
  • Business risk – occurs due to different economic conditions and competition from other local and Multi-National firms including imports.
  • Access to capital markets – the capital market may not be well-developed and its access may be restricted.
  • Government controls and regulations e.g. labour relations, sale price, product quality, non-repatriation of profits.
  • Taxation laws and procedures and cultural risk.b)Methods of raising capital for small and medium-size enterprises.
  • From private investor groups or institutions e.g I.C.D.C, Kenya Industrial Estate (KIE) etc. From venture capitalists e.g. Acacia Fund Commercial banks credit facilities e.g overdrafts and short term loans From micro-finance institutions e.g. Faulu Kenya, K-Rep, Kenya Women Finance Trust.
  • Owner‟s past savings Loans from trade associations and cooperative societies including saccos.
  • Sale of securities to private individuals and groups i.e issue of equity shares, corporate bonds etc. Leasing of assets from lease firms e.g African Retail Traders (ART).

 

 



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