CORPORATE FINANCE AUGUST 2023  PAST PAPER

WEDNESDAY: 23 August 2023. Afternoon Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.

QUESTION ONE

1. In relation to agency theory, summarise FIVE ways of resolving conflicts between the head office and the branches. (5 marks)

2. Jabali Ltd. and Jeza Ltd. are two companies in the manufacturing industry. The companies have the same business risks and are almost identical in all aspects in terms of capital structures and total market values. The companies capital structures are summarised below:

Jeza Ltd.’s ordinary shares are trading at Sh.85 each and debentures at Sh.50 each.

Additional information:
1. Annual earnings before interest and tax for each company is Sh.30 million.
2. Corporate tax rate applicable is 30%.

Required:

If you owned 10% of the ordinary shares of Jeza Ltd. and you agreed with the arguments of Modigliani
and Miller, explain FOUR actions you would take to improve your financial position. (4 marks)

Compute the amount of arbitrage profit. Personal taxes may be ignored and the assumptions made by
Modigliani and Miller may be used. (7 marks)

If Jabali Ltd. was to borrow Sh.20 million, compute the effect this would have on the company’s cost of
capital according to Modigliani and Miller. (4 marks)

(Total: 20 marks)

 

QUESTION TWO

1. Explain the following dividend theories:

Bird-in hand theory. (2 marks)

Information signaling theory. (2 marks)

Clientele effect theory. (2 marks)

2. Describe THREE types of mergers based on industry life cycles. (6 marks)

3. Sparrow Ltd. produces and sells a key component branded “Omega”. The component is sold at Sh.2,000 per unit.

The company’s sales are on credit with customers selected for credit on the basis of a scoring process. With its existing credit standards, Sparrow Ltd. expects to sell 12,000 units over the coming year. Variable costs are Sh.1,200 per unit. The firm’s fixed cost is Sh.2.4 million per year.
Sparrow Ltd. is contemplating a relaxation of credit standards that will have the following effects:
1. A 5% increase in the units sold.
2. An increase in the average collection period from 30 days to 45 days.
3. An increase in bad debt expense from 1% to 2% of sales.
The selling price is expected to remain unchanged.
The company’s required return on investment is 12%.

Required:
Advise Sparrow Ltd. on whether it should relax its credit standards. Assume a 365-day year. (8 marks)

(Total: 20 marks)

 

QUESTION THREE

1. Highlight FOUR advantages of using the net present value (NPV) method over the internal rate of return (IRR) method as an investment appraisal technique. (4 marks)

2. Explain THREE theoretical and methodological approaches used in developing green financial framework. (6 marks)

3. The capital structure of Upendo Ltd. is as follows:

Additional information:
1. Ordinary shares are currently quoted at Sh.100 at the securities exchange.
2. Ordinary shares have a dividend cover of 4 times and earnings per share (EPS) of Sh.8.
3. The 18% debentures have a par value of Sh.1,000 and market price of Sh.1,200. The debentures have
maturity period of 5 years.
4. The 12% preference shares have a market price of Sh.25.
5. The corporation tax rate is 30%.

Required:

The company’s growth rate in equity. (2 marks)

The cost of ordinary shares. (1 mark)

The cost of preference shares. (1 mark)

The cost of long term loan. (1 mark)

The cost of 18% debentures. (2 marks)

The company’s market weighted average cost of capital (WACC). (3 marks)

(Total: 20 marks)

 

QUESTION FOUR

1. Highlight FOUR differences between “Treasury bills” and “Treasury bonds”. (4 marks)

2. Discuss THREE principles of Basel III accord as used in banking regulations. (6 marks)

3. Alpham Ltd. wishes to acquire Omega Ltd. The directors of Alpham Ltd. wish to justify the acquisition on the grounds that it will increase the shareholders wealth. The supporting evidence produced by the directors of Alpham Ltd. is summarised as follows:

Additional information:
1. The earnings per share (EPS) pre-acquisition for Alpham Ltd. and Omega Ltd. were Sh.14.80 and
Sh.29.25 respectively.
2. The market price per share (MPS) pre-acquisition for Alpham Ltd. and Omega Ltd. were Sh.222 and
Sh.322 respectively.
3. Alpham Ltd. would issue three (3) of its ordinary shares for every two (2) ordinary shares of Omega Ltd. in consideration of the acquisition of Omega Ltd.

Required:

The post-acquisition market price per share of Alpham Ltd. (4 marks)

The post-acquisition market price per share (MPS) of Omega Ltd. (2 marks)

Assuming the acquisition is contested by Omega Ltd., determine the maximum price that Alpham Ltd.
should offer without reducing the wealth of its shareholders. (2 marks)

Determine the contested offer price by Omega Ltd. (2 marks)

(Total: 20 marks)

 

QUESTION FIVE

1. Examine TWO international financial institutions that are at the forefront in providing guidance and regulations to Islamic financial institutions. (4 marks)

2. Figo Ltd. operates a production machine that has the following maintenance costs and resale values over its three year useful life. The purchase price of the machine is Sh.50 million.

Required:
Advise the management of Figo Ltd. on how frequent the machine should be replaced. (6 marks)

3. The current earnings per share (EPS) of Uvuno Ltd. is Sh.6. The company has an asset beta (unlevered equity beta) of 0.65 and retention ratio of 0.6. The risk free rate of return is 10%. The expected return of the market portfolio is 18%.

The management of Uvuno Ltd. intends to undertake a financial restructuring which will result in debt-equity ratio change from 0.25 to 0.20. The firm has in issue 15 million ordinary shares and equity capital of Sh.360 million. Corporation tax rate applicable is 30%.

Required:

The share price before financial restructuring. (4 marks)

The share price after financial restructuring. (4 marks)

Advise the management of Uvuno Ltd. on whether to carry out the financial restructuring. (2 marks)

(Total: 20 marks)

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