WEDNESDAY: 6 December 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.


1. Explain THREE principles of Islamic finance. (6 marks)

2. Alpha Ltd. and Beta Ltd. are companies operating in the same line of business. In the recent past, Alpha Ltd. has experienced very stiff competition from Beta Ltd. such that Alpha Ltd. is considering acquiring Beta Ltd. in order to consolidate its market share. The following financial data is available about the two firms:

Both companies are in the 30% income tax bracket.


Maximum exchange ratio that Alpha Ltd. should agree to if it expects no dilution in its post acquisition
earnings per share (EPS). (2 marks)

Alpha Ltd.’s post acquisition earnings per share if the companies agree on an offer price of Sh.40 per
share. (2 marks)

Alpha Ltd.’s post acquisition earnings per share if for every 500 ordinary shares of Beta Ltd. are
exchanged for 10 units of 10% debenture of Sh.500 par value each. (3 marks)

The combined operating profit (EBIT) at the point of indifference between earnings of the firm under the
financing plans in (b) (ii) and (b) (iii) above. (4 marks)

The combined post acquisition earnings per share at the point of indifference between earnings of the
firm under the financing plans in (b) (ii) and (b) (iii) above. (3 marks)

(Total: 20 marks)



1. Describe TWO weaknesses of value at risk (VAR) that necessitates the use of conditional value at risk (CVAR). (4 marks)

2. The following information was extracted from the financial statements of Safi Ltd:

Calculate the intrinsic value of the share using the following dividend theories:

Gordon’s dividend capitalisation model. (3 marks)

Walter’s dividend model. (3 marks)

3. Ufundi Ltd. is considering raising additional Sh.50 million to finance an expansion programme. The firm’s capital structure, which is considered to be optimal, is given as follows:

Additional information:
1. The firm expects to raise Sh.10 million from internal sources.
2. The firm pays a constant ordinary dividend of Sh.4 per share in each year. This is expected to remain so in the foreseeable future.
3. The firm will issue new ordinary shares at Sh.45 per share and will incur a floatation cost of Sh.5 per
4. New 10% irredeemable debentures will be issued at Sh.120 each. Floatation cost of 5% of market price
will be incurred.
5. New 12% preference shares will be issued at Sh.80 each. The par value of each share is Sh.60. Floatation cost of Sh.6 per share will be incurred.
6. Corporate tax rate applicable is 30%.


The cost of ordinary shares. (2 marks)

The cost of 10% debentures. (2 marks)

The cost of 12% preference shares. (2 marks)

The weighted marginal cost of capital (WMCC) of the firm. (4 marks)

(Total: 20 marks)



1. Examine THREE real world influences on a firm’s dividend payout policy. (6 marks)

2. Omo Ltd. is considering expanding its business operations into manufacturing digital devices. Omo Ltd. anticipates an initial investment of Sh.1.3 million and, at best, an operational life of 3 years for the project. Omo Ltd.’s management team has considered several probable outcomes over the life of the project, which it has labelled as either “successes” or “failures”. Accordingly, Omo Ltd. anticipates that in the first year of operations, there is a 65% chance of “success” with after tax cash flow of Sh.800,000 or a 35% chance of “failure” with Sh.1,000 cash flow after tax.

If the project “succeeds” in the first year, Omo Ltd. expects three probable outcomes regarding net cash flows after tax in the second year. These outcomes are Sh.2.2 million, Sh.1.8 million or Sh.1.5 million with probabilities of 0.3, 0.5 and 0.2 respectively. In the third and final year of operation, the net cash flow after tax are expected to be either Sh.35,000 more or Sh.55,000 less than they were in year 2, with an equal chance of occurrence.

If, on the other hand, the project “fails” in year 1, there is a 60% chance that it will produce net cash flow after tax of only Sh.1,500 in year 2 and 3. There is also a 40% chance that it will really fail and Omo Ltd. will earn nothing in year 2, and will get out of this line of business, terminating the project and resulting in no net cash flows after tax in year 3.

The opportunity cost of capital for Omo Ltd. is 10%.


Construct a decision tree representing the possible outcomes. (6 marks)

Determine the joint probability of each possible sequence of events. (2 marks)

Calculate the project’s expected net present value (ENPV). (6 marks)

(Total: 20 marks)



1. A retail trader requires Sh.800,000 per annum to meet his operational needs. Any surplus cash held is deposited in a bank account which yields interest income at a rate of 10% per annum.
Every time the trader withdraws the cash from the bank to meet his operational needs, he is charged Sh.100 per transaction.

Using Baumol model of cash management, determine:

Optimal cash balance. (4 marks)

Annual transaction cost. (2 marks)

Annual opportunity cost. (2 marks)

How frequently should the trader withdraw cash from the bank per annum? (2 marks)

2. The following are the financial statements of Kanga Ltd. for the year ended 31 December 2022:

2. The current market price per share is Sh.6.


Calculate the Z-score of the company and interpret its meaning. (8 marks)

Evaluate two applications of the Altman Z-score in your country. (2 marks)

(Total: 20 marks)



1. Explain THREE causes of conflict between shareholders and management. (6 marks)

2. Describe THREE stages of green lending which are supported by technological advancement. (6 marks)

3. Keya Mine Company (KMC) is currently a family owned company with no debt. The company is considering going public by selling some of its shares in the company at the securities exchange.
Investment bankers have informed the firm that the total market value of the company is Sh.10 million if no debt is employed. In addition to selling shares, the family wishes to consider issuing debt that for computational purposes would be perpetual. The debt then would be used to purchase shares, so the size of the company would stay the same.

Additional information:
1. Based on various valuation studies, the tax advantage of debt is estimated at 30% of the amount
borrowed when only corporation tax rate is considered.
2. Corporation tax rate is 30%.
3. The marginal tax rate on shares income is 5%.
4. The marginal tax rate on debt income is 15%.
5. The investment banker has estimated the following present values of bankruptcy costs associated with
various levels of debt:

Determine the optimal debt level that the company should choose. (8 marks)

(Total: 20 marks)

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