CPA – FINANCIAL MANAGEMENT REVISION KIT (QUESTION AND ANSWER)

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Complete copy of FINANCIAL MANAGEMENT Revision Kit is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP) and in HARD copy 

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INTRODUCTION

Following our continued effort to provide quality study and revision materials at an affordable price for the private students who study on their own, full time and part time students, we partnered with other team of professionals to make this possible.

This Revision kit book (Question and answers) contains kasneb past examination past papers and our suggested answers as provided a team of lecturers who are experts in their area of training. The book is intended to help the learner do enough practice on how to handle exam questions and this makes it easy to pass kasneb exams.

Special appreciation and recognition goes to FA Kegicha William Momanyi (MBA Accounting, CPA, CISA and CCP), FA Bramwel Omogo (B.Sc. Actuarial Science, CIFA, CIIA) Johnmark Mwangi (MSc Finance, CPAK, BCom Finance), CPA Gregory Mailu (Bsc. Economics) CPA Dominic Rasungu and CPA Lawrence Ambunya among others.

 

 

 

 

 

PAPER NO.8 FINANCIAL MANAGEMENT

 

GENERAL OBJECTIVE

This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to effectively manage, control and optimize on institutional finances.

 

8.0       LEARNING OUTCOMES

A candidate who passes this paper should be able to:

  • Explain the nature and scope of financial management
  • Describe the nature and functions of financial institutions and markets
  • Analyse the sources of finance for an organisation and evaluate various financing options
  • Evaluate various investment decision scenarios available to an organisation
  • Evaluate the performance of a firm using relevant financial tools
  • Make appropriate capital structure decisions for a firm, Value financial assets and firms
  • Make appropriate liquidity and dividend decisions for a firm
  • Evaluate current developments in the field of finance and their impact on financial decisions

 

 

CONTENT 

8.1       Overview of financial management

  • Theoretical framework of financial management – The role and responsibilities of a finance manager towards shareholders, employees, society, government and other stakeholders.
  • Goals of a firm and corporate strategy; financial and non-financial objectives, overlaps and conflicts among the objectives
  • Agency theory, stakeholder’s theory and corporate governance
  • Measuring managerial performance, compensation and incentives
  • Ethical issues in financial management

 

8.2       The financing decision

  • Nature and objectives of the financing decision
  • Factors to consider when making financing decisions
  • Sources of finances for enterprises; internally generated funds and the externally generated funds, long term sources (equity, debt, hybrids, lease finance, venture capital, business angel finance, private equity, asset securitisation and sale, Islamic finance and initial coin offerings), medium term sources such as medium term loans and hire purchase financing and short term sources of finance such as overdraft finance, trade credit, issue of commercial papers, accruals, deferred income; characteristics of each source of finance, pros and cons of the various sources of finance.
  • Evaluation of financing options
  • Methods of issuing ordinary shares – Public issue, private placement, bonus issue, employee stock option plans (ESOPS) and rights issues

 

8.3       Financial institutions and markets

  • Overview of a financial system – Financial markets, financial institutions and financial instruments
  • Nature and role of financial markets – primary and secondary securities market, money and the capital markets, over-the counter and organised market, derivatives market, mortgage market, forex market
  • Nairobi securities exchange (NSE, or equivalent entity in other jurisdictions) – The role and functions of the securities exchange, securities exchange terminologies, security exchange listing and cross border listing, share indices, timing of investment at the securities exchange, Central depository system and automated trading system, de-mutualisation
  • Stock market indices
  • Central depository system and automated trading system
  • Timing of investment at the securities exchange – Dow theory and Hatch system of timing
  • The financial institutions and intermediaries: commercial banks, savings and loans associations and co-operative societies, foreign exchange bureaus, unit trusts and mutual funds, insurance companies and pension firms, insurance agencies and brokerage firms, investment companies, investment banks and stock brokerage firms, micro-finance institutions and small and medium enterprises (SMEs)
  • Regulation of financial markets; Central bank of Kenya (CBK, or equivalent entity in other jurisdictions) – The role of the Central bank and the Monetary policy of the central bank; Capital market authority and the Insurance regulatory authority
  • Factors responsible for the rapid development of financial institutions and markets
  • Risks facing financial institutions

 

8.4       Time-value of money

  • Concept of time value of money
  • Relevance of the concept of time value of money in financial management
  • Time value of money versus time preference of money
  • Time line
  • Real versus nominal cash flows
  • Compounding techniques – Compound interest, Future value (FV) of a single cash flow and series of cash flows; Compounding of annuity cash flows
  • Discounting techniques – Present value (PV) of a future cash flow and series of future cash flows and discounting of annuity cash flows
  • Loan amortisation and sinking funds

 

8.5       Business/Financial asset Valuation models

  • Concept of value; book value, going concern value, substitution value, replacement value, conversion value, liquidation value, intrinsic value and market value
  • Reasons for valuing financial assets/business
  • Theories on valuation of financial assets; fundamental theory, technical theory, random walk theory and the efficient market hypothesis
  • Valuation of redeemable, irredeemable and convertible debentures/ corporate bonds
  • Valuation of redeemable, irredeemable and convertible preference shares
  • Valuation of ordinary shares; net asset basis, price-earnings ratio basis, capitalisation of earnings basis, Gordon’s model, finite earnings growth model, Super-profit model, Walter’s model, discounted free cash flow, residual income model, Use of relative measures such as Economic Value added (EVA) and Market Value Added (MVA)
  • Valuation of rights issues
  • Valuation of unit trusts and mutual funds
  • Valuation of private companies: income and market-based approaches

 

8.6       Introduction to capital structure decisions

  • The meaning of capital structure and the factors to be taken into account when making capital structure decision.
  • Cost of capital; Meaning of cost of capital, practical applications of cost of capital, component costs of capital
  • The firm’s overall cost of capital; Weighted average cost of capital (WACC), Weighted marginal cost of capital (WMCC) and factors influencing the firm’s Cost of capital.
  • Leverage and Risk; Operating leverage and Operating risk, financial leverage and financial risk and total leverage and total risk.
  • Analysis of Operating profit (EBIT), Earning per share (EPS) at the point of indifference in the firm’s earnings; Determination of the range of firm’s operating profit (EBIT) within which each financing option will be recommended

 

8.7       Introduction to capital budgeting decisions

  • The nature and importance of capital investment decisions
  • Capital budgeting process
  • Capital investment’s cash flows – initial cash outlay, terminal cash flows and annual net operating cash flows, incremental approach to cash flow estimation
  • Capital investment appraisal techniques
  • Non-discounted cash flow methods – payback period and accounting rate of return
  • Discounted cash flow methods – net-present value, internal rate of return, profitability index, discounted payback period and modified internal rate of return (MIRR)
  • Strengths and weaknesses of the investment appraisal techniques
  • Expected relations among an investment’s NPV, company value and share price
  • Capital investment options – timing option, strategic investment option, replacement option and abandonment option
  • Problems/difficulties encountered when making capital investment decisions in reality

 

8.8       Financial statements analysis and forecasting

  • Scope of financial statement analysis, major financial statements and other information sources, financial statement analysis frame work and users of financial statements and their information needs
  • Financial Statement analysis verses Business analysis
  • Techniques of financial Statement analysis; Cross-Sectional analysis, Time series analysis and a combination of both techniques.
  • Types of financial statement analysis
  • Ratio analysis; nature of financial ratios, classification and calculation of financial ratios and limitation of financial ratios
  • Common size statements – Vertical and horizontal analysis
  • Financial forecasting; cash budgeting and percentage of sales method of forecasting

 

8.9       Working capital management

  • Introduction and concepts of working capital
  • Working capital versus working capital management
  • Factors influencing working capital requirements of a firm
  • Types of working capital
  • Importance and objectives of working capital management
  • Working capital operating cycle; the importance and computation of the working capital operating cycle
  • Working capital financing policies: Aggressive, conservative and matching financing policy
  • Determining the finance mix: basic approaches for determining an appropriate Working Capital finance mix; Hedging or matching approach, conservative approach, aggressive approach.
  • Management of inventory: kinds of inventory, objectives of Inventory Management, Techniques of Inventory Management; stock levels, Economic Order Quantity (EOQ) and Just-In-Time (JIT).
  • Cash Management; Motives of holding cash, techniques of managing cash, cash management models-Baumol model, Miller-Orr model and Orgler’s model
  • Management of accounts receivable and accounts payable; assessing creditworthiness, collecting amounts owing, trade credit

 

8.10    Dividend decision

  • Meaning and significance of dividend policy
  • Factors influencing dividend policy
  • Forms of dividend: script dividend, cash dividend, stock dividend, bond dividend, property dividend
  • Dividend theories; Bird in hand theory, Clientele effect theory, Information signalling theory, Walter’s model, Gordon Model, Tax differential theory, Modigliani and Miller dividend irrelevance theory
  • Types of dividend policy: regular dividend policy, stable dividend policy, irregular dividend policy, zero dividend policy.
  • The impact of dividend payout on share price

 

8.11    Introduction to risk and return

  • Introduction – Risk-return trade off/relationship, Distinction between risk free and risky assets
  • Expected return, Standard deviation of returns and the Relative risk of an individual asset
  • Expected return of a 2 asset-portfolio
  • The Covariance and correlation coefficient of returns of assets.
  • The actual portfolio risk of a 2-asset portfolio using the analytical and mathematical model and its interpretation

 

8.12    Islamic finance

  • Justification for Islamic Finance; history of Islamic finance; capitalism; halal; haram; riba; gharar; usury
  • Benefits and deficiencies of Islamic Finance
  • Principles underlying Islamic finance: principle of not paying or charging interest, principle of not investing in forbidden items; ethical investing; moral purchases
  • The concept of interest (riba) and how returns are made Islamic financial securities
  • Sources of finance in Islamic financing
  • Types of Islamic financial products:- sharia-compliant products: Islamic investment funds; takaful the Islamic version of insurance Islamic mortgage, murabahah, Leasing – ijara; safekeeping – Wadiah; sukuk – islamic bonds and securitisation; sovereign – sukuk; Islamic investment funds; Joint venture – Musharaka, Islamic banking, Islamic contracts, Islamic treasury products and hedging products, Islamic equity funds; Islamic derivatives
  • 7 International standardisation/regulations of Islamic Finance: case for standardisation using religious and prudential guidance, National regulators, Islamic Financial Services Board

 

8.13    Personal financial management

  • Financial Problems encountered in managing individual financial affairs
  • Savings and investment considerations
  • Personal risk management
  • Cost of credit
  • Financial Alterations – Retirements; Estate and Tax planning and family budgeting

 

8.14    Contemporary issues and emerging trends

  • Globalisation and growth of derivative markets and securitisation
  • Cryptocurrency
  • Block chain technology
  • Cloud funding
  • Digitisation of financial transactions
  • Behavioural finance
  • Big data project finance

SAMPLE WORK

Complete copy of FINANCIAL MANAGEMENT Revision Kit is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP) and in HARD copy 

Phone: 0728 776 317

Email: info@masomomsingi.com

PART A

 

 

PAST EXAMINATION QUESTIONS

 

TOPIC 1

 

OVERVIEW OF FINANCIAL MANAGEMENT

 

QUESTION 1

December 2021 Question One A

Describe four possible sources of conflict of interest between shareholders and bondholders.                                                                                                           (4 marks)

 

QUESTION 2

September 2021 Question One B

Highlight four advantages of the wealth maximisation objective of a firm.          (4 marks)

 

QUESTION 3

November 2019 Question One A

(a) In the context of agency theory:

(i) Explain the “principal-agent” problem.                                                 (2 marks)

(ii) Explore two ways of addressing the principal-agent problem.            (4 marks)

 

QUESTION 4

November 2017 Question Four B 

Highlight three agency costs that might arise in the principal-agent relationship between shareholders and managers.                                                           (3 marks)

 

QUESTION 4

May 2017 Question Five C

The goal of profit maximisation is considered to be a short-term objective with long-term survival. The firm’s growth cannot be achieved without continuous profitability.

 

Required:

In relation to the above statement, summarise four arguments-in favour of and four arguments against profit maximisation as a business goal.                                (8 marks)

 

QUESTION 6

May 2016 Question Five C

(i) The agency problem could be resolved using goal congruence.

Explain the term “goal congruence”.                                                          (2 marks)

 

(ii) One of the ways creditors could protect themselves against the inherent risk that might arise from agency conflict is through adopting restrictive covenants.

 

With reference to the above statement, describe three restrictive covenants in a debt contract.                                                                                                       (6 marks)

 

QUESTION 7

2015 Pilot Paper Question Two A

(a) In relation to financing of firm’s activities, distinguish between the term “capital structure” and financial structure”.                                                                   (3 marks)

SAMPLE WORK

Complete copy of FINANCIAL MANAGEMENT Revision Kit is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP) and in HARD copy 

Phone: 0728 776 317

Email: info@masomomsingi.com

 

 

PART B

 

SUGGESTED ANSWERS AND SOLUTIONS

 

TOPIC 1

 OVERVIEW OF FINANCIAL MANAGEMENT

 

QUESTION 1

December 2021 Question one A

Possible sources of conflict of interest between shareholders and bondholders.

  • Dividend payments to shareholders could be very high
  • Default on interest payment.
  • Shareholders could organize mergers which aren’t beneficial to bondholders.
  • Shareholders could acquire additional debt that increases the financial risk of the firm.
  • Manipulation of the financial statements so as to mislead creditors.
  • Shareholders could dispose assets
  • Shareholders could dispose assets which are security for credit given.
  • Shareholders could invest in very risky projects.

 

QUESTION 2

August 2021 Question One B

Advantages of the wealth maximisation objective of a firm.

  • Considers risks and uncertainties associated with the project.
  • Takes into account the time value of money
  • Consistent with the going concern of the firm
  • Can be useful in case of joint ventures and limited companies
  • The various resources are put to economic and efficient use
  • The employees share in the wealth gets increased

 

QUESTION 3

November 2019 Question One A

a) i) Explanation of Principal-agent problem

This is one conflict in priorities between a person or group and the representative authorized to act on their behalf. An agent may behave in a way that prejudices principal interest.

ii) Ways of addressing the principal-agent problem

  1. Lenders may refuse to lend to the firm or charge higher than normal market interest rates to compensate for increased risk.
  2. They could have covenants related to decision making on financing e.g they could require a representative in annual general meetings or board meetings where credit decisions will made.
  3. Creditors can protect themselves adopting restrictive covenants in the debt contract to restrict asset disposals, debt financing and company’s divided and remuneration capacity.
  4. Incur agency cost such as :
  • Monitoring expenses such as audit fees, compliance fees.
  • Reorganization costs to structure the organization so that the possibility of undesirable management behavior would be limited.
  • Opportunity cost associated with Loss of profitable opportunities resulting from structure not to permit manager to take action on a timely basis as would be the case if the managers were also owners.
  1. Threat of hostile takeover: under performance will lead to a situation whereshares become undervalued in the stock market. This highlights the risk of a firm being taken over with the result that firm’s current management will be replaced. The only cure for this is good performance.
  2. Labour market actions whereonly professional managers with a track load of good performance are hired.
  3. Shareholders intervention: herethe shareholders vote out incompetent directors at the annual general meeting.
  4. Use of corporate governance principles which prescribe how firms should be managed and controlled.
  5. Stock option schemes for managers could be introduced. This forces managers to undertake that enhance shareholders wealth.

 

QUESTION 4

November 2017 Question Four B

b) Agency costs that might arise in the principal-agent relationship between shareholders and managers

  1. Monitoring expense such as audit fees and compliance fees
  2. Reorganization costs to structure the organization so that the possibility of undesirable management behavior could is limited (cost of internal controls)
  3. Cost of delaying decision

 

Karem bottling company

  1. Initial net cash outlay
Purchase cost of new machine 4,700,000
Less: disposal proceeds of old machine 1,060,000
Less: tax shield benefit disposal loss

30%(2,400,000 – 1,060,000)

 

(402,000)

  3,238,000

 

The incremental net operating cash flows for years 1 through year 5

Incremental depreciation

Depreciation of new machine = 4,700,000 – 600,000) ÷ 5 = Sh. 820,000

Depreciation of old machine = (2,400,000 – 200,000) ÷ 5 = Sh. 440,000

Incremental depreciation = 820,000 – 440,000 = Sh. 380,000

 

Incremental salvage value

Salvage value of new machine Sh. 600,000

Salvage value of old machine Sh. (200,000)

400,000

 

Total terminal cash flows

Recovery working capital                    0

Add: incremental salvage value      400,000

Sh. 400,000

 

Incremental net operating cash inflows

Savings on electric power usage and repair costs Sh. 920,000

Add: savings in defective bottles annually           Sh. 120,000

Less: incremental depreciation                             Sh. (380,000)

Profit before tax                                                           660,000

Less: tax 30%                                                             (198,000)

Profit after tax                                                             462,000

Add: incremental depreciation                                    380,000

Operating cash inflows                                                842,000

 

 

Whether to purchase new machine

Year Cash flows D.F 12% PV
1-5 842,000 3.6048 3,035,241.60
5 400,000 0.5674 226,960
PV cash inflows 3,262,201.60
Less: initial outlay 3,238,000.00
NPV 24,201.60

 

Advice

Karem bottling company should replace existing machine since it has a positive NPV

 

SAMPLE WORK

Complete copy of FINANCIAL MANAGEMENT Revision Kit is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP) and in HARD copy 

Phone: 0728 776 317

Email: info@masomomsingi.com

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