WEDNESDAY: 6 December 2023. Morning 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 the following sources of competitive advantage enjoyed by a firm:

Price premium. (2 marks)

Cost and capital efficiency. (2 marks)

2. Discuss TWO differences in calculating economic profit from accounting profit as used in Economic Value Added (EVA) analysis. (4 marks)

3.  An analyst has gathered the following information for Pambo Ltd.

• Adjusted net operating profit after tax (NOPAT) is Sh.100 million.
• Total capital is Sh.700 million. The firm has no debt.
• Closing share price is Sh.26.
• Total number of shares outstanding is 30 million.
• The cost of equity is 14%.


Calculate the following:

Economic value added (EVA). (2 marks)

Market value added (MVA). (2 marks)

4. A financial analyst has gathered the following information relating to Bena Ltd., a firm listed at the securities exchange:

1. The risk free rate of return is 4.5%.
2. Expected return on the equity market is 14.5%.
3. The stock beta factor is 1.15.
4. Dividend just paid recently is Sh.1.72.
The analyst has projected that the current dividend will grow at a high extra-ordinary rate of 12% per annum for the next three years. Thereafter, the dividends will grow at a constant rate of 9% to perpetuity.


The cost of equity of Bena Limited. (2 marks)

The intrinsic value of Bena Ltd.’s share today. (6 marks)

(Total: 20 marks)



1. In relation to technical analysis indicators, explain the following terms:

Support and resistance level. (2 marks)

Trend line. (2 marks)

Reversal day. (2 marks)

2. In relation to equity analysis, examine THREE uses of industry analysis. (6 marks)

3. Gilead Ltd.’s shares have a retention ratio of 45%, a return on equity of 14%, an earnings per share (EPS) of Sh.5.25 and sales per share of Sh.245.54. The expected growth rate in dividends and earnings is 6.5%. The required return on investment is 11%.

Calculate the following:

Price to sales (P/S) multiple. (2 marks)

Justified price to book value (P/B) multiple. (2 marks)

Trailing price to earnings (P/E) multiple. (2 marks)

Justified leading price to earnings (P/E) multiple. (2 marks)

(Total: 20 marks)



1. Describe how the following factors affect the lack of marketability of a private firm:

Prospect of public offering or sale. (2 marks)

Information access and reliability. (2 marks)

Put rights. (2 marks)

Restrictive transfer. (2 marks)

2. The value of working capital and non-currents for Mamboleo Ltd. a privately held firm, are Sh.200,000 and Sh.800,000 respectively. The normalised earnings for the year just ended is Sh.100,000. The discount rate for the working capital, non-current assets and intangible assets are 5%, 11% and 12% respectively. The growth rate is 3%.


Estimate the value of the firm using excess earnings method. (6 marks)

3. William Wanjohi purchased 500 shares of ABC Ltd. at Sh.32 per share. The shares were purchased at 75% margin. One month later, Wanjohi had to pay interest on the amount borrowed at a rate of 2% per month. At that time, Wanjohi received a dividend of Sh.0.50 per share from ABC Ltd. Immediately after that he sold the shares at Sh.28 per share. He paid a commission of Sh.10 on the purchase and Sh.10 on the sale of the shares.


Calculate the investor’s rate of return for the investment for the one month period. (6 marks)
(Total: 20 marks)


1. Highlight THREE reasons that could make equity investments analysts prefer to use Enterprise Value (EV) to Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA), that is, (EV/EBITDA) ratio in equity valuation. (3 marks)

2, Analyse TWO strengths of two-stage dividend discount model (DDM) as compared to the constant growth dividend discount model (DDM) in equity valuation. (4 marks)

3. An investor is considering the following equity investments to make in the coming year:

1. Bidii Ltd. that is currently paying no dividend and will not pay for several years. Bidii Ltd. is expected to begin paying a dividend of Sh.100 four years from now and the dividend is expected to grow at a rate of 5% thereafter. The company’s required rate return is 11%.

2. The purchase of Capital City Investments, which has a price to book value (P/B) of Sh.5.00. The
required return on equity is expected to be 18%, the market price per share is Sh.25 and the growth rate is expected to be 8%. The investor believes that the share is currently priced at its fair value.



The value of Bidii Limited’s share price today. (2 marks)

The cost of equity the investor should use in the valuation of Capital City Investments. (4 marks)

4. Fariji Ltd. earned a net profit margin of 20% on revenues of Sh.20 million this year. Fixed capital investment was Sh.2 million and depreciation was Sh.3 million. Working capital investment equals 7.5% of sales every year. Net income, fixed capital investment, depreciation, interest expense and sales are expected to grow at a rate of 10% per annum for the next five years. After five years, the growth in sales, net income, fixed capital investment, depreciation and interest expense will decline to a stable rate of 5% per annum. The tax rate is 30% and Fariji Ltd. has 1 million ordinary shares outstanding and long term debt paying 12.5% interest trading at its par value of Sh.32 million. The weighted average cost of capital (WACC) is 18% during the high growth stage and 15% during the stable stage.

Calculate the value of the firm’s equity using the free cash flow to the firm (FCFF) model. (7 marks)
(Total: 20 marks)



1. With respect to market efficiency in equity investment analysis:

Explain the term “financial market efficiency”. (2 marks)

Discuss THREE forms of market efficiency. (6 marks)

2.  Wote Traders (WT) produces wood carvings for use in homes.
The most recent income statement for Wote Trades (WT) is given below:
Revenue                       1,500,000
Cost of goods sold        630,000
Selling expenses           120,000
Administrative expenses 330,000
Operating profit               420,000

An analyst believes that a new revenue tax of 10% is going to be imposed on the wood carvings. He also believes that the cost of goods sold and selling expenses are a fixed percentage of sales, while administrative expenses are fixed. Wote Traders is expected to pass on the entire cost of the revenue tax to the consumers. The price elasticity of demand for the wood carvings is 0.60.

Forecast Wote Traders (WT) operating margin for the upcoming year given the anticipated 10% increase in taxes. (6 marks)

3. An investor collects the information relating to the markets and the economy as shown below:


Calculate the expected annual equity return using the Grinold-Kroner model assuming no change in the number of shares outstanding. (6 marks)

(Total: 20 marks)

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