WEDNESDAY: 15 December 2021. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
1. Describe four possible sources of conflict of interest between shareholders and bondholders. (4 marks)
2. Securities exchanges across the world play a critical role in the economic development of countries.
In light of the above statement, summarise six roles of the Securities Exchange in the economic development of your country. (6 marks)
3. Outline four characteristics of ordinary share capital as a source of business finance. (4 marks)
4. The following data was extracted from the financial records of Faraja Ltd:
Earnings before interest and tax (EBIT) Sh.400,000,000
Dividend payout ratio 40%
Number of outstanding ordinary shares 100,000,000
Equity capitalisation rate 15%
Return on investment (ROI) 12%
Corporate tax rate 30%
Required:
The value of Faraja Ltd.’s ordinary share using the Gordon model. (6 marks)
(Total: 20 marks)
QUESTION TWO
1. Highlight two factors that are likely to affect the success of a rights issue. (2 marks)
2. QRS Limited is planning to expand its production capacity as per its marketing strategy as a result of access to new markets. The company requires additional capital of Sh.95,000,000 which it intends to raise through a rights issue. The company’s financial year ends on 30 June.
Additional information:
- The company’s pre-tax profits for the year ended 30 June 2021 was Sh.177,500,000. This represents a 30% increase over the profits of the previous year.
- The current market price per share is Sh.12.
- The rights issue will comprise one share for every four shares held at a rights issue price of Sh.8 per share.
- The dividend per share for the year ended 30 June 2021 was Sh.0.70. The company expects to pay a dividend per share of Sh.0.90 for the year ending 30 June 2022.
- Corporate tax rate is 30%.
Required:
The existing number of ordinary shares before the rights issue. (1 mark)
The earnings per share (EPS) and price-earnings (PIE) ratio for the year ended 30 June 2021. (4 marks)
The ex-rights price per share. (3 marks)
3. The following data shows the returns of two stocks, A and B and their respective probabilities of occurrence:
Probability Returns of stock A (%) Returns of stock B (%)
0.30 10 8
0.30 7 12
0.40 13 7
Required:
The expected returns of stock A and stock B. (2 marks)
The standard deviation of the returns of stock A and stock B. (3 marks)
Suppose that a portfolio is created composed of 70% of stock A and 30% of stock B. Determine this portfolio’s risk in terms of portfolio standard deviation. (5 marks)
(Total: 20 marks)
QUESTION THREE
1. Mavazi Ltd. is a firm that operates in the textile industry. Over the last 5 years, the firm has experienced stiff competition that has significantly reduced its turnover. In order to remain profitable, the firm’s management is considering diversifying its operations. This activity will require additional financing of Sh.50 million.
The firm’s existing capital structure is given as follows:
Sh. “000”
Ordinary share capital (Sh.20 par value) 60,000
Reserves 10,000
11% Debentures (Sh.100 par value) 20,000
13% Preference share capital (Sh.15 par value) 10,000
100,000
Additional information:
- The firm’s existing capital structure is considered to be optimal.
- The firm expects to raise Sh.5 million from internal sources in order to finance this diversification activity. However, new ordinary shares will be issued at Sh.32 per share and incur a floatation cost of Sh.2 per share.
- The most recent dividend paid by the company was Sh.2.5 per share which is expected to grow at a constant rate of 5% per annum in perpetuity.
- New 12% redeemable debentures will be issued at Sh.110 each. A floatation cost of Sh.15 per unit will be incurred. The par value of each unit is Sh.100 and the debentures will have a maturity period of 10 years.
- New 14% irredeemable preference shares will be issued at Sh.90 per share. The par value of each irredeemable preference share is Sh.100.
- The corporation tax rate applicable is 30%.
Required:
The cost of ordinary share capital. (2 marks)
The cost of retained profit. (2 marks)
After tax cost of new 12% debenture capital. (4 marks)
Cost of new 14% preference share capital. (2 marks)
Weighted marginal cost of capital (WMCC). (4 marks)
2. Siphony Ltd. borrowed Sh.15,000,000 from Baraka Bank at an annual interest rate of 16% repayable in four equal annual instalments at the end of each year.
Required:
Prepare a loan amortisation schedule for the company. (6 marks)
(Total: 20 marks)
QUESTION FOUR
1. Explain the term “personal financial management”. (2 marks)
Examine four benefits of managing personal finance efficiently. (4 marks)
2. In relation to Islamic Finance, explain the following terms:
Sukuk. (2 marks)
Gharar. (2 marks)
Musharakah. (2 marks)
3. Arctic Developers Ltd. deals in the construction and sale of residential homes. The company is evaluating different forms of paying dividends to its shareholders. In relation to the above statement, advise the company on four forms of paying dividends that it could adopt. (4 marks)
4. The following information relates to Kabaka Ltd. for the year ended 31 March 2021:
Sh.”000″
Profit after tax 12,000
10% Debenture 12,000
Ordinary share capital (Sh.20 par value) 80,000
Additional information:
- The market price per share is Sh.72.
- The corporate tax rate is 30%.
Required:
Calculate the following ratios:
Times interest earned ratio. (2 marks)
Price earnings ratio. (2 marks)
(Total: 20 marks)
QUESTION FIVE
1. Bob Ltd. is contemplating replacing an existing machine which was purchased 5 years ago at a cost of Sh.825,000. The machine was expected to have a useful life of 10 years and an estimated salvage value of Sh.40,000 at the end of the 10th year. However, if replaced the existing machine can be sold in the market today at Sh.300,000. The new machine will have an initial cost of Sh.1,200,000 and will have a useful life of 5 years. As a result of increased efficiency that will arise due to replacement of the existing machine, the firm will save Sh.168,000 per annum in production costs throughout the new machine’s life. In addition, there will be annual savings in reduction of wastages estimated at Sh.80,000.
The salvage value of the new machine is estimated at Sh.100,000 at the end of its useful life.
Additional information:
- The firm provides for depreciation on a straight-line basis.
- The cost of capital is 14%.
- The corporation tax rate applicable is 30%.
Required:
Using the net present value (NPV) approach, advise the firm on the replacement decision. (8 marks)
State any two assumptions you made in your calculations in (a) (i) above. (2 marks)
2. Analyse three motives of holding cash. (6 marks)
3. Jasmine Limited generates Sh.100,000 per month excess cash which it intends to invest in short-term securities. The interest rate it can expect to earn on its investment is 10% per annum. The transaction costs associated with each separate investment of funds is constant at Sh.500.
Required:
The optimal amount of cash to be invested in each transaction. (1 mark)
The number of transactions per annum. (I mark)
The total cost of making the transactions in (ii) above. (1 mark)
The opportunity cost of holding cash per annum. (1 mark)
(Total: 20 marks)
