VALUATION OF FINANCIAL ASSETS
- Zedi Ltd. is forecasting a growth rate of 12% per annum for the next 2 years. The growth rate is likely to fall to 10% for the third and fourth years. After that, the growth rate is expected to stabilise at 8% per annum. The company has just paid a dividend of Sh.1.50 per share and the investors’ required rate of return is 16%.
The intrinsic value per share of Zedi Ltd.
Summit Ltd. issued a new bond five years ago.
The bond was sold at par (Sh 1,000) and has a coupon rate of 12% and a maturity of 30 years. Coupon payments are made semi-annually. The interest rate has currently gone down to 10%.
- The current price of the bond.
- The current yield to maturity of the bond.
- The capital gain on the bond.
- c) Max Enterprises Ltd. had the following pattern of earnings per share (EPS) over the last five years:
|Earnings per share (EPS)||Sh.4.00||Sh.4.20||Sh.4.41||Sh.4.63||Sh.4.86|
The company maintained a constant dividend payout ratio of 40%. The company’s required rate of return is 13%.
The company’s theoretical value of the share
December 2013 Question Five C
- Mongo Ltd. currently pays a dividend of Sh.4 per share. The dividend is expected to grow at 15% per annum for the first 3 years, then at 10% per annum for the next 3 years, after which the dividend will grow at 5% per annum to perpetuity. The required rate of return for the ordinary share is 18%.
The intrinsic value of the ordinary share.
- Richy Ltd. intends to raise Sh.50 million to finance a new project through a rights issue. The project has a 10-year economic life with zero scrap value. The project is expected to generate annual cash inflows of Sh.l4 million. The company has 10 million issued and fully paid up ordinary shares. The market price of the company’s ordinary shares before the announcement of the rights issue was Sh.35 per share. The company’s cost of capital is 14%.
The cum-rights price of the shares.
December 2013 Question One B
- Evarex Ltd. has bonds which currently sell for sh. 1,150 with an 11% coupon interest rate and at sh. 1,000 par value. The bonds pay interest annually and have 18 years to maturity. The company’s tax rate is at 30%
- The current yield of the bond
- The yield to maturity (YTM) of the bond.
- Explain the relationship between the calculated yield to maturity, current yield and coupon rate of the bond.
- b) MNM Ltd. has a current dividend of sh. 2.00 per share. The following are the expected annual growth rates for the dividend:
|Year||Dividend growth rate (%)|
|1 – 3 4 – 6
7 – 9
10 and thereafter indefinitely
The required rate of return for the ordinary share is 10%.
The intrinsic value of the ordinary share.
Naziri investment Ltd. currently sells bonds at Sh.1,200 with an 11% coupon rate and
Sh.1,000 par value. The bond agreement provides for payment of interest on annual basis with 18 years maturity period.
The bond yield to maturity (YTM)
XYZ Ltd. is planning to absorb three other companies so as to realised its sales projection of Sh.50, 000,000 per annum. The company accountant has advised the management to maintain such a size as will enable its shares to sell at minimum price of Sh. 16.
The Company’s last published statement of financial position indicates the following:
|Ordinary shares of Sh. 10 each
Non-current assets Current assets
Profits for the years were as follows:
The price earnings (P/E) ratio applicable is 12:1
Compute the value of the business using the:
Price-earnings (P/E) ratio method ii) Asset method
The 10% convertible loan stock of Nalyaka Ltd. is quoted at Sh.142 per Sh.100 par value. The earliest date of conversion is in 4 years’ time, at the rate of 30 ordinary shares per Sh.100 nominal loan stock. The share price is currently Sh.4.15. Annual interest on the stock has just been paid.
- The average annual growth rate in the share price that is required for the stockholders to achieve an overall rate of return of 12% a year compounded over the next 4 years, including the proceeds of conversion.
- The implicit conversion premium on the stock.
Ufanisi Ltd. is experiencing a period of rapid growth. Earnings and dividends are expected to grow at the rate of 5% per annum during the next two years, 13% in the third year and at a constant rate of 6% per annum thereafter. The last dividend paid by the company was sh. 11.50. The company’s required rate of return is 12%.
- The value of the equity shares of the company today.
- The dividend yield and capital gains yield and total return for year 1 and year 2.
- Pentagon Ltd. issued a 10 year bond two years ago. The bond has a coupon rate of 13% per annum payable semi- annually. Upon maturity, it will be redeemed at sh. 102 for every Sh. 100 par.
The highest amount you can pay to acquire the bond today if the required rate of return is 14%.
Mhusika Ltd. is an all equity financed company with a market capitalisation of Sh720,000,000. The company intends to raise Sh.120, 000,000 through a rights issue to finance a new project. The current market price per share of the company prior to announcement of the rights issue is Sh 30. The proposed offer price is Sh.25.
The new project is expected to generate cash flows of Sh.16, 800,000 per annum to perpetuity. For the year just ended, the company paid a dividend per share of Sh. 2.83. The project’s cash flows and dividends per share have an equal growth rate of 6% per annum.
- Outline three advantages to a company of raising capital through a right issueQUESTION 12(a)
- Advantages of raising capital through a rights issue;
- It is less costly i.e. a company incurs less floatation costs
- There are minimal legal and administrative compliant measures
- Does not subject a company to financial risks
- There are no restrictive covenants, no collateral is required.
- Advantages of raising capital through a rights issue;
- The cum-right market price per share on announcement of the rights issue but just before the issue is made.
- The theoretical ex-right market price share and the value of each right.
Ushindi Ltd. has recently issued a sh. 1,000, 9 percent convertible bond. The bond can be converted into 9 ordinary shares at the end of the five years. The current market price of the shares of Ushindi Ltd. is sh. 25 per share. The price is expected to grow at a rate of 10 per cent per annum. The investors’ required rate of return is 12%.
The current value of the bond.
Kawaida Ltd. is currently engaged in an expansion programme. Consequently, the company has been retaining all its earnings to finance the expansion programme. The company’s management expects to resume the payment of dividends at the end of 3 years with a dividend payment of sh. 1 per share. The dividends will grow at an annual rate of 50% in years 4 and 5. Thereafter, the dividends will grow at a constant rate of 8% indefinitely. The required rate of return on the company’s stock is 15%.
The current value of the company’s stock.
Mauzo Ltd. intends to declare a rights issue of one ordinary share for every five ordinary shares held as at 31 December 2007.
The current market price per share is sh. 16 but subscribers for the rights issue will be offered a 15% discount. The balance sheet of the company as at 31 December 2007 was as follows:
Sh “000” Sh “000”
Non – current assets 26,200
Current assets Inventory 8,000
Accounts receivable 6,000
|Ordinary share capital (par value sh. 5)||8,000|
|12% Bank loans||18,000|
|Total equity loans||32,000|
- i) The theoretical ex- rights price per share. ii) The value of rights per existing share. b)
- List three alternative actions available to the shareholders as regards to the rights issue.
- Determine the effect of each of the alternative actions listed in (b) (i) above on the wealth an investor holding 1,000 shares in the company and hence advise the investor on the best course of action.
June 2008 Question Two A and B
- c Magana’s investment portfolio comprises 490 shares in ABC Ltd. and sh. 20,000 deposited in a savings account. ABC Ltd. has declared a rights issue of one share for every five shares held at an issue of sh. 20 per share. The current market price per share of ABC Ltd. is sh.
- Magana would obtain the funds required to exercise the rights issue from the savings account. Similarly, proceeds from the sale of rights issue would be credited to the savings account.
- The value of each right
- Analyze the effect of the rights issue on the value of D. Magana investment portfolio and hence advise him on whether to exercise, sell or ignore the rights issue. Ignore interest on the savings
QUESTION 16 a)
- Define the term “intrinsic value” with reference to the valuation of ordinary and preference shares
- An investor received a dividend of Sh.1.50 in the current financial year on each of his ordinary shares. The par value per share is Sh.20. The annual growth rate in dividends is 8%. The current market price per share is Sh1.50 while the investor’s required rate of return is 20% Calculate the intrinsic value of each ordinary share.
- Jasho Ltd paid an ordinary dividend of Sh3.60 per share for the year ended 31 March 2005.
The Management of the company projects that the earnings of the company will increase in the coming years as follows:
Year ending 31 December
2009 and subsequent years Projected earnings growth rate
10% Per annum
The investors’ required rate of return is 18%
Determine the value of an ordinary share in Jasho Ltd as at 31 March 2005
- Briefly explain the operations of the central depository system (CDS) in facilitating securities trading.Example: If X and Y are shareholders of ABC ltd then ABC ltd does not need to deliver the share certificate to either of them but a ledger account for both the shareholders will be maintained. This account will be credited with the number of shares held. If investors Y sells shares to investor X the ledger a/c of investor Y will be debited with the ledger a/c for investor X will be credited.
- Discuss the functions of the central bank of your country.QUESTION 18
- CDS is a computerized system which enables the transfer of securities without the need for physical movement. In this case the ownership of the security is through the book entry instead of physical exchange.
- Function of Central bank
- Issuing of Currency.
Central bank is the sole currency –issuing authority in a country. It is the most important function and requires the highest degree of efficiency and trust and efficiency. It prints and mints coins and is required to keep it as secret as possible. The central bank also ensures that just the right quantity of money is in circulation.
- Banker to the Government.
A central bank provides facilitates for the government in the same manner as a commercial bank does for the businessman. It receives deposits on behalf of the government from various sources, e.g. income tax, custom duties, proceeds of the sale of government securities, etc. It provides cheques for the ministries, who issue them to their creditors. All civil servants receive their salaries by means of cheques drawn on the central bank of their country.
- Lender to the government.
The central bank provides the government with necessary funds against securities. It also acts as the government’s agent or raising loans by the sale of government securities to the public. The central bank also manages the public debt, which is the money due by a government to its people.
- Advisor to the Government.
The central bank being a specialized institution is well fitted to give advice on issues of economic nature. It advises on the best way to raise short-term finance for government project or on the ways and means to control inflation in the country and other similar problems.
- Banker to commercial Banks
The central bank provides banking facilities to commercial banks in the country. This enables them to settle any debt arising from the issuing of cheques by their customers to the clients of other banks in the country. They instruct the central bank to make an appropriate entry in the accounts, thereby eliminating the need for actual transfer of money.
- Mauzo ltd has issued 72,000 ordinary shares as at 31 March 2005. The company had maintained an annual dividend payment of Sh.180,000 including for the year ended 31 March 2005
On 3 April 2005 the management of the company identified an investment opportunity, which would cost Sh. 720,000. This cost was expected to be financed through an issue of ordinary shares at par. The return of this investment is expected to be 25% per annum on the cost over the next four years ending 31 March 2009
All earnings would continue to be paid out as dividends to shareholders. The cost of capital is
- i) Calculate the value of an ordinary share as at 31 March 2005. ii) Calculate the value of the company as at 3 April 2005 assuming that the management undertook the investment.
Distinguish between the following terms
Cum dividend and ex dividend: The word cum means inclusive while ex means exclusive. Therefore cum-dividend means inclusive of dividends while ex dividend means exclusive of dividends.
Cum-dividend and ex-dividend ii) Cum-all and ex-all Cum-all and ex- all: Cum-all means inclusive of all the benefits i.e. dividends rights issue, bonus issue etc. and ex-all means exclusive of all the benefits.
Akili limited has issued a debenture whose par value is Sh.1,000. The debenture can be redeemed at par after four years or converted to ordinary shares at a conversion rate of Sh.100 per share. The projected market price of the share after the four-year period could either be Sh.90 or Ah. 120 based on the company’s performance. The investors required rate of return is 10%.
The value of the debenture based on each of the expected share prices
Motor works Limited intends to raise additional capital through an issue of ordinary shares of Sh.80 par value. The company promises to pay dividend at the rate of Sh.8 per annum and the expected market price of the shares after six years is Sh.120
An investor whose required rate of return is 10% intends to hold the shares for six years
The intrinsic value of the shares.
List Three advantages of a rights issue from the point of view of:
Advantages of a rights issue to the
It increases the equity, capital of the firm and if the firm was geared, its gearing level will decrease leading to decrease in financial risk of the company.
It involves lesser procedures e.g. no need to prepare a prospective as the shares are issued to the shareholders who know the company.
With increased number of shares the shareholders will receive higher dividends in the future.
It does not dilute the ownership and control of the firm since the shares are issued to existing shareholders in proportion to their current ownership.
It enables the existing shareholders to enjoy the discounts offered by purchasing the shares at a price below the existing MPS.
The issuing company
Hisa Limited has 1 million ordinary shares outstanding at the current market price of Sh.50 per Share. The company requires Sh. 8 million to finance a proposed expansion project. The board of directors has decided to make a one for five rights issue at a subscription price of Sh. 40 per share.
The expansion project is expected to increase the firm’s annual cash inflow by Sh. 945,000. Information on this project will be released to the market together with the announcement of the rights issue.
The company paid a dividend of Sh. 4.5 in the previous financial year. The dividend, together with the company’s earnings is expected to grow by 5% annually after investing in the expansion project
Compute the price of the shares after the commencement of the rights issue but before they start selling ex-rights
Compute the theoretical ex-rights price of the shares.
Compute the theoretical value of the rights when the shares are selling rights on.
What would be the cum-rights price per share if the new funds are used to redeem a Sh. 8 million 10% debenture at par? (Assume a corporation tax rate of 30%)
- What are the determinants of the price of a bond
- Identify six ways in which a company could make preference shares more attractive to a potential investor
- Determinants of the price of a bond The interest paid on the bond
- The required rate of return on the bond
- The number of years remaining to maturity
- The terminal or maturity value of the bond
- Ways to make preference shares attractive
- Making them to be participating preference shares
- Making the preference shares to be cumulative preference shares
- Making them to be convertible preference shares at the option of the preference shareholders
- Giving the preference shareholders the voting rights by allowing them to appoint a director in the company’s board of Directors
- Issuing preference shares secured against a assets of the firm
- Giving the preference shareholder the option to redeem them at their own will