FUNDAMENTALS OF FINANCE AUGUST 2023 PAST PAPER

TUESDAY: 22 August 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.

QUESTION ONE

1. Explain the following type of decisions made in finance:

Liquidity decisions. (2 marks)

Investment decisions. (2 marks)

2. In a finance and investment forum, one of the facilitators’ noted that “as firms strive to achieve its objectives, at times the objectives may overlap with each other and this might cause conflict”.
With reference to the above statement, describe THREE overlaps among objectives that could arise in the course of a firm’s effort to achieve its objectives. (6 marks)

3. The capital structure of Mandela Ltd. as at 30 June 2023 was as follows:

The company is considering the acquisition of an investment project that will cost Sh.135 million. In order to finance the investment project, the company would be required to raise additional capital.

Additional information:
1. The above capital structure is considered optimum.
2. The company can obtain additional debentures at an interest rate of 18% per annum.
3. The dividend for the year ended 30 June 2022 was Sh.2.40 per share.
4. Dividends are expected to grow at the rate of 8% each year for the foreseeable future.
5. Additional ordinary shares can be issued at the securities exchange at a price of Sh.54 per share net of
floatation cost amounting to Sh.6 per share.
6. Corporations tax rate is 30%.

Required:
Calculate the following:

Cost of additional debentures. (1 mark)

Cost of retained earnings. (1 mark)

Cost of ordinary shares. (1 mark)

The amount to be financed through equity. (1 mark)

The amount of equity to be financed through issue of new ordinary shares if the company is to maintain
the optional capital structure. (1 mark)

The amount to be raised through debentures. (1 mark)

The marginal cost of capital. (4 marks)

(Total: 20 marks)

QUESTION TWO

1. With reference to long-term and short-term sources of finance:

State FOUR advantages of bills of exchange. (4 marks)

Enumerate SIX features of ordinary share capital. (6 marks)

2. Baraka Ltd. is considering the acquisition of a new machine estimated to cost Sh.6 million. An additional Sh.280,000 million would be incurred to install the machine.

1. The machine has an estimated economic life of five years with a residual value of Sh.2 million.
2. The projected profit before tax and depreciation is Sh.2.7 million per annum.
3. To support the increased sales, it is estimated that accounts receivable, inventory and accounts payable would increase by Sh.3 million, Sh.1.7 million and Sh.3.4 million respectively.
4. The company uses the straight-line method of depreciation and the cost of capital is 8%.
5. The corporate tax rate is 30% per annum.

Required:

Using net present value (NPV), advise Baraka Ltd. on whether the machine should be acquired. (10 marks)

(Total: 20 marks)

 

QUESTION THREE

1. In relation to time value of money, distinguish between the following terms:

“Ordinary annuity” and “annuity due”. (2 marks)

“A growing annuity” and “a perpetual annuity”. (2 marks)

2. Maandani Ltd. is considering buying a machine which is expected to generate the following cash flows at the end of each year over the machine’s economic life of 5 years:

Required:
Compute the total present value of the cash flows. (4 marks)

3. John Maneno has computed the profitability index (PI) for a new proposed project to be 1.12. The projects initial cash outlay is Sh.10 million. The project has a useful life of five years. The minimum required rate of return on the project is 16%.

Required:

Compute the following for the project:

Annual cash inflows. (3 marks)

Payback period. (3 marks)

Net present value. (3 marks)

Internal rate of return. (3 marks)

(Total: 20 marks)

QUESTION FOUR

1. Explain THREE benefits of block chain technology to an organisation. (6 marks)

2. Describe THREE ways of resolving conflict between shareholders and debenture holders in an organisation. (6 marks)

3. Nandwa Ltd. maintains a minimum cash balance of Sh.2,000,000. The variance of the daily cash flows is Sh.100 million. The transaction cost of each marketable security is Sh.80.

The interest rate of a marketable security is 12% per annum. Assume 365 days in a year.

Required:
Using the Miller-Orr model of cash management, determine:

The return point. (2 marks)

The upper cash limit. (2 marks)

The average cash balance. (2 marks)

The spread. (2 marks)

(Total: 20 marks)

 

QUESTION FIVE

1. Differentiate between “time value of money” and “time preference for money”. (4 marks)

2. Masii Ltd. has a cost of equity of 10%. Currently, it has 250,000 ordinary shares which are quoted at the securities exchange at Sh.60 per share. The company’s earnings per share is Sh.10 and its expected dividend per share is Sh.5 at the end of the current financial year. The expected net income for the current year is Sh.3 million and the available investment proposals are estimated to cost Sh.6 million.

Using the Modigliani and Miller (MM) model determine:

The price of a share at the end of the year if dividend is not paid. (2 marks)

The price of a share at the end of the year if dividend is paid. (2 marks)

The value of a firm at the end of the year if dividend is not paid. (3 marks)

The value of a firm at the end of the year if dividend is paid. (3 marks)

3. In assessing the credit worthiness of customers, a company should obtain information from certain sources.

Required:

Examine THREE sources of credit information that a bank would rely on when assessing a customer for
consideration for a loan facility. (6 marks)

(Total: 20 marks)

 

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