### WEDNESDAY: 26 April 2023. Afternoon 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 term “fixed income indices”. (2 marks)

Highlight TWO challenges that make it costly and challenging for investors to replicate fixed income

indices. (2 marks)

2. Propose THREE challenges faced by real estate developers in providing affordable housing in developing countries. (6 marks)

3. James Mwangi has invested in a portfolio that comprises of two assets; asset A and asset B as shown below:

Correlation coefficient between the rates of returns of asset A and asset B is 1.0.

**Required:**

Based on correlation coefficient, advise James Mwangi on whether he should hold his portfolio.

(2 marks)

Calculate expected return of the portfolio. (3 marks)

Calculate the covariance of the portfolio. (2 marks)

Compute the standard deviation of the portfolio. (3 marks)

**(Total: 20 marks)**

**QUESTION TWO**

1. Outline FOUR limitations of the profit maximisation goal of firm. (4 marks)

2. Explain THREE types of agency costs. (6 marks)

3. The earnings per share (EPS) and dividend per share (DPS) of Maputo Ltd. for each of the five years ended 31 December 2018 to 31 December 2022 were as follows:

The directors of the company are considering a change in the company’s dividend policy. This change would result to reduction in dividend per share for the year ending 31 December 2023 to Sh.1.25 in order to increase the level of internally generated funds.

**Additional information:**

1. The growth rate in dividend per share after the change in policy is expected to be 12% per annum.

2. The shareholders require a return on investment at a rate of 14% per annum.

**Required:**

Determine the average dividend growth rate over the five-year period. (2 marks)

Using the dividend valuation model, calculate the intrinsic value of a share before the change in dividend

policy. (3 marks)

Determine the intrinsic value of a share after the change in dividend policy using dividend valuation

model. (3 marks)

Advise the directors of the company whether or not to change the dividend policy. (2 marks)

**(Total: 20 marks)**

**QUESTION THREE**

1. Highlight FOUR benefits of Eurobond to the issuers. (4 marks)

2. Explain THREE principles of Islamic finance. (6 marks)

3. The following is the capital structure of Richy Ltd:

**Additional information:**

1. The shareholders of Richy Ltd. expect earnings and dividends to grow at a constant rate of 10% in the

future. The company has just paid a dividend of Sh.3.60 per share.

2. The current market price of one ordinary share is Sh.60.

3. New preference shares can be sold at Sh.90 per share with a dividend of Sh.6 per share and floatation

costs of Sh. 10 per share.

4. The company pays out all its earnings as dividends.

5. The company will sell 12% debentures with a maturity of 10 years at Sh.1,200 per debenture.

6. The corporation tax rate is 30%.

**Required:**

Calculate the following:

The cost of ordinary share capital. (2 marks)

The cost of preference share capital. (2 marks)

The cost of 12% debentures capital. (3 marks)

The weighted average cost capital (WACC) using market values. (3 marks)

**(Total: 20 marks)**

**QUESTION FOUR**

1. Highlight FOUR advantages of using intermediate term loans to finance a business organisation. (4 marks)

2.Describe THREE components of a prospectus as a source of financial and market data. (6 marks)

3. Bali Ltd. is evaluating an investment project whose initial cost is Sh.12 million. It has expected economic life of 5 years after which it will have a zero salvage value. The earnings before depreciation and tax (EBDT) from the project are expected as follows:

The corporation tax rate is 30% and depreciation is on a straight line basis. The firm’s cost of capital is 12%.

**Required:**

Calculate the following:

The annual cash flows after tax. (3 marks)

The net present value (NPV). (3 marks)

The profitability index (PI). (1 mark)

The internal rate of return (IRR). (3 marks)

**(Total: 20 marks)**

**QUESTION FIVE**

1. Outline FOUR assumptions of capital budgeting. (4 marks)

2. Explain TWO components of a financial system. (4 marks)

3. Describe THREE controllable factors that could influence the cost of capital of a firm. (6 marks)

4. At the beginning of the year 2022, Nyiro Wekeza deposited Sh.500,000 in an investment account which earned compound interest at a rate of 10% per annum. At the beginning of each subsequent year, Nyiro Wekeza intend to deposit a further Sh.250,000 in the same account.

**Required:**

The amount of money expected to be in the investment account by the end of year 2026. (4 marks)

The percentage interest to be earned over the investment period. (2 marks)

**(Total: 20 marks)**