WEDNESDAY: 23 August 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. One of the ways of resolving conflicts between shareholders and creditors is by use of restrictive covenants.
Highlight FOUR such restrictive covenants that may be used. (4 marks)
2. Explain THREE differences between accounting and finance. (6 marks)
3. Kipawa Ltd. is considering raising additional Sh.50 million to finance an expansion programme. The firm’s capital structure which is considered to be optimal is given as follows:
Additional information:
1. The firm expects to raise Sh.10 million from internal sources.
2. The firm has paid an ordinary dividend of Sh.3 per share in the last financial year. This is expected to
grow at constant rate of 10% per annum.
3. The firm will issue new ordinary shares at a current price of Sh.35 per share and will incur a floatation
cost of Sh.5 per share.
4. New 10% irredeemable debentures will be issued at Sh.1,200 per debenture. Floatation cost of 5% of
market value will be incurred.
5. New 12% preference shares will be issued at Sh.80 each. The par value of each share is Sh.60.
Floatation cost of Sh.5 per share will be incurred.
6. Corporate tax rate applicable is 30%.
Required:
Cost of retained earnings. (1 mark)
Cost of ordinary shares. (2 marks)
Cost of 10% debentures capital. (2 marks)
Cost of 12% preferences share capital. (2 marks)
Weighted marginal cost of capital of the firm. (3 marks)
(Total: 20 marks)
QUESTION TWO
1. Identify FOUR categories of alternative investments. (4 marks)
2. Explain THREE types of risks that could be faced by investors who own shares of a company. (6 marks)
3. Kwekwe Ltd. is evaluating an investment project which requires the importation of a new machine at a cost of Sh.20 million. The machine has a useful life of five years and will have a salvage value of Sh.4 million.
Additional information:
1. The following additional costs would be incurred in relation to the machine:
2. The annual contribution margin from the product will be Sh.10 million.
3. Fixed production cost excluding depreciation would amount to Sh.2 million per annum.
4. The working capital is expected to increase by Sh.3 million at the start of the year and recovered at the end of the period.
5. The company employs a straight line depreciation policy.
6. The corporate tax rate is 30% per annum.
7. The company’s cost of capital is 10% per annum.
Required:
Total initial cash outlay. (2 marks)
Total terminal cash flow. (2 marks)
Annual net cash flows after tax. (3 marks)
The net present value (NPV) of the machine. (3 marks)
(Total: 20 marks)
QUESTION THREE
1. Outline FOUR reasons for time preference of money. (4 marks)
2. Ndume Limited intends to borrow Sh.18,000,000 from a bank to finance its project. The rate of interest is 12% per annum. Interest is charged on a reducing balance basis. The loan is to be repaid in 4 equal annual instalments.
Required:
Determine the annual instalment. (2 marks)
Prepare a loan amortisation schedule. (4 marks)
3. Bali Ltd. has provided the following information relating to its two securities; security X and security Y under three states of nature:
Required:
The expected return for each security. (2 marks)
The standard deviation for each security. (2 marks)
The covariance between the two securities returns. (2 marks)
The expected return of a portfolio consisting 75% of security X and 25% of security Y. (2 marks)
The standard deviation of the portfolio in (c) (iv) above. (2 marks)
(Total: 20 marks)
QUESTION FOUR
1. Enumerate FOUR reasons why use of debentures as source of finance is unpopular in any developing country. (4 marks)
2. Discuss THREE objectives of financing decisions in a business context. (6 marks)
3. Akili Ltd. generated Sh. 60 million profit after tax (PAT) in the previous financial year. The firm adopts 50% payout ratio as its dividend policy. The total number of issued ordinary shares are 15 million.
The company has a potential investment opportunity. If undertaken, dividends are expected to grow at the rate of 12% each year for the first 2 years, 8% for the next 2 years and then stabilise at the rate of 5% each year thereafter in perpetuity. The investors minimum required rate of return is 10%.
Required:
The earnings per shares (EPS) in last financial year. (2 marks)
The dividend per share (DPS) in the last financial year. (2 marks)
The current intrinsic value of the share. (6 marks)
(Total: 20 marks)
QUESTION FIVE
1. State FOUR differences between Islamic banking and Conventional banking. (4 marks)
2. Explain THREE key investor information documents. (6 marks)
3. Johny Kim intends to make an investment in South Africa. The South African Rand exhibits an interest rate of 16% per annum while the Kenyan Shilling exhibits an interest rate of 18% per annum.
Required:
Compute the forward rate premium of the South African Rand in respect to Kenyan Shilling.
(2 marks)
If the current spot rate of the South African Rand is Ksh. 0.141, compute the one year forward rate of
the rand with respect to Ksh. (2 marks)
4. Moran Ltd. has issued a 10 year bond with a nominal value of Sh.1,000 and a coupon rate of 12%. The coupon payments are made annually in arrears. The yield to maturity of the bond is 10% per annum.
Required:
The value of the bond. (3 marks)
The new value of the bond assuming that the yield to maturity increases to 14% per annum. (3 marks)
(Total: 20 marks)
