INTRODUCTION TO FINANCE AND INVESTMENTS DECEMBER 2022 PAST PAPER

WEDNESDAY: 7 December 2022. 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. The goal of wealth maximisation is considered to be the modern approach to finance and any organisation should strive to ensure it maximises the wealth of its shareholders.

Required:
Argue FOUR cases in support of the above statement. (4 marks)

2. Explain TWO differences between forwards contracts and futures contracts as types of derivatives. (4 marks)

3. Hazina Microfinance Limited intends to borrow Sh.10,000,000 from Pesa Limited. The loan will attract an interest rate of 14% per annum on reducing balance basis. The loan will be repaid in four equal annual instalments.

Required:
Prepare a loan amortisation schedule for Hazina Microfinance Limited. (6 marks)

4. Define the following terms as used in foreign exchange markets in your country:

Bid price. (1 mark)

Ask price. (1 mark)

Bid-Ask spread. (1 mark)

Initial margin. (1 mark)

5. With reference to time value of money, define the following terms:

Compounding. (1 mark)

Future value. (1 mark)

(Total: 20 marks)

QUESTION TWO

1. With reference to cost of capital:

Explain the term “cost of capital” to a firm. (2 marks)

Highlight THREE purposes of cost of capital to a firm. (3 marks)

2. Summarise FIVE advantages of investing in mutual funds as an alternative investment. (5 marks)

3. Outline FOUR challenges facing Islamic banking in your country. (4 marks)

4. Poa Ltd. made profits before tax in the financial year ended 31 December 2021 of Sh.9,320,000. The current market price per share of the company is Sh.60. An extract of the capital structure as at 31 December 2021 is as follows:

Required:
Earnings per share (EPS). (2 marks)

Price/earnings (P/E) ratio. (2 marks)

Return on investment (ROI). (2 marks)

(Total: 20 marks)

QUESTION THREE

1. Highlight FOUR characteristics of a good investment appraisal method. (4 marks)

2. Distinguish between a “Eurobond market” and “foreign exchange market”. (2 marks)

3. Market risk is the risk that the value of an investment will decrease due to changes in market conditions. In relation to the above statement, summarise FOUR types of market risks that could affect an investment. (4 marks)

4. Zamu Ltd. is considering its budget for the year 2023. The following information relates to four mutually exclusive projects that the management is contemplating to undertake:

Additional information:
1. The cost of capital for Zamu Ltd. is 10%.
2. The cash flows are assumed to occur at the end of each year.

Required:

Net present value (NPV) of each investment. (4 marks)

Advise Zamu Ltd. on the best alternative to choose using the NPV criteria. (1 mark)

5. Majibu investments account was analysed for performance in the last three years each ending 31 December and
the data tabulated as below:

Required:

The geometric mean (GM) rate of return. (3 marks)

The arithmetic mean (AM) rate of return. (2 marks)

(Total: 20 marks)

QUESTION FOUR

1.  Distinguish between “primary markets” and “secondary markets”. (4 marks)

2. With reference to agency theory, explain the following terminologies:

Agency relationship. (2 marks)

Agency costs. (2 marks)

3. Jawabu Ltd. is a wholly equity financed company. The shares of the company are currently trading in the securities exchange at a price of Sh.60 per share. The company’s earnings per share is Sh.10 and growth in earnings is expected to remain at 10% per annum for the foreseeable future. Jawabu Ltd. has a policy of paying 30% of the profits after tax as dividends to the shareholders. The company’s cost of capital is 16%.

Required:

The theoretical value of the company’s share using the Gordon’s model. (3 marks)

Comment on its valuation on the securities exchange. (1 mark)

Outline THREE drawbacks of the Gordon dividend growth model. (3 marks)

4. The following information relates to the capital structure of Kora Limited as at 31 December 2021:

Additional information:
1. Mortgage bonds of similar quantity could be sold at a yield of 8%.
2. The ordinary shares sell at Sh.120 each.
3. The ordinary shareholders have just received a dividend of Sh.4 per share. Earnings grow at the rate of 6% per annum.
4. Corporation tax rate is 30%.

Required:

After-tax cost of mortgage bonds. (1 mark)

Cost of equity. (2 marks)

Weighted average cost of capital (WACC) for the firm. (2 marks)

(Total: 20 marks)

QUESTION FIVE

1. Outline FOUR advantages of investing in bonds. (4 marks)

2. Assess three objectives of using a prospectus by companies intending to list at the stock market. (6 marks)

3. The following information relates to the prices of a share of Delight Ltd. under various states of nature:

The current share price of Delight Ltd. is Sh.261.25.

Required:

The rate of return for each state of nature. (4 marks)

The expected rate of return. (3 marks)

The standard deviation. (3 marks)

(Total: 20 marks)

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