ADVANCED FINANCIAL MANAGEMENT
KASNEB SYLLABUS
PAPER NO.15 ADVANCED FINANCIAL MANAGEMENT
GENERAL OBJECTIVE
This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to apply advanced financial management techniques in an organisation.
15.0 LEARNING OUTCOMES
A candidate who passes this paper should be able to:
- Evaluate advanced capital budgeting decisions
- Design an optimal capital structure for an organisation
- Predict corporate failure
- Apply derivatives in financial risk management
- Apply financial management skills in the public sector
- Understand concepts of corporate restructuring and re-organisation
- Apply valuation techniques in real estate finance
CONTENT
15.1 Advanced capital budgeting decision
- Incorporating risk/uncertainty in capital investment decisions
- Nature and measurement of risk and uncertainty
- Techniques of handling risk: sensitivity analysis, scenario analysis, decision trees, simulation analysis, utility analysis, risk adjusted discounting rate(radr) and certainty equivalent method
- Incorporating capital rationing in capital investment appraisal
- Incorporating inflation in capital investment appraisal
- Evaluation of projects of unequal lives
- The real options-strategic investment option, timing option, abandonment option and the replacement option
- Common capital budgeting pitfalls
- 2 Portfolio theory and analysis:
- The modern portfolio theory: background of the theory; portfolio expected return; the actual and weighted portfolio risk; derivation of efficient sets; the capital market line (CML) model and its applications, the mean variance dominance rule; short comings of portfolio theory
- Capital Asset Pricing Model-CAPM : background of the theory; assumptions; beta estimation – beta coefficient of an individual asset and that of a portfolio and the interpretation of the result; security market line(SML) model and its applications; conceptual differences between portfolio theory and capital asset pricing model
- Shortcomings of the capital asset pricing model
- The Arbitrage pricing model (APM) and other multifactor models: background of the theory; conceptual differences between the Capital asset pricing model and the Arbitrage pricing model; application of the Arbitrage pricing model, shortcomings of Arbitrage pricing model; Pastor Stambaugh model
- Evaluation of portfolio performance: Treynor’s measure, Sharpe’s measure, Jensen’s measure, appraisal ratio measure, information ratio, Modigliani and Modigliani (M2)
- 3 Advanced financing decision
- The nature of financing decision, principle objectives of making financing decision
- Overview of cost of capital: meaning and relevance of cost of capital: the firm’s overall cost of capital; weighted average cost of capital (WACC) and weighted marginal cost of capital (WMCC) ; analysis of breakpoints in weighted marginal cost of capital schedule
- Capital structure theories: nature of capital structure and factors influencing the firm’s capital structure; traditional theories of capital structure – assumptions of the theories, Net income theory and Net operating income theory; Franco Modigliani and Merton Miller’s propositions – MM without taxes, MM with corporation taxes, MM with corporation and personal tax rates and MM with taxes and financial distress costs; other theories of capital structure; the pecking order theory and Trade-off theory determination of the firm’s optimal capital structure using the Hamada model, CAPM and WACC
- Special topics in financing decision: analysis of operating profit (EBIT)/EPS at point of indifference in firm’s earnings; establishing the range of operating profit within which each financing option; leverage and risk; operating leverage and operating risk, financial leverage and financial risk, combined leverage and total risk; quantifying leverage using the degree of operating leverage, degree of financial leverage and degree of combined leverage
- Long term financing decisions; bond refinancing decision, lease-buy evaluation and the rights issues
- Impact of financing on investment decisions – the concept of adjusted present value (APV)
- 4 Mergers and acquisitions
- Nature of mergers and acquisitions
- Reasons of mergers and acquisitions
- Acquisition and Mergers verses organic growth
- Valuation of acquisitions and mergers
- Prediction of a takeover target
- Defence tactics against hostile takeovers
- Financing of mergers and acquisitions
- Analysis of combined operating profit (EBIT) and post-acquisition earning per share at the point of indifference in firms earnings under various financing options.
- Determination of range of combined operating profit.
- Regulatory frame work for mergers and acquisitions
- Reasons why there are failed mergers and acquisitions
- Mergers and acquisitions in a global context
- 5 Corporate restructuring and re-organisation
- Background on restructuring and re organisation
- Indicators/symptoms of restructuring
- Considerations in designing an appropriate restructuring programme
- Financial reconstruction: forms of financial reconstruction; impact of financial reconstruction on share price; impact of financial reconstruction on the weighted Average cost of capital (WACC)
- Portfolio reconstruction: various ways of unbundling a firm: divestment, de-merger, spin-off, liquidation, sell-offs, equity curve outs, strategic alliances, management buyout, leveraged buyouts and the management buy-ins.
- The relevance of the various forms of portfolio reconstruction
- Organisational reconstruction: The nature and benefits of this form of restructuring; models of predicting corporate failure; Multiple discriminant analysis (Z-Score model), Beaver failure ratio, Argenti model, Taffler’s model
- Causes of financial distress
- Forms of financial distress and solutions to financial distress
- 6 Derivatives in financial risk management
- The meaning, nature and importance of derivative instruments: futures, forwards, options and swaps
- Pricing and valuations of derivatives: futures, forwards, options and swaps
- Types of risks: operational risks, political risks, economic risks, fiscal risks, regulatory risks, currency risks and interest rate risks
- Foreign currency risk management: Types of forex risks, hedging currency risks, forward contracts, money market hedge, currency options, currency futures and currency swaps
- Interest rate risks: Term structure of interest rates, forward rate agreement, interest rate futures, interest rate swaps, interest rate options
- 7 International financial management
- International investments
- International financial markets
- International financial institutions
- Methods of financing international trade
- International parity conditions: Interest rate parity, purchasing power parity and International fisher effect
- International arbitrage: locational arbitrage, triangular arbitrage and covered interest arbitrage
- Divided policy for multinationals
- International debt instruments: International bonds (euro bond), certificate of deposits, securitisation of loans, commercial paper
- Availability and timing of remittances
- Transfer pricing: impact on taxes and dividends
- 8 Real estate finance
- Overview of real estate business – nature of real estate business, legal and economic framework and participants in real estate business in Kenya
- Valuation approaches (income, cost and sales comparison approaches)
- REITS: types; advantages and disadvantages; valuation: net asset value per share (NAVPS); use of funds from operations (FFO), adjusted funds from operations (AFFO) in REIT valuation
- Instruments of real estate financing – mortgages, lien, title, mortgage requirements and mortgage clauses
- Rights in case of debt – default and its consequence, equity of redemption, foreclosure, statutory redemptions
- Mortgage and financial markets: demand for funds in mortgage market, disintermediation effects, primary and secondary mortgage market, mortgage market and cost of money, role of central bank and the role of government in mortgage markets
- Savings and loan association – classification, state accounts, insurers. Mortgage backed bonds and services
- 9 Emerging issues and trends
CONTENT PAGE
- November 2019………………………..…8
- May 2019…………………………….……..15
- November 2018………………………….22
- May 2018………………………………….30
- November 2017……………………..……37
- May 2017……………………………………43
- November 2016…………………………..49
- May 2016………………………………….…..55
- November 2015……………….…………..61
- May 2015………………………….………….67
Suggested answers and solutions:
- November 2019 …………………………….71
- May 2019……………………………………89
- November 2018…………………………104
- May 2018………………………………..…121
- November 2017……………………………136
- May2017……………………………………..…151
- November 2016……………………………166
- May 2016…………………………………..…181
- November 2015………………………….…193
- May 2015………………………………………208
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
WEDNESDAY: 27 November 2019. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) (i) Distinguish between “insolvency” and “bankruptcy” as used in business restructuring. (2 marks)
(ii) Highlight four causes of business failure. (4 marks)
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
May 2019. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) Discuss four applications of the capital asset pricing model (CAPM). (8 marks)
(b) Dzikunze Manufacturing Limited is considering to raise an extra Sh.10 million in order to finance an expansion programme.
The company’s current capital structure is given as follows:
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 29 November 2018. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) In the context of corporate restructuring and reorganisation, differentiate between the following terms:
(i) “Leveraged buy-out” and “management buy-out” (2 marks)
(ii) “Divestiture” and “spin-off’ (2 marks)
(iii) “Unbundling” and “sell-off’. (2 marks)
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 24 May 2018. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) The objectives of a corporate governance system are to eliminate or mitigate conflicts of interest among stakeholders, particularly between managers and shareholders, and to ensure that the assets of the company are used efficiently and productively in the best interest of the investors and other stakeholders.
Required:
In the context of the above statement, discuss four core attributes of an effective corporate governance system. (4 marks)
(b) In relation to investment appraisal, evaluate four limitations of sensitivity analysis. (4 marks)
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 30 November 2017. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) Discuss how corporate governance might impact the dividend policy of a firm. (6 marks)
(b) Viwanda Ltd. is considering purchasing a machine at a cost of Sh.40 million. The company will incur an additional Sh.20 million to modify the machine for special use.
The machine is expected to have a useful life of 3 years and a scrap value of Sh. 15 million after 3 years.
This investment will require an increase in net working capital of Sh.2 million at the beginning of its useful life.
The additional investment in working capital will return to normal at the end of the machine’s useful life.
The machine’s purchase will not affect revenues but it is expected to save the company Sh.25 million each year in before tax operating costs, mainly labour.
The corporation tax rate is 30% and the company’s cost of capital is 10%.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADV ANCED FINANCIAL MANAGEMENT
THURSDAY: 25 May 2017. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) Explain two ways in which increased investment in corporate social responsibility (CSR) activities might enhance the value of a firm. (4 marks)
(b) Kenzel Ltd. has the following capital structure which it considers optimal under both the present and forecasted conditions:
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 24 November 2016. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question arc show n at the end of the question. Show ALL your workings.
QUESTION ONE
(a) Summarise three assumptions of the Grossman-Hart Model (1986). (6 marks)
(b) SKB Ltd. is considering a proposal to manufacture a new drug named “Millenium”. The drug will be manufactured using a machine which will cost Sh. 13 million.
The cash Hows and drug life relating to “Millenium” have been estimated as stochastic exogenous variables with the following distributions:
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 26 May 2016. Time Allowed: 3 hours
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) In the context of appraisal of capital investments under conditions of uncertainty, explain four limitations of utility analysis. (8 marks)
(b) Planet Ltd. is considering undertaking a 20-year project which requires an initial investment of Sh.250 million in a real estate partnership and whose present value (PV) of expected cash flows is Sh.254 million. Planet Ltd. has the option to abandon the project any time in the next five years for Sh.150 million. The variance in the present value (PV) of the cash flows is 0.09 and the 5-year risk-free rate is 7%.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 26 November 2015. Time Allowed: 3 hours
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.
QUESTION ONE
(a) In the context of financial management, explain what is meant by “stakeholder theory”. (6 marks)
(b) A company is considering whether to purchase equipment to increase its production and sales volumes. The equipment costs Sh.500,000,000 and has a useful life of three years after which it can be sold as scrap for Sh.80,000,000. For each of the three years of usage, the equipment is expected to increase both sales revenue and operating costs by Sh.600,000,000 and Sh.390,000.000 respectively . The company’s cost of capital is 10%.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
KASNEB
CPA PART III SECTION 5
ADVANCED FINANCIAL MANAGEMENT
THURSDAY: 28 May 2015 Time allowed 3 hours
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings
QUESTION ONE
- Evaluate four limitations of the Altman’s Z-score model for predicting corporate failure (8 marks)
- Chuma Ltd. is considering replacing a machine. The existing machine was bought three years ago at a price of Sh.50 million. The price is expected to have a useful life of 5 more years with no scrap value at the end of useful life. The machine could be disposed of immediately at Sh. 35 million. The machine will cost Sh. 80 million with a useful life of 5 years and an expected terminal value of Sh. 5 million. With the introduction of the new machine, sales are expected to increase by Sh. 25 million per annum over the past five years.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
NOVEMBER 2019
QUESTION ONE
Distinction between “insolvency” and “bankruptcy” as used in business restructuring
Bankruptcy is a legal process of liquidating what property and assets a debtor owns to pay off debt where as insolvency is a financial state insolvency is a financial state in which a person’s or a company’s debts exceed their assets.
Insolvency is a pre- requisite for bankruptcy but not every insolvent person is bankrupt.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
MAY 2019
QUESTION ONE
Applications of the capital asset pricing model CAPM
- 1. Estimation of returns: the required return will be equal to risk free rate plus risk premium
Required return = Risk free rate+ Beta coefficient (market return – Risk free rate)
- Capital investment decisions: The computation of cost of equity in the WACC calculation to enable an NPV calculation.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
NOVEMBER 2018
QUESTION ONE
(a) In the context of corporate restructuring and reorganisation, differentiating between the following terms:
- i) “Leveraged buy-out” and “management buy-out”
Leveraged buyout means an acquisition that is financed by use of debt. while, Management buy-out refers to the purchase of a company by its own management. Thus leveraged buyout is done by private investors
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
MAY 2018
QUESTION ONE
Core attributes of an effective corporate governance system
- Complete transparency and accuracy in disclosures regarding operations, performance, risk and financial position.
- Fairness and equitable treatment in all dealings between managers, shareholders and directors.
- Identifiable and measurable accountability for the performance of responsibilities.
- Clearly defined manager and director governance responsibilities to stakeholders.
- Delineation of the rights of shareholders and other core stakeholders.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
NOVEMBER 2017
QUESTION ONE
How corporate governance might impact the dividend policy of a firm
Corporate governance refers to mechanisms, processes and relations by which organizations are monitored and directed. There is a significant relationship. That exists between corporate governance variables like board independence, CEO duality and size of board with dividend payout according to kulathunga (2019) board independence CEO duality have a significant positive impact on dividend policy size of the board has a significant negative impact on dividend policy.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
MAY 2017
QUESTION ONE
Ways in which increased investment in Corporate Social Responsibility (CSR) activities might enhance the value of the firm
- Employees love working for socially responsible firms. This means company will cut down on hiring costs.
- Customers are likely to prefer companies that socially responsible thus CSR helps a company attain sustainable competitive advantages over its competitors
- CSR creates a good reputation for company. The resultant goodwill can be exploited. By a company by charging premium prices for its product offerings
- Perceived deadline in CSR can lead investors to increase explicit claims on the company e.g. investors may require a higher return for firms they deem socially irresponsible.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
NOVEMBER 2016
QUESTION ONE
Assumptions of Grossman-Hart Model (1986)
- All variables are ex-ante non contractible.
- A competitive market in identical potential trading partners at date exists.
- Investments by manager 1 and 2 are choose simultaneously and non-cooperative.
- There is no distinction between employees and outside contractors In the case in which the firm provides all the tools there
- There is no difference between ownership and control and virtually, is the power to exercise control
- The relationship which may be either vertical or lateral is assumed to last for 2 periods. In the first period, the manager each firm makes relationship specific investment while in the second some further production decisions are taken and the benefits from the relationship are realized.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
MAY 2016
QUESTION ONE
Limitations of utility analysis:
- If the decision is taken by a group of people, it is hard to determine the utility functions since individuals differ in their risk preferences.
- It’s hard to determine the utility function. It is subjective.
- The derived utility function is only valid at a point of time.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
NOVEMBER 2015
QUESTION ONE
Meaning of stakeholder theory in the context of financial management
Stakeholder theory in financial management means managers should have a wider view of all parties impacted by a firm directly or indirectly by an organization and not the traditional view whereby organizations only existed to serve the interest of share holders.
Some of the stakeholders for a business include: suppliers, customers, the society and government. Thus the profit of a business must ensure prompt settlement of supplies made on credit to business. It should decent wages and salaries are paid to employees though it may impinge on business profitability.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
SUGGESTED ANSWERS AND SOLUTIONS
ADVANCED FINANCIAL MANAGEMENT
MAY 2015
QUESTION ONE
Limitations of the Altman’s Z-score model for predicting corporate failure
- Irrelevant for non manufacturing firms like banks and insurance companies.
- The score also relies on data from each company. Thus its only as good as the data the corporation provides.
- It doesn’t account for deferred revenue which ends up make software companies in particular look worse off than they really are.
ADVANCED FINANCIAL MANAGEMENT REVISION KIT SAMPLE
