Financial Management May 2019 Past question Paper and answers

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Download Financial Management May 2019 Past Paper


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Financial Management May 2019 Past paper

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QUESTION ONE

 a) Explain the following dividend theories:

  1. Information signalling theory.            (2 marks)
  2. Tax differential theory.     (2 marks)
  • Bird-in-hand theory.   (2 marks)
  1. Agency theory.   (2 marks)

(b) ClareMwatata is planning to invest in a long-term project. An investment banker has provided her with the following two investment options:

Option 1:To invest in a corporate bond selling at Sh.875. The bond would be redeemed after 5 years atSh. 1,600.

Option 2:To invest in a 16% debenture with a face value of Sh. 100 quoted at Sh.95.

The debenture would beredeemed after 5 years.

The minimum required rate of return is 18%.

Required:

Using the yield to maturity (YTM) valuation model, advise Clare Mwatata in making the investment decision.(6 marks)

(c)  An investor holds 1,000 ordinary shares in Upendo Ltd., a company quoted at the securities exchange. The company has been paying average dividends of Sh. 1.50 per share annually in recent years.

The firm’s dividends are expected to grow at a rate of 10% per annum in the coming three years, then grow at a rate of 8% per annum over the next two years and thereafter grow at a constant rate of 5% per annum into perpetuity.

The minimum required rate of return is 12%.

Required:

Using the discounted cash flow valuation method, determine the current value of the 1,000 ordinary shares of Upendo Ltd.        (6 marks) (Total: 20 marks)

 

QUESTION TWO

(a) Propose four reasons that might make a firm use reserves to finance its operations.        (4 marks)

(b) (i) The management of Amani Limited is considering listing at the securities exchange and intends to undertake valuation of its shares.

The following information is provided:

  1. The current earnings per share (EPS) of the firm is Sh.4.
  2. The firm has in issue 10 million ordinary shares with a 40% dividend payout ratio.
  3. The firm has an equity capital of Sh.200 million with a minimum required rate of return of 18%.

Required:

The current theoretical value of the firm’s ordinary shares using dividend growth model.                           (6 marks)

(ii) XYZ Ltd. Has a net tangible assets worth sh.48 million and a return on assets (ROA) of 12%.

Thecompany expects to receive a profit of sh. 10 million annually for the next 5 years.

The company has 2 million outstanding ordinary shares.

 Required:

The theoretical value per share using super-profit model.         (4 marks)

(c)  In an effort to lower its accounts receivable balances, Chizingo Manufacturing Limited is considering to switch from its existing no discount policy to a 2% cash discount for payment done 15,h day after sale.

It is estimated that 60% of the customers would take the discount and the average collection period is expected to decline from 60 days to 45 days.

The company’s management projects an increase of 20,000 units in annual sales to 220,000 units at the existing price of Sh.2,500 per unit.

Additional information:

  1. The variable cost per unit is Sh.2,100 and the average cost per unit is Sh.2,300.
  2. The company requires a 15% return on investment (ROI).
  3. The corporate tax rate is 30%.
  4. All sales are on credit basis.

Assume 365 days in a year.

 Required:

Advise the management of Chizingo Manufacturing Limited on whether to offer the cash discount to customers.      (6 marks) (Total: 20 marks)



QUESTION THREE

 (a) The capital structure of Maweni Limited is given as follows:

 

                                                                                              Sh. “000”

Ordinary share capital (Sh.20 par value)                       50,000

Retained earnings                                                           30,000

12% irredeemable debenture capital (Sh.20 par value) 25,000

14% preference share capital (Sh.25 par value)           15,000

                                                                                                  120,000

 Additional information:

  1. The current market price of the firm’s ordinary shares is quoted at Sh.45 cunt-dividend.
  2. The firm paid a dividend of Sh.5 per share in the just ended year.
  3. The firm adopts a 60% dividend payout ratio.
  4. The firm’s return on equity (ROE) is 20%.
  5. The existing 12% irredeemable debenture is currently trading at Sh. 112 cum-interest.
  6. The 14% preference shares are currently trading at Sh.33.50 cum-dividend at the securities exchange.
  7. The corporate tax rate applicable is 30%.

 Required:

  1. The cost of ordinary share capital. (3 marks)
  2. The cost of 12% irredeemable debenture capital. (2 marks)
  • The cost of 14% irredeemable preference share capit (2 marks)
  1. The firm’s weighted average cost of capital (WACC). (5 marks)

(b) The following is a summary of financial data for Hakika Ltd. for the financial year ended 31 December 2017 and31 December 2018:

  2018

Sh.“000”

2017

Sh.“000”

Income statement:
Earnings before interest and tax (EBIT) 29,498 27,012
Interest (3,106) (3,726)
Tax (8,694) (7,452)
Earnings after interest and tax (EAIT) 17,698 15,834
Dividend payable 9,600 6,200
Statement of financial position:
Shareholders’ funds 79,800 70,174
Long-term debt 28,000 35,000
107,800 105,174
Additional information:
2018 2017
1. The number of outstanding shares (“000”) 28,000 28,000
2. Price-earnings (P/E) ratio : Hakika Ltd. 14,000 13,000
Industry 15,200 15,000

Required:

Calculate the following ratios for years 2017 and 2018:

(i)    Return on capital employed (ROCE).        (2 marks)

(ii)   Interest coverage ratio.                                                                                 (2 marks)

(iii)  Earnings per Share (EPS).      (2 marks)

(iv)  Dividend yield.                   (2 marks) (Total: 20 marks)

 

QUESTION FOUR

(a) Credit card finance has become popular in the recent past compared to usage of cash to effect commercial transactions.

 Required:

With reference to the above statement;

  • Highlight four reasons behind the fast growth of credit card finance in your country.                            (4 marks)
  • Evaluate four limitations of using credit cards as a source of finance.(4 marks)

(b) Juhudi Industries intends to replace an existing machine with a new one which is more efficient. The existing machine was acquired 2 years ago at a cost of Sh.4 million. The useful life of this machine was originally expected to be 5 years with no salvage value. However, the valuer has now estimated that the machine shall have an economic useful life of 10 more years and a salvage value of Sh.500.000.

The new machine is estimated to cost Sh. 8 million. An additional installation cost of Sh.400.000 shall be incurred. The new machine has a useful economic life of 10 years. The financial analyst of the company estimates that the existing machine could be sold for Sh.2.5 million at the current prevailing market price.

The new machine is expected to increase sales wheredebtors would increase Sh.320.000. inventory Sh, 140.000 while creditors would increase Sh.300,000.

The profit before depreciation and tax over the next 10 years for the two machines is given as follows:

Year New machine Existing machine
  Sh.“000” Sh.“000”
1 350 280
2 400 300
3 420 320
4 410 340
5 410 340
6 380 320
7 380 310
8 350 280
9 300 260
10 280 240

Additional information:

  1. The company’s required cost of capital is 10%.
  2. Corporate tax rate is at 30%.
  3. The company uses a straight-line method of depreciation.

 Required:

Using the net present value (NPV) method, advise the management of Juhudi Industries on whether to replace the existing machine with the new one.         (12 marks)  (Total: 20 marks) 

 



QUESTION FIVE

 (a) Summarise four main features of Islamic insurance mortgage (takaful).          (4 marks)

(b) The capital structure of Kara Kara Limited which is considered optimal is given as follows:

  Sh.“000”
Ordinary share capital (Sh. 10 par value) 90,000
Retained earnings 75,000
15% preference share capital (Sh. 100 par value) 45,000
16% debenture capital 90.000
300,000

The company has total assets amounting to Sh. 360 million but it is expected the assets will rise to Sh.500 million the end of the current financial year.

 Additional information:

  1. New equity shares sold will net 90% after floatation costs.
  2. The current market price per share (MPS) of the ordinary shares is Sh.25.
  3. New ordinary shares will be issued at the current market price subject to a floatation cost of 10% of the issue price.
  4. New 16% debentures can be issued at par through the securities exchange.
  5. The past and expected earnings growth rate is 10%. Dividend growth rate is expected to be matched with the earnings growth rate.
  6. The current earnings yield is 24%.
  7. The company adopts a constant dividend payout ratio of 50%.
  8. New 15% preference shares can be issued at the current selling price of Sh. 120 each.
  9. The retained earnings available for investment purposes is Sh.29,700.000.
  10. The corporate tax rate is 30%.

 

Required:

The number of ordinary shares that must be sold in order to raise the required equity capital.                   (6 marks)

(c)i) Explain the term “abandonment” as used in capital budgeting decisions.   (2 marks)

ii) Palakumi Agribusiness Ltd. is analysing a youth empowerment project. The following information is provided:

Year Cash flow

(Sh. “million”)

Abandonment value

(Sh. “million”)

0 (16)
1 8 12
7 6 8
3 5 6
4 4

The company’s cost of capital is 10%.

 Required:

Advise the management of Palakumi Agribusiness Ltd. on the optimal time to abandon the project.                        (5 marks)

(d) Bidii Enterprises is a small medium enterprise (SME) in floriculture industry. The company intends to invest Sh.300.000 in a project that has a useful economic life of 4 years.

The following are the expected cash flows:

Year 1 2 3 4
Cash flows (Sh.) 140,000 120,000 80,000 60,000

The company’s required rate of return is 14%.

Required:

The modified internal rate of return (M1RR) of the project.  (3 marks)  (Total: 20 marks)


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