Financial Management November 2018 Past question Paper and answers

Download Financial Management November 2018 Past Paper


Financial Management November 2018 Past paper

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(a) Examine four assumptions of the Modigliani and Miller (MM) dividend irrelevance Theory.         (4 marks)

(b) Differentiate between the following terms as applied in finance:

  • “Operating leverage” and “financial leverage”.             (2 marks)
  • “Cum-right ’ and “ex-right” market price per share.                               (2 marks)
  • “Time value of money” and “time preference for money”.                     (2 marks)

(c) The fixed operating cost for Gahaleni Pharmaceutical Ltd. are Sh.5.8 million per annum and the variable cost ratio is 0.20.

 Additional information:

  1. The company has Sh.2 million in bonds outstanding with an annual coupon interest rate of 8 per cent.
  2. The company has 30,000 preference shares outstanding which pay Sh.2 dividend per share each year.
  3. The company has 100,000 ordinary shares outstanding.
  4. Revenues of the company are Sh.8 million per annum.
  5. The company is in the 30% corporate tax bracket.


  • The degree of operating leverage.  (4 marks)
  • The degree of financial leverage.   (3 marks)
  • The degree of combined leverage. (3 marks)  (Total: 20 marks)



(a) Describe four limitations of the net present value (NPV) method of investment appraisal.  (4 marks)

(b) The management of Bundacho Limited is in the process of evaluating two projects, namely Alpha and Beta.

The estimated pre-tax cash flows of each of the projects are as follows:

Year Project Alpha Project Beta
  Pre-tax cash flows Pre-tax cash flows
  Sh. “000” Sh. “000”
1 2,590 4,300
2 2,880 3,290
3 3,050 3,200
4 2,950 3,700
5 4,850
6 4,420

Additional information:

  1. Project Alpha costs Sh.3.8 million and has an estimated lifespan of 4 years.
  2. Project Beta costs Sli.8 million with an estimated lifespan of 6 years.
  3. Both projects have a zero salvage value.
  4. An investment in working capital of Sh.825,000 will be required irrespective of the project to be undertaken.
  5. The cost of capital for the company is 12%.
  6. The corporate tax rate is 30%.


Using the discounted payback period method, recommend to the management of Bundacho Limited on which project to undertake.   (8 marks)

(c) The earnings per share (EPS) and dividend per share (DPS) data for Maraba Ltd. over the last five years are provided below:

Year Dividend per share (DPS) Earnings per share (EPS)
  (Sh.) (Sh.)
2013 1.00 2.50
2014 1.10 2.70
2015 1.20 3.00
2016 1.50 3.20
2017 1.80 3.50

Additional information:

  1. A prospective investor is considering buying the shares of this company which are currently selling at Sh.55 each at the securities exchange.
  2. The investor’s required rate of return is 20%.


Advise the investor on whether to buy the shares of Maraba Ltd. using Gordon’s model.           (8 marks)    (Total: 20 marks)


(a) Propose four factors that might lead to soft capital rationing in a limited company. (4 marks)

(b) Explain four roles that are played insurance companies in the financial market of your country.          (4 marks)

(c) Bemunyonge Ltd. has just paid a dividend of Sh.4 per share. The company expects that the dividend will grow at the rate of 20% per annum for the first two years, then grow at the rate of 10% per annum for the next 2 years and thereafter grow at the rate of 6% per annum into perpetuity. The required rate of return for the company is 16%.


The theoretical value of the company’s share.        (4 marks)

(d) Bahati Enterprises is considering amendments to its current credit policy. The firm’s current annual credit sales amount to Sh.6,000,000.

The current credit terms are net 30 with an average debtors collection period of45 days.

The following information relates to the proposed credit policy:

  1. The credit period to be extended to net 60.
  2. Annual sales are expected to increase 20%.
  3. Bad debts are expected to increase from 2% to 2.5% of the annual credit sales.
  4. Credit analysis and debt collection costs are expected to increase Sh.84,000 per annum.
  5. The return on investment in debtors is 12%.
  6. For every Sh.100 of sales, Sh.75 is the variable cost.
  7. Assume one year has 360 days.


Advise the management of Bahati Enterprises on whether to adopt the proposed credit policy.         (8 marks)   (Total: 20 marks)



(a) The following are the financial statements for ABC Ltd. and X YZ Ltd. for the year ended 30 September 2018:

Income statement for the year ended 30 September 2018:

    ABC Ltd.   XYZ Ltd.
    Sh.“million”   Sh.“million’
Revenues   4,000   6,000
Cost of sales   (3,000)   (4,800)
Gross profit   1,000   1,200
Distribution costs 200   150  
Administration expenses 290   250  
Finance costs 10 (500) 400 (800)
Profit before tax   500   400
Tax paid   (120)   (90)
Profit after tax   380   310
Dividends paid   (150)   (100)
Retained profits for the year   230   210
Retained profit brought forward   220   2,480
Retained profit carried forward   450   2,690


Statement of financial position as at 30 September 2018:           

    ABC Ltd.   XYZ Ltd.
    Sh. “million”   Sh. “million’
Non-current assets:        
Land and buildings   1,200   5,000
Furniture and motor vehicles   600   1,000
    1,800   6,000
Current assets:        
Inventories 400   800  
Trade receivables 850   750  
Financial assets 100   230  
Cash at bank 1,350 100 1,880
    3,150   7,880
Financed by:        
Equity and liabilities:        
Ordinary share capital   1,000   1,600
Retained profits   450   2,690
    1,450   4,290
Non-current liabilities:        
Bank loan   500   3,000
Current liabilities:        
Trade payables 1,080   590  
Bank overdraft 120 1,200 590
    3,150   7,880


(i)  Vertical common size statements of income for the year ended 30 September 2018.   (6 marks)

(ii) Vertical common size statements of financial position as at 30 September 2018.           (6 marks)

(b) NewWays Ltd. intends to raise new capital to expand its production level.

The company plans to undertake the following financial decisions:

  1. Issue 200,000 ordinary shares which have a par value of Sh.10 at Sh.16 per share. The floatation cost per share is Sh. 1.
  2. Issue 75,000, 12% preference shares which have a par value of Sh.20 at Sh.18 per share. The total floatation cost is Sh. 150,000.
  3. Issue 50,000, 18% debentures which have a par value of Sh. 100 at Sh.80 per debenture.
  4. Borrow Sh. 5,000.000. 18% long-term loan. The total floatation cost is Sh.200,000.

 Additional information:

  1. The company paid 28% ordinary dividends which is expected to grow at the rate of 4% per annum.
  2. The corporate tax rate is 30%.


(i)  The total capital to be raised net of floatation costs.    (2 marks)

(ii) The weighted marginal cost of capital (WMCC) for the company.     (6 marks)    (Total: 20 marks)


(a) Highlight four circumstances under which investors might find it suitable to use an Islamic equity fund. (4 marks)

(b) William Mgunya intends to invest Sh.200,000 in a redeemable 12%, Sh.100 debentures for 3 years. The current market value of the debentures is Sh.80 per debenture.

The required rate of return on the debentures is 10% per annum.


Advise William Mgunya on whether to invest in the debentures.         (4 marks)

(c) Daima Investment Bank has provided the following information relating to two of its securities namely; A and B:

State of economy Probability (P;) Security returns (%)  
    A B
Stable 0.30 12 6
Expansion 0.40 15 7.5
Recession 0.30 10 5


(i)  The expected return for each security.     (2 marks)

(ii) The standard deviation for each security.           (2 marks)

(iii) The correlation coefficient between the two securities’ returns.           (3 marks)

(iv) Determine the expected return of a portfolio constituting 60% of Security A and 40% of Security B.     (2 marks)

(v) Compute the risk of the portfolio in (c) (iv) above.       (3 marks)(Total: 20 marks)

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