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Bcom 332: Cooporate Finance Question Paper
Bcom 332: Cooporate Finance
Course:Bachelor Of Commerce
Institution: Chuka University question papers
Exam Year:2013
1
UNIVERSITY EXAMINATIONS CHUKA/EMBU
THIRD YEAR EXAMINATION FOR THE AWARD OF
DEGREE OF BACHELOR OF COMMERCE
BCOM 332: CORPORATE FINANCE
STREAM: BCOM Y3S1 TIME: 2 HOURS
DAY/DATE: TUESDAY 13/8/2013 2.30 PM – 4.30 PM
INSTRUCTIONS:
ANSWER QUESTION ONE AND ANY OTHER TWO
QUESTION ONE [30 MARKS]
(a) You are evaluating investment in two securities ABC and XYZ whose returns and
their corresponding probability are indicated below.
Security ABC Security XYZ
Probability Return % Probability Return %
0.3 19 0.3 22
0.4 15 0.4 6
0.3 11 0.3 14
Required:
(i) Calculate standard deviation of each company’s returns. [4 marks]
(ii) What percentage investment in each would result in lowest risk? [4 marks]
(b) Assume that a firm has expected net operating income of shs. 100,000 an overall
market capitalization rate of 10% and 6%, shs 500,000 debt. Determine the effect
of raising the debt portfolio to 6% shs700,000 on the equity capitalization rate.
[7 marks]
CHUKA UNIVERSITY
2
(c) Firm C and D are similar except that firm C is unlevered, while fir m D has shs
200,000 5% debentures outstanding. Assume that the corporate tax rate is 40%
NOI is shs. 40,000 and the cost of equity is 10%.
Required:
(i) Calculate the value of the firm if M-M assumptions are met. [5 marks]
(ii) Suppose VD = shs. 360,000 (VD
=Value of levered firm) according to
M-M, does this represent equilibrium value? Explain. [5 marks]
(iii) Explain the effect of capital structure on the value of the firm when both
corporate and personal taxes are considered. [5 marks]
QUESTION TWO
(a) ABC Limited has 900,000 shares outstanding at current market price of Kshs 130
per share. The company needs Kshs 22,500,000 to finance its proposed
modernization – cum – expansion project. The directors of the company have
decided to issue rights for raising the required money. The subscription (issue)
price (Ps) has been fixed at Kshs 75 per share. The subscription price has been set
below the market price to ensure that the rights issue is fully subscribed.
Required:
(i ) Determine the number of right issues required to purchase a new share.
[6 marks]
(ii ) Calculate the value of a right. [7 marks]
(b) Discuss pros and cons of equity financing. [7 marks]
QUESTION THREE
(a) Manager of Mt. Elgon Company thinks that shareholders always look for the
earning per share. Therefore, he considers maximization of the earnings per share
as his company’s objective. His company’s current net profits are Kshs 80 and
EPS is Kshs. 4. The current market price is Kshs 42. He wants to buy another
firm which has current income of Kshs. 15.75, EPS of Kshs 10.50 and the market
price per share of kshs 85.
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Required:
(i) Calculate the maximum exchange ratio which the manager would offer so
that he could keep EPS at the current level. [5 marks]
(ii) If the manager borrows funds at 15 percent rate of interest and buys out
another company by paying cash, how much should he offer to maintain
his EPS? Assume a tax rate of 52 percent. [5 marks]
b. Discuss five motives behind mergers. [10 marks]
QUESTION FOUR
(a) Briefly explain factors that generally influence the dividend policy of a firm.
[10 marks]
(b) Two enterprises, L Ltd and M Ltd are in the same industry with identical earning
per share for the last five years. The L ltd has a policy of paying 40 per cent of
earnings dividends. While the M. Ltd pays a constant amount of dividend per
share. There is disparity between the market prices of the shares of the two
enterprises. The price of L Ltd is generally lower than that of L Ltd, even though
in some years L Ltd paid more dividend than M Ltd. The data on earnings,
dividends and market price for the two companies are as follows.
L. Ltd
Year EPS DPS Market Price
Sh Sh Sh
2004 4 1.60 12
2005 1.50 0.60 8.50
2006 5 2.00 13.50
2007 4 1.60 11.50
2008 8 3.20 14.50
M Ltd
Sh Sh Sh
2004 4 1.8 13.50
2005 1.50 1.8 12.50
2006 5 1.8 12.50
2007 4 1.8 12.50
2008 8 1.8 15.00
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Required:
(i) For both companies, calculate
(a) Payment ratio [2 marks]
(b) Dividend yield [2 marks]
(c) Earning yield [2 marks]
(ii) What are the reasons for the differences in the market prices of the two enterprises
shares? [2 marks]
(iii) What can be done by L Ltd to increase the market price of its shares. [2 marks]
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