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Financial Management Question Paper

Financial Management

Course:Bachelor Of Commerce

Institution: Strathmore University question papers

Exam Year:2008

1
STRATHMORE UNIVERSITY
FACULTY OF COMMERCE
Bachelor of Commerce
END OF SEMESTER EXAMINATION
BCM 2206: FINANCIAL MANAGEMENT (EVENING COURSE)
DATE: 21ST APRIL 2008 TIME: 2 HOURS
ANSWER QUESTION 1 AND ANY OTHER TWO QUESTIONS.
Question One
(a) Distinguish between systematic and unsystematic risk (4 marks)
(b) Country Wallpapers limited is considering in investing in one of two mutually
exclusive projects I and J. The firm’s cost of capital is 14% and the risk free rate of
return is 8%. The firm’s financial manager has gathered the following information
relating to each project.
Project I Project g
Initial cash
outlay
Sh.40, 000 Sh.56, 000
Risk Index 1.5 2.0
Year Net cash
flows
Certainty
Equivalent
Net cash
flows
Certainty
Equivale
nt
1 Sh.20,000 0.09 20,000 0.95
2 16,000 0.80 25,000 0.09
3 12,000 0.60 15,000 0.85
4 10,000 0.50 20,000 0.08
5 10,000 0.40 10,000 0.80
Required:
i) Find the NPV (unadjusted for risk) for each project. Which project is preferred?
(4 marks)
ii) The firm uses the following equation to determine the risk adjusted discount rate for
each project:
Rx = Rf +(K-Rf)RIx
Where Rx is the RADR for project x
K is the firm’s cost of capital
RIx is the risk index for project x.
2
Using the RADR, method, determine the risk adjusted NPV for each project. Which
project is preferred? (8 marks)
iii) Find the certainty equivalent NPV for each project. Which project is preferred?
(8 marks)
(c) Distinguish between Money markets and Capital markets showing clearly their
distinct characteristics. (6 marks)
(Total 30 marks)
Question Two
Tower Interiors has made the following forecast of sales with associated probabilities.
Sales (KShs) 200,000 300,000 400,000
Probability 0.2 0.6 0.2
The firm has fixed operating costs of KShs. 75,000 and variable operating costs of 70
percent of the sales level. The company pays KShs. 12,000 in interest per period. The
tax rate is 40 percent.
Required:
(a) Compute the EBIT for each level of sales. (4 marks)
(b) Compute the EPS for each level of sales, the expected EPS, the standard deviation of
EPS and the coefficient of variation of EPS, assuming that there are 10000 shares of
common stock outstanding. (6 marks)
(c) Tower has the opportunity to reduce leverage to zero and pay no interest. This will
require that the number of shares outstanding be increased to 15000. Repeat (b)
under this assumption. (6 marks)
(d) Compare your findings in (b) and (c) and comment on the reduction of debt to zero
on the firm’s financial risk. (4 marks)
(Total 20 marks)
Question Three
(a) Identify the factors determining working capital need of a firm. (6 marks)
(b) An analysis of a firm’s credit policy reveals that it is very loose, and as a result, the
firm’s collection period is very long as well as bad-debt losses are building up. The
firm, therefore, is considering to tighten up its credit standards by shortening credit
period from 45 days to 30 days. The expected result of this policy would be to reduce
sales from Sh 600000 to Sh 500000 and bad-debt losses ratio from 4 per cent to 2 per
cent and collection expenses from 2 percent to 1 per cent of total sales. The firm’s
variable cost ratio is 80 per cent, tax rate is 40 per cent and the after-tax cost of funds
is 12 per cent.
3
Required:
Determine whether the new credit policy is worthwhile. (Show all your workings)
(12 marks)
(Total 20 marks)
Question Four.
(a) Explain the term Efficient Market Hypothesis (EMH) showing clearly the various
forms of efficiency (8 marks)
(b) Explain the concept of Agency and show how conflict may arise between
shareholders and directors. What suggestion would you make to solve such problems
(12 marks)
(Total 20 marks)
Question Five
(a) Explain the Modigliani and Miller’s dividend irrelevance theory (assume a no
corporate tax scenario). (14 marks)
(b) In your opinion are dividends irrelevant in firm valuation. (6 marks)
(Total 20 marks)

Financial Management Question Paper

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