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Financial Management Question Paper
Financial Management
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2011
UNIVERSITY EXAMINATIONS: 2010/2011
SECOND YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 200: FINANCIAL MANAGEMENT (D+E)
DATE: AUGUST 2011 TIME: 2 HOURS
INSTRUCTIONS: Answer question ONE and any other TWO questions
Question One
(a)Calculate the degree of operating leverage for a company with the following characteristics:
Quantity in units is 800, selling price per unit is Sh.15, variable cost per unit is Sh.10 and the fixed cost is Sh.1000. (3 Marks)
(b)An agency problem or conflict of interest between the bondholders (principal) and the shareholders (agents) will arise when shareholders take action which will reduce the market value of the bond and by extension, the wealth of the bondholders. Outline any 5 of these actions. (10 Marks)
(c)A company is considering undertaking a project whose initial cash outlay is Sh.100,000. Its annual cash inflows are summarized below:
Year Annual Cash Inflows Certainty Equivalent Coefficient
1 35,000 0.9
2 35,000 0.8
3 35,000 0.7
4 35,000 0.3
5 35,000 0.2
The cost of capital is 10% and the risk free rate is 7.5%.
(i) Determine the projects Net Present Value (NPV) without adjusting for the inherent risk in the respective year cash flows. (3 Marks)
(ii) Calculate the projects NPV after adjusting for the inherent risk in each years cash flows.
(4 Marks)
(d)Outline 5 reasons why it is important to manage working capital. (10 Marks)
Question Two
(a)Discuss 5 reasons for valuation. (10 Marks)
(b)XYZ Ltd. paid Sh.10 as dividends per share in the last accounting period. The dividends are expected to increase by 10% for the first 3 years and at 8% thereafter in perpetuity. If the discounting rate is 12%, determine the intrinsic value of XYZ Ltd’s ordinary share. (5 Marks)
(c)Consider a company that has just paid a dividend of Sh.4. The company expects its dividends to increase by 20% for the first 2 years, 10% for the next 2 years and then at 6% thereafter in perpetuity.
Determine the theoretical value of the company’s ordinary share if the required rate of return is 16%. (5 Marks)
Question Three
(a)Outline 4 differences between capital asset pricing model and the arbitrage pricing model.(8 Marks)
(b)ABC Limited is an all equity financed company with a cost of capital of 18.5%. The company is
considering the following one year investment projects.
Project Outlay Sh.000 Annual Cash flow Sh.000 Beta
A 1000 1,095 0.3
B 1000 1,130 0.5
C 1500 1,780 1.0
D 2000 2,385 1.5
E 2000 2,400 2.0
The risk free rate of return is 8% and the market rate of return is 15%.
Required:
(i) The beta factor of ABC Limited. (2 Marks)
(ii) The required rate of return and expected return of each of the above projects indicating
3
which project the company should undertake and which ones to reject. (8 Marks)
(iii) The beta factor of the investment in the accepted projects. (2 Marks)
Question Four
(a)Outline 3 weaknesses of Jensen’s portfolio performance measure. (6 Marks)
(b)Discuss 4 shortcomings of Treynor’s portfolio performance measure. (8 Marks)
(c)Explain 4 limitations of Sharpes’ portfolio performance measure. (8 Marks)
Question Five
Consider the returns of two securities A and B which depends on the states of nature with the
following probabilities.
State Probability Returns (%)
A B
Recession 0.3 12 6
Stable 0.4 15 7.5
Expansion 0.3 10 7.5
(a)Compute the expected returns of A and B. (2 Marks)
(b)Compute the standard deviation of the individual securities. (3 Marks)
(c)Compute the correlation coefficient between the two securities returns and comment. (4 Marks)
(d)Compute portfolios expected return for a portfolio consisting of 60% of A and 40% of B. (3 Marks)
(e)Compute the risk of the portfolio in (d) above. (4 Marks)
(f) Compute the percentage risk diversification if the correlation coefficient between A and B is -1.
(4 Marks)
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