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Cpa Part Iii Section 6 Question Paper

Cpa Part Iii Section 6

Course:Cpa

Exam Year:2009

QUESTION ONE
(a) Explain the meaning of the term "agency problem" as used in financial management (2 marks)
(b) Explain any three factors that influence interest rates in an economy (6 marks)
(c) Distinguish between "real options" and "financial options" (4 marks)
(d) The Awendo Investment Fund (AIF) ha a total of Sh. 500 million invested in five stocks:
Stock Investment(Sh.) Stock's beta coefficient
A 160 million 0.5
B 120 million 2.0
C 80 million 4.0
D 80 million 1.0
E 60 million 3.0
the risk free rate of return is 8% whereas the market returns have the following probability distribution for the next period:
Probability Market return (%)
0.1 10
0.2 12
0.4 13
0.2 16
0.1 17
Required:
(I) the expected return from market (2 marks)
(ii) The beta coefficient for the investment fund (2 marks)
(iii) The estimated equation for the security market line (SML) (2 marks)
(iv) The investment fund's required rate of return for the next period. (2 marks)
QUESTION TWO
Mapema Ltd has the following capital structure which it considers optimal:
Source of capital Amount Sh. "Million"
ordinary share capital 90.0
preference share capital 22.5
long term debt 37.5
Total 150.0
Mapema Ltd expects an after tax income of Sh. 5,143,000 in the next financial year. The company has a policy of paying out 30% of its earnings as dividends. Investors expect dividends to grow at an annual rate of 9% indefinitely. The dividend last paid by the company was Sh. 5.40 per share. The company's ordinary shares currently sell on the stock market at Sh. 90 per share. The company can obtain additional financing in the market as follows:
Long term debt
Up to Sh. 7.5 million of long term debt can be obtained at an interest of 12%; long term debt in the range of Sh. 7.5 million to Sh. 15 million must carry an interest rate of 14%; and all long term debt over Sh. 15 million will have an interest rate of 16%. The corporate tax rate is 30% and the interest on long term debt is tax allowable.
Ordinary shares
New ordinary shares of up to Sh. 18 million can be raised at Sh. 81 per share. To issue additional shares above Sh. 18 million, a floatation cost of Sh, 18 per share must be incurred.
Preference shares
New preference shares with a par value of Sh. 100 can be issued and the dividend rate is 11%. However, a floatation cost of 5% of the par value per share must be incurred for all preference shares up to Sh. 11.25 million. Additional preference shares (above Sh. 11.25 million) can be raised at a floatation cost of Sh. 10 per share.
The investment opportunities available to the company are as shown below:
Investment outlay Sh. Annual net cash flow Sh. Life (yrs) IRR (%)
I 15,000,000 3,286,800 7 12.0
II 15,000,000 4,731,630 5 71.4
III 15,000,000 3,255,270 8 14.2
IV 30,000,000 5,684,220 10 16.0
V 30,000,000 8,141,760 6 ?
Required:
(a) Determine the breakpoints in the marginal cost of capital (MCC) schedule. (6 marks)
(b) calculate the weighted average cost of capital (WACC) in the intervals between the break points in the MCC schedule. (6 marks)
(c) Calculate the Internal rate of return (IRR) for project V. (3 marks)
(d) Construct the investment opportunity curve (IOC)/marginal cost of capital (MCC) schedule and indicate which projects should be accepted or rejected. (5 marks)
QUESTION THREE
(a) Bidii Ltd has a cost of equity of 10%. The company currently has 250,000 shares outstanding and selling on the stock exchange at Sh. 120 per share. The company's earnings are Sh. 10 per share and it intends to maintain a dividend payout ratio of 50% at the end of the current financial year. The company's expected net income is Sh. 3 million and the available investment proposals are estimate to require Sh. 6 million.
Required:
Using The Modgiliani and Miller (MM) proposition an dividend irrelevance, show that the payment of dividends does not affect the value of the firm. (8 marks)
(b) The management of Shujaa Ltd. is excited that the government has reduced the corporate tax rate from 33% to 30%. The tax cut is expected to increase the net present value of operating cash flows of the company by Sh. 15 million.
The current capital structure of the company is as follows:
Sh. "Million"
Ordinary Share capital (Sh. 5 par value) 30
Retained earnings 70
Share premium 40
Shareholders’ equity 140
10% debenture (Sh. 100 par value) 40
Total 180
The company's shares are currently selling at Sh. 32.00 ex-div and the debentures are selling at Sh 135 cum-interest.
The equity beat is 1.2. The market return is 13%. Debt capital is risk free.
Assume the cost of debt and the market price of the debentures will not change as result of the tax cut.
Required:
(I) Determine Shujaa Ltd.'s weighted average cost of capital (WACC) before tax cut. (6 marks)
(ii) Determine the expected market price per share of Shujaa Ltd. after the tax reduction. (6 marks)
(In answering part (b) (ii) above, use the Modigiliani and Miller's (MM's) hypothesis under corporate taxes).
QUESTION FOUR
Pentel Ltd, a computer assembly company, intends to expand its operations. This will require the expansion of its assets by 50%. The annual incremental sales to be generated by this expansion are estimated to be Sh. 18 million with annual incremental earnings before interest and tax (EBIT) of 25% on the incremental sales. All the financing for this expansion will come from external sources as profit retentions are already committed elsewhere.
A financial analyst hired by the company has submitted the following proposals of financing the expansion for consideration:
Plan A: Issue 10% debenture
Plan B: Issue 10% debenture for the half required amount and issue of ordinary shares at 25% premium for the remaining balance of the amount.
Plan C: Issue of ordinary shares at 25% premium.
The financial statements of the company for the year ended 30 April 2009 are as shown below:
Pentel Ltd.
Balance sheet as at 30 April 2009
Equity and liabilities Sh. "000" Assets Sh. "000"
ordinar share capital (Sh. 10 par value) 32,000 Non-current assets 64,000
8% debentures 24,000 Current assets 32,000
Retained earnings 16,000
Current liabilities 24,000
Total equity and liabilities 96,000 Total assets 96,000

Pentel Ltd.
Income statement for the year ended 30 April 2009
Sh. "000"
Sales 152,000
Operating costs (128,000)
earnings before interest and tax 24,000
Debenture interest (1,920)
Earnings before taxes 22,080
Taxes(30%) 6,624
Earnings availabble to ordinary shareholders 15,456
Earnings per share 3.83
The tax rate is expected to remain constant at 30%
Required:
(a) The number of additional ordinary shares to be issued under financial plans B and C. (3 marks)
(b) The earnings per share (EPS) indifference points between:
(i) Plan a and Plan B. (3 marks)
(ii) Plan A and plan C. (3 marks)
(iii) Plan B and Plan C. (3 marks)
(c) Assume that the price/earnings (P/E) ratio will be 8 if plan C is adopted but will drop to 6 if either Plan A or B is used to finance the expansion.
Determine the market price per share under each financing plan and advise Pentel Ltd. on the best means of financing the expansion. (8 marks)
QUESTION FIVE
(a) The following information has been extracted from the books of Sawa Ltd. for the year ended 30 June 2008:
Earnings after tax Sh. 7.5 million
Total dividends paid Sh. 4.5 million
Number of shares outstanding 1 million
Cost of capital 10%
Rate of return on investment 12.5%
Required:
The theoritical market value of the company's share using Walter's Model. (6 marks)
(b) Explain the effects of the activities of the International Monetary Fund (IMF) on the operations of multinational corporations. (8marks)
(c) Explain the main causes of project failure in the public sector. (6 marks)

Cpa Part Iii Section 6 Question Paper

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