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Corporate Finance Question Paper
Corporate Finance
Course:B.Com
Institution: Kabarak University question papers
Exam Year:2012
KABARAK
UNIVERSITY
UNIVERSITY EXAMINATIONS
2011/2012 ACADEMIC YEAR
FOR THE DEGREE OF BACHELOR OF COMMERCE
FNCE 310 – CORPORATE FINANCE
DAY: WEDNESDAY
DATE: 11/04/2012
TIME: 3.00 – 5.00 P.M.
STREAM: Y3S1
INSTRUCTIONS
1. Answer questions ONE and any other TWO Questions.
2. All necessary workings must be carefully shown.
QUESTION ONE (COMPULSORY)
a) Differentiate between the following term as used in corporate finance:
i)
Golden parachutes and green mail in hostile takeover
(3 marks)
ii)
commercial paper and certificate of deposits
(3 marks)
iii)
Conglomerate mergers and generic mergers
(3 marks)
iv)
Operating leverage and financial leverage
(3 marks)
b) creation of shareholder value has become a generally accepted corporate objective .
To facilitate the realization of this objective ,value based management system (VBMs) have
been developed . required: Identify and explain the factors that have stimulated the
increased interest by companies in value based management system (VBMS)
(6 marks)
Page 1 of 5
c) Mobilinet Ltd manufactures special bathroom fittings. The company’s management is
considering a proposal to manufacture and market a new shower systems product. The
project would require an investment in plant and equipment of sh. 1.5m. The marketing
manager estimates sales of the new unit at 75,000 at selling price of sh.24 per unit.
Relevant cash operating costs are estimated at 75% of the sales value. Assume a cost of
capital of 12% and an economic project life of 10 years.
Required:
a) Compute the project’s NPV (3 marks)
b) Test the sensitivity of project NPV to changes in:
i.
Selling price (3 marks)
ii.
Cost of capital (3 marks)
iii.
Project life (3 marks)
[Total: 30 marks)
QUESTION TWO
a. Distinguish between Risk adjusted discount rate(RADR) and Internal Rate of
Return(IRR)
(4 marks)
b. Baraka Ltd is considering investing in one of three mutually exclusive project
whose cash flow are presented below:
CASH FLOW
year
Project X
Project y
Project Z
Sh. ‘000’
Sh’000’
Sh. ‘000’
0
(15,000)
(10,000)
(20,000)
1
6,000
6,000
4,000
2
6,000
4,000
6,000
3
6,000
5,000
8,000
4
6,000
2,000
12,000
Page 2 of 5
Additional information.
1. The risk indices for the three projects are as follows:
Project
Risk index
X
1.8
Y
1.0
Z
0.6
2. The expected returns in the market portfolio is 12%
3. The risk-tree rate is 10%
4. The company’s overall beta is 2.5
The finance manager of Baraka Ltd has suggested the three project in (b) above
should be analyzed using the risk adjusted discount rate(RADR).
The finance manager has developed the following model to calculate RADR for
each project:
RADRj =RF+bj (Ko-Rf)
Where RADRJ=risk adjusted discount rate for project j
Rf=risk free rate
Bj=risk index for project j
Ko = cost of capital for the company
Required:
i.
Determine the company’s cost of capital
(2 marks
ii.
The risk adjusted discount rate for each project
(6 marks)
iii.
NPV for each project using the risk adjusted discount rates compiled above
(6 marks)
iv.
Based on NPV’s determined in b) iii above ,advice the company on which
project to pursue .Justify your answer (2 marks)
(Total: 20 Marks)
Page 3 of 5
QUESTION THREE
a) i) Briefly explain to the management of B Ltd the following defense strategies
applicable in a hostile takeover situation:
Crown jewels strategy (2marks)
Poison pill strategy
(2marks)
Green mail strategy
(2marks)
ii) Explain why synergy might exist when one company merges with or takes over another
company.
(4 marks)
b) The director of Kabu Ltd met a director of Poa Ltd during a seminar held at Kabarak
University. They had some discussions about their companies merging together. The
Director of Kabu Ltd later proposed to his board of directors about acquisition of Poa Ltd.
During his presentation to the board he stated that “as a result of this takeover we will
diversify our operations and earnings per share will rise by 12.5%”. A bid would be based
on an exchange of shares between the two companies which would be one Kabu Ltd share
for every three Poa shares.
Kabu Ltd.
Poa Ltd.
(ShMillion)
(ShMillion)
Profit before tax
12
10
Profit available to ordinary shareholders
7.8
6.5
Issued ordinary shares in value
20
15
Par value per share
sh. 0.5
0.1
Market price per share
sh. 3.2
0.45
Required:
(i) Explain whether you agree with the Director of Kabu Ltd when he says that
earnings per share will rise by about 12.5%. (Give relevant calculations).
(4 marks)
(ii) Compute the maximum price payable per share of Baraka Ltd. (3 marks)
(iii) Compute the likely post acquisition price of a share (MPS) of Kabu Ltd if the bid is
successful.
(3 marks)
[TOTAL: 20 Marks]
Page 4 of 5
QUESTION FOUR
a) Consider two firms L (Levered) & U (Unlevered) which are identical in all respect except for
the capital structure. Both firms have EBIT of sh.900,000 ,a cost of equity of 10% and no
corporate taxes. Firm L is partially using sh.4,000,000 of 7.5% interest debt while firm U is all
equity financed. All the other traditional assumptions are applicable.
Required:
i)
Using the Net income approach, compute the values of the two firms and WACC
(9 marks)
ii)
Determine whether any of the two firms is overvalued giving an opportunity to make
arbitrage profit. (2 marks)
iii)
When would the arbitrage process cease? (2 marks)
iv)
Consider an investor who owns 10% of L’S Equity stock. He disposes the investment in L
and borrows the amount equal to 10% of L’s debt and invests the entire
proceeds in firm U.
Required: Show the investor’s income position. (3 marks)
b) Write short notes on Modigliani and Miller(MM) theory in relation to capital
Structure (4 marks)
[Total:20 Marks]
Page 5 of 5
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