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Business Finance Question Paper

Business Finance

Course:Bachelor Of Commerce

Institution: Kca University question papers

Exam Year:2010

UNIVERSITY EXAMINATIONS: 2009/2010
FIRST YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 101: BUSINESS FINANCE (SATURDAY)
DATE: AUGUST 2010 TIME: 2 HOURS
INSTRUCTIONS: Answer question ONE and any other TWO questions
QUESTION ONE
a) Highlight six factors you would consider when selecting a source of finance (6 Marks)
b) Give four disadvantages of equity finance (4 Marks)
c) A company is considering a project which requires an initial investment of sh.2,400,000 and
which would generate annual cash inflows as follows:
year amount
sh.
1 780,000
2 600,000
3 420,000
4 740,000
5 920,000
The company’s cost of capital is 18%
Required:
Using internal rate of return, determine whether the project is viable. (10 Marks)
d) Distinguish between
1. primary Market and secondary Market (2 Marks)
2. put option and call option (2 Marks)
3. financial institution and bank (3 Marks)
4. liquidity and solvency (3 Marks)
2
QUESTION TWO
a) Define agency problem and suggest three ways of mitigating it. (3 Marks)
b) State any five non- financial goals of the firm (5 Marks)
c) Distinguish between profit maximization and wealth maximization (2 Marks)
d) Explain nature and structure of venture capital and suggest reasons that limit its growth in Kenya
(10 Marks)
QUESTION THREE
The finance manager of Bidii Industries Ltd., which manufactures edible oils, has identified the
following three projects for potential investment:
Project I
The project will require an initial investment ofSh.18 million and a further investment of Sh.25
million at the end of two years. Cash profits from the project will be as follows:
Sh.
End of year 2
3
4
5
6
7
8
15,000,000
12,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
Project II
This project will involve an initial investment of Sh.50 million on equipment and Sh.18 million
on working capital. The investment on working capital would be increased toSh.20 million at
the end of the second year. Annual cash profit will be Sh.20 million for five years at the end of
which the investment in working capital will be recovered.
Project III
The project will require an initial investment on capital equipment of Sh.84 million and Sh.24
million on working capital. The profits from the project will be as follows:
Contribution
Sh.
Fixed costs
Sh.
End of year
End of year
End of year
1
2
3
35 million
30 million
14 million
8 million
6 million
8 million
3
Fixed costs include an annual depreciation charge ofSh.3 million. At the end of year 3, the
working capital investment will be recovered and the capital equipment will be sold for Sh.8
million.
Bidii Industries Ltd.’s cost of capital is 12%. Ignore taxation.
Required:
(i) Evaluate each project using the net present value (NPV) method. (15 Marks)
(ii) Which of the three projects should Bidii Industries Ltd. accept? (5 Marks)
(Total: 20 Marks)
QUESTION FOUR
The Salinas Company is in the fast foods industry. The following is the company’s balance sheet for
the year ended 31 March 1995:
Assets Liabilities and Owners equity
Sh. ‘000 Sh. ‘000
Current Assets 65,000 Current Liabilities 25,000
16% Debentures (Sh. 1,000 par) 31,250
Net fixed assets 85,000 15% Preference shares 12,500
Ordinary shares (Sh. 10 par) 25,000
Retained Profits 56,250
150,000 150,000
Additional Information
1. The debenture issue was floated 10 years ago and will be due in the year 2005. A similar
debenture issue would today be floated at Sh. 950 net.
2. Last December the company declared an interim dividend of Sh. 2.50 and has now declared
a final dividend of Sh. 3.00 per share. The company has a policy of 10% dividend growth
rate which it hopes to maintain into the foreseeable future. Currently, the company’s shares
are trading at Sh. 75 per share in the local stock exchange.
3. A recent study of similar companies in the fast foods industry disclose their average beta as
1.1
4. There has not been any significant change in the price of preference shares since they were
floated in mid-1990.
4
5. Treasury Bills are currently paying 12% interest per annum and the company is in the 40%
marginal tax rate.
6. The inflation rate for the current year has been estimated to average 8%
Required
a) Determine the real rate of return. (2 Marks)
b) What is the minimum rate of return investors in the fast food industry may expect to earn on
their investments? Show your workings. (6 Marks)
c) Calculate Salina’s overall cost of capital. (6 Marks)
d) Discuss the limitations of using a firm’s overall cost of capital as an investment discount rate.
(6 Marks)
(Total: 20 Marks)
QUESTION FIVE
a) Identify and briefly explain the factors that must be taken into account in the design and
construction of a Market index for shares. (5 Marks)
b) Joseph Kimeu is trying to determine the value of Bidii Ltd’s ordinary shares. The earnings
growth rate over his planned six-year holding period is estimated to be 10% and the dividend
payout ratio is 60%. The ending price earnings (P/E) ratio is expected to be 20 and the current
earnings per share are Shs. 4. The required rate of return for this share is 15%. Compute the
Market price of Bidii Ltd’s ordinary share. (5 Marks)
c) A BAN Bank is offering loans on the following terms
Maturity 10 years
Repayment semiannually
Interest rate 13.97% p.a
Required:
Determine the semiannual installment for a loan of 2,500,500 and show the repayment schedule
for the first three years (10 Marks)

Business Finance Question Paper

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