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Fnce 220 Year 2008 Question Paper
Fnce 220 Year 2008
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2008
KABARAK UNIVERSITY
UNIVERSITY EXAMINATIONS
2008/2009 ACADEMIC YEAR
FOR THE DEGREE OF BACHELOR OF COMMERCE
COURSE CODE: FNCE 220
COURSE TITLE: BUSINESS FINANCE
STREAM: Y2S2
DAY: WEDNESDAY
TIME: 8.30 – 10.30 A.M.
DATE: 13/8/2008
INSTRUCTIONS:
1. Attempt Question One and any other two questions.
2. Question one carries 30 marks and the rest 20 marks each.
3. Show all your workings clearly.
QUESTION ONE
(a) Respond to the following comments:
(i) There is upside-risk and down-side risk. Standard deviation does not
distinguish between them.
(ii) Risk to me is the probability of loss.
(iii) Harry Markowitz was just another non-Kenyan.
(iv) Capital structure is the same as financial structure.
(v) Profits are the same as cash flows.
(10 marks)
(b) Briefly explain the following methods of investment appraisal:
(i) Pay-back period (PBP) (4 marks)
(ii) Accounting rate of return (ARR) (4 marks)
(c) Zawadi Ltd is analyzing two mutually exclusive projects whose details are shown
below:
Year Project A Project B
Cash flow (shs.) Cash flow (shs.)
1 3,000,000 6,000,000
2. 1,000,000 5,000,000
3 4,000,000 4,000,000
4 5,000,000 3,000,000
5 6,000,000 1,000,000
Additional information:
1. The above cash flows have been stated on after-tax basis.
2. Each of the projects will cost sh. 10,000,000 at commencement. The
company intends to raise this finance through an issue of debentures at an
interest rate of 10% per annum.
Required:
Advise the management of Zawadi Ltd on which of the two projects to
undertake using;
(i) Pay-back period approach (7 marks)
(ii) Net present value approach (7 marks)
QUESTION TWO
(a) (i) From an asset manager’s perspective, outline the objectives of portfolio
diversification. (2 marks)
(ii) Why is the risk of individual securities likely to differ from that of a
portfolio as a whole? (2 marks)
(b) As an asset manager, you are considering making an investment in one or both of
two securities, A and B. You are provided with the following information:
Security Possible rates of return Probability of
(%) occurrence
A 30 0.3
25 0.4
20 0.3
B 50 0.2
30 0.6
10 0.2
Required:
(i) Calculate the expected return for each security separately and for a
portfolio comprising 60% A and 40% B assuming no correlation
between the possible rates of return from the shares comprising the
portfolio. (8 marks)
(ii) Calculate the risk of each security separately and of the portfolio as
defined above (measure risk by the standard deviation of returns
from the expected rate of return) (8 marks)
QUESTION THREE
(a) The valuation of ordinary share is more complicated than the valuation of bonds
and preference shares. Explain the factors that complicate the valuation of
ordinary shares. (6 marks)
(b) The most recent data for Kabarak Ltd disclose the following:
Dividend per share shs 3.00
Expected annual dividend growth rate 6%
The current required rate of return 15%
The company is considering a variety of proposals in order to redirect the firms
activities. The following four alternative strategies have been suggested:-
(i) Do nothing in which case key financial variables will remain unchanged.
(ii) Invest in a venture that will increase the dividend growth rate of 7% and
increase the required rate of return to 14%.
(iii) Eliminate any unprofitable product line. The action will increase the
dividend growth rate to 8% and raise the required rate of return to 17%.
(iv) Acquire a subsidiary operation from company. This action will increase
the dividend growth rate to 9% and the required rate of return to 18%.
Required:
For each of the proposed actions determine the resulting market prices per
share and recommend the best alternative strategy. (14 marks)
QUESTION FOUR
(a) A project has a cost of Kshs 1,000,000 and it is expected to generate cash inflows
of Kshs 360,000 each year for 4 years. The firm’s cost of capital is 16%.
Required:
Calculate the project’s internal rate of return (IRR) (8 marks)
(b) PAULU Ltd wants to take advantage of the new commercial paper now popular
in Kenyan market. It wants to issue two debenture papers both bear coupon rates
of 14% and the effective yield required on each is 20%. Paper A has a maturity of
10 years and paper B a maturity of 20 years. Both will be paying interest
annually and Kshs 100,000 at maturity.
Required:
(i) What is the price of each paper? (4 marks)
(ii) If the effective yield of each paper rises to 24%, what is the price of each
paper? (4 marks)
(iii) Explain why the price of one paper falls more than the price of other when
the effective yield rises. (4 marks)
QUESTION FIVE
(a) (i) Comment on the problems of financing which a small business is likely to
encounter at an early stage of its development. (4 marks)
(ii) Explain the role of the financial manager in a modern corporate setting
and environment. (4 marks)
(b) Using knowledge of agency theory, discuss how to resolve the potential conflicts
arising between:
(i) Shareholders and management (6 marks)
(ii) Lenders and owners (6 marks)
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