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Bmit 222: Business Finance 2010 Question Paper

Bmit 222: Business Finance 2010

Course:Bachelor Of Business Management And Information Technology

Institution: Kabarak University question papers

Exam Year:2010

KABARAK UNIVERSITY
UNIVERSITY EXAMINATIONS
2009/2010 ACADEMIC YEAR
FOR THE DEGREE OF BACHELOR OF BUSINESS
MANAGEMENT AND INFORMATION TECHNOLOGY
COURSE CODE: BMIT 222
COURSE TITLE: BUSINESS FINANCE
STREAM: Y2S2
DAY: THURSDAY
TIME: 9.00 – 12.00 P.M.
DATE: 12/08/2010

INSTRUCTIONS:

1. Answer questions ONE and any other THREE questions only.
2. ALL necessary workings must be carefully shown.

QUESTION ONE (COMPULSORY)
a) Although profit maximization has long been considered as the main goal of a firm, shareholder
wealth Maximization is gaining acceptance amongst most companies as key goal of a firm.
Required:
i) Distinguish between the goals of profit maximization and shareholder wealth
maximization (4marks)
ii) Explain limitations of the goal of profit maximization (3marks)
a) i) Discuss the reasons that may drive a company to raise capital by issuing :
a. Equity shares (4marks)
b. Debentures (4marks)
i) Briefly discuss four sources of finance available to small and medium sized enterprises
(SMEs) for financing business ventures. (6marks)
d) (i) Clearly explain the following methods of investment appraisal:-
i. Pay-back period (PBP) (2marks)
ii. Net present value (NPV) (3marks)
iii. Internal rate of return (IRR) (3marks)
(i) Kabu Ltd is analyzing two mutually exclusive projects whose details are given
Below:
Year Project Alpha Project Beta
Cash flow (sh) Cash flow (sh)
1. 2,000,000 5,000,000
2. 1,000,000 4,000,000
3. 3,000,000 3,000,000
4. 4,000,000 2,000,000
5. 5,000,000 1,000,000

1. The above cash flows have been stated on after tax basis.
2. Each of the projects will cost Sh8 million at commencement.
The company‘s cost of capital is 10% p.a.

Required
Advice the management of Kabu Ltd on which of the two projects to undertake using:
(i) Pay –back period approach (4marks)
(ii) Net present value approach (4marks)
(iii) Profitability Index method (3marks)

[TOTAL: 40Marks]
QUESTION TWO

a) Discuss the main factors which a company should consider when determining the appropriate
mix of long term sources of capital for investments. (5marks)

(b) Kabu Ltd has an investment capital of sh1000, 000. The finance manager wishes to invest in
two securities A and B in the following proportion; Sh200, 000 in security A and Sh800, 000
in security B.
The returns on these two securities depend on the state of the economy as shown below:-
State of Returns on Returns on
Economy probability Security A Security B
Recovery 0.4 18% 24%
Normal 0.5 14% 22%
Recession 0.1 12% 21%

Required:
(i) Compute the expected return, Standard deviation and conflict of variation for each
security (8marks)
(ii) Determine covariance, and correlation Coefficient between securities A and B
(5marks)
(iii) What is the expected return of a portfolio consisting of securities A and B
(2marks)
[TOTAL: 20Marks]

QUESTION THREE

a) i) A Ltd is targeting B Ltd for a hostile takeover. The management of B Ltd is considering
which defense mechanism to use in order to block the acquisition. Briefly explain to the
management of B Ltd the following defense strategies applicable in a hostile takeover
situation:
i. Crown jewels strategy (2marks)
ii. Poison pill strategy (2marks)
iii. White knight strategy (2marks)

ii) Explain five reasons why a company seeking to maximize the wealth of its shareholders may
wish to take over another company. (7½marks)
b) A company expects to pay dividends of sh 2 per share in the coming year. The dividends
c) are growing at a constant rate of 10% and this growth rate is expected to continue indefinitely.
The market price of the company’s equity shares is Sh.40 and floatation cost of 10% of the
market price is expected to be incurred.

Required:
(a) i). Calculate the cost of internal equity (3marks)
ii). Calculate the cost of external equity (3marks)
(b) What are your observations in (a) above? (½marks)

[TOTAL: 20Marks]

QUESTION FOUR

a) Distinguish between the following terms:
i. Independent projects and mutually exclusive projects (2marks)
ii. Annuity and perpetuity (2marks)
iii. Compound interest and simple interest (2marks)
iv. Opportunity cost and sunk cost (2marks)
d) An investor can get an annual interest rate of 12% on a deposit in a bank. Assuring he
deposits sh.10,000 and leaves it for 3years, what is the amount at the end of the third year if
interest is compounded:
i. Semi annually (2marks)
ii. Quarterly (2marks)
iii. Continuously (2marks)

c) Complete the following Table, solving for PV and FV.

CASE FV INTEREST
RATE %
NUMBER OF
YEARS
PV
A SH.10,000 5 5 ?
B ? 4 5 20,000
C SH.5,000 ? 3 4,258

(6marks)
[TOTAL: 20Marks]

QUESTION FIVE
a) Explain how sensitivity analysis can be used in appraising risky capital investments

(6Marks)
e) The management of Kabu Ltd is considering undertaking a project with the following
details:
Details Amount
Expected useful life 5 Years
Sales volume 1,200,000 units
Selling price Sh.15 per unit
Variable cost per unit Sh.10
Fixed costs Sh.2000, 000
Initial outlay Sh.7, 360,000
The company’s cost of capital is 15% and corporate tax rate is 30%. Assume straight line method
of depreciation.

Required:
i) Calculate the project’s NPV (4marks)
ii) Calculate the project’s NPV and its % change assuming each of the variables selling price,
and variable costs vary adversely by 10% (Assume each variation in isolation)
(10marks)

[Total 20 marks]

Bmit 222: Business Finance 2010 Question Paper

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