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Fnce 310: Corporate Finance Question Paper

Fnce 310: Corporate Finance

Course:Bachelor Of Commerce

Institution: Kabarak University question papers

Exam Year:2010

COURSE CODE: FNCE 310
COURSE TITLE: CORPORATE FINANCE
STREAM: Y3S1
DAY: WEDNESDAY
TIME: 2.00 – 4.00 P.M
DATE: 8/12/2010

INSTRUCTIONS:

1. Answer question ONE and any other TWO questions only.
2. All necessary workings must be carefully shown.

QUESTION ONE (COMPULSORY)

a) Given the following variables:
Rm=16% sm=6% Rf=8% sj=24% Cor(j,m)=0.3

Required:
i) Compute Beta coefficient of securities (2 marks)
ii) If the expected return on securities, E(Rj) is 30%, evaluate the investment using :
-CML (2 marks)
-SML (2 marks)
b) Baraka Ltd has earned a profit before interest and tax of Sh.600,000 for the year ended
31st

Dec 2009. The Company’s applicable corporate tax rate is 40%.
Required:
Calculate its profit after tax in the following situations:s
i) The company has entirely financed its project through issue of 300,000 equity shares of sh10
each.
ii) The Company has financed its project through issue of 100,000 Equity shares of Sh. 10 each and
20,000, 14% debentures of Sh. 100 each.

(4 marks)

c i) Distinguish between the following terms:-Book value weights (1 mark)
- Market value weights (2 mark)
- Marginal weights (1 mark)
ii) Mololine Nissans Group Ltd has a very good trading year and would like to expand its
business operations. The company has planned to raise additional capital for investment
through a medium term loan of Sh.5000, 000 from a bank at an interest rate of 20% p.a

The present capital structure of the company is made up as follows:

Source Amount (Sh.)
50,000 fully paid Ordinary shares of sh100 each. 5000,000
20,000, 9% Preference shares of sh100 each. 2000,000
10% Debentures 3000,000

Additional information:
i) The current market value of the company’s ordinary shares is sh102 per share.
ii) The expected ordinary share dividend in a year’s time is sh9 per share. The average
growth rate in both dividends and earnings has been 5% over the past years and this
growth rate is expected to be maintained in the foreseeable future.
iii) The preference shares were issued three years ago and still change hands at face
value.
iv) The company’s applicable corporate tax rate is 50%.
v) The company’s expectation is that the business risk associated with new financing
may bring down the market price of ordinary shares from sh102 to sh96 per share.

Required:
i) Compute the component cost of:
-Ordinary share capital (2 marks)
-Debt capital (2 marks)
- Preference share capital (2 marks)
ii) Compute the company’s current weighted average cost of capital (4 marks)
iii) The relevance of the WACC computed in b (ii) above. (2 marks)
iv) Compute the company’s revised WACC if the company raised the additional sh5
million as envisaged.
(4 marks)
[TOTAL: 30 Marks]

QUESTION TWO

a) Briefly explain the following defense strategies applicable in a hostile takeover situation:
Crown jewels strategy (11/2 marks)
Poison pill strategy (11/2 marks)
Golden parachutes strategy (11/2 marks)
Greenmail (11/2 marks)

b) According to Gordon Donaldson, corporate restructuring occurs periodically due to an
ongoing tension between the organizational need for stability and continuity on one hand and
the economic compulsion to adapt to changes on the other.
Identify any six forms of corporate restructuring programmes. (6 marks).

c) The enactment of a pension’s management law will bring with it the need to evaluate the
performance of portfolios and fund managers. This process will require a careful evaluation
of the processes involved in management of funds.

Required:
i) Briefly explain any two commonly used methods of evaluating portfolio performance
(5 marks)
ii) Why would each of the two methods you have stated in a (i) above be preferred to
the other?
(3 marks)
[TOTAL: 20marks]

QUESTION THREE
Rongai innovation Ltd is evaluating new technology equipment for its manufacturing firm. The
technology will have a three year life and would cost shs.500, 000. Its impact on the company’s
cash flows is subject to risk.
In the first year, management estimates that there is an equal chance that the technology will
either succeed and save the company shs.1000, 000 or fail saving it nothing at all.
If the technology succeeds in the first year, the second year cash flows may be shs.500, 000,
400,000 or shs.300, 000 with probabilities of 0.20, 0.60 or 0.20 respectively. Third year cash
flows are then expected to be shs.200,000 greater or shs.200,000 less than cash flows in the
second year, with equal chance of either occurring.
If the technology fails in the first year, savings in the last two years will be zero.
All the cash flows above are after taxes. The company’s cost of capital is 12%.

Required :
a) A probability tree showing the above cash flow possibilities. (6 marks)
b) Net present values (NPV) for each possibility. (9 marks)
c) The expected net present values of the technology (5 marks)
[Total: 20 marks]
QUESTION FOUR
a) Highlight four advantages and limitations of Capital Asset pricing model as an investment
appraisal technique. (4 marks)
b) An investor has the opportunity to invest in the shares of KCB Ltd with an expected return
of 25% but subject to standard deviation of 10%.
The investor can also invest in KCB Bonds with annual risk free rate of 12%
Required: Compute the expected return and standard deviation of a portfolio that consist
investment of shares in the following proportions:
(i) 1.0
(ii) 0.75
(iii) 0.5
(iv) 0
(9 Marks)

c) ABC Ltd designs and manufactures special bathroom fittings. The company’s management is
considering a proposal to manufacture and market a new shower system 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 80,000 units at selling price of sh.26 per unit. The variable
costs are estimated at 75% of the sales value. Assume a cost of capital of 15% and an economic
project life of 10 years.

Required:
a) Compute the projects NPV (4 marks)
b) Test the sensitivity of project NPV to changes in:
-Selling price (3 marks)

[Total: 20 marks]

Fnce 310: Corporate Finance Question Paper

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