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Mbad 731: Advanced Financial Management Question Paper
Mbad 731: Advanced Financial Management
Course:Masters In Business Administration
Institution: Chuka University question papers
Exam Year:2013
CHUKA
UNIVERSITY
UNIVERSITY EXAMINATIONS
SECOND YEAR EXAMINATIONS FOR THE AWARD OF
DEGREE OF MASTERS IN BUSINESS ADMINISTRATION
MBAD 731: ADVANCED FINANCIAL MANAGEMENT
STREAMS: Y2S1 TIME: 3 HOURS
DAY/DATE: THURSDAY 25/4/2013 5.30 PM – 8.30 PM
INSTRUCTIONS:
ATTEMPT ALL QUESTIONS
(a) Distinguish between disintermediation and intermediation as used in financial markets. [2 Marks]
(b) In the recent past, mergers and acquisitions have failed despite their popularity in the past. Evaluate three reasons behind failed mergers and acquisitions. [3Marks]
(c) Huge Ltd and Tiny Ltd are companies operating in the same line of business. In the past few years, Huge Limited has experienced stiff competition from Tiny Ltd to an extent that Huge limited is now contemplating acquiring Tiny Limited to consolidate its market share.
The following financial data is available for the two companies:
Huge Ltd Tiny Ltd
Annual sales (millions) Sh. 3.75 Sh.45
Net income (millions) Sh. 30 Sh.3.75
Outstanding shares (millions) 7.5 1.5
Earnings per share (EPS) Sh.4 Sh.2.5
Market per share Sh.42 Sh.18
Required:
(i) Maximum exchange ratio Huge Ltd should agree to if it expects no dilution in its EPS. [2 Marks]
(ii) Huge limited’s post acquisition EPS if the two companies agree on an offer price of sh.21 [2 Marks]
(iii) Given that the growth rate of Huge Ltd. Is 7% while that of Tiny Ltd. is 12%. Compute the combined growth rate of the two companies. [2 Marks]
(d) A firm is considering an investment whose initial cash outlay and the projected cash outflows are given as follows:
Cost of investment Sh 600,000
Cash inflows Year 1 Sh 400,000
Cash inflows Year 2 Sh 300,000
Cash inflows Year 3 Sh 200,000
Cash inflows Year 4 Sh 100,000
The firm uses the certainty equivalent technique for risk analysis purposes. The financial manager has given the certainty equivalents coefficients for year 1 to year 4 as 0.9, 0.7, 0.5 and 0.3 respectively. Assuming a 10% cost of capital.
Advice if this project should be implemented. [4 Marks]
QUESTION TWO:
(a) A new polishing machine is required by Bahati limited. The polishing machine forms a part of the production process, and most products manufactured required polishing at various stages in Company’s production. A polishing facility is expected to be required for as long as the company factory remains in operation, and no closure can be anticipated.
The details of the two machines under consideration are set out below.
Machine A B
Initial cost (Sh ‘000’) 50,000 90,000
Life – years 4 7
Salvage value at end of:
Year 4 – machine A (sh. ‘000’) 5,000
Year 7 – machine B (sh. ‘000’) 7,000
Annual running costs (sh.’000’) 10,000 8,000
Both machines fulfill the same function and have equal capacities. The company required rate of return is 10%.
Required:
Determine which machine should be purchased. [6 Marks]
(b) A project under consideration has the following projected cash flows which are in current terms.
Time T0 T1 T1 T3 – T10
Cash flows Ksh ‘000’ (1,700) 100 200 300
The rate of inflation which will affect all cash flows equally is 3% and the firms required money return is 10%.
Required:
Determine whether the project is acceptable. [5 Marks]
(c) Highlight the limitations of the following methods of dealing with risk in Capital budgeting;
(i) Simulation analysis [2 Marks]
(ii) Sensitivity analysis [2 Marks]
QUESTION THREE
(a) Briefly explain the approaches that could be used by a company to finance its working capital requirements. [3 Marks]
(b) Pat Ltd faces an interest rate of 18.25% per annum and its brokers commission Sh.75 for each transaction in the money market. The company finance director has stated that the minimum cash balance that is acceptable is Sh.20,000 and that the variance of cash flows on a daily basis is Sh. 160,000. What is the maximum level of cash the firm should hold, and at what point should it start to purchase or sell securities? [6 Marks]
(c) Maima Limited, a manufacturing company has applied for working capital Finance from Southern Commercial bank limited. The bank’s manager has requested for a working capital estimate from the company. The company has provided you with the following data for the next financial year.
Sh.(per unit)
Raw materials 104
Direct labour 39
Overheads 78
Total Cost per unit 221
Profit 39
Selling price per unit 260
===
Additional information:
(a) Average finished goods in stock (holding period) 1.5 months
(b) Average raw materials in stock (holding period) 2 months
(c) Average work in progress (holding period) 1 month
(d) Credit period allowed by suppliers 2 months
(e) Credit period allowed to debtors 3 months
(f) Time lag in payment of wages 0.5 months
(g) Time lag in payment of overheads 2 months
(h) One-quarter of the company sales are on cash basis
(i) The cash balance is expected to be Shs. 240,000
(j) The level of activity is expected to be 100,000 units per annum
Required:
A statement showing the working capital estimate
Assume that production is carried out evenly throughout the year and wages and overheads also accrue evenly. [6 Marks]
QUESTION FOUR
(a) With reference to capital structure decisions, briefly explain the following costs:
(i) Financial distress costs [2 Marks]
(ii) Agency costs [2 Marks]
(b) Two firms U and L are in the same risk class and both have profit before interest and tax of Ksh.40 million. Firm U is all equity financed and its cost of equity KSu = 18%. Firm L has Ksh. 80 million outstanding debt at a cost of Kd = 12%. Corporation tax amounts to 30% and assumptions of MM hold.
Required:
Establish the value and weighted average cost of capital of firms U and L. [5 Marks]
(c) Bidii Ltd has a cost of equity of 10%. The company currently has 250,000 shares outstanding and selling on the securities exchange at Sh. 120 per share.
The company’s earnings are Sh. 10 per share and it intends to maintain a dividend payout ratio of 50% at the end of the financial year. The company’s expected net income is Sh. 3 million and the available investment proposals are estimated to require Sh. 6 million.
Required:
Using the Modigliani and Miller (MM) proposition on dividend irrelevance, show that the payment of dividends does not affect the value of the firm. [6 Marks]
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