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Buss 321: Financial Management 1 Question Paper
Buss 321: Financial Management 1
Course:Financial Management I
Institution: Kenya Methodist University question papers
Exam Year:2010
KENYA METHODIST UNIVERTISY
END OF THIRD TRIMESTER 2009/2010 EXAMINATIONS
FACULTY : BUSINESS STUDIES AND MANAGEMENT
DEPARTMENT : BUSINESS ADMINISTRATION
COURSE CODE : BUSS 321
COURSE TITLE : FINANCIAL MANAGEMENT I
TIME : 2 HOURS
Instructions
• Answer question one and any other two
Question 1
The management of Furaha Packers Ltd. is planning to carry out two activities at the
same time:
i) Determine the best credit policy for its customers.
ii) Find out the optimal level of ordering orange juice from its suppliers.
The following data have been collected to assist in making the decisions:
i) Annual requirements of orange juice are 2,100,000 litres.
ii) The carrying cost of the juice is sh.8 per litre per year.
iii) The cost of placing an order is shs.1,400.
iv) The required rate of return for this type of investment is 18% after tax.
v) Debtors currently are running at sh.60million and have an average collection
period of 40days.
vi) Sales are expected to increase by 20% if the credit terms are relaxed and to
result in an average collection period of 60days.
vii) 60% of sales are on credit.
viii) The gross margin on sales is 30% and is to be maintained in future.
Required:
a) Use the inventory (Baumol) model to determine the economic order quantity and the ordering and holding costs at these levels per annum. (10marks)
b) Highlight any five differences between equity and debt capital. (5marks)
c) Why do different sources of finance have different costs? (5marks)
d) The governments of many less developed countries have experienced problems in recent years as their debt levels have risen leading to what has been called a global debt crisis. Explain briefly why these problems amount to a crisis. (6 marks)
e) What are the limitations of the capital asset pricing model (CAPM) as an investment appraisal technique? (4 marks)
Question 2
A machine (A) has a cost of kshs 80,000 and a net cashflow of ksh 20,000 per year for six years. A substitute machine (B) would cost Kshs 60,000 and generate net cash flow of kshs 15,000 per year for 5 years. The required rate of return of both machines is 10 %.
Required
Calculate the IRR and NPV for the machines
Which machines should be accepted and why. (8 marks)
Njunjiri Company has made plans for the next year. It is estimated that the company will employ total assets of ksh 800,000, 50% of the assets being financed by borrowed capital at an interest cost of 8% per year.
The direct costs for the year are estimated at kshs 480,000 and all other operating expenses are estimated at ksh 80,000. The goods will be sold to customers at 150% of the direct costs. Tax rate is assumed to be 50%
Required: Calculate
a. Net profit margin
b. Return on assets
c. Asset turnover
d. Return on owners equity (12 marks)
Question 3
a) Explain the factors that finance managers should analyze before making a dividends decision (5 marks)
b) Assume all things are held constant other than the item in question, for each of the companies below:
A company with a large proportion of insider ownership all of whom are high income individuals.
A growth company with an abundance of good investment opportunities.
A company experiencing ordinary growth that has high liquidity and much unused borrowing capacity
A dividend paying company that experiences an unexpected drop in earnings from a trend.
A company with volatile earnings and high business risk
Required
Explain whether or not you would expect each company to have a medium/high or low dividend payment ratio and the reasons for such categorization (15 marks)
Question 4
Njeru enterprises limited had the following structure as at 31/12/2009
Ordinary shares: sh
200,000 @ Sh20 each 4,000,000
10% preference shares 3,000,000
14% debentures 6,000,000
14,000,000
The shares of this company sell at 25/= each. It is expected that the company will pay next year a dividend of 3shillings per share which will grow at 8% for ever. You are required to;
a) Compute the weighted average cost of capital based on existing capital structure (5 marks)
b) Compute the new weighted average cost of capital if the company raises an additional Ksh 3,000,000 debt by issuing 16% debenture. This would result in increasing the expected dividends to Ksh 4/= and have the growth rate unchanged, but the price of the share will fall to Ksh 20per share. (7 marks)
c) Explain four factors that influence working capital quantum of organization (8 marks)
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