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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 UNIVERSITY
END OF THIRD TRIMESTER 2010 EXAMINATIONS
FACULTY : BUSINESS AND MANAGEMENT STUDIES
DEPARTMENT : ACCOUNTING AND FINANCE
COURSE CODE : BUSS 321
COURSE TITLE : FINANCIAL MANAGEMENT 1
TIME : 2 HOURS
INSTRUCTIONS
• Answer Question ONE and any Other TWO Questions
Question 1
a) Karagita intends to invest in a piece of land costing Sh 900,000. He is certain that he will sell the piece of land for Sh 960,000 the same time next year, making a sure gain of sh 60,000. Given that banks are offering a 12% interest, should he invest in this project (4marks)
b) Highlight 5 roles of the stock exchange on the economy (5marks)
c) Highlight three advantages of ratio analysis. (3marks)
d) Highlight the relevance and significance of capital budgeting (4marks)
e) The demand for a commodity is 50,000 p.a at a steady rate. It costs sh 300 to
place a order and sh 5 to hold a unit for a year. Find the batch size to minimize
inventory costs, the number of orders placed per year and the length of the
inventory cycle. (5marks)
f) Highlight the Methods of easing cash shortages (5marks)
g) A project has the following characteristics.
Year Cash flow
y0 (950,000)
y1 470,000
y2 480,000
y3 320,000
Required
If the discount rate is 18%, should we accept the project? (4marks)
Question 2
a) Discuss five implications of efficient market hypothesis for financial decision makers (10marks)
b) A machine has a cost of kshs 78,000 and a net cashflow of ksh 15,000 per year for six years. A substitute machine would cost Kshs 60,000 and generate net cash flow of kshs 13,000 per year for six years. The required rate of return of both machines is 12 %.
Required
Calculate the IRR and NPV for the machines and suggest which machines should be accepted and why. (6marks)
c) Highlight four reasons why working capital management is important to a firm.
(4marks)
Question 3
Kimathi company plan to buy a new machine to meet expected demand for new product T. this machine will cost Ksh 250,000 and last for four years, at the end of which time it will be sold for Ksh 5,000.Kimathi Company expects demand for product T to be as follows:
Year 1 2 3 4
Demand (units) 35,000 40,000 50, 0000 25,000
The selling price for product T is expected to be Kshs 12 per unit and the variable cost of production is expected to be ksh 7.80 per unit. Incremental annual fixed production overheads of Ksh 25,000 per year will be incurred. Selling price and costs are all incurrent price terms.
Selling price of product T: 3% per year
Variable cost of product: 4 % per year
Fixed production overheads: 6%
Additional information
Kimathi company has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowance s on a 25% reducing balance basis. General inflation is expected to be 5% per year.
Kimathi Company has a target return on capital employed of 20%. Depreciation is charged on a straight line basis over the life of an asset.
Required
a) Calculate the NPV of buying the new machine and comment on your findings (Work to the nearest ksh 1,000) (10marks)
b) Identify and explain the key areas of accounts receivable management (5marks)
c) Briefly highlight the term structure theories (5marks)
Question 4
a) Discuss factors that influence the working capital quantum of a company
(6marks)
b) A Company has made plans for the next year. It is estimated that the company will employ total assets of ksh 900,000, 60% of the assets being financed by borrowed capital at an interest cost of 10% per year. The direct costs for the year are estimated at kshs 500,000 and all other operating expenses are estimated at ksh 95,000. The goods will be sold to customers at 170% of the direct costs. Tax rate is assumed to be 30%
Required: Calculate
i) Net profit margin
ii) Return on assets
iii) Asset turnover
iv) Return on owners equity (8marks)
c) A bond is sold for kshs 94 at par. And it has a new issue of 7 years, 15% and the company will pay kshs 100 principal to bondholders at maturity. Compute the cost of debt. (6marks)
Question 5
Kamaara company limited had the following capital structure as at 31/12/2009
Ordinary shares: Ksh
300,000 @ Ksh 20 each 6,000,000
10% preference shares 2,000,000
14% debentures 4,000,000
Total Capital Employed 12,000,000
The shares of this company sell at 20/= each. It is expected that the company will pay next year a dividend of 2 shillings per share which will have a perpetual growth of 7%. Assume a 30 % tax rate. You are required to;
a) Compute the weighted average cost of capital based on existing capital structure
b) Compute the new weighted average cost of capital if the company raises an additional Ksh 3,000,000 debt by issuing 15% 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 16per share. (15marks)
c) Discuss the conflict between profitability and liquidity in working capital management
(5marks)
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