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Bac 204 Business Finance 2 Question Paper
Bac 204 Business Finance 2
Course:Bachelor Of Commerce
Institution: Kenyatta University question papers
Exam Year:2011
KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2011/2012
FIRST SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
BAC 204: BUSINESS FINANCE
DATE: Thursday 8th DECEMBER 2011
TIME: 4.30 P.M. – 6.30 P.M.
INSTRUCTIONS: Answer ALL the questions.
QUESTION ONE
a.
A lathe for trimming molded plastics was purchased 10 years ago at a cost of
sh.600,000. The machine had an expected life of 15 years at the time it was purchased and
management originally estimated, and still believes, that the salvage value will be zero at the
end of the 15-year life. the machine is being depreciated on a straight line basis.
The R & D manager reports that a new special purpose machine can be purchased for
sh.960,000 (including freight and installation) and over its five year life, it will reduce
labour and raw material usage sufficiently to cut annual operating costs from sh.560,000
to sh320,000. This reduction in costs will cause before tax profits to rise by Sh.220,000.
It is estimated that the new machine can be sold for sh.160,000 at the end of five years.
The current market price of the old machine is sh.80,000. Net working capital requirements
will also increase by Sh.80,000 at the time of replacement. The firm’s cost of capital is
11.5% and corporate tax bracket of 40%.
Required:
Should the replacement be made? Show all the relevant workings.
(12 marks)
Page 1 of 4
b.
The table below shows the projected cash flows of project B over its 3-year life
Year
Initial Investment and operating cash flows
Sh.
Sh.
0
(384,000)
1
160,000
2
160,000
3
140,000
The project’s cost of capital is 10 percent.
Required:
Determine the project’s optimal abandonment value and time.
(4 marks)
c.
Briefly explain two reasons why capital budgeting is important to a
business organization.
(2 marks)
d)
Explain three reasons why a company would forgo value adding projects. (3 marks)
(Total 21 marks)
QUESTION TWO (15 marks)
a.
FT Company Ltd is considering various levels of debts. Currently it has no debt. It has a
total market value of sh.30 million. By undertaking debt it believes that it can achieve a net
tax advantage equal to 20% of the amount of debt. However the company will incur
bankruptcy and agency costs as well as lenders increasing their interest rate if it borrows too
much. The company’s managing director believes that the company can borrow up to sh.10
million without incurring any of these costs. However, each additional sh.10 million
increments in borrowing is expected to result in the three costs cited being incurred.
Moreover, the three costs are expected to increase at an increasing rate with leverage.
Page 2 of 4
There present value cost of various levels of debts is as follows:
Value of Debt (sh ‘m’)
PV cost of bankruptcy, agency and
increased interest rate (sh ‘m’
10
0
20
0.6
30
2.4
40
4.0
50
6.4
60
10.0
Required:
Advice the managing director on the optimal amount of debt for FT Company.
(8 marks)
b.
Differentiate between the following terms;
i.
Systematic risk and unsystematic risk
(2 marks)
ii.
Business risk and financial risk
(2 marks)
c.
Briefly explain what the signaling theory suggests about capital structure decisions.
(3 marks)
QUESTION THREE (15 marks)
a.
Explain two difference between debt with warrant financing and convertible debt. (4 marks)
b.
Gamma Medical’s stock trades at sh.200 a share. The company is contemplating
a 3-for-2 stock split. Assume that the stock split will have no effect on the total
market value of its equity.
Required:
What will be the company’s stock price following the split.
(2 marks)
c.
Using suitable illustrations, describe the dividend payment procedure.
(3 marks)
d.
Explain two factors that influence dividend payout.
(2 marks)
Page 3 of 4
QUESTION FOUR (15 marks)
a.
The Gentry Garden Center sells 90,000 bags of lawn fertilizer annually. The
optimal safety stock is 1,000 bags. Each bag costs the firm sh.150, inventory
carrying costs are 20 percent, and the cost of placing an order with its supplier
is sh.1,500.
Required:
i.
Determine the economic order quantity.
(2 marks)
ii.
Determine the maximum inventory of fertilizer.
(2 marks)
iii.
Determine the firm’s average inventory
(2 marks)
iv.
How often must the company order?
(2 marks)
b.
i.
Define the term ‘cash conversion cycle’ and state its importance to business
firm.
(2 marks)
ii.
The following information was extracted from the books of Vero Ltd as at
December 2010.
Trade debtors balance (31st December 2010)
sh.10 million
Trade creditors balance (31st December 2010)
sh.3 million
Sales for the year
sh.80 million
Purchase for the year
sh.60 million
Gross profit margin
25%
Inventory turnover
4.8 times
All sales and purchases were on credit. Assume a 360-day year
Required: Determine
1.
Operating cycle
(3 marks)
2.
Cash conversion cycle
(2 marks)
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Page 4 of 4
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