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Financial Management Question Paper

Financial Management

Course:Bachelor Of Commerce

Institution: Strathmore University question papers

Exam Year:2010

STRATHMORE UNIVERSITY
FACULTY OF COMMERCE
Bachelor of Commerce
SUPPLEMENTARY EXAMINATION
BCM 2206: FINANCIAL MANAGEMENT
DATE: 20th June 2010 TIME: 2 hours
INSTRUCTIONS
ANSWER QUESTION ONE AND ANY OTHER TWO QUESTIONS

QUESTION ONE
a) Why is it important for financial managers to understand the valuation process?
(2 marks)
b) Discuss the three key inputs to the valuation process? (9 marks)
c) Does the valuation process apply only to assets that provide an annual cash flow?
Explain with examples? (3 marks)
d) Give and define the general equation for the value of any asset, V0. (6 marks)
e) Engines Company’s current stock price is Sh.36, and its last dividend was
Sh.2.40. In view of Ewald’s strong financial position and its consequent low risk,
its required rate of return is only 12%. If dividends are expected to grow at a
constant rate, g, in the future, what is Ewald’s expected stock price 5 years from
now? (10 marks)
(Total: 30 marks)

QUESTION TWO
Assume that on December 31, 1999 you are provided with the following capital structure
of Hardcore Ltd., which is optimal:
Thousands of KShs.
Long term Debt (16%) 135000
Common Stock (KShs. 10 par) 90000
Retained Earnings 75000
The company has total assets amounting to KShs. 3 million but this figure is expected to
rise to KShs. 500 million by the end of the year 2000. You are also informed that:
1. Any new equity shares will net 90 percent after floatation costs;
2. For the year just ended, the company paid KShs. 3.00 in dividends per share;
3. New 16 percent debt can be raised at par through the stock exchange;
4. The past and expected earnings growth rate is 10 percent;
5. The current dividend yield is 12 percent;
2
6. The company’s dividend payout ratio of 50 percent shall be maintained in 2000;
7. The company is in the 40 percent tax bracket
Required
i) Calculate the amount of capital budget to be financed with equity if 85 percent of
the asset expansion is included in the 2000 capital budget ( 5 marks)
ii) How many shares must be sold to raise the required equity capital? (Express your
answer to the nearest thousand). ( 8 marks)
iii) What is the firm’s marginal cost of capital? (Show your workings).(7 marks)
( 20 marks)

QUESTION THREE
1. The Tuma Barua Machine Company is planning to expand its production because
of the increased volume of mailouts. The increased mailout capacity will cost
Sh.2,000,000. The expansion can be financed either by bonds at an interest rate of
12% or by selling 40,000 shares of common stock at Sh.50 per share. The current
income statement (before expansion) is as follows:
Tuma Barua
Income statement
2000X
Sh.
Sales 3,000,000
Less: Variable costs (40%) 1,200,000
Fixed costs 800,000
Earnings before interest and taxes 1,000,000
Less: interest expense 400,000
Earnings before taxes 600,000
Less: Taxes (@ 35%) 210,000
Earnings after taxes 390,000
Shares 100,000
Earnings per share 3.90
Assume that after expansion, sales are expected to increase by Sh.1,500,000. Variable
costs will remain at 40% of sales and fixed costs will increase by Sh.550,000. The tax
rate is 35%.
a) Calculate the degree of operating leverage, the degree of financial leverage and
the degree of combined leverage, after expansion, for the two financial plans.
(16 marks)
b) Explain which financial plan you favour and the risks involved. (4 marks)
(Total: 20 marks)
3
QUESTION FOUR
a) Why is short-term financial management one of the most important and timeconsuming
activities of the financial manger? (4 marks)
b) David tools, a manufacturer of metal tools, are currently selling a product for
Sh.100 per unit. Sales (all on credit) for last year were 60,000 units. The variable
cost per unit is Sh.60. The firm’s total fixed costs are Sh.1,200,000.
The firm is currently contemplating a relaxation o the credit standards that is
expected to result in the following: a 5% increase in unit sales to 63,000 units; an
increase in the average collection period from 30 days (the current level) to 45
days; an increase in bad debt expenses from 1% of sales (the current level) to 2%.
The firm’s required return on equal risk investments, which is the opportunity
cost of tying up funds in accounts receivable, is 15%.
Determine whether David tools should relax its credit standards. (16 marks)
(Total: 20 marks)

QUESTION FIVE
Recently controversy has been arising in shareholders meetings on issues regarding the
payment or non-payment of dividend. In some companies the directors are
recommending the non-payment of dividends. In others, the shareholders hold the view
that the recommended dividend is too low.
Required:
(a) Explain any six factors to be considered by directors in the design of a dividend
policy. (12 marks)
(b) Should the shareholders be the ones to decide how much dividend should be paid?
Explain your position. (8 marks)
(Total: 20 marks)

Financial Management Question Paper

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