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Financial Management Question Paper

Financial Management

Course:Bachelor Of Commerce

Institution: Strathmore University question papers

Exam Year:2005

STRATHMORE UNIVERSITY
FACULTY OF COMMERCE
BACHELOR OF COMMERCE
END OF SEMESTER EXAMINATION
BCM 2206: FINANCIAL MANAGEMENT
DATE: 31st March 2011 TIME: 2 Hours
INSTRUCTIONS
ANSWER QUESTION ONE AND ANY OTHER TWO QUESTIONS

QUESTION ONE
a) Define the term “cost of capital” and show clearly the factors that affect level of cost of capital of a firm (5 marks)
(b) Explain why the weighted average cost of capital of a firm that uses relatively more debt capital is generally lower than that of a firm that uses relatively less debt capital. (6 marks)
(c) The total of the net working capital and fixed assets of Faida Ltd. as at 30 April 2003
was Sh.100, 000.000. The company wishes to raise additional funds to finance a project
within the next one year in the following manner.
Sh, 30, 000,000 from debt.
Sh, 20, 000, 000, from selling new ordinary shares.
The following items make up the equity of the company:
Sh.
3,000,000 fully paid up ordinary slaves 30,000,000
Accumulated retained earnings 20,000,000
1,000,000 10% preference shares 20,000,000
200,000 6 % long term debentures 30,000,000
The current market value of the company's ordinary shares is Sh.30. The expected
dividend on ordinary shares by 30 April 2004 is forecast at Sh.1.20 per share. The
average growth rate in both earnings and dividends has been 10'% over the last 10
years and this growth rate is expected to be maintained in the foreseeable future.
The debentures of the company have a face value of Sh.150. However, they currently
sell for Sh 100 the debentures will mature in 100 years.
The preference shares were issued four years ago and still sell at
their face value.
Assume a tax rate of 30%
Required:
(i) The expected rate of return on ordinary shares. (3 marks)
2
(ii) The effective cost to the company of
1. Debt capital. (3 marks)
• Preference share capital. (3 marks)
(iii) The company's existing weighted average cost of capital. (5 marks)
(iv) The company's marginal cost of capital if it raised the additional Sh.50, 000,000
as intended. (5 marks) (Total 30 marks)

QUESTION TWO
a) If the required rate of return on a common stock were to increase, what would you
expect to happen to the price of a share of the stock? Explain. (assuming no other
changes) (3 marks)
b) Shakes Computer Chips Inc. is experiencing a period of rapid growth. Earnings
and dividends are expected to grow at a rate of 15% during the next two years, at
13% in the third year, and a constant rate of 6% thereafter. Shakes last dividend
was Sh.1.15, and the required rate of return on the stock is 12%.
a. Calculate the value of the stock today. (9 marks)
b. Calculate P1 and P2. (5 marks)
c. Calculate the dividend yield for years 1, 2 and 3. (3 marks)
(Total 20 marks)

QUESTION THREE
Maridadi Manufacturing and Bidii Brothers Inc. are both involved in the production
of brick for the homebuilding industry. Their financial information is as follows:
Capital Structure
Maridadi Bidii
Debt at 12% 600,000 0
Common stock at Sh.100 per share 400,000 1,000,000
Total 1,00,0000 1,000,000
Operating Plan
Sales (50,000 units at Sh.20 each) 1,000,000 1,000,000
Less: Variable costs 800,000 500,000
Fixed costs 0 300,000
Earnings before interest and taxes (EBIT) 200,000 200,000
a) If you combine Maridadi’s capital structure with Bidii’s operating plan,
what is the degree of combined leverage? (8 marks)
b) If you combine Bidii’s capital structure with Maridadi operating plan,
what is the degree of combined leverage? (8 marks)
c) Explain why you got the results you did in part b. (2 marks)
d) In part b, if sales double, by what percentage will EPS increase?
(2 marks)
(Total 20 marks)
3

QUESTION FOUR
a) Define the term optimal capital structure. (1 mark)
b) Describe the traditional view on the optimum capital structure. Compare and
contrast this view with the Net Operating Income (NOI) approach and the Net
Income (NI) approach. (9 marks)
c) What is the role of the finance manager as regards dividend policy? (5 marks)
d) Explain how any two factors affect a firm’s dividend policy. (5 marks)
(Total 20 marks)

QUESTION FIVE
(a) What is the fundamental trade-off that managers face when managing working
capital? (4 marks)
(b) Why is good inventory management essential to a firm’s success? (4 marks)
(c) Kuongea Limited currently operates with terms of net 30 days. The company has
sales of Sh.12 million and its average collection period is 45 days. To stimulate
demand, the company is considering the possibility of offering terms of net 60
days. If it offers these terms, sales will increase by 20%. After the change, the
average collection period is expected to increase to 75 days with no difference in
payments habits between old and new customers.
The company has variable costs of Sh.70 for every Sh.100 of sales. The required
rate of return on receivables is 20%.
Required:
Should the company extend its credit period? (Assume a 360 days year)
(12 marks)
(Total 20 marks)

Financial Management Question Paper

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