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Financial Management Question Paper

Financial Management

Course:Bachelor Of Commerce

Institution: Strathmore University question papers

Exam Year:2009

STRATHMORE UNIVERSITY
FACULTY OF COMMERCE
Bachelor of Commerce
END OF SEMESTER EXAMINATION
BCM 2206: FINANCIAL MANAGEMENT
DATE: 4th March 2009 Time: 2 Hour
INSTRUCTIONS
ANSWER QUESTION ONE AND ANY OTHER TWO QUESTIONS
Show all your Workings

Question One
a) Ordinary or common shareholders are regarded as the legal and true owners of a
company and therefore enjoy the right to vote on company decisions. Two important
issues arise as regards voting.
i. Shareholders can either vote in person or by proxy.
ii. Shareholders can vote through two main systems.
Required:
(i) Discuss what voting by proxy refers to? (1 marks)
(ii) State and discuss the two main systems by which shareholders can vote.
(5 marks)
b) You are engaged in a discussion with your class group members about the various
methods of issuing common shares. They only remember one method, which is, the
rights issue. One of the members has correctly described this method as a way of
giving the existing shareholders the right but not the obligation to buy common shares
of the company at a specified price (subscription price - which is usually lower than
the market price), during a specified period of time in proportion to the shareholders
current ownership. Another member has now posed the question, “Why is the
subscription price set lower than current market price?”
Required:
As your contribution to the discussion:
a. State three other methods by which common shares can be issued. (3 marks)
b. Give four reasons as to why the subscription price is set lower than current market
price. (6 marks)
c) The profit after tax of Watatu Ltd. As at 31st December, 2009 was Sh.5,500,000. The
company is quoted at the Nairobi Stock Exchange and its shares are selling for Sh.20
each. The company’s dividend policy is to pay out 40% of its earnings per share as
dividends on its 1,100,000 issued and fully paid shares.
The company’s profit after tax is generally expected to increase by 15% per year for
three years, and 8% per year after that. Dividend payments will grow at the same rate
as profits. The shares of Watatu Limited are expected to sell at Sh.32 per share at the
end of five years from now.
Required:
Determine whether Watatu Limited’s shares are currently undervalued or overvalued
for a person expecting to sell them after 5 years. The cost of capital is 12%
(15 marks)
(Total: 30 marks)

Question Two
a) Munch Melon Manufacturers sells exotic melons at one price, Sh.100 each. The firm
has variable costs of Sh.1.6 million on sales of 320,000 melons. Fixed costs are
Sh.800,000. Operating income (Earning before interest and tax-EBIT) this year is
Sh.800,000 and after-tax net income is Sh.300,000. Interest expense is Sh.200,000.
a. What is its degree of financial leverage at the current level of EBIT? (4 marks)
b. Suppose that EBIT were to decline by 10 percent next year. What would be the
percentage decline in earnings per share (EPS)? (2 marks)
b) Explain the relationship between Degree of Operating Leverage, Degree of Financial
Leverage and Degree of Total Leverage and discuss whether firms attempt to achieve
a high Degree of Operating Leverage and a high Degree of Financial Leverage.
(5 marks)
c) What is dividend policy and what decisions does a manager have to make when it
comes to dividend policy. (9 marks)
(Total: 20 marks)

Question Three
a) What is meant by the optimal capital structure? (2 marks)
b) With the aid of graphs explain the Net Operating Income, Net Income and Static
approaches to capital structure (state the assumptions made).
(18 marks)
(Total: 20 marks)

Question Four
Assume that on 31st March, 2009 you are presented with the following capital structure of
Hardcore Ltd. which is considered optimal.
Sh.’000
Long Term Debt (16%) 135,000
Ordinary Share Capital (Sh.10 par) 90,000
Retained Earnings 75,000
300,000
The company has total assets amounting to Sh.360 million. This figure is expected to rise
to Sh.500 million by 31sat March, 2010. You are also informed that:
1. Any new equity shares sold will net 90% after floatation costs.
2. For the year just ended the company paid Sh.3.00 in dividends per share.
3. New 16% debt can be raised at par through the stock exchange.
4. The past and expected earnings growth rate is 10%
5. The current dividend yield is 12%
6. The company’s dividend payout ratio of 50% shall be maintained in 2009.
7. Assume a marginal tax rate of 30%
8. The company’s optimal capital structure will be maintained during the year.
Required:
a) Calculate the amount of the capital budget to be financed with equity if 85% of
the asset expansion is included in the 2009 capital budget. (3 marks)
b) How many shares must be sold to raise the required equity capital? (Round your
figure to the nearest thousand). (8 marks)
c) What is the firm’s marginal cost of capital? (9 marks)
(Total: 20 marks)

Question Five
a) How does a company’s working capital policy impact on its liquidity-profitability
position? (4 marks)
b) What the primary objective of inventory management? Illustrate with the aid of a
graph how it is achieved? (5 marks)
c) The following inventory cost relationships have been established for Meyu Ltd.
Annual purchases, Sh.1, 080,000.
Purchase price per unit, Sh.30.
Carrying costs, 15% of purchases.
Cost per order placed, Sh.120.
Desired safety stock, 1,500 units. This stock level is on hand initially.
Delivery time, 7 days.
Required:
a. Calculate the economic order quantity. (5 marks)
b. What is the optimal number of orders placed? (3 marks)
c. Calculate the company’s re-order level. (3 marks)
(Total: 20 marks)

Financial Management Question Paper

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