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Financial Management Question Paper
Financial Management
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2011
UNIVERSITY EXAMINATIONS: 2010/2011
SECOND YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 200: FINANCIAL MANAGEMENT (SUNDAY)
DATE: APRIL 2011 TIME: 2 HOURS
INSTRUCTIONS: Answer Question ONE and any other TWO questions
QUESTION ONE
Agency theory provides a basis for explaining the relationship between management
of the firm and the shareholders and between shareholders and debt holders.
Required:
a) What costs arise from the principal agency relationship as the one between
shareholders and management? (9 Marks)
b) How do the actions of shareholders of a limited company affect the market
value of bonds? Explain. (5 Marks)
c) Using principles from agency theory, explain how multinationals are able to
monitor performance of their managers posted around the world and ensure that
their financial goals are achieved. (6 Marks)
d) State and briefly explain the main factors that affect dividend policies in
practice (10 Marks)
QUESTION TWO
a) The following information relates to ABC Limited:
Sh.’000’
Purchase of raw materials 13,400
Usage of raw material 13,000
Sale of finished goods (all on credit) 50,000
Cost of sales (finished goods) 36,000
2
Average creditors 2,800
Average raw materials stock 2,400
Average work in progress 2,000
Average finished goods stock 4,200
Average debtors 9,400
Assume a 360 days year
Required
The length of the operating cash cycle. (10 Marks)
b) What is overtrading? (2 Marks)
c) state the major signs of overtrading (4 Marks)
d) How does overtrading differ from overcapitalization? (4 Marks)
QUESTION THREE
a. Explain the defense tactics available to managers of a target company in order to fend of a
hostile takeover attempt. (10 Marks)
b. The following information relates to two firms Bora Limited and Beta limited.
Firm Sales(Shs) Variable cost(Shs) Fixed cost (Shs)
Bora Ltd. 1,800,000 420,000 900,000
Beta Ltd. 1,500,000 725,000 350,000
Required:
i) Degree of operating leverage for each firm (6 Marks)
ii) Comment on how operating leverage has impacted on earnings available to shareholders
of each firm (4 Marks)
QUESTION FOUR
i. State the main assumptions underlying the capital structure theories 4 Marks
ii. A Ltd and B Ltd. Are identical in all aspects with the exception that A Ltd. is unlevered
while B Ltd. has issued a sh.10 million 5% corporate bond. The earnings before
interest and tax (EBIT) for the two companies are sh.2 million per annum and the
cost of equity of A Ltd. is 10%.
Required
Using the Modigliani and Miller (MM) without taxes model, answer the following:
i) Determine the value of each company (4 Marks)
ii) Determine the cost of equity of B Ltd. (4 Marks)
iii) Determine the weighted average cost of capital of each company (4 Marks)
3
iv) Suppose the value of A Ltd. is sh.20 million and that of B Ltd. is sh.22 million,
determine the arbitrage opportunity available to a shareholder who owns 10% of the
ordinary shares in B Ltd. (4 Marks)
QUESTION FIVE
i. Discuss the following dividend policy theories
Bird in hand theory (4 Marks)
Tax differential theory (4 Marks)
Clientele theory (4 Marks)
ii. The following data relates to a given company:-
1. The minimum cash balance sh.8,000
2. The variance of the daily cash flows for the company sh.4m
3. The transactions cost of buying or selling the security sh.50
4. The interest rate of 0.025% per day
Required
Formulate the decision rate using the Miller and Orr’s model. (8 Marks)
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