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Uses of cost of capital
- In determining the optimal mix of debt and equity.
- Using in project appraisal in computing N.P.V.
- Evaluating managerial performance on ability to generate % return above the
cost of securing capital.
- Dividend decisions – do we retain more profits (pay low dividends) since
retained profits is a cheaper source of finance compared to issue of shares?
marto answered the question on February 12, 2019 at 05:57
- Motor Works Limited intends to raise additional capital through an issue of ordinary
shares of Shs. 80 par value. The company promises to pay dividend at...(Solved)
Motor Works Limited intends to raise additional capital through an issue of ordinary
shares of Shs. 80 par value. The company promises to pay dividend at the rate of Shs. 8
per annum and the expected market price of the shares after six years is Shs. 120.
An investor whose required rate of return is 10% intends to hold the shares for six
years.
Required:
The intrinsic value of the shares
Date posted: February 12, 2019. Answers (1)
- Akili Limited has issued a debenture whose par value is Shs. 1,000. The debenture can
be redeemed at par after four years or converted to ordinary...(Solved)
Akili Limited has issued a debenture whose par value is Shs. 1,000. The debenture can
be redeemed at par after four years or converted to ordinary shares at a conversion rate
of Shs. 100 per share. The projected market price of the share after the four year period
could either be Shs. 90 or Shs. 120 based on the company‟s performance.
The investors required rate of return is 10%.
Required:
The value of the debenture based on each of the expected share prices.
Date posted: February 12, 2019. Answers (1)
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Distinguish between the following sets of terms:
(i) Treasury bills and treasury bonds.
(ii) Complementary projects and mutually exclusive projects.
(iii) Stock splits and stock dividends....(Solved)
Distinguish between the following sets of terms:
(i) Treasury bills and treasury bonds.
(ii) Complementary projects and mutually exclusive projects.
(iii) Stock splits and stock dividends.
Date posted: February 12, 2019. Answers (1)
- Since debt capital is cheaper than equity, companies should resort to one hundred
percent use of debt to finance their investments.
Discuss the limitations of the above...(Solved)
Since debt capital is cheaper than equity, companies should resort to one hundred
percent use of debt to finance their investments.
Discuss the limitations of the above financing policy.
Date posted: February 12, 2019. Answers (1)
- Highlight the importance of the following terms in investment appraisal:
(i) Internal rate of return (IRR)
(ii) Payback period.(Solved)
Highlight the importance of the following terms in investment appraisal:
(i) Internal rate of return (IRR)
Date posted: February 11, 2019. Answers (1)
- Explain three key roles of a capital markets regulator in your country.(Solved)
Explain three key roles of a capital markets regulator in your country.
Date posted: February 11, 2019. Answers (1)
- Although profit maximization has long been considered as the main goal of a firm,
shareholder wealth maximization is gaining acceptance among st most companies as the
key...(Solved)
Although profit maximization has long been considered as the main goal of a firm,
shareholder wealth maximization is gaining acceptance among st most companies as the
key goal of a firm.
Required:
(i) Distinguish between the goals of profit maximization and shareholder wealth
maximization.
(ii) Explain three limitations of the goal of profit maximization
Date posted: February 11, 2019. Answers (1)
- Hisa Limited has 1 million ordinary shares outstanding at the current market price of
Sh.50 per share. The company requires Sh.8 million to finance a proposed...(Solved)
Hisa Limited has 1 million ordinary shares outstanding at the current market price of
Sh.50 per share. The company requires Sh.8 million to finance a proposed expansion
project. The board of directors has decided to make a one for five rights issue at a
subscription price of Sh.40 per share.
The expansion project is expected to increase the firm's annual cash inflow by
Sh.945,000. Information on this project will be released to the market together with the
announcement of the rights issue.
The company paid a dividend of Sh.4.5 in the previous financial year. This dividend,
together with the company's earnings is expected to grow by 5% annually
after investing in the expansion project.
Required:
(i) Compute the price of the shares after the commencement of the rights issue
but before they start selling ex-rights.
(ii) Compute the theoretical ex-rights price of the shares.
(iii) Calculate the theoretical value of the rights when the shares are selling rights
on.
(iv) What would be the cum-rights price per share if the new funds are used to
redeem a Sh.8 million 10% debenture at par? (Assume a corporation tax rate of
30%).
Date posted: February 11, 2019. Answers (1)
- List three advantages of a rights issue from the point of view of:
(i) The issuing company.
(ii) The shareholder.(Solved)
List three advantages of a rights issue from the point of view of:
(i) The issuing company.
(ii) The shareholder.
Date posted: February 11, 2019. Answers (1)
- Mapato Limited is a company involved in the processing of cooking oil. The
management is considering whether to replace an existing cooler with a new one.
The...(Solved)
Mapato Limited is a company involved in the processing of cooking oil. The
management is considering whether to replace an existing cooler with a new one.
The old cooler is fully depreciated and has no salvage value. If not replaced, the
company will continue to incur Sh.1.8 million as annual operating expenses and an
additional Sh.500,000 in repair costs per annum over the next fifteen years.
The new cooler costs Sh.3,150,000. Its annual operating expenses and repair costs are
estimated at Sh.1.3 million and Sh.350,000 respectively over its estimated economic life
of fifteen years. It is expected to be worthless after the expiry of this period.
The cost of capital is 10% and the company depreciates its assets using the straight-line
method.
Assume a 30% corporation tax rate.
Required:
(i) Compute the incremental net annual cash flows if the old cooler is replaced.
(ii) Using the net present value (NPV) method, advise the management on whether
or not to replace the old cooler.
Date posted: February 11, 2019. Answers (1)
- Several methods exist for evaluating investment projects under capital budgeting.
Identify and explain three features of an ideal investment appraisal method(Solved)
Several methods exist for evaluating investment projects under capital budgeting.
Identify and explain three features of an ideal investment appraisal method
Date posted: February 11, 2019. Answers (1)
- The management of Faulu Limited intends to change the company's credit
policy, from 'net 30' to 3/10 net 45'. If this change is effected, annual sales
will...(Solved)
The management of Faulu Limited intends to change the company‟s credit
policy, from 'net 30' to '3/10 net 45'. If this change is effected, annual sales
will increase by 12% from the current level of Sh.12 million while the proportion of
bad debts will increase from 1% to 1.4% of credit sales. A new credit assistant will also
have to be employed at a salary of Sh.260,000 per annum. It is expected that 40% of the
credit customers will benefit from the cash discount.
The inventory level and the variable costs will however remain constant at 20% and
75% of the annual credit sales respectively. The rate of return on investment is 14% per
annum. All sales are on credit.
Assume a 360 days financial year and ignore the effects of taxation.
Required:
Advise the management of Faulu Limited on whether or not to adopt the new credit
policy.
Date posted: February 11, 2019. Answers (1)
- List four factors that should be considered in establishing an effective credit policy.(Solved)
List four factors that should be considered in establishing an effective credit policy.
Date posted: February 11, 2019. Answers (1)
- Distinguish between a credit policy and a working capital policy.(Solved)
Distinguish between a credit policy and a working capital policy.
Date posted: February 11, 2019. Answers (1)
- Comment on the view that the price/earnings (P/E) ratio is an “attempt to
value a company in terms of its earnings'.(Solved)
Comment on the view that the price/earnings (P/E) ratio is an “attempt to
value a company in terms of its earnings'.
Date posted: February 11, 2019. Answers (1)
- List and briefly discuss three possible reasons why companies in the same type of business may have different price/earnings (P/E) ratios.(Solved)
List and briefly discuss three possible reasons why companies in the same type of business may have different price/earnings (P/E) ratios.
Date posted: February 11, 2019. Answers (1)
- Identify six ways in which a company could make preference shares more attractive to a
potential investor.(Solved)
Identify six ways in which a company could make preference shares more attractive to a
potential investor.
Date posted: February 11, 2019. Answers (1)
- What are the determinants of the price of a bond?(Solved)
What are the determinants of the price of a bond?
Date posted: February 11, 2019. Answers (1)
- What are the differences between an 'operating lease' and a 'finance lease'?(Solved)
What are the differences between an 'operating lease' and a 'finance lease'?
Date posted: February 11, 2019. Answers (1)
- Identify any five services that financial intermediaries provide.(Solved)
Identify any five services that financial intermediaries provide.
Date posted: February 11, 2019. Answers (1)