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What assumptions must be made in deriving the Capital Asset Pricing Model (CAPM)?
(Solved)
What assumptions must be made in deriving the Capital Asset Pricing Model (CAPM)?
Date posted:
April 16, 2021
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Answers (1)
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A comparative study of the records of two oil companies, A Ltd. and B Ltd., in terms of their asset composition, capital structure and profitability...
(Solved)
A comparative study of the records of two oil companies, A Ltd. and B Ltd., in terms of their asset composition, capital structure and profitability shows that they have been very similar for the past five years. The only significant difference between the two firms is their dividend policy. A Ltd. maintains a constant dividend per share while B Ltd. maintains a constant dividend pay-out ratio. Relevant data is as follows:
Required:
a) For each company, determine the dividend pay-out ratio and the price – earnings ratio for each of
the five years.
b) B Ltd‟s management is surprised that the shares of this company have not performed as well
as A Ltd‟s in the stock exchange. What explanation would you offer for this state of affairs?
c) Comment on the applicability of the Simple Price/Earnings (P/E) ratio to the typical technology
(IT) company with a high valuation and heavy losses.
Date posted:
April 16, 2021
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Answers (1)
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Gathura Ltd. is evaluating the acquisition of a heady duty forklit. The company can either purchase
the equipment through the use of its normal financing mix...
(Solved)
Gathura Ltd. is evaluating the acquisition of a heady duty forklit. The company can either purchase
the equipment through the use of its normal financing mix (30% debt and 70% equity) or lease it.
The following additional information is available:
1. Acquisition price Sh.8,000,000
2. Useful life 4 years
3. Salvage value Sh.1,600,000
Depreciation method – straight line
Annual (before tax and depreciation) cash savings Sh.2,400,000
Rate of interest on a four year period 10%
Marginal tax rate 10%
Annual lease rentals Sh.2,400,000
Annual operating expenses Sh. 400,000
Cost of capital 12%
Required:
i) Evaluate whether acquisition of the forklift through purchase is justified.
ii) Should Gathura Ltd. lease the asset?
Date posted:
April 16, 2021
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Answers (1)
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State the main ways of classifying leases.
(Solved)
State the main ways of classifying leases.
Date posted:
April 16, 2021
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Answers (1)
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Outline the advantages of swaps.
(Solved)
Outline the advantages of swaps.
Date posted:
April 16, 2021
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Answers (1)
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A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced price of
Z 150,000 (Zed (Z) is the currency of...
(Solved)
A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced price of
Z 150,000 (Zed (Z) is the currency of Zedland). Of this amount, Z 60,000 will be payable on
shipment, Z 45,000 one month after shipment and Z 45,000 three months after shipment.
The quoted foreign exchange rates (Z per KSh.) at the date of shipment as as follows:
Spot 1.690 - 1.692
One month 1.687 - 1.690
Three months 1.680 - 1.684
The company decides to enter into appropriate forward exchange contracts through a bank in
order to hedge these transactions.
Required:
i) State the advantages of hedging in this way.
ii) Calculate the amount in Kenya Shillings that the Kenyan Company would receive.
iii) Comment with hindsight on the wisdom of hedging in this instance, assuming that the spot rates at
the dates of receipt of the two instalments of Z 45,000 were as follows:
Fist instalment 1.69 - 1.69
Second instalment 1.700 - 1.704
Date posted:
April 16, 2021
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Answers (1)
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The Lakeside Company Limited is considering investing in a project requiring an initial outlay of Sh.100
million. The project life is two years after which there...
(Solved)
The Lakeside Company Limited is considering investing in a project requiring an initial outlay of Sh.100
million. The project life is two years after which there would be no expected salvage value. The possible
incremental after-tax cash flows and associated probabilities of occurrence as as follows:
The company‟s required rate of return for this investment is 12%.
Required:
a) i) The expected net present value of the project.
ii) Suppose that the possibility of abandonment exists and that the abandonment value of the project at
the end of the first is Sh.50 million after taxes is abandonment the right choice?
iii) Calculate the new expected net present value assuming that the company would abandon the project if it
is advantageous to do so. What are the implications of this calculation to you as a Finance Manager?
b) Identify the case for and against Sensitivity Analysis as a method of handling risk in capital budgeting.
Date posted:
April 16, 2021
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Answers (1)
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In the recent past, the government has been aggressively wooing multinational companies to
come and invest their resources in Kenya.
Analyze the key decision areas that a...
(Solved)
In the recent past, the government has been aggressively wooing multinational companies to
come and invest their resources in Kenya.
Analyze the key decision areas that a financial analyst would have to advise a company that
is considering making direct investment in Kenya and discuss the risks involved.
Date posted:
April 16, 2021
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Answers (1)
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KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business
risk and are almost identical in all respects...
(Solved)
KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business
risk and are almost identical in all respects for their capital structures and total market values. The companies
capital structures are summarized below:
KT‟s ordinary shares are trading at Sh.170 and debentures at Sh.100. Annual earnings
before interest and tax for each company is Sh.50 million.
Corporate tax is at the rate of 30%.
Required:
a) If you owned 4% of the ordinary shares of KT Ltd. and you agreed with the arguments of
Modigliani and Miller, explain what action you would take to improve your financial position.
b) Estimate by how much your financial position is expected to improve. Personal taxes may be
ignored and assumptions made by Modigliani and Miller may be used.
c) If KK Ltd. was to borrow Sh.40 million, compute and explain the effect this would have on the
company‟s cost of capital according to Modigliani and Miller. What implications would this suggest
for the company‟s choice of capital structure?
Date posted:
April 16, 2021
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Answers (1)
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Maendeleo Industries is concerned about interest rates rising. It needs to borrow in the bond market
three months hence. The company believes that an option on...
(Solved)
Maendeleo Industries is concerned about interest rates rising. It needs to borrow in the bond market
three months hence. The company believes that an option on treasury bond futures is the best
hedging device.
i) Should the company buy a put option or a call option? Explain.
ii) Presently, the futures contract trades at Sh.1,000 and 3 month put and call options
both involve premiums of 1½ per cent based on this strike price. During the 3 months,
interest rates rise, so that the price on a treasury bond futures contract goes to Sh.950. What
is your gain or loss on the option per Sh.1,000,000 contract?
Date posted:
April 16, 2021
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Answers (1)
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Jabali Ltd. is a quoted company which is financed by 10,000,000 ordinary shares and Sh.50,000,000 of
irredeemable 8% debentures. The market value of the shares is...
(Solved)
Jabali Ltd. is a quoted company which is financed by 10,000,000 ordinary shares and Sh.50,000,000 of
irredeemable 8% debentures. The market value of the shares is Sh.20 each ex-div and an annual dividend of
Sh.4 per share is expected to be paid in perpetuity. The debentures are considered to be risk-free and are
valued at par.
Mr. Jabali the managing director of the company is wondering whether to invest in a project which cost
Sh.20 million and yield Sh.3.8 million a year before tax in perpetuity. The project has an estimated beta value
of 1.25. The return from a well-diversified market portfolio is 16%.
Required:
a) The weighted average cost of capital of the company.
b) The beta of the company.
c) The beta of an equivalent ungeared company ignoring taxes.
d) Advise the company whether/or not the project should be accepted. In your explanation, highlight
the significance of your calculations in (a), (b) and (c) above.
Date posted:
April 16, 2021
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Answers (1)
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Company A is considering investing in a project which has a three year life. The project would involve an initial investment of Sh.20 million. The...
(Solved)
Company A is considering investing in a project which has a three year life. The project would involve an initial investment of Sh.20 million. The finance manager has come up with expected probabilities for various possible economic conditions as follows:
Required:
Assuming a discount rate of 15% should company A invest in the project?
Date posted:
April 16, 2021
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Answers (1)
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Assume all things are held constant other than the item in question, for each of the
companies below:
A company with a large proportion of insider ownership...
(Solved)
Assume all things are held constant other than the item in question, for each of the
companies below:
A company with a large proportion of insider ownership all of whom are high-income
individuals. A growth company with an abundance of good investment opportunities.
A company experiencing ordinary growth that has high liquidity and much unused borrowing
capacity. A dividend paying company that experiences an unexpected drop in earnings from a trend.
A company with volatile earnings and high business risk.
Required:
Explain whether or not you would expect each company to have a medium/high or a low dividend payment
ratio and the reasons for such categorization.
Date posted:
April 16, 2021
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Answers (1)
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Explain the factors that finance managers should analyze before making a dividend decision.
(Solved)
Explain the factors that finance managers should analyze before making a dividend decision.
Date posted:
April 16, 2021
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Answers (1)
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Highlight the limitations of using commercial paper as a form of short-term credit.
(Solved)
Highlight the limitations of using commercial paper as a form of short-term credit.
Date posted:
April 16, 2021
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Answers (1)
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Chuma Company Ltd is considering various levels of debt. Currently it has no debt. It has a total
market value of Sh.30 million. By undertaking debt...
(Solved)
Chuma Company Ltd is considering various levels of debt. Currently it has no debt. It has a total
market value of Sh.30 million. By undertaking debt it believes that it can achieve a net tax advantage
equal to 20% of the amount of debt. However the company will incur bankruptcy and agency costs
as well as lenders increasing their interest rate if it borrows too much. The company‟s
managing director believes that the company can borrow up to Sh.10 million without incurring
any of these costs. However, each additional Sh.10 million increment in borrowing is expected to
result in the three costs cited being incurred. Moreover, the three costs are expected to increase at
an increasing rate with leverage. The present value cost of various levels of debt is as follows:
Required:
Advise the managing director on the optimal amount of debt for Chuma Company.
Date posted:
April 16, 2021
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Answers (1)
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Mr. Mlachake is currently holding a portfolio consisting of shares of four companies quoted on the Bahati Stock Exchange as follows:
The current market return is...
(Solved)
Mr. Mlachake is currently holding a portfolio consisting of shares of four companies quoted on the Bahati Stock Exchange as follows:
The current market return is 14% per annum and the treasury bills yield is 9% per annum.
Required:
(i) Calculate the risk of Mlachake‟s portfolio relative to that of the market.
(ii) Explain whether or not Mlachake should change the composition of his portfolio.
Date posted:
April 16, 2021
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Answers (1)
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Briefly explain three practical uses of the capital asset pricing model.
(Solved)
Briefly explain three practical uses of the capital asset pricing model.
Date posted:
April 16, 2021
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Answers (1)