Goal congruence refers to the situations where the goals of different groups coincide. In many
companies there are potential conflicts of objectives between the owners of the company, the
shareholders, agents and the managers of the company. Other interest groups such as creditors, the
government, employees and the local community might also have conflicting objectives to the
company's shareholders.
One way by which managers and sometimes employees in general might be motivated to take
decision/engage in actions which are consistent with the goals of the shareholders is through
ESOP?s. ESOP?s will not however assist in encouraging goal congruence between
other interest groups and shareholders and managers.
ESOP?s allow managers to purchase a company's shares at a fixed price during a
specified period of time in the future usually a period of years. They are aimed at encouraging
managers to take decisions which will result in high NPV projects which will lead to an increase in
share price and shareholders wealth. The managers are believed to seek high NPV investments as
they as shareholders will participate in the benefits as share prices increases.
There is however little evidence of a positive correlation between share option schemes and the
creation of extra share value. There is no guarantee that ESOP?s will achieve goal
congruence. Share options will only be part of the total remuneration package and may not be the
major influence on managerial decisions. If share prices fall managers do not have to purchase the
shares and the value of the option to buy shares becomes worthless or very small. Although ESOPs
may assist in the achievement of goal congruence they are by no means a perfect solution.
Kavungya answered the question on April 17, 2021 at 20:48
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Tom Donji an investment specialist has been entrusted with Sh.10 million by a unit trust and instructed to invest the money optimally over a two-year...
(Solved)
Tom Donji an investment specialist has been entrusted with Sh.10 million by a unit trust and instructed to invest the money optimally over a two-year period. Part of the instructions are that:
The funds be invested in one or more of four specified projects and in the money market
The four projects are not divisible and cannot be postponed.
The unit requires a return of 24% over the two years.
Over the two-year period, the risk free rate is estimated to be 16%, the market portfolio return, 27% and
the variance of the return on the market, 100%.
Required:
By analyzing the two-asset portfolios:
i ) Use the mean-variance dominance rule to evaluate how Tom Donji should invest the Sh.10 million.
ii) Determine the betas and required rates of return for the portfolios and then use the Capital Asset
Pricing Model (CAPM) to evaluate how Tom Donji should invest the Sh.10 million.
Date posted:
April 17, 2021
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Answers (1)
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What are the limitations of the Capital Asset Pricing Model (CAPM) as an investment appraisal technique?
(Solved)
What are the limitations of the Capital Asset Pricing Model (CAPM) as an investment appraisal technique?
Date posted:
April 17, 2021
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Answers (1)
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The following data relate to call options on two shares, A and B
Required:
Using the Black-Scholes Option Pricing Model (OPM).
Calculate the price of call option A....
(Solved)
The following data relate to call options on two shares, A and B
Required:
Using the Black-Scholes Option Pricing Model (OPM).
Calculate the price of call option A. Of the two call options, which would you expect to have the higher price? Why? (Do not compute).
Date posted:
April 17, 2021
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Answers (1)
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Given below is the Option Pricing Model (OPM) derived by Black and Scholes in 1973 for predicting the market price of call options.
Required:
State and briefly...
(Solved)
Given below is the Option Pricing Model (OPM) derived by Black and Scholes in 1973 for predicting the market price of call options.
Required:
State and briefly explain the relationship between a call option‟s price and the following determinants:
1) the underlying stock‟s price.
2) the exercise price
3) the time to maturity
4) the risk-free rate.
Date posted:
April 17, 2021
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Answers (1)
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City Graphics Limited is evaluating a new technology for its reproduction equipment. The technology will have a
three-year life and would cost Sh.800,000. Its impact on...
(Solved)
City Graphics Limited is evaluating a new technology for its reproduction equipment. The technology will have a
three-year life and would cost Sh.800,000. Its impact on the company‟s cash flows is subject to risk.
In the first year, management estimates that there is an equal chance that the technology will either
succeed and save the company Sh.800,000 or fail saving it nothing at all.
If the technology fails in the first year, savings in the last two years will be zero. Even worse, there is a 40%
chance that additional Sh.240,000 may be required in the second year to convert back to the original process.
If the technology succeeds in the first year, the second year cash flows may be Sh.1,440,000, Sh.1,120,000 or
Sh.800,000 with probabilities of 0.20, 0.60 or 0.20 respectively. Third year cash flows are then expected to be
Sh.160,000 greater or Sh.160,000 less than cash flows in the second year, with equal chance of either
occurring.
All the cash flows above are after taxes.
Required:
a) A probability tree depicting the above cash flow possibilities.
b) Net present values for each possibility using a risk-free rate of 5%.
c) The expected net present value of the technology using a risk-free rate of 5%
Date posted:
April 17, 2021
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Answers (1)
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Explain with the aid of a diagram a protective put buying strategy.
(Solved)
Explain with the aid of a diagram a protective put buying strategy.
Date posted:
April 16, 2021
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Answers (1)
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Explain and illustrate graphically the options concepts of being:
i) “at the money”
ii) “in the money”
iii) “out of the money”
for both a call and put option.
(Solved)
Explain and illustrate graphically the options concepts of being:
i) “at the money”
ii) “in the money”
iii) “out of the money”
for both a call and put option.
Date posted:
April 16, 2021
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Answers (1)
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Using a numeric example, illustrate and explain the pay-offs of a futures option and a futures
contract.
(Solved)
Using a numeric example, illustrate and explain the pay-offs of a futures option and a futures
contract.
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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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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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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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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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)