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- Highlight the limitations of the following methods of dealing with risk in capital budgeting:
(i) Simulation analysis.
(ii) Sensitivity analysis.(Solved)
Highlight the limitations of the following methods of dealing with risk in capital budgeting:
(i) Simulation analysis.
(ii) Sensitivity analysis.
Date posted: April 19, 2021. Answers (1)
- For each of the companies described below, explain which one you would expect to have a medium,
high or a low dividend payout ratio:
(i) A company...(Solved)
For each of the companies described below, explain which one you would expect to have a medium,
high or a low dividend payout ratio:
(i) A company with a large proportion of inside ownership, all of whom are high income individuals.
(ii) A growth company with an abundance of good investment opportunities.
(iii) A company experiencing ordinary growth, has high liquidity and much unused borrowing capacity.
(iv) A dividend-paying company that experiences an unexpected drop in earnings from the trend.
(v) A company with volatile earnings and high business risk.
Date posted: April 19, 2021. Answers (1)
- Rugongo Ltd. is an ungeared company operating in the processed food industry. The company is planning to take over Sauce Ltd. but is unsure on...(Solved)
Rugongo Ltd. is an ungeared company operating in the processed food industry. The company is planning to take over Sauce Ltd. but is unsure on how to value its net assets. Rugongo Ltd.‟s analysts have assembled the following information:
Sauce Ltd.‟s balance sheet as at 30 September 2003
In its most recent trading period ended 30 September 2003, Sauce Ltd.‟s sales were
Sh.500,000,000, but after operating costs and other expenses including a depreciation charge of
Sh.20,000,000, its profit after tax was Sh.20,000,000. This figure includes an extraordinary item (sale of
property) of Sh.5,000,000. The full years dividend was Sh.5,000,000.
Sauce Ltd. has recently followed a policy of increasing dividends by 12% per annum. Its shareholders require
a return of 17%.
The price earnings ratio of Rugongo Ltd. is 14 times and that of Sauce Ltd. is 8 times.
More efficient utilization of Sauce Ltd.‟s assets could generate operating savings of Sh.5,000,000
per annum after tax.
Required:
(i) Current market value of Sauce Ltd.'s share.
(ii) Explain why the market value might differ from the book value.
(iii) A company experiencing ordinary growth, has high liquidity and much unused borrowing capacity.
(iv) The value of Sauce Ltd. using the discounted cash flow method.
Date posted: April 19, 2021. Answers (1)
- Pwani Limited is planning advertising campaigns in three different market areas. The estimates of
probability of success and associated additional profits in each of the three...(Solved)
Pwani Limited is planning advertising campaigns in three different market areas. The estimates of
probability of success and associated additional profits in each of the three markets are provided
below:
Required:
(i) Compute the expected value and standard deviation of profits resulting from advertising campaigns
in each of the market areas.
(ii) Rank the three markets according to riskiness using the coefficient of variation.
Date posted: April 18, 2021. Answers (1)
- Goldstar Manufacturing Limited is evaluating an investment opportunity that would require an
outlay of sh.100 million. The annual net cash inflows are estimated to vary according...(Solved)
Goldstar Manufacturing Limited is evaluating an investment opportunity that would require an
outlay of sh.100 million. The annual net cash inflows are estimated to vary according to economic
conditions.
The firm's required rate of return is 14 percent. The project has an expected life of six years.
Required:
Compute the expected net present value (NPV) of the proposed investment.
Date posted: April 18, 2021. Answers (1)
- The finance director of Benga Ltd. wishes to find the company's optimal capital structure. The
cost of debt varies according to the level of gearing of...(Solved)
The finance director of Benga Ltd. wishes to find the company's optimal capital structure. The
cost of debt varies according to the level of gearing of the company as follows:
The company's ungeared equity beta (asset beta) is 0.85. The risk free rate is 6% per annum
and the market return is 14% per annum. Corporate taxation is at the rate of 30% per year.
Required:
(a) Estimate the company's optimal weighted average cost of capital.
(b) Recommend whether or not the company should adopt the optimal capital structure identified in (a)
above explain the factors that might influence the capital structure decision.
Date posted: April 17, 2021. Answers (1)
- Your company is proposing to erect a new factory in a foreign country at a cost of 20 million local
currency units. Return cash flows will...(Solved)
Your company is proposing to erect a new factory in a foreign country at a cost of 20 million local
currency units. Return cash flows will amount to 27 million local currency units per annum and will
be spread over five years.
What actions would you take to preserve the profitability of this venture in terms of your
home currency?
Date posted: April 17, 2021. Answers (1)
- The purpose of long-term foreign exchange management is not to cover a given foreign
exchange exposure by dealings on the forward markets, but to minimize and,...(Solved)
The purpose of long-term foreign exchange management is not to cover a given foreign
exchange exposure by dealings on the forward markets, but to minimize and, if possible,
eliminate such exposures before they become critical and therefore costly to cover. (Source:
Havard Business Review – March/April 1977)
Comment on the above statement and suggest what actions the financial manager should take
in both the long and short term in order to reduce risks from foreign currency transactions.
Date posted: April 17, 2021. Answers (1)
- The new credit manager of Kay's Departmental Store plans to liberalize the firm's credit
policy. The firm currently generates credit sales of Sh.575,000,000 annually. The more...(Solved)
The new credit manager of Kay's Departmental Store plans to liberalize the firm's credit
policy. The firm currently generates credit sales of Sh.575,000,000 annually. The more lenient credit
policy is expected to produce credit sales of Sh.750,000,000. the bad debt losses on additional sales
are projected to be 5 per cent despite an additional Sh.15,000,000 collection expenditure. The new
credit manager anticipates production and selling costs other than additional bad debt and collection
expenses will remain at the 85 per cent level. The firm is paying tax at 30% tax bracket, after
deductible allowances.
Required:
If the firm maintains a debtors turnover of 10 times, by how much will the debtors balance increase?
What would be the firm's incremental return on investment?
Assuming additional stocks of Sh.35,000,000 are required to support the additional sales, compute the
after tax return on investment.
Date posted: April 17, 2021. Answers (1)
- In an effort to lower its debtor balances, Zen Manufacturing Ltd. is considering switching from its no
discount policy to a 2% discount for payment by...(Solved)
In an effort to lower its debtor balances, Zen Manufacturing Ltd. is considering switching from its no
discount policy to a 2% discount for payment by the fifteenth day. It is estimated that 60% of
Zen's customers would take the discount and the average collection period is expected to
decline from 60 days. Company officials project a 20,000 unit increase in annual sales to 220,000
units at the existing price of Sh.2,500 per unit. The variable cost per unit is Sh.2,100 and the average
cost per unit is Sh.2,300.
If the firm requires a 15% return on investment, should the discount be offered?
Date posted: April 17, 2021. Answers (1)
- The six-months cash forecast for Ken Electricals Ltd., which manufactures household electrical
goods shows that, unless drastic action is taken, the company will be in a...(Solved)
The six-months cash forecast for Ken Electricals Ltd., which manufactures household electrical
goods shows that, unless drastic action is taken, the company will be in a serious liquidity
problem. It is decided that outlay on all types of expenditure must be reduced without
significantly affecting the forecast sales.
Select six headings of expenditure where you consider economies could be made, and describe how
you would achieve savings in these areas.
Date posted: April 17, 2021. Answers (1)
- What are the advantages and disadvantages of a rights issue from the point of view of:
(i) The issuing company?
(ii) The shareholders?(Solved)
What are the advantages and disadvantages of a rights issue from the point of view of:
(i) The issuing company?
(ii) The shareholders?
Date posted: April 17, 2021. Answers (1)
- Explain two circumstances under which dilution of earnings might be acceptable to the shareholders
of one of the companies in a take-over deal.(Solved)
Explain two circumstances under which dilution of earnings might be acceptable to the shareholders
of one of the companies in a take-over deal.
Date posted: April 17, 2021. Answers (1)
- A Kenyan import-export merchant was contracted on 31 December 2002 to buy 1,500 tonnes of a certain
product from a supplier in Uganda at a price...(Solved)
A Kenyan import-export merchant was contracted on 31 December 2002 to buy 1,500 tonnes of a certain
product from a supplier in Uganda at a price of Ush.118,200 per tonne. Shipment was to be made direct
to a customer in Tanzania to whom the merchant had sold the product at TSh.462,000 per tonne. Of the
total quantity, 500 tonnes were to be shipped during the month of January 2003 and the balance by the
end of the month of February 2003. Payment to the suppliers was to be made immediately on
shipment, whilst one month's credit from the date of shipment was allowed to the Tanzanian customer.
The merchant arranged with his bank to cover those transactions in Kenya shillings (Ksh.) on the forward
exchange market. The exchange rates at 31 December 2002 were as given below:
The exchange commission is Ksh.10 per Ksh.1,000 (maximum Sh.1,000,000) on each transaction.
Required:
Calculate (to the nearest Ksh.) the profit that the merchant made during the transaction.
Date posted: April 17, 2021. Answers (1)
- Discuss the role of financial management in an international setting with particular reference to:
(i) Currency exchange rates.
(ii) Sources of finance
(iii) Investing in overseas countries.(Solved)
Discuss the role of financial management in an international setting with particular reference to:
(i) Currency exchange rates.
(ii) Sources of finance
(iii) Investing in overseas countries.
Date posted: April 17, 2021. Answers (1)
- Butere Sugar Company Ltd. Has been enjoying a substantial net cash inflow. Before the surplus
funds are needed to meet tax and dividend payments, and to...(Solved)
Butere Sugar Company Ltd. Has been enjoying a substantial net cash inflow. Before the surplus
funds are needed to meet tax and dividend payments, and to finance further capital expenditure in
several months time, they are invested in a small portfolio of short-term equity investments.
Details of the portfolio, which consist of shares of four companies listed on the stock exchange are
as follows:
The current market return is 19% a year and treasury bill yield is 11% a
year. Required:
On the basis of the data given above, calculate the risk of Butere Sugar Company
Ltd.'s short-term investment portfolio relative to that of the market.
Date posted: April 17, 2021. Answers (1)
- Juma Company Ltd. Which is effectively controlled by the Juma family although they own only a minority of shares, is to undertake a substantial new...(Solved)
Juma Company Ltd. Which is effectively controlled by the Juma family although they own only a minority of shares, is to undertake a substantial new project which requires external finance of about Sh.400 million, leading to a 40% increase in gross assets. The project is to develop and market a new product and is fairly risky. About 70% of the funds required will be spent on land and buildings. The resale value of the land and buildings is expected to remain equal to or greater than, the initial purchase price. Expenditure during the development period of the first 4 to 7 years will be financed from other revenue of Juma Company Ltd. This
will have a consequent strain on the company's overall liquidity.
If, after the development stage, the project proves unsuccessful, then the project will be terminated and its assets sold. If, as is likely, the development is successful, the project's assets will be utilized in production and the company's profits will rise considerably. However, if the project proves to be very successful, then additional finance may be required to further expand the production facilities.
At present, Juma Company Ltd. Is all equity financed.
The financial manager is uncertain whether he should seek funds from a financial institution in the form of an equity interest, a loan (long or short term) r convertible debentures.
Required:
(a) Describe the major factors to be considered by Juma Company Ltd. In deciding on the method of
financing the proposed expansion project.
(b) Briefly discuss the suitability of equity, loans and convertible debentures for the purpose of
financing the project from the point of view of:
(i) Juma Company Ltd.
(ii) The provider of finance.
Clearly state and justify the type of finance recommended for Juma Company Ltd.
Date posted: April 17, 2021. Answers (1)
- The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing
whether its capital investment projects are acceptable, a compound...(Solved)
The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing
whether its capital investment projects are acceptable, a compound interest (DCF) rate of 8% per annum
will be used in evaluating investment projects.
All investment project is now under consideration. Estimates of the expected cash flows over forty years, are as follows:
The expected residual value of the assets is zero.
Required:
(a) Show whether the project satisfies the normal capital budgeting criteria for acceptance.
(b) Show how sensitive the calculation in (a) above is to:
(i) An increase in the residual asset value from zero to sh.1,000,000.
(ii) A 1% increase in the initial capital outlay (during each year of the outlay).
(iii) A 1% decrease in the estimate of expected cash flow during each of the years from 6 to 10.
(c) Show the effect of adopting the project on the ratio of reported profits in years 5 and 6 to net
balance sheet value of assets at the beginning of those two years. Comment briefly on the usefulness
of the latter type of ratio in the interpretation of accounts in the light of your calculation. (Assume
that the expenditure in years 1 to 5 is capitalized, that straight-line depreciation is charged after year 5 at 5% per annum, and the actual cash flows are according to plan).
You can assume that all cash flows arise on the last day of each year, that all figures are net of tax
and expressed in terms of constant price levels, and that working capital for the investment project
can be ignored.
Date posted: April 17, 2021. Answers (1)
- Two relatively small companies, Elgon Company Ltd. And Kilima Company Ltd., have decided in
principle to merge so that they can complete more effectively with larger...(Solved)
Two relatively small companies, Elgon Company Ltd. And Kilima Company Ltd., have decided in
principle to merge so that they can complete more effectively with larger companies. The boards of
directors of the two companies have decided that a scheme of amalgamation should be drawn by
the end of September 2003 based on the following agreed figures:
Required:
Comment on the values which have been placed on the ordinary shares for the purpose of merging
the two companies.
Date posted: April 17, 2021. Answers (1)
- The Development Company of Kenya Ltd. has operated very successfully over the past few years
despite the adverse economic situation. As a result, the company has...(Solved)
The Development Company of Kenya Ltd. has operated very successfully over the past few years
despite the adverse economic situation. As a result, the company has a good liquidity position and a
relatively advantageous stock exchange valuation. The chairman of the company has suggested that
because of this, it should look for growth through a vigorous acquisition policy.
Required:
Prepare a memorandum outlining the points which should be included in an acquisition strategy paper to
be presented for discussion in the next board meeting.
Date posted: April 17, 2021. Answers (1)