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The managing director of Bicdo Ltd., a company quoted on the Nairobi Stock Exchange (NSE)
has asked you to assist in estimating the firm's equity beta...
(Solved)
The managing director of Bicdo Ltd., a company quoted on the Nairobi Stock Exchange (NSE)
has asked you to assist in estimating the firm's equity beta co-efficient. The firm is all equity
financed and listed in the NSE five years ago. You have gathered the following information from
the NSE for the last four years:
Required:
Use the capital asset pricing model (CAPM) to estimate the beta of Bicdo Ltd.
Date posted:
April 19, 2021
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Answers (1)
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Many of the underlying assumptions of CAPM are violated in the real world. Does that fact invalidate the model's conclusions? Explain.
(Solved)
Many of the underlying assumptions of CAPM are violated in the real world. Does that fact invalidate the model's conclusions? Explain.
Date posted:
April 19, 2021
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Answers (1)
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Bara Ltd. is contemplating a bid for the share capital of Pwani Ltd. with an intention of buying the whole company. The following data for...
(Solved)
Bara Ltd. is contemplating a bid for the share capital of Pwani Ltd. with an intention of buying the whole company. The following data for the two companies have been provided.
After acquisition, Bara Ltd. intends to sell a division of Pwani Ltd. which accounts for Sh.20 million
annually in equity earnings. The division does not form part of the core business of the intended group. The
division has a current market price of Sh. 50 million.
Bara Ltd.'s management believes that by introducing better management, earnings of Pwani Ltd. could
be permanently increased by 25% although the price/earnings multiple will remain the same. To avoid duplication,
some of Bara Ltd.'s own property could be disposed of at an estimated price of Sh. 130 million.
Rationalization costs are estimated at Sh. 100 million, these comprise retrenchment and legal costs
among others.
Required:
(a) Highlight the advantages of growth by acquisition.
(b) Calculate the effect on the current share price of each company, all other things being equal, of a two for
ten share offer by Bara Ltd., assuming that Bara Ltd.'s estimates are in line with those of the market.
(c) Assume that Bara Ltd. is proposing to offer Pwani Ltd.'s shareholders the choice of a two for ten
share exchange or a cash alternative. Giving reasons, advise Bara Ltd. whether the cash alternative
should be more or less that the current value of the share exchange.
Date posted:
April 19, 2021
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Answers (1)
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As a senior financial analyst of an investment bank, you are charged with the responsibility of
estimating the expected returns of various securities. One o the...
(Solved)
As a senior financial analyst of an investment bank, you are charged with the responsibility of
estimating the expected returns of various securities. One o the securities you want to estimate is
expected return in Alpha Steel works Ltd.
You have decided to use arbitrage pricing model and you have derived the following estimates
for the factor betas and risk premiums.
Required:
(i) Identify the risk factor for Alpha Steel Works Ltd.
(ii) If the risk free rate is 5%, estimate the expected return on Alpha Steel Works Ltd.
Date posted:
April 19, 2021
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Answers (1)
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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
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Answers (1)
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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
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Answers (1)
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Discuss the importance and limitations of Executive Share Option Plans (ESOPs) in mitigating
management/shareholder agency conflicts.
(Solved)
Discuss the importance and limitations of Executive Share Option Plans (ESOPs) in mitigating
management/shareholder agency conflicts.
Date posted:
April 17, 2021
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Answers (1)
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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)