Get premium membership and access questions with answers, video lessons as well as revision papers.
Sensitivity analysis – a method of assessing risk in long term projects in which the effects of changes
in projects viability (planned outcome) are evaluated as a result of changes in critical variables eg.
Cashflows, initial capital, economic life etc affecting the project.
- A range of figures for various estimates may be considered to establish whether a positive or negative
NPV results
Kavungya answered the question on April 19, 2021 at 19:52
- Ridges Company Ltd. is the process of preparing its capital budget for the financial year ending 30 June 2005. The company's capital structure as at...(Solved)
Ridges Company Ltd. is the process of preparing its capital budget for the financial year ending 30 June 2005. The company's capital structure as at 1 July 2004 and which the management considers as optimal
is presented below:
The following additional information is available:
1. The company can borrow a Sh.200 million long to on loan at a pre-tax cost 13. Any additional
debt can be obtained at a pre-tax cost of 16%.
2. The company can raise Sh.400 million through a bond issue. Each bond will have a face value of
Sh.1,000 but will be issued at Sh.687. The coupon rate on the bonds will be 10% with maturity period of
twenty years.
3. Preferred stock can be-issued at a pre-tax cost of 16.5%.
4. The company expects to generate Sh.700 million in net income before tax for the year ending 30
June 2005
5. The average annual growth rate in dividends is 5.5% and this rate is expected to continue into the
foreseeable future. The company expects to pay an ordinary dividend per share of Sh.10 for the year
ending 30 June 2005.
6. The following investment proposals will be available to the company in the year ending 30
June 2005.
Assume a corporation tax rate of 30%
Required:
a) Determine the cost of capital for each of the following sources of finance:
i) Long-term loan
ii) Bonds
iii) Additional Debt
iv) Preference share capital
v) Retained earnings
b) Using the marginal cost of capital (MCC) and internal rate of return (IRR) schedules, determine
the investment project(s) that should be accepted for the year ending 30 June 2005.
Date posted: April 19, 2021. Answers (1)
- Madawa Company Limited, a public quoted company, intends to raise additional share capital through a
rights issue. The number of issued ordinary shares currently stands at...(Solved)
Madawa Company Limited, a public quoted company, intends to raise additional share capital through a
rights issue. The number of issued ordinary shares currently stands at 100 million shares. Each
shareholder will have a right to purchase one share for every five shares currently held. The current
market price per share is Sh.60 while the rights price has been fixed at Sh.50 per share.
Required:
i) Calculate the theoretical value of a right in Madawa Company Limited
ii) Determine the theoretical ex-rights price of a share in the company
Date posted: April 19, 2021. Answers (1)
- Creation of shareholder value has become a generally accepted corporate objective. To facilitate the
realization of this objective, value based management systems (VBMs) which integrate finance...(Solved)
Creation of shareholder value has become a generally accepted corporate objective. To facilitate the
realization of this objective, value based management systems (VBMs) which integrate finance theory and
strategic management thinking have been developed by scholars.
Required:
i) Explain the main determinants of shareholder value
ii) Discuss tile factors that have stimulated the increased interest by companies in value based
management systems
Date posted: April 19, 2021. Answers (1)
- The investment portfolio of Mapeni Limited consists of shares in five companies operating in
different industries.
Required:
(i) Compute the expected return from the market (Rm).
(ii) Calculate...(Solved)
The investment portfolio of Mapeni Limited consists of shares in five companies operating in
different industries.
Required:
(i) Compute the expected return from the market (Rm).
(ii) Calculate the beta coefficient for the portfolio (βp).
(iii) Determine the equation for the security market line.
Date posted: April 19, 2021. Answers (1)
- The following details relating to Bidii Limited show how the level of gearing affects the
company's cost of debt.
Required:
Determine the company's optimal capital structure.(Solved)
The following details relating to Bidii Limited show how the level of gearing affects the
company's cost of debt.
Required:
Determine the company's optimal capital structure.
Date posted: April 19, 2021. Answers (1)
- Distinguish between a currency option and a currency swap.(Solved)
Distinguish between a currency option and a currency swap.
Date posted: April 19, 2021. Answers (1)
- Highspeed Electronics Limited has taken delivery of 50,000 electronic devices from an American
company. The seller is in a strong bargaining position and has priced the...(Solved)
Highspeed Electronics Limited has taken delivery of 50,000 electronic devices from an American
company. The seller is in a strong bargaining position and has priced the devices in American dollars
at USD12.00 each.
Highspeed Electronics Limited has been granted three months credit. Assume that interest rates in
America are 3% per quarter (three months). Highspeed electronics Limited has all its money tied up
in its operations but it could borrow in dollars at 3% per quarter if necessary.
Foreign exchange rates
USD = Sh. 1
Spot 0.013
Three month forward 0.0154
A three month dollar call option for USD 600,000 is available at a premium of USD15,000.
Required:
Using suitable computations, illustrate two hedging strategies available to Highspeed
Electronics Limited.
Date posted: April 19, 2021. Answers (1)
- Globalization has resulted in several organizations engaging in corporate alliances and the
establishment of several trading blocks. The advent of e-commerce has enabled companies to greatly
expand...(Solved)
Globalization has resulted in several organizations engaging in corporate alliances and the
establishment of several trading blocks. The advent of e-commerce has enabled companies to greatly
expand their markets.
Required:
Identify and elaborate on five factors that complicate financial management in multi-national firms.
Date posted: April 19, 2021. Answers (1)
- Leo Plastics Limited is an all equity financed company. It had three strategic business divisions as on
1 January 2004:
1. The Polythene division
It has a capital...(Solved)
Leo Plastics Limited is an all equity financed company. It had three strategic business divisions as on
1 January 2004:
1. The Polythene division
It has a capital of Sh. 8 million and is expected to produce returns of 11% on capital for the
next five years. Thereafter, it will produce returns equal to the required rate of return of 14% for
its risk level.
2. The Paper division
It has a capital of Sh. 12 million and a planning horizon of 10 years. During this planning
horizon, it will produce a return of 12% on capital compared with a risk adjusted required rate
of return of 15%.
3. The Container division
It has a capital of Sh. 12 million and a planning horizon of 7 years. The required rate of return
on capital is 16% compared with the anticipated actual rate of 17% over the first seven years.
Required:
Calculate the present value of the company as on 1 January 2004.
Date posted: April 19, 2021. Answers (1)
- The board of directors of Masii Limited is divided on whether to adopt a high or low dividend
payout policy. One of the directors has quoted...(Solved)
The board of directors of Masii Limited is divided on whether to adopt a high or low dividend
payout policy. One of the directors has quoted the „dividend discount model as
proof that the higher the dividends, the higher the share price.
Required:
(i) Highlight two arguments for and against a high dividend payout policy.
(ii) Using a constant growth dividend discount model, evaluate the director's statement.
Date posted: April 19, 2021. Answers (1)
- Kasuku Limited has set aside Sh. 40 million for investments as on 1 January 2004. Five proposals are presented to the company's board of directors...(Solved)
Kasuku Limited has set aside Sh. 40 million for investments as on 1 January 2004. Five proposals are presented to the company's board of directors by the finance manager as shown below:
Additional information:
1. Projects D and E are mutually exclusive.
2. Each project is divisible and can only be undertaken once.
3. Variable costs are 40% of annual revenue.
4. All cash flows will occur at the end of the year commencing 31 December 2004.
5. Cost of capital is 10% (ignore tax).
Required:
i. Determine the optimal allocation of the Sh. 40 million amongst the five projects.
ii. What is the net present value resulting from this allocation?
Date posted: April 19, 2021. Answers (1)
- “Total Risk Management (TRM) will become a common term in finance just like Total Quality
Management (TQM) has in production and marketing.” (Professor Andrew W. Lo....(Solved)
“Total Risk Management (TRM) will become a common term in finance just like Total Quality
Management (TQM) has in production and marketing.” (Professor Andrew W. Lo. 1999).
Required:
(i) Define risk management as used in finance.
(ii) Discuss reasons why risk management might increase shareholders wealth.
Date posted: April 19, 2021. Answers (1)
- Savanna Limited has a cost of equity of 10%. Currently it has 250,000 ordinary shares which are quoted
at the Stock Exchange of Sh. 120 per...(Solved)
Savanna Limited has a cost of equity of 10%. Currently it has 250,000 ordinary shares which are quoted
at the Stock Exchange of Sh. 120 per share. The company's earnings per share is Sh. 10
and it intends to maintain a dividend payout ratio of 50% at the end of the current financial year.
The expected net income for the current year is Sh. 3 million and the available investment
proposals are estimated to cost Sh. 6 million.
Required:
(i) Using the Modigliani and Miller (MM) model, show that the payment of dividends does not affect the value of the firm.
(ii) What are the assumptions inherent in the MM model?
Date posted: April 19, 2021. Answers (1)
- As an expert in the financial management of public projects, you have been requested to present a
seminar paper on “Project Management in the Public Sector;...(Solved)
As an expert in the financial management of public projects, you have been requested to present a
seminar paper on “Project Management in the Public Sector; challenges and dilemmas.”
Required:
Explain the main issues you would address in your paper under the following headings:
(i) Phases of a public project.
(ii) Planning and control techniques for a public project.
(iii) Causes of failure of public projects.
Date posted: April 19, 2021. Answers (1)
- 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. Answers (1)
- 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. Answers (1)
- The financial manager of Town Ltd. is concerned about the volatility of interest rates. His company
needs to borrow Sh. 100 million in six months time...(Solved)
The financial manager of Town Ltd. is concerned about the volatility of interest rates. His company
needs to borrow Sh. 100 million in six months time for a period of two years. Current interest rates
are 15% per year for the type of loan that Town Ltd. needs. The financial manager does not wish to
pay an interest rate higher than this. He is considering using different alternatives. For the following
four alternatives, briefly explain how each could be useful to the financial manager:
(i) Forward rate agreement.
(ii) Interest rate futures
(iii) Interest rate options.
(iv) Interest rate swaps.
Date posted: April 19, 2021. Answers (1)
- As a firm operating in a mature industry, Orchard Farms is expected to maintain a constant dividend
pay out ratio and constant growth rate of earnings...(Solved)
As a firm operating in a mature industry, Orchard Farms is expected to maintain a constant dividend
pay out ratio and constant growth rate of earnings for the foreseeable future. Earnings were Sh. 4.50
per share in the recently completed fiscal year. The dividend pay out ratio has been a constant 55%
in recent years and is expected to remain so. Orchard Farms' return on equity (ROE) is
expected to remain at 10% in the future, and you require an 11% return on the stock.
Required:
(i) Using the constant dividend growth model, calculate the current value of Orchard Farms‟ share.
(ii) After aggressive acquisition and marketing programme, it now appears that Orchard
Farms‟ earnings per share and ROE will grow rapidly over the next two years. Assuming
the Orchard Farms‟dividend will grow at a rate of 15% for the next two years, returning in the
third year, to the historical growth and continuing at the historical rate of the foreseeable future.
Calculate Orchard Farms‟ current market rate.
Date posted: April 19, 2021. Answers (1)
- The Better Shoe Company is considering a major investment in a new product area, novelty
umbrellas. It hopes that this product will become a fashion icon....(Solved)
The Better Shoe Company is considering a major investment in a new product area, novelty
umbrellas. It hopes that this product will become a fashion icon. The following information has
been collected:
1. The project will have a limited life of 11 years.
2. The initial investment in plant and machinery will be Sh. 10 million and a marketing budget
of Sh. 2 million will be allocated to the first year.
3. The net cash flows before depreciation of plant and machinery and before
marketing expenditure for each umbrella will be Sh. 100.
4. The products will be introduced both in Kenya and Uganda.
5. The marketing costs in years 2 to 11 will be Sh. 5 million per annum.
6. If the product catches the imagination of the customers in both countries, then sales in the
first year are anticipated at 1 million umbrellas.
7. If the fashion press ignores the new products in one country but become enthusiastic in
the other, sales ill be 700,000 umbrellas in year 1.
8. If the marketing launch is unsuccessful in both countries, first year sales will be 200,000
umbrellas.
The probability of each of these events occurring is:
1 million sales = 0.3
0.7 million sales = 0.4
0.2 million sales = 0.3
9. If the first year is successful in both countries then two possibilities are envisages.
Sales levels are maintained at 1 million units per annum for the next 10 years – probability of 0.3.
The product is seen as a temporary fad and sales fall to 100,000 units for the remaining 10 years
– probability of 0.7.
10. If success is achieved in only one country in the first year, then for the remaining 10 years
there is:
A 0.4 probability of maintaining the annual sales at 700,000 units and
A 0.6 probability of sales immediately falling to 50,000 units per year.
If the marketing launch is unsuccessful in both countries, the production will cease and the
project will be scraped with zero value. The annual cash flows and marketing costs will be payable
at each year end.
Assume:
Cost of capital is 10 per cent per annum.
No inflation or taxation.
No exchange rate charges.
Required:
(i) Calculate the expected net present value for the project.
(ii) Calculate the standard deviation for the project.
(iii) If the project produces a net present value of less that Sh. 10 million, the directors fear that the
company will be vulnerable to a hostile takeover. Calculate the probability of the firm avoiding a
hostile takeover. Assume normal distribution.
Date posted: April 19, 2021. Answers (1)
- 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. Answers (1)