Get premium membership and access questions with answers, video lessons as well as revision papers.
Got a question or eager to learn? Discover limitless learning on WhatsApp now - Start Now!

Mr. Kakai Manufacturing Co. Ltd has an average selling price of Sh.1000 for a component it manufactures for sale in the local market. Variable costs are...

      

Mr. Kakai Manufacturing Co. Ltd has an average selling price of Sh.1000 for a component it manufactures for
sale in the local market. Variable costs are Sh.700 per unit and fixed costs amount to Sh.17 million.
The company has financed its assets by having issued 40,000 ordinary shares.
Another company in the same industry, Bantu Manufacturers, has the same operating information but has
financed its assets with 20,000 ordinary shares and a loan, which has an interest payments of Sh.160,000 per
year. Both companies are in the same 40% tax bracket and have sales of Sh.70 m in the current financial year.
Required:
(a) For each company, determining the degree of operating leverage and the degree of financial leverage.
(b) Calculate the degree of combined leverage for each firm. Explain the difference in the result.
(c) Compute the break-even points for the two companies. What are your observations?
(d) Calculate the earnings per share (EPS) at the point of indifference between the two companies earnings.
(f) Explain the position of Modigliani and Miller (MM) with respect to the use of leverage in a firm.

  

Answers


Kavungya
fig4234247.png
fig5234249.png
fig6234250.png
Kavungya answered the question on April 23, 2021 at 11:51


Next: The following data have been provided with respect to three shares traded on the Nairobi Stock Exchange (NSE). ...
Previous: Discuss the major theories that explain the behaviour of the yield curve and discuss the implication of yield curve analysis in financial management.

View More CPA Advanced Financial Management Questions and Answers | Return to Questions Index


Learn High School English on YouTube

Related Questions


  • The following data have been provided with respect to three shares traded on the Nairobi Stock Exchange (NSE). ...(Solved)

    The following data have been provided with respect to three shares traded on the Nairobi
    Stock Exchange (NSE).
    Share A Share B Share C
    Risk free rate of return 0.120 0.120 0.120
    Beta coefficient 1.340 1.000 0.750
    Return on the NSE index 0.185 0.185 0.185
    Required:
    (i) What is the beta coefficient?
    (ii) Interpret the beta coefficient of shares A, B and C.
    (iii) Using the Capital Asset Pricing Model, compute the expected return
    on shares A, B and C.
    (iv) Can the beta coefficient be less than zero? Explain

    Date posted: April 23, 2021.  Answers (1)

  • The Capital Asset Pricing Model is a powerful technique in the estimation of risk of a particular security. It nevertheless is not applicable in the real...(Solved)

    The Capital Asset Pricing Model is a powerful technique in the estimation of risk of a particular
    security. It nevertheless is not applicable in the real world due to its many limiting assumptions.
    Required:
    Discuss the above statement.

    Date posted: April 23, 2021.  Answers (1)

  • You have been provided with the following information about a project, which XYZ Ltd. is planning to undertake soon. Required: (a) Calculate the project?s net investment. (b) Using...(Solved)

    You have been provided with the following information about a project, which XYZ Ltd. is planning to undertake soon.
    fig30224625.png
    Required:
    (a) Calculate the project‟s net investment.
    (b) Using the net present value method, show whether or not the project should be undertaken by the company.
    (c) Suppose in addition to the information given above you are provided with the following cash
    flows certainty equivalents:
    Year 0: 1.00
    Year 1: 0.90
    Year 2: 0.80
    Year 3: 0.60
    Year 4: 0.50
    Year 5: 0.40
    Does your conclusion about the acceptability of the project in part (c) above change? Explain.

    Date posted: April 22, 2021.  Answers (1)

  • Explain briefly what is meant by foreign currency options and give examples of the advantages and disadvantages of exchange traded foreign currency options to the...(Solved)

    Explain briefly what is meant by foreign currency options and give examples of the advantages and disadvantages of exchange traded foreign currency options to the financial manager.

    Date posted: April 22, 2021.  Answers (1)

  • You are required to discuss whether a multinational company should hedge translation exposure by incurring transaction exposure.(Solved)

    You are required to discuss whether a multinational company should hedge translation exposure by incurring transaction exposure.

    Date posted: April 22, 2021.  Answers (1)

  • A company operating in a country having the dollar as its unit of currency has today invoiced sales to the United Kingdom in sterling, payment being...(Solved)

    A company operating in a country having the dollar as its unit of currency has today invoiced sales to the
    United Kingdom in sterling, payment being due three months from the date of invoice. The invoice
    amount is £3,000,000 which, at today's spot rate of 1.5985 is equivalent to USD4,795,500.
    It is expected that the exchange rate will decline by about 5% over the three month period and in
    order to protect the dollar proceeds from the sale, the company proposes taking appropriate
    action through either the foreign exchange market or the money market.
    The USD/£ three-months forward exchange rate is quoted as 1.5858-1.5873. the three-months
    borrowing rate for Eurosterling is 15.0% and the deposit rate quoted by the company's own
    bankers is currently 9.5%.
    You are required to
    Explain the alternative courses of action available to the company, with relevant calculations to four
    decimal places, and to advise which course of action should be adopted.

    Date posted: April 22, 2021.  Answers (1)

  • Fidden is a medium-sized UK company with export and import trade with the USA. The following transactions are due with the next six months. Transactions...(Solved)

    Fidden is a medium-sized UK company with export and import trade with the USA. The following transactions are due with the next six months. Transactions are in the currency specified.
    Purchases of components, cash payment due in three months: £116,000
    Sales of finished goods, cash receipt due in three months: USD 197,000
    Purchase of finished goods for resale, cash payment due in six months: USD 447,000
    Sale of finished goods, cash receipt due in six months: USD 154,000
    fig24224612.png
    Assume that it is now December with three months to expiry of the March contract and that the option
    price is not payable until the end of the option period, or when the option is exercised.
    You are required:
    (i) to calculate the net sterling receipts/payments that Fidden might expect for both its three and
    six month transactions if the company hedges foreign exchange risk on:
    the forward foreign exchange market; the money market.
    (ii) If the actual spot rate in six months time was with hindsight exactly the present six months forward
    rate, calculate whether Fidden would have been better to hedge through foreign currency
    options rather than the forward market or money market.
    (iii) to explain briefly what you consider to be the main advantage of foreign currency options.

    Date posted: April 22, 2021.  Answers (1)

  • Provincial plc is contemplating a bid for the share capital of National plc. The following statistics are available: Provincial plc?s plan is to reduce the scale...(Solved)

    Provincial plc is contemplating a bid for the share capital of National plc. The following statistics are available:
    fig20224606.png
    Provincial plc's plan is to reduce the scale of National plc's operations by selling off a division
    which accounts for Sh.1,500,000 of National plc's latest earnings, as indicated above. The estimated
    selling price for the division is Sh.10.2 million.
    Earnings in National plc's remaining operations could be increased by an estimated 20% on a
    permanent basis by the introduction of better management and financial controls. Provincial plc does not anticipate
    any alteration to National plc's price/earnings multiple as a result of these improvements in earnings.
    To avoid duplication, some of Provincial plc's own property could be disposed of at an
    estimated price of Sh.16 million.
    Rationalization costs are estimated at Sh.4.5 million.
    You are required:
    (a) to calculate the effect on the current share price of each company, all other things being equal, of a two-for nine share offer by Provincial plc, assuming that Provincial plc's estimates are in line with
    those of the market;
    (b) to offer a rational explanation of why the market might react to the bid by valuing National plc's
    shares at (i) a higher figure and (ii) a lower figure than that indicated by Provincial plc's offer
    even though the offer is in line with market estimates of the potential merger synergy.
    (c) Assume that Provincial plc is proposing to offer National plc shareholders the choice of the two-fornine
    share exchange or a cash alternative.
    You are required to advice Provincial plc whether the cash alternative should be more or less
    than the current value of the share exchange, giving your reasons.
    (d) Assume now that Provincial plc, instead of making a two-for-nine share exchange offer, wishes
    to offer an exchange which would give National plc shareholders a 10% gain on the existing
    value of their shares.
    You are required to calculate what share exchange would achieve this effect, assuming the same
    synergy forecasts as before.

    Date posted: April 22, 2021.  Answers (1)

  • The board of directors of Rutherford plc is arguing about the company's dividend policy. Director A is infavour of financing all investment by retained earnings and...(Solved)

    The board of directors of Rutherford plc is arguing about the company's dividend policy.
    Director A is infavour of financing all investment by retained earnings and other internally generated funds.
    He argues that a high level of retentions will save issue costs, and that declaring dividends always results in a
    fall in share price when the shares are traded ex div.
    Director B believes that the dividend policy depends upon the type of shareholders that the company
    has, and that dividends should be paid according to shareholders' needs. She presents data
    relating to the company's current shareholders.
    fig19224556.png
    She argues that the company‟s shareholder „clientele‟ must be identified, and dividends
    fixed according to their marginal tax brackets.
    Director C agrees that shareholders are important, but points out that many institutional shareholders
    and private individuals rely on dividends to satisfy their current income requirements, and prefer a known
    dividend now to an uncertain capital gain in the future.
    Director D considers the discussion to be a waste of time. He believes that one dividend policy is as good as
    other, and that dividend policy has no effect on the share price.
    You are required to discuss critically the arguments for each of the four directors using both
    the information provided and any other evidence on the effect of dividend policy on share price that
    you consider to be relevant.

    Date posted: April 22, 2021.  Answers (1)

  • The managing director of Wemere, a medium -sized private company, wishes to improve the company's investment decision-making process by using discounted cash flow techniques. He is disappointed...(Solved)

    The managing director of Wemere, a medium -sized private company, wishes to improve the
    company's investment decision-making process by using discounted cash flow techniques. He is
    disappointed to learn that estimates of a company‟s cost of capital usually require information on
    share prices which, for a private company, are not available. His deputy suggests that the cost of equity
    can be estimated by using data for Folten Ltd., a similar sized company in the same industry whose shares
    are listed on the SE, and he has produced two suggested discount rates for use in Wemere's future
    investment appraisal. Both of these estimates are in excess of 17% per year which the managing director
    believes to be very high, especially as the company has just agreed a fixed rate bank loan at 13% per year to
    finance a small expansion of existing operations. He has checked the calculations, which are numerically
    correct, but wonders if there are any errors of principle.
    Estimate 1: capital asset pricing model
    Data have been purchased from a leading business school:
    Equity beta of Folten 1.4
    Market return 18%
    Treasury bill yield 12%
    The cost of capital is 18% +(18% - 12%)1.4 = 26.4%.
    This rate must be adjusted to include inflation at the current level of 6%. The recommended discount rate is 32.4%.
    fig10224459.png
    Notes:
    (1) The current ex-div share price of Folten plc is Sh.13.80.
    (2) Wemere's board of directors has recently rejected a take-over bid of Sh.10.6 million.
    (3) Corporate tax is at the rate of 35%.
    You are required:
    (a) to explain any errors of principle that have been made in two estimates of the cost of capital
    and produce revised estimates using both of the methods.
    State clearly any assumptions that you make.
    (b) to discuss which of your revised estimates Wemere should use as the discount rate for capital
    investment appraisal.

    Date posted: April 22, 2021.  Answers (1)

  • A division of Bewcast plc has been allocated a fixed capital sum by the main board of directors for its capital investment during the next year....(Solved)

    A division of Bewcast plc has been allocated a fixed capital sum by the main board of directors for its
    capital investment during the next year. The division's management has identified three capital
    investment projects, each potentially successful, each of similar size, but has only been allocated enough
    funds to undertake two projects. Projects are not divisible and cannot be postponed until a later date.
    The division's management proposes to use portfolio theory to determine which two projects
    should be undertaken, based upon an analysis of the projects‟ risk and return. The success of
    the projects will depend upon the growth rate of the economy. Estimates of project returns at different
    levels of economic growth are shown below:
    fig5224451.png
    You are required:
    (a) to use the above information to evaluate and discuss which two projects the division is likely to
    undertake. All relevant calculations must be shown.
    (b) What are the weaknesses of the evaluation technique used in (a) above, and what further information
    might be useful in the evaluation of these projects?
    (c) Suggest why portfolio theory is not widely used in practice as a capital investment evaluation technique.
    (d) Recommend, and briefly describe, an alternative investment evaluation technique that might be
    applied by the division.

    Date posted: April 22, 2021.  Answers (1)

  • Ceder Ltd has details of two machines which could fulfill the company's future production plans. Only one of these machines will be purchased. The standard model costs...(Solved)

    Ceder Ltd has details of two machines which could fulfill the company's future production
    plans. Only one of these machines will be purchased.
    The standard model costs Sh.50,000, and the deluxe Sh.88,000, payable immediately. Both
    machines would require the input of Sh.10,000 working capital throughout their working lives, and both
    machines have no expected scrap value at the end of their expected working lives of four years for the
    standard machine and six years for the deluxe machine.
    The forecast pre-tax operating net cash flows associated with the two machines are:
    fig1224445.png
    The de-luxe machine has only recently been introduced to the market and has not been fully tested in
    operating conditions. Because of the higher risk involved, the appropriate discount rate for the de-luxe
    machine is believed to be 14% per year, 2% higher than the discount rate for the standard machine.
    The company is proposing to finance the purchase of either machine with a term loan at a fixed interest
    rate of 11% per year.
    Taxation at 35% is payable on operating cash flows one year in arrears, and capital allowances are available
    at 25% per year on a reducing balance basis.
    You are required:
    (a) to calculate for both the standard and the de-luxe machine:
    (i) pay-back period;
    (ii) net present value
    Recommend, with reasons, which of the two machines Ceder Ltd should purchase.
    (Relevant calculations must be shown)
    (b) If Ceder Ltd were offered the opportunity to lease the standard model machine over a four year
    period at a rental of Sh.15,000 per year, not including maintenance costs, evaluate whether the
    company should lease or purchase the machine.

    Date posted: April 22, 2021.  Answers (1)

  • You are presented with the following different views of stock market behaviour. (1) If a company publishes an earnings figure that is better than the market...(Solved)

    You are presented with the following different views of stock market behaviour.
    (1) If a company publishes an earnings figure that is better than the market expects, the shares of that
    company will usually experience an abnormally high return both on the day of the earnings
    announcement and over the two or three days following the date of the announcement.
    (2) The return on professionally managed portfolios of equities is likely to be no better than that which
    ` could be achieved by a naïve investor who holds the market portfolio.
    (3) Share prices usually seem to rise sharply in the first few days of a new fiscal year. However, this can
    be explained by the fact that many investors sell loosing stocks just before the fiscal year end in
    order to establish a tax loss for Capital Gains Tax purposes. This causes abnormal downward
    pressure which is released when the new fiscal year begins.
    You are required:
    (a) to describe the three forms of the Efficient Market Hypothesis;
    (b) to discuss what each of the above three statements would tell you about the efficiency of the stock
    market. Where appropriate relate your comments to one or more forms o f the Efficient Market Hypothesis.

    Date posted: April 22, 2021.  Answers (1)

  • The annual reports of commercial corporations increasingly contain details of share option schemes. You are required: (a) To discuss whether share option schemes for either directors or...(Solved)

    The annual reports of commercial corporations increasingly contain details of share option schemes.
    You are required:
    (a) To discuss whether share option schemes for either directors or employees generally, can benefit the
    interest of the shareholders in the company;
    ( b) Contrast share option schemes with other schemes for relating managers' rewards to the financial
    performance of the company;
    (c) Describe the treatment of share option schemes in calculations of earnings per share.

    Date posted: April 22, 2021.  Answers (1)

  • Describe the main types of foreign exchange rate system. Briefly discuss how such systems might affect the ability of financial managers to forecast exchange rates.(Solved)

    Describe the main types of foreign exchange rate system. Briefly discuss how such systems might affect the
    ability of financial managers to forecast exchange rates.

    Date posted: April 22, 2021.  Answers (1)

  • The following data relates to a large company operating in the electronics industry: A major institutional shareholder has criticized the level of dividend payment of the...(Solved)

    The following data relates to a large company operating in the electronics industry:
    fig5224930.png
    A major institutional shareholder has criticized the level of dividend payment of the company suggesting that it should be substantially increased.
    Required:
    (a) Briefly discuss the factors that are likely to influence the company's dividend policy, and
    (b) Discuss whether or not the institutional shareholder's criticism is likely to be valid.

    Date posted: April 22, 2021.  Answers (1)

  • Discuss the arguments for and against the introduction of statutory controls on corporate governance.(Solved)

    Discuss the arguments for and against the introduction of statutory controls on corporate governance.

    Date posted: April 22, 2021.  Answers (1)

  • The objective of financial management is to maximize the value of the firm. You are required to discuss how the achievement of this objective might be...(Solved)

    The objective of financial management is to maximize the value of the firm.
    You are required to discuss how the achievement of this objective might be compromised by the conflicts which may arise between the various stakeholders in an organization.

    Date posted: April 22, 2021.  Answers (1)

  • Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its electricity using a coal fueled power station, but...(Solved)

    Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
    electricity using a coal fueled power station, but as a result of the closure of many coal mines and
    depleted coal resources, is now considering what type of new power station to invest in. The alternatives
    are a gas fueled power station, or a new type of efficient nuclear power station.
    Both types of power station are expected to generate annual revenues at current prices of Sh.800 million.
    The expected operating life of both types of power station is 25 years.
    fig1224850.png
    Other information:
    (i) Whichever power station is selected, electricity generation is scheduled to commence in three
    years time.
    (ii) If gas is used most of the workers at the existing coal fired station can be transferred to the new
    power station. After tax redundancy costs are expected to total Sh.4 million in year four. If nuclear
    power is selected fewer workers will be required and after tax redundancy costs will total Sh.36
    million, also in year four.
    (iii) Both projects would be financed by Euro-bond issues denominated in Euros. The gas powered
    station would require a bond issue at 8.5% per year, the bond for the nuclear project would be
    at 10% reflecting the impact on financial gearing of a larger bond issue.
    (iv) Costs of building the new power stations would be payable in two equal installments in one and two
    years time.
    (v) The existing coal fired power station would need to be demolished at a cost of Sh.10 million in
    three years time.
    (vi) The company‟s equity beta is expected to be 0.7 if the gas station is chosen and 1.4 if
    the nuclear station is chosen. Gearing (debt to equity plus debt) is expected to be 35% with gas
    and 60% with nuclear fuel.
    (vii) The risk free rate is 4.5% per year and the market return is 14% per year. Inflation is currently 3%
    per year in the UK and an average of 5% per year in the member countries of the Euro bloc in
    the European Union.
    (viii) Corporate tax is at the rate of 30% payable in the same year that the liability arises.
    (ix) Tax allowable depreciation is at the rte of 10% per year on a straight line basis.
    (x) At the end of twenty-five years of operations the gas plant is expected to cost Sh.25 million
    (after tax) to demolish and clean up the site. Costs of decommissioning the nuclear plant are
    much less certain, and could be anything between Sh.500 million and Sh.1,000 million (after tax)
    depending upon what form of disposal is available for nuclear waste.
    Required:
    (a) Estimate the expected NPV of EACH OF investment in a gas fueled power station and
    investment in a nuclear fueled power station.
    State clearly any assumptions that you make.
    (NB: It is recommended that annuity tables are used wherever possible)
    (b) Discuss other information that might assist the decision process.

    Date posted: April 22, 2021.  Answers (1)

  • Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.(Solved)

    Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.

    Date posted: April 22, 2021.  Answers (1)