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- Karim plc and Roshan plc are quoted companies. The following figures are from their current balance sheets:
Both companies earn an annual profit, before charging debenture...(Solved)
Karim plc and Roshan plc are quoted companies. The following figures are from their current balance sheets:
Both companies earn an annual profit, before charging debenture interest of Sh.500,000 which is expected to
remain constant for the indefinite future. The profits of both companies, before charging debenture interest,
are generally regarded as being subject to identical levels of risk. It is the policy of both companies to
distribute all available profits as dividends at the end of each year.
The current market value of Karim Ltd.‟s ordinary shares is Sh.3.00 per share cum div. An
annual dividend is due to be paid in the very near future.
Roshan Ltd. has just made annual dividend and interest payments both on its ordinary shares and on its
debentures. The current market value of the ordinary shares is Sh.1.40 per share and of the debentures,
Sh.50.00 percent.
Mr. Hashim owns 50,000 ordinary shares in Roshan Ltd. He is wondering whether he could increase his
annual income, without incurring any extra risk, by selling his shares in Roshan Ltd and buying some of the
ordinary shares of Karim Ltd. Mr. Hashim is able to borrow money at an annual compound rate of interest
of 12%.
You are required:
(a) to estimate the cost of ordinary share capital and the weighted average cost of capital of Karim Ltd
and Roshan Ltd;
(b) to explain briefly why both the cost of ordinary share capital and weighted average cost of capital of
Karim Ltd differ from those of Roshan Ltd;
(d) to prepare calculations to demonstrate to Mr. Hashim how he might improve his position in the way
he has suggested, stating clearly any reservations you have about the scheme; and
(d) to discuss the implications of your answers to (a), (b) and (c) above for the determination of a
company‟s optimal financial structure in practice.
Date posted: April 23, 2021. Answers (1)
- Mirror Young Cycles Ltd. wishes to design a new sports bicycle. The Company would have to invest
Ksh.10,000 at the beginning of the first year for...(Solved)
Mirror Young Cycles Ltd. wishes to design a new sports bicycle. The Company would have to invest
Ksh.10,000 at the beginning of the first year for the design and model testing of the new bicycle.
Mirror's managers believe that there is a 60% probability that this phase will be successful and the project
will continue. If phase 1 is not successful the project will be abandoned with zero salvage value.
The next phase, if undertaken would consist of making the molds and producing two prototype bicycles. This
would cost Ksh.500,000 at the end of the first year. If the bicycles test well, Mirror would go into production.
If they do not, the molds and prototypes could be sold for Ksh.100,000. The managers estimate that the
probability is 80 percent that the bikes will pass testing and that Phase 3 will be undertaken.
Phase 3 consists of changing over one current production line to produce the new design. This would cost
Ksh.1 million in Year 2. If the economy is strong at this point, the net value of sales would be Ksh.3 million,
while if the economy is weak the net value would be Ksh.1.5 million. Both net values occur during Year 3,
and the two states of the economy are equally likely. Mirror's cost of capital is 12 percent.
Required:
(a) Construct a decision tree and determine the project's expected NPV assuming that the project has average risk.
(b) Calculate the project's standard deviation of NPV and coefficient of variation of NPV.
(c) If Mirror's average project had a coefficient of variation of between 1.0 and 2.0, would this project be
of high, low or average stand-alone risk?
Date posted: April 23, 2021. Answers (1)
- The following data have been developed for the Ujasiri Company Limited:
The yield to maturity on Treasury Bills is 0.066 and is expected to remain at...(Solved)
The following data have been developed for the Ujasiri Company Limited:
The yield to maturity on Treasury Bills is 0.066 and is expected to remain at this point for the
foreseeable future.
Required:
(a) The equation of the Security Market Line.
(b) The required return for the Ujasiri Company Limited.
(c) Is the Company correctly priced, underpriced or overpriced in the market? Explain.
Date posted: April 23, 2021. Answers (1)
- You are given that assets X and Y are perfectly correlated such that Ry = 6 + 0.2RX and the probability distribution of X is:
What...(Solved)
You are given that assets X and Y are perfectly correlated such that Ry = 6 + 0.2RX and the probability distribution of X is:
What is the percentage of your wealth to put into asset X to achieve zero variance?
Date posted: April 23, 2021. Answers (1)
- Let R1 and R2 be the returns from two securities with E(R1) = 3% and E(R2) = 8%, VAR(R1) = 0.02,
VAR(R2) = 0.05, and COV(R1...(Solved)
Let R1 and R2 be the returns from two securities with E(R1) = 3% and E(R2) = 8%, VAR(R1) = 0.02,
VAR(R2) = 0.05, and COV(R1 R2) = -0.01.
Assuming that the two securities above are the only investment vehicles available:
(i) If we want to minimize risk, how much of our portfolio will we invest in Security 1?
(ii) Find the mean and standard deviation of a portfolio that is 40% in Security 1.
Date posted: April 23, 2021. Answers (1)
- Rodfin plc is considering investing in one of two short-term portfolios of four short-term financial
investments in diverse industries. The correlation between the returns of the...(Solved)
Rodfin plc is considering investing in one of two short-term portfolios of four short-term financial
investments in diverse industries. The correlation between the returns of the individual components of these
investments is believed to be negligible.
The managers of Rodfin are not sure of how to estimate the risk of these portfolios, as it has been
suggested to them that either portfolio theory or the capital asset pricing model (CAPM) will give the same
measure of risk. The market return is estimated to be 12.5% and the risk free rate 5.5%.
Required:
(a) Discuss whether or not portfolio theory and CAPM give the same portfolio risk measure.
(b) Using the above data estimate the risk and return of the two portfolios and recommend which one
should be selected.
Date posted: April 23, 2021. Answers (1)
- Kianjoya company Ltd has 2 million ordinary shares outstanding at the current market price of Sh.60 per
share. The company requires Sh.8 million to finance a...(Solved)
Kianjoya company Ltd has 2 million ordinary shares outstanding at the current market price of Sh.60 per
share. The company requires Sh.8 million to finance a proposed expansion project. The board of directors
has decided to issue a 2 for 25 rights at a subscription price of Sh.50 per share. The expansion project is
expected to increase the firm's annual cash flows by Sh.1,660,000. Information on this project
will be released to the market together with the announcement of the rights issue. The company paid a
dividend of sh.6 per share last year. This dividend together with the company‟s earnings is
expected to grow at 6% annually.
Required:
(i) Compute the price of the shares after the announcement of the rights issue but before they start
selling ex-rights.
(ii) Compute the theoretical value of rights and the theoretical ex-rights price of the shares.
Date posted: April 23, 2021. Answers (1)
- Canalot Ltd is an all equity company with an equilibrium market value of Sh.32.5 million and a cost
of capital of 18% per year. The company...(Solved)
Canalot Ltd is an all equity company with an equilibrium market value of Sh.32.5 million and a cost
of capital of 18% per year. The company proposes to repurchase Sh.5 million of equity and to
replace it with 13% irredeemable loan stock. Canalot Ltd's earnings before interest
and taxes are expected to be constant for the foreseeable future. Corporate tax is at the rate of
30%. All profits are paid out as dividends.
Required:
Using the assumptions of Modigliani and Miller explain and demonstrate how this change in capital
structure will affect:
(i) the market value
(ii) the cost of capital
(iii) the cost of equity of Canalot Ltd.
Date posted: April 23, 2021. Answers (1)
- Karim Ltd has annual earnings before interest and taxes of Sh.150 million. These earnings are
expected to remain constant. The market price of the company's ordinary...(Solved)
Karim Ltd has annual earnings before interest and taxes of Sh.150 million. These earnings are
expected to remain constant. The market price of the company's ordinary shares is
Sh.8.60 per share cum dividend and of debentures sh.1055.0 per debenture ex. Interest. An
interim dividend of Sh.0.60 per share has been declared. Corporate tax is at the rate of 30% and all
available earnings are distributed as dividends.
Karim's long term capital structure is shown below:
Required:
Calculate the cost of capital of Karim Ltd according to the traditional theory of capital structure. Assume it is
now 31.12.X1 and the capital structure is optimal.
Date posted: April 23, 2021. Answers (1)
- XYZ company Limited is considering a major investment in a new productive process. The total
cost of the investment has been estimated at Sh.2,000,000 but if...(Solved)
XYZ company Limited is considering a major investment in a new productive process. The total
cost of the investment has been estimated at Sh.2,000,000 but if this were increased to Sh.3,000,000,
productive capacity would be substantially increased. Because of the nature of the process, once the
basic plant has been established, to increase capacity at some future date is exceptionally costly. One
of the problem facing management is that the demand for process output is very uncertain.
However, the market research and finance departments have been able to produce the following
estimate:
Required:
Compute the expected NPV of each of the project and state the one to be chosen.
Date posted: April 23, 2021. Answers (1)
- You are the chief accountant of Deighton Plc. which manufactures a wide range of building and plumbing
fittings. It has recently taken over a small unquoted...(Solved)
You are the chief accountant of Deighton Plc. which manufactures a wide range of building and plumbing
fittings. It has recently taken over a small unquoted competitor, Linton Ltd. Deighton is currently checking
through various documents at Linton's head office. Including a number of investment appraisals.
One of these, a recently rejected application involving an outlay of equipment of Sh.900,000, is produced below.
It was rejected because it failed to offer Linton‟s target return on investment of 25% (average profit to-
initial investment outlay). Closer inspection reveals several errors in the appraisal.
Evaluation of profitability of proposed project
NT17 (all values in currency year prices)
You discover the following further details:
1. Linton's policy was to finance both working capital and fixed investment by a bank
overdraft. A12% interest rate applied at the time of the evaluation.
2. A 25% writing down allowance (WDA) on a reducing balance basis is offered for new investments.
Linton's profits are sufficient to utilize fully this allowance throughout the project.
3. Corporate tax is paid a year in arrears.
4. Of the overhead charge, about half reflects absorption of existing overhead costs.
5. The market research was actually undertaken to investigate two proposals, the other project also
having been rejected. The total bill for all this research has also been paid.
6. Deighton itself requires a nominal return on new project of 20% after taxes, is currently
ungeared and has no plans to use any debt finance in the future.
Required:
(a) Identify the mistakes made in Linton's evaluation.
(b) Restate the investment appraisal in terms of post-tax net present value and recommend whether or
not Deighton should undertake the project.
Date posted: April 23, 2021. Answers (1)
- Outline the major causes of public projects failure.(Solved)
Outline the major causes of public projects failure.
Date posted: April 23, 2021. Answers (1)
- Discuss the major theories that explain the behaviour of the yield curve and discuss the implication
of yield curve analysis in financial management.(Solved)
Discuss the major theories that explain the behaviour of the yield curve and discuss the implication
of yield curve analysis in financial management.
Date posted: April 23, 2021. Answers (1)
- 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...(Solved)
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.
Date posted: April 23, 2021. Answers (1)
- 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.
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)