Get premium membership and access questions with answers, video lessons as well as revision papers.
i) Investments are rated by investors using their returns which are ascertained using the market values of such investment.
ii) When investors acquire investment they pay market prices of such investment and will always compare the viability of their investment using market prices.
iii) Historical book values may not represent the true valuation of capital employed as shown in the balance sheet.
iv) Use of market value weights is more accurate especially for new issues of shares and debentures.
v) The assets used by capital providers as security are valued at market price for collateral purposes.
Kavungya answered the question on April 13, 2022 at 11:00
- Mount Elgon Ltd. is considering the launch of a new product. Exel, for which an investment of Sh.6,000,000 in plant and machinery will be required....(Solved)
Mount Elgon Ltd. is considering the launch of a new product. Exel, for which an investment of Sh.6,000,000 in plant and machinery will be required. The production of Exel is expected to last five years after which the plant and machinery would be sold for Sh. 1,500,000.
Additional Information:
1) Exel would be sold at Sh.600 per unit with a variable cost of Sh240 per unit
2) Fixed production costs (excluding depreciation) would amount to Sh.600,000 per annum
3) The Company applies the straight line method of depreciation
4) The cost of capital is 10% per annum
5) The units of Exel expected to be sold per annum for the next five years as shown below
Year: Units expected to be sold
1 : 8,000
2 : 7,000
3 : 7,000
4 : 5,000
5 : 3,000
6) The corporation tax rate is 30%
Required:
i. Calculate the net present value (NPV) of the project and advise the management on the
appropriate course of action.
ii. Calculate the internal rate of return (IRR) of the project and advise the management on the
appropriate course of action.
iii. Outline the main drawbacks of the IRR method of investment.
Date posted: April 13, 2022. Answers (1)
- Distinguish between compounding and discounting of cash flows.(Solved)
Distinguish between compounding and discounting of cash flows.
Date posted: April 13, 2022. Answers (1)
- Upendo Ltd. is in the process of raising additional finance. The company’s financial structure
comprises ordinary share capital, reference share capital, debenture capital and retained earnings.
Each...(Solved)
Upendo Ltd. is in the process of raising additional finance. The company’s financial structure
comprises ordinary share capital, reference share capital, debenture capital and retained earnings.
Each of these sources of finance is analyzed below:
Ordinary Share Capital
• The current market price per share is Sh.80
• The company expects to pay a cash dividend of Sh.6 per share in the next financial year
• The annual rate of growth in dividend per share is 6%
• Flotation costs amounting to Sh8 per share
11% Preference Share Capital
• The par value per share is Sh.100
• The share are currently trading at par
• Flotation costs amounting to Sh.4 per share 10% Debenture Capital
• The per value is Sh1,000 for each debenture stock
• The debenture have ten-year maturity period
• The flotation cost for each debenture stock is Sh.50 Retained Earnings
• The company expects to have Sh.225,000 of retained earnings available for the next financial year.
• Should the retained earnings balance to exhausted, the company will use common stock as the form of equity financing
Required:
i) Calculate the cost of Capital for ordinary share capital, preference share capital, debenture
capital and retained earnings
ii) Calculate the marginal cost of capital applying the target capital proportions and using
retained earnings to represent equity finance
iii) Comment on the relevance of the marginal cost of capital in (ii) above to Upendo Ltd.
Date posted: April 13, 2022. Answers (1)
- The following was the capital structure of Fahari Ltd. as at 31 October 2007.
Additional information:
1. The market prices per ordinary share, preference share and debenture...(Solved)
The following was the capital structure of Fahari Ltd. as at 31 October 2007.
Additional information:
1. The market prices per ordinary share, preference share and debenture were sh. 45, and sh. 30
and sh. 1,200 respectively on 31 October 2007.
2. The dividend per ordinary share for the year ended 31 October 2006 was sh. 8.00. Dividends
are expected to grow at an annual rate of 12 percent.
3. The rate of corporation tax is 30 per cent.
Required:
The weighted average cost of capital (WACC) of fahari Ltd. Use market value weights
Date posted: April 13, 2022. Answers (1)
- Jasmin Ltd. a quoted company intends to raise sh. 14,000,000 to finance a capital project. The company is considering issuing the following securities in order...(Solved)
Jasmin Ltd. a quoted company intends to raise sh. 14,000,000 to finance a capital project. The company is considering issuing the following securities in order to raise the required amount.
• 200,000 ordinary shares at the ex- div market price subject to a 10% floatation cost per share.
The company’s issued shares are currently trading at sh. 32.40 per share cum – div. Dividends for the year ended 31 December 2008 have not yet been paid to shareholders.
• 40,000 12% debentures at the current market price of sh. 80 per debenture. The par value of each debenture is sh. 100.
• 100,000 10% preference shares at the current par value of sh. 20 per share.
The balance of the capital required would be obtained from retained earnings.
Required:
i) Ex – div market price per ordinary share.
ii) Cost of capital for each component of additional finance.
iii) Marginal cost of capital of the company.
iv) Comment on the application of the marginal cost of capital obtained in b(iii) above.
Date posted: April 11, 2022. Answers (1)
- Karatasi Ltd. had the following capital structure as at 31 December 2008.
Additional information:
1. The current market price per ordinary share, preference share and debenture is...(Solved)
Karatasi Ltd. had the following capital structure as at 31 December 2008.
Additional information:
1. The current market price per ordinary share, preference share and debenture is sh.. 50, sh. 24 and sh. 1,200 respectively.
2. For the year ended 31 December 2008, the company paid an ordinary dividend of sh. 6.00 per share. Analysts estimate that the company’s earnings and dividends will grow at an annual rate of 15 per cent indefinitely.
3. The corporation tax rate is 30 per cent.
Required;-
The company’s market weighted average cost of capital.
Date posted: April 11, 2022. Answers (1)
- The capital structure of Jmaa Ltd. Which is considered optimal, as at 30 September 2009 was as follows :
The company intends to raise additional funds...(Solved)
The capital structure of Jmaa Ltd. Which is considered optimal, as at 30 September 2009 was as follows :
The company intends to raise additional funds for investing in a new project which is estimated to
cost sh. 240 million.
Additional information:
1. Any new ordinary shares issued will incur a 12% floatation cost per share.
2. The most recent ordinary dividend per share was sh. 5.
3. The past and expected future earnings growth rate is 10%. The earnings growth rate is expected
to be matched with growth rate in dividends.
4. The current dividend rate is 6.25%.
5. The company expects to raise a maximum of sh. 36 million from retained earnings to finance
the project.
6. Additional 8% preference shares can be issued at the current market price of sh. 80 per share.
7. A new 12% debenture can be issued at sh. 960 for each debenture through the stock exchange.
8. Corporation tax rate is 30%.
Required:
i) The current market price per ordinary share.
ii) The number of ordinary shares that should be issued to finance the project.
iii) The company’s weighted marginal cost of capital (WMCC)
Date posted: April 11, 2022. Answers (1)
- Pick Ltd has the following capital structure which is considered optimal. The investors of Pick ltd expect earnings and dividends to grow at a constant...(Solved)
Pick Ltd has the following capital structure which is considered optimal.
The investors of Pick ltd expect earnings and dividends to grow at a constant rate of 9% in the future.
The company has just paid a dividend of sh.3.6 per share and its stock currently sells at a price of sh.60 per share. Treasury bonds yield 11% and the return on the market is 14%.Pick ltd beta is 1.51 New preferred stock can be sold at sh.100per share with a dividend of sh.11 per share and flotation costs of sh.5 per share.
The company’s tax rate is 30%and it pays out all its earnings as dividend.12% debentures with a maturity of 10 years can be sold at sh.92 per debenture
Required
The weighted average cost of capital (WACC) using market values
Date posted: April 11, 2022. Answers (1)
- The optimal capital structure of DP Ltd. is as shown below.
The company has sh. 300,000 in retained earnings and is considering investing in a project...(Solved)
The optimal capital structure of DP Ltd. is as shown below.
The company has sh. 300,000 in retained earnings and is considering investing in a project which will cost sh. 1,200,000
Required:
i) The marginal cost of capital (MCC) assuming a 30% tax rate.
ii) Retained earnings break point.
Date posted: April 11, 2022. Answers (1)
- Explain the meaning of the term “enterprise value” in the context of the valuation of a business entity.(Solved)
Explain the meaning of the term “enterprise value” in the context of the valuation of a business entity.
Date posted: April 11, 2022. Answers (1)
- Laura Ltd intends to raise Sh.25 million to finance a new project through a rights issue. The project has a 10 year economic life with...(Solved)
Laura Ltd intends to raise Sh.25 million to finance a new project through a rights issue. The project has a 10 year economic life with ho salvage value and is expected to generate annual cash inflows of Sh.7, 372,280. The company has 4 million issued and fully paid shares. The cost of capital is 15% and before the announcement of the rights issue, the market price per share was Sh. 18.
Required:
The cum-rights market puce per share.
Date posted: April 11, 2022. Answers (1)
- Chairimani Ltd. is contemplating to issue 8% bonds redeemable at Sh.100 par value in three years' time. Alternatively, each bond may be converted on that...(Solved)
Chairimani Ltd. is contemplating to issue 8% bonds redeemable at Sh.100 par value in three years' time. Alternatively, each bond may be converted on that date into 30 ordinary shares of the company. The current market price per share is Sh.3.30 and this is expected to grow at 5% per annum into perpetuity. The company's cost of debt is 6% per annum.
Required:
(i) Market value of the bond.
(ii) Floor value of the bond.
(iii) Conversion premium per share.
Date posted: April 11, 2022. Answers (1)
- Rock Ltd. is planning to issue 10 million Sh.0.25 shares with a current market price of Sh. 1.55 cum-dividend. An annual dividend of Sh.0.09 has...(Solved)
Rock Ltd. is planning to issue 10 million Sh.0.25 shares with a current market price of Sh. 1.55 cum-dividend. An annual dividend of Sh.0.09 has been proposed. The company earns an accounting rate of return on equity (R.O.E) of 10% and a dividend payout of 40%. The company also has 13%. Sh. 100 redeemable debentures with a nominal value of Sh.7 million, trading at Sh. 105. The debentures are due to be redeemed at par in five years' time.
Assume a corporation tax rate of 30%.
Required:
The weighted average cost of capital (WACC) of the company.
Date posted: April 11, 2022. Answers (1)
- Moran Ltd. earnings and dividend per share have been growing at a rate of 18% per annum. This rate is expected to be constant for...(Solved)
Moran Ltd. earnings and dividend per share have been growing at a rate of 18% per annum. This rate is expected to be constant for four years, after which it will fall to 12% for another four years.
Thereafter, the growth rate will be 6% in perpetuity. The last dividend per share to be paid was Sh.2 and the investors' required rate of return is 15%.
Required:
The intrinsic value per share.
Date posted: April 11, 2022. Answers (1)
- Distinguish between the following sets of terms:
(i) Disintermediation and intermediation.
(ii) Mutual funds and hedge funds.(Solved)
Distinguish between the following sets of terms:
(i) Disintermediation and intermediation.
(ii) Mutual funds and hedge funds.
Date posted: April 11, 2022. Answers (1)
- Highlight three reasons why accounting profit might not be the best measure of a company's achievement.(Solved)
Highlight three reasons why accounting profit might not be the best measure of a company's achievement.
Date posted: April 11, 2022. Answers (1)
- Explain the following terms as used in capital structure of a firm:
i) Operating leverage.
ii) Financial leverage.(Solved)
Explain the following terms as used in capital structure of a firm:
i) Operating leverage.
ii) Financial leverage.
Date posted: April 11, 2022. Answers (1)
- Differentiate between “Running yield and “flat yield”.(Solved)
Differentiate between “Running yield and “flat yield”.
Date posted: April 5, 2022. Answers (1)
- The following data is available for Firm A
Required:
i. Overall break – even point in units.
ii. Degree of operating leverage.
iii. Degree of financial leverage.
iv. Degree of...(Solved)
The following data is available for Firm A
Required:
i. Overall break – even point in units.
ii. Degree of operating leverage.
iii. Degree of financial leverage.
iv. Degree of total leverage.
Date posted: April 5, 2022. Answers (1)
- The following data show the capital structure of Samma Ltd.
The company’s current dividend yield is 5% while the tax rate is 30%.
Required:
The weighted marginal cost...(Solved)
The following data show the capital structure of Samma Ltd.
The management of Samma Ltd. intends to invest in a project estimated to cost sh.16, 800,000.
The cost of the project will be raised as follows:
• Issue 10% 100 debentures at the current price of sh. 5,000.
• Issue 10% sh. 20 preference shares at the market price of sh. 25.
• Issue ordinary shares at the current market price of sh. 45 with floatation cost of 12%.
• Utilise 60% shares at the current market price of sh. 45. with floatation cost of 12%
The company’s current dividend yield is 5% while the tax rate is 30%.
Required:
The weighted marginal cost of capital.
Date posted: April 5, 2022. Answers (1)