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Explain the advantages of using market value weights over book value weights in computing the weighted average cost of capital.
(Solved)
Explain the advantages of using market value weights over book value weights in computing the weighted average cost of capital.
Date posted:
April 13, 2022
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Answers (1)
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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
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Answers (1)
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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
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Answers (1)
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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
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Answers (1)
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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
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Answers (1)
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An investor received a dividend of Sh.1.50 in the current financial year on each of his ordinary shares. The par value per share is Sh.20....
(Solved)
An investor received a dividend of Sh.1.50 in the current financial year on each of his ordinary shares. The par value per share is Sh.20. The annual growth rate in dividends is 8%. The current market price per share is Sh1.50 while the investor’s required rate of return is 20%.
Calculate the intrinsic value of each ordinary share.
Date posted:
April 5, 2022
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Answers (1)
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Kawaida Ltd. is currently engaged in an expansion programme. Consequently, the company has been retaining all its earnings to finance the expansion programme. The company’s...
(Solved)
Kawaida Ltd. is currently engaged in an expansion programme. Consequently, the company has been retaining all its earnings to finance the expansion programme. The company’s management expects to resume the payment of dividends at the end of 3 years with a dividend payment of sh. 1 per share. The dividends will grow at an annual rate of 50% in years 4 and 5. Thereafter, the dividends will grow at a constant rate of 8% indefinitely. The required rate of return on the company’s stock is 15%.
Required:
The current value of the company’s stock.
Date posted:
March 30, 2022
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Answers (1)
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Ushindi Ltd. has recently issued a sh. 1,000, 9 percent convertible bond. The bond can be converted into 9 ordinary shares at the end of...
(Solved)
Ushindi Ltd. has recently issued a sh. 1,000, 9 percent convertible bond. The bond can be converted into 9 ordinary shares at the end of the five years. The current market price of the shares of Ushindi Ltd. is sh. 25 per share. The price is expected to grow at a rate of 10 per cent per annum. The investors’ required rate of return is 12%.
Required:
The current value of the bond.
Date posted:
March 30, 2022
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Answers (1)
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The 10% convertible loan stock of Nalyaka Ltd. is quoted at Sh.142 per Sh.100 par value. The earliest date of conversion is in 4 years’...
(Solved)
The 10% convertible loan stock of Nalyaka Ltd. is quoted at Sh.142 per Sh.100 par value. The earliest date of conversion is in 4 years’ time, at the rate of 30 ordinary shares per Sh.100 nominal loan stock. The share price is currently Sh.4.15. Annual interest on the stock has just been paid.
Required:
(i) The average annual growth rate in the share price that is required for the stockholders to achieve an overall rate of return of 12% a year compounded over the next 4 years, including the proceeds of conversion.
(ii) The implicit conversion premium on the stock.
Date posted:
March 30, 2022
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Answers (1)
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Max Enterprises Ltd. had the following pattern of earnings per share (EPS) over the last five years:
(Solved)
Max Enterprises Ltd. had the following pattern of earnings per share (EPS) over the last five years:
The company maintained a constant dividend payout ratio of 40%. The company's required rate of return is 13%.
Required:
The company's theoretical value of the share
Date posted:
March 30, 2022
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Answers (1)
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Malikia Guyo borrowed Sh.1, 000,000 from Huduma Bank at an annual compound interest of 14% on the reducing balance. The loan was repayable in annual...
(Solved)
Malikia Guyo borrowed Sh.1, 000,000 from Huduma Bank at an annual compound interest of 14% on the reducing balance. The loan was repayable in annual instalments over a period of four years. The installments were payable at end of the year.
Required:
A loan amortisation schedule.
Date posted:
March 30, 2022
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Answers (1)
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Shadrack Chando borrowed Sh.80,000 from XYZ commercial bank at an interest rate of 1.25% compounded monthly. The loan is to be amortized using the reducing...
(Solved)
Shadrack Chando borrowed Sh.80,000 from XYZ commercial bank at an interest rate of 1.25% compounded monthly. The loan is to be amortized using the reducing balance method and be repaid in 12 equal monthly installments payable at the end of each month.
Required:
A loan amortization schedule.
Date posted:
March 30, 2022
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Answers (1)
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John Matata has just borrowed Sh.220,000 from a bank payable at 12% per annum compounded annually to be repaid in six equal annual instalments.
(Solved)
John Matata has just borrowed Sh.220,000 from a bank payable at 12% per annum compounded annually to be repaid in six equal annual instalments.
These payments are to be sufficient to repay the principal amount together with interest.
Required;-
The loan amortization schedule.
Date posted:
March 30, 2022
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Answers (1)
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Explain four reasons that may drive a company to raise equity finance rather than debt finance.
(Solved)
Explain four reasons that may drive a company to raise equity finance rather than debt finance.
Date posted:
March 30, 2022
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Answers (1)
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In relation to the financial objectives of a business entity, distinguish between the terms “maximizing” and “satisficing”.
(Solved)
In relation to the financial objectives of a business entity, distinguish between the terms “maximizing” and “satisficing”.
Date posted:
March 30, 2022
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Answers (1)
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Explain three causes of conflict of interest between shareholders and debt holders.
(Solved)
Explain three causes of conflict of interest between shareholders and debt holders.
Date posted:
March 30, 2022
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Answers (1)
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Executive compensation plans hinder value creation in a company. Citing three reasons, justify the above statement.
(Solved)
Executive compensation plans hinder value creation in a company. Citing three reasons, justify the above statement.
Date posted:
March 30, 2022
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Answers (1)
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Gopher Ltd has issued 300,000 ordinary shares of £1 each, which are at present selling for £4 per share. The company plans to issue rights...
(Solved)
Gopher Ltd has issued 300,000 ordinary shares of £1 each, which are at present selling for £4 per share. The company plans to issue rights to purchase one new equity share at a price of £3.20 per share for every 3 shares held. A shareholder who owns 900 shares thinks that he will suffer a loss in his personal wealth because the new shares are being offered at a price lower than market value. On the assumption that the actual market value of shares will be equal to the theoretical ex-rights price, what would be the effect on the shareholder's wealth if:
(a) He sells all the rights;
(b) He exercises one half of the rights and sells the other half;
(c) He does nothing at all?
Date posted:
December 15, 2021
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Answers (1)
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The Independent Film Company plc is a film company which purchases distribution rights on films from small independent producers, and sells the films on to...
(Solved)
The Independent Film Company plc is a film company which purchases distribution rights on films from small independent producers, and sells the films on to cinema chains for national and international screening. In recent years the company has found it difficult to source sufficient films to maintain profitability. In response to the problem, the Independent Film Company has decided to invest in commissioning and producing films in its own right. In order to gain the expertise for this venture, the Independent Film Company is considering purchasing an existing
filmmaking concern, at a cost of Sh.400,000. The main difficult that is anticipated for the business is the increasing uncertainty as to the potential success/failure rate of independently produced films. Many cinema chains are adopting a policy of only buying films from large international film companies, as they believe that the market for independent films is very limited and specialist in nature. The Independent Film Company is prepared for the fact that they are likely to have more films that fail than that succeed, but believe that the proposed film
production business will nonetheless be profitable.
Using data collection from the existing distribution business and discussions with industry
experts, they have produced cost and revenue forecasts for the five years of operation of the
proposed investment. The company aims to complete the production of three films per year.
The after tax cost of capital for the company is estimated to be 14%.
Year 1 sales for the new business are uncertain, but expected to be in the range of Sh.4-10
million. Probability estimates for different forecast values are as follows:
Sales are expected to grow at an annual rate of 5%.
Anticipated costs related to the new business are as follows:
Additional Information
(i) No capital allowances are available.
(ii) Tax is payable one year in arrears, at a rate of 33% and full use can be made of tax
refunds as they fall due.
(iii) Staff wages (technical and non-production staff) and actors‟ salaries, are
expected to rise by 10% per annum.
(iv) Studio hire costs will be subject to an increase of 30% in Year 3.
(v) Screenplay costs per film are expected to rise by 15% per annum due to a shortage of
skilled writers.
(vi) The new business will occupy office accommodation which has to date been let out for
an annual rent of Sh.20,000. Demand for such accommodation is buoyant and the
company anticipates in finding future tenants at the same annual rent.
(vii) A market research survey into the potential for the film production business cost Sh.25,000.
Required:
Using DCF analysis, calculate the expected Net Present Value of the proposed investment.
(Workings should be rounded to the nearest Sh.‟000‟)
Date posted:
December 15, 2021
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Answers (1)
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Write notes on the following cash management models:
(i) The Baumol model.
(ii) The Miller – Orr model.
(Solved)
Write notes on the following cash management models:
(i) The Baumol model.
(ii) The Miller – Orr model.
Date posted:
December 15, 2021
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Answers (1)