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“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
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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
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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
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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
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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
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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
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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
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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
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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
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The Minister for Finance has stated that he wants to put a limit to the Public Sector Borrowing
Requirements. What difficulties and economic problems are likely to arise due to this?
Date posted:
April 19, 2021
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You have just finished reading the budget speech by the Minister of Finance where you came
across the term “Public Sector Borrowing Requirements.” What is meant by this term?
Date posted:
April 19, 2021
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On the basis of a one-factor model, Mwangi assumes that the risk free rate is 6% and the expected return on a portfolio work unit sensitivity to the factor is 8.5%. Consider a portfolio of two securities with the following characteristics:
According to the arbitrage pricing theory, what is the portfolio‟s equilibrium expected return?
Date posted:
April 19, 2021
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As a senior financial analyst of an investment bank, you are charged with the responsibility of
estimating the expected returns of various securities. One o the securities you want to estimate is
expected return in Alpha Steel works Ltd.
You have decided to use arbitrage pricing model and you have derived the following estimates
for the factor betas and risk premiums.
Required:
(i) Identify the risk factor for Alpha Steel Works Ltd.
(ii) If the risk free rate is 5%, estimate the expected return on Alpha Steel Works Ltd.
Date posted:
April 19, 2021
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The Moon Company Ltd. has issued 10,000,000, Sh. 10 par equity shares which are at present selling for
Sh. 30 per share. It has also issued 5,000,000 warrants, each entitling the holder to buy one equity share.
The warrants are protected against dilution.
(a) The company has plans to issue rights to purchase one new equity share at a price of Sh. 20 per
share for every four shares held.
Required:
(i) Calculate the theoretical ex-rights price of Moon Company Ltd.'s equity shares.
(ii) The theoretical value of a right of the Moon Company Ltd. before the shares sell ex rights.
(b) The chairman of the company receives a phone call from an angry shareholder who owns 100,000
shares. The shareholder argues that he will suffer a loss in his personal wealth due to this rights issue,
because the new shares are being offered at a price lower than the current market value.
The chairman assures him that his wealth will not be reduced because of the rights issue, as long
as the shareholder takes appropriate action.
Required:
(i) Explain whether the chairman is correct. What should the shareholder do?
(ii) A statement showing the effect of the rights issue on this particular
shareholder's wealth, assuming:
He sells all the rights.
He exercises one half of the rights and sells the other half.
He does nothing at all.
(iii) Are there any real circumstances which might lend support to the shareholder's claim?
Date posted:
April 19, 2021
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The following data currently exist for the ordinary shares of four companies quoted on a stock exchange for the period between 1 July 1998 to 1 July 2003.
During the same time period (1 July 1998 to 1 July 2003), the four companies:
Issued no additional shares
Had no stock dividends or split
Paid no cash dividend.
Required:
(i) A four-stock index that is value-weighted.
(ii) A four-stock index that is price-weighted.
(iii) A four-stock index that is equally weighted.
Date posted:
April 19, 2021
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Highlight the limitations of the following methods of dealing with risk in capital budgeting:
(i) Simulation analysis.
(ii) Sensitivity analysis.
Date posted:
April 19, 2021
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For each of the companies described below, explain which one you would expect to have a medium,
high or a low dividend payout ratio:
(i) A company with a large proportion of inside ownership, all of whom are high income individuals.
(ii) A growth company with an abundance of good investment opportunities.
(iii) A company experiencing ordinary growth, has high liquidity and much unused borrowing capacity.
(iv) A dividend-paying company that experiences an unexpected drop in earnings from the trend.
(v) A company with volatile earnings and high business risk.
Date posted:
April 19, 2021
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Rugongo Ltd. is an ungeared company operating in the processed food industry. The company is planning to take over Sauce Ltd. but is unsure on how to value its net assets. Rugongo Ltd.‟s analysts have assembled the following information:
Sauce Ltd.‟s balance sheet as at 30 September 2003
In its most recent trading period ended 30 September 2003, Sauce Ltd.‟s sales were
Sh.500,000,000, but after operating costs and other expenses including a depreciation charge of
Sh.20,000,000, its profit after tax was Sh.20,000,000. This figure includes an extraordinary item (sale of
property) of Sh.5,000,000. The full years dividend was Sh.5,000,000.
Sauce Ltd. has recently followed a policy of increasing dividends by 12% per annum. Its shareholders require
a return of 17%.
The price earnings ratio of Rugongo Ltd. is 14 times and that of Sauce Ltd. is 8 times.
More efficient utilization of Sauce Ltd.‟s assets could generate operating savings of Sh.5,000,000
per annum after tax.
Required:
(i) Current market value of Sauce Ltd.'s share.
(ii) Explain why the market value might differ from the book value.
(iii) A company experiencing ordinary growth, has high liquidity and much unused borrowing capacity.
(iv) The value of Sauce Ltd. using the discounted cash flow method.
Date posted:
April 19, 2021
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Pwani Limited is planning advertising campaigns in three different market areas. The estimates of
probability of success and associated additional profits in each of the three markets are provided
below:
Required:
(i) Compute the expected value and standard deviation of profits resulting from advertising campaigns
in each of the market areas.
(ii) Rank the three markets according to riskiness using the coefficient of variation.
Date posted:
April 18, 2021
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Goldstar Manufacturing Limited is evaluating an investment opportunity that would require an
outlay of sh.100 million. The annual net cash inflows are estimated to vary according to economic
conditions.
The firm's required rate of return is 14 percent. The project has an expected life of six years.
Required:
Compute the expected net present value (NPV) of the proposed investment.
Date posted:
April 18, 2021
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The finance director of Benga Ltd. wishes to find the company's optimal capital structure. The
cost of debt varies according to the level of gearing of the company as follows:
The company's ungeared equity beta (asset beta) is 0.85. The risk free rate is 6% per annum
and the market return is 14% per annum. Corporate taxation is at the rate of 30% per year.
Required:
(a) Estimate the company's optimal weighted average cost of capital.
(b) Recommend whether or not the company should adopt the optimal capital structure identified in (a)
above explain the factors that might influence the capital structure decision.
Date posted:
April 17, 2021
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What are the advantages and disadvantages of a rights issue from the point of view of:
(i) The issuing company?
(ii) The shareholders?
Date posted:
April 17, 2021
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Explain two circumstances under which dilution of earnings might be acceptable to the shareholders
of one of the companies in a take-over deal.
Date posted:
April 17, 2021
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A Kenyan import-export merchant was contracted on 31 December 2002 to buy 1,500 tonnes of a certain
product from a supplier in Uganda at a price of Ush.118,200 per tonne. Shipment was to be made direct
to a customer in Tanzania to whom the merchant had sold the product at TSh.462,000 per tonne. Of the
total quantity, 500 tonnes were to be shipped during the month of January 2003 and the balance by the
end of the month of February 2003. Payment to the suppliers was to be made immediately on
shipment, whilst one month's credit from the date of shipment was allowed to the Tanzanian customer.
The merchant arranged with his bank to cover those transactions in Kenya shillings (Ksh.) on the forward
exchange market. The exchange rates at 31 December 2002 were as given below:
The exchange commission is Ksh.10 per Ksh.1,000 (maximum Sh.1,000,000) on each transaction.
Required:
Calculate (to the nearest Ksh.) the profit that the merchant made during the transaction.
Date posted:
April 17, 2021
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Discuss the role of financial management in an international setting with particular reference to:
(i) Currency exchange rates.
(ii) Sources of finance
(iii) Investing in overseas countries.
Date posted:
April 17, 2021
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Butere Sugar Company Ltd. Has been enjoying a substantial net cash inflow. Before the surplus
funds are needed to meet tax and dividend payments, and to finance further capital expenditure in
several months time, they are invested in a small portfolio of short-term equity investments.
Details of the portfolio, which consist of shares of four companies listed on the stock exchange are
as follows:
The current market return is 19% a year and treasury bill yield is 11% a
year. Required:
On the basis of the data given above, calculate the risk of Butere Sugar Company
Ltd.'s short-term investment portfolio relative to that of the market.
Date posted:
April 17, 2021
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Juma Company Ltd. Which is effectively controlled by the Juma family although they own only a minority of shares, is to undertake a substantial new project which requires external finance of about Sh.400 million, leading to a 40% increase in gross assets. The project is to develop and market a new product and is fairly risky. About 70% of the funds required will be spent on land and buildings. The resale value of the land and buildings is expected to remain equal to or greater than, the initial purchase price. Expenditure during the development period of the first 4 to 7 years will be financed from other revenue of Juma Company Ltd. This
will have a consequent strain on the company's overall liquidity.
If, after the development stage, the project proves unsuccessful, then the project will be terminated and its assets sold. If, as is likely, the development is successful, the project's assets will be utilized in production and the company's profits will rise considerably. However, if the project proves to be very successful, then additional finance may be required to further expand the production facilities.
At present, Juma Company Ltd. Is all equity financed.
The financial manager is uncertain whether he should seek funds from a financial institution in the form of an equity interest, a loan (long or short term) r convertible debentures.
Required:
(a) Describe the major factors to be considered by Juma Company Ltd. In deciding on the method of
financing the proposed expansion project.
(b) Briefly discuss the suitability of equity, loans and convertible debentures for the purpose of
financing the project from the point of view of:
(i) Juma Company Ltd.
(ii) The provider of finance.
Clearly state and justify the type of finance recommended for Juma Company Ltd.
Date posted:
April 17, 2021
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The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing
whether its capital investment projects are acceptable, a compound interest (DCF) rate of 8% per annum
will be used in evaluating investment projects.
All investment project is now under consideration. Estimates of the expected cash flows over forty years, are as follows:
The expected residual value of the assets is zero.
Required:
(a) Show whether the project satisfies the normal capital budgeting criteria for acceptance.
(b) Show how sensitive the calculation in (a) above is to:
(i) An increase in the residual asset value from zero to sh.1,000,000.
(ii) A 1% increase in the initial capital outlay (during each year of the outlay).
(iii) A 1% decrease in the estimate of expected cash flow during each of the years from 6 to 10.
(c) Show the effect of adopting the project on the ratio of reported profits in years 5 and 6 to net
balance sheet value of assets at the beginning of those two years. Comment briefly on the usefulness
of the latter type of ratio in the interpretation of accounts in the light of your calculation. (Assume
that the expenditure in years 1 to 5 is capitalized, that straight-line depreciation is charged after year 5 at 5% per annum, and the actual cash flows are according to plan).
You can assume that all cash flows arise on the last day of each year, that all figures are net of tax
and expressed in terms of constant price levels, and that working capital for the investment project
can be ignored.
Date posted:
April 17, 2021
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Two relatively small companies, Elgon Company Ltd. And Kilima Company Ltd., have decided in
principle to merge so that they can complete more effectively with larger companies. The boards of
directors of the two companies have decided that a scheme of amalgamation should be drawn by
the end of September 2003 based on the following agreed figures:
Required:
Comment on the values which have been placed on the ordinary shares for the purpose of merging
the two companies.
Date posted:
April 17, 2021
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Write notes distinguishing the following instruments used in international financial markets:
i) The Euro.
ii) The Euro bonds
iii) The Euro dollars.
Date posted:
April 17, 2021