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Cfm 200 Financial Management (D+E) Question Paper
Cfm 200 Financial Management (D+E)
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2011
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UNIVERSITY EXAMINATIONS: 2010/2011
SECOND YEAR EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
CFM 200 FINANCIAL MANAGEMENT (D+E)
DATE: DECEMBER2011 TIME: 2 HOURS
INSTRUCTIONS: Answer Question One and Any Other Two Questions
Question One
(a) XYZ Limited maintains a minimum cash balance of Sh.500,000. The standard deviation of
the company’s cash changes is Sh.200,000. The annual interest rate is 14%. The
transaction cost of buying or selling securities is Sh.150 per transaction.
Using Miller-Orr cash management model determine the following:
(i) The upper cash limit. (2 Marks)
(ii) The average cash balance. (2 Marks)
(iii) The return point (3 Marks)
(iv) Give the decision rule. (3 Marks)
(b) Outline 3 theories of valuation of securities. (6 Marks)
(c) 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.
Economic Conditions Probability Cash flow (Sh. Millions)
Very good 0.1 35
Good 0.45 28
Fair 0.30 24
Poor 0.15 14
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The firm’s required rate of return is 14%. The project has an expected life of six years.
Compute the expected net present value of the proposed investment. (5 Marks)
(d) Chuma Ltd. is considering various levels of debt. Currently the company has no debt and it
has a total market value of Sh.30 million. By undertaking debt the company believes that it
can achieve a net tax advantage equal to 20% of the amount of debt. However, the
company will incur bankruptcy and agency cost if it borrows too much. The company’s
Managing Director (MD) believes that the company can borrow up to Sh.10m without
incurring any of this costs. However each additional Sh.10m increment in borrowing is
expected to result to the cost cited being incurred. Moreover the costs are expected to
increase at an increasing rate with leverage. The present value (PV) cost of various levels
of debt is as follows:
Debt (Sh.M PV cost of bankruptcy
and agency cost Sh.M)
10 0
20 0.6
30 2.4
40 4.0
50 6.4
60 10
Advice the MD on the optimal amount of debt for the company. (9 Marks)
Question Two
(a) Consider two firms L and U with the following characteristics:
L U
EBIT 900,000 900,000
Cost of equity 10% 10%
7.5% debt 2,000,000 -
Required:
(i) Calculate the weighted average cost of capital of L and U. (2 Marks)
(ii) Calculate the value of each firm using the net income approach. (2 Marks)
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(iii) Demonstrate the arbitrage opportunity available to an investor who owns 10% of
the overvalued firm. (2 Marks)
(b) Outline 5 general assumptions of the capital structure theories. (5 Marks)
(c) Discuss 3 assumptions relevant to the net operating income approach. (6 Marks)
Question Three
(a) Discuss 4 solutions to the agency problem between creditors and shareholders. (8 Marks)
(b) Outline 4 causes of conflict between shareholders and management. (8 Marks)
(c) Explain 4 solutions to the agency problems between the government and shareholders.
(4 Marks)
Question Four
(a) Consider three firms with the following results:
A B C
Sales (Sh.000) 10,000 10,000 10,000
Operating cost Sh.(000)
Fixed cost 7,000 2,000 Nil
Variable cost 2,000 7,000 9,000
EBIT Sh.000 1,000 1,000 1,000
Suppose sales for each firm increases by 50% next year, calculate the percentage change in
explaining the choice of capital structure. (8 Marks)
(b) Explain the pecking order theory as used in explaining the choice of capital structure.
(6 Marks)
(c) Outline the three types of leverage. (6 Marks)
Question Five
(a) Discuss four different dividend policies which influence the amount of dividend per share a
company can pay. (8 Marks)
(b) Outline 6 dividend theories which attempt to explain whether the payment of dividends
affects the value of the firm. (12 Marks)
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