Fnce 220: Business Finance 2008 Question Paper
Fnce 220: Business Finance 2008
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2008
KABARAK UNIVERSITY
EXAMINATIONS
2008/2009 ACADEMIC YEAR
FOR THE DEGREE OF BACHELOR OF COMMERCE
COURSE CODE: FNCE 220
COURSE TITLE: BUSINESS FINANCE
STREAM: Y2S2
DAY: MONDAY
TIME: 8.30-10.30 A.M.
DATE: 15/12/2008
INSTRUCTIONS:
1. Attempt question ONE and ANY OTHER TWO questions
2. Question ONE carries 30 marks and the rest 20 marks each
3. Show all your workings clearly
QUESTION ONE
(a) What forces or mechanisms might serve to reduce potential conflicts between
management and shareholders? (6 marks)
(b) Write brief explanation notes on the following concepts as used in business
finance:
(i) Capital structure
(ii) Use of interlocking directorships
(iii) Japanese corporate governance style
(iv) Financial structure
(v) Risk
(vi) Having staggered boards (12 marks)
(c) As an asset manager, you are considering making an investment in one or both of
two securities, A and B. You are provided with the following information:
Security Possible Probability of
Rates of return (%) occurrence
A 30 0.3
25 0.4
20 0.3
B 50 0.2
30 0.6
10 0.2
Required:
(i) Calculate the expected return for each security separately and for a portfolio
comprising 60% A and 40% B assuming no correlation between the possible rates
of return from the shares comprising the portfolio. (6 marks)
(ii) Calculate the risk of each security separately and of the portfolio as defined above
(measure risk by the standard deviation of returns from the expected rate of
return). (6 marks)
QUESTION TWO
(a) Respond to the following comments:
(i) There is upside-risk and down-side risk. Standard deviation does not
distinguish between them.
(ii) Harry Markowitz was just another non-Kenyan
(iii) Profits are the same as cash flows.
(iv) USA Corporate governance system gives shareholders less say and workers
more in the running of enterprise. (4 Marks)
(b) A company has an investment opportunity costing £ 40,000 with the following
expected net cash inflow (after taxes):
Year Net Cash Inflow (£)
1 7,000
2 7,000
3 7,000
4 7,000
5 7,000
6 8,000
7 10,000
8 15,000
9 10,000
10 4,000
Using 10% as the cost of capital determine the following:
(i) Payback period (3 marks)
(ii) Net present value at 10% discounting factor. (5 marks)
(iii) Profitability index at 10% discounting factor. (3 marks)
(iv) Internal rate of return (5 marks)
QUESTION THREE
(a) Valuation of ordinary shares in more complicated than the valuation of bonds and
preference shares. Explain the factors that complicate the valuation of ordinary
shares. (6 Marks)
(b) KABU Co. Ltd is using a machine whose original cost was Kshs. 720,000. The
machine is two years old and it has a current market value of Kshs. 160,000. The
asset is fully being depreciated over a 12 years; the asset will have a zero salvage
value. The management is contemplating the purchase of a new machine to
replace the old one. The new machine costs Kshs. 750,000 and has an estimated
salvage value of Kshs. 100,000. The new machine will have a greater
technological capacity and therefore annual sales are expected to increase from
Kshs. 10 million to Kshs. 10.1 million. Operating efficiencies wit the new
machine will produce an expected savings of Kshs. 100,000 a year. Depreciation
will be on a straight line basis over a 10 year period. The cost of capital is 12%
and a 40% tax rate is applicable. In addition, if the new machine is purchased
inventories may increase by Kshs. 150,000 and payables by Kshs. 50,000 during
the life of the project.Page 4 of 5
Required:
(i) Should the machine be purchased? (10 marks)
(ii) What factors in addition to quantitative ones above are likely to require
consideration in practical situation (4 marks)
QUESTION FOUR
(a) (i) Comment on the problems of financing which a small business is likely to
encounter at early stage of its development. (10 marks)
(ii) Using the knowledge of agency theory, discuss how to resolve the conflicts
arising between tenders and owners. (6 marks)
.
(b) Explain the role of the financial manager in a modern corporate setting
environment. (4 marks)
QUESTION FIVE
(a) Merica Hotel Ltd wants to take advantage of the new commercial paper now
popular in Kenyan market. It wants to issue tow debenture papers both bear
coupon rates of 14% and the effective yield required on each is 20%. Paper A has
a maturity of 10 years and paper B a maturity of 20 years. Both will be paying
interest annually and Kshs. 100,000 at maturity.
Required:
(i) What is the price of each paper? (4 marks)
(ii) If the effective yield of each paper rises to 24%, what is the price of each paper?
(4 marks)
(iii) Explain why the price of one paper falls more than the price of others when the
effective yield B rises. (4 marks)
(b) The most recent data for Water Buck Ltd, disclose the following:-
Dividend per share 3.00
Expected annual dividend growth rate 6%
The current required rate of return 15%
The company is considering a variety of proposals in order to redirect the firms’
activities. The following four alternative strategies have been suggested:
i) Do nothing in which case key financial variables will remain unchanged.
ii) Invest in a venture that will increase the dividend growth rate of 7% and
increase the required rate of return to 14%.
iii Eliminate any unprofitable product line. The action will increase the dividend
growth rate to 8% and raise the required rate of return to 17%.
iv) Acquire a subsidiary operation from company. This action will increase the
dividend growth rate to 9% and the required rate of return 18%.
Required:
For each of the proposed actions, determine the resulting market prices per share and
recommend the best alternative strategy. (8 marks)
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