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Corporate Finance Y3s1 Question Paper
Corporate Finance Y3s1
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2010
COURSE CODE: FNCE 310
COURSE TITLE: CORPORATE FINANCE
STREAM: Y3S1
DAY: MONDAY
TIME: 4:00 – 6:00 PM
DATE: 12/04/2010
INSTRUCTIONS:
1. Answer questions ONE and any other TWO questions only.
2. ALL necessary workings must be carefully shown.
QUESTION ONE (COMPULSORY)
a) Distinguish between the following terms as used in corporate finance:
(i) Capital Structure and financial structure (2marks)
(ii) Money market and capital market (2marks)
iii) Business risk and financial risk (2Marks)
iv) External equity and Internal equity (4marks)
b) Giving examples, distinguish between systematic risk and Non-systematic risk (Illustrate with
the help of a diagram). (5marks)
b) Briefly explain the uses of Capital Asset Pricing Model (C.A.P.M) as an investment appraisal
technique. (4 Marks)
c) Kabu Ltd is considering two investment projects A and B for which the following
information has been given:
Investment A (sh) Investment B (sh)
Investment outlay sh. 2, 000,000 sh.2,000,000
Expected return 0.2 0.2
Standard deviation 0.4 0.6
Beta of returns 1.8 1.2
The finance manager has formulated a risk adjustment relationship based on coefficient of
variation as follows;
Required return on project = Risk free return + 0.4 C.V
He also takes into consideration the security market line (SML) relationship using 6% as
the estimate of the risk free return and 5% as the market risk premium.
Required:
i) Calculate the required return on each project using separately the two alternative methods
of calculating the risk adjustment factor. (6 marks)
ii) Advice the company management on which project should be accepted first by assuming
that the projects are independent and secondly that they are mutually exclusive. (5marks)
[Total: 30 Marks]
QUESTION TWO
A company that is all equity finance has a cost of capital (Required rate of return) of
18.5%. The risk free rate of return is 8% and the expected return on the aggregate market
Portfolio is 15%.
The company is considering investing in the following projects:
Project Outlay (sh ‘000’) Receipts (sh. ‘000’) Beta (Bj)
A 1000 1095 0.3
B 1000 1130 0.5
C 1500 1780 1.0
D 2000 2385 1.5
E 2000 2400 2.0
NOTE: All projects are single period.
Required;
a) The company’s Beta coefficient. (2mks)
b) The CAPM required rate of return for each project (5mks)
c) The expected rate of return for each project. (5mks)
d) Based on B and C above which projects would you recommend and why? (5mks)
e) If all the projects were evaluated using the company’s cost of capital (18.5%),
which project(s) would be recommended and why? (3mks)
(TOTAL: 20 Marks)
QUESTION THREE
a) A company expects to pay dividends of sh 2 per share in the coming year. The dividends
are growing at a constant rate of 10% and this growth rate is expected to continue indefinitely.
The market price of the company’s equity shares is Sh.40 and floatation cost of 10% of the
market price is expected to be incurred.
Required:
i). Calculate the cost of internal equity (2marks)
ii). Calculate the cost of external equity (2marks)
iii) What are your observations in (a) above? (1mark)
(b) Kabarak University has an investment capital of sh 1000,000. The finance manager wishes
to invest in Two securities A and B in the following proportion; Sh 200,000 in
security A and Sh 800,000 in security B .
The returns on these two securities depend on the state of the economy as shown
below:-
Returns on Returns on
State of economy probability Security A Security B
Recovery 0.4 18% 24%
Normal 0.5 14% 22%
Recession 0.1 12% 21%
Required
i) Compute the expected return and standard deviation for each security (5marks)
(ii) Determine the covariance, Coefficient between security A and security (5marks)
(iii) Compute the expected portfolio return (2marks)
(iv) Compute the portfolio risk (3marks)
[Total: 20 mark]
QUESTION FOUR
a) The management of Kabu Ltd is considering undertaking a project with the following details:
Details Amount
Expected useful life 5 Years
Sales volume 1,200,000 units
Selling price Sh.15 per unit
Variable cost per unit Sh.10
Fixed costs Sh.2000,000
Initial outlay Sh.7,360,000
The company’s cost of capital is 15% and corporate tax rate is 30%. Assume straight line method
of depreciation.
Required:
a. Calculate the project’s NPV (3 Marks)
b. Calculate the project’s NPV and its % change assuming each of the variables selling
price, variable costs and sales volume vary adversely by 10% (Assume each variation in
isolation) (11 Marks)
b) A Ltd is targeting B Ltd for a hostile takeover. The management of B Ltd is considering
which defense
mechanism to use in order to block the acquisition. Briefly explain to the management of B
Ltd the following defense strategies applicable in a hostile takeover situation:
i. Crown jewels strategy (2marks)
ii. Poison pill strategy (2 marks)
iii. White knight strategy (2 marks)
(TOTAL: 20Marks)
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