Dpba 022: Financial Management Question Paper
Dpba 022: Financial Management
Course:Financial Management
Institution: Kenya Methodist University question papers
Exam Year:2008
KENYA METHODIST UNIVERSITY
END OF FIRST TRIMESTER 2008 EXAMINATION
FACULTY : BUSINESS AND MANAGEMENT STUDIES
DEPARTMENT : BUSINESS ADMINISTRATION
COURSE CODE : DPBA 022
COURSE TITLE : FINANCIAL MANAGEMENT
TIME : 3 HOURS
INSTRUCTIONS
• Answer Question ONE and any other THREE questions
Question 1
Dasani Company Limited had the following capital structure at 31st January 2006 which is considered optimum.
14% debentures Kshs. 3,000,000
11% Preference Shares Kshs. 1,000,000
Equity (1,000,000) Shares Kshs. 16,000,000
Kshs. 20,000,000
The Company’s share has a current market price of Kshs. 23.60 per share. The expected
Dividend per share is 50% of the 2006 earnings per share (EPS). The following are the
Earnings per share (EPS) for the company during the preceding ten years. The past trends
Are expected to continue.
Year EPS Year EPS
1997 1.00 2002 1.67
1998 1.10 2003 1.77
1999 1.21 2004 1.95
2000 1.33 2005 2.15
2001 1.46 2006 2.36
The company can issue 16 % new debentures. The company debenture is currently
selling at Kshs. 96. The new preference issue can be sold at a net price of Kshs.
9.20 paying a dividend of Kshs. 1.1 per share. The company’s marginal tax rate is 50%.
Required
a) i) Calculate the after tax cost of
• New Debt (2 Marks)
• New Preference share capital (2 Marks)
• Ordinary equity assuming new equity comes from retained earnings (2 Marks)
ii) Find the weighted average cost of the new capital, assuming no new ordinary shares are sold. (3 Marks)
iii) How much can be spent for investment before new ordinary shares must be
sold? Assume that retained earnings available for next year’s investment are
50 % of 2006.
b) Explain any four roles of the stock exchange in the economy (4 Marks)
c) Highlight the various measures that would minimize agency problems between the owners and the management (6 Marks)
d) Explain why shareholders wealth maximization is considered to be a superior criterion for measuring the performance of a firm when compared to profit maximization (6 Marks)
Question 2
a) Three project A, B, and C have the following estimates of the possible one year
Returns in their common stock
Probability of occurrence Project Possible Return
A B C
0.25 10% 9% 14%
0.5 14% 13% 12%
0.25 16% 18% 10%
Required
i) Calculate the expected return, risk and co-efficient of variation for each project. (9 Marks)
ii) Assuming a potential investor is contemplating on which project to undertake, what would be your advice (1 Marks)
b) Bright industries limited have a beta of 1.45. The risk free rate is 8 % and the expected return on a market portfolio is 13 %. The company presently pays a dividend of Kshs. 2 per share and investors expect it to experience growth in dividends of 10% per annum for many years to come.
Required
i) What is the stocks required rate of return according to CAPM (2 Marks)
ii) Highlight any four limitation of CAPM (4 Marks)
c) Give four reasons why a company should calculate its cost of capital with care
(4 Marks)
Question 3
The management of Sharpener Limited are receiving the company’s capital Investment options for the coming year and are considering two projects.
Project W
This would involve a current outlay of £ 50,000 on equipment and £ 15,000 on working capital would be increased to £ 21,000 at the end of the first year. Annual cash profits would be £ 18,000 per annum for 5 years, at the end of which the investment in working capital would be recovered. The cost of capital is 12%.
Project X
This is a long term project involving an immediate outlay of £ 32,000 and an annual cash flow of £ 4,500 p.a. in perpetuity. The cost of capital is 15%.
Required
a) Calculate the a NPV of each project and advise the management of the company on the project they should take. (10 Marks)
b) Outline any five factors that an investor needs to consider in making investment decisions. (10 Marks)
Question 4
Distinguish between the following set of terms
i) Primary market and secondary market (4 Marks)
ii) Commercial paper and debenture (4 Marks)
iii) Stock markets and Financial Markets (4 Marks)
iv) Factoring and invoice discounting (4 Marks)
v) Systematic and Unsystematic risk (4 Marks)
Question 5
The following information represents the financial position and financial results of Aminata limited for the year ended 31st December 2006.
Amanita Limited
Trading Profit and loss Account for the year ended 31st December 2006
Kshs.’000 Kshs. ‘000
Sales - Cash
- Credit
Less: cost of sales
opening sock
Less: closing stock
Gross Profit
Less expenses
Depriciation
Directors emoluments
General expenses
Interest on loan
Net profit before tax
Corporation tax at 30%
Preference dividend
Ordinary dividend
210,000
660,000
870,000
150,000
13,100
15,000
20,900
4,000
4,800
10,000 300,000
600,000
900,000
720,000
180,000
(53,000)
127,000
(38,100)
88,900
14,800
74,100
Aminata limited
Balance sheet as at 31st December 2006
Kshs.’000 Kshs. ‘000 Kshs. ‘000
Fixed assets 213,000
Current assets
Stocks 150,000
Debtors 35,900
Cash 20,000 205,900
Current Liabilities
Trade Creditors 60,000
Corporation tax 63,500
Proposed Dividend 14,800 138,300 67,600
281,500
Financed by:
Ordinary Share capital (Kshs 10 par value) 100,000
8% Preference shares 60,000
Revenue reserves 81,500
10% Bank Loan 40,000 281,500
Additional Information
1. The company’s ordinary shares are selling Kshs 20 in the stock market.
2. The company has a constant dividend payout of 10%.
Required
a) Determine the following ratios
i) Acid test ratio (2 Marks)
ii) Operating ratio (2 Marks)
iii) Return on capital employed (2 Marks)
iv) Price earning ratio (2 Marks)
v) Interest coverage ratio (2 Marks)
vi) Total assets turnover (2 Marks)
vii) Debtors collection period (2 Marks)
b) Outline any six limitations of using ratios as a basis for financial analysis
(6 Marks)
Question 6
a. Cliff Company Limited is considering a new product line to supplement its range line. It is anticipated that the new product line will involve cash investments of Shs. 700,000 at time 0 and sh1.0 million in year 1. After-tax inflows of Shs. 250,000 are expected in year 2, Shs. 300,000 in year 3, Shs 350,000 in year 4 and Shs 400,000each year thereafter through year 10. Though the production line might be viable after year 10, the company prefers to be conservative and end all calculations at that time.
The require rate of return is 15%.
Required
Determine-: i) The net present value of the project. Is it acceptable? (5 marks)
ii) The internal rate of return. (5 marks)
iii) Payback period (3 marks)
b. With aid of a diagram explain the Miller Orr-model of cash management and state any three of its disadvantages. (7 marks)
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