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Buss 321: Financial Management 1 Question Paper

Buss 321: Financial Management 1

Course:Financial Management I

Institution: Kenya Methodist University question papers

Exam Year:2010

KENYA METHODIST UNIVERSITY

END OF THIRD TRIMESTER 2010 EXAMINATIONS

FACULTY : BUSINESS AND MANAGEMENT STUDIES
DEPARTMENT : BUSINESS ADMINISTRATION
COURSE CODE : BUSS 321
COURSE TITLE : FINANCIAL MANAGEMENT 1
TIME : 2 HOURS
INSTRUCTIONS
• Answer Question ONE and any Other TWO Questions

QUESTION ONE
a) Kisauni Company Ltd. is considering a project that would require an outlay of sh. 2.4M. If there was no inflation then the cash flows for the three-year life of the project would be:
PROJECT Y Annual cash flows (sh. M)
Inflows from sales 2
Cash outflows:
Materials 0.6
Labour 0.3
Overheads 0.06
(0.96)
Net cash flow 1.04
Specific annual inflation rates have been estimated for each of the cash flow elements:
Sales 6%
Materials 12%
Labour 9%
Overheads 8%
The money cost of capital is 12% p.a.

Required:
Use the money cash flows and the money cost of capital to calculate the NPV of the project and advise management on its viability. (16 marks)

b) Give three reasons why we cannot directly compare sh.1 today with sh.1 after a year.
(6 marks)
c) Explain the following terms.
i) Cum-dividend (2 marks)
ii) Ex-dividend (2 marks)
iii) Cum-right (2 marks)
iv) Ex-right (2marks)

Question 2
a) What is business risk and financial risk. (4 marks)

b) Some writers advocate for the increased use of debt because of its beneficial effect on: i) Managerial motivation
ii) Reinvestment
iii) Operating and strategic efficiency.

Explain these ideas. (9 marks)

c) What is financial distress and how does it affect the gearing decision. (7marks)

Question 3
a) Explain any four roles of the Stock Exchange in an economy. (4 marks)

b) Explain the following terms used in the Stock Exchange.
i) Market value of shares (4 marks)
ii) Par value of a share (4 marks)
iii) Dividend (4 marks)
iv) Speculation (4 marks)

Question 4
Kilifi Company Ltd. is considering a project with the following cash flows:

Initial outlay: 100
TIME (YEARS) Probability of economic event
Economic Condition 1 2 Pi
Economic boom 130 130 0.15
Good growth 110 110 0.20
Growth 90 90 0.30
Poor growth 70 70 0.20
Recession 50 50 0.15
The risk-free discount rate is 6%.

Required:
a) Calculate the Expected NPV of the project. (5 marks)

b) Calculate the Variance. (5 marks)

c) Calculate the standard deviation. (5 marks)

d) What is the probability of the project producing a negative NPV. (5 marks)

Question 5
a) Explain the Modigliani and Miller’s dividend irrelevancy hypothesis. (4 marks)

b) How might clientele effects influence dividend policy. (4 marks)

c) What is the Agency Theory and the Agency Costs (4 marks)

d) List and explain four solutions to the Agency problem. (4 marks)

Buss 321: Financial Management 1 Question Paper

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