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Introduction To Finance Question Paper
Introduction To Finance
Course:Bachelor In Commerce
Institution: University Of Nairobi question papers
Exam Year:2011
QUESTION ONE
(a) " Few trends could so thoroughly undermine the very foundation of our society as the acceptance by the corporate officials of a society responsibility other than to make as much money to their stockholders as possible"
(Milton Triedman, Capitalism and Freedom, 1962)
Required:
1) what do you understand by the term "corporate social responsibility"? (4 marks)
2) what factor have you driven the interest in corporate social responsibility? (4 marks)
3) briefly outline the arguments for or against corporate social responsibility in the maximization of firm value and shareholder wealth. (4 marks)
(b) Two firms A and B have the same EBIT as follows:
..........................A...............................B
sales.................100,000........................100,000
variable cos..30,000..................60,000
fixed cost... 60,000..90,000..........30,000..........90,000
EBIT..................10,000..........................10,000
Assume that sales and variable cost increase by 50%
Required:
calculate the operating leverage and interpret your results (8 marks)
(c) Distinguish between financial and business risks. (5 marks)
QUESTION TWO
The Yamo Kudho Corporation is considering two mutually exclusive pieces of machinery that perform the same task. The two alternatives available provide the following set of after-tax cash flows.
Year................Equipment A...............Equipment B
0...................sh (20,000)...............sh (20,000)
1.......................12,590....................6,625
2.......................12,590....................6,625
3.......................12,590....................6,625
4.................................................6,625
5.................................................6,625
6.................................................6,625
7.................................................6,625
8.................................................6,625
9.................................................6,625
Equipment A has an expected life of 3 years, whereas equipment B has an expected life of 9 years.
Required:
1) calculate each projects pay back period (5 marks)
2) calculate each projects net present value (5 marks)
3) calculate each projects internal rate of return (8 marks)
4) which project should be selected? support your recommendation (7 marks)
QUESTION THREE
(a) The dividends last paid for Merit Company common shares is sh. 3.50. The dividends are expected to grow at a rate of 15% for two years and there after at a constant rate of 8% indefinitely. If Merit cost of equity is 17%, calculate the theoretical market price of common shares ( 8 marks)
(b) On January 1, the total market value of Komoro was sh. 60 million. During the year, the company plans to raise and invest sh. 30 million in new projects. The firms present market value capital structure shown below is considered to be optimal. Assume that there is no short term debt.
..........................sh.
debt.................30,000,000
equity...............30,000,000
total capital........60,000,000
New bonds will have an 8% coupon rate, and they will be sold at par. Common stock currently selling at sh. 30 a share can be sold to net the company sh. 27 a share. Stockholders required rate of return is estimated to be 12%, consisting of dividend yield of 4% and an expected constant growth of 8%. The current dividend is sh.1.20. Retained earnings for the year are estimated to be sh.3 million. The corporate tax rate is 30%.
Required:
1) How much of the new investment must be financed by equity to maintain the present capital structure. (2 marks)
2) how much of the needed new equity must be generated externally? (3 marks)
3) calculate the cost of each component of capital (6 marks)
4) calculate the firms WACC using: the cost of retained earnings and, the cost of new equity. (6 marks)
QUESTION FOUR
(a) You have just been hired as a cash manager of the Mumbi Company. Your first take is to determine the target cash balance. The firm expects to need sh. 1,000,00 of the net new cash during the coming year. The firm plans to meet this cash requirement by borrowing from bank A at an annual interest rate of 10%. The fixed cost of transferring funds form the bank is sh. 50 per transfer.
Required:
1) Assume that the firm will not carry a cash "safety stock", what is the average cash as indicated by the Baumol model? how many cash transfer are expected over the year? (5 marks)
2) calculate the total cost of the cash balances. (3 marks)
3) suppose the firm wants to maintain a sh. 5,000 cash "safety stock" which is currently on hand, what would be the new average cash balance.(3 marks)
(b) The Mwenge Company expects to have sales of sh. 20 million this year under the current operating policies. Its variable cost as a proportion of sales are 0.8 and its cost of receivable financing is 8%. Currently, the firms credit policy is net 25. However, its average collection period is 30 days, indicating that some customers are paying late , and its bad debt losses are 3% of sales.
The Company's credit manager is considering two alternative credit policies.
Proposal 1: lengthen the credit period to net40. If this were done, it is estimated that sales would increase to sh. 20,500,000 that days outstanding would increase to 45 days and that the bad debt losses on the incremental sales would be 5%. Existing customer debt losses would remain at 3%
Proposal 2: Shorten the credit period to net 30. Under these terms, sales would be expected to decrease to sh. 18 million, days sales outstanding would drop to 22 days, and bad debts losses would decrease to 1% of new sales level.
Required:
Advice the company on which proposal should be adopted. (15 marks)
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