Importance of capital budgeting decision
- They have long term implications to the firm e.g. they influence long term variability
of cashflows
- They are irreversible and very costly to reverse
- They involve significant amount of initial capital.
marto answered the question on February 11, 2019 at 09:12
- The total of the net working capital and fixed assets of Faida Ltd as at 30 April 2003
was Sh.100,000,000. The company wishes to raise additional...(Solved)
The total of the net working capital and fixed assets of Faida Ltd as at 30 April 2003 was Sh.100,000,000. The company wishes to raise additional funds to finance a project within the next one year in the following manner.
The current market value of the company's ordinary shares is Sh.30. The expected dividend on ordinary shares by 30 April 2004 is forecast at Sh.1.20 per share. The average growth rate in both earnings and dividends has been 10% over the last 10
years and this growth rate is expected to be maintained in the foreseeable future. The debentures of the company have a face value of Sh.150. However, they currently sell for Sh.100. The debentures will mature in 100 years.
The preference shares were issued four years ago and still sell at their face value.
Assume a tax rate of 30%
Required:
(i) The expected rate of return on ordinary shares.
(ii) The effective cost to the company of:
- Debt capital
- Preference share capital
(iii) The company's existing weighted average cost of capital.
(iv) The company's marginal cost of capital if it raised the additional Sh.50,000,000 as intended.
Date posted: February 11, 2019. Answers (1)
- In recent years, there has been a trend towards “cross-border” listing of securities of
quoted companies. This has reduced the over-reliance by companies on domestic capital...(Solved)
In recent years, there has been a trend towards 'cross-border' listing of securities of
quoted companies. This has reduced the over-reliance by companies on domestic capital markets.
Required:
(a) Explain the meaning of 'cross-border' listing.
(b) Identify and explain six reasons why companies in your country may seek 'cross border' listing.
(c) Identify five barriers to “cross-border” listing.
Date posted: February 11, 2019. Answers (1)
- Safaricom and Shelter Afrique are examples of companies that have in the recent past issued
floating rate bonds.
Required:
(a) Briefly explain the meaning of a 'floating rate'...(Solved)
Safaricom and Shelter Afrique are examples of companies that have in the recent past issued
floating rate bonds.
Required:
(a) Briefly explain the meaning of a 'floating rate' bond.
(b) From the point of view of a company's financial manager, outline the merits
and demerits, to the company, of issuing floating rate debt as a means of raising capital.
Date posted: February 11, 2019. Answers (1)
- Madawa Chemicals Ltd. is in the process of forecasting its financial needs for the coming year
ending 31 October 2003. The company attained a turnover of...(Solved)
Madawa Chemicals Ltd. is in the process of forecasting its financial needs for the coming year ending 31 October 2003. The company attained a turnover of Sh.300 million for the current year ended 31 October 2002.
Required:
(a) The amount of external finance that will be needed during the year ending 31 October 2003 if sales are expected to increase by 15% in the year.
(b) The maximum expected sales growth that can be achieved in the year ending 31 October 2003 if only internally generated funds are used.
(c) The maximum growth in sales that can be achieved in the year ending 31 October 2003 if the company wishes to maintain its current level of financial gearing.
(d) Briefly comment upon the weaknesses of the method of forecasting used above.
Date posted: February 11, 2019. Answers (1)
- (a) Explain the term 'agency costs' and give any three examples of such costs.
(b) On 1 November 2002, Malaba Limited was in the process...(Solved)
(a) Explain the term 'agency costs' and give any three examples of such costs.
(b) On 1 November 2002, Malaba Limited was in the process of raising funds to undertake
four investment projects. These projects required a total of Sh.20 million.
Given below are details in respect of the projects:
Required:
(i) The levels of total new financing at which breaks occur in the Weighted
Marginal Cost of Capital (WMCC) curve.
(ii) The weighted marginal cost of capital for each of the 3 ranges of levels of total
financing as determined in (i) above.
(iii) Advise Malaba Limited on the projects to undertake assuming that the projects
are not divisible.
Date posted: February 11, 2019. Answers (1)
- Mwamba Limited is considering replacing a production machinery at its Mtwapa plant.
The existing machinery at the plant was bought 3 years ago at a cost...(Solved)
Mwamba Limited is considering replacing a production machinery at its Mtwapa plant.
The existing machinery at the plant was bought 3 years ago at a cost of Sh.50 million. It
is expected to have a useful life of 5 more years with no scrap value at the end of this
period. The machinery could be disposed of immediately with net proceeds of Sh.35
million after tax.
The new machinery will cost Sh.80 million, with a useful life of 5 years and expected
terminal value of Sh.5 million. With the introduction of the new machinery, sales are
expected to increase by Sh.25 million per annum over the next 5 years. Variable costs
are 60 per cent of sales and the corporate tax rate is at 30 per cent per annum.
The operation of the new machinery will also require an immediate investment of Sh.8
million in working capital which will be recovered at the end of its useful life.
Installation costs of the new machinery will amount to Sh.6 million.
Assume that capital allowances are to be provided for on a straight-line basis and
Mwamba Limited's cost of capital is 12 per cent per annum.
Required:
(i) The initial cash outflow for the replacement decision.
(ii) The annual incremental after tax operating cash flows.
(iii) The NPV of the replacement decision and advise Mwamba Limited on whether
to replace the machinery.
(iv) The minimum after tax annual operating cash flows that will make the
replacement feasible
Date posted: February 11, 2019. Answers (1)
- In evaluating investment decisions, cash flows are considered to be more relevant than
profitability associated with the project.
Explain why this is the case.(Solved)
In evaluating investment decisions, cash flows are considered to be more relevant than
profitability associated with the project.
Explain why this is the case.
Date posted: February 11, 2019. Answers (1)
- The following information relates to the current trading operations of Maji Mazuri Enterprises (MME) Ltd:
(Solved)
The following information relates to the current trading operations of Maji Mazuri Enterprises (MME) Ltd:
The management of the company is in the process of reviewing the
company's credit management system with the objectives of reducing the operating
cycle and improving the firm's liquidity. Two alternative strategies, now being
considered by management are detailed as follows:
Alternative A: change of credit terms:
The proposal requires the introduction of a 2% cash discount which is expected to have
the following effects:
-50 per cent of the credit customers (and all cash customers) will take advantage
of the 2 per cent cash discount.
- There will be no change in the level of annual sales, the percentage of credit
- sales and the contribution of sales ratio.
- There will be savings in collection expenses of Sh.2,750,000 per month.
- Bad debts will remain at 2 per cent of total credit sales.
- The average collection period will be reduced to 32 days.
Alternative B: contracting the services of a factor:
The factor would charge a fee of 2% of total credit sales and advance MME Ltd. 90%
of total credit sales invoiced by the end of each month at an interest rate of 1.5% per
month.
The effects of this alternative are expected to be as follows:
- No change is expected in the level of annual sales, proportion of credit sales
and contributions -
-margin ratio.
- Savings on debt administration expenses of Sh.1,400,000 per month will result
-All bad debt losses will be eliminated
-The average collection period will drop to 20 days.
Required:
i) Evaluate the annual financial benefits and costs of each alternative (Assume 360 –day year)
ii) Advise MME Ltd. management on the alternative to implement.
iii) Explain briefly other factors that should be considered in reaching the decision in (ii) above.
Date posted: February 11, 2019. Answers (1)
- A firm may adopt a conservative policy or an aggressive policy in financing its working
capital needs
Clearly distinguish between
i) A conservative policy and
ii) An aggressive...(Solved)
A firm may adopt a conservative policy or an aggressive policy in financing its working
capital needs.
Clearly distinguish between:
i) A conservative policy and
ii) An aggressive policy.
Date posted: February 11, 2019. Answers (1)
- (a) Discuss the main factors which a company should consider when determining the
appropriate mix of long-term and short-term debt in its capital structure.
(b) Malindi...(Solved)
(a) Discuss the main factors which a company should consider when determining the
appropriate mix of long-term and short-term debt in its capital structure.
(b) Malindi Leisure Industries is already highly geared by industry standards, but wishes to
raise external capital to finance the development of a new beach resort.
Outline the arguments for and against a rights issue by Malindi Leisure Industries.
(c) Examine the relative merits of leasing versus hire purchase as a means of acquiring
capital assets.
Date posted: February 11, 2019. Answers (1)
- Discuss the main factors which a company should consider when determining the appropriate mix of long-term and short-term debt in its capital structure.
(Solved)
Discuss the main factors which a company should consider when determining the appropriate mix of long-term and short-term debt in its capital structure.
Date posted: February 11, 2019. Answers (1)
- What is meant by the term 'capital flight'?
(Solved)
What is meant by the term 'capital flight'?
Date posted: February 11, 2019. Answers (1)
- P. Muli was recently appointed to the post of investment manager of Masada Ltd. a quoted
company. The company has raised Sh.8,000,000 through a rights issue.
P....(Solved)
P. Muli was recently appointed to the post of investment manager of Masada Ltd. a quoted company. The company has raised Sh.8,000,000 through a rights issue.
P. Muli has the task of evaluating two mutually exclusive projects with unequal economic lives. Project X has 7 years and Project Y has 4 years of economic life. Both projects are expected to have zero salvage value. Their expected cash flows are as follows:
The amount raised would be used to finance either of the projects. The company expects to pay a dividend
per share of Sh.6.50 in one year's time. The current market price per share is Sh.50.
Masada Ltd. expects the future earnings to grow by 7% per annum due to the undertaking of
either of the projects. Masada Ltd. has no debt capital in its capital structure.
Required:
(a) The cost of equity of the firm.
(b) The net present value of each project.
(c) The Internal Rate of return (IRR) of the projects. (Rediscount cash flows at 24% for project X and 25% for Project Y).
(d) Briefly comment on your results in (b) and (c) above.
(e) Identify and explain the circumstances under which the Net Present Value (NPV) and the Internal Rate of Return (IRR) methods could rank mutually exclusive projects in a conflicting way.
Date posted: February 11, 2019. Answers (1)
- The management of Afro Quatro Ltd. want to establish the amount of financial needs for the
next two years. The balance sheet of the firm as...(Solved)
The management of Afro Quatro Ltd. want to establish the amount of financial needs for the next two years. The balance sheet of the firm as at 31 December 2001 is as follows:
For the year ended 31 December 2001, sales amounted to Sh.240,000,000. The firm projects
that the sales will increase by 15% in year 2002 and 20% in year 2003.
The after tax profit on sales has been 11% but the management is pessimistic about future
operating costs and intends to use an after-tax profit on sales rate of 8% per annum.
The firm intends to maintain its dividend pay out ratio of 80%. Assets are expected to vary
directly with sales while trade creditors and accrued expenses form the spontaneous sources of
financing. Any external financing will be effected through the use of commercial paper.
Required:
(a) Determine the amount of external financial requirements for the next two years.
(b) (i) A proforma balance sheet as at 31 December 2003.
(ii) State the fundamental assumption made in your computations in (a) and b(i) above.
Date posted: February 11, 2019. Answers (1)
- Ngomongo Holdings Limited has investment interests in three companies. Kirinyaga
Video Limited (KVL), Kilgoris Hauliers Limited (KHL) and Turkana Fisheries Limited
(TFL). The following financial data relate...(Solved)
Ngomongo Holdings Limited has investment interests in three companies. Kirinyaga Video Limited (KVL), Kilgoris Hauliers Limited (KHL) and Turkana Fisheries Limited (TFL). The following financial data relate to these companies.
Required:
(i) For Kirinyaga Video Ltd. (KVL) and Kilgoris Hauliers Ltd. (KHL),
determine and compare:
- Dividend yields
- Price/Earnings ratios
-Dividend covers.
(ii) Using the dividends growth model, determine the market value of 1,000 shares
held in Turkana Fisheries Ltd. (TFL) as at 31 December 2001.
Date posted: February 11, 2019. Answers (1)
- Discuss the drawbacks of using the following approaches in estimating a
security's value:
(i) Book value;
(ii) Replacement value;
(iii) Substitution value;
(iv) Intrinsic value.
(Solved)
Discuss the drawbacks of using the following approaches in estimating a
security's value:
(i) Book value;
(ii) Replacement value;
(iii) Substitution value;
(iv) Intrinsic value.
Date posted: February 11, 2019. Answers (1)
- Three years ago, Mrs. Rehema Waziri was retrenched from the Civil Service. She invested
substantially all her terminal benefits in the shares of ABC Ltd., a...(Solved)
Three years ago, Mrs. Rehema Waziri was retrenched from the Civil Service. She invested substantially all her terminal benefits in the shares of ABC Ltd., a company quoted on the stock exchange. The dividend payments from this investment makes up a significant position of Mrs Waziri's income. She was alarmed when ABC Ltd. dropped its year 2001 dividend to Sh.1.25 per share from Sh.1.75 per share which it had paid in the previous two years. Mrs Waziri has approached you for advice and you have gathered the information given below regarding the financial condition of ABC Ltd. and the finance sector as a whole.
Notes:
1. Industry ratios have been roughly constant for the past four years.
2. Inventory turnover, total assets turnover and fixed assets turnover are based on the year-end balance sheet figures.
Required:
(a) The financial ratios for ABC Ltd for the past three years corresponding to industry ratios given above.
(b) Arrange the ratios calculated in (a) above in columnar form and summarize the strengths and weaknesses revealed by these ratios based on:
(i) Trends in the firm's ratios
(ii) Comparison with industry averages.
(The summary should focus on the liquidity, profitability and turnover ratios).
Date posted: February 8, 2019. Answers (1)
- Magharibi Cane Millers Ltd. is a company engaged in the pressing and processing of sugar cane
juice into refined sugar. For some time, the company has...(Solved)
Magharibi Cane Millers Ltd. is a company engaged in the pressing and processing of sugar cane
juice into refined sugar. For some time, the company has been considering the replacement of
its three existing machines.
The production manager has learnt from a professional newsletter on sugar of the availability of
a new and larger machine whose capacity is such that it can produce the same level of output per
annum currently produced by the three machines. Furthermore, the new machine would cut
down on the wastage of juice during processing. If the old machines are not replaced, an
extraordinary overhaul would be immediately necessary in order to maintain them in operational
condition. This overhaul would at present cost Sh.5,000,000 in total.
The following additional information is available:
Required:
(a) (i)Net present values of the proposed replacement decision using discount rates
of 10% and 20%.
(ii) The estimated internal rate of return (IRR) of the replacement decision using
the values determined in (i) above.
(iii) Advice management on the proposal based on your answer in (ii) above.
(b) Decision as to whether the project meets the financial viability test.
(c) Comment on any other qualitative considerations that could influence this decision.
Date posted: February 8, 2019. Answers (1)
- Multi-Link Ltd., a trading company, currently has negligible cash holdings but expects
to make a series of cash payments totaling Sh.150 million over the forthcoming year.
These...(Solved)
Multi-Link Ltd., a trading company, currently has negligible cash holdings but expects
to make a series of cash payments totaling Sh.150 million over the forthcoming year.
These payments will become due at a steady rate. Two alternative ways have been
suggested of meeting these obligations.
Alternative I
The company can make periodic sales from existing holdings of short-term securities.
The average percentage rate of return on these securities is 12 over the forthcoming
year. Whenever Multi-Link Ltd. sells the securities, it will incur a transaction fee of
Sh.15,000. The proceeds from the sale of the securities are placed on short-term deposit
at 7% per annum interest until needed.
Alternative II
The company can arrange for a secured loan amounting to Sh.150 million for one year
at an interest rate of 18% per annum based on the initial balance of the loan. The lender
also imposes a flat arrangement fee of Sh.50,000 which would be met out of existing
balances. The sum borrowed could be placed in a notice deposit at 9% per annum and
drawn down at no cost as and when required. Multi-Link Ltd.'s treasurer believes that
cash balances will be run down at an even rate throughout the year.
Required:
Explain the weaknesses of the Baumol model in the management of
cash.
Date posted: February 8, 2019. Answers (1)
- In relation to the stock exchange
(i) Explain the role of the following members:
- Floor brokers
-Market makers
-Underwriters
(ii) Explain the meaning of the...(Solved)
In relation to the stock exchange
(i) Explain the role of the following members
- Floor brokers
- Market makers
- Underwriters
(ii) Explain the meaning of the following terms:
-Bull and bear markets
- Bid-ask spread
- Short selling
Date posted: February 8, 2019. Answers (1)