Systematic risk
This is also called non-diversifiable or market risk. By holding a multiple of assets to
form a portfolio, thus risk cannot be eliminated. It is economy-wide risk and affects all
firms in the economy. Examples include political instability, inflation, energy crisis
(power rationing), increase in interest rates (cost of debt), increase in corporate taxes,
industrial strikes etc.
Unsystematic risk
Also called diversifiable risk. Its unique to the company and affects only a single firm. It
can be reduced by holding a portfolio. Example include legal suits against the firm, loss
of clients and supplies, strike by employees of the firm etc.
(ii) Conservative credit policy
A policy of selling goods on credit on highly selective basis to only credit worth
customers. It?s meant to reduce bad debts losses and debtors
collection costs. It?s applicable where the seller is a monopoly or the
product has low profit margin or the product is a premium good.
Liberal credit policy
Selling on credit to as many and even red customers as possible. The aim is to increase
sales and profit but it may result in high bad debts, high credit administration costs, high
debtors collection costs etc. Usually common where the product has high profit margin,
is new in the market, is attaining declining stage in its lifecycle or is out of fashion.
marto answered the question on February 12, 2019 at 06:19
- Distinguish between primary and secondary securities market.(Solved)
Distinguish between primary and secondary securities market.
Date posted: February 12, 2019. Answers (1)
- Beta Leather Company Limited is considering acquiring an additional leather processing
machine at a cost of Shs. 18 million. The machine is expected to generate after...(Solved)
Beta Leather Company Limited is considering acquiring an additional leather processing
machine at a cost of Shs. 18 million. The machine is expected to generate after tax
savings of Shs. 3,600,000 per year over an eight year period.
The policy of the company is to finance capital investments with a 50% debt. The
company is able to borrow Shs. 9 million at 10% interest per annum to finance the
purchase of the machine in part. The loan principal is to be paid in equal annual
installments of Shs. 1,125,000 payable at the year end. The company's
required rate of return is 13% and the company is in the 30% tax bracket.
Required:
(i) The net present value (NPV) of the machine if fully financed by equity to
acquire the machine. Advise the management on whether to finance it by
equity or loan.
(ii) The net present value (NPV) of 'the machine with part debt financing. Would
your advice to the management in (b) (i) above change?
Date posted: February 12, 2019. Answers (1)
- Mwongozo Limited has approached you for advice on an equipment to be purchased
for use in a five year project.
The investment will involve an initial capital...(Solved)
Mwongozo Limited has approached you for advice on an equipment to be purchased
for use in a five year project.
The investment will involve an initial capital outlay of Shs. 1.4 million and the expected
cash flows are given below:
The equipment is to be depreciated on a straight line basis over the duration of the
project with a nil residual value.
The cost of capital and the tax rate are 12% and 30% respectively.
Required:
The net present value (NPV) of the investment.
Date posted: February 12, 2019. Answers (1)
- Highlight four uses of the cost of capital to a limited liability company.(Solved)
Highlight four uses of the cost of capital to a limited liability company.
Date posted: February 12, 2019. Answers (1)
- Motor Works Limited intends to raise additional capital through an issue of ordinary
shares of Shs. 80 par value. The company promises to pay dividend at...(Solved)
Motor Works Limited intends to raise additional capital through an issue of ordinary
shares of Shs. 80 par value. The company promises to pay dividend at the rate of Shs. 8
per annum and the expected market price of the shares after six years is Shs. 120.
An investor whose required rate of return is 10% intends to hold the shares for six
years.
Required:
The intrinsic value of the shares
Date posted: February 12, 2019. Answers (1)
- Akili Limited has issued a debenture whose par value is Shs. 1,000. The debenture can
be redeemed at par after four years or converted to ordinary...(Solved)
Akili Limited has issued a debenture whose par value is Shs. 1,000. The debenture can
be redeemed at par after four years or converted to ordinary shares at a conversion rate
of Shs. 100 per share. The projected market price of the share after the four year period
could either be Shs. 90 or Shs. 120 based on the company‟s performance.
The investors required rate of return is 10%.
Required:
The value of the debenture based on each of the expected share prices.
Date posted: February 12, 2019. Answers (1)
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Distinguish between the following sets of terms:
(i) Treasury bills and treasury bonds.
(ii) Complementary projects and mutually exclusive projects.
(iii) Stock splits and stock dividends....(Solved)
Distinguish between the following sets of terms:
(i) Treasury bills and treasury bonds.
(ii) Complementary projects and mutually exclusive projects.
(iii) Stock splits and stock dividends.
Date posted: February 12, 2019. Answers (1)
- Since debt capital is cheaper than equity, companies should resort to one hundred
percent use of debt to finance their investments.
Discuss the limitations of the above...(Solved)
Since debt capital is cheaper than equity, companies should resort to one hundred
percent use of debt to finance their investments.
Discuss the limitations of the above financing policy.
Date posted: February 12, 2019. Answers (1)
- Highlight the importance of the following terms in investment appraisal:
(i) Internal rate of return (IRR)
(ii) Payback period.(Solved)
Highlight the importance of the following terms in investment appraisal:
(i) Internal rate of return (IRR)
Date posted: February 11, 2019. Answers (1)
- Explain three key roles of a capital markets regulator in your country.(Solved)
Explain three key roles of a capital markets regulator in your country.
Date posted: February 11, 2019. Answers (1)
- Although profit maximization has long been considered as the main goal of a firm,
shareholder wealth maximization is gaining acceptance among st most companies as the
key...(Solved)
Although profit maximization has long been considered as the main goal of a firm,
shareholder wealth maximization is gaining acceptance among st most companies as the
key goal of a firm.
Required:
(i) Distinguish between the goals of profit maximization and shareholder wealth
maximization.
(ii) Explain three limitations of the goal of profit maximization
Date posted: February 11, 2019. Answers (1)
- Hisa Limited has 1 million ordinary shares outstanding at the current market price of
Sh.50 per share. The company requires Sh.8 million to finance a proposed...(Solved)
Hisa Limited has 1 million ordinary shares outstanding at the current market price of
Sh.50 per share. The company requires Sh.8 million to finance a proposed expansion
project. The board of directors has decided to make a one for five rights issue at a
subscription price of Sh.40 per share.
The expansion project is expected to increase the firm's annual cash inflow by
Sh.945,000. Information on this project will be released to the market together with the
announcement of the rights issue.
The company paid a dividend of Sh.4.5 in the previous financial year. This dividend,
together with the company's earnings is expected to grow by 5% annually
after investing in the expansion project.
Required:
(i) Compute the price of the shares after the commencement of the rights issue
but before they start selling ex-rights.
(ii) Compute the theoretical ex-rights price of the shares.
(iii) Calculate the theoretical value of the rights when the shares are selling rights
on.
(iv) What would be the cum-rights price per share if the new funds are used to
redeem a Sh.8 million 10% debenture at par? (Assume a corporation tax rate of
30%).
Date posted: February 11, 2019. Answers (1)
- List three advantages of a rights issue from the point of view of:
(i) The issuing company.
(ii) The shareholder.(Solved)
List three advantages of a rights issue from the point of view of:
(i) The issuing company.
(ii) The shareholder.
Date posted: February 11, 2019. Answers (1)
- Mapato Limited is a company involved in the processing of cooking oil. The
management is considering whether to replace an existing cooler with a new one.
The...(Solved)
Mapato Limited is a company involved in the processing of cooking oil. The
management is considering whether to replace an existing cooler with a new one.
The old cooler is fully depreciated and has no salvage value. If not replaced, the
company will continue to incur Sh.1.8 million as annual operating expenses and an
additional Sh.500,000 in repair costs per annum over the next fifteen years.
The new cooler costs Sh.3,150,000. Its annual operating expenses and repair costs are
estimated at Sh.1.3 million and Sh.350,000 respectively over its estimated economic life
of fifteen years. It is expected to be worthless after the expiry of this period.
The cost of capital is 10% and the company depreciates its assets using the straight-line
method.
Assume a 30% corporation tax rate.
Required:
(i) Compute the incremental net annual cash flows if the old cooler is replaced.
(ii) Using the net present value (NPV) method, advise the management on whether
or not to replace the old cooler.
Date posted: February 11, 2019. Answers (1)
- Several methods exist for evaluating investment projects under capital budgeting.
Identify and explain three features of an ideal investment appraisal method(Solved)
Several methods exist for evaluating investment projects under capital budgeting.
Identify and explain three features of an ideal investment appraisal method
Date posted: February 11, 2019. Answers (1)
- The management of Faulu Limited intends to change the company's credit
policy, from 'net 30' to 3/10 net 45'. If this change is effected, annual sales
will...(Solved)
The management of Faulu Limited intends to change the company‟s credit
policy, from 'net 30' to '3/10 net 45'. If this change is effected, annual sales
will increase by 12% from the current level of Sh.12 million while the proportion of
bad debts will increase from 1% to 1.4% of credit sales. A new credit assistant will also
have to be employed at a salary of Sh.260,000 per annum. It is expected that 40% of the
credit customers will benefit from the cash discount.
The inventory level and the variable costs will however remain constant at 20% and
75% of the annual credit sales respectively. The rate of return on investment is 14% per
annum. All sales are on credit.
Assume a 360 days financial year and ignore the effects of taxation.
Required:
Advise the management of Faulu Limited on whether or not to adopt the new credit
policy.
Date posted: February 11, 2019. Answers (1)
- List four factors that should be considered in establishing an effective credit policy.(Solved)
List four factors that should be considered in establishing an effective credit policy.
Date posted: February 11, 2019. Answers (1)
- Distinguish between a credit policy and a working capital policy.(Solved)
Distinguish between a credit policy and a working capital policy.
Date posted: February 11, 2019. Answers (1)
- Comment on the view that the price/earnings (P/E) ratio is an “attempt to
value a company in terms of its earnings'.(Solved)
Comment on the view that the price/earnings (P/E) ratio is an “attempt to
value a company in terms of its earnings'.
Date posted: February 11, 2019. Answers (1)
- List and briefly discuss three possible reasons why companies in the same type of business may have different price/earnings (P/E) ratios.(Solved)
List and briefly discuss three possible reasons why companies in the same type of business may have different price/earnings (P/E) ratios.
Date posted: February 11, 2019. Answers (1)