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Factors determining cost of finance
1. Terms of reference – if short term, the cost is usually low and vice versa.
2. Economic conditions prevailing – If a company is operating under inflationary conditions, such a
company will pay high costs in so far as inflationary effect of finance will be passed onto the
company.
3. Risk exposed to venture – if a company is operating under high risk conditions, such a company will
pay high costs to induce lenders to avail finance to it because the element of risk will be added on the
cost of finance which may compound it.
4. Size of the business – A small company will find it difficult to raise finance and as such will pay
heavily in form of cost of finance to obtain debt from lenders.
5. Availability – Cost of finance (COF) prices will also be influenced by the forces of demand and
supply such that low demand and low supply will lead to high cost of finance.
6. Effects of taxation – Debt finance is cheaper by the amount equal to tax on interest and this means
that debt finance will entail a saving in cost of finance equivalent to tax on interest.
7. Nature of security – If security given depreciates fast, then this will compound implicit costs (costs of maintaining that security).
8. Company’s growth stage – Young companies usually pay less dividends in which case the cost of this
finance will be relatively cheaper at the earlier stages of the company’s development.
marto answered the question on February 12, 2019 at 08:00
- State two advantages and two disadvantages of a bank overdraft as a source of finance
to a business.(Solved)
State two advantages and two disadvantages of a bank overdraft as a source of finance
to a business.
Date posted: February 12, 2019. Answers (1)
- Mauzo Ltd. has issued 72,000 ordinary shares as at 31 March 2005. The company had
maintained an annual dividend payment of Shs. 180,000 including for the...(Solved)
Mauzo Ltd. has issued 72,000 ordinary shares as at 31 March 2005. The company had
maintained an annual dividend payment of Shs. 180,000 including for the year ended 31
March 2005.
On 3 April 2005, the management of the company identified an investment
opportunity which would cost Shs. 720,000. This cost was expected to be financed
through an issue of ordinary shares at par. The return on this investment is expected to
be 25% per annum on cost over the next four years ending 31 March 2009.
All earnings would continue to be paid out as dividends to shareholders. The cost of
capital is 20%.
Required
(i) Calculate the value of an ordinary share as at 31 March 2005.
(ii) Calculate the value of the company as at 3 April 2005 assuming that the
management undertook the investment.
Date posted: February 12, 2019. Answers (1)
- Discuss the functions of the central bank of your country.(Solved)
Discuss the functions of the central bank of your country.
Date posted: February 12, 2019. Answers (1)
- Briefly explain the operations of the central depository system (CDS) in facilitating
securities trading.(Solved)
Briefly explain the operations of the central depository system (CDS) in facilitating
securities trading.
Date posted: February 12, 2019. Answers (1)
- The management of Biashara Ltd. is in the process of evaluating two
alternative machine models, Alpha and Beta for possible purchase in order to
increase the company's...(Solved)
The management of Biashara Ltd. is in the process of evaluating two
alternative machine models, Alpha and Beta for possible purchase in order to
increase the company's production level.
The following additional information is available:
1. Alpha costs Shs. 3,800,000 and will have a useful life of four years.
2. Beta costs Shs. 8,000,000 and will have a useful life of six years.
3. Both machines have no salvage value after their useful lives.
4. An investment in working capital amounting to Shs. 825,000 will have to be made
at the beginning of the first year of the machine‟s life regardless of the
model purchased.
5. The estimated pre-tax cash inflows for each of the machines are shown below:
6. The cost of capital to the company is 12% and the corporation tax rate is 30%.
Required:
(i) Calculate the undiscounted pay back period for each machine model.
(ii) Calculate the net present value (NPV) for each machine model.
(iii) Using the net present values computed in
(ii) above, advise the management on
which model to purchase.
(iv) The management of the company has received an alternative offer to lease
Alpha at an annual lease charge of Shs. 1,200,000 for four years, payable at
the year end. All other details remain unchanged.
Will this offer affect your selection in part
(iii) above? Explain.
Date posted: February 12, 2019. Answers (1)
- Outline four limitations of the accounting rate of return (ARR) method of appraising
new investments.(Solved)
Outline four limitations of the accounting rate of return (ARR) method of appraising
new investments.
Date posted: February 12, 2019. Answers (1)
- Jasho Ltd. paid an ordinary dividend of Shs. 3.60 per share for the year ended 31 March
2005. The management of the company projects that the...(Solved)
Jasho Ltd. paid an ordinary dividend of Shs. 3.60 per share for the year ended 31 March
2005. The management of the company projects that the earnings of the company will
increase in the coming years as follows:
The investors' required rate of return is 18%.
Required:
Determine the value of an ordinary share in Jasho Ltd. as at 31 March 2005.
Date posted: February 12, 2019. Answers (1)
- (a) Define the following finance terms:
(i) Term structure of interest rates. (2 marks)
(ii) Scrip dividends. (2 marks)
(iii) Share splits (2 marks)
(b) Zatex Ltd. had the...(Solved)
(a) Define the following finance terms:
(i) Term structure of interest rates.
(ii) Scrip dividends.
(iii) Share splits
(b) Zatex Ltd. had the following capital structure as at 31 March 2005:
Shs.
Ordinary share capital (200,000 shares) 4,000,000
10% Preference share capital 1,000,000
14% Debenture capital 3,000,000
8,000,000
Additional information:
1. The market price of each ordinary share as at 31 March 2005 was Shs. 20.
2. The company paid a dividend of Shs. 2 for each ordinary share for the year
ended 31 March 2005.
3. The annual growth rate in dividends is 7%.
4. The corporation tax rate is 30%.
Required:
(i) Compute the weighted average cost of capital of the company as at 31 March
2005.
(ii) The company intends to issue a 15% Shs. 2 million debenture during the year
ending 31 March 2006. The existing debentures will not be affected by this
issue. The dividend per share for the year ending 31 March 2006 is expected to
be Shs. 3 while the average market price per share over the same period is
estimated to be Shs. 15. The average annual growth rate in dividends is
expected to remain at 7%.
Compute the expected weighted average cost of capital as at 31 March 2006.
Date posted: February 12, 2019. Answers (1)
- Define the following finance terms:
(i) Term structure of interest rates.
(ii) Scrip dividends.
(iii) Share splits
(Solved)
Define the following finance terms:
(i) Term structure of interest rates.
(ii) Scrip dividends.
(iii) Share splits
Date posted: February 12, 2019. Answers (1)
- Write short notes on the following:
(i) Systematic and unsystematic risk.
(ii) Conservative credit policy and liberal credit policy.(Solved)
Write short notes on the following:
(i) Systematic and unsystematic risk.
(ii) Conservative credit policy and liberal credit policy.
Date posted: February 12, 2019. Answers (1)
- 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)
-
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)