Valuation of ordinary shares is more complicated than valuation of bonds
and preference shares because of:
- Uncertainty of dividend unlike interest charges and preference dividends which
are certain
- The data for valuation of ordinary shares is historical which may not reflect
future expectations.
- A constant stream of dividends per share is assume
- The growth rate is assumed constant and is computed from past dividends.
- The cost of equity/required rate of return on equity is assumed to be constant
though it changes over time.
marto answered the question on February 12, 2019 at 10:04
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Within a Financial Management context, discuss the problems that might exist in the
relationships (sometimes referred to as agency relationships) between:
1. Shareholders and managers, and
2. Shareholders...
(Solved)
Within a Financial Management context, discuss the problems that might exist in the
relationships (sometimes referred to as agency relationships) between:
1. Shareholders and managers, and
2. Shareholders and creditors.
Date posted:
February 12, 2019
.
Answers (1)
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Distinguish between the following terms:
(i) Weighted average cost of capital and marginal cost of capital.
(ii) Finance lease and operating lease.
(Solved)
Distinguish between the following terms:
(i) Weighted average cost of capital and marginal cost of capital.
(ii) Finance lease and operating lease.
Date posted:
February 12, 2019
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Answers (1)
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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
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Answers (1)
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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)
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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)
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Identify and briefly explain the three main forms of agency relationship in a firm.
(Solved)
Identify and briefly explain the three main forms of agency relationship in a firm.
Date posted:
February 11, 2019
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Answers (1)
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Dawamu Ltd., which operates in the retail sector selling a single product, is considering
a change of credit policy which will result in an increase in...
(Solved)
Dawamu Ltd, which operates in the retail sector selling a single product, is considering
a change of credit policy which will result in an increase in the average collection period
of debts from one to two months. The relaxation of the credit policy is expected to
produce an increase in sales in each year, amounting to 25% of the current sales
volume. The following information is available.
1. Selling price per unit of product – Sh.1,000
2. Variable cost per unit of product – Sh.850
3. Current annual sales of product – Sh.240,000,000
4. Dawamu Ltd.'s required rate of return on investments is 20%.
5. It is expected that increase in sales would result in additional stock of
Sh.10,000,000 and additional creditors of Sh.2,000,000.
Required:
Advise Dawamu Ltd. on whether or not to extend the credit period offered to
customers, if
(i) All customers take the longer credit period of two months.
(ii) Existing customers do not change their payment habits and only the new
customers will take a full two months' credit.
Date posted:
February 11, 2019
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Answers (1)
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Briefly explain how the Miller-Orr cash management model operates.
(Solved)
Briefly explain how the Miller-Orr cash management model operates.
Date posted:
February 11, 2019
.
Answers (1)
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Identify and briefly explain three conditions which have to be satisfied before the use of
the weighted average cost of capital (WACC) can be justified.
(Solved)
Identify and briefly explain three conditions which have to be satisfied before the use of
the weighted average cost of capital (WACC) can be justified.
Date posted:
February 11, 2019
.
Answers (1)
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Magma Ltd. wishes to make a choice between two mutually exclusive projects. Each of
these projects requires Sh.400,000,000 in initial cash outlay. The details of the...
(Solved)
Magma Ltd. wishes to make a choice between two mutually exclusive projects. Each of
these projects requires Sh.400,000,000 in initial cash outlay. The details of the two
projects are as follows:
Project A
This project is made up of two sub-projects. The first sub-project will require an initial
outlay of Sh.100,000,000 and will generate Sh.25,600,000 per annum in perpetuity. The
second sub-project will require an initial outlay of Sh.300,000,000 and will generate
Sh.85,200,000 per annum for the 8 years of its useful life. This sub-project does not
have a residual value at the end of the 8 years. Both sub-projects are to commence
immediately.
Project B
This project will generate Sh.87,000,000 per annum in
perpetuity. The company has a cost of capital of 16%.
Required:
(i) Determine the net present value (NPV) of each project.
(ii) Compute the internal rate of return (IRR) for each project.
(iii) Advise Magma Ltd. on which project to invest in, and justify your choice
Date posted:
February 11, 2019
.
Answers (1)
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The following information represents the financial position and financial results of
AMETEX Limited for the year ended 31 December 2002.
(Solved)
The following information represents the financial position and financial results of
AMETEX Limited for the year ended 31 December 2002.
Required:
Determine the following financial ratios:
(i) Acid test ratio.
(ii) Operating ratio
(iii) Return on total capital employed
(iv) Price earnings ratio.
(v) Interest coverage ratio
(vi) Total assets turnover
(c) Determine the working capital cycle for the company.
Date posted:
February 11, 2019
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Answers (1)
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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
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Answers (1)
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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)
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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)
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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)
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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
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Answers (1)
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Highlight four advantages and disadvantages to a company of being listed on a stock
exchange.
(Solved)
Highlight four advantages and disadvantages to a company of being listed on a stock
exchange.
Date posted:
February 8, 2019
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Answers (1)
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Explain fully the effect of the use of debt capital on the weighted average cost of capital of a company.
(Solved)
Explain fully the effect of the use of debt capital on the weighted average cost of capital of a company.
Date posted:
February 8, 2019
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Answers (1)
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Rafiki Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30. Its
financial statements for the last three years are as follows:
(Solved)
Rafiki Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30. Its
financial statements for the last three years are as follows:
Required:
(a) For each of the three years, calculate the following ratios:
Acid test ratio, Average collection period, inventory turnover, Total debt/equity, Net
profit margin and return on assets.
(b) From the ratios calculated above, comment on the liquidity, profitability and gearing
positions of the company
Date posted:
February 8, 2019
.
Answers (1)
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Define agency relationship from the context of a public limited company and briefly
explain how this arises.
(Solved)
Define agency relationship from the context of a public limited company and briefly
explain how this arises.
Date posted:
February 8, 2019
.
Answers (1)