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
- The Weka Company Ltd. has been considering the criteria that must be met before a capital
expenditure proposal can be included in the capital expenditure programme....(Solved)
The Weka Company Ltd. has been considering the criteria that must be met before a capital
expenditure proposal can be included in the capital expenditure programme. The screening
criteria established by management are as follows:
1. No project should involve a net commitment of funds for more than four years.
2. Accepted proposals must offer a time adjusted or discounted rate of return at least
equal to the estimated cost of capital. Present estimates are that cost of capital as 15
percent per annum after tax.
3. Accepted proposals should average over the life time, an un adjusted rate of return on
assets employed (calculated in the conventional accounting method) at least equal to the
average rate of return on total assets shown by the statutory financial statements
included in the annual report of the company.
A proposal to purchase a new lathe machine is to be subjected to these initial screening
processes. The machine will cost Shs. 2,200,000 and has an estimated useful life of five years at
the end of which the disposal value will be zero. Sales revenue to be generated by the new
machine is estimated as follows:
Additional operating costs are estimated to be Shs. 700,000 per annum. Tax rates may be
assumed to be 35% payable in the year in which revenue is received. For taxation purpose the
machine is to be written off as a fixed annual rate of 20% on cost.
The financial accounting statements issued by the company in recent years shows that profits
after tax have averaged 18% on total assets.
Required:
Present a report which will indicate to management whether or not the proposal to purchase the
lathe machine meets each of the selection criteria.
Date posted: February 12, 2019. Answers (1)
- Assume that on 31 December 2001 you are provided with the following capital structure of
Hatilcure Ltd which is optimal.(Solved)
Assume that on 31 December 2001 you are provided with the following capital structure of
Hatilcure Ltd which is optimal.
The company has total assets amounting to sh.360 million but this figure is expected to rise to
Sh.500 million by the end of 2002. You are also informed that:
1. Any new equity shares sold will net 90% after flotation costs.
2. For the year just ended the company paid Sh.3.00 in dividends per share.
3. New 16% debt can be raised at par through the stock exchange.
4. The past and expected earnings growth rate is 10%
5. The current dividend yield is 12%
6. The company's dividend payout ratio of 50% shall be maintained in 2002.
7. Assume marginal at rate of 40%
8. The company's capital structure is optimal
Required:
a) Company's net amount to the capital budget to be financed with equity if 85% of the
asset expansion is included in the 2002 capital budget.
b) How many shares must be sold to raise the required equity capital? Round your figure
to the nearest thousand.
c) What is the firm‟s marginal cost of capital? Show full workings.
Date posted: February 12, 2019. Answers (1)
- The following financial statements relate to the ABC Company
Required:
a) Calculate:
i) Inventory turnover ratio;
ii) Times interest earned ratio;
iii) Total assets turnover;
iv) Net profit...(Solved)
The following financial statements relate to the ABC Company
Required:
a) Calculate:
i) Inventory turnover ratio;
ii) Times interest earned ratio;
iii) Total assets turnover;
iv) Net profit margin
(Note: Round your ratios to one decimal place)
b) The ABC Company operates in an industry whose norms are as follows:
Ratio Industry Norm
Inventory turnover 6.2 times
Times interest earned ratio 5.3 times
Total assets turnover 2.2 times
Net profit margin 3%
Required:
Comment on the revelation made by the ratios you have computed in part (a) above
when compared with the industry average.
Date posted: February 12, 2019. Answers (1)
- The Chuma Ngumu Company needs to finance a seasonal rise in inventories of Sh.4 million.
The funds are needed for six months. The company is considering...(Solved)
The Chuma Ngumu Company needs to finance a seasonal rise in inventories of Sh.4 million.
The funds are needed for six months. The company is considering using the following
possibilities to finance the inventories:
i) A warehouse loan from a finance company. The terms are 18 per cent annualized with
an 80% advance against the value of the inventory. The warehousing costs are
Sh.350,000 for the six-month period. The residual financing requirement which is Sh.4
million less the amount advanced will need to be financed by forgoing cash discounts
on its payables. Standard terms are 2/10 net 30; however the company feels it can
postpone payment until the fortieth day without adverse effect.
ii) A floating lien arrangement from the supplier of the inventory at an effective interest
rate of 24 per cent. The supplier will advance the full value of the inventory.
iii) A bank loan from the company‟s bank for Sh.4 million. The bank can lend at the
rateof 22%. In addition, a 10% compensating balance will be required which otherwise
would not be maintained by the company.
iv) Establish a one year line of credit. The commitment fees is 5% of the total borrowings.
The interest rate is 17% p.a.
Explain
Which is the cheapest option for the company?
Date posted: February 12, 2019. Answers (1)
- 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)
- Explain five uses of security market indices(Solved)
Explain five uses of security market indices
Date posted: February 12, 2019. Answers (1)
- Highlight the main problems encountered in the construction and use of a stock(Solved)
Highlight the main problems encountered in the construction and use of a stock market
index.
Date posted: February 12, 2019. Answers (1)
- Define a 'stock market index.'(Solved)
Define a 'stock market index.'
Date posted: February 12, 2019. Answers (1)
- 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. Answers (1)
- Describe the benefits to a country of integrating its financial markets with those of
other countries.(Solved)
Describe the benefits to a country of integrating its financial markets with those of
other countries.
Date posted: February 12, 2019. Answers (1)
- Banda Ltd. has four categories of debtors; A, B, C and D. The average collection
period and the percentage of bad debts for each category of...(Solved)
Banda Ltd. has four categories of debtors; A, B, C and D. The average collection
period and the percentage of bad debts for each category of debtors is shown below:
The company has the opportunity to increase its sales by Shs. 10,000,000 per annum,
split between categories C and D of the debtors in the proportion 2:3 respectively. The
company borrows at an interest rate of 11.5% per annum (assume a year has 365 days).
Required:
(i) Calculate the additional contribution to be realized from the increased sales.
(ii) Calculate the bad debts expense arising from the increased sales for each
category of debtors.
(iii) Compute the net profit or loss realized from the increased sales.
Date posted: February 12, 2019. Answers (1)
- Highlight the factors that determine the cost of finance to a business.(Solved)
Highlight the factors that determine the cost of finance to a business.
Date posted: February 12, 2019. Answers (1)
- 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)