Ordinary share capital have a high cost relative to debt capital because:
- There is high uncertainty of dividends income unlike interest which is fixed.
- Dividends are not tax allowable unlike interest which provide tax shield.
- Owners of the provide take most risk by providing equity capital hence they
require a higher rate of return compared to other investors.
- Share prices are highly volatile and makes the value of equity uncertain and cost
of equity high.
marto answered the question on February 12, 2019 at 11:16
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What practical problems are faced by finance managers in capital budgeting decisions.
(Solved)
What practical problems are faced by finance managers in capital budgeting decisions.
Date posted:
February 12, 2019
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Answers (1)
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What are the features of a sound appraisal technique?
(Solved)
What are the features of a sound appraisal technique?
Date posted:
February 12, 2019
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Answers (1)
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What are the advantages of having a farmers' bank compared with an ordinary
commercial bank in the provision of services to farmers
(Solved)
What are the advantages of having a farmers' bank compared with an ordinary
commercial bank in the provision of services to farmers
Date posted:
February 12, 2019
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Answers (1)
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Why do different sources of finance have different costs?
(Solved)
Why do different sources of finance have different costs?
Date posted:
February 12, 2019
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Answers (1)
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The Kitale Maize Mills is contemplating the purchase of a new high-speed grinder to replace an
existing one. The existing grinder was purchased two years ago...
(Solved)
The Kitale Maize Mills is contemplating the purchase of a new high-speed grinder to replace an
existing one. The existing grinder was purchased two years ago at an installed cost of Sh.300,000.
The grinder was estimated to have an economic life of 5 years but a critical analysis of its
performance now shows it is usable for the next five years with no resale value.
The new grinder would cost Sh.525,000 and require Sh.25,000 in installation costs. It has a five
year usable life. The existing grinder can currently be sold for Sh.350,000 without incurring any
removal costs. To support the increased business resulting from purchase of the new grinder,
accounts receivable would increase by Sh.200,000, inventories by Sh.150,000 and trade creditors
by Sh.290,000. At the end of 5 years the new grinder would be sold to net Sh.145,000 after
removal costs and before taxes. The company provides for 40% taxes on ordinary income. The
estimated profit before depreciation and taxes over the five years for both machines are given as
follows:
The company uses straight line method of depreciation for both machines.
Required:
a) Calculate the initial investment associated with the replacement of the existing grinder
with the new one. Show your full workings.
b) Determine the incremental operating cash flows associated with the proposed grinder
replacement.
c) Calculate the terminal cash flow expected from the proposed grinder replacement.
Date posted:
February 12, 2019
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Answers (1)
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The valuation of ordinary shares is more complicated than the valuation of bonds and
preference shares. Explain the factors that complicate the valuation of ordinary shares.
(Solved)
The valuation of ordinary shares is more complicated than the valuation of bonds and
preference shares. Explain the factors that complicate the valuation of ordinary shares.
Date posted:
February 12, 2019
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Answers (1)
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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
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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
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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
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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
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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
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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
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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
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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
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Answers (1)