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
- Using illustrative examples, explain the payback period and accounting rate of return methods of
projects appraisal and explain the advantages and disadvantages of each method.(Solved)
Using illustrative examples, explain the payback period and accounting rate of return methods of
projects appraisal and explain the advantages and disadvantages of each method.
Date posted: February 12, 2019. Answers (1)
- 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. Answers (1)
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What are the features of a sound appraisal technique?
Date posted: February 12, 2019. Answers (1)
- The Altman formula for prediction of bankruptcy is given as follows:(Solved)
The Altman formula for prediction of bankruptcy is given as follows:
Date posted: February 12, 2019. Answers (1)
- The following information is provided in respect to the affairs of Pote Limited which prepares
its account on the calendar year basis.(Solved)
The following information is provided in respect to the affairs of Pote Limited which prepares
its account on the calendar year basis.
Required:
a) Calculate the rate of stock turnover expressed:
i) as a ratio;
ii)in days for each of the years 1994 and 1995.
b) Calculate the rate of collection of debtors, in days, for each of the years 1994 and 1995.
(3 marks)
c) Calculate the rate of payment to creditors, in days, for each year 1994 and 1995.
(3 marks)
d) Show the cash operating cycle for each year.
e) Comment on the results.
Date posted: February 12, 2019. Answers (1)
- Mr. Castro uses a 20% hatch system of timing when to invest in a stock market. In a
given year, the top of a given share...(Solved)
Mr. Castro uses a 20% hatch system of timing when to invest in a stock market. In a
given year, the top of a given share was Sh.150 and its bottom was Sh.90. During the
year, the company paid an interim DPS of Sh.1.50 and a final DPS of Sh.4.50.
Determine the % return on investment.
Date posted: February 12, 2019. Answers (1)
- With reference to capital market, define the following terms:
i) Contango operation
ii) Backwardation
iii) Stags
iv) Role of investment banker(Solved)
With reference to capital market, define the following terms:
i) Contango operation
ii) Backwardation
iii) Stags
iv) Role of investment banker
Date posted: February 12, 2019. Answers (1)
- 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. Answers (1)
- Why do different sources of finance have different costs?(Solved)
Why do different sources of finance have different costs?
Date posted: February 12, 2019. Answers (1)
- Love Ltd is considering acquiring Beautiful Ltd. For the past six years, the profits of Beautiful
Ltd. has been as follows.(Solved)
Love Ltd is considering acquiring Beautiful Ltd. For the past six years, the profits of Beautiful
Ltd. has been as follows.
Love Ltd expects to pay a DPS of Sh.3.20. The current MPS is Sh.40. The growth in dividends
will be matched with the growth in earnings of Beautiful Ltd. once acquired. The future
expected profits p.a. (equal to the average of past profits) will also grow a rate equal to past
profits growth rate. Love Ltd is an all equity firm. Beautiful Ltd has 50 million ordinary shares.
Required:
a) Compute the cost of equity of Love Ltd.
b) Using the cost of equity computed in (a) above, determine the maximum price with
Love Ltd should pay for each share of Beautiful Ltd to acquire it.
c) What is the significance of valuation of securities.
Date posted: February 12, 2019. Answers (1)
- Swale Ltd. wants to raise Shs. 15,000,000 in additional funds through a rights offering. The
following statements were prepared just before the planned rights offerings:(Solved)
Additional information:
i) The company had a price-earnings ratio of 7.5 at the time of the rights offering. Its
dividend payout ratio is 40%.
i i) The proposed rights offering subscription price per share is Sh.15.
iii) No change is expected in the return on total assets or dividend payout ratio after the
rights offering.
Required:
a) How many rights are required to buy one new share?
b) Calculate the return on total assets.
c) Calculate the following immediately before the rights issue:
- Dividend per share;
- Market price per share.
d) Calculate the dividend per share and market price per share one year after the rights of
offering and state whether you would recommend the rights offering. (Give reasons)
e) Prepare the company's balance sheet immediately after the rights offering under (c)
above.
Date posted: February 12, 2019. Answers (1)
- 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. Answers (1)
- The most recent financial data for the Rare Watts disclose the following:
Dividend per share Sh.3.00
Expected annual dividend growth rate 6 percent
Current required rate of return...(Solved)
The most recent financial data for the Rare Watts disclose the following:
Dividend per share Sh.3.00
Expected annual dividend growth rate 6 percent
Current required rate of return 15 percent
The company is considering a variety of proposals in order to redirect the
firm‟s activities. The following four alternatives have been suggested:
1. Do nothing in which case the key financial variables will remain unchanged.
2. Invest in venture that will increase the dividend growth rate to 7% and lower
the required rate of return to 14%.
3. Eliminate an unprofitable product line. The action will increase the dividend
growth rate to 8% and raise the required rate of return to 17%.
4. Acquire a subsidiary operation from another company. This action will increase
the dividend growth rate to 9% and required rate of return to 18%.
Required:
For each of the proposed actions, determine the resulting impact price and recommend
the best alternative.
Date posted: February 12, 2019. Answers (1)
- 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. Answers (1)
- 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)