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Factors affecting value of a call:
Stock price:
The call value increases with the stock price. If price is higher than exercise price one would be
willing to pay more for the call.
Exercise Price
The lower the exercise price the more valuable the call will be.
Time to maturity:
The longer the time to maturity, the greater the chance that the stock price will climb higher
above the exercise price hence the higher the value of call.
The risk-free rate:
If the risk-free rate increases (and nothing else changes), then the call must be worth more because
the discounted present value of the exercise price declines.
Kavungya answered the question on April 17, 2021 at 14:02
- Quality Products (QP), Ltd a leading manufacturer in its field, is planning an expansion programme. It has
estimated that it will need to raise an additional...(Solved)
Quality Products (QP), Ltd a leading manufacturer in its field, is planning an expansion programme. It has
estimated that it will need to raise an additional Sh.100 million. QP Ltd. is discussing with its investment
banker the alternatives of raising the Sh.100 million through debt financing or through issuing additional
shares of equity. The debt to total asset ratio in its industry is 40%. QP Ltd.‟s balance sheet
and income statements are as follows:
The company expects to increase its total revenue by Sh.200 million and net operating income by Sh.26
million if the expansion is undertaken. The company‟s effective tax rate is 40% and dividend
payout has averaged about 60% of net income. At present, its cost of debt is 10% and its cost of equity
is 15%. If the additional funds are raised through debt, the cost of debt will be 10% and cost equity will be
15.2%. If the funds are raised by equity, the cost of debt will be 10% and the cost of equity will be 14.8%.
The current share price at which new equity can be sold is Sh.100.
Required:
Calculate the effects of the alternative forms of financing on:
a) The total value of equity of the firm.
b) The firm‟s total debt to equity ratio (based on balance sheet figures)
c) Price per ordinary share.
d) Total market-value of the firm.
e) The firm‟s weighted average cost of capital.
Date posted: April 17, 2021. Answers (1)
- City Graphics Limited is evaluating a new technology for its reproduction equipment. The technology will have a
three-year life and would cost Sh.800,000. Its impact on...(Solved)
City Graphics Limited is evaluating a new technology for its reproduction equipment. The technology will have a
three-year life and would cost Sh.800,000. Its impact on the company‟s cash flows is subject to risk.
In the first year, management estimates that there is an equal chance that the technology will either
succeed and save the company Sh.800,000 or fail saving it nothing at all.
If the technology fails in the first year, savings in the last two years will be zero. Even worse, there is a 40%
chance that additional Sh.240,000 may be required in the second year to convert back to the original process.
If the technology succeeds in the first year, the second year cash flows may be Sh.1,440,000, Sh.1,120,000 or
Sh.800,000 with probabilities of 0.20, 0.60 or 0.20 respectively. Third year cash flows are then expected to be
Sh.160,000 greater or Sh.160,000 less than cash flows in the second year, with equal chance of either
occurring.
All the cash flows above are after taxes.
Required:
a) A probability tree depicting the above cash flow possibilities.
b) Net present values for each possibility using a risk-free rate of 5%.
c) The expected net present value of the technology using a risk-free rate of 5%
Date posted: April 17, 2021. Answers (1)
- Agency problems can be resolved by proper corporate governance. Corporate governance lays emphasis on
shareholders rights and enhancement of shareholder value. In many countries including Kenya,...(Solved)
Agency problems can be resolved by proper corporate governance. Corporate governance lays emphasis on
shareholders rights and enhancement of shareholder value. In many countries including Kenya, the concept
of corporate governance has gained increasing prominence in recent times as evidenced by the issue of
corporate governance guidelines by the Capital Markets Authority (CMA).
Required:
a) Explain the reasons motivating the increasing interest in corporate governance.
b) Identify the benefits of good corporate governance to shareholders.
e) Write short notes on any five corporate governance guidelines issued by the Capital Markets
Authority (CMA) or similar authority in your country.
Date posted: April 17, 2021. Answers (1)
- The directors of ABC Electronics Ltd. are considering a takeover bid for XYZ Electronics Ltd. However,
they recognize that there are potential problems with any proposed...(Solved)
The directors of ABC Electronics Ltd. are considering a takeover bid for XYZ Electronics Ltd. However,
they recognize that there are potential problems with any proposed bid. First, the directors of ABC Ltd.
believe that any take-over bid would be resisted by the directors of XYZ Ltd.
Secondly, ABC Ltd. is short of cash and so any offer made to the shareholders of XYZ Ltd. would have to
be either in form of a share-for-share exchange or a loan capital-for-share exchange.
Required:
a) Identify and discuss four reasons why a company seeking to maximize the wealth of its shareholders
may wish to take over another company.
b) Evaluate the share-for-share exchange and loan capital-for-share exchange options as methods of
purchase consideration from the viewpoint of the shareholders of both companies.
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Date posted: April 17, 2021. Answers (1)
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Date posted: April 16, 2021. Answers (1)
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i) “at the money”
ii) “in the money”
iii) “out of the money”
for both a call and put option.(Solved)
Explain and illustrate graphically the options concepts of being:
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ii) “in the money”
iii) “out of the money”
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Date posted: April 16, 2021. Answers (1)
- Using a numeric example, illustrate and explain the pay-offs of a futures option and a futures
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Date posted: April 16, 2021. Answers (1)
- The table below gives the end-of-year levels of the price of an ordinary share in Kamili Ltd. and of
a representative Stock Exchange Index.
Required:
Use the information...(Solved)
The table below gives the end-of-year levels of the price of an ordinary share in Kamili Ltd. and of
a representative Stock Exchange Index.
Required:
Use the information to calculate the beta coefficient of Kamili Ltd.s ordinary shares, ignoring any
dividend payments. (Work to four decimal places only at each stage of calculation).
Using the beta calculated in the question above above, and given a risk-free rate of 5% a year and an expected return from equities generally of 8% a year, calculate the expected rate of return on Kamili
Ltd.‟s ordinary shares.
Date posted: April 16, 2021. Answers (1)
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Date posted: April 16, 2021. Answers (1)
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A comparative study of the records of two oil companies, A Ltd. and B Ltd., in terms of their asset composition, capital structure and profitability shows that they have been very similar for the past five years. The only significant difference between the two firms is their dividend policy. A Ltd. maintains a constant dividend per share while B Ltd. maintains a constant dividend pay-out ratio. Relevant data is as follows:
Required:
a) For each company, determine the dividend pay-out ratio and the price – earnings ratio for each of
the five years.
b) B Ltd‟s management is surprised that the shares of this company have not performed as well
as A Ltd‟s in the stock exchange. What explanation would you offer for this state of affairs?
c) Comment on the applicability of the Simple Price/Earnings (P/E) ratio to the typical technology
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Date posted: April 16, 2021. Answers (1)
- Corporate bonds have recently started gaining prominence as disintermediation financial instruments in developing countries.
i) Distinguish between financial intermediation and financial facilitation.
ii) Explain the relationship between...(Solved)
Corporate bonds have recently started gaining prominence as disintermediation financial instruments in developing countries.
i) Distinguish between financial intermediation and financial facilitation.
ii) Explain the relationship between the price of bonds and:
1. Interest rates in the market generally.
2. Term to maturity of the bonds.
iii) Explain any three theories that can help explain the term “structure of interest rates”
Date posted: April 16, 2021. Answers (1)
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the equipment through the use of its normal financing mix...(Solved)
Gathura Ltd. is evaluating the acquisition of a heady duty forklit. The company can either purchase
the equipment through the use of its normal financing mix (30% debt and 70% equity) or lease it.
The following additional information is available:
1. Acquisition price Sh.8,000,000
2. Useful life 4 years
3. Salvage value Sh.1,600,000
Depreciation method – straight line
Annual (before tax and depreciation) cash savings Sh.2,400,000
Rate of interest on a four year period 10%
Marginal tax rate 10%
Annual lease rentals Sh.2,400,000
Annual operating expenses Sh. 400,000
Cost of capital 12%
Required:
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ii) Should Gathura Ltd. lease the asset?
Date posted: April 16, 2021. Answers (1)
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Date posted: April 16, 2021. Answers (1)
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Date posted: April 16, 2021. Answers (1)
- Large companies with significant borrowings or overseas trade often use interest rate swaps and currency swaps.
Required:
Explain how interest rate swaps and currency swaps may be...(Solved)
Large companies with significant borrowings or overseas trade often use interest rate swaps and currency swaps.
Required:
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Date posted: April 16, 2021. Answers (1)
- A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced price of
Z 150,000 (Zed (Z) is the currency of...(Solved)
A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced price of
Z 150,000 (Zed (Z) is the currency of Zedland). Of this amount, Z 60,000 will be payable on
shipment, Z 45,000 one month after shipment and Z 45,000 three months after shipment.
The quoted foreign exchange rates (Z per KSh.) at the date of shipment as as follows:
Spot 1.690 - 1.692
One month 1.687 - 1.690
Three months 1.680 - 1.684
The company decides to enter into appropriate forward exchange contracts through a bank in
order to hedge these transactions.
Required:
i) State the advantages of hedging in this way.
ii) Calculate the amount in Kenya Shillings that the Kenyan Company would receive.
iii) Comment with hindsight on the wisdom of hedging in this instance, assuming that the spot rates at
the dates of receipt of the two instalments of Z 45,000 were as follows:
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Second instalment 1.700 - 1.704
Date posted: April 16, 2021. Answers (1)
- The Lakeside Company Limited is considering investing in a project requiring an initial outlay of Sh.100
million. The project life is two years after which there...(Solved)
The Lakeside Company Limited is considering investing in a project requiring an initial outlay of Sh.100
million. The project life is two years after which there would be no expected salvage value. The possible
incremental after-tax cash flows and associated probabilities of occurrence as as follows:
The company‟s required rate of return for this investment is 12%.
Required:
a) i) The expected net present value of the project.
ii) Suppose that the possibility of abandonment exists and that the abandonment value of the project at
the end of the first is Sh.50 million after taxes is abandonment the right choice?
iii) Calculate the new expected net present value assuming that the company would abandon the project if it
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Date posted: April 16, 2021. Answers (1)
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The Kenyan economy has been performing poorly in the recent past and many companies have
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Date posted: April 16, 2021. Answers (1)
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come and invest their resources in Kenya.
Analyze the key decision areas that a...(Solved)
In the recent past, the government has been aggressively wooing multinational companies to
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Date posted: April 16, 2021. Answers (1)
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debt levels have risen leading to what has been called a...(Solved)
The governments of many less developed countries have experienced problems in recent years as their
debt levels have risen leading to what has been called a “global debt crisis”.
Required:
a) Explain briefly why these problems amount to a “crisis.
b) Discuss the approaches that have been used to overcome the problems.
c) Outline the benefits to multinational business enterprises of resolving the current global debt problems.
Date posted: April 16, 2021. Answers (1)