(i)Currency exchange rates
The problem of fluctuating exchange rates can be reduced by decreasing the level of exposure.
Protection can be achieved by requiring the invoice to be at a fixed rate of exchange (from
supplier) or by buying forward the necessary amount of foreign currency. Incase of longer
term transactions (e.g investing in an overseas country) it may be desirable to reduce the level
of exposure buy gearing up through foreign currency borrowings.
(ii) Sources of finance
As export trade often mean a longer period of credit, the company may well need to
raise additional finance. The more likely sources are euro-currency borrowings, dollar borrowings,
documentary credits and loans from banks; the latte may need insurance.
(iii) Investing in overseas countries
Apart from the problems outlined above, investing in overseas countries involves one
further problem – the need to translate the assets or investment into Head Office currency
at the year end. The rates used will depend on the particular transaction under consideration
but the most important principle is that the treatment should be consistent from year to
year.
Kavungya answered the question on April 17, 2021 at 21:23
- Butere Sugar Company Ltd. Has been enjoying a substantial net cash inflow. Before the surplus
funds are needed to meet tax and dividend payments, and to...(Solved)
Butere Sugar Company Ltd. Has been enjoying a substantial net cash inflow. Before the surplus
funds are needed to meet tax and dividend payments, and to finance further capital expenditure in
several months time, they are invested in a small portfolio of short-term equity investments.
Details of the portfolio, which consist of shares of four companies listed on the stock exchange are
as follows:
The current market return is 19% a year and treasury bill yield is 11% a
year. Required:
On the basis of the data given above, calculate the risk of Butere Sugar Company
Ltd.'s short-term investment portfolio relative to that of the market.
Date posted: April 17, 2021. Answers (1)
- Juma Company Ltd. Which is effectively controlled by the Juma family although they own only a minority of shares, is to undertake a substantial new...(Solved)
Juma Company Ltd. Which is effectively controlled by the Juma family although they own only a minority of shares, is to undertake a substantial new project which requires external finance of about Sh.400 million, leading to a 40% increase in gross assets. The project is to develop and market a new product and is fairly risky. About 70% of the funds required will be spent on land and buildings. The resale value of the land and buildings is expected to remain equal to or greater than, the initial purchase price. Expenditure during the development period of the first 4 to 7 years will be financed from other revenue of Juma Company Ltd. This
will have a consequent strain on the company's overall liquidity.
If, after the development stage, the project proves unsuccessful, then the project will be terminated and its assets sold. If, as is likely, the development is successful, the project's assets will be utilized in production and the company's profits will rise considerably. However, if the project proves to be very successful, then additional finance may be required to further expand the production facilities.
At present, Juma Company Ltd. Is all equity financed.
The financial manager is uncertain whether he should seek funds from a financial institution in the form of an equity interest, a loan (long or short term) r convertible debentures.
Required:
(a) Describe the major factors to be considered by Juma Company Ltd. In deciding on the method of
financing the proposed expansion project.
(b) Briefly discuss the suitability of equity, loans and convertible debentures for the purpose of
financing the project from the point of view of:
(i) Juma Company Ltd.
(ii) The provider of finance.
Clearly state and justify the type of finance recommended for Juma Company Ltd.
Date posted: April 17, 2021. Answers (1)
- The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing
whether its capital investment projects are acceptable, a compound...(Solved)
The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing
whether its capital investment projects are acceptable, a compound interest (DCF) rate of 8% per annum
will be used in evaluating investment projects.
All investment project is now under consideration. Estimates of the expected cash flows over forty years, are as follows:
The expected residual value of the assets is zero.
Required:
(a) Show whether the project satisfies the normal capital budgeting criteria for acceptance.
(b) Show how sensitive the calculation in (a) above is to:
(i) An increase in the residual asset value from zero to sh.1,000,000.
(ii) A 1% increase in the initial capital outlay (during each year of the outlay).
(iii) A 1% decrease in the estimate of expected cash flow during each of the years from 6 to 10.
(c) Show the effect of adopting the project on the ratio of reported profits in years 5 and 6 to net
balance sheet value of assets at the beginning of those two years. Comment briefly on the usefulness
of the latter type of ratio in the interpretation of accounts in the light of your calculation. (Assume
that the expenditure in years 1 to 5 is capitalized, that straight-line depreciation is charged after year 5 at 5% per annum, and the actual cash flows are according to plan).
You can assume that all cash flows arise on the last day of each year, that all figures are net of tax
and expressed in terms of constant price levels, and that working capital for the investment project
can be ignored.
Date posted: April 17, 2021. Answers (1)
- Two relatively small companies, Elgon Company Ltd. And Kilima Company Ltd., have decided in
principle to merge so that they can complete more effectively with larger...(Solved)
Two relatively small companies, Elgon Company Ltd. And Kilima Company Ltd., have decided in
principle to merge so that they can complete more effectively with larger companies. The boards of
directors of the two companies have decided that a scheme of amalgamation should be drawn by
the end of September 2003 based on the following agreed figures:
Required:
Comment on the values which have been placed on the ordinary shares for the purpose of merging
the two companies.
Date posted: April 17, 2021. Answers (1)
- The Development Company of Kenya Ltd. has operated very successfully over the past few years
despite the adverse economic situation. As a result, the company has...(Solved)
The Development Company of Kenya Ltd. has operated very successfully over the past few years
despite the adverse economic situation. As a result, the company has a good liquidity position and a
relatively advantageous stock exchange valuation. The chairman of the company has suggested that
because of this, it should look for growth through a vigorous acquisition policy.
Required:
Prepare a memorandum outlining the points which should be included in an acquisition strategy paper to
be presented for discussion in the next board meeting.
Date posted: April 17, 2021. Answers (1)
- Write notes distinguishing the following instruments used in international financial markets:
i) The Euro.
ii) The Euro bonds
iii) The Euro dollars.(Solved)
Write notes distinguishing the following instruments used in international financial markets:
i) The Euro.
ii) The Euro bonds
iii) The Euro dollars.
Date posted: April 17, 2021. Answers (1)
- Highlight the potential advantages and disadvantages for the host country of Foreign Direct
Investment (FDI) by multinational companies.(Solved)
Highlight the potential advantages and disadvantages for the host country of Foreign Direct
Investment (FDI) by multinational companies.
Date posted: April 17, 2021. Answers (1)
- Discuss the importance and limitations of Executive Share Option Plans (ESOPs) in mitigating
management/shareholder agency conflicts.(Solved)
Discuss the importance and limitations of Executive Share Option Plans (ESOPs) in mitigating
management/shareholder agency conflicts.
Date posted: April 17, 2021. Answers (1)
- A local supermarket chain wishes to increase the number of its retail outlets in the country. The board of directors of the company have decided...(Solved)
A local supermarket chain wishes to increase the number of its retail outlets in the country. The board of directors of the company have decided to finance the acquisition by raising funds from the existing
shareholders through a one for four rights issue. The recently published income statement of the company
for the year ended 31 October 2002 has the following information:
The share capital of the company consists of 12 million ordinary shares with a par value of Sh.5 per share.
The shares of the company are currently being traded on the Stock Exchange with a price/earnings ratio
of 22 times. The board of directors has decided to issue the shares at a discount of 20 per cent on the
current market value.
Required:
a) The theoretical ex-rights price of an ordinary share of the company.
b) The price at which the rights in the company are likely to be traded.
c) Assuming an investor held 4,000 ordinary shares of the company before the rights issue
announcement, evaluate the following options and identify the best option to the investor.
i) Exercise the rights.
ii) Sell the rights
iii) Do nothing.
Date posted: April 17, 2021. Answers (1)
- Matibabu Pharmacia Ltd. recently carried out clinical trials on a new drug which was developed to reduce the effects of diabetes.
The research and development costs...(Solved)
Matibabu Pharmacia Ltd. recently carried out clinical trials on a new drug which was developed to reduce the effects of diabetes.
The research and development costs incurred on the drug amount to Sh.160 million. In order to evaluate the market potential of the drug, an independent research firm conducted a market research at a cost of Sh.15 million. The independent researchers submitted a report indicating that the drug is likely to have a useful life of 4 years (before new advanced drugs are introduced into the market). It is projected that in the year the drug is launched it could be sold to authorized drug stores (chemists and hospitals) at Sh.20 per 500mg capsule. After the first year, the price is expected to increase by 20% per annum.
For each of the four years of the drug's life, the sales have been estimated stochastically as shown below:
Number of
Capsules sold Probability
11 million 0.3
14 million 0.6
16 million 0.1
If the company decides to launch the new drug, it is possible for production to commence immediately. The equipment required to produce the drug is already owned by the company and originally cost Sh.150 million.
At the end of the drug life, the equipment could be sold for Sh.35 million. If the company decides against the launch of the new drug, the equipment will be sold immediately for Sh.85 million as it will be of no further use to the company.
The new drug requires two hours of direct labour for each 500 mg capsule produced. The cost of labour for the new drug is Sh.4 per hour. New workers will have to be recruited to produce the new drug. At the end of the life, the workers are unlikely to be offered further employment with the company and redundancy costs of Sh.10 million are expected. The cost of ingredients for the new drug is Sh.6 per 500mg capsule.
Additional overheads arising from the production of the drug are expected to be Sh.15 million per annum.
Additional work capital of Sh.2 million will be required during the drug's 4-year life.
The drug has attracted interest of the company's main competitors and if the company decides
not to produce the drug, it could sell the patent right to Welo Kam (K) Ltd., its competitor, at Sh.125
million. The cost of capital is estimated to be 12%.
Required:
a) The expected Net Present Value of the new drug.
b) State with reasons whether the company should launch the new drug.
c) Discuss one strength and weakness of the expected Net Present Value approach for making
investment decisions.
Date posted: April 17, 2021. Answers (1)
- Safariloam Limited issued a Sh.100 million par value, 10-year bond, five years ago. The bond was issued at a 2
per cent discount and issuing costs...(Solved)
Safariloam Limited issued a Sh.100 million par value, 10-year bond, five years ago. The bond was issued at a 2
per cent discount and issuing costs amounted to Sh.2 million. Due to the decline in Treasury bill rates in the
recent past, interest rates in the money market have been falling presenting favourable opportunities for
refinancing. A financial analyst engaged by the company to assess the possibility of refinancing the debt
reports that a new Sh.100 million par value, 12 per cent, 5 -year bond can be issued by the company. Issuing
costs for the new bond will be 5 per cent of the par value and a discount of 3 per cent will have to be given
to attract investors. The old bond can be redeemed at 10 per cent premium and in addition, two months
interest penalty will have to be paid on redemption. All bond issue expenses (including the interest penalty)
are amortised on a straight-line basis over the life of the bond and are allowable for corporate tax purposes.
The applicable corporate tax rate is 40 per cent and the after tax cost of debt to the company is
approximately 7%.
Required:
a) Cash investment required for the refinancing decision.
b) Annual cash benefits (savings) of the refinancing decision.
c) i) Net Present Value (NPV) of the refinancing decision.
ii) Is it worthwhile to issue a new bond to replace the existing bond? Explain.
Date posted: April 17, 2021. Answers (1)
- Tom Donji an investment specialist has been entrusted with Sh.10 million by a unit trust and instructed to invest the money optimally over a two-year...(Solved)
Tom Donji an investment specialist has been entrusted with Sh.10 million by a unit trust and instructed to invest the money optimally over a two-year period. Part of the instructions are that:
The funds be invested in one or more of four specified projects and in the money market
The four projects are not divisible and cannot be postponed.
The unit requires a return of 24% over the two years.
Over the two-year period, the risk free rate is estimated to be 16%, the market portfolio return, 27% and
the variance of the return on the market, 100%.
Required:
By analyzing the two-asset portfolios:
i ) Use the mean-variance dominance rule to evaluate how Tom Donji should invest the Sh.10 million.
ii) Determine the betas and required rates of return for the portfolios and then use the Capital Asset
Pricing Model (CAPM) to evaluate how Tom Donji should invest the Sh.10 million.
Date posted: April 17, 2021. Answers (1)
- What are the limitations of the Capital Asset Pricing Model (CAPM) as an investment appraisal technique?(Solved)
What are the limitations of the Capital Asset Pricing Model (CAPM) as an investment appraisal technique?
Date posted: April 17, 2021. Answers (1)
- On 1 March 2001, a Kenyan importer purchased goods from the United States of America worth USD120,000 to be paid for two months later on...(Solved)
On 1 March 2001, a Kenyan importer purchased goods from the United States of America worth USD 120,000 to be paid for two months later on 30 April 2001.
Kenyan shillings futures were available in the money market and could be bought in blocks of Ksh.100,000 and each future contract cost Ksh.1,000.
Spot exchange rate on 1 March 2001 was Ksh.76.50 = USD 1. The two-month forward exchange rate on
30 April 2001 was Ksh.79.50 = USD 1 and the exchange rate at which futures were closed out was
Ksh.77.50 = USD1.
Required:
The net loss(gain) of using the futures contract.
Date posted: April 17, 2021. Answers (1)
- The following data relate to call options on two shares, A and B
Required:
Using the Black-Scholes Option Pricing Model (OPM).
Calculate the price of call option A....(Solved)
The following data relate to call options on two shares, A and B
Required:
Using the Black-Scholes Option Pricing Model (OPM).
Calculate the price of call option A. Of the two call options, which would you expect to have the higher price? Why? (Do not compute).
Date posted: April 17, 2021. Answers (1)
- Given below is the Option Pricing Model (OPM) derived by Black and Scholes in 1973 for predicting the market price of call options.
Required:
State and briefly...(Solved)
Given below is the Option Pricing Model (OPM) derived by Black and Scholes in 1973 for predicting the market price of call options.
Required:
State and briefly explain the relationship between a call option‟s price and the following determinants:
1) the underlying stock‟s price.
2) the exercise price
3) the time to maturity
4) the risk-free rate.
Date posted: April 17, 2021. Answers (1)
- 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.
c) Identify and discuss six defensive tactics the directors of XYZ Ltd. may employ to resist an
unwelcome bid.
Date posted: April 17, 2021. Answers (1)