According to an important 1961 paper by Modigliani and Miller (MM) (1961), if a few assumptions can
be made, dividend policy is irrelevant to share value. Those assumptions include:
a. No tax
b. No transaction cost
c. No bankruptcy cost
d. Equivalence in borrowing costs for both companies and investors
e. Symmetry of market information, meaning companies and investors have the same
information
f. No effect of debt on a company's earnings before interest and taxes.
MM concluded that the determinant of value is the availability of prospects with positive NPVs and the
pattern of dividends makes no difference to the acceptance of these. The share price would not move if the firm declared either a zero dividend policy or a policy of high near-term dividends.
If a company chose not to pay any dividends at all and shareholders required a regular income then this could be achieved while leaving the firm's value intact. Home-made dividends can be created by
shareholders selling a portion of their shares to other investors – again as there are no transaction costs and no taxation the result is identical to the receipt of cash in the form of an ordinary dividend from the firm.
Kavungya answered the question on April 19, 2021 at 20:04
- Distinguish between the residual dividend theory and clientele preference theory as they relate to dividend policy formulation.(Solved)
Distinguish between the residual dividend theory and clientele preference theory as they relate to dividend policy formulation.
Date posted: April 19, 2021. Answers (1)
- Mr. Charles Kabazi has a capital of Sh.1,000,000 which he wishes to invest in three sectors of
the economy; agriculture, service and manufacturing. The funds will...(Solved)
Mr. Charles Kabazi has a capital of Sh.1,000,000 which he wishes to invest in three sectors of
the economy; agriculture, service and manufacturing. The funds will be allocated as follows:
Details on the possible future economic states, their probabilities of occurrence and the expected return
for each of the sectors are presented below:
Required:
i) Determine the risk associated with the investment in each of the three sectors above.
ii) Determine the expected portfolio return
Date posted: April 19, 2021. Answers (1)
- A company is considering whether it is necessary to purchase equipment to increase its production and
sales volumes. The equipment costs Sh.500,000 and has a useful...(Solved)
A company is considering whether it is necessary to purchase equipment to increase its production and
sales volumes. The equipment costs Sh.500,000 and has a useful life of three years after which it can be
sold as scrap for Sh.80,000. For each of the three years of usage, the equipment is expected to increase
both sales revenue and operating costs by Sh.600,000 and Sh.390,000 respectively. The company's cost
of capital is 10%
Required:
i) Calculate the project's net present value (NPV)
ii) Compute the percentage changes required in the cost of the equipment, the scrap value and the sales
revenue for the project to be rejected.
Date posted: April 19, 2021. Answers (1)
- Briefly explain the importance of sensitivity analysis, with specific reference to investment appraisal
under uncertainty.(Solved)
Briefly explain the importance of sensitivity analysis, with specific reference to investment appraisal
under uncertainty.
Date posted: April 19, 2021. Answers (1)
- Ridges Company Ltd. is the process of preparing its capital budget for the financial year ending 30 June 2005. The company's capital structure as at...(Solved)
Ridges Company Ltd. is the process of preparing its capital budget for the financial year ending 30 June 2005. The company's capital structure as at 1 July 2004 and which the management considers as optimal
is presented below:
The following additional information is available:
1. The company can borrow a Sh.200 million long to on loan at a pre-tax cost 13. Any additional
debt can be obtained at a pre-tax cost of 16%.
2. The company can raise Sh.400 million through a bond issue. Each bond will have a face value of
Sh.1,000 but will be issued at Sh.687. The coupon rate on the bonds will be 10% with maturity period of
twenty years.
3. Preferred stock can be-issued at a pre-tax cost of 16.5%.
4. The company expects to generate Sh.700 million in net income before tax for the year ending 30
June 2005
5. The average annual growth rate in dividends is 5.5% and this rate is expected to continue into the
foreseeable future. The company expects to pay an ordinary dividend per share of Sh.10 for the year
ending 30 June 2005.
6. The following investment proposals will be available to the company in the year ending 30
June 2005.
Assume a corporation tax rate of 30%
Required:
a) Determine the cost of capital for each of the following sources of finance:
i) Long-term loan
ii) Bonds
iii) Additional Debt
iv) Preference share capital
v) Retained earnings
b) Using the marginal cost of capital (MCC) and internal rate of return (IRR) schedules, determine
the investment project(s) that should be accepted for the year ending 30 June 2005.
Date posted: April 19, 2021. Answers (1)
- Madawa Company Limited, a public quoted company, intends to raise additional share capital through a
rights issue. The number of issued ordinary shares currently stands at...(Solved)
Madawa Company Limited, a public quoted company, intends to raise additional share capital through a
rights issue. The number of issued ordinary shares currently stands at 100 million shares. Each
shareholder will have a right to purchase one share for every five shares currently held. The current
market price per share is Sh.60 while the rights price has been fixed at Sh.50 per share.
Required:
i) Calculate the theoretical value of a right in Madawa Company Limited
ii) Determine the theoretical ex-rights price of a share in the company
Date posted: April 19, 2021. Answers (1)
- Creation of shareholder value has become a generally accepted corporate objective. To facilitate the
realization of this objective, value based management systems (VBMs) which integrate finance...(Solved)
Creation of shareholder value has become a generally accepted corporate objective. To facilitate the
realization of this objective, value based management systems (VBMs) which integrate finance theory and
strategic management thinking have been developed by scholars.
Required:
i) Explain the main determinants of shareholder value
ii) Discuss tile factors that have stimulated the increased interest by companies in value based
management systems
Date posted: April 19, 2021. Answers (1)
- The investment portfolio of Mapeni Limited consists of shares in five companies operating in
different industries.
Required:
(i) Compute the expected return from the market (Rm).
(ii) Calculate...(Solved)
The investment portfolio of Mapeni Limited consists of shares in five companies operating in
different industries.
Required:
(i) Compute the expected return from the market (Rm).
(ii) Calculate the beta coefficient for the portfolio (βp).
(iii) Determine the equation for the security market line.
Date posted: April 19, 2021. Answers (1)
- The following details relating to Bidii Limited show how the level of gearing affects the
company's cost of debt.
Required:
Determine the company's optimal capital structure.(Solved)
The following details relating to Bidii Limited show how the level of gearing affects the
company's cost of debt.
Required:
Determine the company's optimal capital structure.
Date posted: April 19, 2021. Answers (1)
- Distinguish between a currency option and a currency swap.(Solved)
Distinguish between a currency option and a currency swap.
Date posted: April 19, 2021. Answers (1)
- Highspeed Electronics Limited has taken delivery of 50,000 electronic devices from an American
company. The seller is in a strong bargaining position and has priced the...(Solved)
Highspeed Electronics Limited has taken delivery of 50,000 electronic devices from an American
company. The seller is in a strong bargaining position and has priced the devices in American dollars
at USD12.00 each.
Highspeed Electronics Limited has been granted three months credit. Assume that interest rates in
America are 3% per quarter (three months). Highspeed electronics Limited has all its money tied up
in its operations but it could borrow in dollars at 3% per quarter if necessary.
Foreign exchange rates
USD = Sh. 1
Spot 0.013
Three month forward 0.0154
A three month dollar call option for USD 600,000 is available at a premium of USD15,000.
Required:
Using suitable computations, illustrate two hedging strategies available to Highspeed
Electronics Limited.
Date posted: April 19, 2021. Answers (1)
- Globalization has resulted in several organizations engaging in corporate alliances and the
establishment of several trading blocks. The advent of e-commerce has enabled companies to greatly
expand...(Solved)
Globalization has resulted in several organizations engaging in corporate alliances and the
establishment of several trading blocks. The advent of e-commerce has enabled companies to greatly
expand their markets.
Required:
Identify and elaborate on five factors that complicate financial management in multi-national firms.
Date posted: April 19, 2021. Answers (1)
- Leo Plastics Limited is an all equity financed company. It had three strategic business divisions as on
1 January 2004:
1. The Polythene division
It has a capital...(Solved)
Leo Plastics Limited is an all equity financed company. It had three strategic business divisions as on
1 January 2004:
1. The Polythene division
It has a capital of Sh. 8 million and is expected to produce returns of 11% on capital for the
next five years. Thereafter, it will produce returns equal to the required rate of return of 14% for
its risk level.
2. The Paper division
It has a capital of Sh. 12 million and a planning horizon of 10 years. During this planning
horizon, it will produce a return of 12% on capital compared with a risk adjusted required rate
of return of 15%.
3. The Container division
It has a capital of Sh. 12 million and a planning horizon of 7 years. The required rate of return
on capital is 16% compared with the anticipated actual rate of 17% over the first seven years.
Required:
Calculate the present value of the company as on 1 January 2004.
Date posted: April 19, 2021. Answers (1)
- The board of directors of Masii Limited is divided on whether to adopt a high or low dividend
payout policy. One of the directors has quoted...(Solved)
The board of directors of Masii Limited is divided on whether to adopt a high or low dividend
payout policy. One of the directors has quoted the „dividend discount model as
proof that the higher the dividends, the higher the share price.
Required:
(i) Highlight two arguments for and against a high dividend payout policy.
(ii) Using a constant growth dividend discount model, evaluate the director's statement.
Date posted: April 19, 2021. Answers (1)
- Kasuku Limited has set aside Sh. 40 million for investments as on 1 January 2004. Five proposals are presented to the company's board of directors...(Solved)
Kasuku Limited has set aside Sh. 40 million for investments as on 1 January 2004. Five proposals are presented to the company's board of directors by the finance manager as shown below:
Additional information:
1. Projects D and E are mutually exclusive.
2. Each project is divisible and can only be undertaken once.
3. Variable costs are 40% of annual revenue.
4. All cash flows will occur at the end of the year commencing 31 December 2004.
5. Cost of capital is 10% (ignore tax).
Required:
i. Determine the optimal allocation of the Sh. 40 million amongst the five projects.
ii. What is the net present value resulting from this allocation?
Date posted: April 19, 2021. Answers (1)
- “Total Risk Management (TRM) will become a common term in finance just like Total Quality
Management (TQM) has in production and marketing.” (Professor Andrew W. Lo....(Solved)
“Total Risk Management (TRM) will become a common term in finance just like Total Quality
Management (TQM) has in production and marketing.” (Professor Andrew W. Lo. 1999).
Required:
(i) Define risk management as used in finance.
(ii) Discuss reasons why risk management might increase shareholders wealth.
Date posted: April 19, 2021. Answers (1)
- Savanna Limited has a cost of equity of 10%. Currently it has 250,000 ordinary shares which are quoted
at the Stock Exchange of Sh. 120 per...(Solved)
Savanna Limited has a cost of equity of 10%. Currently it has 250,000 ordinary shares which are quoted
at the Stock Exchange of Sh. 120 per share. The company's earnings per share is Sh. 10
and it intends to maintain a dividend payout ratio of 50% at the end of the current financial year.
The expected net income for the current year is Sh. 3 million and the available investment
proposals are estimated to cost Sh. 6 million.
Required:
(i) Using the Modigliani and Miller (MM) model, show that the payment of dividends does not affect the value of the firm.
(ii) What are the assumptions inherent in the MM model?
Date posted: April 19, 2021. Answers (1)
- As an expert in the financial management of public projects, you have been requested to present a
seminar paper on “Project Management in the Public Sector;...(Solved)
As an expert in the financial management of public projects, you have been requested to present a
seminar paper on “Project Management in the Public Sector; challenges and dilemmas.”
Required:
Explain the main issues you would address in your paper under the following headings:
(i) Phases of a public project.
(ii) Planning and control techniques for a public project.
(iii) Causes of failure of public projects.
Date posted: April 19, 2021. Answers (1)
- The managing director of Bicdo Ltd., a company quoted on the Nairobi Stock Exchange (NSE)
has asked you to assist in estimating the firm's equity beta...(Solved)
The managing director of Bicdo Ltd., a company quoted on the Nairobi Stock Exchange (NSE)
has asked you to assist in estimating the firm's equity beta co-efficient. The firm is all equity
financed and listed in the NSE five years ago. You have gathered the following information from
the NSE for the last four years:
Required:
Use the capital asset pricing model (CAPM) to estimate the beta of Bicdo Ltd.
Date posted: April 19, 2021. Answers (1)
- Many of the underlying assumptions of CAPM are violated in the real world. Does that fact invalidate the model's conclusions? Explain.(Solved)
Many of the underlying assumptions of CAPM are violated in the real world. Does that fact invalidate the model's conclusions? Explain.
Date posted: April 19, 2021. Answers (1)