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Financial Engineering
Design, development and implementation of innovative financial instruments and processes and the
formulation of creative solutions to problems in finance.
It is concerned with three critical issues:
Securities innovations which would add value to the firm and shareholders e.g issue a security
which increases the present value of tax shields available to the issues without increasing the
investors tax liability.
Innovative financial processes e.g on-line banking, use of central depositing system (CDS) in stock
market trading to reduce transaction costs etc.
Creative strategies to corporate finance problem.
Involves the use of tax-effective cash management strategies and corporate restructuring due
to internal and external factors e.g leveraged buyout, sale and lease back, outsourcing of
financial services, project finance etc.
Kavungya answered the question on April 20, 2021 at 09:53
- MK Ltd is comprised of 4 major projects, details of which as follows:
The risk free rate is 5% and the market return is 14% p.a....(Solved)
MK Ltd is comprised of 4 major projects, details of which as follows:
The risk free rate is 5% and the market return is 14% p.a. The standard deviation or the market return is 13%.
Required:
a) Evaluate whether or not the share price of MK Ltd is overvalued or undervalued.
b) Discuss why your results in (a) above might not correctly identify whether or not the share price of MK Ltd is undervalued or overvalued.
Date posted: April 20, 2021. Answers (1)
- The management of Viwanda Ltd. is in the process of evaluating the company's dividend policy.
The following information is provided:
1. The company paid Sh.1.2 million as...(Solved)
The management of Viwanda Ltd. is in the process of evaluating the company's dividend policy.
The following information is provided:
1. The company paid Sh.1.2 million as dividends in the last financial year.
2. The profit after tax for the last financial year was Sh.3.6 million.
3. The company has not issued any preference shares
4. The earnings growth rate has been consistent at 10% per annum for the past ten years.
5. The expected profit after tax for the current financial year is Sh.4.8 million
6. The company anticipates investment opportunities worth Sh.1.4 million in the current financial year.
7. The capital structure of the company consists of sixty per cent equity and forty per cent debt.
Required:
Determine the optimal total dividends for the current financial year if the company wishes to adopt each of the following independent dividend policies
i) Pure residual policy
ii) Constant payout ratio policy
iii) Stable predictable dividend policy, the growth rate being equivalent to the earnings growth rate.
iv) Regular plus extra dividend policy. The regular dividends would be based on the long run growth
rate of earnings while the extra dividends would be based on the residual income
Date posted: April 20, 2021. Answers (1)
- Securitization may be the wave for the future, as it appears to be a more efficient mechanism for bringing borrowers and investors together than traditional...(Solved)
Securitization may be the wave for the future, as it appears to be a more efficient mechanism for bringing borrowers and investors together than traditional financing through intermediaries (Fabozzi and Modigliani).
Required:
i) Explain the term “securitization”.
ii) Discuss the benefits that may accrue to a company that uses securitization in preference to traditional
financing through intermediaries.
Date posted: April 20, 2021. Answers (1)
- Mr. K. Patel has an investment capital of Sh.1,000,000. He wishes to invest in two securities, A and B in
the following proportion; Sh.200,000 in security...(Solved)
Mr. K. Patel has an investment capital of Sh.1,000,000. He wishes to invest in two securities, A and B in
the following proportion; Sh.200,000 in security A and Sh.800,000 in security B.
The returns on these two securities depend on the state of the economy as shown below:
Required:
i) Compute the expected portfolio return
ii) Determine the correlation coefficient between security A and security B
iii) Calculate the portfolio risk
iv) Calculate the reduction in risk due to portfolio diversification
Date posted: April 20, 2021. Answers (1)
- With the help of a diagram show the difference between an efficient portfolio and an optimum portfolio.(Solved)
With the help of a diagram show the difference between an efficient portfolio and an optimum portfolio.
Date posted: April 20, 2021. Answers (1)
- The management of Dawanu Ltd. is evaluating five investment projects whose expected cash flows are shown below:
Additional Information:
1. None of the five projects can be...(Solved)
The management of Dawanu Ltd. is evaluating five investment projects whose expected cash flows are shown below:
Additional Information:
1. None of the five projects can be delayed or bought forward.
2. All the projects are divisible
3. The required rate of return on investments is 15%
Required:
i) Using the net present value (NPV) approach, determine which project(s) should be undertaken assuming
capital will be available when required.
ii) Using the NPV approach, determine which project(s) should be undertaken assuming capital available on
1 January 2006 is limited to Sh.100 million
Date posted: April 20, 2021. Answers (1)
- Distinguish between one-period rationing and multi-period rationing with specific reference to capital rationing.(Solved)
Distinguish between one-period rationing and multi-period rationing with specific reference to capital rationing.
Date posted: April 20, 2021. Answers (1)
- Proton Ltd. has a capital structure consisting of Sh.250 million in 12% debentures and Sh.150 million in
ordinary shares of Shs.10 par value. The company distributes...(Solved)
Proton Ltd. has a capital structure consisting of Sh.250 million in 12% debentures and Sh.150 million in
ordinary shares of Shs.10 par value. The company distributes all its net earnings as dividends.
The finance manager of Proton Ltd. intends to raise an additional Sh.50million to finance an
expansion programme and is considering three financing options.
Option one: Issue an 11% debenture stock
Option two: Issue 13% cumulative preference shares
Option three: Issue additional ordinary shares of Sh.10 par value.
The corporation tax rate is 30%.
Required:
Calculate the earnings before interest and tax (EBIT ) and the earnings per sharee (EPS)at the
point of indifference between the following financing options:
i) Option one and option three
ii) Option two and option three
Date posted: April 20, 2021. Answers (1)
- Two firms, A Ltd and B Ltd. operate in the same industry. The two firms are similar in all aspects
except for their capital structures.
The following...(Solved)
Two firms, A Ltd and B Ltd. operate in the same industry. The two firms are similar in all aspects
except for their capital structures.
The following additional information is available:
1. A Ltd is financed using Sh.100 million worth of ordinary shares.
2. B Ltd is financed using Sh.50 million in ordinary shares and Sh.50 million in 7% debentures
3. The annual earnings before interest and tax are Sh.10million for both firms. These earnings are
expected to remain constant indefinitely.
4. The cost of equity in A Ltd is 10%
5. The corporate tax rate is 30%
Required:
Using the Modigliani and Miller (MM) model, determine the following:
i) The market value of A Ltd. and B Ltd.
ii) The weighted average cost of capital of A Ltd and B Ltd.
Date posted: April 20, 2021. Answers (1)
- Explain two ways in which a firm can hedge against a currency transaction exposure.(Solved)
Explain two ways in which a firm can hedge against a currency transaction exposure.
Date posted: April 19, 2021. Answers (1)
- Define the following types of foreign currency risk exposure:
i) Transaction exposure
ii) Translation exposure
iii) Economic exposure(Solved)
Define the following types of foreign currency risk exposure:
i) Transaction exposure
ii) Translation exposure
iii) Economic exposure
Date posted: April 19, 2021. Answers (1)
- Huge Ltd. is contemplating a complete share acquisition of Tiny Ltd. Huge Ltd is offering three of its
shares for every two shares of Tiny Ltd....(Solved)
Huge Ltd. is contemplating a complete share acquisition of Tiny Ltd. Huge Ltd is offering three of its
shares for every two shares of Tiny Ltd. The data is relating to the two companies are shown below:
The corporate tax rate is 30%
Required:
i) Determine the maximum offer price that will not dilute the EPS of Huge Ltd.
ii) Compute the premium payable to the shareholders of Tiny Ltd
iii) Given that the growth rate of Huge Ltd. is 8% while that of Tiny Ltd is 12%, compute the combined
growth rate of the two companies
Date posted: April 19, 2021. Answers (1)
- Discuss the Modigliani and Miller's (MM) dividend irrelevancy proposition.(Solved)
Discuss the Modigliani and Miller's (MM) dividend irrelevancy proposition.
Date posted: April 19, 2021. Answers (1)
- 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)