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- Components Manufacturing Corporation (CMC) has an all-common-equity capital structure. It has 200,000 shares of Sh.2 par value common stock outstanding. When CMC's founder, who has...(Solved)
Components Manufacturing Corporation (CMC) has an all-common-equity capital structure. It has 200,000 shares of Sh.2 par value common stock outstanding. When CMC‟s founder, who has also its research director and most successful inventor; retired unexpectedly to the South Pacific in late 2000, CMC was left suddenly and permanently with materially lower growth expectations and relatively few attractive new investment opportunities. Unfortunately, there was no way to replace the founder's contributions to the firm.
Previously, CMC found it necessary to plow back most of its earnings to finance growth, which averaged 12 percent per year. Future growth at a five percent rate is considered realistic, but that level would call for an increase in the dividend payout. Further, it now appears that new investment projects with at least the 14 percent rate of return required by CMC's stockholders (ks= 14%) would amount to only Sh.800,000 for 2001in comparison to a projected Sh.2,000,000 of net income. If the existing 20 percent dividend payout were continued, retained earnings would be Sh.1.6 million in 2001, but as noted, investments that yield the 14 percent cost of capital would amount to only Sh.800,000.
The one encouraging thing is that the high earnings from existing assets are expected to continue, and
net income of Sh.2 million is still expected for 2001. Given the dramatically changed
circumstances, CMC's management is reviewing the firm's dividend policy.
(a) Assuming that the acceptable 2001 investment projects would be financed entirely by earnings
retained during the year, calculate DPS in 2001 if CMC follows the residual divided policy.
(b) What payout ratio does your answer to part a imply for 2001?
(c) If a 60 percent payout ratio is maintained for the foreseeable future, what is your estimate of
the present market price of the common stock? How does this compare with the market price
that should have prevailed under the assumptions existing just before the news
about the founder's retirement? If the two values of P0 are different, comment on why.
(d) What would happen to the price of the stock if the old 20 percent payout were continued? Assume
that if this payout is maintained, the average rate of return on the retained earnings will fall to 7.5
percent and the new growth rate will be
g = (1.0 – Payout ratio)(ROE)
= (1.0 – 0.2)(7.5%) = (0.8)(7.5%) = 6.0%
Date posted: April 20, 2021. Answers (1)
- Lancaster Engineering Inc. (LEI) has the following structure, which it considers to be optimal:
LEI's expected net income this year is Sh.34,285.72; its established dividend payout...(Solved)
Lancaster Engineering Inc. (LEI) has the following structure, which it considers to be optimal:
LEI's expected net income this year is Sh.34,285.72; its established dividend payout ratio is 30
percent; its marginal tax rate is 40 percent; and investors expect earnings and dividends to grow at a
constant rate of nine percent in the future. LEI paid a dividend of Sh.3.60 per share last hear, and its stock currently sells at a price of Sh.60 per share.
LEI can obtain new capital in the following ways:
Common: New common stock has a flotation cost of ten percent for up to Sh.12,000 of new stock and
20percent for all common stock over Sh.12,000.
Preferred: New preferred stock with a dividend of Sh.11 can be sold to the public at a price of Sh.100
per share. However, flotation costs of Sh.5 per share will be incurred for up to Sh.7,500 of preferred stock, and flotation costs will rise to Sh.10 per share, or ten percent, on all preferred stock over Sh.7,500.
Debt: Up to Sh.5,000 of debt can be sold at an interest rate of 12 percent; debt in the range of Sh.5,001 to Sh.10,000 must carry an interest rate of 14 percent; and all debt over Sh.10,000 will have an interest rate of 16 percent.
LEI has the following independent opportunities:
(a) Find the break points in the MCC schedule
(b) Determine the cost of each capital structure component.
(c) Calculate the weighted average cost of capital in the interval between each break in the
MCC schedule.
(d) Calculate the IRR for Project E.
(e) Construct a graph showing the MCC and IOS schedules.
(f) Which projects should LEI accept?
Date posted: April 20, 2021. Answers (1)
- Summarized below are financial data in respect of Kevinko Ltd:
As a result of recent capital expansion, market analysts expect pre-tax earnings to increase at the...(Solved)
Summarized below are financial data in respect of Kevinko Ltd:
As a result of recent capital expansion, market analysts expect pre-tax earnings to increase at the rate of 25% for the next two years before reverting to the company's existing growth rate.
The company's overall beta is 0.763 while the beta for debt is 0.20. The risk free rate is 12%
and the market return is 17%. Currently, the shares of the company are selling at Sh.21.70 on the stock
exchange cum 1996 dividend. The debentures are selling at Sh.8 9.50 ex-interest.
The corporate tax is 35%.
Required:
a) Using the dividend growth model, estimate what a fundamental analyst might consider to be the
intrinsic value of Kevinko's shares. Comment on this value.
b) If interest rates were to go by 5% what would be the effect of this increase on the company's share
price?
c) What is the difference between fundamental analysis and a chartist's analysis in the valuation of
shares?
Date posted: April 20, 2021. Answers (1)
- Dove Construction Company Ltd made a Sh.100 million bondage 5 years ago when interest rates were
substantially high. The interest rates have now fallen and the...(Solved)
Dove Construction Company Ltd made a Sh.100 million bondage 5 years ago when interest rates were
substantially high. The interest rates have now fallen and the firm wishes to retire this old debt and replace it with a new and cheaper one. Given here below are the details about the two bond issues:
Old Bonds: The outstanding bonds have a nominal value of Sh.1,000 and 24% coupon interest rate. They
were issued 5 years ago with a 15-year maturity. They were initially sold a their nominal value of Sh.1,000 and the firm incurred Sh.390,000 in floatation costs. They are callable at Sh.1,120.
New Bonds: The new bonds would have a Sh.1,000 nominal value and a 20% coupon interest rate. They
would have a 10-year maturity and could be sold at their par value. The issuance cost of the new bonds
would be Sh.525,000.
Assume the firm does not expect to have any overlapping interest and is in the 35% tax bracket.
Required:
a) Calculate the after-tax cash inflows expected from the unamortized portion of the old bond's
issuance cost.
b) Calculate the annual after-tax cash inflows from the issuance of the new bonds assuming the 10-year
amortization.
c) Calculate the after-tax cash outflow from the call premium required to retire the old bonds.
d) Determine the incremental initial cash outlay required to issue the new bonds.
e) Calculate the annual cash-flow savings, if any, expected from the bond refunding.
f) If the firm has a 14% after-tax cost of debt, would you recommend the proposed refunding and
reissue? Explain.
Date posted: April 20, 2021. Answers (1)
- Explain the types of political risks that face multi-national firms in foreign countries.(Solved)
Explain the types of political risks that face multi-national firms in foreign countries.
Date posted: April 20, 2021. Answers (1)
- Your firm is considering the acquisition of a new fork lift truck. It is uncertain about whether to purchase the truck outright or to finance...(Solved)
Your firm is considering the acquisition of a new fork lift truck. It is uncertain about whether to purchase the truck outright or to finance it through a leasing arrangement with Kasneb Bank Ltd. The purchase price is Sh.5,200,000 and it will have a salvage value of Sh.400,000 at the end of its 8-year useful life. The annual lease cost would be Sh.996,000 for 8 years.
The company uses the straight-line method for analysis investment decisions.
The company can borrow funds (to purchase the forklift) at 22% and it has an effective tax rate of
35%. Its after tax cost of capital is 12%.
Required:
a) Analyze the decision situation and advise the firm about the appropriate acquisition method.
b) If the company could get a 20% investment allowance on this investment, how would this affect
your answer in (a) above?
Date posted: April 20, 2021. Answers (1)
- Mr. Upendo, a director of Yote Limited met Mr. Mapenzi, a director of Toa Limited during a conference
in Mombasa. They had some discussion about their...(Solved)
Mr. Upendo, a director of Yote Limited met Mr. Mapenzi, a director of Toa Limited during a conference
in Mombasa. They had some discussion about their various companies. After flying back to Nairobi, Mr.
Upendo proposed to his board of directors acquisition of Toa Limited.
During his presentation to the board he stated that: “As a result of this takeover we will diversify
our operations and our earnings per share will rise by 13%, bringing great benefits to our shareholders.
No bid has yet been made and Yote Limited currently owns only 2% of Toa Limited.
A bid would be based on an exchange of shares between the two companies which would be one Yote
share for every six Toa shares. Financial data for the two companies include the following:
Required:
a) Explain whether you agree with Mr. Upendo when he says that the takeover would bring great benefits to our shareholders. Support your explanation with relevant calculations. State clearly any
assumptions made.
b) On the basis of information provided, calculate the likely post acquisition price of a share of Yote
Limited if the bid is successful.
c) What alternative forms of payment are available in a bid?
Date posted: April 20, 2021. Answers (1)
- EMC Ltd has a paid up share capital of 1.2 million shares of Sh.20 each. The current market price per share
is Sh.36. The company has...(Solved)
EMC Ltd has a paid up share capital of 1.2 million shares of Sh.20 each. The current market price per share
is Sh.36. The company has no loan capital. Maintainable earnings before tax are forecast at Sh.4.8 million.
The company‟s effective tax rate is 40%. The company requires to raise a further Sh.15
million in order to achieve additional earnings of Sh.2.2 million per annum and proposes doing this by
means of a rights issue. Suggested alternative prices for the rights issue are Sh.32 and Sh.25 per share.
Required:
a) Calculate, when the price is Sh.32 per share, the theoretical market price per share of the enlarged capital after the issue (the ex-rights price) and also the market value of a right.
b) Calculate as in (a) above when the price is Sh.25 per share.
c) Suggest, with reasons, what issue price is most likely to be adopted by the company.
d) What factors might, in practice, invalidate your calculations?
Date posted: April 20, 2021. Answers (1)
- Explain the factors responsible for financial innovations.(Solved)
Explain the factors responsible for financial innovations.
Date posted: April 20, 2021. Answers (1)
- Define the term “Financial Engineering” and explain 3 main components of financial engineering.(Solved)
Define the term “Financial Engineering” and explain 3 main components of financial engineering.
Date posted: April 20, 2021. Answers (1)
- 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)