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Bond covenants might include:
(i) An asset covenant. This would govern the company's acquisition, use
and disposal of assets. This could be for specified types of assets, or assets in
general.
(ii) Financing covenant. This covenant often defines the type and amount of
additional debt that the company can issue, and its ranking and potential claim
on assets in case of future default.
(iii) Dividend covenant. A dividend restricts the amount of dividend that the
company is able to pay. Such covenants might also be extended to share
repurchases.
(iv) Financial ratio covenants, fixing the limit of key ratios such as the gearing level,
interest cover, net working capital, or a minimum ratio of tangible assets to
total debt.
(v) Merger covenant, restricting future merger activity of the company.
(vi) Investment covenant, concerned with the company's future investment policy.
(vii) Sinking fund covenant whereby the company makes payments, typically to the
bond trustees, who might gradually repurchase bonds in the open market, or
build up a fund to redeem bonds.
There will often also be a „bonding covenant? that describes the mechanisms
by which the above covenants are to be monitored and enforced. This often includes
an independent audit and the appointment of a trustee representing the interests of the
bondholders.
From the company's perspective the major disadvantages of covenants is that they
restrict the freedom of action of the managers, and could prevent viable investments, or
mergers from occurring. They also necessitate monitoring and other costs. However,
covenants are also of value to companies. Without covenants the company might not be
able to raise as much funds in the form of debt, as lenders would not be prepared to
take the risk. Even if lenders were to take the risk they would require a higher default
premium (higher interest rates) in order to compensate for the risk. The existence of
covenants therefore reduces the cost of borrowing from a company.
Kavungya answered the question on December 15, 2021 at 07:53
- State any 5 stakeholders of the firm and identify their financial objectives.(Solved)
State any 5 stakeholders of the firm and identify their financial objectives.
Date posted: December 15, 2021. Answers (1)
- The Salima company is in the fast foods industry. The following is the company's balance sheet for the year ended 31 March 1995:
Additional information:
1. The...(Solved)
The Salima company is in the fast foods industry. The following is the company's balance sheet for the year ended 31 March 1995:
Additional information:
1. The debenture issue was floated 10 years ago and will be due in the year 2005. A similar
debenture issue would today be floated at Sh.950 net.
2. Last December the company declared an interim dividend of Sh.2.50 and has now declared
a final dividend of Sh.3.00 per share. The company has a policy of 10% dividend growth
rate which it hopes to maintain into the foreseeable future. Currently the company's
shares are trading at Sh.75 per share in the local stock exchange.
3. A recent study of similar companies in the fast foods industry disclose their average beta as 1.1.
4. There has not been any significant change in the price of preference shares since they
were floated in mid 1990.
5. Treasury Bills are currently paying 12% interest per annum and the company is in the
40% marginal tax rate.
6. The inflation rate for the current year has been estimated to average 8%.
Required:
(a) Determine the real rate of return.
(b) What is the minimum rate of return investors in the fast foods industry may expect to
earn on their investment? Show your workings.
(c) Calculate Salina's overall cost of capital.
(d) Discuss the limitations of using a firm's overall cost of capital as an investment discount rate.
Date posted: December 15, 2021. Answers (1)
- Westwood Ltd. has projected its working capital for the next 12 months as follows:
Required:
(a) Prepare a schedule showing the amount of permanent and seasonal funds...(Solved)
Westwood Ltd. has projected its working capital for the next 12 months as follows:
Required:
(a) Prepare a schedule showing the amount of permanent and seasonal funds requirements each month.
(b) What is the average amount of long-term and short-term financing that will be required each month?
(c) Calculate the total cost of working capital financing if the firm adopts:
(i) An aggregate financing strategy
(ii) A conservative financing strategy.
Date posted: December 15, 2021. Answers (1)
- State and explain two Theories used to explain when to time investment in the stock exchange.(Solved)
State and explain two Theories used to explain when to time investment in the stock exchange.
Date posted: December 15, 2021. Answers (1)
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What advantages do investors derive from investment in shares?
Date posted: December 15, 2021. Answers (1)
- Explain the case for and against development financial institutions.(Solved)
Explain the case for and against development financial institutions.
Date posted: December 15, 2021. Answers (1)
- Define development financial institutions and justify their existence in the economy concerns.(Solved)
Define development financial institutions and justify their existence in the economy concerns.
Date posted: December 15, 2021. Answers (1)
- The Pesa Company Unlimited is using a machine whose original cost was Sh.720,000. The machine is two years old, and it has a current market...(Solved)
The Pesa Company Unlimited is using a machine whose original cost was Sh.720,000. The machine is two years old, and it has a current market value of Sh.160,000. The asset is fully being depreciated over a twelve-years period. At the end of the twelve-years the asset will have a zero salvage value. Depreciation is on a straight line basis.
The Management is contemplating the purchase of a new machine to replace the old one. The new machine costs Sh.750,000 and has an estimated salvage value of Sh.100,000. The new machine will have a greater technological capacity, and therefore annual sales are expected to increase from Sh.10,000,000 to Sh.10,100,000. Operating efficiencies with the new machine will produce an expected saving of Sh.100,000 a year. Depreciation would be on a straight line basis over a ten-year life. The cost of capital is 12%, and a 40% tax rate is applicable. In addition, if the new machine is purchased, inventories will increase by sh.150,000 and payables by Sh.50,000
during the life of the project.
Required:
(a) Should the new machine be purchased? (Use Net Present Value (NPV) approach).
(b) What factors in addition to the quantitative ones above are likely to require consideration in a practical situation?
Date posted: December 15, 2021. Answers (1)
- RITE Ltd. maintains an average monthly balance of Sh.320,000 in accounts receivable throughout the year. The company is in need of additional working capital and...(Solved)
RITE Ltd. maintains an average monthly balance of Sh.320,000 in accounts receivable throughout the year. The company is in need of additional working capital and is considering two alternative methods of raising it.
METHOD 1 Factoring accounts receivable
METHOD 2 A commercial bank loan secured by accounts receivable.
The company's bankers have agreed to lend the firm 80% of its average accounts receivable at an interest of 30% per annum. The amount will be made available in a series of 30 day advances. The advances would be discounted and a 6% compensating balance will be required.
The factor is willing to establish a factoring arrangement on a continuing basis. It charges 2% for servicing the accounts and 15% per annum on any advances taken. Both charges are made on discount basis. In addition, the factor requires a 5% reserve to cover returned items. RITE Ltd. sells its merchandise on terms of net 30.
Required:
(a) Calculate the amount of advances RITE Ltd. can expect to have under each alternative.
(b) Calculate the effective rate of interest for each financing alternative.
(c) Which alternative would you recommend and why?
Date posted: December 15, 2021. Answers (1)
- The following are the financial statements of Richardo Ltd. for the year ended 31 March 1995:
Required
(a) Calculate the ratios shown above for Richardo Ltd. and...(Solved)
The following are the financial statements of Richardo Ltd. for the year ended 31 March 1995:
Required
(a) Calculate the ratios shown above for Richardo Ltd. and present them in columnar form
along the industry averages.
(b) Comment upon the following about Richardo Ltd. in relation to the industry averages:
(i) Liquidity position
(ii) Financial risk
(iii) Overall performance
Date posted: December 15, 2021. Answers (1)
- Gopher Ltd has issued 300,000 ordinary shares of £1 each, which are at present selling for £4 per share. The company plans to issue rights...(Solved)
Gopher Ltd has issued 300,000 ordinary shares of £1 each, which are at present selling for £4 per share. The company plans to issue rights to purchase one new equity share at a price of £3.20 per share for every 3 shares held. A shareholder who owns 900 shares thinks that he will suffer a loss in his personal wealth because the new shares are being offered at a price lower than market value. On the assumption that the actual market value of shares will be equal to the theoretical ex-rights price, what would be the effect on the shareholder's wealth if:
(a) He sells all the rights;
(b) He exercises one half of the rights and sells the other half;
(c) He does nothing at all?
Date posted: December 15, 2021. Answers (1)
- What is rights issue and what are the advantages?(Solved)
What is rights issue and what are the advantages?
Date posted: December 15, 2021. Answers (1)
- How can a firm overcome capital rationing problems?(Solved)
How can a firm overcome capital rationing problems?
Date posted: December 15, 2021. Answers (1)
- Distinguish between 'Hard' and 'soft' capital rationing clearly indicating the causes of each.(Solved)
Distinguish between 'Hard' and 'soft' capital rationing clearly indicating the causes of each.
Date posted: December 15, 2021. Answers (1)
- Explain how tax treatment of capital expenditure can affect investment decision.(Solved)
Explain how tax treatment of capital expenditure can affect investment decision.
Date posted: December 15, 2021. Answers (1)
- The Independent Film Company plc is a film company which purchases distribution rights on films from small independent producers, and sells the films on to...(Solved)
The Independent Film Company plc is a film company which purchases distribution rights on films from small independent producers, and sells the films on to cinema chains for national and international screening. In recent years the company has found it difficult to source sufficient films to maintain profitability. In response to the problem, the Independent Film Company has decided to invest in commissioning and producing films in its own right. In order to gain the expertise for this venture, the Independent Film Company is considering purchasing an existing
filmmaking concern, at a cost of Sh.400,000. The main difficult that is anticipated for the business is the increasing uncertainty as to the potential success/failure rate of independently produced films. Many cinema chains are adopting a policy of only buying films from large international film companies, as they believe that the market for independent films is very limited and specialist in nature. The Independent Film Company is prepared for the fact that they are likely to have more films that fail than that succeed, but believe that the proposed film
production business will nonetheless be profitable.
Using data collection from the existing distribution business and discussions with industry
experts, they have produced cost and revenue forecasts for the five years of operation of the
proposed investment. The company aims to complete the production of three films per year.
The after tax cost of capital for the company is estimated to be 14%.
Year 1 sales for the new business are uncertain, but expected to be in the range of Sh.4-10
million. Probability estimates for different forecast values are as follows:
Sales are expected to grow at an annual rate of 5%.
Anticipated costs related to the new business are as follows:
Additional Information
(i) No capital allowances are available.
(ii) Tax is payable one year in arrears, at a rate of 33% and full use can be made of tax
refunds as they fall due.
(iii) Staff wages (technical and non-production staff) and actors‟ salaries, are
expected to rise by 10% per annum.
(iv) Studio hire costs will be subject to an increase of 30% in Year 3.
(v) Screenplay costs per film are expected to rise by 15% per annum due to a shortage of
skilled writers.
(vi) The new business will occupy office accommodation which has to date been let out for
an annual rent of Sh.20,000. Demand for such accommodation is buoyant and the
company anticipates in finding future tenants at the same annual rent.
(vii) A market research survey into the potential for the film production business cost Sh.25,000.
Required:
Using DCF analysis, calculate the expected Net Present Value of the proposed investment.
(Workings should be rounded to the nearest Sh.‟000‟)
Date posted: December 15, 2021. Answers (1)
- A working capital policy of any business is critical to its viability as a going concern. The board of directors would ignore the information of...(Solved)
A working capital policy of any business is critical to its viability as a going concern. The board of directors would ignore the information of such a policy to its great disadvantage.
The finance director of Watu Limited is formulating the company's capital policy for next year.
Sales have been protected at Sh.240 million next year. Three alternative policies are under
consideration as follows:
1. Maintain current asset level at 40 per cent of projected sales.
2. Maintain current asset level at 50 per cent of projected sales.
3. Maintain current asset level at 60 percent of projected sales.
Required:
(a) Discuss the expected impact of policies (1) and (3).
(b) The fixed assets of Watu Limited are Sh.100 million and the company wishes to
maintain a 60 percent debt ratio. The cost of capital for Watu Limited is currently 12
percent on both short-term and long-term debt. This is the rate which the firm also
applies on its permanent capital structure. The company earns 15 percent on sales.
What is the expected return on equity under each of the three policies above?
(c) Are earnings and level of sales independent of current asset policy in real life? Explain.
(d) What is meant by “maturity matching”, in finance?
Date posted: December 15, 2021. Answers (1)
- Can market forces be able to eliminate insider trading? Explain.(Solved)
Can market forces be able to eliminate insider trading? Explain.
Date posted: December 15, 2021. Answers (1)
- One of the objectives of the Capital Markets Authority is “the protection of investor interests;” [Capital Markets Authority Act, Cap.485A, Section 11, (1) (c)].
Several statements...(Solved)
One of the objectives of the Capital Markets Authority is “the protection of investor interests;” [Capital Markets Authority Act, Cap.485A, Section 11, (1) (c)].
Several statements have appeared in the papers to suggest that some instances of share price manipulation have been observed in Kenya.
Required:
Specify those measures which the Capital Markets Authority has taken and publicized in order to protect the investor.
Date posted: December 15, 2021. Answers (1)
- Explain the term 'Invoice discounting' and the merits and demerits of its use as a way of improving cash flow.(Solved)
Explain the term 'Invoice discounting' and the merits and demerits of its use as a way of improving cash flow.
Date posted: December 15, 2021. Answers (1)