Agency costs
These are cost borne by shareholders of an organization as a result of not being directly involved in decision making, when the decisions are made by the directors. Agency costs are incurred when management decisions are based on the interests of directors rather than shareholders.
Types of agency costs;-
i. Expenditures to monitor managerial activities such as audit costs.
ii. Expenditures to structure the organization in a way that will limit undesirable managerial behaviour, such as appointing outside managers to the board of directors or restructuring the company's business units and management
hierarchy.
iii. Opportunity costs which are incurred when shareholders imposed restriction, e.g. requirement for shareholders rate on specific issues, limit the ability of managers to take actions that advance shareholders wealth.
Kavungya answered the question on April 13, 2022 at 11:31
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Biashara Ltd, has the following capital structure
The finance manager of Biashara Ltd. has a proposal for a project requiring Sh.45 million. He has
proposed the following...
(Solved)
Biashara Ltd, has the following capital structure
The finance manager of Biashara Ltd. has a proposal for a project requiring Sh.45 million. He has
proposed the following method of raising the funds.
• Utilise all the existing retained earning.
• Issue ordinary share at the current market price.
• Issue 100,000 10% preference shares at the current market price of Sh.100 per share which
is the same as par value.
• Issue 10% debentures at the current market price of Sh.1,000 per debenture
Additional Information:
1. Currently Biashara Ltd. Pays a dividend of Sh5 per share which is expected to grow at the rate of
6% due to increased returns from the intended project. Biashara Ltd.’s. price/earnings (P/E) ratio
and earnings per share (EPS) are Sh5 and Sh.8 respectively.
2. The ordinary share would be issued at a floatation cost of 10% based on the market price
3. The debenture par value is Sh.1,000 per debenture
4. The corporate tax rate is 30%
Required:
Biashara Ltd.’s weighted average cost of capital (WACC)
Date posted:
April 13, 2022
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Answers (1)
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Zatex ltd, had the following capital structure as at 31 March 2005
Additional Information;-
1. The market price of each of ordinary share as at 31 March...
(Solved)
Zatex ltd, had the following capital structure as at 31 March 2005
Additional Information;-
1. The market price of each of ordinary share as at 31 March 2005 was Sh.20
2. The company paid a dividend of Sh.2 for each ordinary share for the year ended 31 March 2005
3. The annual growth rate in dividends is 7%
4. The corporation tax rate is 30%
Required:
i) Compute the weighted average cost of capital of the company as at 31 March 2005.
ii) The company intends to issue a 15% Sh.2 million debenture during the year ending 31 March
2006. The existing debentures will not be affected by this issue. The dividend per share for the
year ending 31 March 2006 is expected to be Sh.3 While the average market price per share
over the same period is estimated to be Sh.15. The average annual growth rate in dividend is
expected to remain at 7%.
Compute the expected weighted average cost of capital as at 31 March 2006.
Date posted:
April 13, 2022
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Answers (1)
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The following information was extracted from the books of Faida Limited as at 31 December Required:
i. Cost of ordinary share capital.
ii. Cost of 8% preference...
(Solved)
The following information was extracted from the books of Faida Limited as at 31 December Required:
i. Cost of ordinary share capital.
ii. Cost of 8% preference share capital.
iii. Cost of 10% preference share capital.
iv. Cost of 10% debentures.
v. Market –weighted average cost of capital2005.
Date posted:
April 13, 2022
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Answers (1)
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Explain the advantages of using market value weights over book value weights in computing the weighted average cost of capital.
(Solved)
Explain the advantages of using market value weights over book value weights in computing the weighted average cost of capital.
Date posted:
April 13, 2022
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Answers (1)
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Mount Elgon Ltd. is considering the launch of a new product. Exel, for which an investment of Sh.6,000,000 in plant and machinery will be required....
(Solved)
Mount Elgon Ltd. is considering the launch of a new product. Exel, for which an investment of Sh.6,000,000 in plant and machinery will be required. The production of Exel is expected to last five years after which the plant and machinery would be sold for Sh. 1,500,000.
Additional Information:
1) Exel would be sold at Sh.600 per unit with a variable cost of Sh240 per unit
2) Fixed production costs (excluding depreciation) would amount to Sh.600,000 per annum
3) The Company applies the straight line method of depreciation
4) The cost of capital is 10% per annum
5) The units of Exel expected to be sold per annum for the next five years as shown below
Year: Units expected to be sold
1 : 8,000
2 : 7,000
3 : 7,000
4 : 5,000
5 : 3,000
6) The corporation tax rate is 30%
Required:
i. Calculate the net present value (NPV) of the project and advise the management on the
appropriate course of action.
ii. Calculate the internal rate of return (IRR) of the project and advise the management on the
appropriate course of action.
iii. Outline the main drawbacks of the IRR method of investment.
Date posted:
April 13, 2022
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Answers (1)
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Upendo Ltd. is in the process of raising additional finance. The company’s financial structure
comprises ordinary share capital, reference share capital, debenture capital and retained earnings.
Each...
(Solved)
Upendo Ltd. is in the process of raising additional finance. The company’s financial structure
comprises ordinary share capital, reference share capital, debenture capital and retained earnings.
Each of these sources of finance is analyzed below:
Ordinary Share Capital
• The current market price per share is Sh.80
• The company expects to pay a cash dividend of Sh.6 per share in the next financial year
• The annual rate of growth in dividend per share is 6%
• Flotation costs amounting to Sh8 per share
11% Preference Share Capital
• The par value per share is Sh.100
• The share are currently trading at par
• Flotation costs amounting to Sh.4 per share 10% Debenture Capital
• The per value is Sh1,000 for each debenture stock
• The debenture have ten-year maturity period
• The flotation cost for each debenture stock is Sh.50 Retained Earnings
• The company expects to have Sh.225,000 of retained earnings available for the next financial year.
• Should the retained earnings balance to exhausted, the company will use common stock as the form of equity financing
Required:
i) Calculate the cost of Capital for ordinary share capital, preference share capital, debenture
capital and retained earnings
ii) Calculate the marginal cost of capital applying the target capital proportions and using
retained earnings to represent equity finance
iii) Comment on the relevance of the marginal cost of capital in (ii) above to Upendo Ltd.
Date posted:
April 13, 2022
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Answers (1)
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Karatasi Ltd. had the following capital structure as at 31 December 2008.
Additional information:
1. The current market price per ordinary share, preference share and debenture is...
(Solved)
Karatasi Ltd. had the following capital structure as at 31 December 2008.
Additional information:
1. The current market price per ordinary share, preference share and debenture is sh.. 50, sh. 24 and sh. 1,200 respectively.
2. For the year ended 31 December 2008, the company paid an ordinary dividend of sh. 6.00 per share. Analysts estimate that the company’s earnings and dividends will grow at an annual rate of 15 per cent indefinitely.
3. The corporation tax rate is 30 per cent.
Required;-
The company’s market weighted average cost of capital.
Date posted:
April 11, 2022
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Answers (1)
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Highlight three reasons why accounting profit might not be the best measure of a company's achievement.
(Solved)
Highlight three reasons why accounting profit might not be the best measure of a company's achievement.
Date posted:
April 11, 2022
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Answers (1)
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An investor received a dividend of Sh.1.50 in the current financial year on each of his ordinary shares. The par value per share is Sh.20....
(Solved)
An investor received a dividend of Sh.1.50 in the current financial year on each of his ordinary shares. The par value per share is Sh.20. The annual growth rate in dividends is 8%. The current market price per share is Sh1.50 while the investor’s required rate of return is 20%.
Calculate the intrinsic value of each ordinary share.
Date posted:
April 5, 2022
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Answers (1)
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Kawaida Ltd. is currently engaged in an expansion programme. Consequently, the company has been retaining all its earnings to finance the expansion programme. The company’s...
(Solved)
Kawaida Ltd. is currently engaged in an expansion programme. Consequently, the company has been retaining all its earnings to finance the expansion programme. The company’s management expects to resume the payment of dividends at the end of 3 years with a dividend payment of sh. 1 per share. The dividends will grow at an annual rate of 50% in years 4 and 5. Thereafter, the dividends will grow at a constant rate of 8% indefinitely. The required rate of return on the company’s stock is 15%.
Required:
The current value of the company’s stock.
Date posted:
March 30, 2022
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Answers (1)
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Ushindi Ltd. has recently issued a sh. 1,000, 9 percent convertible bond. The bond can be converted into 9 ordinary shares at the end of...
(Solved)
Ushindi Ltd. has recently issued a sh. 1,000, 9 percent convertible bond. The bond can be converted into 9 ordinary shares at the end of the five years. The current market price of the shares of Ushindi Ltd. is sh. 25 per share. The price is expected to grow at a rate of 10 per cent per annum. The investors’ required rate of return is 12%.
Required:
The current value of the bond.
Date posted:
March 30, 2022
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Answers (1)
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The 10% convertible loan stock of Nalyaka Ltd. is quoted at Sh.142 per Sh.100 par value. The earliest date of conversion is in 4 years’...
(Solved)
The 10% convertible loan stock of Nalyaka Ltd. is quoted at Sh.142 per Sh.100 par value. The earliest date of conversion is in 4 years’ time, at the rate of 30 ordinary shares per Sh.100 nominal loan stock. The share price is currently Sh.4.15. Annual interest on the stock has just been paid.
Required:
(i) The average annual growth rate in the share price that is required for the stockholders to achieve an overall rate of return of 12% a year compounded over the next 4 years, including the proceeds of conversion.
(ii) The implicit conversion premium on the stock.
Date posted:
March 30, 2022
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Answers (1)
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Max Enterprises Ltd. had the following pattern of earnings per share (EPS) over the last five years:
(Solved)
Max Enterprises Ltd. had the following pattern of earnings per share (EPS) over the last five years:
The company maintained a constant dividend payout ratio of 40%. The company's required rate of return is 13%.
Required:
The company's theoretical value of the share
Date posted:
March 30, 2022
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Answers (1)
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Malikia Guyo borrowed Sh.1, 000,000 from Huduma Bank at an annual compound interest of 14% on the reducing balance. The loan was repayable in annual...
(Solved)
Malikia Guyo borrowed Sh.1, 000,000 from Huduma Bank at an annual compound interest of 14% on the reducing balance. The loan was repayable in annual instalments over a period of four years. The installments were payable at end of the year.
Required:
A loan amortisation schedule.
Date posted:
March 30, 2022
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Answers (1)
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Shadrack Chando borrowed Sh.80,000 from XYZ commercial bank at an interest rate of 1.25% compounded monthly. The loan is to be amortized using the reducing...
(Solved)
Shadrack Chando borrowed Sh.80,000 from XYZ commercial bank at an interest rate of 1.25% compounded monthly. The loan is to be amortized using the reducing balance method and be repaid in 12 equal monthly installments payable at the end of each month.
Required:
A loan amortization schedule.
Date posted:
March 30, 2022
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Answers (1)
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John Matata has just borrowed Sh.220,000 from a bank payable at 12% per annum compounded annually to be repaid in six equal annual instalments.
(Solved)
John Matata has just borrowed Sh.220,000 from a bank payable at 12% per annum compounded annually to be repaid in six equal annual instalments.
These payments are to be sufficient to repay the principal amount together with interest.
Required;-
The loan amortization schedule.
Date posted:
March 30, 2022
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Answers (1)
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Explain four reasons that may drive a company to raise equity finance rather than debt finance.
(Solved)
Explain four reasons that may drive a company to raise equity finance rather than debt finance.
Date posted:
March 30, 2022
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Answers (1)
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In relation to the financial objectives of a business entity, distinguish between the terms “maximizing” and “satisficing”.
(Solved)
In relation to the financial objectives of a business entity, distinguish between the terms “maximizing” and “satisficing”.
Date posted:
March 30, 2022
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Answers (1)
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Explain three causes of conflict of interest between shareholders and debt holders.
(Solved)
Explain three causes of conflict of interest between shareholders and debt holders.
Date posted:
March 30, 2022
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Answers (1)
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Executive compensation plans hinder value creation in a company. Citing three reasons, justify the above statement.
(Solved)
Executive compensation plans hinder value creation in a company. Citing three reasons, justify the above statement.
Date posted:
March 30, 2022
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Answers (1)