FINANCIAL MANAGEMENT TUTORIAL QUESTIONS QUESTION ONE Outline FOUR main objectives, which conflict and at the same

time overlap explain these overlap and conflicts. QUESTION TWO Within a business finance context, discuss the problems that might exist in the relationships (sometimes referred to as agency relationships) between: a) b) Shareholders and managers, and Shareholders and creditors.

QUESTION THREE a) What are the practical difficulties of a small scale enterprise wishing to obtain credit to expand production? (10 marks) Distinguish between internal and external sources of finance for a limited liability company. (10 marks)

b)

QUESTION FOUR a) b) Why do different sources of finance have different costs? (8 marks)

What are the advantages of having a farmers bank compared with an ordinary commercial bank in the provision of services to farmers? (12 marks)

QUESTION FIVE a) b) What is venture capital? (4 marks)

Why is the market for venture capital not yet well developed in Kenya or your country? (16 marks)

QUESTION SIX a) b) Distinguish between debt and equity capital. (10 marks)

What are the advantages of leasing an asset compared to borrowing to buy an asset? (10 marks) QUESTION SEVEN The following is the existing capital structure of Company XYZ Ltd. Shs. 1,000,000 800,000 400,000

Ordinary shares at Shs.10 par Retained 12% preference shares Shs.10 par

16% loan Shs.100 par Total capital employed

300,000 2,500,000

The companys ordinary shares have a dividend cover of 3 times and pays a dividend of 10% on its ordinary share capital. Ordinary shares sells at Shs.18 Preference shares sell at Shs.15 Debentures are selling at par. The tax rate is 30% Compute a) b) Growth in Equity. W.A.C.C. (10 marks) (10 marks)

QUESTION EIGHT Distinguish between Capital structure and financial structure. Distinguish between Business risk and Financial risk. What is the effect of introduction of debt capital on weighted average cost of capital (WACC) Differentiate between marginal weighted cost of capital (MWCC) and WACC

QUESTION NINE a) b) c) Define the term weighted average cost of capital. (3 marks) What is meant by the marginal weighted average cost of capital? (3 marks) Com-Tech Company Ltd. is in the Telecommunications Industry. The companys balance sheet as at 31 March 2000 is as below: Liability and Owners Equity Current liabilities 18% debentures (sh.1,000 par) 10% preference shares Ordinary shares (Sh.10 par) Retained earnings Assets Sh.000 12,500 Current assets 16,000 Net fixed assets 6,250 12,500 28,125 75,375 Sh.000 32,500 42,875

_____ 75,375

Additional information The debentures are now selling at Sh.950 in the market and will be redeemed 10 years from now. By the end of last financial period, the company had declared and paid Sh.5.00 as dividend per share. The dividends are expected to grow at an annual rate of 10% in the foreseeable future. Currently, the companys shares are trading at Sh.38 per share at the local stock exchange.

The preference shares were floated in 1995 and their prices have remained constant. Most banks are lending money at an interest of 22% per annum. The Corporation tax rate is 40% per annum. Required i) ii) Calculate the market weighted cost of capital for this firm. (12 marks) The book-value weights should be used discreetly when computing weighted cost of capital. Why (2 marks)

QUESTION TEN Assume that on 31 December 2001 you are provided with the following capital structure of Hatilcure Ltd which is optimal. Sh.000 135,000 90,000 75,000 300,000

Long term debt (16%) Ordinary share capital (Sh.10 par) Retained earnings

The company has total assets amounting to sh.360 million but this figure is expected to rise to Sh.500 million by he end of 2002. You are also informed that: 1. 2. 3. 4. 5. 6. 7. 8. Required a) b) c) Companys net amount to the capital budget to be financial with equity if 85% of the asset expansion is included in the 2002 capital budget. (3 marks) How many shares must be sold to raise the required equity capital? Round your figure o the nearest thousand. (8 marks) What is the firms marginal cost of capital? Show full workings. (10 marks) Any new equity shares sold will net 90% after flotation costs. For the year just ended the company paid Sh.3.00 in dividends per share. New 16% debt can be raised at par through the stock exchange. The past and expected earnings growth rate is 10% The current dividend yield is 12% The companys dividend payout ratio of 50% shall be maintained in 2002. Assume marginal at rate of 40% The companys capital structure is optimal

QUESTION ELEVEN What are the advantages of discounted cash flows methods? QUESTION TWELVE

Kiwanda Limited is considering the purchase of a new machine. Two alternative machines, Pesi TZO and Upesi MO2, which will cost Sh.6,000,000 and Sh.7,000,000 respectively are available in the market. The cash flow after taxation of each machine are as follows: Cash flow Pesi TZO Upesi MO2 Sh. Sh. 600,000 1,800,000 1,800,000 2,400,000 2,000,000 3,000,000 3,000,000 1,800,000 2,400,000 1,600,000

Year 1 2 3 4 5 Required a) b)

Compute the net present value of each machine.

(8 marks)

Assuming that each machine represents a project: Compute the return Kiwanda Limited expects to earn from each of the two projects. (10 marks) Comment on the use of the results obtained in (a) and (b)(i) above in selecting between the two projects. (4 marks) (Total: 22 marks)

QUESTION THIRTEEN The Weka Company Ltd. has been considering the criteria that must be met before a capital expenditure proposal can be included in the capital expenditure programme. The screening criteria established by management are as follows: No project should involve a net commitment of funds for more than four years. Accepted proposals must offer a time adjusted or discounted rate of return at least equal to the estimated cost of capital. Present estimates are that cost of capital as 15 percent per annum after tax. Accepted proposals should average over the life time, an unadjusted rate of return on assets employed (calculated in the conventional accounting method at least equal to the average rate of return on total assets shown by the statutory financial statements included in the annual report of the company. A proposal to purchase a new lathe machine is to be subjected to these initial screening processes. The machine will cost Sh.2,200,000 and has an estimated useful life of five years at the end of which the disposal value will be zero. Sales revenue to be generated by the new machine is estimated as follows:

Year 1,320 1,440 1,560 1,600 1,500

Revenue (Sh.000)

Additional operating costs are estimated to be Sh.700, 000 per annum. Tax rates may be assumed to be 35% payable in the year in which revenue is received. For taxation purpose the machine is to be written off as a fixed annual rate of 20% on cost. The financial accounting statements issued by the company in recent years shows that profits after tax have averaged 18% on total assets. Required Present a report which will indicate to management whether or not the proposal to purchase the lathe machine meets each of the selection criteria. (Total: 19 marks) QUESTION FOURTEEN a) b) What are the features of a sound appraisal technique? (6 marks)

What practical problems are faced by finance managers in capital budgeting decisions? (6 marks) Describe the features of long term investment decisions. (8 marks)

c)

QUESTION FIFTEEN KK Ltd has six projects available for investment as follows: Initial cost Sh.M 60 15 20 55 30 40

Project 1 2 3 4 5 6

NPV @ 15% cost of capital 21 9 9 15 20 -2

The firm has Sh.100 M available for investment. Identify which projects should be undertaken. Using P.I and NPV ranking, comment on your answer. QUESTION SIXTEEN

a) Explain why proper working capital management is important for the financial success of a company. b) At a recent seminar on Gender Empowerment in Business the invited financial consultant, Madame Hesabu Advised the participants that extending credit is one of the comerstone of modern business. Madame Biashara, the managing director of Biashara Limited took note of this important fact. After the seminar, she authorised a review of the credit system of her company. The following facts are relevant. (8 marks) a) b) c) d) e) f) Annual sales of the company are Sh.5,000,000 Credit sales are 25 per cent of all sales Bad debts average 2% of all credit sales Average collection period for debtor is 40 days The companys cost of capital is 14 per cent per annum Net profit on sales is 15 per cent.

Based on these facts, she is recommending a thorough revamping of the credit policy of the company. The expected outcome of this action will be: a) b) c) d) e) Increase in total sales by 30 per cent Credit sales will be 40 per cent of all sales Average collection period will decrease to 35 days Bad debts will increase to 3 per cent of credit sales An additional part time credit control assistant will be hired for Sh.50,000 per annum.

Required The effectiveness or otherwise of the proposed revamping of credit policy. (Show all your workings). (8 marks) Who should determine credit policy? (2 marks)

QUESTION SEVENTEEN The following information is reported in a daily newspaper with respect to shares traded on the Nairobi Stock Exchange:

1 2 3 4

Last 12 months L H Shs. Shs. 200.00 75.00 90.50 43.50 40.00 4.00 362.00 102.00

Security

Yesterday Shs. 120.00

Previous Deal Shs.

Shares traded

Kakuzi Limited Ord. Sh.5 Express Kenya Ltd. Ord. Sh.5 ATH Ltd. Ord. Sh.10

130.00CD 10,000 43.50

Suspended 317.00CB 318.00

140.00

90.00

Unga Ltd. Ord. Sh.5 Barclays Bank Ltd. Ord. Sh.10

90.00

90.00

Required a) b) Why does the price of a share change? i) ii) iii) iv) v) (6 marks)

What does the CD against Kakuzis share price mean?(2 marks) Under the yesterdays column for Express Kenya Ltd., there is a dash (-). Explain. (2 marks) ATH is indicated as suspended. Explain why a company may be suspended from the stock exchange. (6 marks) Explain the CB against the Unga share price. (2 marks) What is the meaning of the Ord. Sh.10 indicated against the Barclays Bank? (2 marks)

QUESTION EIGHTEEN a) In relation to capital markets, differentiate between the terms stock markets and financial markets. (4 marks) The Nairobi Stock Exchange is set to undergo major changes in terms of services when the Central Depository System (CDS) is put in place after the Parliament passes the Bill on the issue. i) ii) c) What is the Central Depository System (CDS)? How will it benefit the parties to be affected by it? (4 marks) (4 marks)

b)

The shares of Ndege Airways Company Ltd. have been trading at Sh.8.00 per share for the last several months. The existing shareholders argue that such shares are undervalued. They say that, the shares should normally be trading at around Sh.15 per share.

i) When would a share price said to be unfair? (4 marks) ii) If the price earnings ratio for Nege Airways Company Ltd. ordinary shares is 2.5 times while the price earnings ratio of the shares of Piki Piki Company Ltd. is 10 times, which share is more attractive to a potential investor? Give reasons. QUESTION NINETEEN a) With reference to capital market, define the following terms: i) ii) iii) iv) Contango operation Backwardation Stags Role of investment banker (2 marks) (2 marks) (2 marks) (4 marks)

b)

Mr. Castro uses a 20% hatch system of timing when to invest in a stock market. In a given year, the top of a given share was Sh.150 and its bottom was Sh.90. During the year, the company paid an interim DPS of Sh.1.50 and a final DPS of Sh.4.50. Determine the % return on investment. (4 marks)

QUESTION TWENTY a) Explain how the savings and credit co-operative societies mobilise savings and aid investments. (7 marks) b) How do the Non-Governmental organisations (NGOs) that extend credit to informal businesses and small traders ensure that the level of credit default is low? (6 marks) Would you consider it prudent to convert savings and credit co-operative societies and the institutions which are used by Non-Governmental Organisations in (b) above into banks? (5 marks)

c)