Financial Management December 2023 Past Paper

THURSDAY: 7 December 2023. Afternoon Paper. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.
(a) Explain FOUR corporate objectives that may conflict with the financial objective of a firm. (8 marks)

(b) Mapema Ltd. is considering investing in one of the following two mutually exclusive projects. The relevant cash flows of each of the projects are as shown in the table below:
Annual cash flows

Initial investment Project X Sh.“000”
(57,750) Project Y Sh.“000”
Cash flows
Year: 1 37,500 45,000
2 (16,500) 12,000
3 30,000 (6,000)
4 22,500 33,000
5 9,000 (15,000)
6 7,500 22,500
Additional information:
1. The firm’s cost of capital is 15%.
2. Cash flows accrue at the end of the year.

Compute the following for each project:
(i) Discounted payback period. (5 marks)

(ii) Modified internal rate of return (MIRR). (5 marks)

(iii) Profitability index (PI). (2 marks)
(Total: 20 marks)

(a) Explain the following terms as used in personal financial management:
(i) Retirement planning. (2 marks)

(ii) Estate tax planning. (2 marks)

(b) Job Nyangaya plans to invest in two securities; security A and security B.
The returns on each security is dependent on the state of the economy as shown below:

State of economy Probability Return on security A Return on security B
Boom 0.40 27% 36%
Average 0.50 21% 33%
Recession 0.10 18% 31.5%

(i) The standard deviation for security A and security B. (4 marks)

(ii) The covariance between security A and security B. (2 marks)

(iii) The correlation of coefficient between security A and security B. (2 marks)

(c) Tabaka Fabricators Enterprise purchases one of its raw materials branded “Zed” externally. The annual demand for material “Zed” is 400,000 units. The company is planning to change its purchasing system to a just in time (JIT) system to improve efficiency.

The following information is provided:

Current System Proposed system (JIT)
Purchase cost per unit (Sh.) 25 25
Ordering cost per order (Sh.) 10,000 2,500
Inventory holding cost 20% 20%
Additional information:
1. To implement the new system, a one time cost of Sh.140,000 will be incurred.
2. The new system is expected to have a lifespan of 8 years.
3. The required rate of return for the firm is 18%.
4. The corporate tax rate is 30%.

Advise the management of Tabaka Fabricators Enterprise on whether to implement the proposed system. (8 marks)
(Total: 20 marks)

(a) Outline FIVE eligibility requirements for public offering of shares and listing at the securities exchange in your country. (5 marks)

(b) EFG Ltd. issued 300,000, 15% preference shares of Sh.100 each, redeemable at 10% premium after 20 years. Floatation costs amounted to Sh.3,000,000.

Determine the cost of preference share capital where the shares are issued at:

(i) Par. (2 marks)

(ii) A premium of 10%. (2 marks)

(iii) A discount of 10%. (2 marks)

(c) An investor plans to borrow a loan of Sh.3 million to purchase a piece of land for his family. The interest rate agreed upon is discounted at a rate of 10% per annum. The loan is repayable in 4 years of equal instalments.

(i) Amount payable per instalment. (1 mark)

(ii) A loan amortisation schedule. (4 marks)

(d) Jane Kiyo has the following investment options to choose from:

• Post Office MIS Scheme, monthly interest 8% per annum.
• ICD Bank Deposit, quarterly interest 8.25% per annum.
• HDFC Ltd., half-yearly interest 8.50% per annum.

Using effective interest rate (EIR) method, advise Jane Kiyo on the preferred investment option. (4 marks)
(Total: 20 marks)

(a) In relation to measuring business performance in a company:

(i) Examine FOUR applications of financial ratio analysis by the management of the company. (4 marks)

(ii) Describe FOUR weaknesses associated with financial ratio analysis. (4 marks)

(b) The following is an extract of statement of financial position for Oak Timber Ltd. for the year ended 30 September 2023:

Oak Timber Ltd.
Extract of statement of financial position for the year ended 30 September 2023

Sh.“million” Sh.“million”
Equity and liabilities:
Share capital 17
Retained earnings 15 32
Total equity 32
Non-current liabilities:
Long term borrowings 13
Current liabilities 21 34
Total liabilities 34
Total equity and liabilities

Additional information: 66
1. The share capital of Oak Timber Ltd. consists of Sh.12 million of ordinary shares and Sh.5 million, 5% irredeemable preference shares.
2. The ordinary shares of Oak Timber Ltd. have a nominal value of Sh.0.50 per share, an ex-dividend market price of Sh.7.07 per share and a cum dividend market price of Sh.7.52 per share. The dividend for the year 2023 will be paid in the near future.
Dividends paid in recent years have been as follows:

Year 2022 2021 2020 2019
Dividend per share (Sh.) 0.43 0.41 0.39 0.37
3. The 5% irredeemable preference shares of Oak Timber Ltd. have a nominal value of Sh.0.50 per share and an ex-dividend market price of Sh.0.31 per share.
4. The long-term borrowings of the firm consist of Sh.10 million of 7% loan notes and Sh.3 million bank loan. The bank loan has a variable interest rate.
5. The 7% loan notes have a nominal value of Sh.100 per loan note and a market price of Sh.102.34 per loan note. Annual interest has just been paid and the loan notes are redeemable in four years’ time at a rate of 5% premium to nominal value.
6. The corporation tax rate is 30%.

Compute the following:

(i) Cost of equity. (3 marks)

(ii) Cost of preference shares. (2 marks)

(iii) The cost of 7% loan notes. (3 marks)

(iv) After tax weighted average cost of capital (WACC) for the firm using market value. (4 marks)
(Total: 20 marks)

(a) Describe THREE contracts applied in Islamic Finance. (6 marks)

(b) Summarise FOUR distinct features of commercial paper as a short term source of finance. (4 marks)

(c) Merip Ltd. expects to make payments of Sh.9,000,000 in the coming year. The firm’s investment in marketable securities generates an annual return of 20%. The minimum cash balance maintained by the firm at all times is Sh.300,000. The firm incurs a cost of Sh.30 per transaction when converting marketable securities into cash.

Assume a year has 360 days.

Using Baumol’s model of cash management, determine:

(i) The optimal cash balance. (2 marks)

(ii) Total relevant cost incurred in each year. (2 marks)

(iii) The average cash balance. (2 marks)

(d) The following financial information relates to Steps Ltd. for the year ended 30 September 2023:

1. Adjusted net operating profit after tax (NOPAT) is Sh.180 million.
2. Total capital is Sh.900 million (no debt).
3. Closing market share price is Sh.29.
4. Total number of shares outstanding is 86 million.
5. The cost of equity is 13%.

Compute the following relative performance measures for Steps Ltd.:

(i) Economic value added (EVA). (2 marks)

(ii) Market value added (MVA). (2 marks)
(Total: 20 marks)

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