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Introduction to capital structure decisions

Unit: Financial Management

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August 2025

 3 Questions
Question 1b
​ ​ ​ ​​Shabana Ltd. is intending to raise additional capital to finance a new project. The current market price per share (MPS) of the company is Sh.44 Cum-Div of the year 2024 declared but not yet paid. For the past six years, the company paid the following stream of dividends:

Year
2019
2020
2021
2022
2023
2024
Dividend per share (Sh.) 
3.0 
3.2
3.4
3.6
3.8
4.0

The existing capital structure of the firm is as follows:
 
Sh."000"
Ordinary share capital (Sh.20 par value) 
60,000
Reserves
20,000
14% debenture (Sh.100 par value) 
30,000
10% preference share capital (Sh.30 each) 
20,000
130,000

Additional information: 
1. The existing 14% debentures are currently selling at Sh.124 cum-interest. 
2. The existing 10% preference shares are currently trading at Sh.25 each. 
3. Corporation tax rate is 30%. 

Required: 
Compute the company’s existing overall weighted average cost of capital (WACC). 


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Question 1a
​​(i) Explain FOUR functions of a finance manager in an organisation. 

(ii) Highlight FOUR mechanisms that might be used to ensure that managers act in the best interest of the shareholders.


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Question 1c
​ ​ ​​Suppose the company in (b) above wants to raise additional Sh.50 million to finance an expansion programme as follows: 

  • 30% from retained earnings. 
  • 30% from the issue of new ordinary shares at Sh.40 each. A floatation cost of 2% of the issue price will be incurred and discount cost of Sh.3 per share issued will also be incurred. 
  • 40% of the additional funds will be raised from the issue of new 12% irredeemable debentures at current market value of Sh.110 each. The firm will incur Sh.10 floatation cost per unit issued. 
Required: 
(i) Compute the firm’s weighted marginal cost of capital (WMCC). 

(ii) Compute the number of ordinary shares to be issued to raise the desired external equity capital.


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April 2025

 1 Questions
Question 1b
​ ​ ​​Pivot Ltd. is considering raising an additional Sh.20 million to finance an expansion programme. The firm’s existing capital structure which is considered to be optimal is as follows:

Sh.“000”
Ordinary share capital 
100,000
Reserves 
50,000
16% debentures (Sh.1,000 par value) 
62,500
14% preference shares capital (Sh.20 per value)
37,500
250,000

Additional information: 
  1. The firm expects to generate Sh.4 million from retained earnings for this expansion programme. 
  2. Additional new ordinary shares will be issued at Sh.90 each subject to a floatation cost of Sh.10 per share. The most recent dividend paid by the company is Sh.4 per share. The firm’s dividends are expected to grow at the rate of 5% per annum in perpetuity. 
  3. The company will issue new 16% debentures at a price of Sh.1,100 with a floatation cost of Sh.5 per debenture. 
  4. New 14% preference shares will be issued at Sh.30 with a floatation cost of Sh.2 per share. 
  5. Corporation tax rate applicable is 30%. 

Required: 
(i) The cost of retained earnings. 

(ii) The cost of new ordinary share capital. 

(iii) The cost of new 16% debentures.

(iv) The cost of new preference shares. 

(v) The company’s weighted marginal cost of capital (WMCC). 


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December 2024

 2 Questions
Question 1c
​ ​ ​ ​​Transline Ltd. is a newly incorporated company. The directors are considering various alternatives of raising Sh.200 million as venture capital to buy a new equipment. Two options of raising the needed capital have been presented to them: 

 Option.A:
Issue ordinary shares of Sh.10 each at par for the full amount of Sh.200 million.
 Option.B:
Issue ordinary shares of Sh.10 each at par for Sh.120 million and issue new 8% debentures to raise the remainder of the funds.

Additional information: 
  1. Earnings before interest and tax (EBIT) is expected to be 20% of the cost of the equipment. 
  2. The corporate tax rate is 30%. 
  3. The company’s price earnings (P/E) ratio is 8 times. 

Required: 
(i) Advise on the most preferable financing option for the company based on earnings per share (EPS). 

(ii) Calculate the possible range of ordinary share prices within which each of the financing options in (c) (i) above would be recommended.


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Question 2a
​​Outline FOUR applications of cost of capital to a firm


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August 2024

 1 Questions
Question 2c
​ ​ ​​Sytrax Ltd. is a listed company with 100 million shares in issue. 

 The following additional information is available:

1.
The company has a current ex-dividend ordinary share price of Sh.25.00 per share.
2.
The company also has in issue bond with a book value of Sh.60 million with a current ex-interest market price of Sh.104 per Sh.100 bond.
3.
The current after tax cost of debt of Sytrax Ltd. is 7% and the corporate tax rate is 30%.
4.
The dividends per share of the company are as follows:
4.
Year
2019
2020
2021
2022
2023
Dividend per share (Sh.)
1.94
2.00
2.06
2.12
2.18
5.
The finance director proposes to decrease the weighted average cost of capital of Sytrax Ltd. and hence increase its market value by issuing Sh.40 million bonds at their par value of Sh.100 per bond. These bonds would pay annual interest rate of 8% before tax and would be redeemed at a 5% premium to par after 10 years.

        
Required: 
Calculate the market value after tax weighted average cost of capital of Sytrax Ltd. in the following circumstances: 

(i) Before the new issue of bonds take place. 

(ii) After the new issue of bonds takes place.


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December 2023

 1 Questions
Question 4b
​ ​ ​ ​ ​​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: 
Equity:
Share capital 
17
Retained earnings 
15
32
Total equity
22
Non-current liabilities: 
Long term borrowings 
13
Current liabilities 
21
34
Total liabilities 
34
Total equity and liabilities  
66

Additional information:    
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: 
2.
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%.

Required: 
Compute the following: 

(i) Cost of equity. 

(ii) Cost of preference shares. 

(iii) The cost of 7% loan notes. 

(iv) After tax weighted average cost of capital (WACC) for the firm using market value. 


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August 2023

 2 Questions
Question 4d
​ ​​Using the information in (c) above, calculate the weighted average after tax cost of capital (WACC) of Zora Ltd. using market values.


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Question 5c
​ ​​Penda Ltd. deals with laboratory accessories. A dropper sells for Sh.500 per piece and has a variable cost equivalent to 50% of the selling price per piece of the dropper. The firm has a fixed operating cost of Sh.500,000 and fixed financing cost of Sh.750,000. 

Further analysis of the firm reveals that if the firm sales increase by 10%, the firm’s earnings before interest and taxes (EBIT) increase by 15% and if the firm’s EBIT increase by 10%, the firm’s earnings per share (EPS) increases by 12%. 

Required: 
Calculate the following measures of leverage for the firm: 

(i)  Break-even quantity of sales in units. 

(ii) Operating break-even quantity of sales in units. 

(iii) Degree of operating leverage (DOL). 

(iv) Degree of financial leverage (DFL). 

(v) Degree of total leverage (DTL).


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April 2023

 1 Questions
Question 2b
​ ​ ​ ​​The following information was extracted from the financial statements of Rembo Ltd. for the year ended 31 December 2022:
 
Capital structure
Amount Sh.“000”
Ordinary shares: 750,000 shares of Sh.20 each
15,000
Retained earnings 
48,900
8% preference shares (Sh.100 par value) 
5,000
10% debentures 
7,500
76,400

Additional information: 
  1. The preference shares were originally sold in 2014 at Sh.104 per share. The current price is Sh.94 although a similar issue can be made at Sh.89 net. 
  2. Ordinary shares are currently selling at Sh.38.40 on the securities exchange. 
  3. The debentures were sold in 2015 and realised Sh.96 per unit. The current price is Sh.80 and it is anticipated that a similar issue would also sell at Sh.80 per unit. Corporate tax rate is 30%. 
  4. Last year’s dividend amounted to Sh.3,000,000 which was 70% of the net earnings. The company expects these dividends to grow at a rate of 6% per annum and the dividend payout ratio to remain the same. 
  5. New ordinary shares can be sold at Sh.40 but in order to guarantee success, they would have to be sold at Sh.35 per share. 
Required: 
(i) Cost of preference shares. 

(ii) Cost of ordinary shares. 

(iii) Cost of debentures. 

(iv) Market weighted average cost of capital (WACC) of the firm. 


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December 2022

 1 Questions
Question 5c
​ ​​Kanga Ltd. expects earnings before interest and tax (EBIT) of Sh.7,500,000 in the current financial year. The company pays interest of 8% per annum on a long term loan of Sh.25,000,000. 
 
The company has 1,200,000 ordinary shares and the corporate tax rate is 30%. The finance manager is currently examining two options: 
 
Option I: A case where earnings before interest and tax (EBIT) is 20% more than expected. 

Option II: A case where earnings before interest and tax (EBIT) is 20% less than expected. 

Required: 
(i) Determine the earnings per share (EPS) under option I and option II and where there is no change in the expected earnings before interest and tax (EBIT). 
 
(ii) Degree of financial gearing for option I and option II.


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August 2022

 1 Questions
Question 1c
​ ​ ​​The following information relates to the capital structure of Tamu Caterers Limited for the year ended 31 December 2021:

Capital source
Current market value
Sh.“000”
Corporate bond
11,927
Ordinary shares
26,170
Ordinary shares
  7,203

Additional information: 
1. The corporate bond has a Sh.1,000 face value, pays interest at a rate of 11% annually and will mature in 10 years time. The bond is currently trading at Sh.1,125 at the securities market and its yield-to-maturity is 9.05%. 
2. The ordinary shares paid a dividend of Sh.1.80 last year and each share is selling at Sh.27.50 at the securities market. The firm’s dividend on ordinary shares is expected to grow at a rate of 7% per annum to perpetuity. 
3. The firm’s preference shares pays a 9% dividend on a Sh.100 par value. 
4. The corporation tax rate is 30%. 

Required: 
(i) The weighted average cost of capital (WACC) for the firm. 

(ii) Explain two factors that will determine the cost of capital for Tamu Caterers Limited. 


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April 2022

 1 Questions
Question 3c
​ ​ ​ ​​​​​The following financial information relates to Panda Ltd.: 

Statement of financial position extract as at 31 December 2021
Sh."000"
Sh."000"
Equity:
Ordinary shares (each Sh.5 par value)
16,000
Reserves
72,000
88,000
Long term liabilities:
4% preference shares (each Sh.10 par value)
12,000
7%, 6 year redeemable bonds
12,000
Long term bank loan
4,000
28,000
116,000

Additional information:
1.
The ordinary shares of Panda Ltd. have an ex-dividend market value of Sh.47 per share and an ordinary dividend of Sh.3.63 per share has just been paid.

Historic dividend payments have been as follows:
1.
Year
2018
2019
2020
2021
Dividend per share (Sh.)
3.09
3.22
3.36
3.50
2.
The preference shares of Panda Ltd. are not redeemable and have an ex-dividend market value of Sh.4 per share.
3.
The 7% bonds are redeemable at a 5% premium to their nominal value of Sh.100 per bond and have an ex-interest market value of Sh.104.50 per bond. 
4.
The bank loan has a variable interest rate that has averaged 4% per year in recent years.
5.
The corporate tax rate applicable to Panda Ltd. is 30% per year.
 
Required: 
The market value weighted average cost of capital (WACC) of Panda Ltd.


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Pilot December 2021

 1 Questions
Question 3
​ ​​Office Point Ltd. is considering two alternative proposals for financing a major expansion scheme requiring an investment of Sh.100 million. The first is to raise the required funds through a public issue of ordinary shares at the current market price per share of Sh.2.00. 

The other proposal is to raise the finance by way of a term loan at an interest rate of 4% over the base rate of 5% per annum. 

The terms and conditions under which the company's existing loan capital has been raised include the following special covenants: 

1. The company's debt ratio should not exceed 40%. 
2. A times interest earned ration of not less than 10 times should be maintained. Office Point Ltd’s earnings before interest and tax (EBIT) during the financial year ended 31

December 2020 was Sh.150 million, and the company's latest financial statement reveals the following information:

Sh. “million”
Total Assets
425
Debt 8% loan stock
 75
Common stock (200m ordinary
100
Retained earnings shares)
250
Total liabilities & equity
425

Additional information: 
1. Investment of the additional capital of Sh.100 million is expected to result in the earnings before interest and tax (EBIT) for 2021 being 30% higher than the figure for 2020. 
2. Interest at the rate of 8% would continue to be paid on the existing loan capital of Sh.75 million. 
3. The company would maintain its existing policy of paying a dividend of Sh.0.25 per share. 
4. Corporation tax rate is 30%.

Required: 
(i) Assess the impact of the two alternative financing proposals on the company's earnings per share (EPS). 

(ii) Calculate the EBIT - EPS indifference point. 

(iii) Calculate Office Point Ltd.’s debt ratio and times interest earned ratio for 2020, and assess the impact of each of the two alternative financing proposals on these ratios in the company's financial statement for year 2021. 

(iv) Discuss six key factors that are considered by businesses when deciding between debt and equity finance. 


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December 2021

 1 Questions
Question 3a
​ ​ ​​Mavazi Ltd. is a firm that operates in the textile industry. Over the last 5 years, the firm has experienced stiff competition that has significantly reduced its turnover. In order to remain profitable, the firm's management is considering diversifying its operations. This activity will require additional financing of Sh.50 million. The firm's existing capital structure is given as follows:

Sh. "000"
Ordinary share capital (Sh.20 par value)
60,000
Reserves
10,000
11% Debentures (Sh.100 par value)
20,000
13% Preference share capital (Sh.15 par value)
10,000
100,000

Additional information: 
1. The firm's existing capital structure is considered to be optimal. 
2. The firm expects to raise Sh.5 million from internal sources in order to finance this diversification activity. However, new ordinary shares will be issued at Sh.32 per share and incur a floatation cost of Sh.2 per share.
3. The most recent dividend paid by the company was Sh.2.5 per share which is expected to grow at a constant rate of 5% per annum in perpetuity.
4. New 12% redeemable debentures will be issued at Sh.110 each. A floatation cost of Sh.15 per unit will be incurred. The par value of each unit is Sh.100 and the debentures will have a maturity period of 10 years. 
5. New 14% irredeemable preference shares will be issued at Sh.90 per share. The par value of each irredeemable preference share is Sh.100. 
6. The corporation tax rate applicable is 30%. 

Required: 
(i) The cost of ordinary share capital. 

(ii) The cost of retained profit. 

(iii) After tax cost of new 12% debenture capital.

(iv) Cost of new 14% preference share capital.

(v) Weighted marginal cost of capital (WMCC).


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September 2021

 1 Questions
Question 5b
​ ​ ​ ​​The management of Biashara Ltd. are in the process of determining the optimal capital budget of the company for the year ending 31 December 2021. 

The following information is available:           
1.
The profit after tax for the year ending 31 December 2021 is estimated to be Sh.22,500,000. 
2.
The retention ratio is 60%.
3.
The ordinary shares of the company are currently trading on the securities exchange at Sh.80 per share.
4.
Ordinary shareholders expect a dividend of Sh.6 per share for the year ending 31 December 2021.
5.
The annual growth rate in dividend is 6% per annum. 
6.
Floatation costs amounts to Sh.8 per share issued.
7.
The company could issue an unlimited number of 11% preference shares at Sh.96 per share. The par value is Sh.100. 
8.
The company could obtain a bank loan of upto Sh.24,000,000 at a pre-tax interest rate of 10% per annum.
Thereafter, an unlimited amount of bonds could be issued under the following terms:
  • Coupon interest rate of 12% per annum.
  • Par value at Sh.1,000 per bond.
  • Discount of Sh.30 per bond.
  • Floatation cost of Sh.20 per bond.
  • Maturity period of ten years.
9.
 The optimal capital structure of the company comprises 15% debt, 40% preference shares capital and 45% equity.
10.
Corporate tax rate is 30%. 

Required:
(i)
The cost of capital for each source of finance available to Biashara Ltd.
(ii)
The break-point(s) in the marginal cost of capital (MCC) schedule with respect to retained earnings and debt.
(iii)
The marginal cost of capital (MCC) at each break-point identified in (b) (ii) above.


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November 2020

 3 Questions
Question 4b
​ ​​Upendo Ltd. has issued 5,000,000, Sh.20 par value ordinary shares which are presently trading at Sh.25 per share at the Securities Exchange. Upendo Ltd. has plans to issue rights to purchase one new ordinary share at a price of Sh.20 per share for every four shares held.

Required:
(i).  The theoretical ex-right price of Upendo Ltd.'s share.
(ii). The theoretical value of a right of Upendo Ltd. before the shares sell ex-right.


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Question 3b
​ ​​The following information was extracted from the books of Domingo General Merchants Ltd:
Statement of financial position as at 31 December 2019:

Sh."000"
Sh."000"
Non-current assets
10,115
Investments
821
Current assets
3,658
Less: Current liabilities
(1,735)
1,923
Total assets
12,859
Financed by:
Ordinary share capital: 3,000,000 shares each Sh.1
3,000
General reserves
7,125
Shareholders' funds
10,125
7% Bonds
1,300
Corporation taxation
1,434
Corporation taxation
12,859

Summary of profits and dividends:

Year ended 31 December
2015
Sh. "000"
2016
Sh. "000"
2017
Sh. "000"
2018
Sh. "000"
2019
Sh. "000"
Profit after interest and before tax
1,737
2,090
1,940
1,866
2,179
Less: Tax
(573)
(690)
(640)
(616)
(719)
Profit after interest and tax
1,164
1,400
1,300
1,250
1,460
Less: Dividends
620
680
740
740
810
Retained earnings
544
720
560
510
650

Additional information:

  1.  The bonds are redeemable at par in ten years time.
  2.  The current (1 January 2020) market value of ordinary shares is Sh.3 per share ex div.
  3.  The current market value of the bonds is Sh.77.10 per Sh/100 of nominal value and the annual interest has just been paid on the bonds.
  4.  There have been no issues or redemptions of ordinary shares or bonds during the past five years.
  5.  The corporate tax rate is 30%. Assume that there have been no changes in corporate tax rate for the past five years.

Required:
The weighted average cost of capital (WACC) that the company should use as a discount rate when upprausing new investment opportunities


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Question 2a
​ ​ ​ ​ ​ ​​Jaribu Ltd has been operating in the country for many years. The directors of the company wish to raise additional capital through a rights issue in order to explore opportunities in the region. The directors have decided to make a one-for-five rights issue at a discount rate of 30% on the current market value. The company's most recent financial statements are presented below:

Income statement for the year ended 31 March 2020
Sh. "million"
Sales
1,400
Net profit before interest and taxation
52
Interest payable
24
Net profit before faxation
28
Corporation taxation
7
Net profit after taxation
21
Ordinary dividends payable
14
Retained profit for the year
7
Capital and reserves as at 31 March 2020
Sh. "million"
Sh. 0.25 ordinary shares
60
Revaluation reserves
140
Accumulated profits
320
520

Additional information:
  1. The shares of the company are currently traded at the local Securities Exchange at a price to earnings(P/E) ratio of 16.
  2. An investor holding 10,000 ordinary shares in the company has received the information on the forthcoming rights issue, but cannot decide whether to take up the rights issue, sell the rights or allow the rights to lapse.

Required:
(i).    The theoretical ex-rights price of an ordinary share.
(ii).   The price at which the rights are likely to be traded.
(ii).   Evaluate each of the three options available to the investor with 10.000 ordinary shares.
(iv).  Comment on the wealth of the investor hased on each of the options evaluated in (a) (ii) above.


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November 2019

 2 Questions
Question 4b
​​Riverside Ltd. requires Sh.4,500,000 to finance an upcoming project. The firm's existing share capital constitutes 120,000 ordinary shares whose current market price per share is Sh.100. The management of the company has proposed to raise funds through a rights offering at a discount rate of 25% on current share price.

Required: 
(i).   The number of ordinary shares to be issued to raise the required capital. 
(ii).  The number of rights required to subscribe for one new ordinary share.
(iii). The theoretical ex-right market price per ordinary share.


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Question 1c
​​The current capital structure of Ahadi Ltd. is given as follows:

Sh."000"
Ordinary shares (Sh.10 each)
30,000
10% debentures
15,000
12% preference shares (Sh.20 each)
5,000
50,000

Additional information: 
1. The current market value of ordinary shares and preference shares is Sh.50 and Sh.30 respectively. 
2. The debentures are irredeemable and have a market value of Sh.120 per Sh.100 nominal value.  
3. The most recent earnings per share (EPS) of the company is Sh.6. 
4. The company currently adopts a 60% dividend payout ratio as its dividend policy. However, the firm's future dividends are expected to grow at a rate of 7% each year for the foreseeable future. 
5. Corporate tax rate is 30%.

Required: 
The company's weighted average cost of capital (WACC) using market value weights.


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May 2019

 2 Questions
Question 3a
​​The capital structure of Maweni Limited is given as follows:

Sh. "000"
Ordinary share capital (Sh.20 par value)
50,000
Retained earnings 
30,000
12% irredeemable debenture capital (Sh.20 par value)
25,000
14% preference share capital (Sh.25 par value) 
15,000
120,000

Additional information: 
1. The current market price of the firm's ordinary shares is quoted at Sh.45 cum-dividend. 
2. The firm paid a dividend of Sh.5 per share in the just ended year. 
3. The firm adopts a 60% dividend payout ratio. 
4. The firm's return on equity (ROE) is 20%. 
5. The existing 12% irredeemable debenture is currently trading at Sh. 112 cum-interest. 
6. The 14% preference shares are currently trading at Sh.33.50 cum-dividend at the securities exchange. 
7. The corporate tax rate applicable is 30%. 

Required:
(i) The cost of ordinary share capital. 
(ii) The cost of 12% irredeemable debenture capital. 
(iii) The cost of 14% irredeemable preference share capital. 
(iv) The firm's weighted average cost of capital (WACСС). 


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Question 5b
​The capital structure of Karakara Limited which is considered optimal is given as follows:
Sh."000"
Ordinary share capital (Sh.10 par value)
90,000
Retained earnings
75,000
15% preference share capital (Sh.100 par value)
45,000
16% debenture capital
90,000
300,000

The company has total assets amounting to Sh. 360 million but it is expected the assets will rise to Sh.500 million by the end of the current financial year.

Additional information: 
1.    New equity shares sold will net 90% after floatation costs. 
2.    The current market price per share (MPS) of the ordinary shares is Sh.25. 
3.    New ordinary shares will be issued at the current market price subject to a floatation cost of 10% of the issue price. 
4     New 16% debentures can be issued at par through the securities exchange. 
5.    The past and expected earnings growth rate is 10%. Dividend growth rate is expected to be matched with the earnings growth rate. 
6.    The current earnings yield is 24%. 
7.    The company adopts a constant dividend payout ratio of 50%. 
8.    New 15% preference shares can be issued at the current selling price of Sh.120 each. 
9.    The retained earnings available for investment purposes is Sh.29,700,000. 
10.  The corporate tax rate is 30%. 

Required: 
The number of ordinary shares that must be sold in order to raise the required equity capital. 
​


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November 2018

 1 Questions
Question 4b
​​New Ways Ltd. intends to raise new capital to expand its production level. 
The company plans to undertake the following financial decisions: 

1.      Issue 200,000 ordinary shares which have a par value of Sh.10 at Sh.16 per share. The floatation cost per share is Sh.1.
2.      Issue 75,000, 12% preference shares which have a par value of Sh.20 at Sh.18 per share. The total floatation cost is Sh.150,000. 
3.      Issue 50,000, 18% debentures which have a par value of Sh.100 at Sh.80 per debenture. 
4.      Borrow Sh.5,000.000, 18% long-term loan. The total floatation cost is Sh.200,000.

Additional information: 
1.      The company paid 28% ordinary dividends which is expected to grow at the rate of 4% per annum. 
2.      The corporate tax rate is 30%. 

Required:
(i).     The total capital to be raised net of floatation costs. 
(ii).    The weighted marginal cost of capital (WMCC) for the company.


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May 2018

 2 Questions
Question 3a
​​Argue three cases for and three cases against the use of market values for various components of cost of capital in determining the weighted average cost of capital (WACC) of a firm


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Question 3b
​​Akiba Limited has the following capital structure:

Sh. "000"
3,000,000 fully paid ordinary shares
30,000
Retained earnings
20,000
1,000,000 10% preference shares
20,000
6% debentures (Sh.150 par value)
30,000

Additional information: 
1.    The current market price per share (MPS) is Sh.30. 
2.    The expected dividend per share in the following year is Sh.1.20. 
3.    The average growth rate in both earnings and dividends has been maintained at 10% over the last 10 years. The trend is expected to remain the same into the foreseable future. 
4.    The debentures are trading at Sh.110 at the securities market. 
5.    The debentures mature in 100 years period. 
6.    The preference shares were issued 4 years ago and they are still trading at face value. 
7.    The corporate tax rate is 30%. 

Required: 
Weighted average cost of capital (WACC) for the company.


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November 2017

 3 Questions
Question 2c
​​Evaluate the impact of the rights issue in (b) above on the value of wealth of an existing shareholder who holds 1,600 ordinary shares in Maji Mazuri Ltd. and Sh.10,000 in his savings account assuming that this shareholder decides to: 

(i).    Exercise all his rights. 
(ii).   Sell all his rights.
(iii).  Ignore the rights issue.


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Question 3b
​​Ray Properties Ltd. is planning to build a business mall. The project will cost Sh.180 million. 

The firm's current optimal capital structure is as follows:

Sh."000"
Ordinary shares (Sh.10 par value)
480,000
10% debt (Sh.100 par value)
384,000
Retained profit
96,000
960,000

Additional information: 
1.    The firm will issue a new 15% debenture at Sh.120 each with a floatation cost of Sh.10 per unit. The par value of each debenture is Sh.100. 
2.    New ordinary shares will be issued at the current market price of Sh.30 each with a floatation cost of Sh.5 per share. 
3.    The most recent dividend paid by the company was Sh.5 per share. 
4.    The dividend is expected to grow at the rate of 5% per annum in perpetuity. 
5.    The firm expects to retain Sh.18 million to finance this investment. 
6.    The corporate tax rate is 30%. 

Required: 
(i) The amount to be raised from equity capital, if the capital structure is to remain unchanged. 
(ii) The number of ordinary shares the company should issue to raise the desired external equity capital. 
(iii) The firm's weighted marginal cost of capital (WMCC).


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Question 2b
​​Maji Mazuri Ltd. an all equity financed company has an issued share capital of Sh.10 million ordinary shares of Sh.10 par value. The company paid a dividend of Sh.0.4 per share last period and the market price per share is Sh.20 ex-dividend.

The company is contemplating raising additional funds through a rights issue. The management has proposed a 1 for 4 rights issue at an issue price of Sh.15 per share. The funds raised are intended to be used to finance a major new project which is expected to increase the company's annual after tax cash flows by Sh.950,000 in perpetuity.

Required:
(i) The cum-right market price per share (MPS) after the announcement of the rights issue. 
(ii) The theoretical ex-right market price per share. 
(iii) The theoretical value of each right. 


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May 2017

 4 Questions
Question 2b
​​Nyadzua Limited is making a 1 for 4 rights issue costing Sh.6.40. The company has 4 million shares in issue with a market price of Sh.10.80 per share. The new shares are expected to yield 5% earnings and price to earnings (P/E) ratio of 10.

Required:

(i) The theoretical ex-right price.
(ii) The value per share after the rights issue.


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Question 1c
Upendo Ltd.'s existing capital structure is given as follows:


Ordinary share capital (Sh.20 par)
Reserves
10% Debenture (Sh.100 par)
8% Preference shares (Sh.20 par)

Sh."000"
20,000
5,000
10,000
15,000
50,000

Additional information:

1.The most recent earnings per share (EPS) of the company is Sh.5
2.The firm adopts 40% pay-out ratio as its dividend policy.
3.Ordinary shares of the company are currently selling for Sh.50 each
4.The existing 10% debenture is currently trading at 110% of par at the securities exchange
5.Existing 8% preference shares are currently trading at Sh.25 each
6.Corporate tax rate applicable is 30%.

Required:

(i) The annual dividend growth rate using Gordon's growth model

(ii) Cost of ordinary share capital

(iii) Cost of 10% debenture capital

(iv) Cost of 8% preference share capital

(v) The weighted average cost of capitat (WACC) of the firm.


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Question 1b
​​Discuss the relevance of cost of capital to a business enterprise.


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Question 1a
​ ​​Highlight four limitations of long-term debt finance to an organisation.


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November 2016

 1 Questions
Question 2b
​​Sandy Ltd. presented the following extracts of the statement of financial position as at 31 October 2016:

Equity
Sh. "000"
Sh. "000"
Ordinary shares (Sh.5 nominal value)
800,000
Reserves
3,600,000
4,400,000
Long term liabilities
4% preference shares (Sh.1 nominal value)
600,000
7% bonds (redeemable after 6 years)
600,000
Long term bank loan
200,000
1,400,000

Additional information: 
1.     Ordinary shares of Sandy Ltd. have an ex-div market value of Sh.47.00 per share and an ordinary dividend of Sh.3.63 per share has just been paid. 
2.     The following dividends have been paid over the past four years:

Year
2013
2014
2015
2016
Dividend per share (Sh.)
3.09
3.22
3.36
3.50

3.    The preference shares are not redeemable and have an ex-div market value of 40 cents per share. 
4.    The 7% bond is redeemable at 5% premium to their nominal value of Sh.100 per bond and have an exinterest market value of Sh.104.50.
5.    The bank loan has a variable interest rate that has averaged 4% per year in recent years. 
6.    The corporate tax rate is 30%. 

Required: 
(i)    The weighted average cost of capital (WACC). 
(ii)   Explain four reasons why the cost of equity could be greater than the cost of debt.


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May 2016

 1 Questions
Question 2a
​​The existing capital structure of Mwarakaya Limited is given as follows:

Sh. "000"
Ordinary share capital (Sh.100 par value)
40,000
Reserves
15,000
12% debentures (Sh.100 par value)
25,000
10% preference share capital (Sh.20 par value)
20,000
100,000

Additional information: 
1. Ordinary shares of Mwarakaya Limited are currently selling at Sh.80 each. 
2. The 12% debentures and 10% preference shares are currently selling at Sh.90 and Sh.30 respectively. 
3. The most recent ordinary dividend paid by the company is Sh.2.00. This is expected to grow at the rate of 10% each year in perpetuity. 
4. The corporate tax rate is 30%. 

Required: 
The weighted average cost of capital (WACC).


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November 2015

 2 Questions
Question 4a
​ ​​Fila Ltd. intends to raise finance as follows:

Debenture: Raise Sh.100 million through a debenture issue. Each debenture will have a face value of Sh.1,000 and will be issued at 2% floatation cost and a discount of Sh.60. The coupon rate will be 10% with a maturity period of 10 years.

Equity: The firm will raise Sh.100 million from ordinary shares. The current level of dividend is Sh.5 per share and this has been growing at 10% per annum. The current market price per share is Sh.40 and floatation cost will be 5% of the market price.

Long term debt: Raise Sh.20 million long-term debt at par with an interest rate of 10% per annum.

Corporate tax rate is 30%.

Required:
The marginal cost of capital (MCC) of Fila Ltd.


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Question 2b
Wendy Limited has the following capital structure:

Debt
Equity
Preference shares		35%
50%
15%

The management of the company has provided the data below:

Bond yield to maturity
Corporate tax rate
Growth rate of ordinary dividends
Market price of one ordinary share
Dividend for one ordinary share
Market price of one preference share
Floatation cost of one preference share
Dividend for one preference share		9%
30%
9%
Sh.30
Sh.1.20
Sh.100
Sh.2.00
Sh.8.50

The company's weighted average cost of capital (WACC)


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Pilot September 2015

 3 Questions
Question 1b
​​ MM Company Ltd. is contemplating raising additional finance for an expansion programme. The company is considering Sh.50 million for this expansion programme. The company's existing capital structure is given below:


Ordinary share capital (Sh.20 par)
10% debenture capital
12% preference share capital
Reserves

Sh."000"
60,000
25,000
15,000
50,000
150,000

Two alternative financing options available to the company are given as follows:

Option 1
Issue new ordinary shares at par to raise all the desired funds.

Option II
Issue new ordinary shares at par to raise Sh.30 million and the balance will be raised through the issue of 15% debentures.

The management are optimistic that this investment will enable the company to generate annual operating profit (EBIT) whose forecasted values in different states of nature and their probability of occurrence are given as follows:

State of Nature
Good
Moderate
Poor		Probability
0.40
0.25
0.35		Operating profit (EBIT)
20,000
15,000
10,000

The firm pays corporation tax at the rate of 30%.

Required:
(i) Determine the level of expected operating profit (EBIT) and expected earnings per share at the point of indifference between the firm's earning under financing options I and II.

(ii) Determine the range of expected operating profit within which each financing option will be recommended (Hint: a graph may be used to answer this question).


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Question 1c
​ ​​With reference to (b) above, indicate the financing option you would recommend assuming that the company's expected operating profits are:

(i) As forecasted by the organisation.
(ii) Sh.6,000,000 per annum.
(iii) Sh.15,000,000 per annum.


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Question 3b
​ ​​Ruiru Tanners Ltd. has a total of Sh.100 million invested in net assets as at the end of December 2014. The firm intends to increase its production capacity during the year 2015 by Sh.100 million. The company utilises debt, preferred stock and equity capital within its capital structure. Several alternative financing arrangements are available, namely; 

  • The company can issue 9% debentures with a par value of Sh.100 each at an issue price of Sh.90 each (market price). Maximum amount available is Sh.20,000,000. Any extra debt finance will be raised through the issue of 12% debentures at Sh.960 each. The par value ofthis debenture is Sh.1,000 each.
  • The company can issue additional 15% preference shares with a par-value of Sh.50 at Sh.75 each. 
  • The company can issue new ordinary shares at the current market price of Sh.88 per share. Floatation cost equal to Sh.8 per share sold.The company's ordinary shareholders have consistently enjoyed a dividend whose annual growth rate on average has been 10% and this is expected to continue into the foreseeable future. The company's earning per share this year is Sh.10 and adopts a constant dividend payout ratio of 40% each year. 
  • The company can generate Sh.10 million from the internal sources to finance this expansion programme.

 Additional information: 
1. The company pays corporation tax at the rate of 30%. 
2. The firm's existing capital structure which is considered to be optimal is given below:

Sh.000"
Sh.000"
Debt capital:
6% debenture capital
10.000
8% term loan
20,000
30,000
Preference shares (Sh.50 par value) 
30,000
Ordinary shares (Sh.5 par value) 
15,000

Retained earnings
25,000
40,000
100,000

Required: 
(i).       The amount of funds to be raised from each source during the year 2015 so as to maintain the firm's existing optimal capital structure. 
(ii) .     The number of ordinary shares to be issued to raise desired external equity. 
(iii).     The levels of financing at which marginal cost of capital changes (Hint: break points in weighted marginal cost of capital curve). 
(iv).     The firm's weighted marginal cost of capital if it were to raise only Sh.20 million. 
(v).      The firm's weighted marginal cost of capital for the funds to be raised during the year 2015 for the three levels of financing. 


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