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The financing decision

Unit: Financial Management

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August 2025

 1 Questions
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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April 2025

 3 Questions
Question 2b
​ ​ ​​Montage Limited’s ordinary shares are currently trading at the securities exchange at Sh.30 each. The firm is considering raising additional capital to finance an expansion programme. The board of directors has proposed to raise the funds using a rights issue. 

The expansion programme is expected to cost Sh.5,000,000. This investment will generate additional net operating cash flows of Sh.1,700,000 each year for a period of 5 years. 

This information has not been released but shall be released upon announcement of the rights issue. The firm has in issue 2,000,000 ordinary shares. The cost of capital is 12%. 

Required: 
Calculate the cum-right market price per share of the company.


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Question 2a
​​Distinguish between the following terms as used in finance: 
 
(i) “Finance lease” and “Operating lease”. 
 
(ii) “Capital structure” and “Financial structure”.  
 
(iii) “Scrip issue” and “rights issue”.


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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

 1 Questions
Question 1a
​ ​​Explain FOUR reasons why a listed company would prefer to raise capital using equity finance instead of using debt finance.


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August 2024

 2 Questions
Question 3c
​ ​ ​​Quantum Product Limited wishes to increase the number of its retail outlets in the country. The board of directors of the company has decided to finance the acquisition by raising funds from the existing shareholders through a one for four rights issue.

The recently published comprehensive income statement of the company for the year ended 31 December 2023 provided the following information:

Sh.“million”
Turnover
246.75
Profit before interest and tax
18.90
Interest
(9.30)
Profit before taxation
9.60
Corporate tax
(2.85)
Profit after taxation
6.75
Ordinary dividends
(3.00)
Retained profit for the year
3.75
 
Additional information: 
  1. The share capital of the company consists of 12 million ordinary shares with a par value of Sh.5 per share. 
  2. The shares of the company are currently being traded on the Securities Exchange with a price earnings (P/E) ratio of 22 times. 
  3. The board of directors of the company has decided to issue the shares at a discount rate of 10% on the current market value. 
Required: 
(i) The theoretical ex-rights price of an ordinary share of the company. 

(ii) The price at which the rights in the company are likely to be traded. 


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Question 1a
​​Distinguish between the following sources of finance: 
(i) “Venture capital” and “private equity”. 

(ii) “Business angel finance” and “lease finance”.


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April 2024

 1 Questions
Question 4a
​​Ploughing back profits of a company is an internal source of funds for an organisation. 

Required: 
(i) Identify FOUR merits of ploughing back profits by a company. 

(ii) Outline FOUR demerits of ploughing back profits by a company.


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December 2023

 3 Questions
Question 3b
​ ​ ​​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. 

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

(i) Par. 

(ii) A premium of 10%. 

(iii) A discount of 10%.


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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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Question 5b
​​Summarise FOUR distinct features of commercial paper as a short term source of finance.


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August 2023

 2 Questions
Question 1c
​ ​ ​​Maca Ltd. is considering raising funds for an expansion programme through a rights issue. The expansion programme is expected to cost Sh.20 million. The company has currently issued 2,400,000 ordinary shares which are currently selling for Sh.30 each. The board of directors have proposed an offer price of Sh.25 per share.  
 
The funds to be raised will be invested in a project which is expected to generate net operating cash flow of Sh.6,000,000 each year over the project’s useful life of five years. The salvage value of the project after five years is estimated at Sh.5,000,000. The cost of capital for the firm is 12% per annum. 
 
Required: 
(i) Cum-right market price per share (MPS).
 
(ii) Number of rights required to buy one new ordinary share. 
 
(iii) Theoretical ex-right market price per share. 
 
(iv) Theoretical value of each right. 
 
(v) Evaluate the impact of the rights issue on the value of wealth of an existing shareholder who owns 1,200 ordinary shares in the company and Sh.15,000 in his savings account under the various options available to him.


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Question 1b
​​Evaluate FOUR features of preference shares as a source of capital to a firm.


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April 2023

 1 Questions
Question 2a
​​Summarise FIVE factors that firms should consider when making financing decisions.


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December 2022

 1 Questions
Question 1b
​​Highlight FOUR factors that influence the choice of debt finance by a company.


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August 2022

 3 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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Question 2c
​ ​ ​​Horizon Construction Limited wishes to increase the number of its branches in the country. The board of directors of the company has decided to finance the expansion programme by raising funds from the existing shareholders through a one for four rights issue. 

The published income statement of the company for the year ended 31 December 2021 had the following information:

Sh.“000”
Turnover
250,000
Profit before interest and tax 
9,000
Interest
(500)
Profit before tax 
8,500
Corporation tax 
(2,550)
Profit after tax
5,950
Ordinary dividend 
(2,950)
Retained profit for the year 
3,000

The share capital of the company comprises of 10 million ordinary shares which have a par-value of Sh.10 per share. 

The shares of the company are currently being traded on the securities exchange with a price-earnings (P/E) ratio of 20 times. 

The firm’s board of directors have decided to issue the new shares at a 25% discount on the current market price. 

Required: 
(i) The theoretical ex-right price of an ordinary share of the company. 

(ii) The theoretical value of each right.  

Assuming an investor held 5,000 ordinary shares of the company before the rights issue announcement and Sh.15,000 in his savings account. Calculate the following options and identify the best option to the investor if he: 

(iii) Exercises all his rights. 

(iv) Sells all his rights. 

(v) Ignores the rights issue. 


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Question 3b
​ ​​Discuss three causes of conflict between shareholders and managers in relation to agency theory.


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April 2022

 2 Questions
Question 4a
​​Explain four methods that a company could use to issue ordinary shares.


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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

 2 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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Question 1a
​​Summarise five methods of issuing ordinary shares.


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December 2021

 5 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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Question 2b
​​QRS Limited is planning to expand its production capacity as per its marketing strategy as a result of access to new markets. The company requires additional capital of Sh.95,000,000 which it intends to raise through a rights issue. The company's financial year ends on 30 June. 

Additional information: 
1. The company's pre-tax profits for the year ended 30 June 2021 was Sh.177,500,000. This represents a 30% increase over the profits of the previous year. 
2. The current market price per share is Sh.12.
3.The rights issue will comprise one share for every four shares held at a rights issue price of Sh.8 per share. 
4.The dividend per share for the year ended 30 June 2021 was Sh.0.70. The company expects to pay a dividend per share of Sh.0.90 for the year ending 30 June 2022. 
5.Corporate tax rate is 30%. 

Required: 
(i) The existing number of ordinary shares before the rights issue.

(ii) The earnings per share (EPS) and price-earnings (P/E) ratio for the year ended 30 June 2021. 

(iii) The ex-rights price per share.


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Question 2a
​​Highlight two factors that are likely to affect the success of a rights issue.


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Question 1c
​​Outline four characteristics of ordinary share capital as a source of business finance.


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Question 1a
​​Describe four possible sources of conflict of interest between shareholders and bondholders.


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September 2021

 3 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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Question 3b
​​Hakika Ltd. is a newly listed company in the local Securities Exchange. The company has 1 million ordinary shares trading at Sh.49.50 per share. To finance a restructuring exercise, the company requires Sh.7,855,000. To raise the amount, the company intends to issue a one for five rights issue at a subscription price of Sh.39 per share. The finance manager has projected that upon restructuring, the company's annual cash inflows would increase by Sh.965,000. 

In the previous financial year, the company paid a dividend of Sh.5 per share. The dividend and the company's earnings are expected to grow by 5% annually upon restructuring. 

Required: 
(i) The price of the shares after the rights issue but before they start selling ex-rights. 

(ii) The theoretical ex-rights price of the shares.

(iii) The theoretical value of the rights when the shares are selling cum-rights.


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Question 1c
​ ​​Belta Limited issued a 16% corporate bond with a par value of Sh.1,000. The bond will either be redeemed at 20% premium after 5 years or convertible into equity at a conversion rate of Sh.100 per 2 ordinary shares. Each ordinary share is currently trading at the Securities Exchange for Sh.50. It is expected that the share price will increase at a constant rate of 5% each year. 

The minimum required rate of return by investors is 12%. 

Required: 
(i) The current value of the redeemable bond. 

(ii) The current value of the convertible bond. 

(iii) Propose four advantages that would accrue to Belta Limited by using commercial papers as a source finance.


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May 2021

 3 Questions
Question 4a
​​Outline four factors that could hinder the success of a rights issue.


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Question 3b
​ ​ ​​The following are extracts from Riziki Ltd.'s statement of financial position as at 30 March 2021:

Book values
Sh. "Million"
Ordinary shares (Sh.50 par value)
9,600
6% preference shares (Sh.100 par value)
7,900
4.8% debenture (Sh.100 par value)
6,400
23,900

Additional information:
1.
The ordinary shares of Riziki Ltd. are currently quoted at Sh.72 per share (cum dividend).
2.
The most recently declared dividend was Sh.2 per share and will be paid in a years' time. The dividend growth rate is 5%.
3.
The dividend will continue to grow at the rate of 5% into the foreseeable future.
4.
 The preference shares currently trade at Sh. 80 per share. There is no preference dividend owing at this point in time.  
5.
The debentures are irredeemable and currently trade at 120% of their nominal value.
6.
The corporation tax rate is 30%.
 Required:
(i)
The cost of capital for each source of finance for Riziki Ltd. 
(ii)
The weighted average cost of capital (WACC) for Riziki Ltd.
 


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Question 1d
​​Propose four factors to consider when choosing between long term loan capital and ordinary share capital as a source of finance.


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November 2019

 1 Questions
Question 1a
​​ In the context of agency theory: 

(i) Explain the "principal-agent" problem. 
(ii) Explore two ways of addressing the principal-agent problem.


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May 2019

 1 Questions
Question 2a
​​Propose four reasons that might make a firm use reserves to finance its operations.


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November 2017

 1 Questions
Question 4b
​ ​​Highlight three agency costs that might arise in the principal-agent relationship between shareholders and managers.


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November 2016

 2 Questions
Question 1a
​​Explain four disadvantages of public private partnerships (PPPs).


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Question 1b
​​Describe six steps involved in personal financial planning


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May 2016

 1 Questions
Question 5c
​​(i) The agency problem could be resolved using goal congruence.

Explain the term "goal congruence".

(ii) One of the ways creditors could protect themselves against the inherent risk that might arise from agency conflict is through adopting restrictive covenants.

With reference to the above statement, describe three restrictive covenants in a debt contract.


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November 2015

 1 Questions
Question 2a
​​Summarise four advantages of debentures over preference shares


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Pilot September 2015

 2 Questions
Question 1a
​ ​​"Provision for depreciation is an internally generated source of finance to a company". 
Explain the basis upon which provision for depreciation is a source of finance to an organisation.


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Question 2a
​ ​​In relation to financing of firm's activities, distinguish between the term "capital structure" and financial structure".


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