KASNEB Advanced Financial Management - Question 5a

Outline THREE factors that complicate the financial management in multinational corporations.... [Click to view full question and step-by-step solution]

CPA Advanced Financial Management April 2026 Past Paper with Answers (PDF)

1a

Advanced capital budgeting decision

Explain FOUR common capital budgeting pitfalls and briefly illustrate how each may distort investment decision making.

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1b

Ramara Innovations Ltd. is considering the launch of a new fintech payment platform. The project will be undertaken in three stages, as set out below:

Stage 1: Research and development (Year 0)

An initial investment of Sh.150 million is required immediately.

• Probability of technical success: 70%

• If Stage 1 is unsuccessful, the project will be abandoned immediately with no salvage value

Stage 2: Pilot testing (End of Year 1)

If Stage 1 is successful, a further Sh.250 million will be invested at the end of Year 1 to undertake pilot testing.

• Probability of commercial success: 80%

• If Stage 2 is unsuccessful, the project will be abandoned and the related assets will be sold for Sh.100 million at the end of Year 1

Stage 3: Full commercial launch (Years 3 to 7)

If Stage 2 is successful, the project will proceed to full commercial launch. No additional investment will be required at Year 2, and the project is expected to generate annual after-tax cash inflows from Years 3 to 7 as follows:

• Strong economy (probability 0.6): Sh.220 million per year

• Weak economy (probability 0.4): Sh.160 million per year

Assume that the economy outcome is revealed at the start of operations and remains unchanged throughout the project life. The economy-state probabilities apply only if the project reaches Stage 3.

Additional information:

The general rate of inflation is 4% per annum.
The annual cash inflows given above are stated in real terms.
The risk-free rate is 7% per annum.
The expected market return is 15% per annum.
The project beta is 1.3.
The company pays corporate tax at 30%.
Assume that the risk-free rate and expected market return are nominal rates.
For discounting purposes, use the real discount rate derived from the capital asset pricing model(CAPM).

Required:

(i) Determine the appropriate nominal discount rate for the project using the Capital Asset Pricing Model (CAPM) and hence calculate the real discount rate to be used in appraisal.

(ii) Construct a decision tree for the project and compute the expected net present value (ENPV) of the project.

(iii) Advise whether Ramara Innovations Ltd. should undertake the project, giving reasons for your answer.

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2a

Advanced financing decision

Highlight FOUR differences between a “finance lease” and an “operating lease” from the perspective of the lessee.

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2b

Advanced financing decision

Peak Limited is considering acquiring a piece of equipment costing Sh.200,000,000. The equipment has an economic life of 6 years and an estimated salvage value of Sh.20,000,000 at the end of year 6. The company uses the straight line method of depreciation.

The equipment may be acquired under either of the following options:

Option 1: Borrowing and buying

The equipment would be purchased using a bank loan carrying interest at the rate of 14% per annum. The loan would be repaid in six equal annual instalments of Sh.51,427,100, payable at the end of each year.

Option 2: Leasing

The equipment would be leased for 6 years at an annual lease rental of Sh.40,000,000, payable in advance at the beginning of each year. Under the lease agreement, all maintenance costs will be borne by the lessor.

Additional information:

The corporate tax rate is 30%.
The company uses the after-tax cost of debt as the appropriate discount rate.
Tax savings on interest, depreciation and lease rentals are assumed to arise at the end of the year in which they occur.
The salvage value may be treated as an after-tax cash inflow at the end of year 6.
Ignore maintenance costs under the borrowing-and-buying option unless otherwise stated.

Required:

(i) Calculate the present value of cash outflows under the borrowing-and-buying option.

(ii) Calculate the present value of cash outflows under the leasing option.

(iii) Advise management on the most suitable acquisition method.

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2c

Advanced financing decision

Belaviu Manufacturing Ltd. is evaluating its capital structure to determine the optimal level of leverage. The company is currently financed entirely by equity.

The following information is available:

1. Risk-free rate is 7%

2. Expected market return is 15%

3. Asset beta (βₐ) is 0.90

4. Corporate tax rate is 30%

The company is considering introducing debt into its capital structure. The proposed debt to equity ratio (D/E) is 0.50.

Additional information:

1. The cost of debt before tax is 10% per annum.

2. The company intends to maintain the proposed capital structure permanently.

3. Assume debt beta is zero.

Required:

(i) Using the Hamada model, determine the equity beta after introducing debt.

(ii) Using the Capital Asset Pricing Model (CAPM), determine the cost of equity after the change in capital structure.

(iii) Determine the weighted average cost of capital (WACC) after introducing debt.

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3a

Mergers and acquisitions

Summarise FOUR reasons why mergers and acquisitions may fail despite positive valuation results.

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3b

International financial management

A developing country experiencing a balance of payments deficit approaches the International Monetary Fund (IMF) for financial assistance. Examine FOUR roles that the IMF may play in assisting the country.

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3c

Mergers and acquisitions

Bamuda Holdings Ltd. intends to acquire Mawimbi Ltd. through a share exchange arrangement.

The following information relates to the two companies:

	Bamuda Holdings Ltd.	Mawimbi Ltd.
Earnings after tax (Sh. million)	200	60
Number of ordinary shares (million)	40	15
Market price per share (Sh.)	75	40
Price/earnings (P/E) ratio	15	10

Additional information:

1.	Bamuda Holdings Ltd.’s weighted average cost of capital (WACC) is 12%.
2.	The acquisition will be financed through a share exchange.
3.	The exchange ratio is 1 Bamuda Holdings Ltd. share for every 2 Mawimbi Ltd. shares acquired.
4.	Expected synergy benefits after tax are as follows: • Year 1: Sh.30 million • Year 2: Sh.50 million • Year 3: Sh.70 million, growing at 5% per annum thereafter
5.	The appropriate discount rate for synergy cash flows is 14%.
6.	Integration costs of Sh.40 million will be incurred immediately.
7.	The post-acquisition P/E ratio of Bamuda Holdings Ltd. is expected to fall to 13.
8.	For the purpose of earnings per share (EPS) and post-merger market price calculations, use Year 1 synergy benefits.

Required:

(i) Determine the standalone market value of Mawimbi Ltd. using its earnings and P/E ratio.

(ii) Calculate the present value of synergy benefits and hence determine the total value of Mawimbi Ltd. to Bamuda Holdings Ltd., after taking account of integration costs.

(iii) Calculate the number of new shares to be issued by Bamuda Holdings Ltd.; and the post-acquisition earnings per share (EPS) before synergy and after incorporating Year 1 synergy benefits.

(iv) Estimate the post-merger market price per share and state whether the acquisition is expected to create or destroy shareholder value.

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4a

Contemporary issues and emerging trends

The financial sector has experienced significant changes due to the digitisation of financial services. Explain THREE impacts of digitisation on financial transactions in modern economies.

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4b

Financial risk management

Simba Exporters Ltd., a Kenyan-based company expects to receive 4 million United States Dollars (USD) in six months’ time from Faraz Limited, in United States of America (USA).

Additional information:

1. Spot rate: Sh.130/USD.

2. Six‑month forward rate: Sh.135/USD.

3. Kenya borrowing rate: 12% per annum.

4. Kenya deposit rate: 10% per annum.

5. United States of America (USA) borrowing rate: 6% per annum.

6. USA deposit rate: 4% per annum.

Required:

(i) Using a forward hedge, determine the Shilling receipts.

(ii) Using a money market hedge, determine the Shilling receipts.

(iii) Advise Simba Exporters Ltd. on the most appropriate hedging strategy, giving a reason.

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4c

Financial risk management

High-Yield Fund Managers Ltd. is evaluating a potential investment in a European put option for the ordinary shares of Zidi Ltd., a company listed on the Najira Securities Exchange (NSE). The following data relates to Zidi Ltd. and the option contract:

The current market price per ordinary share is Sh. 45.
The exercise price of the option is Sh. 50.
The time to expiration is 6 months.
The risk-free rate of return is 10% per annum, compounded continuously.
The volatility of the share’s return is 25% per annum.

Required:

(i) Using the Black‑Scholes option pricing model (BSOPM), estimate the value of the corresponding European call option.

(ii) Using the results obtained in (c) (i) above and the Put-Call Parity relationship, estimate the value of the European put option.

(iii) In the context of the derivatives market, describe THREE circumstances under which an investor would prefer to buy a put option rather than selling the underlying asset in the spot market.

NOTE: Formulae for Black-Scholes Option Pricing Model (BSOPM) and Put-Call Parity:

\(C = S_0N(d_1)-Ke^{-rT}N(d_2)\)

\(\displaystyle d_1:\frac{ln(S_0/K)+(r+0.5\sigma^2)T}{\sigma\sqrt{T}}\)

\(d_2:d_1- \sigma\sqrt{T}\)

Put-call Parity:\(P=C+Ke^{-rT}-S_0\)

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5a

Financial risk management

Outline THREE factors that complicate the financial management in multinational corporations.

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5b

Portfolio theory and analysis

An investment analyst is constructing a portfolio consisting of three shares listed on the NYM Securities Exchange with the following details:

Asset	Expected return (%)	Standard deviation (%)	Weight	Beta
X	22.0	25.0	0.40	1.50
Y	15.0	18.0	0.35	0.80
Z	18.5	20.0	0.25	1.10

Additional information:

Correlation coefficients between the assets are: XY 0.60; XZ 0.40; YZ 0.50.
Market return is 14%.
Risk‑free rate is 8%.
Market standard deviation is15%.

Required:

(i) Calculate the expected return of the portfolio.

(ii) Determine the standard deviation of the portfolio.

(iii) Decompose the total risk of Asset X into systematic and unsystematic components.

(iv) Determine the required return of the portfolio using the capital asset pricing model (CAPM).

(v) Assess whether the portfolio is underpriced or overpriced.

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5c

International financial management

Ubuntu Real Estate Ltd., a real estate investment firm based in the United Kingdom (UK) is evaluating a project in Kenya. The project requires an initial investment of Sh.6,000 million payables immediately.

The project is expected to generate the following annual net cash inflows in Kenyan shillings (Sh. million):

Year	1	2	3	4	5
Cash flows (Sh. million)	800	950	1,100	1,250	1,400

Additional information:

1. The project will have a terminal value of Sh.5,500 million at the end of Year 5.

2. The current spot exchange rate is Sh.170/£1.

3. The annual interest rate in Kenya is 8%.

4. The annual interest rate in the UK is 5%.

5. Ubuntu Real Estate Ltd.’s UK cost of capital is 14% per annum.

6. Withholding tax of 10% is payable on all cash remittances from Kenya to the UK, including the terminal value.

7. Assume that all annual cash inflows and the terminal value are remitted to the UK at the end of each year.

8. Future spot exchange rates should be estimated using the International Fisher Effect based on the interest rates given above.

Required:

(i) Using the International Fisher Effect, determine the expected spot exchange rate after one year.

(ii) Using the home currency approach, compute the Net Present Value (NPV) of the Kenyan project in pounds Sterling’s.

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