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CPA Advanced Financial Management – August 2026 Past Paper & Answers

Unit: Advanced Financial Management

15 Questions

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Download CPA Advanced Financial Management August 2026 past paper with detailed answers and marking scheme. This paper is based on KASNEB examination standards and is ideal for revision and exam preparation.

Access the full paper online, download the PDF, or study offline. Each question includes step-by-step solutions to help you understand key concepts in Advanced Financial Management.

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1a
Advanced capital budgeting decision
​ ​​Outline FOUR common errors that could arise when incorporating inflation into capital investment appraisal.
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1b
Portfolio theory and analysis
​ ​​Meridian Fund Managers Ltd. applies a three-factor model to evaluate listed equities. The risk-free rate is 8% per annum. The expected risk premiums on the three factors are as follows:

FactorExpected risk premium (%)
Market factor6.5
Size factor3.2
Liquidity factor2.4

The factor sensitivities and forecast returns for three securities are as follows:

SecurityMarket sensitivitySize sensitivityLiquidity sensitivityAnalyst forecast return (%)
A1.100.600.4019.10
B0.850.400.2518.30
C1.350.200.8020.80
 
Required: 
(i) Compute the required return for each security using the multifactor model. 

(ii) Determine whether each security is undervalued, overvalued or fairly valued by comparing its forecast return with its required return. 
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1c
Financial risk management
​ ​ ​​Jupiter Imports Ltd. is required to pay USD 600,000 to a supplier in the United States in three months. The company is considering hedging the foreign currency payable using either a forward market hedge or a money market hedge. 

The following information is available:

Exchange rateRate
Spot exchange rateSh.132.40 per USD
Three-month forward exchange rateSh.134.10 per USD

Interest rateKenya shillingUS dollar
Annual borrowing rate14%7%
Annual deposit rate10%4%

Assume simple interest. Ignore transaction costs. 

Required: 
(i) Compute the Kenya shilling cost under a forward market hedge. 

(ii) Compute the Kenya shilling cost under a money market hedge. 

iii) Recommend the cheaper hedging alternative.   
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2a
Advanced financing decision
​​Explain FOUR reasons why convexity should be considered together with duration when assessing a bond portfolio exposed to large interest rate changes.
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2b
Real estate finance
​​Palm Real Estate Investment Trust (REIT) is evaluating the purchase of a mixed-use property in Nairobi. The expected net operating income from the property is shown below:

Year12345
Net operating income (Sh. million)96103111118125

Additional information:
1. The property is expected to be sold at the end of year 5. Its gross terminal value will be estimated by applying an exit capitalisation rate of 11% to the expected net operating income for year 6.
2. Selling costs at disposal are estimated at 2% of the terminal value.
3. Net operating income is expected to grow at the rate of 5% in year 6.
4. The required return for this class of real estate is 13% per annum.
5. The seller’s asking price is Sh.1,250 million, payable immediately. Acquisition transaction costs of Sh.35 million are also payable immediately.

Required:
(i) Compute the net terminal value expected at the end of year 5. 

(ii) Estimate the value of the property using the discounted cash flow approach. 

(iii) Advise whether the REIT should acquire the property at the seller’s asking price, after taking account of the immediate transaction costs. 
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2c
Corporate restructuring and re-organisation
​ ​ ​​Lengo Plastics Ltd. has experienced persistent losses and declining market share. The board is considering whether the company is approaching financial distress. The following information relates to the year ended 30 June 2026:

IndicatorAmount/ratio
Working capital / total assets0.06
Retained earnings / total assets-0.09
Earnings before interest and tax / total assets0.04
Market value of equity / book value of liabilities0.55
Sales / total assets0.88
Altman Z-score distress zone threshold for manufacturing firmsBelow 1.81

Required: 
(i) Compute the Altman Z-score for Lengo Plastics Ltd. Where: Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 

(ii) Evaluate the likelihood of corporate failure based on the computed score and the company circumstances. 

(iii) Recommend THREE restructuring actions that could be considered by Lengo Plastics Ltd.    
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3a
International financial management
​​A Kenyan manufacturing company intends to establish a wholly owned subsidiary in Rwanda as part of its regional expansion strategy. 

Required: 
Evaluate FOUR challenges that the company might experience as a multinational corporation when undertaking foreign direct investment in Rwanda.
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3b
Advanced capital budgeting decision
​ ​​Jua Kali Logistics Ltd. is evaluating a five-year automated warehousing project. The project requires an immediate investment of Sh.900,000,000 and additional working capital of Sh.80,000,000 at the start of the project. The working capital will be fully recovered at the end of year 5. 

Expected annual operating cash flows before tax, in current price terms, are as follows:

Year1
2345
Sales receipts (Sh."million")480540620680710
Cash operating costs (Sh."million")210235260285310

Additional information:
1. Tax allowable depreciation is calculated on a straight-line basis over five years.
2. The equipment is expected to have a disposal value of Sh.160,000,000 at the end of year 5. Ignore any tax consequences arising from this disposal.
3. Corporation tax is 30% and is paid in the year in which taxable profits arise.
4. The all-equity cost of capital is 16% per annum.
5. The project will be partly financed by a subsidised development loan of Sh.360,000,000 at an interest rate of 8% per annum, repayable in equal principal instalments at the end of each year. The market borrowing rate for similar risk debt is 12% per annum.
6. Loan arrangement fees of Sh.12,000,000 will be paid immediately.
7. Discount the tax relief on interest at the market borrowing rate for similar risk debt.
8. Assume the benefit of the subsidised loan is measured as the present value of the interest saving compared with borrowing at the market rate.

Required:
(i) Calculate the base case net present value of the project assuming it is financed entirely by equity. 

(ii) Calculate the financing side effects and determine the adjusted present value of the project.

(iii) Advise whether Jua Kali Logistics Ltd. should undertake the project, giving reasons.  
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3c
Mergers and acquisitions
​​Amaran Foods Limited has received an unsolicited takeover offer from a foreign bidder. The directors believe that the offer undervalues the company and are considering measures to protect the interests of the company and its shareholders. 

Required: 
Assess THREE takeover defense measures that could be adopted by Amaran Foods Limited.
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4a
Financial risk management
​​Explain the following derivative instruments as used in financial risk management: 
 
(i) Forward rate agreement. 
 
(ii) Interest rate swap. 
 
(iii) Currency option.  
 
(iv) Commodity futures contract. 
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4b
Portfolio theory and analysis
​ ​​Peacock Pension Scheme has the following three actively managed portfolios for the year ended 31 July 2026:

PortfolioAverage returnStandardBetaTracking errorBenchmark return
(%)deviation (%)(%)(%)
P17.211.50.954.814.1
Q19.015.61.205.516.3
R14.88.40.703.111.6

Additional information:
1. The risk-free rate is 7% per annum.
2. The market return is 15% per annum.

Required:
(i) Compute Sharpe, Treynor and information ratios for each portfolio

(ii) Analyse which portfolio should be retained if the trustees emphasise risk-adjusted performance relative to total risk and active risk. 
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4c
Corporate restructuring and re-organisation
​​Maridadi Textiles Ltd. is negotiating with lenders after breaching debt covenants. The company has viable core operations but an unsustainable debt burden and obsolete non-core assets. Management proposes to dispose of non core assets, convert part of bank debt into preference shares, reschedule the balance of debt, close one loss-making plant and retrain affected staff for outsourced logistics operations. 

Required: 
Design a corporate restructuring programme covering financial, operational and governance measures that balances creditor recovery, shareholder value preservation, employee continuity and long-term competitiveness.
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5a
Contemporary issues and emerging trends
​​Diamond Infrastructure Ltd. is considering using cloud-based project finance platforms and distributed ledger records to monitor a toll-road project funded partly through green infrastructure notes. 

Required: 
Explain FOUR ways in which digitisation of project finance could improve the reliability of project cash-flow forecasts.
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5b
Mergers and acquisitions
​​Kijani Flowers Ltd. proposes to acquire Tamco Organics Ltd. to expand its export product range. The free cash flows to the firm of Tamco Organics Ltd., including expected operating synergies but before acquisition financing costs, are forecast as follows:

Year12345
Free cash flow (Sh."million")92110126144158

Additional information
1. After year 5, free cash flows are expected to grow at 5% per annum indefinitely.
2. The risk-adjusted cost of capital applicable to the target is 14% per annum.
3. Integration costs of Sh.180,000,000 will be incurred immediately after acquisition.
4. Tamco Organics Ltd. has debt with a market value of Sh.240,000,000 and surplus cash of Sh.35,000,000.
5. There are 50,000,000 ordinary shares in issue. The current market price per share is Sh.31.
6. The board will not approve any offer that gives away more than 60% of the estimated synergy value to Tamco Organics Ltd. shareholders.

Required:
(i) Estimate the equity value of Tamco Organics Ltd. using the discounted free cash flow approach. 

(ii) Determine the maximum offer price per share that Kijani Flowers Ltd. should consider, taking account of the board policy on sharing synergy value. (2 marks)

(iii) Evaluate whether the acquisition should proceed if Tamco Organics Ltd. demands Sh.38 per share.
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5c
Advanced financing decision
​​Orion Engineering Ltd. is preparing a weighted marginal cost of capital schedule for the next financial year. The target capital structure is 55% equity, 10% preference shares and 35% debt.

Source of financeAmount available beforeCost before breakpointCost after breakpoint
cost changes (Sh.)(%)(%)
Retained earnings220,000,00016New equity at 19
Preference shares60,000,0001214
Debt175,000,00010 before tax13 before tax

Additional information:
1.Corporation tax is 30%.
2.
The company has the following independent projects:
ProjectAmount required (Sh.“000”)Expected Return (%)
A180,00017.2
B240,00015.6
C300,00014.4
D160,00013.1

Required: 
(i) Determine the breakpoints in the weighted marginal cost of capital schedule. 

(ii) Compute the weighted marginal cost of capital for each financing range. 

(iii) Recommend the projects that should be accepted based on the investment opportunity schedule.
 
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