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CPA Advanced Financial Management – May 2017 Past Paper & Answers

Unit: Advanced Financial Management

11 Questions

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Download CPA Advanced Financial Management May 2017 past paper with detailed answers and marking scheme. This paper is based on KASNEB examination standards and is ideal for revision and exam preparation.

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Other Advanced Financial Management Past Papers

1a
Contemporary issues and emerging trends
​​Explain two ways in which increased investment in corporate social responsibility (CSR) activities might enhance the value of a firm.
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1b
Advanced capital budgeting decision
​​Kenzel Ltd. has the following capital structure which it considers optimal under both the present and forecasted conditions:

Source of capitai
%
Long-term debt
Equity capital
45
55
Total
100

The management of Kenzel Ltd. forecasts the after-tax earnings for the forthcoming year at Sh.2.5 million. The company has been paying 60 per cent of its earnings as dividend and this payment ratio is expected to continue nto the foreseeable future. The company's present loan commitment will allow it to incur additional leverage according to the schedule presented below: 

Loan amount (Sh.)
Interest rate on incremental debt
0-500,000
 9%
500,000 - 900,000
11%
900,000 and above
13%

The company's corporate tax rate is 30%. The current market price of the equity shares ofthe company is Sh.22. The last dividend on equity shares was paid at Sh.2.20 per share and the expected growth rate is 5%. New equity shares can be sold at a floatation cost of 10% ofthe issue price.

Kenzel Ltd. has the following investment opportunities for the coming year:

Project
Cash outlay

Sh.
Annual net
cash flow
Sh.
Project life
(years)
Sh.
Internal rate of
return
%
A
B
C
D
E
675,000
900,000
375,000
562,500
750,000 
155,401
268,484
161,524
185,194
127,351
8
5
3
4
10  
?
15
?
12
11

Required: 
(i) The amounts in shillings at which breaks in the marginal cost of capital (MCC) schedule occur. 

(ii) The weighted marginal cost of capital (WMCC) in each of the intervals between the breaks in the MСС schedule. 

(iii) The internal rate of return (IRR) for project A and project C. 

(iv) Using the investment opportunities schedule (IOS), advise on which project(s) should be accepted. 
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2a
Corporate restructuring and re-organisation
​​ Analyse three factors that might be responsible for financial distress in a firm.
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2b
Portfolio theory and analysis
​​The following information relates to the performance of six portfolios over a seven-year period:

Portfolio
Average annual
returns(%)
Standard deviation of the average
annual returns(%)
Correlation with
Market returns
P
Q
R
S
T
U
18.6
14.8
15.1
22.0
-9.0
26.5
27.0
18.0
  8.0
21.2
  4.0
19.3
0.81
0.65
0.98
0.75
0.45
0.63
Market return
12.0
12.0
Risk-free rate
 9.0


Required: 
Rank the performance of the above portfolios using: 
(i) Sharpe's method. 

(ii) Treynor's method.
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2c
Portfolio theory and analysis
​​Compare the rankings using the two methods in (b) above and explain two reasons behind the differences.
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3a
Mergers and acquisitions
​​Examine four strategies that a company couid adopt to defend itself against a hostile takeover.
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3b
Mergers and acquisitions
​ ​​The following data relate to two companies namely; V Ltd. and J Ltd. operating in the same line of business.

Financial data as at 30 April 2017:

V Ltd.
J Ltd.
Market value of debt (Sh."billion")
6.60
11.60
Market value of equity (Sh."billion")
19.80
13.40
Number of shares in issue ("million")
680.00
880.00
Share options outstanding ("million") 
50.80
-
Exercise price per option (Sh. per share)
22.00
Corporate tax rate
30%
30%
Equity beta
1.85
1.95
Default risk premium 
1.6%
3.0%
Net operating profit after tax and net re-investment (Sh."million")
900
410
Current earnings per share (Sh. per share) 
1.19
0.44

Additional information: 
1. The global equity risk premium is 4% and the most appropriate risk-free rate derived from government securities is 3%. 

2. The share options held by the employees were exercisable subject to the employees working for the company for the next three years. 

3. The company has an annual employee attrition rate of 5% as employees leave and out of those remaining, 20% are expected not to have achieved the standard of performance required to exercise the options. 

4. The options have a time value of Sh.7.31. 5. J Ltd. operates a defined benefit pension scheme which, at its current actuarial valuation, shows a deficit of Sh.860 million. 

6. V. Ltd. which has managed to sustain a 5% growth rate in earnings per annum, is considering a debt-financed acquisition of J Ltd. In addition, V Ltd. believes that J Ltd. could register a growth rate of 4% per annum under its current management. 

Required:
(i) The weighted average cost of capital (WACC) of both J Ltd. and V Ltd. 

(ii) The current value of both J Ltd. and V Ltd. 
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4a
International financial management
​​ Explain three functions of the African Development Bank.
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4b
Financial risk management
​ ​​Biashara Ltd. is an import-export company based in Kenya. On 1 January 2017, the company exported coffee worth LUS $140,000 to the United States (US) of America on a five-month credit. 

Additional information:
1
The exchange rates in the forex markets were (are expected to be) as follows:
                           KSh/1 USS
1 January 2017       100
31 May 2017           102
2
The lending and borrowing rates in the two countries are as follows:
Annual lending rate
Annual borrowing rate
Kenya
USA
18%
14%
19%
15%
3
The importer will settle the outstanding amount on 31 May 2017.

Required: 
(i).  Cin Using the interest rate parity relationship, compute the expected 5-month forward exchange rate as at 31 May 2017. 

(ii). Advise Biashara Ltd, on which is the better hedging strategy berween a forward contract and a money market hedge.
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5a
Mergers and acquisitions
​ ​​A Ltd. is considering acquiring B Ltd. The selected financial data for the two companies are as follows:

A Ltd.
B Ltd.
Annual sales (Sh."million")
600
120
Net income (Sh."million")
35
3
Ordinary shares outstanding ("millions")
10
2
Earnings per share (EPS) - Sh.
3.5
1.5
Market price per share (MPS) - Sh.
40
15

Both companies are in the 30% tax bracket.

Required:
(i) The maximum exchange ratio that A Ltd. should agree to if it expects no dilution in earnings per share. 

(ii) Total premium that the shareholders of B Ltd. would receive at the exchange ratio caiculated in (a) (i) above. 

iii) A Ltd.'s post acquisition earnings per share, if the two companies settle on a price of Sh.20 per share. 

(iv) A Ltd.'s post-acquisition earnings per share if every 50 ordinary shares of B Ltd. were exchanged for one 8% debenture of a par value of Sh.1,000 each.
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5b
Advanced capital budgeting decision
​​Chuma Ltd. operates a machine which has the following maintenance costs and resale values over its four-year life. The purchase price of the machine is Sh.25,000,000.

Year 1
Sh."000"
Year 2
Sh."000"
Year 3
Sh."000"
Year 4
Sh."000"
Maintenance costs
 7,500
11,000
12,500
15,000
Resale value (end of year)
15,000
10,000
  7,500
  2,500

The company's cost of capital is 10%.

Required: 
Advise the management of Chuma Ltd. on how frequently the machine should be replaced.
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