KASNEB Advanced Financial Management - Question 4b

Apco Limited is considering to acquire Alpha Limited. The following are the financial data for the two companies: Apco LimitedAlpha LimitedNet sales (Sh.) ... [Click to view full question and step-by-step solution]

KASNEB Advanced Financial Management - Question 5b

Examine four advantages of investing in real estate. ... [Click to view full question and step-by-step solution]

May 2021

Q: KASNEB Advanced Financial Management - Question 3a

(i) Explain the meaning of the term 'unbundling' as used in corporate restructuring and reorganisation.(ii) Describe four forms of unbundling a firm. ... [Click to view full question and step-by-step solution]

1a

Advanced financing decision

Citing four reasons, argue the case why firms undertake capital rationing decisions in your country.

1b

Advanced capital budgeting decision

You have been appointed by Biosoft Limited to review three investment project proposals. The investment funds are limited to Sh.8.000,000 in the current financial year. Details of the three possible investment projects. none of which can be delayed are given below:

Project 1: An investment of Sh.3,000,000 in workstation assessments. Each assessment would be on an individual employee basis and would lead to a saving in labour costs from increased efficiency and reduced absenteeism. In money terms, the savings in labour costs are expected to be as follows:

Year	1	2	3	4	5
Cash Flow (Sh. "000")	850	900	950	1,000	950

Project 2: An investment of Sh.4,500,000 in individual workstations for staff that is expected to reduce administration costs by Sh.1,408.000 per annum in money terms for the next five years.

Project 3: An investment of Sh.4,500,000 in new ticket machines. A net cash savings of Sh.1,200,000 per annum is expected in current money terms and is projected to increase by 3.6% per annum due to inflation during the five years life of the machines.

The money cost of capital for Biosoft Limited is 12%.

Required:

Advise the company on the project(s) to invest the available funds and calculate the resultant net present value (NPV) assuming:

(i) The three projects are divisible.

(ii) None of the projects is divisible.

1c

Financial risk management

Dafina Limited is an export - import firm based in Kenya.

On 1 August 2020, the company exported tea to the United States of America (USA) on a 3-month credit amounting to US$10.000.000.

Additional information:

1.	The rates in the forex and money market were as follows:

		Ksh/1USS
	1 August 2020	105
	1 December 2020	101
		Interest rates (per annum)
	Kenya	18%
	USA	12%
2.	The customer will settle the amount on I December 2020.

Required:

(i) Using the interest rate parity, determine the expected 3-months forward exchange rate as at 1 December 2020.

(ii) Using suitable computations, advise Dafina Limited on the better hedging strategy between a forward market and money market hedge.

2a

International financial management

In this era of globalisation, the functions of finance executives of multinational corporations (MNCs) have become complex.

Propose five factors that the Chief Finance Officer (CFO) of a MNC should consider in making international financial management decisions.

2b

Portfolio theory and analysis

The arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) have received much attention from practitioners and academicians for their use in asset pricing and valuation.

Required:

Explain the difference between APT and the CAPM with respect to:

(i) Investor utility functions.

(ii) Distribution of returns.

(iii) The market portfolio.

2c

Portfolio theory and analysis

Zachary Mosomi, an investor holds the following portfolio of four risky assets and a deposit in a risk-free asset.

He has provided the information below:

Asset	Weighting	Current return	Beta
A	20	12	1.5
B	10	18	2.0
C	15	14	1.2
D	25	8	0.9
Risk-free asset	30	5	0

The overall return on the market portfolio of risky assets is 11%.

Required:

(i) Portfolio return and beta.

(ii) Using the results in (i) above, deduce the type of investor Zachary is.

(iii) Using suitable computations, determine the assets that are inefficient, efficient or super efficient.

(iv) Calculate the equilibrium return for the portfolio.

3a

Mergers and acquisitions

(i) Explain the meaning of the term "unbundling" as used in corporate restructuring and reorganisation.

(ii) Describe four forms of unbundling a firm.

3b

Advanced financing decision

Bamboo Ltd. is currently an unlevered firm. The firm is expected to generate a constant operating profit (EBIT) of Sh.20 million per annum in perpetuity. The firm's current market value is Sh.80 million.

The management is considering undertaking an expansion activity by use of debt financing. The firm's financial analysts have estimated that the present value of any future financial distress cost is Sh.8 million. However, the probability of distress would increase with leverage according to the following schedule:

Value of debt Sh. "million"	Probability of financial distress (%)	Pre-tax cost of debt (%)
2.5	0.00	4
5.0	1.25	6
7.5	2.50	10
10.0	6.25	15
12.5	12.50	18
15.0	31.25	20
20.0	75.00	22

Corporation tax rate applicable is 30%.

Required:

(i) The current cost of equity and weighted average cost of capital (WACC) of the firm.

(ii) Using the "pure" Modigliani and Miller (MM) with tax model, determine the optimal level of debt.

(iii) Evaluate the firm's optimal capital structure when financial distress costs are included.

4a

Mergers and acquisitions

Evaluate five defensive tactics available to a firm threatened by a hostile takeover in the industry.

4b

Mergers and acquisitions

Apco Limited is considering to acquire Alpha Limited. The following are the financial data for the two companies:

	Apco Limited	Alpha Limited
Net sales (Sh.)	350,000	45,000
Profit after tax (Sh.)	18,130	3,750
Number of outstanding ordinary shares	7,500	1,500
Earnings per share (EPS)	3.75	2.50
Dividend per share (DPS)	1.30	0.60
Total market capitalization (Sh.)	420,000	45,000

Required:

(i) Determine the pre-merger market value per share for both companies.

(ii) Determine the post merger EPS, market price per share (MPS) and price earnings (P/E) ratio.

(iii) Compare Apco Limited's EPS assuming Alpha Limited's shareholders are offered Sh.100,000, 5% convertible debenture for each share held in Alpha Limited.

Assume a corporate tax rate of 30%.

4c

Mergers and acquisitions

Makazi Ltd.'s current earnings per share is Sh.6.0. The firm has in issue 50 million ordinary shares which have a par value of Sh.20 each. The firm's total revenue and capital reserves amounts to Sh.500 million.

The company has an asset beta of 0.9 and a retention ratio of 60%.

The management of Makazi Ltd. intends to undertake a financial reconstruction which will result in a debt-equity ratio change from 0.45 to 0.2.

Additional information:

1. The risk free rate of return is 8%.

2. Expected rate of return of a market portfolio is 18%.

3. Corporation tax rate is 30%.

4. The firm's return on equity before and after the financial reconstruction will remain unchanged.

Required:

Evaluate the impact of the financial reconstruction on the firm's share price.

5a

Mergers and acquisitions

Discuss four circumstances in which a decision could be made to liquidate a failing company rather than attempt to carry out a reconstruction.

5b

Real estate finance

Examine four advantages of investing in real estate.

5c

Advanced capital budgeting decision

Zedtech Ltd. wishes to design a new product so as to catch the interest of their target market which is currently very competitive.

The company will have to invest Sh.100,000 at the beginning of the first year (year 0) for the design and model testing of the new product.

The company's marketing manager believes that there is an 80% chance that this phase will be successful and the project will continue. If phase 1 is not successful, the project will be abandoned with zero salvage value.

The next phase, if undertaken would consist of making the moulds and producing ten prototype products at a cost of Sh.500,000 at the end of the first year. If the'products test well, the company would go into full scale production. If they do not, the moulds and prototypes will all be sold for Sh.400,000. The manager estimates that there is a 90%

probability that the products will pass testing and phase 3 will be undertaken.

Phase 3 consists of changing over the firm's current production line so as to be able to produce the new products. This will cost Sh.1,000,000 at the end of year 2. If the economic conditions are favourable at this juncture, the net value of the firm's cash flows are estimated to be Sh.3,500,000, while if the economic conditions are unfavourable the net cash inflows are estimated at Sh.2,500,000. Both net cash flows are expected at the end of year 3, and the two states of economy are equally likely.

The firm's opportunity cost of capital is 11%.

Required:

(i) Construct a decision tree to depict payoffs, and hence determine the expected net present value (NPV) of the project.

(ii) The project's expected standard deviation and coefficient of variation.

(iii) Assuming the firm's average project had a coefficient of variation of between 1.0 and 2.0, explain whether the project would be of high, low or average risk.

May 2021

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