November 2020

1a

Corporate restructuring and re-organisation

Discuss four reasons for restructuring and reorganising an organisation

1b

Corporate restructuring and re-organisation

Professor Edward Altman's model for prediction of bankruptcy is given as follows:

Z-score = 1.2\(X_1\) +1.4\(X_2\) +3.3\(X_3\) + 0.6\(X_4\) + 0.999\(X_5\)

\(X_1\), \(X_2\), \(X_3\) \(X_{4}\) and \(X_{5}\) are the financial ratios which according to Prof. Altman have the discriminating power

Where:

\(X_{1}\) = Networking capital/Total assets

\(X_{2}\) = Retained earnings/Total assets

\(X_{3}\) = Operating profit (EBIT)/Total assets

\(X_{4}\) = Market value of equity shares/Book value of debt including preference share capital

\(X_{5}\) = Sales/Total assets

Given below are summarised financial statements of Alpha Limited for the year ended 31 December 2019:

Alpha Limited Income statement for year ended 31 December 2019
	Sh."000"
Sales	400,000
Cost of sales	(300,000)
Gross earnings	100,000
Operating expenses	(60,000)
Operating profit	40,000
Fmancing cost. Interest	10,000
Profit before tax	30,000
Corporation tax (@ 30%	(9,000)
Profit after tax	21,000
Ordinary dividend proposed and paid	(11,000)
Ratamed profit for the year	10,000

Alpha Limited Statement of financial position as at 31 December 2019
Assets:	Sh."000"
Non-current assets	300,000
Current assets	100,000
Total assets	400,000
Financed by:
Ordinary share capital (Sh.10 each)	100,000
Retained profit	120,000
Share premium	40,000
Equity capital	260,000
Total current liabilities:
12% preference share capital	20,000
10% debenture capital	40,000
Total equity and liabilities	400,000

In this model, a Z-score of 2.7 or more indicates no signs of failure and a Z-score of 1.8 or less indicates there are signs of failure. The firm's ordinary shares are currently trading at Sh.15 each.

Required:

(i). The Z-score for Alpha Limited.

(ii). Comment on the results obtained in (b) (i) above.

1c

Advanced capital budgeting decision

Chanzu Ltd. is considering a project which would cost Sh.5,000,000 now. The annual benefits for four years, would be a fixed income of Sh.2,500,000 per annum plus other savings of Sh.500,000 in year 1. rising by 5% each year because of inflation. Running costs will be Sh. 1,000,000 in the first year but would increase at a rate of 10% each year because of inflating labour costs.

The general rate of inflation is expected to be 7.5% per annum and the firm's required nominal rate of return is 16%.

Required:

(i). Advise the management of Chanzu Limited on whether to undertake the project.

(ii). Comment on the impact of inflation in (c) (i) above.

2a

Portfolio theory and analysis

The following information relates to two mutual funds operating in your country:

	Omega Mutual fund	Beta Mutual fund
Reahsed return	13%	18%
Beta	1.0%	2.0%
Standard deviation	19%	15%

Additional information:

1. The return on the market index is 12%.

2 The risk free rate is 8%.

Required:

For each of the above mutual funds, compute the following performance index scores

(i). Jensen's alpha.

(ii). Treynor's alpha.

(iii). Sharpe index for the funds and the market,

2b

Portfolio theory and analysis

The estimated factor sensitivities of Diamond Ltd. to Fama-French factors and the Pastor-Stambaugh model factors and the risk premium associated with those factors are given in the table below:

	Factor sensitivity	Risk premium (%)
Market factor	1.05	5.00
Size factor	-0.65	2.50
Value factor	-0.20	4.50
Liquidity factor	0.20	4.50
The treasury bill rate is 5%

Required:

(i). The required rate using the Fama-French model.

(ii). The required rate of retumusing the Pastor-Stambaugh model (PSM).

2c

Financial risk management

You have recently been hired as a financial manager at Panblock Limited, a locally incorporated company that deals in imported building materials from the United States of America (USA). As the person in charge of negotiating the exchange rates, you have noted the following indicative exchange rates and interest rates:

3-months forward exchange rates	105 KES/USD
Spot exchange rate	100 KES/USD
3-months interest rate in Kenya	8% per annum
3-months interest rate in USA	5.8% per annum

Assume that Panblock Limited can borrow as much as KES 1,000,000.

Required:

(i) Determine whether the interest rate parity (IRP) is currently holding.

(ii) Demonstrate how you could undertake a covered interest arbitrage assuming that IRP is not holding.

(iii) Determine the arbitrage profit.

3a

Real estate finance

Explain the difference between the following terms as applied in mortgage and financial markets:

(i). "Primary mortgage market" and "secondary mortgage market".

(ii). "Fixed-rate mortgage" and "adjustable-rate mortgage

(iii) "Lien" and "recourse"

3b

Portfolio theory and analysis

The shareholders of Mali Investment Holdings have for the last two years managed to save an accumulated fund of Sh.15 million available for investment. A financial analyst they hired to appraise some possible projects they can invest in, has availed the following information,

Project	Initial cash outlay Sh."000"	Expected return (%)	Standard deviation (%)
P Q R S	9,000 7,000 6,000 8,000	12 21 16 14	2.5 1.8 2.3 1.6

The co-variances between various projects contribution are as follows:

Project pairing	Covariance
PQ PR PS QR QS RS	-3.1 1.3 -4.1 1.5 1.7 2.7

Additional information:

1. The management is planning to invest by pairing the projects.

2 The maximum capital that can be invested is the accumulated fund as shown above.

3. Any paired project is mutually exclusive and none of the projects is divisible.

Required:

(i) For each possible project pair combination, calculate the expected return, correlation coefficient and standard deviation.

(ii) Advise the shareholders of Mali Investment Holdings on the optimal project pair based on the mean variance criterion.

4a

International financial management

Explain the following terms as used in the context of international parity conditions:

(i). Interest rate parity.

(ii). Purchasing power parity.

(iii) International Fisher effect.

4b

Financial risk management

An investor has acquired a call option whose exercise price is Sh. 100. The option's premium is Sh.5 per option.

The following are the possible market prices (in shillings) of the option:

114 112 110 108 106 105 104 102 100 98 96 94

Required:

(i). Determine the options value based on each of the above market prices.

(ii). Determine the profit or loss associated with the option on the basis of each of the possible market prices

(iii).Represent the information in (b) (ii) above in a diagram where the x- axis represents market price and y - axis represents profit or loss for the option buyer.

(iv).Interpret the graph in (b) (iii) above.

4c

Advanced capital budgeting decision

Describe four types of real options available to the management while making strategie capital budgeting decisions of a firm.

5a

Mergers and acquisitions

Explain six reasons why mergers and acquisition deals fail despite good planning,

5b

Advanced financing decision

Zeltex Ltd. is an unlevered firm. The firm expects to generate operating profit (EBIT) of Sh.20 million each year to perpetuity.

The firm's current market value is Sh.80 million and pays corporation tax at the rate of 30%. The management of the firm is considering the use of debt financing. The firm's financial analysts have estimated that the present value of any future financial distress costs is Sh.8 million and that the probability of financial distress would increase with leverage according to the following schedule

Value of debt(Sh.m)	Probability of financial distress	Pre-tax cost of debt (%)
2.5 5.0 7.5 10 12.5 15 20	0.00 0.0125 0.025 0.0625 0.125 0.3125 0.75	6 7.5 9 10 11.5 12.5 14

Additional information:

1 The firm's ungeared asset beta is 0.60.

2. The risk free rate of return is 8%-

3. Expected return of the market portfolio is 15%.

4. The cost of equity of a levered firm shall be captured using capital asset pricing model (CAPM).

5. The Hamada model shall be applied to capture the levered equity Beta.

Required:

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

(ii). The firm's optimal level of debtising the "pure" Modigliani and Miller with corporation tax model

(iii).The firm's optimal weighted average cost of capital (WACC) and hence its optimal capital structure proportions

November 2020

Download Complete Period

Questions

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?

Want to join the discussion?