KASNEB Financial Management - Question 2a

Outline FOUR applications of cost of capital to a firm ... [Click to view full question and step-by-step solution]

KASNEB Financial Management - Question 2b

Kugoh Ltd. is considering whether or not to purchase a new machinery on 15 December 2024. Additional information: The machinery will cost Sh.4,000,000 an... [Click to view full question and step-by-step solution]

KASNEB Financial Management - Question 4a

Highlight FOUR limitations of profit maximisation goal of a firm. ... [Click to view full question and step-by-step solution]

KASNEB Financial Management - Question 5b

Explain THREE components of a financial plan in relation to personal financial management. ... [Click to view full question and step-by-step solution]

FM December 2024 Past Paper & PDF Solutions

1a

The financing decision

Explain FOUR reasons why a listed company would prefer to raise capital using equity finance instead of using debt finance.

1b

Introduction to capital budgeting decisions

(i) In relation to capital budgeting decisions, explain the term “abandonment value”.

(ii) Magenty Ltd. has presented the following information relating to a project under consideration:

Year	Cash flows	Abandonment value
	Sh.“000”	Sh.“000”
0	(6000)	-
1	3,000	6,000
2	2,800	5,000
3	2,500	4,000
4	2,000	-

The company’s cost of capital is 12%.

Required:

Using suitable computations, advise the management of Magenty Ltd. on when to abandon the project.

1c

Introduction to capital structure decisions

Transline Ltd. is a newly incorporated company. The directors are considering various alternatives of raising Sh.200 million as venture capital to buy a new equipment. Two options of raising the needed capital have been presented to them:

Option.A:	Issue ordinary shares of Sh.10 each at par for the full amount of Sh.200 million.
Option.B:	Issue ordinary shares of Sh.10 each at par for Sh.120 million and issue new 8% debentures to raise the remainder of the funds.

Additional information:

Earnings before interest and tax (EBIT) is expected to be 20% of the cost of the equipment.
The corporate tax rate is 30%.
The company’s price earnings (P/E) ratio is 8 times.

Required:

(i) Advise on the most preferable financing option for the company based on earnings per share (EPS).

(ii) Calculate the possible range of ordinary share prices within which each of the financing options in (c) (i) above would be recommended.

1d

Islamic finance

While Islamic finance offers an alternative approach of finance based on sharia principles, it is not without its challenges and deficiencies.

Required:

Explain TWO common deficiencies associated with Islamic finance.

2a

Business/Financial asset Valuation models Introduction to capital budgeting decisions Introduction to capital structure decisions

Outline FOUR applications of cost of capital to a firm

2b

Introduction to capital budgeting decisions

Kugoh Ltd. is considering whether or not to purchase a new machinery on 15 December 2024.

Additional information:

The machinery will cost Sh.4,000,000 and it would have a useful life of four years, after which it would be sold for Sh.500,000.
The machinery would attract tax allowable depreciation at the rate of 25% per annum on a reducing balance basis which could be claimed against taxable profits of the current year.
A balancing allowance or charge would arise on disposal. The tax rate is 30% per annum. Half of the tax is payable in the current year and the balance the following year in arrears.
The machinery would create annual cost savings of Sh.1,400,000.
The after tax cost of capital of Kugoh Ltd. is 8%.
Depreciation is first claimed against year zero profits.

Required:

(i) Compute the annual after tax cash flows associated with purchasing the machinery.

(ii) Compute the net present value (NPV) of purchasing the machinery.

2c

Business/Financial asset Valuation models

Lama Ltd. currently pays a dividend of Sh.2 per share on its ordinary shares. The company expects to increase the dividend at an annual rate of 20% for the first four years and at 13% annual rate for the next four years and then grow the dividend at an annual rate of 7% thereafter to perpetuity. This phased-growth pattern is in keeping with the expected life cycle of earnings. The company require a 16% return to invest in these shares.

Required:

Determine the value of Lama Ltd. shares using the Gordon’s growth model.

3a

Business/Financial asset Valuation models Introduction to portfolio analysis

Distinguish between “Fundamental theory” and “Random walk theory” in relation to valuation of financial assets.

3b

Financial statements analysis and forecasting

The following information has been extracted from the published financial statements of Simlon Ltd., a company listed at the securities exchange:

	Sh.“000”
Net profit after tax	2,000
Dividend payable for the period	(500)
Transfer to reserves	1,500
Accumulated reserves brought forward	700
Accumulated reserves carried forward	2,200
Ordinary share capital (Sh.20 par value)	16,000

The current market price per share (MPS) is Sh.15.

Required:

Calculate the following financial ratios and indicate the importance of each ratio to Janet Okari, a shareholder in the company:

(i) Earnings per share (EPS).

(ii) Earnings yield.

(iii) Dividend cover.

(iv) Market value to book value ratio.

3c

Introduction to capital budgeting decisions

Safari Ltd. is contemplating purchase of a motor van for their rental business activities. The firm expects that the investment in the motor van shall generate annual after tax cash benefits of Sh.300,000 and that they can sell it for Sh.150,000 after five years. All the monies for purchasing the van shall come from the firm’s savings which are currently earning an interest rate of 16% per annum after taxes.

Required:

(i)	Compute the maximum price payable to acquire the van today (Time 0).
(ii)	Assuming that the firm is of good credit rating and that it chooses to borrow the funds instead of using its savings. The firm has two alternative financing options of raising the funds as provided below:
	Option 1:	Finance Company: The firm can borrow from a finance company which requires it to make five annual equal instalments of Sh.277,963.75 covering both principal and interest.
	Option 2:	Insurance Company: The insurance company requires the firm to make a lumpsum payment of Sh.1,850,000 covering both principal and interest at the end of five years.
	Required: Using suitable computations, advise the management of the firm on the suitable financing option to apply.

4a

Overview of financial management

Highlight FOUR limitations of profit maximisation goal of a firm.

4b

Financial institutions and markets

Financial institutions often employ risk management strategies and adhere to regulatory requirements to mitigate these risks and ensure stability in their operations. However, the dynamic nature of the financial industry requires ongoing monitoring and adaptation to emerging risks.

Required:

In relation to the above statement, describe SIX types of risks facing financial institutions in your county.

4c

Working capital management

Nyota Ltd. is a firm operating in the manufacturing industry. The firm currently adopts a very stringent credit policy but is considering relaxing its terms of sale. The firm currently sells goods on credit on terms of net 60. However, the management is considering offering terms of 3/10 net 75. The current average collection period is 45 days. This period is expected to increase to 60 days after the change of terms. All credit customers will take the discount offer.

The firm’s current level of sales is Sh.15,000,000 per annum but is expected to increase by 25% after the change of terms. The variable costs are usually 40% of sales and 80% of sales are on credit basis.

The bad debts are 5% of credit sales and debt collection expenses are expected to increase by 10% from the current level of Sh.300,000.

The corporate tax rate is 30% and the cost of capital is 18%.

Assume 360 days in a year.

Required:

Advise on whether the firm should change its current terms of sale or not.

5a

Dividend decision

A newly listed company at the securities exchange is planning to pay its first dividends. The finance director has been requested by the Board of Directors to formulate the dividend policy of the company.

Required:

Summarise FOUR factors to be considered while formulating the dividend policy of this newly listed company.

5b

Personal financial management

Explain THREE components of a financial plan in relation to personal financial management.

5c

Introduction to portfolio analysis

The returns of Saflox Limited shares and the returns on the securities exchange index and associated probabilities in different possible economic states of the economy that might prevail next year are illustrated below:

Economic conditions	Probability	Market return (%)	Saflox Limited returns (%)
Rapid expansion	0.30	25	13
Moderate expansion	0.25	20	10
No growth	0.45	15	8

Required:

(i) The expected return of the market and that of Saflox Limited shares.

(ii) The correlation coefficient between the returns at the securities exchange with the returns of Saflox Ltd. shares.

December 2024

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