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CPA Financial Management – November 2016 Past Paper & Answers

Unit: Financial Management

13 Questions

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Questions

Download CPA Financial Management November 2016 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 Financial Management Past Papers

1a
The financing decision
​​Explain four disadvantages of public private partnerships (PPPs).
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1b
The financing decision
​​Describe six steps involved in personal financial planning
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1c
Financial statements analysis and forecasting
​ ​​The following data was extracted from the financial statements of XYZ Limited for the year ended 30 September 2016.
  
Total assets
Sh.7,000,000
Total liabilities
Sh.4,000,000
Preference share capital
Sh.500,000
Earnings per share (EPS)
Sh.1.10
Price-earnings (P/E) ratio
15
Outstanding number of ordinary shares
400,000

Required: 
(i) Book value per share. 
(ii) Market price per share. 
(iii) Market value to book value ratio.
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2a
Contemporary issues and emerging trends
​​Discuss three possible solutions to adverse selection.
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2b
Introduction to capital structure decisions
​​Sandy Ltd. presented the following extracts of the statement of financial position as at 31 October 2016:

Equity
Sh. "000"
Sh. "000"
Ordinary shares (Sh.5 nominal value)
800,000
Reserves
3,600,000
4,400,000
Long term liabilities
4% preference shares (Sh.1 nominal value)
600,000
7% bonds (redeemable after 6 years)
600,000
Long term bank loan
200,000
1,400,000

Additional information: 
1.     Ordinary shares of Sandy Ltd. have an ex-div market value of Sh.47.00 per share and an ordinary dividend of Sh.3.63 per share has just been paid. 
2.     The following dividends have been paid over the past four years:

Year
2013
2014
2015
2016
Dividend per share (Sh.)
3.09
3.22
3.36
3.50

3.    The preference shares are not redeemable and have an ex-div market value of 40 cents per share. 
4.    The 7% bond is redeemable at 5% premium to their nominal value of Sh.100 per bond and have an exinterest market value of Sh.104.50.
5.    The bank loan has a variable interest rate that has averaged 4% per year in recent years. 
6.    The corporate tax rate is 30%. 

Required: 
(i)    The weighted average cost of capital (WACC). 
(ii)   Explain four reasons why the cost of equity could be greater than the cost of debt.
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3a
Financial statements analysis and forecasting
​The management of Georgina Ltd. wishes to establish the amount of external financial needs for the year ending 31 December 2016. The statement of financial position of the company as at 31 December 2015 was as follows:

Sh."000"
Plant and machinery
31,200
Furniture and fittings
18.720
Motor vehicles
12,480
Inventory
19,200
Account receivablés
14,400
Cash and bank
3,600

99,600
Financed by:
Ordinary share capital
42,000
Retained profit
17,600
14% debenture capital
10,000
Account payables
18,000
Accrued expenses
12,000
99,600

Additional information: 
1.   The sales for the year ended 31 December 2015 amounted to Sh.120.000.000. 
2.   The company forecasts that sales will increase by 10% for the year ending 31 December 2016. 
3.   For the year ended 31 December 2015, the after-tax profit of the company amounted to Sh.18,000,000. 
4.   The company adopts 80% payout ratio as its dividend policy. The payout ratio is expected to remain constant each year in perpetuity. 
5.   The after-tax profit margin is also expected to remain constant each year. 
6.   Assets are expected to vary directly with sales while account payables and accrued expenses form the spontaneous sources of financing. 
7.   Any external financing will be effected through long term debt financing.

Required: 
(i) The amount of external 12% long term debt financing that would be required for the year ending 31 December 2016. 
(ii) A forecast statement of financial position as at 31 December 2016. 
(iii) Comment on two weaknesses of the method of forecasting applied in (a)(i) and (a)(ii) above.
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3b
Working capital management
​​The following information was extracted from the financial statements of a manufacturing company:

Sh.
Average total debtors outstanding
48,000
Raw materials consumption
440,000
Total production cost
1,000,000
Total cost of sales
1,050,000
Sales for the year
1,600,000
Value of average stock maintained:

         Raw material
32,000
         Work in progress
35,000
         Finished goods
26,000
Number of days in a year
365
Average period of credit allowed to suppliers
16 days

Required:
(i) The operating cycle in days. 
(ii) The amount of working capital required.
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4a
Business/Financial asset Valuation models
​ ​​Bundacho Ltd. generated Sh.50 million profit after-tax in the previous financial year. The firm adopts 40% payout ratio as its dividend policy. The total number of issued ordinary shares are 10,000,000. 

The company has a potential investment opportunity. If undertaken, dividends are expected to grow at the rate of 10% each year for the first 3 years and then stabilise at the rate of 5% each year thereafter in perpetuity. 

The investor's minimum required rate of return is 18%. 

Required: 
The current intrinsic value of the share.
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4b
Business/Financial asset Valuation models
​​A firm issued 10% preference shares to raise funds. The shares have a par value of Sh.100 each and are currently selling at Sh.110 each. 

The minimum required rate of return by the investors is 8%. 

Required: 
Explain whether the share is overvalued or undervalued by the market.
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4c
Introduction to capital budgeting decisions
​​Mwarakaya Ltd. is considering the acquisition of a new machine to replace the existing machine currently being used in production processes. The existing machine was acquired 2 years ago at a cost of Sh.2,000,000. It was originally estimated to have a useful life of 5 years with no salvage value.

A critical evaluation of the machine now shows that the machine is usable for another 5 years with a salvage value of Sh.250,000 at the end of this period. The disposal value of the existing machine is currently estimated at Sh.1,250,000.

The new machine is estimated to cost Sh.3,140,000 and its estimated salvage value is Sh.1,000,000 at the end of its useful life of 5 years. The new machine will also require an additional investment in working capital of Sh.650,000 at the start of the asset's useful life.

The investment in working capital will however be recovered at the end of the 5 years useful life.

The following information relates to the estimated earnings before depreciation and tax (EBDT) over the coming five-vear period for the two machines. 

Year
New machine
Sh.
Existing machine
Sh.
1
2
3
4
5
1.400.000
1,350,000
3,000,000
1,450,000
1,200,000
800,000
700,000
750,000
650,000
600,000

The cost of capital is 10% and the firm applies the straight line method of depreciation. The corporate tax rate is 30%. 

Required: 
Using the net present value (NPV) technique, advise the company's management on whether to replace the existing machine. 
 
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5a
Business/Financial asset Valuation models
​ ​​ Explain the following terms as used in the bond market: 

(i) .   Yield-to-maturity (YTM). 
(ii).   Yield-to-call (YTC).
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5b
Business/Financial asset Valuation models
​​Kaoyeni Limited has issued a Sh.10,000 par value 10-year bond with a coupon rate of 12% per annum. The bond is currently trading at Sh.8,830 and is callable at Sh.10.500 after 5 years. 

The company pays interest on its bonds semi-annually. 

Required: 
(i) Yield-to-maturity of the bond. 
(ii) Yield-to-call of the bond.
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5c
Financial statements analysis and forecasting
​​​The following data was extracted from Mwakuhenga Limited's financial statements for the year ended 30 June 2016:
  
Sh.
Total sales
3,000,000
Variable costs
(900,000)
Contribution
2,100,000
Fixed costs
(1,500,000)
Earning before interest and tax (EBIT)
600,000
Interest
(75,000)
Profit before tax
525,000

Required: 
Using the concept of leverage, determine: 
(i).    The percentage taxable income if EBIT increases by 6%. 
(ii).   The percentage EBIT if there is a 10% increase in sales. 
(iii).  The percentage taxable income if sales increase by 8%.
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