CPA › Financial Management › November 2020

CPA Financial Management – November 2020 Past Paper & Answers

Unit: Financial Management

11 Questions

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Download CPA Financial Management November 2020 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
Islamic finance
​ ​​Islamic banking is grounded on Sharia Law. To earn money, Islamic banks use equity participation system.

Required:
With reference to the above statement

(i).    Explain the term "equity participation system".
(ii).   Discuss three principles of Islamic finance.
(iii).  Describe two types of financing arrangements that could be adopted under Islamic finance
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1b
Financial institutions and markets
​ ​​In the context of financial markets.

(i).  Distinguish between "commodities markets" and "derivatives markets"
(ii). Summarise four functions of financial markets
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2a
Introduction to capital structure decisions
​ ​ ​ ​ ​ ​​Jaribu Ltd has been operating in the country for many years. The directors of the company wish to raise additional capital through a rights issue in order to explore opportunities in the region. The directors have decided to make a one-for-five rights issue at a discount rate of 30% on the current market value. The company's most recent financial statements are presented below:

Income statement for the year ended 31 March 2020
Sh. "million"
Sales
1,400
Net profit before interest and taxation
52
Interest payable
24
Net profit before faxation
28
Corporation taxation
7
Net profit after taxation
21
Ordinary dividends payable
14
Retained profit for the year
7
Capital and reserves as at 31 March 2020
Sh. "million"
Sh. 0.25 ordinary shares
60
Revaluation reserves
140
Accumulated profits
320
520

Additional information:
  1. The shares of the company are currently traded at the local Securities Exchange at a price to earnings(P/E) ratio of 16.
  2. An investor holding 10,000 ordinary shares in the company has received the information on the forthcoming rights issue, but cannot decide whether to take up the rights issue, sell the rights or allow the rights to lapse.

Required:
(i).    The theoretical ex-rights price of an ordinary share.
(ii).   The price at which the rights are likely to be traded.
(ii).   Evaluate each of the three options available to the investor with 10.000 ordinary shares.
(iv).  Comment on the wealth of the investor hased on each of the options evaluated in (a) (ii) above.
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2b
Working capital management
​ ​​Nderu Suppliers Ltd. is reviewing its working capital commitments for enhanced efficiency.

The following information relating to the period ended 31 March 2020 is provided:

Turnover for the year
Sh.15,000,000
Costs as percentages of sales
(%)
Direct materials
30
Direct labour
25
Variable overheads
10
Fixed overheads
15
Selling and distribution
  5

Additional information: 

1.  On average:
  • Account receivables take two and a half months before payment.
  • Raw materials are in inventory for three months.
  • Work in progress represents two months worth of half produced goods
  • Finished goods represent one month's production.
2. Credit is taken as follows:

  • Direct materials             2 montlis    
  • Direct labour                  1 week
  • Variable overheads        1 month
  • Fixed overheads            1 month
  • Selling and distribution   Half a month
3.  Work in progress and finished goods are valued at material, labour and variable expenses cost.
4.  Labour force is paid for 50 working weeks a year.

Required:
Assess the working capital requirements for the conmpany.
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3a
​ ​ ​​The following information relates to Bawabu Traders:

  1. The minimum cash balance is Sh.8,000.
  2. The variance of daily cash flows is Sh.4,000,000, equivalent to a standard deviation of Sh. 2,000 per day.
  3. The transaction cost for buying or selling securities is Sh.50.
  4. The interest rate is 0.025 per cent per day.

Required:
Using Miller-Orr Model of managing cash, determine the following:

(i).   The spread.
(ii).  Upper cash limit.
(iii). Return point.
(iv). Propose a decision rule for cash management to the company based on your calculations in (a)(i) to (a) (iii) above
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3b
Introduction to capital structure decisions
​ ​​The following information was extracted from the books of Domingo General Merchants Ltd:
Statement of financial position as at 31 December 2019:

Sh."000"
Sh."000"
Non-current assets
10,115
Investments
821
Current assets
3,658
Less: Current liabilities
(1,735)
1,923
Total assets
12,859
Financed by:
Ordinary share capital: 3,000,000 shares each Sh.1
3,000
General reserves
7,125
Shareholders' funds
10,125
7% Bonds
1,300
Corporation taxation
1,434
Corporation taxation
12,859

Summary of profits and dividends:

Year ended 31 December
2015
Sh. "000"
2016
Sh. "000"
2017
Sh. "000"
2018
Sh. "000"
2019
Sh. "000"
Profit after interest and before tax
1,737
2,090
1,940
1,866
2,179
Less: Tax
(573)
(690)
(640)
(616)
(719)
Profit after interest and tax
1,164
1,400
1,300
1,250
1,460
Less: Dividends
620
680
740
740
810
Retained earnings
544
720
560
510
650

Additional information:

  1.  The bonds are redeemable at par in ten years time.
  2.  The current (1 January 2020) market value of ordinary shares is Sh.3 per share ex div.
  3.  The current market value of the bonds is Sh.77.10 per Sh/100 of nominal value and the annual interest has just been paid on the bonds.
  4.  There have been no issues or redemptions of ordinary shares or bonds during the past five years.
  5.  The corporate tax rate is 30%. Assume that there have been no changes in corporate tax rate for the past five years.

Required:
The weighted average cost of capital (WACC) that the company should use as a discount rate when upprausing new investment opportunities
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4a
Introduction to capital budgeting decisions
​ ​​Ulanda Engineering Works Ltd. is contemplating the purchase of a new machine to replace the existing one. The existing machine was purchased two years ago at an installed cost of Sh.500,000. The machine was estimated to have an economic life of 5 years with nil salvage value but a critical analysis of its performance now shows that it is usable for the next five years with a resale value of Sh.100,000. The current disposal value of existing machine is Sh 200,000

The new machine would cost Sh.600,000 and require Sh.50,000 in installation cost. Since the machine is not locally available, the company plans to import it and will pay import duty and freight charges of Sh. 150,000 and Sh.100,000 respectively The new machine shall require an overhaul at the end of third year which is expected to cost Sh. 100,000.

The overhaul cost is to be amortised on a straight line basis over the remaining useful life of the machine

To support the increased business resulting from purchase of the new machine, accounts receivable would increase by Sh.250,000, inventories and accounts payable shall increase by Sh.200,000 and Sh.300,000 respectively

At the end of five years, the new machine would be sold for Sh.250,000.

The estimated profit before depreciation and taxes over the next five years period for both machines are given as follow's.

Year
Existing machine
Sh."000"
New machine
Sh."000"
1
2
3
4
5
120
150
180
145
135
260
280
250
240
270

Additional Information:

  1. The corporation tax rate is 30%.
  2. The company uses the straight line method of depreciation,
  3. The cost of capital is 13%.
  4. Capital gains are tax exempt.

Required:
(i).  The incremental initial cash outlay.
(ii). The incremental net operating cash flows associated with the proposed machine replacement.
(iii). Should the existing machine be replaced? Justify your answer
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4b
Introduction to capital structure decisions
​ ​​Upendo Ltd. has issued 5,000,000, Sh.20 par value ordinary shares which are presently trading at Sh.25 per share at the Securities Exchange. Upendo Ltd. has plans to issue rights to purchase one new ordinary share at a price of Sh.20 per share for every four shares held.

Required:
(i).  The theoretical ex-right price of Upendo Ltd.'s share.
(ii). The theoretical value of a right of Upendo Ltd. before the shares sell ex-right.
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5a
Introduction to capital budgeting decisions
​ ​​Donese Bid has a capital structure that consists of Sh.150 million, 15% debentures and Sh.450 million in ordinary shares of Sh. 20 par value.

The company adopts a 100% payout ratio as its dividend policy.

The finance manager of Donnat Ltd. intends to raise an additional Sh.20 million to finance an expansion programme and is considering two alternative financing options:

Option 1: IIssue a 12% debenture stock.
Option 2: IIssue additional ordinary shares of Sh.20 par value.

The corporation tax rate is 30%

Required:
Calculate the earnings before interest and tax (EBIT) and earnings per share (EPS) at the point of indifference in firm's earnings under financing option (1) and (2) above,
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5b(i)
Dividend decision
​​​(i). ​Walter's model on dividend policy believes in the relevance concept of a dividend. According to this concept, a dividend decision of the company affects its valuation.
     
      Required:
      Discuss four assumptions of Walter's model,
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5b(ii)
Introduction to portfolio analysis
​​Explain the risk-return trade off in the context of investments,
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