FINANCIAL MANAGEMENT CAT 2 

QUESTION 1 

Tezo ltd is in the process of modernizing its operation. The factory manager has proposed the proposed the replacement of the milling machine with a new fully computerized machine. The milling machine was purchased two years ago at a cost of sh 4 million. 

The economic life of the machine was 5 years. However, a management review has established that the machine has a further useful life of 5 years with a zero salvage value. The machine can be disposed of immediately at sh.2.8million. The new machine has a purchase price of sh.8 million with an additional installation cost of sh.2 million and a salvage value of sh. 1.5 million. 

The new machine will lead to increase efficiency and annual savings in costs of sh. 2.5 million. However, electricity costs will increase by sh.100, 000 per annum. 

The operation of the new machine will also require an increase of sh.500, 000 of working capital. The company uses the straight line method of depreciation. The company cost of capital is 10% and the corporate tax rate is 30% Required: Advise the management of Tezo ltd on whether to replace the machine. (10 marks)

 QUESTION 2 

The following details relates to the capital project in JM ltd. Project cost sh. 65 million. Annual cash flows after tax sh. 21 million. 

Project economic life 5 years Required rate of return 12% Required: 

(a) Internal rate of return (IRR) (2 marks) 

(b) Profitability index (PI) (2 marks) 

(c) Net present value (NPV) (2 marks) (d) Explain 4 factors to consider when making capital structure decisions. (4 marks 

QUESTION 3 

The following data show the returns of two stocks, A and B and their respective probabilities of occurrence: probability Returns of stock A (%) Returns of stock B (%) 0.30 10 8 0.30 7 12 0.40 13 7

 Required: 

a) The expected returns of stock A and B (2 marks) 

b) The standard deviation of the returns of stock A and stock B (3 marks) 

c) Suppose that a portfolio is created composed of 70% of stock A and 30% of stock B. Determine this portfolio's risk in terms of portfolio standard deviation (5 marks) 

 

d) The Correlation coefficient between security A and B returns (4 marks) 

QUESTION 4

 New ways ltd intends to raise new capital to expand its production level. The company plans to undertake the following financial decisions; 1. Issue 200,000 ordinary shares which have a par value of sh.10 at sh.16 per share. 

The floating cost per share is sh.1. 2. Issue 75,000, 12% preference shares which have a par value of sh.20 at sh.18 per share. 

The total floatation cost is sh. 150,000. 3. Issue 50,000, 18% debentures which have a par value of sh.100 at sh.80 per debenture. 4. Borrow sh. 5million, 18%long term loan. The total floatation cost is sh. 200,000. Additional information:  

The company paid 28% ordinary dividends which are expected to grow at the rate of 4% per annum.  The corporate tax rate is 30%. Required: a. The total capital to be raised net of floatation cost (3 marks) b. The weighted marginal cost of capital (7 marks) 

QUESTION 5 

JED ltd intends to invest surplus funds in shares with the following returns expectations: Economic conditions probability share returns Boom 0.20 40% Average 0.60 15% Recession 0.20 -10% Required: Using the coefficient of variation, assess the risk level associated with the investment (6 marks)