Question 1:

a) In making capital structure decisions, managers face the "risk-return" dilemma.

Describe the risk return dilemma in the context of capital structure decisions and explain ways in which managers may resolve this dilemma.

Question 2:

Innovative Solutions Limited, a company listed at the Securities Exchange is planning to raise Sh. 110 Million through a rights issue. The new shares will be offered at a 20% discount to the current share price of which is Sh. 35 per share. The rights issue will be on a 1 share for every 5 and issue costs will be Sh. 2,800,000 (will be paid out of the cash raised).

The funds raised will be used to pay off a loan that had been borrowed 3 years ago essentially eliminating debt from the capital structure.

Discuss the effect that the rights issue will have on: -

The voting rights of the shareholders

The shareholders who will not take up the rights

The overall cost of capital

The value of the shares

The Debt/Equity ratio and comment if a rights issue would be the optimal solution to the elimination of debt.

Question 3:

New Ventures Limited is newly incorporated company. Its directors are considering alternatives of raising Sh. 100 million being the capital required to start the company's operations. The facts relating to the company are as follows:

a) Ordinary shares can be issued at a price of Sh. 10 per share. The company's projections are that they will be able to pay a dividend of Sh. 2 per share after one year. After the first-year dividends will increase by 6% every year.

b) The company can borrow at the rate of 14% per annum for 6 years.

c) The company's income tax rate is 30%.

Required:

i. How can the directors of New Ventures Limited use the Weighted Average Cost of Capital to inform their decisions?

ii. Determine the Weighted Average Cost of Capital if New Ventures Limited: -

Uses 100% equity to finance its operations

- Uses 60% equity and 40% debt to finance its operations

- Uses 50% equity and 50% debt

iii. What challenges would the Directors of New Ventures Limited face in using the Weighted Average Cost of Capital to inform their decisions

Question 4:

Uptown Interior Design has the same market value as the book value of its balance sheet accounts. The company has 80,000 shares of stock outstanding and trading in the market. The company's balance sheet as at 31 July 2020 is presented in the following table.

Assets: Sh.

Non-current assets 1,600,000

Cash 250,000

Inventories 50,000

Total Assets 1,900,000

Equity Ordinary shares 80,000 shares @ 15 1,200,000

Retained profits 400,000

Total Equity 1,600,000

Long-term Debt 300,000

Equity and Debt 1,900,000

The directors' are planning for a meeting that will be held on 20 August 2020 and amongst other things, they will be discussing the dividends to be proposed to the shareholders during the Annual General Meeting and the effect that that dividend will have on the current share price. Since its incorporation, Uptown Interior Design has never had a dividend policy and the payment of dividends has been erratic. The Company Secretary has advised you to structure a board paper that will guide the decisions on the agenda "Dividends for the year ended 31 July 2020"as follows:

Part I: Provide A Critical Analysis of the need for the company to have a Dividend Policy. In your response state the various ways in which the dividend policy can be designed.

Part II: The main arguments or theories that if applicable would influence the value of the company's share moving forward.

Part III: Using the information available in the balance sheet, considerations that the directors should follow in proposing the dividend policy.

Part IV: The legal propositions that guide payment of dividends for companies that are listed at the Nairobi Securities Exchange.

Part V: Calculate the value of the share of Uptown Interior Design on 31 July 2020 and explain the immediate effect of declaring a dividend of Sh. 3.5 per share on the value of the share and liquidity of the company.

Part VI: Conclusions based on your personal recommendations to the directors.