There are two mutually exclusive projects under active consideration of a company. Both the projects have a life of 5 years and have initial cash outlays of $100,000 each. The company pays tax at 50% rate and the maximum required rate of company has been given as 10%. The straight line method of depreciation will be charged on the projects. The projects are expected to generate a net cash flow before taxes as follows:

Year	Project X	Project X
1 2 3 4 5	40,000 40,000 40,000 40,000 40,000	60,000 30,000 20,000 50,000 50,000

Required:

With the help of the above given information, calculate.

1. The pay-back period of each project
2. The average rate of return of each project
3. The net present value of each project. (14 Marks)

QUESTION TWO [15 MARKS]

KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business risk and are almost identical in all respects for their capital structures and total market values. The companies capital structures are summarised below:

KK Ltd. Sh.’000’

Ordinary shares (Sh.50 par value) 40,000

Share premium account 90,000

Profit and loss account 73,000

Shareholders’ funds 203,000

KK Ltd shares are trading at Sh.140

KT Ltd. Sh.’000’

Ordinary shares (Sh.100 per value) 50,000

Share premium account 16,000

Profit and loss account 88,000

Shareholders’ funds 154,000

12% debentures (newly issued) 50,000

204,000

KT’s ordinary shares are trading at Sh.170 and debentures at Sh.100. Annual earnings before interest and tax for each company is Sh.50 million.

Corporate tax is at the rate of 30%.

Required:

1. If you owned 4% of the ordinary shares of KT Ltd. and you agreed with the arguments of Modigliani and Miller, explain what action you would take to improve your financial position. (7 marks)
2. Estimate by how much your financial position is expected to improve. Personal taxes may be ignored and assumptions made by Modigliani and Miller may be used. (8 marks)

Question THREE

There has been controversy, especially in a number of shareholders meetings regarding the payment and non-payment of dividends. In some companies, the directors are recommending nonpayment of dividends while in others, the shareholder hold view that the recommended dividend is too low.

Required:

1. In line with the above statement explain any three factors to be considered by the directors in the design of dividend policy (3 Marks)

1. Should the shareholders be the ones to decide how much divided to be paid? Explain your position. (4 Marks)

1. Does the payment of dividends influence the share price? Explain using examples (3 Marks)