CPA INTERMEDIATE LEVEL FINANCIAL MANAGEMENT
THURSDAY: 22 August 2024. Afternoon Paper. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.
QUESTION ONE
(a) Distinguish between the following sources of finance:
(i) “Venture capital” and “private equity”. (4 marks)
(ii) “Business angel finance” and “lease finance”. (4 marks)
(b) The principles that govern all ethical behaviour for finance managers in practice and in business helps them to navigate the complexity of their work.
Required:
In reference to the above statement, explain THREE fundamental principles of ethical behaviour. (6 marks)
(c) Zamole Ltd. is considering a project which requires an initial investment of Sh.156,000,000 in machinery. The machinery will last for four years after which it will have a scrap value of Sh.26,000,000. The additional investment in working capital will be Sh.19,500,000. The expected annual profits before depreciation are as follows:
| Year | Sh.“000” |
| 1 | 58,500 |
| 2 | 58,500 |
| 3 | 52,000 |
| 4 | 32,500 |
The company requires a minimum accounting rate of return of 15% from the projects of this type.
Required:
Determine the Accounting Rate of Return (ARR) and advise whether the project should be undertaken. (6 marks)
(Total: 20 marks)
QUESTION TWO
(a) Describe THREE types of money market instruments and their related transactions available in the financial system. (6 marks)
(b) (i) Samuel Mwongeka intends to invest Sh.200,000 at the beginning of each year in treasury bonds which earns a return of 9% per annum.
Required:
Determine the accumulated value of investment after ten years. (2 marks)
(ii) Determine the present value of Sh.1.2 million annuity payable for 20 years at an interest rate of 8% per annum. (2 marks)
(c) Sytrax Ltd. is a listed company with 100 million shares in issue. The following additional information is available:
1. The company has a current ex-dividend ordinary share price of Sh.25.00 per share.
2. The company also has in issue bond with a book value of Sh.60 million with a current ex-interest market price of Sh.104 per Sh.100 bond.
3. The current after tax cost of debt of Sytrax Ltd. is 7% and the corporate tax rate is 30%.
4. The dividends per share of the company are as follows:
| Year | 2019 | 2020 | 2021 | 2022 | 2023 |
| Dividend per share (Sh.) | 1.94 | 2.00 | 2.06 | 2.12 | 2.18 |
5. The finance director proposes to decrease the weighted average cost of capital of Sytrax Ltd. and hence increase its market value by issuing Sh.40 million bonds at their par value of Sh.100 per bond. These bonds would pay annual interest rate of 8% before tax and would be redeemed at a 5% premium to par after 10 years.
Required:
Calculate the market value after tax weighted average cost of capital of Sytrax Ltd. in the following circumstances:
(i) Before the new issue of bonds take place. (5 marks)
(ii) After the new issue of bonds takes place. (5 marks)
(Total: 20 marks)
QUESTION THREE
(a) Remi Limited anticipates to spend Sh.150 million cash outlay to install a new production line in their factory. The cash outlays are expected to occur equally throughout the year. The company’s treasurer reports that the firm can invest in marketable securities yielding 8% per annum. The cost of shifting funds from marketable securities portfolio to cash is Sh.7,500 per transaction.
Assume the company will meet its cash demands by selling marketable securities.
Required:
Using the Baumol cash management model:
(i) Determine the optimal size of the company’s transfer of funds from marketable securities to cash. (2 marks)
(ii) Compute the company’s average cash balance. (1 mark)
(iii) Determine the number of transfer from marketable securities to cash during the year. (1 mark)
(iv) Compute the total cost associated with the company’s cash requirements. (2 marks)
(b) The following information relates to the market price per share of Wendoh Limited over a period of five years:
| Year | Market price per share (Sh.) |
| 2023 | 28 |
| 2022 | 22 |
| 2021 | 18 |
| 2020 | 25 |
| 2019 | 28 |
Required:
(i) The expected return of the shares of the company. (4 marks)
(ii) Comment on the performance of the company based on the movement of its share price over the last five years. (2 marks)
(c) Quantum Product Limited wishes to increase the number of its retail outlets in the country. The board of directors of the company has decided to finance the acquisition by raising funds from the existing shareholders through a one for four rights issue.
The recently published comprehensive income statement of the company for the year ended 31 December 2023 provided the following information:
| Sh.“million” | |
| Turnover | 246.75 |
| Profit before interest and tax | 18.90 |
| Interest | (9.30) |
| Profit before taxation | 9.60 |
| Corporate tax | (2.85) |
| Profit after taxation | 6.75 |
| Ordinary dividends | (3.00) |
| Retained profit for the year
|
3.75 |
Additional information:
1. The share capital of the company consists of 12 million ordinary shares with a par value of Sh.5 per share.
2. The shares of the company are currently being traded on the Securities Exchange with a price earnings (P/E) ratio of 22 times.
3. The board of directors of the company has decided to issue the shares at a discount rate of 10% on the current market value.
Required:
(i) The theoretical ex-rights price of an ordinary share of the company. (6 marks)
(ii) The price at which the rights in the company are likely to be traded. (2 marks)
(Total: 20 marks)
QUESTION FOUR
(a) Highlight FOUR disadvantages of securitisation as used in Islamic Finance. (4 marks)
(b) In relation to personal financial management:
(i) Explain the term “estate freezing”. (2 marks)
(ii) Describe TWO advantages of estate freezing. (2 marks)
(c) Faidika Enterprises is in the process of preparing a cash budget for the four months starting 1 September 2024. The business produces and sells a single product branded “K” whose details are as follows:
• Direct materials is Sh.5 per unit.
• Direct labour cost is Sh.10 per unit.
• Variable overheads is Sh.6 per unit.
• The selling price per unit is Sh.40.
Additional information:
1. Projected sales and production units information is provided as follows:
| 2024 | ||||||
| Details | July | August | September | October | November | December |
| Sales (units) | 130,000 | 150,000 | 170,000 | 190,000 | 180,000 | 180,000 |
| Production (units) | 140,000 | 150,000 | 180,000 | 200,000 | 220,000 | 220,000 |
2. Variable overheads are paid in the month that they are incurred.
3. Fixed overheads are budgeted at Sh.700,000 per month which includes depreciation of Sh.100,000.
4. Wages are paid 75% during the month in which they are earned and 25% in the following month.
5. Material costs are paid 2 months in arrears.
6. A tax liability of Sh.1,400,000 to be settled in the month of October 2024.
7. A new van will be purchased in the month of September 2024 for Sh.2,000,000.
The current motor vehicle shall be sold in the month of November 2024 and it is expected to fetch Sh.300,000 from a prospective buyer.
8. The cash balance at the end of the month of August 2024 is expected to be Sh.1,000,000.
9. The business makes a monthly cash sale of 5% of total sales in a specific month while the remainder is on credit which is settled one month after the month of sale.
Required:
Prepare a cash budget for the months commencing 1 September 2024 to 31 December 2024. (12 marks)
(Total: 20 marks)
QUESTION FIVE
(a) Examine THREE types of dividend policies that might be adopted by a company. (6 marks)
(b) Analyse FOUR differences between “efficient market hypothesis and “behavioural finance”. (4 marks)
(c) Bamboo Limited is contemplating reviewing its credit policy by introducing a cash discount of 2% for payment made within 10 days of purchase.
Additional information:
1. The firm’s current average collection period is 30 days.
2. The company makes an annual credit sales of 120,000 units at a unit price of Sh.10.
3. Variable cost per unit is Sh.6 and average cost per unit is Sh.8.
4. If the cash discount is initiated, 70% of sales will be on discount and sales will increase by 10%.
5. The average collection period will drop to 15 days.
6. Bad debt expenses currently at 2% of sales will fall to 1%.
7. Total working capital needed will not be affected by the cash discount.
8. The firm’s required return on investment is 12%.
Assume no additional capital investment will be necessary.
Required:
(i) Compute the net benefit or net loss arising from review of the credit policy. (8 marks)
(ii) Advise Bamboo Limited on whether or not to introduce a cash discount to its customers. (2 marks)
(Total: 20 marks)
