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CPA PART Ill SECTION 5

ADVANCED FINANCIAL MANAGEMENT.

THURSDAY: 20 so 2021. : Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to packs Hiestion areechawn at the ond of he pico
Show ALL your ee
QUESTION ONE.
(a) Citing four reasons. roe othe case he, fume lene kes Saal: rationing decisions ifin your mae -<-(4 marks)
(b) You have been appointed by Biosoft Limited to review three-investment project proposals.
The investment funds are
limited to Sh.8.000,000 in the current financial year. Details of the three possible
investment projects. none of which
can be delayed are given below:

Project 1: An investment of Sh.3,000,000 in workstation assessments. Each assessment would

Ke on an individual
_ employee basis and would lead to a saving in labour costs from increased effi iciency and
reduced “absenteeism: In
money terms, thé savings in labour costs are expected to be as follows:
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Year a. 2 Sie 4 5
Cash Flow (Sh. “000”) 850° «900° «9501.00 «950
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Project2: An investment of $h.4.500,000 in individual workstations

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for staff that is expected to reduce

administration cess by Sh.1,408, 000 per: anna in ey
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ferms oe Be nee five years.

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Project 3: ‘An investment of Sh.4, 500. 000 In new feket ee a net cash savings of Sh.1 .200,000 per annum is
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expected in current money terms and is projected to increase by3. a per annum Oe to inflebi.
during the five years
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life of the ince: :

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The money cost of capital for Biosoft Tinted is 12%.

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Required:
Advise the company on the project(s) to invest the available funds and calculate the
resultant net present fog (Nev)
assuming: ; : : - :
(i) The three projects are divisible.
(7 marks)
(ii) None of the projects is divisible. fas Be gate Cainer ee (3 marks)

(c) _ Dafina Limited is an export - import firm based in’Kenya. :

On | August 2020, the company exported tea to the United. States offAmerica (USA)
on a 3-month credit amounting
to US$10, 000.000.

a Additional information:
|, The rates in the forex and money market were as follows:
Ksh/LUSS
1 Decciie? 2020 101
Ree ey need t rates (per annum)
Kenya ue 18%
USA : i 12%
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2. The customer will settle the amount on | December 2020.

CAS3 Page 1
Out of 4
 Required: :
(i) Using the interest rate parity, determine thecexpected 3 -months forward exchange rate as at | December 2020.
(2 marks)

(ii) Using suitable computations, advise Dafina Limited on the better hedging strategy between a forward market
and money market hedge. (4 marks)
(Fotal: 20 marks)

QUESTION TWO
(a) In this era of globalisation, the functions of finance executives of multinational corporations
rp (MNCs) have become
complex.

eacee five
ive factors that the Chief Finance Officer ee) ofa MNC should EOP iter in inane international financial
management decisions.- j : (5 marks)

(b) The arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) have received much attention from
practitioners and academicians for their use in asset pricing and valuation,

Required:
Explain the difference between APT and the CAPM with respect to:

(ise Sector valley tinction: e mse)

(ii) Distribution of ae ie = | 5; S55 8 0 anarks)

(ii) The market portfolio. : ; | 2 marks)

() Zachary Se an investor holds the following pele of four risky assets and : a deposit in a risk-free asset.
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He has provided the information below:

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Asset Weighting — Current return

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Beta
-(%) — (%) ee
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A 20 12 1.5
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B 10 18 ; 2.0
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is 15 14 art?
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D 25 8
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0.9
Risk-free asset she 5 e

The overall return on the market portfolio of risky assets is 11%.

Required:
(i) _ Portfolio return and beta. Beis (2 marks)

(i) Using the results in (1) above, deduce the type of investor Zachary is. ~ (mark) -

(ill) Using suitable computations, determine the assets that are inefficient, efficient or super efficient. (4 marks)

(iv) Calculate the equilibrium return for the portfolio. 7 : (2 marks)

- (Total: 20 marks)

QUESTION THREE
(a) (i)_ Explain the meaning of the term “unbundling” as used in corporate restructuring and reorganisation. (2 marks)

(ii} Describe four forms of unbundling a firm. (4 marks)

CAS53 Page 2
Out of4
 (b) Bamboo Ltd. is caently an unlevered firm. The firm is expected to generate ; a constant operating profit (EBIT) of
$h.20 million per annum in perpetuity. The firm’s current market value is Sh.80- million.
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The management is considering undertaking an expansion activity by use of debt financing. The firm’s fi ea
analysts have estimated that the- present value of aiany future financial distress cost is Sh. 8 milfion. However, the
probability of distress would increase with leverage according to the following schedule:

Value of debt Proba bility of Pre-tax

Sh. “million” financial distress (%) cost of debt (“%)
2S: 0.00 ad
5.0 1.25 6
TS 2.5 10
l= 6.25 a 15
12.5 12.50 ye
15. 31.25 20
20 75 22
Corporation tax rate applicable is 30%.

_ Required: :
(i) The current cost of equity and weighted average cost of capital (WACC) of the firm. (2 marks)

(ii) Using the “pure” Modigliani and Miller (MM) with tax model, determine the optimal level of debt. (4 marks)

(iii) Evaluate the firm’s optimal capital structure when financial distress costs are included. (8 marks)
(Total: 20 marks)
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QUESTION FOUR
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Evaluate five defensive tactics available to a firm threatened iy a hostile takeover in the industry.
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— @) (5 marks)
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(b) Apco Limited is considering to acquire Alpha Limited. The following are the financial data for the two companies: —
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Apco Limited Alpha Limited

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Net sales (Sh.) 350,000 45,000

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Profit after tax (Sh.) 18,130 3,750

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Number of outstanding ordinary shares 7,500

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1,500
Earnings per share (EPS) 3.75 2.50
Dividend per share (DPS) 1.30 : 0.60
Total market capitalization (Sh.) 420,000 ~ 45,000

Required:
(i) Determine the pre-merger market value per share for both companies. (2 marks)

(it) Determine the post merger EPS, market price Pe share (hak) and price earnings (P/E) ratio. (3 marks)

(ili) Compare Apco Limited’s EPS assuming Alpha Limited’s shareholders are offered Sh.100,000, 5%
convertible debenture for each share held in Alpha Limited.

Assume a corporate tax rate of 30%. (2 marks)

(c) Makazi Ltd.’s current earnings per share is Sh.6.0. The firm has in issue 50 million ordinary shares which have a par
value of Sh.20 each. The firm’s total revenue and capital reserves amounts to Sh.500 million.

The company has an asset beta of 0.9 and a retention ratio of 60%.

The management of Makazi Ltd. intends to undertake a financial reconstt uction which will result in a debt-equity ratio
change from 0.45 to 0.2.

CA53 Page 3
Out of 4
 Additional information:
1. The risk free rate of return is 8%.
2. Expected rate of return of a market portfolio is 18%.
a Cuparcien tax rate is 30%.
4. The firm’s return on equity before and after the financial reconstruction will remain unchanged.

Required:
Evaluate the impact of the fi nancial reconstruction on the firm’s's share price. (8 marks)
(Total: 20 marks)

QUESTION FIVE
(a) Discuss four circumstances in which a decision could be made to liquidate a failing company rather than attempt to
carry out a reconstruction. (4 marks)

(b) Examine four advantages of investing in real estate. (4 marks)

(¢) Zedtech Ltd. wishes to design a new puecrel so as to catch the interest of their target market which is currently very
pee:

The company will have to invest Sh.100,000 at the ecinine of the first year (year 0) foe the design and oe testing ”
of the new pe

The company’s
¢ marketing manager believes that there is an 80% chance that this phase will be successful and the
project wil continue. If phase I is not successful, the projet wil be oie with zero salvage value.

The next phase, if uiideriaken would consist of mibie the moulds and atotucing &ten prototype products at a cost of .
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Sh.500,000 at the end of the first yedr. If the’ products test well, the company would go into full scale production. If
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they do not, the moulds and prototypes will all be sold for Sh.400,000. The manager estimates that oS is a 90%
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probability that the ae wail pass testing and phase 3 will be undertaken.
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Phase 3 consists of cheno over the firm’s current production line so as to be able to produce the new products.
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This will cost Sh.1,000,000 at the end of year 2. If the economic conditions are favourable at this juncture, the net
value of the firm’s cash flows are estimated to be Sh.3,500,000, while if the economic conditions are unfaVourable the
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net cash inflows are estimated at Sh.2,500 000. Both net cash flows are expected at the end of year 3,-and the two
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states of economy are equally likely.

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The firm’s opportunity cost of capital is 11%.

Required:
(i) Construet a Res tree to depict payoffs, aid hence determine the expected net rt value (NPV) of the
project. (6 marks)

(it) The project's Sepacee standard deviation and coefficient of NaarICIr (5 marks)

(iti) Assuming the firm’s average project had a coefficient of variation of between 1.0 and 2.0, explain dete:
_ the project would be of high, low or average risk.. (1 mark)
(Total: 20 marks) —
SS e cee se H enews ee ee tne n sence nantes Hee DOE Ose e eee eo ene Heer ter Hen HEuEeoHeee

CAS53 Page 4
Out of 4
 Present Value Interest factor of 1 Received at the End of n Periods atr Percent:

PVIF pn = 4/ (14> = (1 4+)"

1a 200 245%

0.7834 | 0.7695 | 0.7561 | 0.7432.| 0.6944 | 6.6504

4. |. 8.6750" | 6.6575 O.5787 |) 6.5245
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_ Present Value Interest factors for Annuity of 1 Discounted atr Percent for n Periods:
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(é) : Boas
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PVIFA;.n
= [t= 1/ (141) "Jr
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Dera ray coe : rE

0.9804: | 0.9709 |! 9.5645 09178 : a.g696 | o.eez1 | 0.8333
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49406 [9 1.8861 4.7584 4 4.6052 || 4.5278

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oF 27754 : 2.5313 | : : Figasa | 21065

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3.8077. 3.6205 3.2397-|- 3. z.

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47935

5.6014 ‘ 44859
5.0330.
T3255
8.1622
9.9326

$.7868

| é 47413
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49.600

3 21.832
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