FINANCIAL MANAGEMENT

Assignment
..

INSTRUCTIONS:
1. Answer All questions.
2. Present Logical and complete answers.
3. Marks for every question are indicated at the end of each question.

Q.1
a) We routinely assume that investors are risk averse risk seekers: i.e. they like returns
and dislike risk. If so, why do we contend that only systematic risk and not total risk is
important?
(5 Marks)
b) Achieng sold her produce to Migori cereals and produce board sometimes during the
year, due to some cash constraints, the company has pledged to pay her an annuity of Kshs.
5000 per year for four years beginning at year six. In addition, the company will also pay an
amount of kshs 500 forever as pension thereafter. If the interest rate is 10%, what is the
present value of her earnings?
(3 Marks)

c) What is the price of Musomi Academys stock today, assuming that they are just about to
pay a dividend of Kshs. 3.00 per share and that it is anticipate that the annual dividend will
rise by 6% a year forever. The applicable discount rate is 11%
(3 Marks)
d) Assume that Muhoroni sugar co. is going to pay kshs. 100,000 at the end of four years for
the supplies made by a farmer today. If the annual continuously compounded rate of interest
is 8%, what is the present value of this payment?
(4 Marks)

Q2
a) Wanamataifa Ltd has just paid a dividend of kshs. 2, the growth rate which is constant
of 8% has a share price of ksh. 30 today. The firms beta is 1.2, risk free rate is 6% and
the risk premium of 8%
Required:
Compute the average cost of capital of the Wanamataifa Ltd

(5 Marks)
1

b) Jabali Ltd. is a quoted company which is financed by 10,000,000 ordinary shares and
sh.50, 000,000 of irredeemable 8% debentures. The market value of the shares is
sh.20 each ex-div and an annual dividend of sh.4 per share is expected to be paid in
perpetuity. The debentures are considered to be risk-free and are value at par.
Mr. Jabali the managing director of the company is wondering whether to invest in project
which cost sh.20 million and yield sh.3.8 billion a year before tax in perpetuity. The project
has an estimated beta value of 1.25. the return from a well-diversified market portfolio is
16%.
Required:
i) The weighted average cost of capital of the company.
ii) The beta of the company.
iii) The beta of an equivalent ungeared company ignoring taxes.
Advise the company whether/ or not the project should be accepted. In your explanation,
highlight the significance of your calculations in (a), (b) and (c) above.
(10 Marks)

Q3
a) Discuss the three motives of holding cash
(5 Marks)
b) The Triad Company anticipates sh.15 million in cash outlays during the next year. The
outlays are expected to occur equally throughout the whole year. Triads treasurer reports
that the firm can invest in marketable securities portfolio to cash is sh. 7,500 per transaction.
Assume the company will meet its cash demands by selling marketable securities. Using the
Baumol model:
i) Determine optimal size of Triads transfer of funds from marketable securities to cash.
ii) What will be Triads average cash balance?
iii) How many transfers from the marketable securities to cash will be required during the
year?
iv) What will be the total cost associated with Triads cash requirements?
v) How would you answer to (a) and (b) change if transaction cost could be reduced to
sh. 5,000 per transaction? Or if Triad could invest in marketable securities to yield
10%?
(10 Marks)

Q4

MINI CASE
Assume that you recently graduated with a degree in finance and have just reported to work as an
investment advisor at the brokerage firm of Balik & Kiefer Inc. your first assignment is to explain the
nature of the Kenya financial market to Michelle Cheruiyot, a professional athlete who has just come
to Kenya from Poland. Cheruiyot is a highly ranked long distance runner who expects to invest
substantial amounts of money through Balik & Kiefer. She is also very bright and therefore would like
to understand in general terms what will happen to her money. Your boss has developed the following
set of questions which you must ask and answer to explain the Kenya financial system to Cheruiyot.
a. What is a market? How are the physical asset market diffentiated from financial markets?
b. Differentiate between money markets and capital markets
c. Differentiate between a primary market and a secondary market. If Equity Bank Ltd decided to
issue additional common stock and Cheruiyot purchased 10,000 shares of this stock from Dye
Inc, the underwriter, would this transaction be a primary market transaction or a secondary
market transaction? Would it make a difference if Cheruiyot purchased previously outstanding
Equity Bank stock in the over the counter market?
d. Describe the three primary ways in which capital is transferred between savers and borrowers
e. Securities can be traded on organized exchanges or in the over the counter market. Define each
of these markets and describe how stocks are traded in each of them.
f. What do we call the price that a borrower must pay for debt capital? What is the price of equity
capital? What are the four most fundamental factors that affect the cost of money or the general
level of interest rate, in the economy?
g. What is risk free rate of interest and nominal risk free rate? How are these two rates measured?
h. Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP),
and maturity risk premium (MRP). Which of these premiums is included when determining the
interest rate on (i) short term Kenya Treasury securities (ii) long term Kenya Treasury
securities (iii) short term corporate securities and (iv) long term corporate securities? Explain
how the premiums would vary over time and among the different securities listed above
i. Cheruiyot is also interested in investing in countries other than Kenya. Describe the various
types of risks that arise when investing abroad.
60 Marks