Answer the following two questions

QUESTION ONE

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 valued at par.

Mr. Jabali the managing director of the company is wondering whether to invest in a project which cost Sh.20 million and yield Sh.3.8 million 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:

a) The weighted average cost of capital of the company. (5 marks)

b) The beta of the company. (4 marks)

c) The beta of an equivalent ungeared company ignoring taxes. (4 marks)

d) 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. (7 marks)

QUESTION THREE

(a) The Chuma Ngumu Company needs to finance a seasonal rise in inventories of Sh.4 million. The funds are needed for six months. The company is considering using the following possibilities to finance the inventories:

1. A warehouse loan from a finance company. The terms are 18 per cent annualized with an 80% advance against the value of the inventory. The warehousing costs are Sh.350,000 for the six-month period. The residual financing requirement which is Sh.4 million less the amount advanced will need to be financed by forgoing cash discounts on its payables. Standard terms are 2/10 net 30: however the company feels it can postpone payment until the fortieth day without adverse effect.

2. A floating lien arrangement from the supplier of the inventory at an effective interest rate of 24 per cent. The supplier will advance the full value of the inventory.

3. A bank loan from the company?s bank for Sh.4 million. The bank can lend at the rate of 22%. In addition, a 10% compensating balance will be required which otherwise would not be maintained by the company.

Required:

Which is the cheapest option for the company? (15 marks)

(b) Highlight the limitations of using commercial paper as a form of short-term credit. (5 marks)

(Total: 20 marks)

QUESTION ONE 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 valued at par. Mr. Jabali the managing director of the company is wondering whether to invest in a project which cost Sh.20 million and yield Sh.3.8 million 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: a)\tThe weighted average cost of capital of the company. (5 marks) b)\tThe beta of the company. (4 marks) c)\tThe beta of an equivalent ungeared company ignoring taxes. (4 marks) d)\tAdvise 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. (7 marks) QUESTION THREE (a)\tThe Chuma Ngumu Company needs to finance a seasonal rise in inventories of Sh.4 million. The funds are needed for six months. The company is considering using the following possibilities to finance the inventories: 1.\tA warehouse loan from a finance company. The terms are 18 per cent annualized with an 80% advance against the value of the inventory. The warehousing costs are Sh.350,000 for the six-month period. The residual financing requirement which is Sh.4 million less the amount advanced will need to be financed by forgoing cash discounts on its payables. Standard terms are 2/10 net 30: however the company feels it can postpone payment until the fortieth day without adverse effect. 2.\tA floating lien arrangement from the supplier of the inventory at an effective interest rate of 24 per cent. The supplier will advance the full value of the inventory. 3.\tA bank loan from the companys bank for Sh.4 million. The bank can lend at the rate of 22%. In addition, a 10% compensating balance will be required which otherwise would not be maintained by the company. Required: Which is the cheapest option for the company? (15 marks) (b)\tHighlight the limitations of using commercial paper as a form of short-term credit.\t(5 marks) (Total: 20 marks)