Corporate Finance

QUESTION ONE a) Briefly explain the following corporate finance terminology; (i) Investment decisions (ii) Financing decisions (iii) Liquidity management decisions (iv) Dividend decisions (v) Capital restructuring decisions (10 mks)

b) Early 2018 NASA was considering acquisition of two properties in Canaan the land of milk and honey. The properties included two pieces of land for the construction of milk and honey processing plants. The projects required an initial cash outlay of Sh 1000000 each and with a useful life of 5 years up to 2022. NASA has a required rate of return of 10% and the tax rate in Tingas Kingndom being 50%. The projects would be depreciated on a straight line basis. Once the projects were complete, the before depreciation and taxes cash flows expected to be generated by the projects were as follows. YEAR 1 2 3 4 5 Milk project Shs 400000 400000 400000 400000 400000 Honey project Shs 6000000 3000000 200000 500000 500000 NASA secretariat led by General Miguna generated cash flows for approval by Tinga as follows; Computation of after tax cashflows Depreciation = 1000000 - 0 = Sh 200000 5 Milk project Annual Cashflow Cashflows before depreciation 4,00000 Less Depreciation 2,00000 Profits before taxes 2,00000 Less taxes (50%) 1,00000 Profits after tax 1,00000 Add back depreciation 2,00000 Cashflows after taxes 3,00000 Honey project Year 1 2 3 4 5 Cashflow before depreciation 600000 300000 200000 50000000 500000 Less depreciation 200000 200000 200000 200000 200000 Profits before taxes 400000 100000 0 300000 300000 Less taxes (50%) 200000 50000 0 150000 150000 Profits after taxes 200000 50000 0 150000 150000 Add back depreciation 200000 200000 200000 200000 200000 Net cashflows after taxes 400000 250000 200000 350000 350000 Assume that you were co-opted by General Miguna in the NASA Secretariat and were to make your presentation using the payback period, average rate of return, net present value and the profitability index appraisal methods to advise NASA on whether the two projects would be viable or not ( 12 mks )

c) Explain the concept of corporate valuation ( 3 mks )

QUESTION TWO a) Explain the difference between corporate capital structure and corporate financial structure (3mks)

b) Briefly discuss TWO types of mergers and acquisitions (4 mks)

c) Explain TWO reasons why companies merge and the benefits that may arise from such action (4 mks)

c) The capital structure of Makuti Company currently stands as follows: Sources of finances Amount (Shs) Ordinary share capital 80,000,000.00 7% preference share capital 40,000,000.00 12% debentures 15,000,000.00 Total capital employed 135,000.000.00 The company is proposing to increase its capital employed by additional Kes 60,000,000/- without altering its capital structure. Required Show the relationship between the sources of finance employed before and after additional financing (6 mks) d) The principles of corporate governance provide that shareholders are the principal stakeholders of the corporate organ. However there are other interest groups referred to as internal and external stakeholders of the corporate firm. Briefly explain this statement. (8 mks)

QUESTION THREE a) The Agency Theory attempts to explain the potential conflict of interest that persists between shareholders and management on one hand and between creditors and shareholders on the other hand within the corporate firm. The theory, also, proposes ways of resolving the Agency problem (i) State the Agency problem and explain THREE potential causes of the problem (9 mks) (ii) Suggest THREE ways by which the potential causes of the problem explained in (a) above can be mitigated. (9mks) b) The profit maximization objective has been criticized as the fundamental goal of the corporate firm. Briefly discuss this statement and outline other corporate goals that have been touted to overshadow the profit maximization goal. (7mks)

QUESTION FOUR a) Using relevant examples explain three fundamental factors that influence the cost of finance (9 mks) b) Omoja investment company ltd has had a successful trading period over the last three years and wants to raise further finance from the following sources. ? To issue 100,000 ordinary shares of sh.10 par at sh.15 each ? To issue 100,000 10% preference shares of sh.10 at sh 12 each. ? Issue 100,000 15% debentures of sh100 at sh. 90 each. ? Raise a medium term loan of sh5 million from a financial institution at an interest rate of 20% p.a. ? The company will pay an annual dividend to ordinary shares of 14%. Corporate tax is at 50%. (Ignore floatation costs) Required a) Calculate the total amount that the company will raise if this plan is implemented. (6mks) b) Establish the overall cost of the additional finance. (10 mks)