Give detailed explanations and solutions for ALL questions

The main way is to insist on restrictive covenants being incorporated into the loan agreements. Such covenants might Restrict the level of additional debt finance that can be raised. ii Prevent the firm from disposing off major fixed assets without the consent of the providers of debt. iii. Restrict the level of dividend that can be paid. If creditors perceive that they are being unfairly dealt with, they can refuse to provide further credit or only provide future credit at higher than normal rates, both of which are likely to have adverse effects on shareholder's wealth and are deterrent to managers acting unfairly against the creditors interest. (a) The objectives of the nationalised electricity supply industry are likely to be strongly influenced by the government and may not be primarily financial. State owned enterprises exist to provide a service and to ensure that social needs are satisfied: they are not usually profit maximising. The prime objective of a nationalised electricity supply industry might be to promote the development of an efficient co-ordinated and economic system of electrical supply with subsidiary objectives concerned with earning an acceptable return on capital employed (acceptable being defined by the government) and achieving efficiency through cost control. Service considerations might mean the provision of electricity facilities to remote areas at far less than the cost price. In order to provide reasonably priced electricity for all people a government might be prepared to subsidize the nationalised industry and set a negative target return on capital. Alternatively the target return might be set such that the industry is a substantial contributor to government finances. The objectives of a private sector electrical supply company will mainly be determined by the senior management of the company. The prime objective of a company is mainly the maximisation of shareholders wealth. In practice they might be content to achieve a "satisfying level of shareholders wealth" and also be concerned with a number of non-financial objectives. Such objectives include market share, growth, environmental factors, good working conditions and to facilitate employee and corporate survival. Some of these non-financial objectives will strongly affect the financial success of the company and shareholders wealth. A vital industry like provision of electricity, even if privately owned, might still be subject to strong government influence and constraints especially in provision of services and pricing. (b) Strategic investment planning in a nationalised industry is subject to government approval. Small scale investments will be planned and approved by the management of the nationalised industry. However, the amount of investment undertaken is likely to be influenced by the government and the use of external sources from the capital market will usually be limited by the government. Strategic investment planning in the private sector is strongly influenced by market forces with managers considering the possible effects of investments on share prices and shareholder's wealth. Private sector investment appraisal techniques usually assume that the company is seeking to maximize shareholders wealth in an efficient market. As there are no share prices in a nationalised industry and investor wealth maximisation is not the assumed objective, some private sector investment appraisal techniques will not be appropriate. However, this does not mean that all private sector techniques cannot be used in the public sector. Discounted cashflow for example is often used in a nationalised industry.(a) (b) A single working capital investment and nancing policy that is optimal for all rms is not practical. Why is this? (5 marks} Prime Shoes Ltd manufactures various types of shoes. The company is now considering its working capital policy for 1994. Fixed assets are projected at Sh 30 million and current liabilities at Sh 27 million. Sales and Earnings before interest and Tastes (EBI'I) are partially a function of the company's investment in working capital particularly its investment in stocks and debtors. Prime Shoe Ltd is considering the following three different working capital investment policies: Aggressive policy small inveStment in current assets Conservative policy large investment in current assets Moderate policy moderate investment in current assets The following information relates to three policies: Aggressive Moderate Conservative Sh'000' Sh'000' Sh'000' Investment in Current Assets 42,000 45,000 48,000 Projected Sales 88,500 90,000 91,500 EBIT 8,500 9,000 9,150 Required: (a) Determine the working capital investment policies for each of the following: i. Rate of return on total assets (3 marks) ii. Net working capital (3 marks) iii. Current ratio (3 marks) (b) Describe the profitability-risk trade offs of these three policies. (Smarks) (Total 20 marks) Umma Ltd and Lemma Ltd are identical in every respect except that Umma is unlevered while Lemma has Sh 10 million of 5% loan stock outstanding. You are also informed that: - All of W assumptions are satised - There are no corporate or personal taxes - Earnings before interest and taxes (EBI'I) is Sh 2 million - The cost of equity to Umma is 10% pa. Required: (a) What market value would W estimate for each rm? (4marks) (b) What is the cost of equity for Lemma? (Smarks) (c) What is the market value of Lemma's equity? (3marks) (d) What is the weighted average cost of capital for each rm? (3 marks) (e) Suppose the market value of the assets of Umma is Sh 20 million and the market value for those of Lemma is Sh 22 million. Are these equilibrium valuations? Use these gures to explain how equilibrium is established. (7 marks} (Total 20 marks)