QUESTION 1

Chama Industries Ltd (CIL) operates a bakery that produces a wide variety of bread, cookies, pastries, cakes and pies from its headquarters in Industrial Area, Kampala. CIL has distribution outlets throughout the country and is considering changing the delivery mechanism to these outlets. At present, CIL outsources transport services for all its deliveries to Transocean Ltd, a commercial carrier. There is a proposal that instead of outsourcing, the company should purchase and operate its own fleet 10 delivery vans. It is anticipated that the new delivery vans would solve the ever-escalating costs of vehicle hire and delayed delivery challenges currently faced by CIL.

The finance manager has estimated that the delivery vans will cost Shs 150 million each, with each incurring annual running costs of Shs 500 million. These vans are expected to operate successfully for six years, at the end of which period they will all have to be sold at about Shs 30 million per van. It is expected that if the status quo remains, the outsourced carrier will charge a total of Shs 5.3 billion each year for the next six years to undertake the deliveries promptly.

Regarding the financing method for the purchase of delivery vans, management of CIL is expected to make a decision of the best financing option based on the two choices provided below:

1. (i)By using a loan facility from any conventional bank. The only issue here is that in order to speed up the acquisition of the loan, the finance director has proposed that some facilitation would be given to the bank manager. Approval of this facilitation would be sought from the finance committee.
2. (ii)By undertaking any Islamic finance contract available.

In addition to the proposed procurement of delivery vans, CIL is planning to introduce new equipment, estimated to cost Shs 80 million, with the aim of speeding up the production process that has fallen below set standards. This new equipment is expected to last four years and its scrap value will be zero. The expected project net cash flows are Shs 20 million in the first year and Shs 40 million for the next three years. The discount rate is 15% and corporation tax rate is 30%

Other key financial policy areas and variables are as follows:

1. Investment appraisal technique:
2. It is the policy of CIL to use the accounting rate of return (ARR) as a favored method of investment appraisal. This policy has been in use for all the years of its existence, and there are no indications of its revision in the near future.
3. Required rate of return on the new fleet of delivery vans:
4. The board of directors recently resolved that a 10% real rate of return, or required rate of return would be appropriate for the new fleet of delivery vans.
5. Depreciation method:
6. It is the policy of CIL to depreciate all fixed assets using the straight-line method of depreciation.

Required:

1. (a)Evaluate the accounting rate of return (ARR) as a method of investment appraisal and use it to appraise the decision to procure delivery vans fleet.
2. (15 marks)
3. (b)Assess the viability of the proposed project of acquiring new equipment under conditions of taxation.
4. (15 marks)
5. (c)Evaluate debt financing as one of the available options of financing the purchase of delivery vans.
6. (8 marks)
7. (d)Advise the management of CIL on:

(i) the implications of the proposed facilitation to the bank manager as

proposed by the finance director.

(ii) how they can structure financing for the acquisition of delivery vans

using any four (4) Islamic Finance contracts.

Attempt any two of the four questions in this section

Question 2

Mr. Jay Bulldozer is a rational investor who aims at obtaining maximum returns at a given minimum level of risk. He invested in shares of Soda Bottlers' Ltd (SBL), a company operating in the soft drinks industry within Uganda.

An economist's analysis of the likely situation of Uganda's economy in the coming year 2018, together with the estimates of sales and earnings for the soft drinks industry, have led to the conclusion that the expected rate of return from Mr. Jay Bulldozer's investment in SBL common stock will range between -4 percent and +25 percent with probabilities as indicated in the table below:

State of the economy

Probability ,Ps (%)

Expected rate of return, R (%)

Good

30

25

Average

40

15

Bad

10

0

Poor

20

-4

Because of the risk associated with single form of investment, Mr Jay Bulldozer is considering diversifying into the alcoholic drinks industry; and is thus considering investing in the shares of Beer Breweries Ltd (BBL). He has been advised by his portfolio analyst that the overall risk of his investment, after the new diversification plan, would not go above 10% yet the expected rate of return is likely to remain constant.

Required:

(a) Discuss the concept of risk diversification and strategies you would employ to reduce portfolio risk of an investor like Mr. Jay Bulldozer.

(9 marks)

(b) Advise Mr. Jay Bulldozer, based on relevant computations, on whether the diversification plan would produce the desired goals.

Question 3

Monde Company Ltd (MOCOL) is a medium enterprise specialising in the processing and distribution of dairy products in Uganda. At a recent stakeholders' meeting, the chief executive officer (CEO) of MOCOL was put to task to explain the company's financial strategy, in view of the recent developments in financial markets in East Africa. Being a former investment banker on Wall Street, he went rather technical, as can be seen from extracts of his response below:

'A couple of decades ago, the efficient market hypothesis (EMH) was widely accepted in academia. Around the 1970s, it was generally believed that securities markets were extremely efficient. The accepted view was that when information arises, the news spread very quickly and such information is incorporated into the prices of securities without delay. Thus, neither technical analysis, nor fundamental analysis, would help investors select "undervalued" stocks, and enable them achieve returns greater than those that could be obtained by holding a randomly selected portfolio of individual stocks, at least not with comparable risk. The EMH is also associated with the "random walk hypothesis.'

At the end of the CEO's response, many participants in the audience appeared to be confused by his submission. Some participants later sent requests to their financial advisors seeking more specific responses to their concerns, among them: to simplify the terms the CEO had used; to explain how a company like MOCOL can issue shares on a securities exchanges; to assess why capital markets in Uganda were lagging behind other markets like Kenya's and South Africa's.

Required:

1. (a)Discuss the random walk hypothesis mentioned in the CEO's speech and distinguish it from technical and fundamental analysis.

1. (b)Advise MOCOL on the:

(i) various methods by which a company like MOCOL can issue ordinary

shares on the Uganda Securities Exchange (USE).

(ii) barriers to the growth of capital markets in Uganda.

(iii) relevanceoftheEMHtocompaniesandtheirmanagers.