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W1-2-60-1-6 JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY UNIVERSITY EXAMINATIONS 2020/2021 YEAR IV EXAMINATION FOR THE DEGREE OF BACHELOR OF COMMERCE HBF 2404: CONTEMPORARY ISSUES IN FINANCIAL MANAGEMENT DATE: JANUARY 2021 TIME: 2 HOURS INSTRUCTIONS: Answer question one and any other two questions. 1.a) Assume a perfect market in which investors are constrained to holding portfolios consisting of a single stock ( risky asset) and a riskless asset. Two risky securities I and I were observed. Stock I had expected return of 18% and risk (c) of 8% while stock J had expected return of 25% and risk of 12% what is the riskless interest rate in this market? Assume that an investor was confronted with two mutually exclusive alternatives; a portfolio of sh90000 worth of stock I and a portfolio of sh 60000 worth of stock J plus sh 30000 of riskless asset which of the two is preferable? (8 marks) b) Ebulbul Limited is considering an acquisition of Menengai Company. Ebulbul expects to receive net cash flow from menengai of Sh. 9 million the first year. For the second year, Menengai is expected to have EBIT of Sh. 25 million and interest expense of Sh. 5 million Also, in the second year only Menengai will require reinvestment of an additional 40 percent of its net income to finance future growth. Menengai's applicable marginal tax rate is 34 percent. After second year, the net cash flow from Menengai to Ebulbul will grow at a constant rate of 4 percent. The firm has determined that 17.5 percent is the appropriate discount rate to apply to this merger. Assume that all cash flow are end-of-year and that the Menengai acquisition will cost Ebulbul Sh. 45 million. Required: i) Calculate the net cash flow to Ebulbul for the second year. ii) On the basis of suitable analysis advice on whether or not the proposed merger should take place. (10marks) c) Discuss the main applications of modern portfolio theory is a securities market such as NSE (6 marks) d) Are financial innovations necessary? Discuss (6 marks) a 2.a) Arkelof (1970) discusses the market for lemons as a major concern in market mechanism. What are the main issues highlighted in his paper. What are the practical implications of these theories in modern financial system? What are the criticisms? (10 marks) b) Explain at least five determinants of capital structure choice for a firm as highlighted by Titman on the article "capital structure puzzle revisited" (10marks) W1-2-60-1-6 JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY UNIVERSITY EXAMINATIONS 2020/2021 YEAR IV EXAMINATION FOR THE DEGREE OF BACHELOR OF COMMERCE HBF 2404: CONTEMPORARY ISSUES IN FINANCIAL MANAGEMENT DATE: JANUARY 2021 TIME: 2 HOURS INSTRUCTIONS: Answer question one and any other two questions. 1.a) Assume a perfect market in which investors are constrained to holding portfolios consisting of a single stock ( risky asset) and a riskless asset. Two risky securities I and I were observed. Stock I had expected return of 18% and risk (c) of 8% while stock J had expected return of 25% and risk of 12% what is the riskless interest rate in this market? Assume that an investor was confronted with two mutually exclusive alternatives; a portfolio of sh90000 worth of stock I and a portfolio of sh 60000 worth of stock J plus sh 30000 of riskless asset which of the two is preferable? (8 marks) b) Ebulbul Limited is considering an acquisition of Menengai Company. Ebulbul expects to receive net cash flow from menengai of Sh. 9 million the first year. For the second year, Menengai is expected to have EBIT of Sh. 25 million and interest expense of Sh. 5 million Also, in the second year only Menengai will require reinvestment of an additional 40 percent of its net income to finance future growth. Menengai's applicable marginal tax rate is 34 percent. After second year, the net cash flow from Menengai to Ebulbul will grow at a constant rate of 4 percent. The firm has determined that 17.5 percent is the appropriate discount rate to apply to this merger. Assume that all cash flow are end-of-year and that the Menengai acquisition will cost Ebulbul Sh. 45 million. Required: i) Calculate the net cash flow to Ebulbul for the second year. ii) On the basis of suitable analysis advice on whether or not the proposed merger should take place. (10marks) c) Discuss the main applications of modern portfolio theory is a securities market such as NSE (6 marks) d) Are financial innovations necessary? Discuss (6 marks) a 2.a) Arkelof (1970) discusses the market for lemons as a major concern in market mechanism. What are the main issues highlighted in his paper. What are the practical implications of these theories in modern financial system? What are the criticisms? (10 marks) b) Explain at least five determinants of capital structure choice for a firm as highlighted by Titman on the article "capital structure puzzle revisited" (10marks)