WORKBASED ASSIGNMENT

JANUARY-JUNE 2014
Due on April 15th 2014
Attempt all questions
1. Explain the benefits that are enjoyed by investors because of the existence of organized
security exchanges.
(8 Marks)
2. Discuss the main factors which a company should consider when determining the
appropriate mix of long-term and short-term debt in its capital structure. (6 Marks)
3. Magma Ltd. wishes to make a choice between two mutually exclusive projects. Each of
these projects requires Sh.400,000,000 in initial cash outlay. The details of the two
projects are as follows:
Project A
This project is made up of two sub-projects. The first sub-project will require an initial
outlay of Sh.100,000,000 and will generate Sh.25,600,000 per annum in perpetuity. The
second sub-project will require an initial outlay of Sh.300,000,000 and will generate
Sh.85,200,000 per annum for the 8 years of its useful life. This sub-project does not have
a residual value at the end of the 8 years. Both sub-projects are to commence
immediately.
Project B
This project will generate Sh.87,000,000 per annum in perpetuity. The company has a
cost of capital of 16%.
Required:
(i)

Determine the net present value (NPV) of each project.

(6 Marks)

(ii)

Compute the internal rate of return (IRR) for each project.

(6 Marks)

(iii)

Advise Magma Ltd. on which project to invest in, and justify your choice.
(4 Marks)

4. The financial data given below shows the capital structure of Akabebi Company Limited.
10% Sh.1,000 debenture
Ordinary share capital (Sh.20)
Retained earnings

4,900,000
18,000,000
6,000,000
28,900,000

The structure is considered optimum and the management would wish to maintain this level.
Akabebi Company Limited intends to invest in a new project which is estimated to cost
Sh.16,800,000 with an expected net cash flow of Sh.3,000,000 per annum for 10 years. The
management has proposed to raise the required funds through the following means:
1.
2.
3.
4.

Issue 100 10% debentures at the current market value of Sh.5,000 per debenture.
Utilise 60% of the existing retained earnings.
Issue 10% Sh.20 preference shares at the current market price of Sh.25 per share
Issue ordinary shares at the current market price of Sh.45 per share. Floatation cost per
share is estimated to be 12% of the share value.
The companys current dividend yield is 5% which is expected to continue in the near
future. Corporation tax rate is 30%.
Required:
(a)
Determine the current dividend per share.
(3 Marks)
(b)
Determine the number of ordinary shares to be issued.
(2 Marks)
(c)
Determine the marginal cost of capital for Akabebi Company Ltd based on the above
information.
(8 Marks)
(d)
Evaluate whether it is viable to invest in the proposed project (Round off your answer for
cost of capital to the nearest 1)
(2 Marks)
(e)
Explain clearly the sense in which depreciation is said to be a source of funds to business
firms.
(5Marks)