CORPORATE FINANCE SOLUTION MANUAL

VOLUME 1

BY
PRINCE DANIELS +260972286191
SOLUTIONS TO CHAPTER QUESTIONS 3. Present value of annuity at retirement
date.
CHAPTER ONE – Time Value of Money
1− (1+𝑟)−𝑡
1. (i) Bank A
PVA = PMT [ ]
𝑟
𝑃𝑉𝐴 1− (1.1)−20
PVIFA = PVA = 20000 [ ]
𝑃𝑀𝑇 0.1

r=
𝑥
, t = 4 x 4 =16 PVA = K170 271.27
4
Present Value today (25 years
150000 before retirement)
PVIFA =
12872.96

PVIA = 11.652 PV = 170271.27 (1.1)-25

PV = K15715.36
Using the tables

𝑥
= 0.04 𝑃𝑉𝐴
4 4. (i) PVIFA = 𝑃𝑀𝑇

x= 0.16 25000000
PVIFA =
2545160
Bank A offers 16% interest. PVIFA = 9.823

(ii) Bank B Using the PVIFA table (t =25)

r = 9%
PV = FV (1 + r)-t

150000 = 276360(1 + r) -5
ii) Amortization Schedule
Period Principal Interest Payment Principal
Solving form r we get r = 13%
At start 9% Repaid
Bank B offers 13% interest. K’000 K’000 K’000 K’000

1 25000 2250 2545.16 295.16

Therefore bank B is the better Bank
2 24704.84 2223.45 2545.16 321.72
2. .
(1+𝑟)𝑡 −1 3 24383.12 2194.48 2545.16 350.68
FVA = PMT [ ]
𝑟
(1.1)8 −1
FVA = 1200 [ ]
0.1 5. PV = FV (1 + r)-t
FVA = K13 723.07 PV = 50 000 000 (1.1)-10
PV = K19 277 164.47

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

6. FV = PV (1 + r)t 14. r=
0.104
= 0.0086667
12
FV = 247000(1.11)9
t = 24
FV = K631 835.12
PVA = 3500 000
1− (1+𝑟)−𝑡
7. FV = PV (1 + r)t PVA = PMT [ ]
𝑟
468 000 = 136 000(1.08)t 1− (1.0086667)−24
468000 3500000 = PMT [ ]
0.0086667
(1.08)t =
136000
t = 16.06 years. PMT = K162 154.239

8. FV = PV (1 + r)t 15. .
475000 =137000(1 + r)10
1− (1+𝑟)−𝑡
r = 0.132
PVA = PMT [ ](1+ r)-t
𝑟
r = 13.2% 1− (1.08)−19
PVA = 2000 [ ](1.08)-3
0.08
PVA = K15 247.293
9. PV = FV (1 + r/m)-mt
PV = 197000(1 +0.13/2)-2 x 5
PV = K104947.029 16. PMT = K54078.85
Period Principal Interest Payment Principal
10. FV = K558 386.38
At start 8% Repaid

11. t = 12.97 years K K K K

1 250000 20000 54078.85 34078.85

12. PVA =K136 486.59
2 215921.15 17273.7 54078.85 36805
13. Price of Policy
3 179115.99 14329.3 54078.85 39749.6
𝑃𝑀𝑇
PVA =
𝑟 139366.4 11149.3 54078.85 42929.5
𝟐𝟎𝟎𝟎𝟎 4
PVA =
𝟎.𝟎𝟔𝟓
5 96436.9 7714.95 54078.85 46364
PVA = K307 692.3
6 50073 4005.84 54078.85 50073

Interest rate
74473.1 324473.1 250000
20000
340000 = 𝑟

r = 0.0588
r = 5.88%
 𝑟
17. Effective annual rate = (1 + 𝑚)m - 1 20. Worth of Promise:
0.04 2 PV = 24000 000 (1.1)-1
EAR = (1 + ) -1
2
PV = K21 818 181.82
EAR = 0.0404

The promise is not worth it

(i) FVA at 0.0404
because it is not worth more
FVA = K16599.12
than the K22 500 000 that
The amount won’t be enough
he is asking for today.

(ii) FVA = K24909.85

21. .
(i) PV = K14 700 597.06
18. .
(ii) PMT = K4 438 416.089
(i) FV = K28543.4
(iii) r is between 15% and
(ii) FV = K33995.64
16%
(iii) FV = K102857.2
(iv) FV = K329876.91

19. Stock Account

FVA = K1580992.04

Bond Account
FVA = K301 354.51

Total = K1 882 346.553

After retirement
PVA = K1 882 346.553
r = 0.006667
t = 12 x 25 = 300

PMT = K14 528.75 per month

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

 CHAPTER 2 – RISK AND RETURN. A perfect positive correlation
gives a portfolio with a standard
1. .
deviation of 0.0516 while a
(i) .
perfect negative correlation
P ra Pra P(ra - 𝑟̅ a)2 gives a correlation of 0.0012

0.2 0.05 0.01 0.002 (ii) The fund manager can

assess which portfolios are
more risky than others by
0.6 0.15 0.09 0
paying attention on the
correlation as shown in the
0.2 0.25 0.05 0.002 calculations in (i)
𝑟̅ a= 0.15 δ2 =0.004
The investors can increase
δ =0.063 the value of a portfolio by
contrasting a portfolio with
assets which are less than
P Rb Prb P(rb - 𝑟̅ b)2 perfectly positively
correlated to enjoy the
0.2 0.07 0.014 0.00098
benefits of diversification.

0.6 0.14 0.084 0 2. ..

(i) Average return = ∑ 𝑃𝑖𝑅𝑖
0.2 0.21 0.042 0.00098 𝑟̅ a = 0.113
𝑟̅ b= 0.14 δ2 =0.00196 𝑟̅ b = 0.113
δb=0.044
(ii) 𝑟̅ p =Wa𝑟̅ a + Wb𝑟̅ b
= (0.5) (0.113) +
CORRELATION OF 1 0.5(0.113)
= 0.113
δp = √𝑊𝑎2 δa2 + 𝑊𝑏 2 𝛿𝑏 2 + 2𝑊𝑎𝑊𝑏𝛿𝑎𝛿𝑏(𝑟)
ra rb Wa𝑟̅ a + Wb𝑟̅ b
δp =

√(0.4)2 (0.063)2 + (0.6)2 (0.044)2 + 2(0.4)(0.6)(0.063)(0.044)(1)

-0.18 -0.145 -0.1625

δp = 0.0516
0.33 0.218 0.2740
CORRELATION OF -1
0.15 0.305 0.2275
δp = √𝑊𝑎2 δa2 + 𝑊𝑏 2 𝛿𝑏 2 + 2𝑊𝑎𝑊𝑏𝛿𝑎𝛿𝑏(𝑟)

δp =
√(0.4)2 (0.063)2 + (0.6)2 (0.044)2 + 2(0.4)(0.6)(0.063)(0.044)(−1) -0.005 -0.076 -0.0405
δp = 0.0012
0.27 0.263 0.2665
 CVm = 0.0502/0.165 = 0.304
(iii) δa=0.186, δb=0.186 CVa = 0.0898/0.1925 =0.466

Cova, b = √∑ 𝑃(𝑟𝑎 − 𝑟𝑎 ̅̅̅)

̅̅̅)(𝑟𝑏 − 𝑟𝑏 (iv) Beta = Cova,m
δm2

P ra rb 𝑃(𝑟𝑎 − 𝑟𝑎
̅̅̅)(𝑟𝑏 Beta of a = 0.0042375 = 1.68
̅̅̅
− 𝑟𝑏 (0.0502)2
0.2 -0.18 -0.145 0.0151188 Beta of market = 1
(v) Ra = Rf + β(Rm – Rf)
0.2 0.33 0.218 0.004557
Ra = 0.08 + 1.68(0.165 – 0.08)
Ra = 0.2228 or 22.28%
0.2 0.15 0.305 0.0014208
(vi) Since 𝑟𝑎
̅̅̅ is greater than the
market rate, the project
0.2 -0.005 -0.076 0.0044604 should be accepted.
4. .
(i) ̅̅̅̅̅ = 0.1, ̅̅̅̅
𝑅𝑚 𝑅𝑓 = 0.07
0.2 0.27 0.263 0.00471
Cova, b= ̅̅̅̅ = 0.5(0.1) +
𝑅𝑝
0.030267 0.5(0.07)
̅̅̅̅ = 0.085
𝑹𝒑

δp = (ii) ̅̅̅ = 𝑅𝑓
𝑅𝑖 ̅̅̅̅ + β(𝑅𝑚 – 𝑅𝑓)
√𝑊𝑎2 δa2 + 𝑊𝑏 2 𝛿𝑏 2 + 2𝑊𝑎𝑊𝑏𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒
(iii) Cov(Rm, Ra) =
δp =
0.0174825
√(0.5)2 (0.186)2 + (0.5)2 (0.186)2 + 2(0.5)(0.5)(0.0303 δm2 = 0.011655
δp = 0.18.
Beta of A = 0.0174825 = 1.5
0.011655
(iv) Both stocks have the same return and Since Ba > 1, the
standard deviation, therefore they have security is aggressive.
the same risk and return.
(iv) ̅̅̅̅ = 0.1332
𝑅𝑎
̅̅̅̅ = ̅̅̅̅
𝑅𝑎 𝑅𝑓 + β(𝑅𝑚 – 𝑅𝑓)
3. . = 0.07 + 1.5(0.1 –
(i) 𝑟̅ m= 0.165 0.07)
=0.115
r̅ a= 0.1925

(ii) δa=0.0898, δm=0.0502

(iii) CV = δ/r

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

5. .
(i) ̅̅̅̅ = ̅̅̅̅
𝑅𝑎 𝑅𝑓 + β(𝑅𝑚 – 𝑅𝑓)
0.2 = ̅̅̅̅
𝑅𝑓 + 1.5(0.15 - ̅̅̅̅̅
𝑅𝑓 )
𝑅𝑓 =0.05
̅̅̅̅

𝑅𝑏 = ̅̅̅̅
̅̅̅̅ 𝑅𝑓 + β(𝑅𝑚 – 𝑅𝑓)
0.25 = ̅̅̅̅
𝑅𝑓 + 2(0.15 – ̅̅̅̅
𝑅𝑓 )
𝑅𝑓 = 0.025
̅̅̅̅

(ii) Using ̅̅̅̅

𝑅𝑓 = 0.05
𝛽 p = Waβa + Wbβb + Wrβr
𝛽 p = 0.3(1.5) + 0.5(2) + 0.2(0)
𝛽 p = 1.45

6. .
(i) Expected return = 0.261
Standard deviation = 0.109

(ii) Portfolio beta = 0.9

(iii) Required rate of return = 0.14
(iv) Required rate of return = 0.143
CHAPTER 3 – BOND VALUATION 8. .
(i) LACKSON BOND
1. Since the required rate of return equals
1− (1.05)−4
the coupon rate, the value of price of Bond Price = 40[ ] + 1000(1.05)-4
0.05
will equal the par value. Price of both
bonds will be K1000 each.
Price = K964.5

2. .
1− (1+𝑟)−𝑡
(i) Vb = I[ ] + M(1 + r)-t Percentage change = P1 – P0
𝑟
1− (1.04)−20 P0
Vb = 3[ ] + 100(1.04)-20
0.04
Vb = K86.4 Percentage change = 964.5 – 1000 x 100 = -3.6%

1000
(ii) EAR = (1 + r/m)m – 1
EAR = (1.04)2 – 1 = 0.0816 HARDY CORP BONDS
=8.16% 1− (1.05)−20
3. . Price = 40[ ] + 1000(1.05)-30
0.05
(i) Vb = K948.89
(ii) YTM = 9%
Price = K846.3
Percentage change = -15.37%
4. When i = r, Price = Par Value
Therefore, price of Bond A and Bond B is (ii) When r = 6%
K1000 each.
LACKSON BOND
5. YTM = I + (M –V)/n Price = K1037.17
(M + V)/2 Percentage = 3.72%

YTM = 100 + (1000 – 1052)/3 HARDY BOND

(1000 + 1052)/2 Price = K1196
Percentage change = 19.6%
YTM = 0.081 or 8.1%

(iii) If maturity is held constant, an

6. . increase in interest reduces the value
(i) YTM = 800 + (10000 – 11500)/9 of the bond. A decrease however,
(10000 + 11500)/2 increases the price of the bond.

YTM = 0.0589 or 5.89% 9. .

V = M(1 +r)-t
(ii) YTC = I + (V - CP)/n 627 = 1000(1 + r)-6
(CP + V)/2 r = 0.06

YTC = 9.3%

7. T = 37.5 years

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

CHAPTER 4 – STOCK VALUATION 3. Coming year dividend = K2.117
1. .
4. r = 14%
(i)

Year D0 (1 +g) D1 5. Price = K24.51

2014
2015 6. r = 10%
2016 80
2017 80 1.1 88 7. D1 = 5(1.06) = 5.3
2018 88 1.1 96.8
2019 96.8 1.08 104.544 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
Dividend yield =
𝑃𝑟𝑖𝑐𝑒
(ii) Value of stock on 31 December 2018
5.3
= = 0.106
50
Price = D0 (1 +g) = 104.544
r–g 0.12 – 0.08
Capital gains = growth rate = 6%

Price = K2613.6
8. Value of stock = K94.164

Price of stock Jan 1, 2014

9. Price of stock today =K39.2
Year D0 (1 D1 PVIF PV
+g) 10. .
2014 0.892 0
2015 0.797 0
2016 80 0.712 56.96 Year D0 (1 +g) D1 PVIF PV
2017 80 1.1 88 0.636 55.968 1 2.5 1.1 2.75 0.877 2.412
2018 88 1.1 96.8 0.567 54.89 2 2.75 1.1 3.025 0.769 2.326
167.818 3 3.025 1.1 3.33 0.675 2.248
6.986
Price today = 167.818 + 2613.6(1.12)-5
Price today = K1650.84
Price = 6.986 + 50(1.14)-3
Price = K40.735
2. 10 ( 1+g)6 = 13.4
g = 0.05
11. .
(i) Value of stock = 13.4(1.05)
0.2 – 0.05 Year D1 PVIF PV
1 1 0.909 0.909
Value of stock = K93.8 2 1 0.826 0.826
3 1.1 0.751 0.826
(ii) A stock of K110 is overpriced and 4 1.25 0.683 0.854
should be bought. 5 1.25 0.621 0.776
4.191
20 = 4.191 + P5 (1.1)-5
P5 = K25.46
12. .
(i) Ps = Dividend = 0.08 x 125 = K83.3
R 0.12

(ii) No it’s not likely to be called because

it’s cheaper to buy from the market at
K83.3. If interest rates reduced, the
value of the share would increase
which might make the company the
shares.
13. .
Dividend = div rate x par value
Dividend = 0.15 x 85 =K12.75
Expected return = Dividend = 12.75
Current Price 90
Expected return = 0.142 or 14.2%
Statement (i) is correct. The market rate is
less than the 14.2%, therefore the stock has a
higher return than the market and should be
bought.
14. .
Price of redeemable preferred stock:

1− (1+𝑟)−𝑡
Ps = Div. [ ] + M(1 +r)-t
𝑟
1− (1.12)−10
Price = Div. [ ] + 80(1.12)-10
0.12
Price = K93.56

15. .
Current Value = K28.17

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

CHAPTER 5- Short Term Sources of 3. .
Funds. (i) Cost of foregoing
discount
1. .
(i) Cost = d x 365
(i) Cost = d x 365
1–d FDD – DP
1–d FDD – DP
Cost = 0.01 X 365
(i) Cost = 0.02 x 365
1 – 0.01 30 – 10
1 – 0.02 60 – 10
Cost = 0.1843 0r 18.43%
Cost = 0.149
(ii) Cost = Interest
Cost of 60 day note
1 – Interest – Comp
Cost = Interest
rate
1 – Interest
Cost = 0.15 = 0.176
Cost = 0.15
1 – 0.15
1 – 0.15 – 0.18
Alternative of foregoing discount has
Cost = 0.224 or 22.4% a lower cost.
(ii) Outsiders might conclude that
2. .
the company is incapable of
(i) Set up a 1-year credit line
settling their short term debt in
Commitment fee time.
(0.01 x 500000 x (11/12)
4. .
K4583
Invoice price = Usable funds
Interest (0.18 x 500000 x (1/12)
K7500 1 – Commission rate –
interest/m
12083 Invoice Price = 20000000
(ii) Do not take advantage of a 1/10, 1 – 0.02 – 0.15/12
net/40 discount
Invoice Price = K20671834.63
Cost = 0.01 x 500000 = K5000

(iii) Issue K500,000 of commercial

paper
Cost = 0.17 x 500000 x (1/12) =K7083
5. .
(i) Cost = 18.8%
(ii) Cost = 16.7%
(iii) Factor fee for the year would be:
2% × (10,000,000 × 12) = K2400 000

The savings effected, however, would be

(1500000 x 12= K1800000), giving a net
factoring cost of K600 000.

Borrowing K7.5m on the receivables

would thus cost approximately
[(0.12 × 7500000) + K600000]/7500000

= 20%

Bank borrowing would thus be the

cheapest source of funds

6. .
Option one
Net Benefits = K56027
Option two
Net Benefits = K48904

7. .
(i) Cost = 27.83%
(ii) Cost = 11.67%
(iii) Cost = 13.64%

8. .
(i) Cost (A) = 14.7%
Cost (B) = 13.92%

(ii) Cost of a discount loan

= Interest
1 – Interest
= 0.05 = 0.053
1 – 0.05
(iii) Recommended supplier is supplier B.

11

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

CHAPTER 6 – CAPITAL STRUCTURE Number of shares 2000 000

EPS K1.269
1. ..
(i) Profit statement before the investment (iii) Profit statement after CS

K’000
financing

Sales (230 x 450) 10350 K’000

Variable cost (6500) Sales (230 x 450 x 1.1) 11385

Fixed cost (900) Variable cost (5200)

EBIT 2950 Fixed cost (1050)

Interest (9% of K2m) (180)

EBIT 5135
EBT 2770
Interest (180)
Tax (40%) (1108)
EBT 4955
EAIT 1662
Tax (40%) (1982)
Pref Div (40)
EAIT 2973
Net Income 1622
Pref Div (40)
Number of shares 2000 000
Net Income 2933
EPS K0.811
Number of shares 2200 000
(ii) Profit statement after debt financing
EPS K1.333
K’000

Sales (230 x 450 x 1.1) 11385

Variable cost (5200)

(iv) Debt financing is the better
option because it gives the
Fixed cost (1050)
higher EPS.
EBIT 5135

Interest (840)

EBT 4295

Tax (40%) (1718)

EAIT 2577

Pref Div (40)

Net Income 2537

 4. .
2. .
(i) Debt Financing
(i) 1 2 3 K’000

K’000 K’000 K’000 EBIT 13000

EBIT 60000 60000 60000
Interest (1100)
Interest 8000 14000 8000
EBT 11900
EBT 52000 46000 52000
Tax (50%) (5950)
T(35%) 18200 16100 18200
Net Income 5950
EAIT 33800 29900 33800

Pref Div - - 5000 Number of shares 1000 000

Net Income 33800 29900 28800 EPS K5.95

Shares 1350 000 1100 000 1100000 (ii) Equity financing

EPS K25.04 K27.18 K26.18 K’000

(ii) Alternative 2 is better EBIT 13000

Interest (500)
3.
1 2 3
EBT 12500
K’000 K’000 K’000 Tax (50%) (6250)
EBIT (20% of K50m) 10000 10000 10000 Net Income 6250
Interest - - 1200
Number of shares 1200 000
EBT 10000 10000 8800
EPS K5.208
T(35%) 3500 3500 3080
EAIT 6500 6500 5720
Pref Div - 800 320 5. .
Net Income 6500 5700 5400 (i) TERP = K4.83
Retained income 3000 3000 3000
(ii) Revised EPS = K0.42
Ordinary dividends 3500 2700 2400
(iii) Revised EPS =K0.45
Ordinary shares 5000000 4000000 3100000
EPS K3.1 K1.425 K1.741
(iv) Share Price = 12.5 x 0.42 =K5.25
(Equity)
Alternative 3 gives the highest EPS Share Price = 12.5 x 0.45 = K5.625
(Debt)
(v) Debt financing should be used because it
gives a higher EPS.

13

CORPOTATE FINANCE – A PRINCE DANIELS PRODUCTION - +260972286191

6. .

TERP =K28

Value of a right = K30 – K28 = K2

(i) Sell all the rights

100000 old shares @K28 = K2800000
100000 rights @K2 = K200000 cash
New Position = K3000 000

(ii) Exercise half, sell half

112500 shares @K28 = K3150 000
50000 rights @K2 = K100 000
K3250 000
Less cash payment
Buy 12500@K20 K250 000
New Position K3000 000

(iii) Do nothing

100000 old shares @28 = K2800000

He will lose a K200 000 wealth

7. .
(i) EPS Debt financing = K12.3
EPS CS financing = K13.75

(ii) CS financing is better because it gives a

higher EPS.
The Company would be expected to change
to a new process if sales or earnings rise.
This would also make debt financing a
preferable method.
CHAPTER 7 – COST OF CAPITAL WACC = WeKe + WpKp + WdKd
1. . WACC with dividend model
Gordon’s Model WACC = 0.308(0.065) + 0.077(0.1) + 0.615(0.18)
𝐷1 WACC = 0.138
Ke = +g
𝑃
1.6(1.06)
Ke = + 0.06 = 0.106
37 WACC with SML
WACC = 0.308(0.065) +0.077(0.1) + 0.615(0.195)
CAPM WACC = 0.148
Ke = 𝑅𝑓 + β(Rm – Rf)
Ke = 0.05 + 0.85(0.08) = 0.118 (v) A company is raising funds from different sources of
finance and doing business with those funds. The company
has a responsibility to give a return to its funding providers. If
a company has only one source of financing, it is the rate at
2.
which it is required to earn from the business. However, the
(i) Kd = Ki (1 – t) company may have raised funds from more than one source
Kd = 0.1(1 -0.35) = 0.065 of finance, in which case WACC (Weighted Average Cost of
Capital) must be found, which indicates the minimum rate at
𝐷 2.5 which the company should earn from the business to give a
(ii) Kp = = = 0.1 return to its finance providers, as per their expectations. Let’s
𝑃 25
see the importance of the weighted average cost of capital in
detail.

(iii) . The importance and usefulness of the weighted average cost

of capital (WACC) as a financial tool for both investors and
companies are well accepted among financial analysts. It’s
Dividend Model important for companies to make their investment decisions
2
Ke = + 0.08 = 0.18 and evaluate projects with similar and dissimilar risks.
20 Calculating important metrics like net present values and
economic value added requires the WACC. It is equally
important for investors making valuations of companies.
Cost of equity: Assumptions
CAPM
- No Change in Capital Structure
Ke = 0.06 + 1.5(0.15 – 0.06) = 0.195
- No change in Risk of New Projects

(iv)

Capital structure (market values)

K’000 Weights
10% Debt 20000 0.308
Preferred Stock 5000 0.077
Common stock 40000 0.615
65000

15

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 3. . COST OF DEBT
(i) Market Values
K’000 wi Kd = 0.084
Ordinary shares 8320 0.502 WACC with dividend model
Preference shares 3240 0.196
14% Debentures 5000 0.302 WACC = 0.4093
16560 WACC with CAPM

Cost of Debt WACC = 0.184

Kd = 0.14(1 – 0.33) = 0.0938

Cost of Equity
Ke =0.04/0.8 + 0.12 = 0.17
Cost of Preferred stock
Kp = 0.09/0.72 = 0.125
WACC = 0.138.
(ii) The capital asset pricing model (CAPM) provides an
alternative to the dividend valuation model in
calculating the cost of equity. Unlike the dividend
valuation model, the CAPM seeks to differentiate
between the various types of risk faced by a firm and
to allow for the fact that new projects undertaken
may carry a different level of risk from the existing
business.
5. .
(i) Ke = 0.159
(ii) Ke = 0.1
(iii) .
Assumptions in Dividend Model
Basic assumptions in the dividend growth model
assume a stock’s value is derived from a company’s
current dividend, historical dividend growth
percentage, and the required rate of return for
business investments.
Assumptions in CAPM
CAPM assumes the availability of risk-free
assets to simplify the complex and paired
covariance of Markowitz’s theory. The risk-
free asset leads to the curved efficient
frontier of MPT and makes the linear efficient
frontier of the CAPM simple.

4. CAPITAL STRUCTURE 6. .
Km weights (i) Ke = 0.2
CS (50m x 1.2) 60 8/9 Kd = 0.07
Reserves 100 WACC = 0.148
Debt 20 1/9
180
(ii) Ke = 0.17
Kd = 0.056
COST OF EQUITY WACC = 0.132
Dividend Model
7. WACC = 0.1236
Ke = 0.45
CAPM
Ke = 0.197
 8. . (iii) According to the Net income approach,
capital structure decision is relevant to the
BEFORE value of the firm. An increase in financial
leverage will lead to decline in the weighted
CAPITAL STRUCTURE average cost of capital (WACC), while the
value of the firm as well as the market price
K’million of ordinary share will increase.
Equity (2.5 x 100) 250
9. .
7% Bonds 62.4 (i) Cost of debt (Mortgage)
Net Assets 312.4 Kd= 0.14(1 – 0.4) = 0.084

AFTER Cost of debt (Debentures)

CAPITAL STRUCTURE Kd= 0.14(1 – 0.4) = 0.084
K’million
Equity (2.5 x 100) 250 Cost of Preferred stock
7% Bonds 62.4 𝐷 0.13(100)
Kp = = = 0.131
8% Bonds 40 𝑃 99.25

Net Assets 352.4 Cost of equity

1.8
Ke = 67.5 + 0.1 = 0.127

The dividends grew from 19.38 to 21.8 in 4

(ii) Capital Structure
years
19.38(1 +g)4 = 21.8 Km weights
Mortgage 135 0.09
g =0.03
Debentures 225 0.154
Preferred Stock 89.35 0.061
Cost of K60m debt CS 1012.5 0.693
1461.825
Kd = 0.07
Cost of K40m debt
WACC= 0.09(0.084) + 0.154(0.084)
Kd= 0.08(1 – 0.3) = 0.056 + 0.061(0.131) + 0.693(0.127)
WACC = 0.116

Ke = 0.22(1.03) + 0.03 = 0.12064

2.5
(i) WACC = 0.111
(ii) WACC = 0.104

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 10. CAPITAL STRUCTURE CAPITAL STRUCTURE (Plan A)
Km weights K weights
CS 125 0.357 CS(20000 x 20) 400000 0.556
Preferred Stock 75 0.214 Preferred Stock 240000 0.333
Debt 150 0.428 Debt 80000 0.111
350 720000
(i) COST OF EQUITY
Ke = 0.218
Ke = 0.15, Kp = 0.1, Kd = 0.054
(ii) Cost of Preferred Stock WACC = 0.123
Kp = 0.1

(iii) Cost of Debt CAPITAL STRUCTURE (Plan B)

Kd= 0.1224
K weights
(iv) WACC =0.152 CS(23000 x 20) 460000 0.630
Preferred Stock 120000 0.164
11. Profit Statement Debt 150000 0.205
A B 730000
K K
EBIT 400000 400000 Ke = 0.115, Kp = 0.117, Kd = 0.06
I 7200 15000 WACC = 0.104
EBT 392800 385000
T(40%) 157120 154000
EAIT 235680 231000
Pref Div 24000 14000
Net Income 211680 217000
Shares 2 0000 23000
EPS K10.584 K9.43
CHAPTER 8 –CAPITAL BUDGETING
1. . (iii) IRR
(i) PAYBACK
𝑁𝑃𝑉1
BOARD GAME IRR = A1 + ( ) x (B2 – A1)
𝑁𝑃𝑉1−𝑁𝑃𝑉2
Payback period = 0.86 years
BOARD GAME
CD – ROM
Assuming A1 = 10%, NPV1 = 235.3
Payback period = 1.56 years
And B2 = 20%, NPV2 = 145.4
Decision: Board Game because it takes a 235.3
shorter period to recover the investment. IRR = 0.1 + ( ) x (0.2 – 0.1)
235.3−145.4
(ii) NET PRESENT VALUE IRR = 0.362 or 36.2%
BOARD GAME

yr CF PVIF PV
CD – ROM
0 (600) 1 (600)
Assuming A1 = 10%, NPV1 = 416.4
1 700 0.909 636.3
And B2 = 20%, NPV2 = 123.1
2 150 0.826 123.9
416.4
3 100 0.751 75.1 IRR = 0.1 + ( ) x (0.2 – 0.1)
416.4−123.1
235.3 IRR = 0.242 or 24.2%
Decision: Board Game because it gives a
higher internal rate of return.

CD – ROM

yr CF PVIF PV

0 (1900) 1 (1900)
1 1400 0.909 1272.6
2 900 0.826 743.4
3 400 0.751 300.4
416.4

Decision: CD – ROM because it has a higher

NPV.

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 2. 3. .
Annual Benefits 1− (1.11)^−5
(i) NPV = 210000( )– 77000
yr 1 2 3
0.11
NPV = K699 136.37
K’m K’m K’m

Sales 20 30 10
(ii) Investment = 672000 – 77000 = K595000
Costs (14) (21) (7) Annual Benefit = 378000 – 210000

Profit 6 9 3 = K168000
1− (1.11)^−5
Dep 2.33 2.33 2.33 NPV = 168000( )+
0.11
8.33 11.33 5.33 147000(1.11)-5 – 595000

WC 6
NPV = K113148.04
R.V 11

CF 8.33 11.33 22.33 (iii) Yes company should purchase the machine as
NPV of the New machine is Positive
PVIF 0.877 0.769 0.675

PV 7.31 8.713 15.073 (iv) Some of the challenges that put by

using the NPV is that it is difficult
to compare two projects with
different sizes because the NPV
method results in an answer in
(i) . dollars, the size of the net present
value output is determined mostly
NPV = 7.31 + 8.713 + 15.073 – 24
by the size of the input. For
NPV = K7.096 million. example, a K1 million project will
likely have a much higher NPV than
a K1,000 project, even if the
(ii) IRR = 46.762% K1,000 project provides much
higher returns in percentage terms.
(iii) With a positive NPV of K7.096
If capital is scarce -- and it usually
million and IRR of 46.762% the is -- the NPV method is a poor
project is viable and the project method to use because projects of
different size are not immediately
should be undertaken.
comparable based on the output.
In this case it would be better to
use IRR method to evaluate the
returns in percentage form.
 IRR.
4. .
Using the formula
(i) Payback Period
Project A IRR = 18.011%
PBP = 2.8125 years (ii).
Project B NPV of 1st method=189.04 and 2nd is 5445.7.
PBP = 2.265 years IRR for 1st method is 20% or 10% and 2nd is
18.011%
In both the case method 2 is giving better
Decision: Project B
result.
But these are projects with unequal lives.
(ii) NPV Project a is only for 1 year and project 2 is for
NPV of A = K86344.85 4 years. That's why these two methods cannot
NPV of B = K147826 be compared.
(iii) .
Decision: Project B
Mrs kangwa did not consider time value of the
(iii) IRR money and hence directly compared costs
IRR of A =22.848% with benefits and arrived at the decision to
IRR of B = 40.1% compare. And in project 2 Kangwa said that
for first year no revenue but he has not taken
Decision = Project B that for next 3 years the project is giving a
positive revenue.

5. .
(i) Method 1
NPV = 230000(1.15)-1 – 132000(1.15)-2 – 100000
NPV = K189.04
IRR.
At IRR, Total present value = investment
230000(1+IRR)-1 – 132000(1+IRR)-2 =100000
IRR = 20% or IRR = 10%

Method 2
NPV = 38000(1.15)-1 + 38000(1.15)-2 +
38000(1.15)-3 – 70000
NPV = K5445.7

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 6. . 8. .
(i) PROJECT A (a) PBP = 4.2 years
(b) NPV = 525.23
Using A1 =5%, B2 = 15% (c) PI = 1.007
NPV1 = 8463.7, NPV2 = -8058.9 (d) ARR = 26.3%
IRR = 14.1%
A positive NPV, a PI that is greater
PROJECT B than 2 and an ARR that is greater
than the cost of capital suggests that
Using A1 =5%, B2 = 15% the project is profitable and the
NPV1 = 109444.62, NPV2 = -6327.5 company should invest in the project.
IRR = 14.5%
9. .
K’000
(ii) Project A has an IRR that is slightly higher Cost of new machine 80000
than the cost of capital of 13%. While Proceeds from sale of old (30000)
project B has an IRR slightly lower than the Tax on profit (0.35 x 6m) 2100
adjusted risk cost of capital of 15%. Working Capital 15000
Therefore the company should consider Investment 67100
investing in Project A rather than Project B.
ANNUAL BENEFITS
(iii) Although the IRR allows you to calculate K’000
the value of future cash flows, it makes an Increase in sales 5000
implicit assumption that those cash flows Decrease in costs 2500
can be reinvested at the same rate as the 7500
IRR. That assumption is not practical as the Tax (35%) (2625)
IRR is sometimes a very high number and 4875
opportunities that yield such a return are Dep x tax (7500 x 0.35) 2625
generally not available or significantly 7500
limited.
NPV CALCULATION
7. . Yr CF PVIF PV
(i) PBP of A = 1.53 years K’000 K’000
PBP of B = 1.5 years 0 (67100) 1 (67100)
PBP of C = 1.37 years 1–6 7500 3.784 28383.6202
Recommendation: Project C S.V 8000 0.432 3458.621
WC 15000 0.432 6484.92
(ii) IRR of A =18.91% NPV = -28772.84
IRR of B = 20.36%
IRR of C = 32.1% A negative NPV suggests that the company should
Recommendation: Project C not replace the old machine because the new
machine is not profitable.
(iii) NPV of A =31990.13
NPV of B = -186.4
NPV of C = 50222.82
Recommendation: Project C
 10. . 1 2 3 4
Dep = Cost – SV =27m – 0 = K9m K’000 K’000 K’000 K’000
Useful life 3 Sales 32000 36000 40000 28000
YR Profit Dep Cashflow VC 12000 13500 15000 10500
K’000 K’000 K’000
FC 500 500 500 500
1 7500 9000 16500
2 (5250) 9000 3750 EBITD 19500 22000 24500 17000
3 6750 9000 15750 DEP 5000 5000 5000 5000
EBIT 14500 17000 19500 12000
(i) ARR = Average Profit x100 TAX 5800 6800 7800 4800
Average Investment 8700 10200 11700 7200
DEP 5000 5000 5000 5000
ARR = (7.5m – 5.25m + 6.75m)/3 x 100 Cf 13700 15200 16700 12200
(27m)/2
(ii) Net Present Value Computation
ARR = 22.2%
YR CF PVIF(12%) PV
(ii) PBP = 2.43 years K’000 K’000
(iii) NPV = K2.93 million
0 (20200) 1 (20200)
(iv) IRR = 16.3%
1 13700 0.8929 12232.143
11. .
2 15200 0.797 12117.35
(i) INVESTMENT
3 16700 0.712 11886.73
K’000
4 12200 0.636 7753.32
Cost 19900
4 200 0.636 127.104
Installation Cost 100
NPV= 23916.64
WC 200
Decision: Invest because of the positive NPV.
Investment 20200

(iii) The payback period is the length of time it

takes to recover the cost of an investment or
the length of time an investor needs to reach a
breakeven point.

Advantages
 The formula is straightforward to know and
calculate
 Payback Period Helps in Project Evaluation
Quickly

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 Disadvantages 15. .
It doesn’t take Time Value of Money into (a) INVESTMENT
consideration. This method doesn’t consider the
K
fact that a dollar today is way more valuable
than a dollar promised in the future. Cost 800000
The method additionally doesn’t take into consideration
Installation (100000/1.1) 90900
the inflow of cash after the payback period.
Tax on sale (100000 x0.3) (30000)
WC 65000
12. .
(i) Investment = K7500 000 925900
(ii) Annual Cash flow = K1100 000
(b) Cash flows
(iii) NPV = -225 527.93
Year 1 – 544800
Year 2 – 766560
13. .
Year 3 – 563280
(a) Initial Investment = K11000
Year 4 – 885840
(b) Cash flows
Year 5 – 952200
Year 1 – K3733
Year 2 – K4333
Non- operating CF is 120000 +65000 =
Year 3 – K4933
K185000
(c) Non-operating CF is the salvage value of K5000
(c) NPV = K1936755
(d) ARR = 18.18%
NPV = K3438
Decision is accept
PI = 1.3

16. Initial Outlay = K19091

The project should be undertaken because the
PI is greater than 1 and NPV is positive. 17. PBP = 3.5 years
NPV = -7925
14. .
NPV = -31132
18. IRR = 9%
IRR = 9.175%
19. PBP = 2.54 years
20. NPV of gas station = 29.06
IRR is less than the cost of capital therefore the NPV of Apartment = 29.79
project should be accepted.

Decision: Project Apartment Building

CHAPTER 9 – DIVIDNEND POLICY 2. .
1.
Equity requirement = 5/8 x 40000 000
A dividend policy is the policy a company uses = K25000 000
to structure its dividend pay-out to
shareholders. Some researchers suggest the Dividends= Net Income – Equity requirement
dividend policy is irrelevant, in theory, = K32.4m – K25m
because investors can sell a portion of their = K7.4million
shares or portfolio if they need funds. This is
the dividend irrelevance theory, which infers Pay-out ratio = 7.4/32.4 x 100 = 22.84%
that dividend pay-outs minimally affect a
stock's price. 3. .

Dividends are often part of a company's The factors that are taken into consideration when
strategy. However, they are under no setting a company's dividend policy are -
obligation to repay shareholders using
dividends.
Type of Industry
Stable, constant, and residual are the three
types of dividend policy. Industries with stable earnings may adopt a
consistent dividend policy as opposed to the
The finance manager analyses following
industries where earnings are uncertain and
factors before dividing the net earnings
variable. Such risky industries usually have a
between dividend and retained earnings:
conservative approach to dividend pay-out.
1. Earning:
Ownership Structure
Dividends are paid out of current and previous
If promoters own a major part of the company
year’s earnings. If there are more earnings
then they prefer fewer dividends as dividend
then company declares high rate of dividend
distribution drives down the share price.
whereas during low earning period the rate of
dividend is also low. If institutional investors own a major part of the
company then they favour high dividend pay-out
2. Stability of Earnings:
as it helps to increase control over the
Companies having stable or smooth earnings management.
prefer to give high rate of dividend whereas
Age of Company
companies with unstable earnings prefer to
give low rate of earnings. New companies retain a major chunk of their
earnings to finance future expansion needs.
3. Cash Flow Position:
However, established companies, which have often
Paying dividend means outflow of cash. reached a level of saturation pay high dividends
Companies declare high rate of dividend only and do have huge reserves.
when they have surplus cash. In situation of
shortage of cash companies declare no or
very low dividend.

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 Concentration of Ownership 5. .
(i) A residual dividend policy
If a company has a large number of
means companies use earnings
shareholders with small holdings then it is
to pay for CapEx
difficult to convince so many people over a
first. Dividends are then paid
conservative dividend policy. Fewer people are
with any remaining earnings
easier to convince.
generated. A company's capital
Business Cycle structure typically includes both
long-term debt and equity.
In times of booming business, it is prudent to
CapEx can be financed with a
save and make reserves for recession/dips.
loan (debt) or by issuing more
These reserves will help a company to maintain
stock (equity).
dividends even in depressing markets.
Impact on Shareholder wealth Alternative one
Capital expenditure =K4000000
Bird-in-hand theory by Linter and Gordon
Investors are always risk-averse and desire to Equity = 0.6 x 4000000
obtain dividends instead of capital gains in the = K2400 000
future. The dividend pay-out has a great impact
on the market price of shares. The theory says Dividend = RE – equity
that the bird in hand (dividend) is better than =4000000 – 2400000
the bird in the bush (capital gain). It is better to =K1600 000
receive an income right now that to wait for
future gain which is uncertain. Investors buy Pay-out ratio = 40%
share of those companies whose dividend policy
satisfy their needs. Alternative two
1.
Capital expenditure =K6000000
4. .
(i) Equity requirement = 60% of K800000 Equity = 0.6 x 6000000
= K480000 = K3600 000

Dividends = 600000 – 480000 Dividend = RE – equity

= K120000 =4000000 – 3600000
=K400 000
(ii) At Net Income of K400000
Dividend = 400000 – 480000 = -80000 Pay-out ratio = 10%
The company will not manage paying out
the equity dividends. They should
changing their capital structure.

At net income of K800000

Dividend = 800000 – 480000 = K320000
(ii) .
Alternative one sees a dividend pay-out
of 40% while alternative two sees 10%
ratio.
How does dividend policy affect stock
prices?
After the declaration of a stock
dividend, the stock's price often
increases. However, because a stock
dividend increases the number of shares
outstanding while the value of the
company remains stable, it dilutes the
book value per common share, and the
stock price is reduced accordingly.
Stable Dividend Policy
A stable dividend policy is the easiest
and most commonly used. The goal of
the policy is a steady and predictable
dividend payout each year, which is what
most investors seek. Whether earnings
are up or down, investors receive a
dividend.
The goal is to align the dividend policy
with the long-term growth of the
company rather than with quarterly
earnings volatility. This approach gives
the shareholder more certainty
concerning the amount and timing of the
dividend.
Constant Dividend Policy
The primary drawback of the stable
dividend policy is that investors may not
see a dividend increase in boom years.
Under the constant dividend policy, a
company pays a percentage of its
earnings as dividends every year. In this
way, investors experience the full
volatility of company earnings.

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CHAPTER 10 – LEVERAGE AND 2. .
BREAKEVEN ANALYSIS (a) Fixed Cost = K180 000
(b) Degree of operating leverage =160%
1. .
Degree of financial leverage = 150%
Income statement Degree of total leverage = 240%
K
(c) EPS = K1.488
Sales (0.45 x 500000) 225000 (d) Break Even Sales = K300000
(e) The firm should use a lower leverage
VC (0.25 x 500000) (125000)
because with a lower leverage ratio it
Contribution 100000 would be easier for the firm to secure a
loan.
Fixed Costs (50000)
EBIT 50000
Interest (6000)
EBT 44000

Degree of operating leverage

= Contribution x 100 = 100000 x 100 = 200%
EBIT 50000
100% rise in sales will result into a 200% rise
in EBIT
Degree of financial leverage
= EBIT x 100
EBIT – Pref Div( 1- t)-1

= 50000 x 100
44000 – 2400(0.6)-1
= 125%
A 100% rise in EBIT will lead to a 125% rise
in EPS.
Degree of total leverage = 2 x 1.25 = 2.5
= 250%
A rise in Sales of 100% will result into a 250%
rise in EPS.
CHAPTER 11 – FOREIGN POLICY
1. .
When receiving we use the buying rate, when
paying we use the selling rate
(i) Receiving $100,000

Value in sterling = 100000/1.8101

= £55245.57

(ii) Paying 40,000,000 yen.

Value in sterling = 40000000/194.347

= £205817.43

(iii) Paying €250,000.

Value in sterling = 250000/1.4380
= £173852.57

(iv) Receiving €40,000.

Value in sterling = 40000/1.4366
= £27843.52

(v) Paying $600,000.

Value in sterling = 600000/1.8113
= £331253.8

AUTHOR: DANIEL MUGALA

AFFILIATIONS:

BACHELOR IN ACCOUNTANCY

Master’s in Business Administration

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