ST.

PAUL’S UNIVERSITY
FACULTY OF BUSINESS AND COMMUNICATION STUDIES
BACHELOR OF BUSINESS ADMINISTRATION
CAT 1
BFI 220: BUSINESS FINANCE

Instructions:
 Answer ALL questions
 Ensure your answers are well argued and clear
 Avoid copying from your colleague. Similar work will be heavily penalized
 Avoid copy and pasting information/answers from the internet
 The CAT should be submitted only through the E-learning portal
 CAT is due on 15/10/2022

Question one
Financing and Leverage
Leverage is one of the most powerful concepts in finance, and it is critical in financing choices and capital structure. You
may have friends who get weepy- eyed when they talk about leverage and robustly argue against it. Empires have been
built and destroyed because of leverage. However leverage in finance allows owners to control assets they couldn’t
control otherwise.
Required
a. Discuss five ways that Kenyan companies have used leverage to their advantage.

● Companies use leverage to finance their assets—instead of issuing stock to raise capital, companies can
use debt to invest in business operations in an attempt to increase shareholder value.
● increases the liquidity available to the company- when a company takes out a loan or debt, it receives cash
from the lender, this debt is paid in small installments over a relatively long period of time .and that cash can be
used for a variety of activities . These activities include purchasing new machinery or constructing a new
building, which will increase the efficiency of the company, or the company can use the cash to purchase other
companies, which will increase the scale of operations of the company,
● companies use leverage to multiply their buying power in the market. -Buying power is the money an
investor has available to buy securities in a trading context..Additional buying power magnifies both profits and
losses. leverage gives the investor an opportunity to make increased gains with the use of more buying power
● Magnification of Shareholder Profits-If a company is solely financed by shareholder equity, then its
profitability to the shareholders will change in proportion to its own change in profitability. For example, should
profits increase by ten percent, the shareholders' dividends or share value will increase by ten percent. If the firm
is leveraged, then that increase in profitability of the operation will not increase the payments needed to service
the debt. Thus the excess profit is all passed to the shareholders and will necessarily increase the value of shares
or dividends to a greater degree than the increase in the operation's profitability.
● multiplication of profits for the company-in the case of a growing company that requires cash for its operations,
the use of debt can result in a multiplication of profits for the company. As long as the company is growing,
leverage tends to magnify the company's profits.

(10 marks)
b. With reference to the Kenyan context, explain five ways in which you can use leverage to your advantage.
(10 marks)
● Make a relatively small upfront investment.Leverage is an investment strategy that involves
borrowing money to increase the potential return on investment.by this it will be easy to start a large
business with your little amount and be able to keep up with the competition with an already existing
market.
 ● Higher Profits-Leverage gives you the possibility to enjoy increased profits that are much more that
what you will initially get from your upfront investment .The interest rates are always low hence one can
get much profit even after paying the loan
● Bigger Exposure-You don’t have to restrict yourself from taking a single or a few lots of any call or put
option just because you are short of money. With leverage, you can actually have bigger exposure in the
index or stock whose option or futures contract you are planning to take.

● Gaining a competitive advantage-A small business builds a competitive advantage by

providing a better overall value to customers than competitors are able to.Kenya being an
economy with full SME one can use leverage to his/her advantage by gaining more capital to
increase its marketing effort and also meet customer satisfaction.

Question two
Three suggestions for investors
First, beware of companies displaying weak accounting. If a company still does not expense options, or if its pension
assumptions are fanciful, watch out. When managements take the low road in aspects that are visible, it is likely they are
following a similar path behind the scenes. There is seldom just one cockroach in the kitchen....
Second, unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or other
managerial explanation, it’s usually because the CEO doesn’t want you to. Enron’s descriptions of certain transactions
still baffles.
Finally, be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate
in a tranquil, no-surprise environment, and earnings simply don’t advance smoothly (except, of course, in the offering
books of investment bankers).
Required
Read the write up above and evaluate it from the agency theory perspective. (10 marks)