INSTITUTE OF BANKERS IN MALAWI

DIPLOMA IN BANKING EXAMINATION

SUBJECT: FINANCIAL CONCEPTS A (IOBM D206)
Date: Tuesday, 1st May 2012
Time Allocated: 3 hours

(08:00 11:00 am)

INSTRUCTIONS TO CANDIDATES
1

This paper consists of TWO Sections, A and B.

Section A consists of 4 questions, each question carries 15 marks.

Answer ALL questions.

Section B consists of 4 questions, each question carries 20 marks.

Answer ANY TWO questions.

You will be allowed 10 minutes to go through the paper before the start of the
examination, you may write on this paper but not in the answer book.

Begin each answer on a new page.

Please write your examination number on each answer book used.

Answer sheets without examination numbers will not be marked.

DO NOT open this question paper until instructed to do so.

SECTION A

(60 MARKS)

Answer ALL questions from this section.

QUESTION 1
Recently Reserve Bank of Malawi has increased its monitoring and control of bank
charges that are levied by banks to its customers. The Reserve Bank reduced the
prime rate from 17% per annum to 15% per annum, effectively the banks commercial
rate was reduced from 19.75% per annum to 17.75% per annum?
(a)

List five reasons why banks charges interest on loans.

(b)

Given the pressure that Reserve Bank pauses to commercial banks to reduce
interest rates, banks have started focusing on Non Interest Revenue
generating activities in order to sustain profitability of the banks.
(i)

(5 marks)

Briefly explain two activities that banks carries out to increase its fees from
customers.
( 4 marks)

(ii) Briefly explain two activities that the banks carries out to increase its
commissions.
(4
marks)
(iii) Distinguish between Nominal and Real Interest rates.
marks)

(2
(Total 15 Marks)

Question 2
(a) Calculate the payback time period of the following project:
Year
0
1
2
3
4
5
6

Cash Flows (MK000)

- 80,000
- 80,000
+
50,000
+
50,000
+
50,000
+
10,000
- 30,000
(4 Marks)

(b) Mr Phiri plans to invest an amount of money at the beginning of every year in
order to accrue a sum of MK 100,000.00 at the end of a five year period. What
is the value of the amount, if the investment rate is 14%?
(5 marks)

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(c) All Fashions Boutique would like to invest in property, the total debt needed is
MK 2,500,00.00 taken over 4 years (with no inter-mediate payments) where
the borrowing rate is 12% and the worth of money (discount rate) is 9.5%,
Required:
Calculate the net present value of the debt.

(6 marks)
(Total 15 Marks)

Question 3
(a) What is the NPV decision rule for simple accept and reject decision rule?
(1 mark)
(b) What is the NPV decision rule when faced with mutually exclusive projects?
(2 marks)
(c) Given a 10% discount rate, what are the present values of the following five
annuities?
Year

Annuity 1

+
100

+
+
100 100

Annuity 2

+
+
100 100

+100 +100

+100

Annuity 4

+ 100

+ 100

+100 +
+
100 100

+ 100

Annuity 3

Annuity 5

+ 100

(10 marks)
(d) What is the annual equivalent of a 4 year immediate annuity which has a
present value of Mk 1 Million, when discounted at 10%?
(2 marks)
(Total 15 Marks)

Question 4
Mr Phiri runs a manufacturing business. He is considering whether to accept one of
two mutually exclusive investment projects and, if so, which one to accept. Each
project involves an immediate cash outlay of MK 100,000.00.
Mr Phiri estimates that the net cash inflows from each project will be as follows: -

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Net cash flows at the

end of:
Immediate cash outlay
Year 1
Year 2
Year 3

Project A

Project B

MK

MK

-100,000
60,000
40,000
30,000

-100,000
10,000
20,000
110,000

Mr Phiri does not expect capital or any other resources to be in short supply during
the next three years.
(a) On the basis of the information given, advise Mr Phiri which project to accept
if his discount rate is
(i)
(ii)

15%
20%

(9 marks)

(b) List three advantages and three disadvantages of accounting rate of return.

(6 marks)
(Total 15 marks)

SECTION B

(40 MARKS)

Answer ANY TWO questions from this section

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QUESTION 5
Swagga Barbershop Limited would like to get a debt from Mohoc Bank, Swagga
Barbershop Limited is prepared to obtain debt of MK 42,800.00 armotised over 5
years. If the borrowing rate is 16.5%
a) How much are the annual payments?
b) How much interest is paid on the loan each year?

(5 marks)
(5 marks)

(a) Swagga Barbershop Limited purchases a house from Mohoc Bank for MK
18.5 Million over 25 years at a fixed rate of 11%, and is armotized by equal
annual payments
i)

How much are the annual payments?

(5 marks)

ii) If the annual payments is divided by 12 and charged monthly (in

arrears), what is the Societys annual gain as a percentage of the original
principal borrowed? (Assume the Society can invest at 9% compounded
monthly).
(5
marks)
(Total 20 Marks)
QUESTION 6
(i)

Gladiator Shoes Limited has to repay a loan of MK 1 Million in exactly four

years from now. It is planned to set aside nine equal amounts of MK X every
six months, first one now, each attracting an interest at a nominal rate of 12%
per annum, but compounded twice a year.
Required:
Find X .

(5 Marks)

(ii) Supra Shoes Limited plans to buy equipment for MK 100,000.00 half of which

is due on delivery, with the balance due exactly one year later. The year-end
cash flows are expected to be MK 25,000.00 per annum, for five years. After
exactly five years the equipment will be sold for MK 10,000.00.
Required:
Analyse whether it is a worthwhile purchase, if the company has to borrow
at 14% per annum.
(5 marks)

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(iii)

The Finance Director for Skinnies Chain stores estimates that his company
will have spent MK 0.25 Million on New Machinery in two years from now. Two
alternative methods of providing the money are being considered, both
assuming an annual rate of interest of 10%.
a) A single sum of Money, MK B to be set aside and invested now,
with interest compounded every six months. How much should this
single sum be, and what is the effective annual rate of interest?
(5 Marks)
b) MK C to be put into a reserve fund every six months, starting from
now. If the interest is compounded every six months, what should Mk
B be, in order that the MK 0.25 Million will be available in two years?
(5 Marks)
(Total 20 Marks)

QUESTION 7
Getwellsoon Limited has been offered a contract to manufacture a batch of
chemicals. The companys manager Mr Chirani estimates that it will take two years
to produce the chemicals. The price offered is MK 235 Million.
The price will be increased in line with increases in the retail price index during the
contract period, and the adjusted amount will be paid in full when the chemicals are
delivered at the end of two years.
Production of the chemicals will require the following resources:
(i) A machine will be purchased immediately for MK 75 Million for exclusive use
on the contract. The machine will have a two year life and no scrap or resale
value.
(ii) Ten men who are currently employed by the company will each work for two
years on production of the chemicals. The total cost of employing one man is
currently MK 6 Million per annum, based on wage rate which have recently
been agreed for the coming year; as a result, they expect that total
employment costs for the second year of the contract will rise by a factor of
1.25 multiplied by the rate of increase in retail price index.
(For example, if the Retail Price Index increases by 8%, total employment
costs will rise by 8% x 1.25, which equals 10%)
You may assume that all employment costs are payable on the last day of the
year to which they relate.

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If the chemicals contract is not accepted, there will be no work within the
company for the ten men during the coming two years and they will be made
redundant. The company will incur redundancy cost of MK 200,000 for each
man payable immediately.
The managers expect new orders after two years and the company will reemploy the ten men at the end of the second year.
Administrative and advertising costs associated with the re-employment are
expected to be MK 500,000.00 per man. This amount will not be affected by
inflation during the next two years.
(iii) 2,000 units of raw material D will be needed immediately and 2,000 units will
be needed at the end of each year. Zachikuda Pharmaceutical Limited has
2,000 units in stock. These units originally cost MK 18.00 per unit and have a
current replacement cost of MK 20 per unit.
The company has no use for material D other than on the contract offered,
and if the contract is rejected, the units in stock will be disposed of at
immediate cost of MK 1.50 per unit.
(The material is highly specialised and cannot be re-sold)
The cost of buying material D is expected to rise during the coming year by a
factor of 1.5 multiplied by the rate of increase in the retail Price Index.
Zachikuda Pharmaceutical Limited has a money discount rate of 15% per
annum, which is not expected to be affected by any future change in the
inflation rate.
Mr Chirani estimate that retail price index will increase at a rate of 10% per
annum compounding during the next two years.
You are required to:
(a) Calculate the Net Present Value of the contract which has been offered to
Getwellsoon Limited.
(12 marks)
(b) Estimate, to the nearest 1%, the rate of increase in the Retail Price Index over
the next two years at which the net present value of the contract is zero.
(8 Marks)
(Total 20 Marks)

QUESTION 8

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Pray and Play Club is a famous Religious Club which is in Blantyre, the management
is considering which, if any, of four independent projects to undertake. The forecast
cash flows for each project are listed below; receipts arise at the end of each year.
Net cash flows
Project Immediate Year 1
Year 2
Year 3
Outlay
Chakhumi
-2,500 +1,000
+1,000
+1,000
Chopatulika
-1,000
+100
+1400
0
Choletsedwa
-1,000
+800
+600
0
Chovomelezek
-4,000
0
0
+5,000
a
The company faces a perfect capital market, in which the interest rate for the
projects risk level is 10%
You are required to: (a) Using the NPV decision rule, indicate which projects the company should
accept. State clearly the reasons for your decisions.
(12 marks)
(b) How would your calculations in (a) differ if the projects were mutually
exclusive.
(2 marks)
(c) Estimate the Internal Rate of Return of projects 2 and 3. Would it be valid to
choose between projects 2 and 3 on the basis of their expected IRRs? If not
present revised calculations so that the internal rate of return method and the
method you have used in (a), lead to the same, unambiguous conclusions.
(4 Marks)
(d) In practice, the IRR method has been observed to be far more widely used
than Net Present Value. Suggest reasons for this relative popularity. Why
might the supposed superiority of NPV be an illusion or an irrelevant in
reality?
(2 Marks)
(Total 20 Marks)

END OF THE EXAMINATION PAPER

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