THE COPPERBELT UNIVERSITY

DIRECTORATE OF DISTANCE EDUCATION AND OPEN LEARNING (DDEOL)

JUNE 2016 – SESSIONAL EXAMINATIONS

DBA 320 – FINANCIAL MANAGEMENT

INSTRUCTION:

a) TIME ALLOWED THREE HOURS

b) MARKS ALLOCATED INDICATE THE LENGTH AND DEPTH OF EXPECTED
ANSWER

SECTION A: ANSWER BOTH QUESTIONS

QUESTION ONE

The following financial information is available from the financial position of DBA plc at 31st
December, 2016:

K’000

Ordinary shares K40 each 450

Share premium 120
20% convertible debt K100 each 150
30% bank loan 100

Additional information:

 The current market price per share is K50, and debt K105 respectively
 The debt can be converted in 2 shares in 5 years’ time or be redeemed at par
 The ordinary share is expected to grow at 5% indefinitely and tax is 30%
 The return on government bonds is 5%, beta 0.7 and risk premium is 14%

Required:
a. compute the cost of capital for
i. bank loan [4 marks]
ii. equity [6 marks]
iii. convertible loan [10 marks]
b. using market values, where possible, compute the company’s weighted average
cost of capital(WACC) [7 marks]
c. explain why the financial manager will favour debt to equity finance in the
financing decision [3 marks]

QUESTION TWO
a. The following financial information is available:
K’000
Revenue 590
Cost of sales 230
Inventory 25
Trade receivables 60
Trade payable 20
Required:
Compute the following perimeters in months:
i. receivables collection period [5 marks]
ii. payables payment period [5 marks]
iii. inventory turnover period [5 marks]
iv. cash operating cycle and comment on it [5 marks]
b. explain three[3] key factors that the financial manager has to consider when formulating
the dividend policy decision [6 marks]
 c. list four key stakeholders in the financial policy of the corporation [4 marks]

SECTION B: ANSWER ANY TWO QUESTIONS

QUESTION THREE
As the financial manager of your company, you have been tasked to evaluate the following
capital project and advise on its viability
i. the project will cost K120,000 to be spent immediately and it will last for five years with
K20,000 working capital
ii. the asset will have zero residue value at the end of the fifth year
iii. corporate tax is paid a year in arrears at 30%
iv. starting year one, profits are as follows:(K) 38,000, 33,000, 20,000, 37,000 and 40,000
respectively
v. the cost of capital is 10% and capital allowances are available at 25% reducing balance
basis
Required:
a. compute the net present value [8 marks]
b. what’s the return on capital employed [5 marks]
c. what’s the payback period [5 marks]
d. advise management if this project is to be undertaken [2 marks]

QUESTION FOUR
Write brief notes on the following:
i. the capital asset pricing model [5 marks]
ii. systematic and unsystematic risks [5 marks]
iii. capital and money markets [5 marks]
iv. capital structure of a corporation [5 marks]

QUESTION FIVE
You are a Zambian trader engaged in the import and export business. As at 1st January 2016, you
had sold goods worth $50,000 and at the same time bought goods costing $20,000 both on credit.
The net amount to be hedged is to paid or received in equal instalments up to three equal
installments; now, three months’ time and six months time respectively
The following are the exchange rates as provided by your local bank:
$/K
Spot 8.9-9.0
A quarter ahead 9.3-10.5
2 quarters ahead 9.1-9.7
Required:
i. find the amount to be hedged [2 marks]
ii. using the forward contract, how much is to be received or paid in Zambian kwacha over
three instalments [2 marks]
iii. assuming that the exchange rate on the date of the last instalment is $/K 8.0-8.5 calculate
the gain or loss on this hedging [4 marks]
iv. Explain three [3] key factors that account for the fluctuation in the foreign currency.
[6 marks]
v. Explain other three[3] methods that a local international trader can use to hedge foreign
currency exposure [6 marks]

SUGGESTED SOLUTIONS
QUESTION ONE
a.
Kd=i(1-T)
Kd =30%(1-30%)
Kd = 21%
i.

Ke =Rf+β(Rm-Rf)
Ke =5%+0.7(19%-5)
Ke =14.8
ii.
 P = Po(1+r)n*R
Po =50(1+0.05)^5*2
Po =K127.63
iii.

Therefore this debt will be converted in 5 years’ time as it’s more economical than redeeming it at par
year cashflows DF(10%) PV DF(20%) PV
0 -105 1.000 -105.00 1 -105.0000
1 to 5 14 3.791 53.07 2.991 41.8740
5 127.63 0.621 79.26 0.402 51.3073
NPV 27.33 NPV -11.8187

Using the IRR method, the cost debt is 16.98%

Market Values K'000

ordinary share capital(450/40*50) 562.5
20% convertible debt(150/100*105) 157.5
30% bank loan 100
TOTAL 820

Market Values Cost(%) WACC

562.5 14.8 10.15
157.5 16.98 3.26
100 21 2.56
820 15.97
b.

c. The finance manager will favour debt capital to equity because of the following:

 The interest on debt capital is tax deductible hence it’s cheaper than dividends on equity which
is not
 Debt is secured hence less risk than equity that’s why it’s cheaper to the borrower; the company
 It’s easier, faster and less bureaucratic to contracting debt than equity

QUESTION TWO

a.
Recievables days =Recievables/Sales Revenue*365/30
Recievables =60/590*365/30
Recievables = 1.2
i.
 Payables days = Payables/Cost of Sales*365/30
Payables = 20/230*365/30
Payables = 1.1
ii.

Inventory = Inventory/Cost of sales*365/30

Inventory = 25/230*365/30
Inventory = 1.3
iii.

Cash Cycle Months

Recievables 1.2
Payables -1.1
Inventory 1.3
1.5
iv.

b. The following are the consideration in formulating dividend policy

 The future capital expenditure of the company
 The signaling effect of dividends
 The reaction of markets to the dividend policy of the company

c. Key stakeholders are:

 Shareholders
 Lenders of finance
 Management
 Employees suppliers

QUESTION THREE
 Capital Allowances
Year Allowances Tax
1 30.0 -
2 22.5 9.0
3 16.9 6.8
4 12.7 5.1
5 37.9 3.8
6 - 11.4

Year 0 1 2 3 4 5 6
Cashflows 62.0 57 44 61 64 0
Tax(30%) 0 18.60 17.10 13.20 18.30 19.20
Tax Savings 9.0 6.8 5.1 3.8 11.4
Asset Cost -120
Working Capital -20 20
Net Cashflows -140 62.0 47.4 33.7 52.9 69.5 (7.8)
DF(10%) 1 0.909 0.826 0.751 0.683 0.621 0.564
PV -140.0 56.4 39.2 25.3 36.1 43.2 -4.4
NPV 55.64
a.

b.
Year profit/loss Average Capital =120,000+0/2
1 38,000 60,000
2 33,000
3 20,000
4 37,000 average
ROCEprofit/average
= capital*100
5 40,000 ROCE = 56 %
168,000
5
Average Profit 33,600
 Year Cashflow Cumulative
0 (120,000) (120,000)
1 62,000 (58,000)
2 57,000 (1,000) PBP = 2+(1/44)
3 44,000 43,000 2 years
4 61,000 104,000
5 64,000 168,000
c.

d. Looking at the results of the appraisal methods above, the project is viable.

QUESTION FOUR

i. THE CAPITAL ASSET PRICING MODEL

This is a model very important in modern financial management used in the estimation of cost of equity,
specific cost of capital if the project to be appraised presents special features and risks as well as used in
finding out the relationship between risk and return; security market line. This model, unlike the
dividend growth model, involves risk and return (both on risky and none risky investments)

ii. SYSTEMATIC AND UNSYSTEMATIC RISKS

Systematic risks are specific risks that are in the market and cannot be diversified despite the investor
creating a well-diversified portfolio of assets. This is the risk the investor is concerned with and it’s
factored in the cost of equity by beta.
Unsystematic risk, on the other hand are risks that are eliminated when an investor diversify his
investment well; hence it’s not of concern to a well-diversified investor.

iii. CAPITAL AND MONEY MARKET

A capital market is a market where long term capital is raised by corporations. Both debt and equity can
be raised from the stock exchange therefore keeping companies afloat in terms of capital for expansion
and growth. A money market is an example of a commercial bank where capital is raised both on long
and short term basis. A money market is also a foreign exchange market among other things it provides.

iv. CAPITAL STRUCTURE OF A CORPORATION

Capital structure refers to the combination of debt and equity capitals of a company. This combination,
financing decision, is crucial because it presents risks to the corporations (financial risk) and the average
cost of capital of the company depends on this structure. There are two conflicting theories on capital
structure; the traditional and the net operating (MM) views.

Traditional views argues that the average cost of capital of a company depends on the combination of
debt and equity capital and hence there is an optimal capital structure; the best combination that gives
lowest weighted average cost of capital. The net operating view argues that the value of the company
depends on the earnings of the company in the future and its business risks only, assuming there’s a
perfect market.
QUESTION FIVE
$
export(reciept) 50,000
import(payment 20,000
net reciept 30,000
i.

1st instalment K
10,000 8.9 89,000

2nd instalment K
10,000 9.3 93,000

3rd instalment K
10,000 9.1 91,000
ii.

hedged reciept 91,000

actual reciept
10,000 8 80,000
Gain 11,000
iii.

iv. Key factors are as follows:

 Balance of payment –imports and exports

 Strength of the economy
 Interest rates
 Inflation rates
v. Other methods are:
 Invoicing in local currency
 Using bills of exchange
 Matching assets and liabilities
 Leading ad lagging