FIN

210 DL SEP 2016

{ASSIGNMENT 2}:




The Assignment covers three areas:
Part ACapital Budgeting (45 Marks)
Part B Financial Planning & Financial Statements Analysis (25 Marks)

1|P a g e

PART ACAPITAL BUDGETING.

Question 1:
1. (a) Briefly explain the importance of capital budgeting in a business organization.
(4 marks)
(b) Describe in brief the greatest difficulties faced in capital budgeting in the real world.

(6 marks)

(c) Several methods exist for evaluating investment projects under capital budgeting.
Identify and explain three features of an ideal investment appraisal method. (6 marks)
(d) In evaluating investment decisions, cash flows are considered to be more relevant
than profitability associated with the project.

Explain why this is the case.

(4 marks)

Question 2:
(2.)

Jordan was recently appointed to the post of investment manager of Adaptive Metals

Ltd. a quoted company. The company has raised Sh.8,000,000 through a rights issue.
Jordan has the task of evaluating two mutually exclusive projects with unequal economic
lives. Project X has 7 years and Project Y has 4 years of economic life. Both projects are
expected to have zero salvage value. Their expected cash flows are as follows:


Project

Year

Cash flows (Sh.)

Cash flows (Sh.)

2,000,000

4,000,000

2|P a g e

2,200,000

3,000,000

2,080,000

4,800,000

2,240,000

800,000

2,760,000

3,200,000

3,600,000

The amount raised would be used to finance either of the projects. The company expects to
pay a dividend per share of Sh.6.50 in one years time. The current market price per share is
Sh.50. Masada Ltd. expects the future earnings to grow by 7% per annum due to the
undertaking of either of the projects. Adaptive Metals Ltd. has no debt capital in its capital
structure.

Required:
(a)

The cost of equity of the firm (Use Gordon Model) or another appropriate valuation

model
(b)

(4 marks)

The net present value of each project using the cost of equity calculated above as the

required rate of return

(6 marks)

(c)

The Internal Rate of return (IRR) of the projects. (Rediscount cash flows at 24%

for project X and 25% for Project Y).

(d)

Briefly comment on your results in (b) and (c) above.

3|P a g e

(6 marks)

(4 marks)

(e)

Identify and explain the circumstances under which the Net Present Value (NPV) and
the Internal Rate of Return (IRR) methods could rank mutually exclusive projects in
a conflicting way.

4|P a g e

(5 marks)

Part BFinancial Planning & Financial Statements Analysis.

Hertz Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30. Its
financial statements for the last three years are as follows:

1998

1999

2000

Sh.000

Sh.000

Sh.000

30,000

20,000

5,000

Accounts receivable

200,000

260,000

290,000

Inventory

400,000

480,000

600,000

Net fixed assets

800,000

800,000

800,000

1,430,000

1,560,000

1,695,000

Accounts payable

230,000

300,000

380,000

Accruals

200,000

210,000

225,000

Bank loan, short term

100,000

100,000

140,000

Long term debt

300,000

300,000

300,000

Common stock

100,000

100,000

100,000

Retained earnings

500,000

550,000

550,000

1,430,000

1,560,000

1,695,000

Additional information:

Cash

5|P a g e

Sales

4,000,000

4,300,000

3,800,000

Cost of goods sold

3,200,000

3,600,000

3,300,000

300,000

200,000

100,000

Net profit

Required:
(a)

For each of the three years, calculate the following ratios:

Acid test ratio, Average collection period, inventory turnover, total debt/equity, Net
profit margin and return on assets.

(b)

From the ratios calculated above, comment on the liquidity, profitability and gearing
positions of the company.

6|P a g e