CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 19 August 2025. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) Highlight FOUR reasons for soft capital rationing in a firm. (4 marks)

(b) Ushindi Ltd. is considering the following projects:

Project Initial outlay Annual revenue Annual fixed costs Project life
Sh.“million” Sh.“million” Sh.“million” (Years)
A 100 200 50 3
B 300 300 100 5
C 150 180 60 4
D 120 170 80 10
E 180 80 20 15

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Additional information:

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1. Variable costs are 40% of annual revenue.

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2. Each project is divisible.

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3. Projects D and E are mutually exclusive.
4. Cash flows are confined within the lifetime of each project.
5. Cost of capital is 10%.
6. Ignore taxation and depreciation.
7. The company has a capital limitation of Sh.400 million for investment.
8. All cash flows occur at anniversary dates.

Required:
(i) Optional allocation of the available capital to the projects. (8 marks)

(ii) Maximum resultant Net Present Value (NPV) from the optimal allocation. (4 marks)

(c) Describe FOUR advantages Eurobond market offer over a domestic bond market that makes it an attractive way
for companies to raise capital. (4 marks)
(Total: 20 marks)

QUESTION TWO
(a) Modigliani and Miller contended that in a perfect capital market, the value of a company depended simply on its
income stream and the degree of business risk attached to this regardless of the way in which its income was split
between the owners and lenders.

Required:
With reference to the above statement, explain FIVE assumptions of Modigliani and Miller hypothesis. (5 marks)

(b) Securitisation has become an important tool in modern financial markets, enabling financial institutions to
transform illiquid assets into tradeable assets.

Required:
In relation to the above statement, evaluate FIVE advantages of securitisation as a vehicle of financing real estate
development in your country. (5 marks)

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 (c) Prime Actual Investors Limited have the following portfolio of four risky assets and have deposited in a risk free
asset. The table shows portfolio weightings and the current asset returns together with their beta coefficients:

Asset Weightings (%) Current return (%) Beta

A 30 18 1.8
B 15 20 2.2
C 20 16 1.5
D 35 10 1.2
Risk free asset 30 8 0
The overall return on the market portfolio of risky assets is 12% and this is expected to continue for the foreseeable
future.
Required:
(i) Compute the current return on the portfolio. (2 marks)

(ii) Ascertain the beta value of the portfolio. (1 mark)

(iii) Identify out of the four risky assets, the one(s) that are inefficient/efficient and super-efficient. (3 marks)

(iv) Based on the findings in (c) (iii) above, state the predictions that you would make regarding future asset
values and their rates of return. (2 marks)
(v) Compute the equilibrium return on this portfolio assuming the weightings remain unchanged. (2 marks)
(Total: 20 marks)
QUESTION THREE
(a) Explain FOUR factors leading to differences in cost of capital of domestic firms and multinational corporations
(MNCs). (4 marks)
(b)
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Discuss FOUR challenges facing developing countries in establishing and operating derivatives market.
.k (4 marks)

(c) Suppose the Pound Sterling is bid at US dollars 1.9822 in New York, USA and the Euro is offered at US dollars
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1.3517 in Frankfurt, Germany. At the same time Manchester Banks in United Kingdom are offering the Pound
Sterling at 1.4582 Euros.
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Required:
Show the steps an astute trader would follow to earn riskless profits through a triangular arbitrage.
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Assume that the trader begins in New York with US dollars 1,050,000. (6 marks)

(d) Reno Limited is engaged in plastics manufacture. It is now considering a new investment that would involve
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diversification into chemical manufacturing, where the business risk is very different from the plastic
manufacturing industry.
Research has produced the following information about three companies currently engaged in chemicals
manufacturing, in the same part of the industry that Reno Limited is planning to invest.
Company Equity beta Financed by:
X 1.33 40% equity capital, 60% debt capital
Y 0.78 75% equity capital, 25% debt capital
Z 0.725 80% equity capital, 20% debt capital
Additional information:
1. Reno Limited is financed by 60% equity capital and 40% debt capital and would intend to maintain this
same capital structure if the new capital investment is undertaken.
2. The risk free rate of return is 5% and the return on the market portfolio is 9%.
3. The corporation tax is at the rate of 30%.
4. Assume that the debt capital of Reno Limited and companies X, Y and Z is risk free.
Required:
(i) Calculate a suitable cost of equity for the proposed investment by Reno Limited in chemicals
manufacturing. (4 marks)

(ii) Suggest a weighted average cost of capital (WACC) that should be used to carryout an investment
appraisal (Net Present Value calculation) of the proposed project. (2 marks)
(Total: 20 marks)

CA33 Page 2
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QUESTION FOUR
(a) Assess THREE ways in which block chain technology as an emerging issue in finance could contribute to financial
inclusion in your country. (6 marks)
(b) KK Ltd. and JP Ltd. are companies operating in the same line of business. In the recent past, KK Ltd. has
experienced very stiff competition from JP Ltd. such that KK Ltd., is considering acquiring JP Ltd. in order to
consolidate its market share.
The following financial data is available about the two firms:
KK Ltd. JP Ltd.
Annual sales (Sh.“million”) 1,200 300
Net income (Sh.“million”) 450 60
Outstanding number of ordinary shares (million) 150 30
Earnings per share (Sh.) 3.0 2.0
Market price per share (Sh.) 60 30

Both companies are in the 30% income tax bracket

Required:
(i) Maximum exchange ratio that KK Ltd. should agree to if it expects no dilution in its post acquisition
earnings per share (EPS). (3 marks)

(ii) KK Ltd.’s post acquisition EPS assuming the companies agree an offer price of Sh.45. (3 marks)

(iii) KK Ltd.’s post acquisition EPS assuming that for every 600 ordinary shares of JP Ltd.’s are exchanged
for 10 units of 10% debentures of Sh.1,000 par value each. (3 marks)

(iv) The operating profit, Earnings Before Interest and Tax (EBIT) at point of indifference between earnings
of the firm under the financing plans in (b) (ii) and (b) (iii) above. (3 marks)

(v) The EPS at the point of indifference between earnings of the firm under the financing plans in (b) (ii) and

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(b) (iii) above. (2 marks)

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(Total: 20 marks)

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QUESTION FIVE

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(a) The following statement of financial position and statement of profit or loss relate to Tola Ltd. for the year ended

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31 December 2024:
Tola Ltd.
Statement of financial position as at 31 December 2024:

Assets: Sh.“000” Liabilities and equity Sh.“000”

Cash 40,000 Accounts payable 500,000
Receivables 300,000 Notes payable 100,000
Inventories 400,000 Total current liabilities 600,000
Total current assets 740,000 Mortgage 400,000
Land and buildings 100,000 Debentures 600,000
Plant (Net book value) 500,000 Total long term liabilities 1,000,000
Equipment (Net book value) 800,000 Preference share capital (10,000 shares) 100,000
Total fixed assets 1,400,000 Ordinary share capital (50,000 shares) 100,000
Paid in capital 200,000
Retained earnings 140,000
________ Total shareholders equity 540,000
Total assets 2,140,000 Total liabilities and equity 2,140,000

Tola Ltd.
Statement of profit or loss for the year ended 31 December 2024:
Sh.“000”
Sales 600,000
Cost of goods sold (350,000)
Selling and administration expenses (100,000)
Earnings before interest and taxes (EBIT) 150,000
Interest (110,000)
Earnings before tax (EBT) 40,000
Corporation taxes at 30% (12,000)
Net income 28,000
The company’s ordinary shares are currently priced at Sh.4 per share.
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 Required:
(i) Using the Springate Model, assess the financial health of the company. (6 marks)

(ii) Other than the Springate Model, evaluate TWO other models of predicting corporate failure. (4 marks)

Note: The Springate model takes the following form:

Z = 1.03A + 3.07B + 0.66C + 0.4D

Where;
A = Net working capital
Total assets

B = Operating profit
Total assets

C = Net profit before tax

Current liabilities

D = Sales
Total assets

(b) Mark Otieno who trades in shares at the Securities Exchange in the spot market follows the rule “When prices are
rising - Buy; when prices are falling - Sell”. He ensures that his portfolio is intact at the end of every three months.
He has a basic understanding that buy equates to call option and sell equates to put option. For a three-month period,
he carried out trade in five listed companies as follows:

Company Spot price Three months expected price Exercise price

Safariland
Sh.
445
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Increase by 20%
Sh.
470
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Absaland 415 Increase by 15% 450
CICD 395 Decrease by 10% 370
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Jubila 380 Increase by 5% 390
KCIQ 405 Decrease by 15% 395

Additional information:
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1. Assume that Mark Otieno only deals with 100 shares at a time.
2. Assume that Mark Otieno exercises his option.
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Required:
(i) Compute the price of the shares and indicate the option chosen in each of the five companies. (3 marks)
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(ii) Using appropriate computations, determine the gain or loss in each of the tradings in the above companies
after three months. (7 marks)
(Total: 20 marks)
………………………………………………………………………..

CA33 Page 4
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 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

WEDNESDAY: 23 April 2025. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) Describe SIX roles of the World Trade Organisation (WTO) in the international financial system. (6 marks)

(b) As the finance manager of Popo Ltd., the Board has approached you to evaluate the proposed acquisition of
new machinery. The purchase price of the machinery is Sh.100 million. It will cost another Sh.20 million to
modify it for special use. The machine will be sold after 5 years for Sh.40 million and it will require an increase
in net operating working capital (NOWC) of Sh.8 million.

Additional information:
1. The purchase of the new machine will not have any effect on revenues but it is expected to save the
company Sh.45 million per year before tax operating costs mainly labour.
2. The corporate tax rate is 30%.

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3. The company uses the straight line method of depreciation.

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4. The project cost of capital is 12%.

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Required:
(i) Using the net present value (NPV) method, evaluate whether the machinery should be purchased.
(5 marks)
(ii) Assume the Board suggests that you conduct a scenario analysis for this project because of the
uncertainties of cost savings, salvage value and net operating working capital. After an extensive
analysis, you come up with the following probabilities and the values for the scenario analysis:

Scenario Probability Before tax Salvage value Net operating working

savings capital (NOWC)
Sh.“million” Sh.“million” Sh.“million”
Worst case 0.30 36 32 6.4
Base case 0.40 45 40 8.0
Best case 0.30 54 48 9.6

Required:
The project’s expected net present values (ENPV). (6 marks)

(iii) Analyse THREE common pitfalls that could arise in estimating cash flows in capital budgeting.
(3 marks)
(Total: 20 marks)
QUESTION TWO
(a) Discuss the following theories of capital structure:

(i) Pecking order theory. (2 marks)

(ii) Static trade off theory. (2 marks)

(iii) Agency effect theory. (2 marks)

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 (b) A financial manager has the following bond portfolio:

Bond Price (Sh.) Yield (%) Par amount owed (Sh.“million”) Duration
A 120 10 4 3.86
B 85.50 10 5 8.05
C 130.50 10 3 9.17

The three bonds are option-free.

Required:
(i) The bond portfolio duration. (6 marks)

(ii) Interpret the result obtained in (b) (i) above. (1 mark)

(c) Solomon Wasike took a mortgage product to acquire a family house with the following characteristics:

1. Mortgage loan amount was Sh.10,000,000.

2. Annual interest rate is at 8% per annum.
3. The loan is for a one year term.
4. Solomon pays an extra Sh.200,000 per month.

Required:
(i) Calculate the monthly payment for a fixed mortgage of this type. (2 marks)

(ii) Prepare the mortgage amortisation schedule for Solomon Wasike. (5 marks)
(Total: 20 marks)

QUESTION THREE
(a) Explain FOUR advantages of over-the-counter agreements in relation to the operations of the derivatives
markets. (4 marks)
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(b) In relation to corporate reorganisation and restructuring, examine SIX financial restructuring strategies
available to a firm. (6 marks)
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(c) Huge Ltd. is considering acquisition of Tiny Ltd. through a share exchange arrangement. Under the terms of
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acquisition, Huge Ltd. will offer two of its ordinary shares in exchange for every three ordinary shares in Tiny
Ltd.
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The summarised financial information relating to the two companies for the year ended 31 December 2024 are
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as shown below:
Huge Ltd. Tiny Ltd.
Profit after tax (Sh.) 225 million 45 million
Number of ordinary shares 37.5 million 12 million
Earnings per share (Sh.) 7.20 4.50
Market price per share (Sh.) 93.60 40.50
Price earnings (P/E) ratio 13 times 9.00 times

Required:
(i) The earnings per share (EPS) of the combined company after acquisition. (3 marks)

(ii) Assume the price earnings ratio after acquisition falls to 12 times, determine the premium received by
the shareholders of Tiny Ltd. (Use the combined company’s new share price). (3 marks)

(iii) Assume that the price earnings (P/E) ratio after acquisition falls to 12 times, justify whether acquisition
would be beneficial to the shareholders of Huge Ltd. (4 marks)
(Total: 20 marks)

CA33 Page 2
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QUESTION FOUR
(a) Explain FOUR differences between “portfolio theory” and “arbitrage pricing theory”. (4 marks)

(b) The table below gives the end of year levels of the price of an ordinary share in Tausi Ltd. and a representative
stock exchange index:

Year Tausi Ltd. share price (Sh.) Stock Exchange Index

2019 75 752
2020 78 815.5
2021 81 875
2022 79 840
2023 85 900
2024 76.5 795

Additional information:
1. The risk free rate is 5% per year.
2. The expected return from equities is 8% per year.

Required:
(i) The beta coefficient of Tausi Ltd.’s ordinary shares. (6 marks)

(ii) The required rate of return of Tausi Ltd.’s ordinary shares. (2 marks)

(iii) Assume that the expected rate of return of Tausi Ltd. is 10%. Establish whether Tausi Ltd. share is
undervalued or overvalued. (2 marks)

(c) Hakika business solutions is a newly established firm based in Kenya and is a subsidiary of United Kingdom
(UK) based company, Quick Solutions Ltd. The foreign country is Kenya while the home country is United
Kingdom (UK). The projected cash flows in Ksh. from 2025 to 2029 are shown below:

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Year 2025 2026 2027 2028 2029

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KSh. KSh. KSh. KSh. KSh.

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“000” “000” “000” “000” “000”

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Cash inflows 2,000 2,200 2,420 2,662 2,928
Less: Variable cash outflows (600) (660) (726) (799) (878)
Less: Fixed cash outflows (200) (200) (200) (200) (200)
Less: Depreciation (1,000) (1,000) 1,000 1,000 1,000
Cash flows before corporate tax 200 340 494 663 850
Less: 33% corporate tax (66) (112) (163) (219) (280)
Add: Depreciation 1,000 1,000 1,000 1,000 1,000
After tax corporate tax flows 1,134 1,228 1,331 1,444 1,569
Less: 10% withholding tax on dividend (113) (123) (133) (144) (157)
Net cash to be repatriated 1,021 1,105 1,198 1,300 1,412

Additional information:
1. The exchange rate of KSh/GBP is KSh 170 to 1GBP.
2. The difference in the interest rates between Kenya shillings (KSh) and Great Britain Pound (GBP) is
provided by the following formula:
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Ft = S0 × 1+rd
1+rf

Where:
Ft is the forward exchange rate at time “t”
So is the spot exchange rate
rd is the nominal interest rate in domestic currency
rf is the nominal interest rate in foreign currency
3. The expected interest rates for Kenya and United Kingdom are given as 6% and 4% respectively.
4. Quick Solutions Ltd. spent Ksh 6 billion to set up the business in Kenya. A UK business conglomerate
has agreed to buy the business for Ksh.10 billion in 5 years.
5. The UK cost of capital is 15%.

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 Required:
Compute the Net Present Value (NPV) of the project using home currency approach and comment on your
findings. (6 marks)
(Total: 20 marks)

QUESTION FIVE
(a) Jawabu Ltd. is a 100% equity financed company. The company is considering undertaking a major
diversification in the consumer electronics industry. Its current equity Beta is 1.2, while the average equity Beta
(β) of electronics industry is 1.6.

Gearing in the electronics industry averages 30% debt and 70% equity. Corporate debt is considered risk free.

Additional information:
1. Expected return on the market is 25%.
2. The risk-free rate of return is 10%.
3. The corporation tax rate is 30% per annum.

Required:
Using suitable discount rate for the new investment, determine the weighted average cost of capital (WACC)
assuming Jawabu Ltd. were to be financed in each of the following ways:

(i) By 20% debt and 80% equity. (3 marks)

(ii) By 30% debt and 70% equity. (3 marks)

(b) Viruga Ltd. is an unlevered firm. The firm expects to generate earnings before interest and tax (EBIT) of Sh.20
million each year in perpetuity. The firm’s current market value is Sh.120 million and pays corporation tax at
the rate of 30%. The management of the firm is considering the use of debt financing. The firm’s financial
analyst has estimated that the present value of any future financial distress cost is Sh.80 million and that the
probability of financial distress would increase with leverage according to the following schedule:
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Value of debt Probability of financial distress Pre-tax cost of debt (%)
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Sh.“million”
25 0.000 7
50 0.0125 8
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75 0.0250 9
100 0.0625 10
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125 0.1250 11
150 0.3125 12
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200 0.750 13

Required:
(i) The current cost of equity and weighted average cost of capital (WACC) of the firm. (2 marks)

(ii) The firm’s optimal level of debt financing using the “Pure” Modigliani and Miller with corporate tax
model. (6 marks)

(iii) The firm’s optimal level of debt financing using Modigliani and Miller with corporate taxes and
financial distress. (6 marks)
(Total: 20 marks)
………………………………………………………………………..

CA33 Page 4
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 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 3 December 2024. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) Summarise FIVE benefits of restructuring in the public sector. (5 marks)

(b) Highlight FOUR key European Union achievements and tangible benefits in the context of international
financial systems. (4 marks)

(c) The directors of Jasiri Ltd. wishes to identify the optimum replacement cycle that will minimise the cost of
operating its fleet of vehicles.

The relevant data is as follows:

Age of vehicles (years) 0 1 2 3 4

Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000”

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Replacement cost 7,000 - - - -

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Annual operating and maintenance cost 500 750 1,000 2,000

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Residual value at the end of the year 4,750 3,500 3,000 2,250

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Additional information:
1. The company’s cost of capital is 10%.
2. Ignore taxation.

Required:
Using the annual equivalent cost (AEC) technique, advise Jasiri Ltd. on the best time to replace the vehicles. (11 marks)
(Total: 20 marks)

QUESTION TWO
(a) Describe FOUR assumptions of the capital asset pricing model (CAPM). (4 marks)

(b) Peter Mwangangi, an investor at the securities exchange intends to construct a minimum variance portfolio
comprising the shares of two companies; Simba Ltd. and Nyati Ltd. The projected returns on the shares of the
two companies under three different states of the economy are as follows:

State of economy Probability Simba Ltd. (%) Nyati Ltd. (%)

Boom 0.30 18 10
Normal 0.45 16 14
Recession 0.25 9 16

Required:
(i) The weights of the two company’s shares in the minimum variance portfolio. (4 marks)
(ii) The expected return for the minimum variance portfolio. (2 marks)
(iii) The standard deviation for the minimum variance portfolio. (2 marks)

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 (c) Jamla Ltd. is considering undertaking a financial reconstruction during which it would repurchase its
outstanding ordinary shares using debt. This will raise its debt to equity ratio to 1.80. The following information
was available for the company:

1. Existing debt to equity ratio is 1.20.

2. The asset beta is 0.60.
3. The risk-free rate of return is 6%.
4. The return of market portfolio is 12%.
5. Debt finance is considered to be risk free.
6. The corporate tax rate is 30%.

Required:
(i) The firm’s levered equity beta before and after the financial reconstruction. (2 marks)

(ii) The firm’s cost of equity before and after the financial reconstruction using the capital asset pricing
model (CAPM). (2 marks)

(iii) The firm’s weighted average cost of capital (WACC) before and after the financial reconstruction.
(4 marks)
(Total: 20 marks)

QUESTION THREE
(a) Examine THREE instruments that could be used in financing real estate. (6 marks)

(b) The following extract of statement of financial position of Varma Ltd. shows the capital structure of the
company as at 31 March 2024 which the management of the company considers optimal:

Sh.“000”
Ordinary share capital (Par value Sh.375) 187,500
Reserves 364,500
Shareholder’s equity 552,000
Long-term liability:
14% debenture stock (Par value Sh.1,500) 355,500
Capital employed 907,500

Additional information:
1. The company’s earnings before interest and tax (EBIT) averages Sh.150,000,000 per annum. These
earnings are expected to be maintained in the foreseeable future.
2. The ordinary shares are currently trading at Sh.800 per share.
3. The market price of the debenture is Sh.1,575 per debenture.
4. The corporate tax rate for the company is 30% per annum.

Required:
Using the net income approach (incorporating taxes), calculate the company’s:

(i) Cost of equity. (4 marks)

(ii) After tax cost of debt (market weighted). (4 marks)
(iii) Weighted average cost of capital (WACC). (4 marks)

(c) Outline TWO assumptions of the net income approach used in determining the capital structure of a firm.
(2 marks)
(Total: 20 marks)
QUESTION FOUR
(a) Assess THREE differences between “exchange traded options (ETO)” and “over the counter (OTC)” options in
relation to derivatives markets. (6 marks)

(b) Financial Technology (FinTech) startups have had a profound and disruptive impact on traditional banking and
payment systems in the global context. This disruption has been driven by several key factors.

In relation to the above statement, explain FOUR key factors that Financial Technology (FinTech) startups may
have contributed to disruption on traditional banking and payment systems in the global context. (4 marks)

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2

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(c) ABA Ltd. has a 20-year, 14% debenture worth Sh.250 million which has been in operation for the last 10 years.
ABA Ltd. still has in its books issue costs amounting to Sh.900,000 being half the total amount originally
capitalised. This debenture can be paid off at any time but the financiers will charge a penalty amounting to 9%
of face value.

The directors of the company are considering replacing this debenture with a new 10-year, 12% debenture with
a face value of Sh.250 million. The issue costs will amount to 10% of gross proceeds. The company is in the
30% tax bracket and there will be interest overlap for 3 months.

Required:
(i) The net cash investment that will be required to replace the existing debenture. (4 marks)

(ii) The annual cash benefits to be derived from refinancing the current debenture. (4 marks)

(iii) Using the Net Present Value (NPV) method, advise ABA Ltd. on whether or not to refund the existing
debenture. (2 marks)
(Total: 20 marks)

QUESTION FIVE
(a) Discuss FOUR potential pitfalls that a merger analyst should consider when reviewing acquisition transactions.
(8 marks)

(b) Kopa Ltd., a United Kingdom (UK) firm sold goods on credit to Belfast Ltd., a firm in the United States of
America (USA). This firm expects to receive United States Dollars (USD) 365,000 in six months’ time from
now. The firm is considering various choices in order to hedge the transactions exposure and has collected the
following data:

The following exchange rates are provided:

Spot rate USD($)/UK(£): 1.5617 – 1.5773

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Six months forward rate (USD($)/UK(£): 1.5510 – 1.5625

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The money market annual rates are as follows:

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Borrowing Deposit
(%) (%)
United States Dollars ($) 12 9
Sterling pounds (£) 14 11

Foreign currency option prices in cents per sterling pound for a contract size of £12,500 in six months are as
follows:

Exercise price Call option Put option

(six months) (six months)
USD($) 1.70/1 UK(£) 3.7 9.6

Required:
Using appropriate computations, advise Kopa Ltd. on the most suitable hedging strategy to use among the
following:

(i) Forward market hedge. (3 marks)

(ii) Money market hedge. (5 marks)

(iii) Currency options. (4 marks)

(Total: 20 marks)
..............................................................................................................

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 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 20 August 2024. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) In relation to real estate finance, highlight FOUR differences between a “residential property” and a “commercial
property”. (4 marks)

(b) A company is considering two mutually exclusive projects namely; project A and project B. The company uses
the certainty equivalent approach to evaluate capital projects. The estimated cash flows and certainty equivalents
for each project are as follows:

Year Project A Project B

Cash flows Certainty equivalents Cash flows Certainty equivalents
Sh.“000” Sh.“000” Sh.“000” Sh.“000”
0 (45,000) 1.00 (60,000) 1.00
1 22,500 0.85 37,500 0.80

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2 22,500 0.80 30,000 0.70

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3 15,000 0.75 22,500 0.60

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4 15,000 0.60 15,000 0.50

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The risk free rate is 5%.

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Required:
Advise the company on which project to undertake using the certainty equivalent method. (6 marks)

(c) Mavuno Bora Ltd. is an agro-based company incorporated in Kenya. The company intends to invest in a capital
project which will be based in Cape Town, South Africa.

Additional information:
1. The project will commence on 1 January 2025 with the initial capital of 5 million South Africa Rands
(ZAR) which will be used in acquiring agricultural machinery with an estimated useful life of 5 years
with a zero salvage value. The straight line method of depreciation will be applied.
2. To enable the firm pay land rates and other working capital requirements, an additional 2.5 million ZAR
will be required and it is expected that this amount will be recouped in full at the end of the project’s
useful life.
3. Annual sales revenue from the project are estimated as follows:
Year Revenue (ZAR) Fixed costs (ZAR)
2025 2,600,000 600,000
2026 3,500,000 780,000
2027 5,000,000 905,000
2028 4,200,000 880,000
2029 2,800,000 450,000
4. Variable operating costs are expected to be 20% of the sales and are assumed to accrue evenly.
5. The exchange rates between the Kenya Shilling and the South Africa Rand are as follows:
ZAR/KES
1 January 2025 8.00
31 December 2025 8.50
31 December 2026 9.00
31 December 2027 9.50
31 December 2028 10.00
31 December 2029 10.30
6. All the cash flows are expected to occur at the year end.

CA33 Page 1
Out of 4
 7. The cost of capital for both South Africa and Kenya is assumed to be 12% per annum.
8. Assume that the corporation tax rate in South Africa is 30% and no further taxation will be levied in
Kenya.
Required:
(i) The net present value (NPV) of the project in Kenya Shillings (KSh.). (8 marks)

(ii) Based on your results in (c) (i) above, advise the management of Mavuno Bora Ltd. on
appropriate course of action. (2 marks)
(Total: 20 marks)
QUESTION TWO
(a) Examine THREE methods that could be used by multinational corporations to finance international trade.
(6 marks)
(b) Kiwanda Ltd., an all equity financed company is contemplating setting up a manufacturing plant overseas.

The expected pay-off from the project would depend on the future state of the economy that might prevail as
shown below:
State of economy Probability Forecasted rate of return (%)
A 0.20 10
B 0.30 15
C 0.40 7
D 0.10 12
Additional information:
1. The company’s portfolio of existing activities are expected to generate an overall return of 18% with a
standard deviation of 5%.
2. The correlation coefficient of returns of the new project and existing portfolio of activities is 0.60 while
its correlation with the market portfolio is 0.24. e
3. The forecasted rate of return of the market portfolio and their probability of occurrence in different states
.k
of nature are given as follows:
.co

State of economy Probability Forecasted rate of return (%)

1 0.20 20
2 0.30 15
pi

3 0.40 10
4 0.10 5
ho

4. The risk free rate of return is 8%.

C

Required:
(i) Compute the covariance of returns of the new project and existing portfolio returns. (4 marks)
(ii) Advise the management of Kiwanda Ltd. on whether to accept the proposed project using the capital
market line (CML) analysis. (5 marks)

(iii) Determine whether the project is acceptable using the Capital Asset Pricing Model (CAPM). (5 marks)
(Total: 20 marks)
QUESTION THREE
(a) Highlight FOUR reasons why firms make bond refinancing decisions. (4 marks)

(b) Palm Limited has Sh.12.5 billion of equity capital and Sh.2.5 billion of debt capital, all at current market value.
The cost of equity is 14% and the cost of debt is 8%. The company is planning to raise Sh.2.5 billion by issuing
new ordinary shares. It will use the money to redeem all the debt capital.

Required:
Using the Modigliani and Miller (MM) proposition, determine the cost of equity of the company after the debt has
been redeemed. Assume that there is no corporate tax if the company issues new equity. (4 marks)

(c) Jaribu Ltd. is considering acquiring Upendo Ltd. Selected financial data for the two companies is provided:
Jaribu Ltd. Upendo Ltd.
Annual sales (Sh.million) 1,500 180
Net income (Sh.million) 120 15
Ordinary shares outstanding (million) 30 6
Earnings per share (EPS) (Sh.) 8 5
Market price per share (Sh.) 88 40
Both companies are in the 30% tax bracket.
For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2
Out of 4
 Required:
(i) The maximum exchange ratio that Jaribu Ltd. should agree to if it expects no dilution in earnings per
share (EPS). (3 marks)

(ii) Post merger EPS of Jaribu Ltd. and Upendo Ltd. if the two companies settle on a price of Sh.48.40 per
share. (4 marks)

(iii) Jaribu Ltd.’s EPS if Upendo Ltd.’s shareholders accept one (1) 12% convertible preference share with a
par value of Sh.100 for every 5 ordinary shares they own. (3 marks)

(iv) Explain the term “bootstrapping earnings” as used in mergers and acquisition. (2 marks)
(Total: 20 marks)

QUESTION FOUR
(a) Summarise FOUR financial difficulties a company may experience during financial distress. (4 marks)

(b) Kilop Ltd. is considering a financial restructuring plan that involves converting a portion of its debt into equity.
Currently, the company has 1 million ordinary shares outstanding with a current market value of Sh.20 per share.
The total debt to be converted into equity amounts to Sh.5 million.

Required:
Assuming the conversion is successful, evaluate the impact of financial restructuring on the share price of Kilop
Ltd. (6 marks)

(c) The finance director of Dambo Ltd. wishes to find the company’s optimal capital structure. The cost of debt varies
according to the company’s credit rating, which itself depends, amongst other factors, the level of gearing of the
company as shown below:

Percentage (%) of debt (Debt/Debt + Equity) Likely credit rating Pre-tax cost of debt (%)
10 AAA 6.5

ke
20 AA 7.1

o.
30 A 7.8

i.c
op
40 BBB 8.5

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50 BB 10

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60 B 12
70 C 15

Additional information:
1. The company’s ungeared equity beta (asset beta) is 0.85.
2. The risk free rate is 6% per annum.
3. The market return is 14% per annum.
4. The corporate tax rate is 30%.

Required:
(i) The optimal weighted average cost of capital (WACC) for the company. (9 marks)

(ii) Interpret your results in (c) (i) above. (1 mark)

Hint: Formula for computing equity beta

βe = βa E + D(1 – t)
E
Where: βe = Equity beta
βa = Asset beta
D = Debt
E = Equity
t = Corporate tax rate
(Total: 20 marks)

CA33 Page 3
Out of 4
 QUESTION FIVE
(a) Discuss THREE types of crowdfunding. (6 marks)

(b) Ujezi Ltd., a property development company, has gained planning permission for the development of a housing
complex at Mua Greens Estate which will be developed over a three-year period.

The resulting property sales less building costs have an expected net present value of Sh.4,000,000 with a cost of
capital of 10% per annum. Ujezi Ltd. has an option to acquire land in Mua Greens Estate at an agreed price of
Sh.24,000,000 which must be exercised within the next two years.

Immediate building of the housing complex would be risky as the project has a volatility attaching to its net
present value of 25%.

One source of risk is the potential for development of Mua Greens Estate as a regional commercial centre for the
large number of firms leaving the capital, because of high rents and local business taxes. Within the next two
years, an announcement by the government will be made about the development of transport links into Mua
Greens Estate from the outlying areas including the area where Ujezi Ltd. hold the land option.

The risk free rate of interest is 5% per annum.

Required:
(i) Estimate the value of the option to delay the start of the project for two years using the Black Scholes
Option Pricing Model (BSOPM) and comment on your findings.

Assume that the government will make its announcement about the potential transport link at the end of
the two years. (10 marks)

(ii) On the basis of valuation of the option to delay, estimate the overall value of the project, giving a concise
rationale for the valuation method used. e (2 marks)

(iii) Explain TWO other types of real options that may be present relating to the Mua Greens Estate housing
.k
development. (2 marks)
.co

Hint:
rf
Value of call option: Ps (Nd1) – Pe (Nd2). e– T
pi

Where: d1 = ln (Ps/Pe) + (rf + 0.5σ2)T

ho

σ√T
C

d2 = d1 – σ√ T
Ps = Underlying price
Pe = Strike price
σ = Volatility
rf = Continuity compounded risk-free interest rate
T = Time to expiration
(Total: 20 marks)
..............................................................................................................

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 4

Out of 4
 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 23 April 2024. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) Summarise FOUR causes of hard capital rationing as used in capital budgeting. (4 marks)

(b) Outline FOUR limitations of Treynor’s measure of portfolio performance. (4 marks)

(c) Kangaro Youth Sports Ltd. wishes to design a new sports bicycle. The company will have to invest Sh.100
million at the beginning of the first year for the design and model testing of the new bicycle.

The firm’s managers believe that there is an 80% probability that this phase will be successful and the project will
continue.

If Phase 1 is not successful, the project will be abandoned with zero salvage value.

The next phase, if undertaken, would consist of making the molds and producing twenty prototype bicycles. This

ke
o.
would cost Sh.400 million at the end of the first year. If this phase is successful, the firm would go into full scale

i.c
op
production. If the phase is not successful, the molds and prototypes could be sold for Sh.150 million. The

.ch
managers estimate that the probability that the bicycles will pass the test is 90% and that Phase 3 will be

w
w
undertaken.

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Phase 3 consists of changing over current production line to produce the new design. This would cost Sh.1,100
million in year 2.

If the economy is strong at this point, the net value of cash flows would be Sh.3,500 million, while if the economy
is weak the net value of cash inflows would be Sh.2,600 million. Both net values of cash inflows will be realised
at the end of year 3 and both states of the economy are equally likely.

The company’s cost of capital is 13%.

Required:
(i) Using a decision tree, determine the project’s expected net present value (ENPV). (5 marks)

(ii) Calculate the project’s standard deviation of expected net present value and comment on the result.
(4 marks)

(iii) Using the normal probability distribution, compute the probability that the project’s net present value
will be at least Sh.80 million. (3 marks)
(Total: 20 marks)

QUESTION TWO
(a) Two assets, A and B are known to lie on the security market line (SML). Asset A has a beta of 0.5 and a risk
premium of 4%. Asset B has an expected rate of return of 20% and a beta of 1.75.

You are considering the following securities which are available in the market:

Security Expected return (%) Beta

A 20 2.00
B 14 0.75
C 15 1.25
D 12 –0.25
E 31 3.25

CA33 Page 1
Out of 4
 Required:
(i) Determine the risk free rate of return. (2 marks)

(ii) Calculate the required rate of return of each security. (4 marks)

(iii) Identify which security is undervalued, overvalued or correctly valued. (2 marks)

(b) Cosmos Operators Ltd. have an optimal capital structure given as follows:

Sh.“000”
Ordinary share capital (Sh.20 par value each) 80,000
Reserves 20,000
16% debt (Sh.100 par value each) 40,000
10% preference share capital (Sh.30 per value each) 60,000
200,000

Additional information:
1. The firm is considering raising Sh.20 million for an expansion programme of which Sh.2,000,000 is
expected to be raised from internal sources.
2. New ordinary shares will be issued at Sh.35 each. A floatation cost of Sh.5 per share issued will be
incurred.
3. The firm’s most recent earnings per share (EPS) is Sh.3. The firm adopts 50% pay out ratio as its
dividend policy. Dividends are expected to grow at a rate of 5% each year in a perpetuity.
4. New 10% irredeemable debentures will be issued at Sh.110 each. A floatation cost of Sh.10 per
debenture will be incurred.
5. New 10% irredeemable preference shares will be issued at Sh.40 each.
6. Corporation tax rate is 30%.

Required:
(i) The retained earnings break point. e (2 marks)

(ii) The number of new ordinary shares to be issued to raise the desired external equity. (2 marks)
.k
(iii) The weighted marginal cost of capital (WMCC) in each of the intervals between the breakpoints.
.co

(8 marks)
(Total: 20 marks)
pi

QUESTION THREE
(a) Explain the following option trading strategies:
ho

(i) Bull spread. (2 marks)

C

(ii) Bear spread. (2 marks)

(iii) Covered call. (2 marks)

(b) Duet Ltd. is considering a takeover bid for Small Ltd., another company in the same industry. Small Ltd. is
expected to have earnings next year of Sh.129,000,000.

If Duet Ltd. acquires Small Ltd., the expected results from Small Ltd. will be as follows:

Year after acquisition

Year Year 1 Year 2 Year 3
Sh.“000” Sh.“000” Sh.“000”
Sales 300,000 420,000 480,000
Cash costs/expenses 180,000 240,000 270,000
Capital allowances 30,000 45,000 60,000
Interest charges 15,000 15,000 15,000
Cash flows to replace assets and finance growth 37,500 45,000 52,500

Additional information:
1. From year 4 onwards, it is expected that the annual cash flows from Small Ltd. will increase by 4% each
year in perpetuity.
2. Tax is payable at the rate of 30%. Tax is paid in the same year it falls due.
3. If Duet Ltd. acquires Small Ltd., it estimates that gearing after the acquisition will be 35% (measured as
the value of its debt capital as proportion of total equity plus debt).
4. The cost of debt is 7.4% before tax. Duet Ltd. has an equity beta of 1.60.
5. The risk free rate of return is 6% and the return on the market portfolio is 11%.

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2

Out of 4
 Required:
(i) The offer price for Small Ltd. assuming Duet Ltd. chooses to value Small Ltd. on a forward price
earnings (P/E) multiple of 8 times. (2 marks)

(ii) The cost of capital of Duet Ltd. (4 marks)

(iii) Determine the offer price for Small Ltd. using discounted free cash flow (DCF) valuation method.
(8 marks)
(Total: 20 marks)

QUESTION FOUR
(a) Explain FOUR advantages of real estate investments. (4 marks)

(b) Jacob Ouma, a financial analyst, gathered the following financial information from the banking industry in Kenya.
The interest rate on a one year Kenyan bank is 16%.

The interest rate on a one year foreign bank deposit is 22%.

Required:
(i) Compute the percentage change in the value of the foreign currency according to International Fisher
Effect. (3 marks)

(ii) Given a spot rate of Tsh1 = Ksh. 6.06, calculate the forward rate of Tsh after one year. (2 marks)

(c) The following are the financial statements of Bobi Ltd. for the year ended 31 December 2023:

Bobi Limited
Statement of profit or loss for the year ended 31 December 2023:
Sh.“000”
Revenue 60,000

ke
Cost of sales (35,000)

o.
i.c
Gross profit 25,000

op
Operating expenses (10,000)

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w
Operating profit 15,000

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Finance cost (11,000)
Earnings before tax 4,000
Income tax expense (1,200)
Profit for the year 2,800

Bobi Limited
Statement of financial position as at 31 December 2023:
Sh. “000” Sh.“000”
Net tangible assets 126,000
Intangible assets 42,000
168,000
Current assets:
Inventory 48,000
Trade receivables 36,000
Bank balance 4,800 88,800
256,800
Financed by:
Equities and liabilities:
Equity:
480,000 preference shares (Sh.25 each) 12,000
500,000 ordinary shares (Sh.24 each) 12,000
Share premium 24,000
Retained earnings 16,800
64,800
Non-current liabilities:
Mortgage (20 years) 48,000
8% debentures 72,000 120,000
Total equity and reserve 184,800
Current liabilities:
Trade payables 12,000
Notes payable 60,000 72,000
Total liabilities and equity 256,800
CA33 Page 3
Out of 4
 Additional information:
1. The Z-score is to be calculated using the following formula:
Z-score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

Where:
X1 = Working capital/Total assets
X2 = Retained earnings/Total assets
X3 = Earnings before interest and tax/Total assets
X4 = Market value of equity/Book value of debt
X5 = Sales/Total assets
2. The current market price per share is Sh.42.

Required:
(i) The Z-score of Bobi Ltd. for the year ended 31 December 2023. (6 marks)

(ii) Interpret the meaning of Z-score obtained in (c) (i) above. (2 marks)

(iii) Outline THREE limitations of Z-score model. (3 marks)

(Total: 20 marks)

QUESTION FIVE
(a) Discuss THREE factors that distinguish between the cost of capital of a multinational corporation and the cost of
capital of a domestic firm. (6 marks)

(b) In relation to financial risk management, explain FOUR advantages of plain vanilla currency swaps with monthly
delivery compared with a strip of forward contracts. (4 marks)

(c) Kawaida Ltd. has Sh.3,000,000 in equity capital and Sh.1,000,000 in debt capital (at market values). The beta
value of the equity is 1.126 and the beta of the debt capital is 0. e
The risk free cost of capital is 5% and the market portfolio return is 11%.
.k
The tax rate is 30%.
.co

Required:
pi

(i) Calculate the current weighted average cost of capital (WACC). (3 marks)
ho

(ii) Compute the asset beta for the company and explain what this means. (3 marks)
C

(iii) Calculate the equity beta, the cost of equity and the WACC would be if the company consisted of 60%
equity and 40% debt. (4 marks)
(Total: 20 marks)
..............................................................................................................

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 4

Out of 4
 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 5 December 2023. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) The management of Kapricon Ltd. are in the process of estimating utile and establishing the categories of
investors. The management has approached CPA Samuel Okeyo, a financial management consultant and provided
him with the following cases:

Case 1: There is 0.50 chance of receiving Sh.30 million and 0.50 chance of receiving Sh.100 million. The
investor is willing to pay a maximum of Sh.60 million.

Case 2: There is 0.40 chance of receiving Sh.55 million and 0.60 chance of receiving Sh.100 million. The
investor is willing to pay a maximum of Sh.82 million.

Case 3: There is 0.30 chance of receiving Sh.30 million and 0.70 chance of receiving Sh.60 million. The investor
is willing to pay a maximum of Sh.45 million.

ke
o.
i.c
op
Assume that utile values of 0 and 1 are assigned to a pair of wealth representing the two extremes Sh.0 and Sh.100

.ch
million respectively.

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w
w
Required:
(i) Using the expected monetary value (EMV) technique, determine the category of investor in case 1, case
2 and case 3 above. (6 marks)

(ii) Compute the utile value for case 1, case 2 and case 3 respectively. (3 marks)

(b) In a study carried out by a financial analyst, the earnings before interest and tax (EBIT) of Papa Ltd. and Kaka
Ltd. was found to be Sh.10 million.

Papa Ltd. is fully equity financed while Kaka Ltd. is financed partly using equity and debt. The capital structures
of both firms are given as follows:

Papa Ltd. Kaka Ltd.

Sh.“million” Sh.“million”
Equity (market value) 100 70
5% debt (trading at par) - 50

Additional information:
1. Both firms adopt a 100% pay out ratio as their dividend policy.
2. The cost of equity of Papa Ltd. is 10%.

Required:
Using Modigliani and Miller’s proposition in the absence of taxes:

(i) Determine the cost of equity of Kaka Ltd. (3 marks)

(ii) Comment on the equilibrium position on the value of both firms and hence show that the capital structure
decision will have no effect on both value of the firms and their weighted average cost of (WACC).
(4 marks)

(iii) Calculate the arbitrage profit (if any) for a shareholder holding 10% of the shares of Kaka Ltd. (4 marks)
(Total: 20 marks)
CA33 Page 1
Out of 4
 QUESTION TWO
(a) Economic and Monetary Union (EMU) was formulated by European leaders. On 1 January 1999, the new
European currency, the Euro, came into being. From that date, there was to be no change in the exchange rates of
the member countries.

Euro notes and coins were introduced into circulation on 1 January 2002. Dual circulation of the Euro and the
legacy currencies of each country continued for a short period of time. Thereafter, participating countries have
only used Euro notes and coins.

Required:
In regards to the above statements, explain SIX arguments in favour of Economic and Monetary Union (EMU).
(6 marks)

(b) Daniel Wekesa, an investment specialist has been entrusted with Sh.5,000,000 by an investment club and
instructed to invest the money optimally over a 1-year period.

Part of the instructions are given as follows:

1. The funds be invested in one or more of the three specified projects and in the money market.
2. The three projects are not divisible and cannot be postponed.
3. The investment club requires a return of 14% per annum.
4. The following details relate to the projects and money market:

Initial cash Forecasted rate of return Expected standard

outlay Sh. “000" (%) deviation of return (%)
Project 1(P1) 3,000 16 8
Project 2(P2) 2,000 15 6
Project 3 (P3) 2,000 22 10
e
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Money market (MM) 3,000 12 4
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5. The correlation coefficients of returns of the above combination of projects are as follows:
pi

Between projects Between projects and Between projects and Between money market
market portfolio (MP) money market (MM) (MM) and market
ho

portfolio (MP)
P1 and P2 = 0.90 P1 and MP = 0.80 P1 and MM = 0.30 MM and MP = 0.40
C

P1 and P3 = 0.50 P2 and MP = 0.10 P2 and MM = 0.75

P2 and P3 = 0.20 P3 and MP = 0.65 P3 and MM = 0.15

Additional information:
1. The risk free rate of return is 12%.
2. Expected return of the market portfolio is a weighted average return. Given below are forecasted rate of
returns from a market portfolio and their probability of occurrence in different states of nature:

State of nature Probability Forecasted rate of return (%)

Recession 0.30 10
Average 0.40 15
Boom 0.30 20

Required:
Evaluate how Daniel Wekesa should invest the Sh.5 million using:

(i) Capital market line (CML) analysis in portfolio theory. (7 marks)

(ii) Capital asset pricing model (CAPM). (7 marks)

(Total: 20 marks)

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2

Out of 4
QUESTION THREE
(a) Highlight SIX economic and financial justifications advanced for mergers and acquisitions. (6 marks)

(b) Kubwa Ltd. is considering acquisition of Ndogo Ltd., a firm in an unrelated line of business in order to diversify
their risks.

Selected financial data for both firms are provided as follows:

Kubwa Ltd. Ndogo Ltd.
Sales (Sh.million) 100 50
Cost of sales (Sh.million) 30 10
Operating costs (Sh.million) 10 5
Finance cost (Sh.million) 5 2
Number of issued shares (million) 10 7
Market price per share (Sh.) 40 20

Additional information:
1. Kubwa Ltd. is considering financing the acquisition of Ndogo Ltd. using a share for share exchange or
share debenture exchange.
2. Corporation tax rate applicable is 30%.

Required:
(i) Non-diluting maximum exchange ratio. (3 marks)

(ii) The post acquisition earning per share (EPS) assuming an offer price is set at Sh.30 per share. (2 marks)

(iii) The post acquisition EPS assuming 1,000 ordinary shares are exchanged for 10 units of 15% debenture
with par value of Sh.100 each. (3 marks)

(iv) Considering your results in (b) (ii) above and (b) (iii) above, advise on the best financing plan. (1 mark)

ke
(c) A bond with a five year to maturity has a current value of Sh.92.41, a coupon rate of 8% per annum and a current

o.
i.c
market yield of 10% per annum.

op
.ch
The bond will be redeemed at a par value of Sh.100.

w
w
w
Required:
Using the Macaulay duration method, compute the bond’s duration. (5 marks)
(Total: 20 marks)

QUESTION FOUR
(a) Discuss FOUR real estate financing options available to real estate investors in your country. (8 marks)

(b) Highspeed Electronics Ltd. has taken delivery of 50,000 electronic devices from an American company. The
seller is in a strong bargaining position and has priced the devices in American dollars at $ 12.00 each.

Highspeed Electronics Ltd. has been granted three months credit. Assume that interest rates in America are 3%
per quarter. Highspeed Electronics Ltd. has all its money held up in its operations but it could borrow in United
States dollars at an interest rate of 3% per quarter if necessary.

Additional information:
1. The following foreign exchange rates are applicable:
United State Dollar (US$)/Kenya Shilling (KES)
Spot rate 0.013
Three month forward rate 0.0154
2. A three month dollar call option for US $ 600,000 is available at a premium of US $ 15,000.

Required:
Determine the amount payable by Highspeed Electronics Ltd. using the following hedging strategies:

(i) Forward contract. (2 marks)

(ii) Leading. (2 marks)
(iii) Money market hedge. (2 marks)
(iv) Use of options. (2 marks)
(v) Distinguish between a “currency option” and a “currency swap”. (4 marks)
(Total: 20 marks)

CA33 Page 3
Out of 4
 QUESTION FIVE
(a) Explain the following terms as used in behavioural finance:

(i) Market paradox. (2 marks)

(ii) Herd mentality bias. (2 marks)

(iii) Loss aversion bias. (2 marks)

(b) One of the most notable qualitative model of predicting corporate failure is Argenti’s A model score. Argenti
suggested that the failure process follows a predictable sequence.

Required:
Examine the THREE failure sequence processes as predicted by Argenti’s model score. (6 marks)

(c) The current share price of Nonop Ltd. is Sh.7.00.

Additional information:
1. The continuously compounded risk free rate of interest is 8% per annum.
2. The variance of the rate of return on the share has been 12% per annum.

Required:
Using the Black-Scholes option pricing model, estimate the value of a European call option on the shares of the
company that has an exercise price of Sh.6.60 and has 3 months to run before it expires.

Note: The Black-Scholes formula is given as follows:

Pc = PS N(d1) – Xe –rTN(d2)

Where: e
N(d) = Cumulative distribution function
.k
d1 = ln Ps + rT
x + 0.5δT
.co

δ√T
d2 = d1 - δ√T
Ps = Share price
pi

e = The exponential constant 2.7183

ho

X = Exercise price of option

r = Annual (continuously compounded) risk free rate of return
T = Time of expiry of option in years
C

δ = Share price volatility, the standard deviation of the rate of return on shares.
N(dx) = Delta, the probability that a deviation of loss than dx will occur in a normal distribution with a
mean of zero and a standard deviation of one
ln = Natural log
(8 marks)
(Total: 20 marks)
..............................................................................................................

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 4

Out of 4
 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 22 August 2023. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) Over the years, the World Bank has evolved from a single institution to a group of five unique and collaborative
institutions known collectively as the World Bank or the World Bank Group.

Required:
In relation to the above statement, describe FIVE functions of the World Bank. (5 marks)

(b) Analyse FIVE differences between portfolio theory and capital asset pricing model (CAPM). (5 marks)

(c) Simon Kobia, an investor is evaluating six portfolios with the following characteristics:

Portfolio Expected return Standard deviation

ke
o.
of the portfolio (%) of the portfolio (%)

i.c
op
1 19 8

.ch
2 25 12

w
w
3 16 6

w
4 32 16
5 22.5 10
6 8 2

The expected return of the market portfolio is 12% with an accompanying standard deviation of 4% while the risk
free rate of interest is 5%.

Required:
(i) Using capital market line (CML), advise the investor on which portfolio(s) is inefficient, efficient or
superefficient. (6 marks)

(ii) In case of inefficient and superefficient portfolio(s) in (c) (i) above, compute the standard deviation that
the portfolio should have for efficiency to be achieved with the given expected return. (4 marks)
(Total: 20 marks)

QUESTION TWO
(a) Explain the following terms as used in mergers and acquisitions:

(i) Poison pill. (2 marks)

(ii) Staggered board of directors. (2 marks)

(iii) Golden parachutes. (2 marks)

(b) Tobin Ltd. is appraising an investment project which has a cost of Sh.20 million payable in full at the start of the
first year of operation. The project life is expected to be four years. Forecast sales, volumes, selling prices,
variable costs and fixed costs are as follows:

Year 1 2 3 4
Sales (units per year) 300,000 410,000 525,000 220,000
Selling price per unit (Sh.) 125 130 140 120
Variable cost per unit (Sh.) 71 71 71 71
Annual fixed cost (Sh.“000”) 3,000 3,100 3,200 3,000
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 Additional information:
1. Selling price and cost information are in current price terms before applying selling price inflation of 5%
per year, variable cost inflation of 3.5% per year and fixed cost inflation of 6% per year.
2. Tobin Ltd. pays annual corporation tax of 30%, with the tax liability being settled in the year in which it
arises.
3. The company can claim tax allowable depreciation on the full initial investment of Sh.20 million on a
25% straight line basis.
4. The company’s investment project is expected to have zero residual value at the end of four years.
5. Tobin Ltd. has a nominal after tax cost of capital of 12% and a real after tax cost of capital of 8%.
6. The general rate of inflation is expected to be 3.7% per year for the foreseeable future.

Required:
The nominal net present value (NPV) of Tobin Ltd.’s investment project. (8 marks)

(c) James Kamau had Ksh. 3,600,000 to invest and is considering the foreign exchange market (forex market). The
following information relates to two forex bureaus:

Forex Bureau X Forex Bureau Y

Bid/buy Ask/sell Bid/buy Ask/sell
Ksh. Ksh. Ksh. Ksh.
Tsh. quote 0.08 0.09 0.10 0.11

The two forex bureaus are in the same location.

Required:
(i) Calculate the locational arbitrage gain for James Kamau with Ksh. 3,600,000 to invest, if any. (4 marks)

(ii) Explain the scenario that is necessary for locational arbitrage to exist. (2 marks)
e (Total: 20 marks)

QUESTION THREE
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(a) Discuss THREE challenges that organisations face while adopting blockchain technology in their operations.
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(6 marks)

(b) The following information relates to an office complex:

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Sh.“000”
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Gross potential rental income 1,050,000

Insurance and taxes 78,000
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Utilities 54,000
Repairs and maintenance 69,000
Depreciation 120,000
Interest on proposed financing 54,000

Additional information:
1. Vacancy and collection losses are estimated at 6%.
2. Recently, two buildings have been sold in the same locality:
• The first building had a net operating income of Sh.1,500,000 and was sold for Sh.12 million.
• The second building had a net operating income of Sh.675,000 and was sold for Sh.4.8 million.

Required:
(i) The net operating income (NOI) for the office complex. (4 marks)

(ii) The appraised price of the office complex using the income approach. (4 marks)

(c) You are provided with the following information on put and call options on a stock:

Call price, Co =Sh.6.64

Put price, Po = Sh.2.75
Exercise price, X = Sh.30
Days to option expiration = 219 days
Current stock price, So = Sh.33.19
Number of days in a year = 365 days
Risk free rate is 5%

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2

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 Required:
Using put-call parity, calculate prices of the following:

(i) Synthetic call option. (2 marks)

(ii) Synthetic put option. (2 marks)

(iii) Synthetic bond. (2 marks)

(Total: 20 marks)

QUESTION FOUR
(a) Kobe Ltd. is about to replace its existing delivery vehicle with a new design of a vehicle that offers greater fuel
economy. The company estimates that replacing the existing vehicle will save running costs of Sh.200,000 per
year. There are two financing options available:

Option 1: Borrowing funds and purchasing the vehicle

The vehicle could be purchased for Sh.3,400,000 using a bank loan with an after tax cost of borrowing of 4% per
year. The vehicle would have a useful life of four years and would have a residual value of Sh.1,400,000 at the
end of that period. Straight line tax allowable depreciation is available on the vehicle. The vehicle would be
subject to a special tax of Sh.60,000 at the end of each year of operation. The tax expenses are corporation tax
deductible.

Option 2: Leasing the vehicle

The vehicle could be leased for a period of four years for a payment of Sh.600,000 per year, payable at the start of
each year. The lessor will pay the special tax. Lease payments are a corporation tax deductible expense.

The firm after tax weighted average cost of capital is 8%. The company pays corporation tax at a rate of 30% one
year in arrears.

Required:
(i) Advise Kobe Ltd. on whether it should lease or borrow to finance the new vehicle. (8 marks)

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(ii) Examine THREE reasons other than possible after tax cost advantages why Kobe Ltd. may choose to

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lease rather than buy the new delivery vehicle. (3 marks)

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(b) The statement of financial position of two companies, Aco Ltd. and Bero Ltd. as at 31 December 2022 are shown
below:
Aco Ltd. Bero Ltd.
Sh.“000” Sh.“000”
Ordinary share capital (Sh.10 par value) 10,000 5,000
Preference share capital 2,000 -
Share premium account - 200
Profit and loss account balance 3,800 400
10% debentures 1,500 500
17,300 6,100
Non-current assets 12,200 3,500
Net current assets 5,100 2,600
17,300 6,100

Additional information:
1. Aco Ltd. is proposing to acquire Bero Ltd. by means of an issue of its own ordinary shares in exchange
for the ordinary shares of Bero Ltd.
2. The management of the two companies have availed the following information to assist in the takeover:
Aco Ltd. Bero Ltd.
Maintainable annual profits after tax
attributable to equity holders Sh.2,400,000 Sh.1,500,000
Current market price per ordinary share Sh.24 Sh.27
Current earnings per share (EPS) Sh.2.4 Sh.3.0
3. The corporation tax rate is 30%.

Required:
Using the following valuation basis and assuming no synergy effects accrue from the takeover, determine the total
number of shares the directors of Aco Ltd. will have to offer to the shareholders of Bero Ltd:

(i) Net asset value basis. (2 marks)

(ii) Earnings per share basis. (2 marks)

CA33 Page 3
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 (iii) Market value basis. (2 marks)

(iv) Present value of future earnings basis. (3 marks)

(Total: 20 marks)

QUESTION FIVE
(a) Assess THREE indicators of an organisation restructuring. (6 marks)

(b) Mapato Ltd. has the following capital structure which it considers optimal:
Debentures 25%
Preference share capital 15%
Ordinary share capital 60%
100%

Additional information:
1. Mapato Ltd.’s expected profit after tax for the year ended 30 June 2023 was Sh.34,285,714. Mapato Ltd.
has an established dividend pay-out ratio of 30%. The tax rate for the company is 30% and investors
expect earnings and dividends to grow at a constant rate of 9% per annum in the future.
2. The company paid a dividend of Sh.3.6 per share in the year ended 30 June 2023. The company’s shares
currently sells at Sh.60 per share.
3. The company can obtain new capital as follows:

Ordinary shares: New ordinary share capital can be issued at a floatation cost of 10%.
Preference share capital: New preference share capital can be issued to the public at Sh.100 per
share.
The floatation cost is Sh.5 per share and a dividend of Sh.11 per share.
Debentures: Debentures can be issued at an interest rate of 12% per annum.
4. Assume that the cost of capital is constant beyond the retained earnings breakpoint.
5. Mapato Ltd. has the following investment opportunities: e
Project Cost (Sh.) Internal rate of return (IRR)
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A 10,000,000 17.4%
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B 20,000,000 16.0%
C 10,000,000 14.2%
D 20,000,000 13.7%
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E 10,000,000 12.0%
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Required:
(i) Calculate the break point in the marginal cost of capital (MCC) schedule. (2 marks)
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(ii) Determine the cost of each capital structure component. (4 marks)

(iii) Calculate the weighted average cost of capital (WACC) in the intervals between the break points in the
marginal cost of capital (MCC) schedule. (4 marks)

(iv) Using the marginal cost of capital schedule, identify the projects that the company should accept and
why. (4 marks)
(Total: 20 marks)
..............................................................................................................

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 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 25 April 2023. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) (i) Explain the term “static trade off theory of capital structure”. (2 marks)

(ii) Selected financial information for Tembo Ltd. is shown below:

• Yield to maturity on debt 8%

• Market value of debt Sh.100 million
• Number of ordinary shares 10 million
• Market price per ordinary share Sh.30
• Cost of capital if all equity financed 10.3%
• Marginal tax rate 30%

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Additional information:

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1. Johnson Njogu, a financial analyst expects that an increase in Tembo Ltd’s financial leverage will

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increase its costs of debt and equity.

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2. Based on an examination of similar companies in Tembo Ltd. industry, Johnson Njogu estimates that the

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company’s cost of debt and cost of equity at various debt to total capital ratios are as shown below:

Estimates of Tembo Ltd. before tax costs of debt and equity:

Debt to total capital ratio (%) Cost of debt (%) Cost of equity (%)
20 7.7 12.5
30 8.4 13.0
40 9.3 14.0
50 10.4 16.0

Required
Determine the debt to total capital ratio that would minimise Tembo Ltd.’s weighted average cost of capital
(WACC). (5 marks)

(b) Adept Consultants is a research firm that provides market related data for use by market participants. Michael
Aloo is a financial manager at Adept Consultants tasked with estimating stock beta.

Required:
Explain THREE practical considerations that Adept Consultants should take when forecasting beta of an asset.
(3 marks)

(c) XYZ Limited is considering six investment projects with the following details:

Project Initial outlay Net present value

Sh. “000” Sh. “000”
1 1,000 390
2 750 325
3 1,125 590
4 1,850 840
5 1,300 635
6 1,500

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 Additional information:
1. Project 6 is expected to generate the following annual cash flows:
Year 1 2 3 4
Sh. “000” Sh. “000” Sh. “000” Sh. “000”
Sales 725 765 885 612
Cost 145 168 202 94
Project 6 cash flows are exclusive of inflation at the rate of 4% per year for sales income and 5% per year
for costs.
2. The cost of capital is 10%.
3. Due to management reluctance to raise additional finance, the capital for investment is currently
restricted to Sh.5,000,000.
4. Project 1, 3, 5 and 6 are all independent but project 2 and 4 are mutually exclusive.
5. All of the above projects are divisible and none can be delayed or repeated.

Required:
(i) The net present value (NPV) for project 6. (3 marks)

(ii) The optimum investment combination given the capital constraint. (6 marks)

(iii) The resulting net present value (NPV) in (c) (ii) above. (1 mark)
(Total: 20 marks)

QUESTION TWO
(a) (i) Differentiate between “white knight” and “white squire” in relation to mergers and acquisitions.
(4 marks)

(ii) Felix Bodo has collected the following information relating to the pro-forma financial statements of ABC
Ltd., a company that is a target of its competitors.

Pro forma statement of profit or loss:

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Year
2022 2023 2024 2025 2026
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Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000”

Revenue 15,752 17,327 19,060 20,966 23,023
Cost of goods sold 8,664 9,530 10,483 11,531 12,685
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Gross profit 7,088 7,797 8,577 9,435 10,378

Selling, general expenses 2,363 2,599 2,859 3,145 3,459
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Depreciation 551 606 667 734 807

Earning before interest and taxes 4,174 4,592 5,051 5,556 6,112
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Net interest expense 642 616 583 543 495

Earning before taxes 3,532 3,976 4,468 5,013 5,617
Income tax 1,236 1,392 1,564 1,755 1,966
Net income 2,296 2,584 2,904 3,258 3,651

Selected pro forma statement of financial position:

Year
2022 2023 2024 2025 2026
Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000”
Change in deferred income tax 19 21 23 26 28

Selected pro forma cash flow statement:

Year
2022 2023 2024 2025 2026
Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000”
Change in networking capital 455 551 607 667 734
Capital expenditures 1,461 1,709 1,880 2,068 2,275

Additional information:
1. ABC Ltd. has a corporate tax rate of 30%.
2. The weighted average cost of capital is 10%.
3. The terminal growth rate is 6%.

Required:
Determine using the discounted free cash flow analysis the value of ABC Ltd. (10 marks)

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2

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(b) Consider a two-period binomial model in which a share currently trades at a price of Sh.65. The share price can
go up 20% or down 17% each period. The risk free rate is 5%.

Required:
The price of a put option expiring in two periods with an exercise price of Sh.60. (6 marks)
(Total: 20 marks)

QUESTION THREE
(a) In regards to restructuring in the public sector, the ministry of finance or an equivalent body can use performance
results to motivate agencies to improve performance.

Required:
Examine THREE broad categories of potential mechanisms available to the Ministry of Finance to motivate
performance including the rewards and sanctions in each category line. (6 marks)

(b) One of the instruments of real estate financing is mortgages.

Highlight FOUR methods by which the interest on a mortgage may be charged. (4 marks)

(c) You have been appointed as a finance manager of Mamba Ltd. After evaluating the investment portfolio of the
company, you have divided the market into four portfolios following two dimensions; value/growth and
small/large.

The weight of each portfolio in the index is given below:

Portfolio Weight Sensitivity to factor 1 Sensitivity to factor 2 Sensitivity to factor 3

(%) (Market beta) (Price/book) Average capitalisation
Small value 10 0.87 0.83 2
Small growth 10 0.97 0.33 2
Large value 30 0.92 5 20

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Large growth 50 1.12 6 22

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Risk premium 8% –3% 0.40%

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The risk free rate is 3%.

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Required:
(i) Using the arbitrage pricing theory (APT), determine the portfolio that has the highest expected return.
(4 marks)

(ii) The portfolio that would maximise your return if you decide to use capital asset pricing model (CAPM).
(4 marks)

(iii) In order to diversify his perceived risk, a competitor wants to combine the small value and large growth
portfolios. The new portfolio should have an overall sensitivity to factor 1 (market beta) of 1.

Determine the proportion to be invested in the small value and large growth. (2 marks)
(Total: 20 marks)

QUESTION FOUR
(a) Explain THREE differences between “futures contracts” and “forward contracts”. (6 marks)

(b) Pine Ltd. is considering an investment in one of two corporate bonds namely A and B. Both bonds have a par
value of Sh.1,000 and pay coupon interest on an annual basis.

The market price of bond A is Sh.1,079.60 with a coupon rate of 6% and is due to be redeemed at par in five
years. Bond B is about to be issued with a coupon rate of 4% and will also be redeemable at par in five years.

Additional information:
1. Both bonds are expected to have the same gross redemption yield (yield to maturity).
2. The yield to maturity of a company bond is determined by its credit rating.
Pine Ltd. considers duration of the bond to be a key factor when making decisions on which bond to invest in.

Required:
(i) The Macaulay duration for bond A and bond B. (10 marks)

(ii) Discuss TWO limitations of duration as a measure of a bond price to changes in interest rates. (4 marks)
(Total: 20 marks)
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 QUESTION FIVE
(a) Globalisation has resulted in several organisations engaging in corporate alliances and the establishment of
trading blocks. The advent of e-commerce has enabled companies to greatly expand their market.

Required:
Elaborate on FOUR factors that complicate financial management in multinational firms. (8 marks)

(b) Explain THREE divestment strategies available to a company undertaking restructuring. (6 marks)

(c) A group of companies controlled from the United States has subsidiaries in the United Kingdom (UK), South
Africa (SA) and France (FR).

As at 30 November 2022, intercompany indebtness were as follows:

Debtors Creditors Amount Currency

UK SA 1,236,000 SA Rand
UK FR 494,400 Euro
FR SA 824,000 SA Rand
SA UK 76,220 Sterling Pound
SA FR 386,250 Euro

Additional information:
1. It is the company’s policy to net off inter-company balances to the greatest extent possible.
2. The central treasury is to use the following exchange rates for netting off purposes:

US$ = SA Rand 6.4323/£0.7140/Euro 6.1740

Required:
Calculate the net payment to be made between the subsidiaries after netting of inter-company balances. (6 marks)
(Total: 20 marks)
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 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 6 December 2022. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) (i) Explain the term “real option” as used in capital investment appraisal. (2 marks)

(ii) Evaluate THREE types of real options. (6 marks)

(b) The management of College Publishers Ltd. has estimated the following initial cash outlays and net cash flows
and probabilities for a new printing process in each case scenario:

Year Worst case Most probable case Best case

Sh.“000” Sh.“000” Sh.“000”
0 (100,000) (100,000) (100,000)
1 20,000 30,000 40,000
2 20,000 30,000 40,000

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3 20,000 30,000 40,000

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4 20,000 30,000 40,000

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5 20,000 30,000 40,000

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5* 5,000 20,000 30,000

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Probability 0.20 0.60 0.20

Year 0 is the initial cost of the new printing process, years 1 – 5 are the operating net cash flows and year 5* is the
estimated salvage value. The firm’s cost of capital for a project of average risk is 13% per annum.

Required:
(i) Assuming that the above project has an average risk, compute the expected net present value (ENPV) of
the project. (4 marks)

(ii) A sensitivity analysis of the salvage value if this variable changes from the base case value by + (plus or
minus) 80%. (4 marks)

(iii) Assume that all cash flows are positive perfectly correlated and that there are only three possible cash
flow scenarios over time namely; worst case, most probable case and best case with probabilities of 0.2,
0.6 and 0.2 respectively.

Determine the project’s standard deviation of the net present value (NPV). (4 marks)
(Total: 20 marks)
QUESTION TWO
(a) The modern portfolio theory (MPT) is a practical method for selecting investments in order to maximise their
overall returns within an acceptable level of risk.

Required:
Outline FIVE assumptions of modern portfolio theory (MPT). (5 marks)
(b) The following information is provided on the market, risk free rate and two stocks A and B:
Expected return Correlation with market Standard deviation
% %
Treasury bill rate 4 0.00 0.00
S & P 500 index 11 1.00 15.00
Stock A 14 0.70 25.00
Stock B 9 0.40 20.00
CA33 Page 1
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 Required:
(i) Draw the capital market line (CML). (3 marks)

(ii) Calculate the betas of Stock A and Stock B. (2 marks)

(iii) Calculate the Alphas (α) of the Stock A and Stock B. (2 marks)

(iv) Plot the Stocks A and Stock B relative to the CML and comment. (3 marks)

(c) Describe five forms of debt financing in regards to real estate. (5 marks)
(Total: 20 marks)

QUESTION THREE
(a) Two firms, A Ltd. and B Ltd. operate in the same industry. The two firms are similar in all aspects except for their
capital structures.

The following additional information is available:

1. A Ltd. is financed using Sh.100 million worth of ordinary shares.

2. B Ltd. is financed using Sh.50 million in ordinary shares and Sh.50 million 7% debentures.
3. The earnings before interest and tax (EBIT) are Sh.10 million for both firms. These earnings are
expected to remain constant indefinitely.
4. The cost of equity in A Ltd. is 10%.
5. The corporate tax rate is 30%.

Required:
Using the Modigliani and Miller (MM) model, determine the following:

(i) The market value of A Ltd. and B Ltd. e (4 marks)

(ii) The weighted average cost of capital (WACC) of A Ltd. and B. Ltd. (4 marks)
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(b) Rema Limited, a United Kingdom (UK) based firm bought goods from a United States (US) supplier and must
pay US Dollars 4,000,000 in three months time.
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The company is considering three choices in order to hedge the transaction exposure and has collected the
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following information:
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Annual interest rates and exchange rates currently available:

US Dollar Sterling Pound (£)

Deposit rate Borrowing rate Deposit rate Borrowing rate
% % % %
1 month 6 9.25 9.75 13.00
3 months 6 9.75 10.00 13.25

$/£ Exchange rate ($ = £1)

Spot 1.8625 – 1.8635
1 month forward 1.8565 – 1.8577
3 months forward 1.8445 – 1.8460

Required:
Determine the amount payable using the following methods:

(i) Forward exchange contracts. (4 marks)

(ii) Money market borrowing or lending. (4 marks)

(iii) Making a leading payment. (2 marks)

(c) Advise on the cheapest method based on your results in (b) (i) – (b) (iii) above. (2 marks)
(Total: 20 marks)

For Solutions/Answers WhatsApp: 0724 962 477 CA33 Page 2

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QUESTION FOUR
(a) Examine FOUR stages that a company might go through during restructuring. (4 marks)

(b) The Altman formula for prediction of bankruptcy is given as follows:

Z-score = 1.2X1 + 1.4X2 + 3.3X3 + 1X4 + 0.6X5

Where:
X1 = Working capital/Total assets.
X2 = Retained earnings/Total assets
X3 = Earnings before interest and tax/Total assets
X4 = Sales/Total assets
X5 = Market value of equity/Book value of debt

You are provided with the following information in respect of three listed companies:
Working Retained Earnings before Market value Total Liabilities Sales
capital Earnings interest and tax of equity assets
Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000” Sh.“000”
A Ltd. 4,000 60,000 10,000 20,000 200,000 120,000 200,000
B Ltd. 2,000 20,000 0 5,000 100,000 80,000 120,000
C Ltd. 6,000 20,000 –30,000 48,000 800,000 740,000 900,000

Required
(i) The Z-score for each of the three companies. (6 marks)

(ii) Comment on your results in (b) (i) above. (2 marks)

(c) Kilop Ltd. has decided to instal a new milling machine.

Additional information:

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Sh.5,600,000 at the end of year five.

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2. The company has two options:

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Option A
Purchase the machine for cash using a bank facility. The current rate of interest is 15% before tax.

Option B
Lease the machine under an agreement which would entail payment of Sh.6,720,000 at the end of each
year for the next five years.
3. The corporate rate of tax is 30%.
4. Capital allowance is given at the rate of 100% in year one if the machine is purchased.
5. Tax is payable one year in arrears.
Required:
Advise Kilop Ltd. whether to lease or buy the machine. (8 marks)
(Total: 20 marks)
QUESTION FIVE
(a) Explain FIVE limitations of financial derivatives used in financial risk management. (5 marks)

(b) The International Monetary Fund (IMF) has implemented many reforms in recent years designed to strengthen its
cooperative nature and improve its ability to serve its membership.

In context of the above statement, propose FOUR main reforms that have been designed by IMF in recent years.
(4 marks)

(c) Alpha Ltd. and Beta Ltd. are companies operating in the same line of business. In the recent past, Alpha Ltd. has
experienced very stiff competition from Beta Ltd. such that Alpha Ltd. is considering acquiring Beta Ltd. in order
to consolidate its market share.
The following financial data is available about the two firms:
Alpha Ltd. Beta Ltd.
Annual sales (Sh.million) 400 100
Net income (Sh.million) 150 20
Outstanding number of ordinary shares (millions) 50 10
Earnings per share (Sh.) 3.0 2.0
Market price per share (Sh.) 30 15
CA33 Page 3
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 Both companies are in the 30% income tax bracket.

Required:
(i) Maximum exchange ratio that Alpha Ltd. should agree to if it expects no dilution in its post acquisition
Earning Per Share (EPS). (2 marks)

(ii) Alpha Ltd.’s post acquisition earning per share if the companies agree on an offer price of Sh.40.
(2 marks)

(iii) Alpha Ltd.’s post acquisition earning per share if for every 200 ordinary shares of Beta Ltd.’s are
exchanged for 5 units of 10% debenture of Sh.500 per value each. (3 marks)

(iv) Combined operating profit (EBIT) and post acquisition earning per share at point of indifference between
earnings of the firm under the financing plans in (c) (ii) and (c) (iii) above. (4 marks)
(Total: 20 marks)
...............................................................................................................

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 CPA ADVANCED LEVEL

ADVANCED FINANCIAL MANAGEMENT

TUESDAY: 2 August 2022. Morning paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your
workings. Do NOT write anything on this paper.

QUESTION ONE
(a) A project requires an initial investment of Sh.500,000. It is expected to generate cash inflows of Sh.200,000 per
annum for the next 5 years.

Additional information:
1. The firm is indifferent between a certain amount of Sh.181,347 at the end of the first year and the
expected amount of Sh.200,000.
2. The risk free rate of return is 5% per annum.

Required:
(i) The net present value (NPV) of the project incorporating certainty equivalent coefficient (CEC).(5 marks)

(ii) Advise the management on whether the project is worthwhile. (1 mark)

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(b) An investor has decided to invest Sh.2,000,000 in the shares of two companies namely Dela Ltd. and Alpha Ltd.

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The projections of returns from the shares of the two companies along with their associated probabilities are as

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follows:

Probability Returns %
Dela Ltd. Alpha Ltd.
0.20 6 8
0.25 7 5
0.25 –3.5 14
0.30 14 –1

Required:
(i) Determine the proportion of each of the above shares required to formulate a minimum risk portfolio.
(8 marks)
(ii) The amount (in shillings) that should be invested in each share using the proportions determined in (b) (i)
above. (2 marks)

(c) Describe four factors that could significantly impact on the price of cryptocurrencies. (4 marks)
(Total: 20 marks)

QUESTION TWO
(a) Libe Ltd. debt-equity ratio, by market value is 2:5. The corporate debt, which is assumed to yield a return similar
to treasury bills have a rate of 10% before tax.

The beta value of the company’s equity is currently 1.1. The average returns on stock market equity are 15%.

The company is now proposing to invest in a project which would involve diversification into a new industry.

The following information is available relating to this industry:

1. Average beta coefficient of equity capital is 1.60.
2. Average debt-equity ratio in the industry is 1:2 (by market value).
3. The corporation rate of tax is 30%.

Required:
Determine the suitable cost of capital to apply to the project. (6 marks)
CA33 Page 1
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 (b) Rona Hotel Ltd. is currently evaluating a proposal to take over Duet Restaurant Ltd. The Board of directors of
Rona Ltd. is in the process of making a proposal for acquisition of Duet Restaurant Ltd. but first needs to place a
value on the company.

Rona Ltd. has gathered the following financial data:

Rona Hotel Ltd.:

1. Weighted average cost of capital 12%
2. Price to earnings (P/E) ratio 12 times
3. Shareholders required rate of return 15%

Duet Restaurant Ltd.:

1. Current dividend payment per share (DPS) Sh.2.7
2. Past five years dividend payment:
Year 2017 2018 2019 2020 2021
Dividend per share (DPS) (Sh.) 1.5 1.7 1.8 2.1 2.3
3. The current Earnings Per Share (EPS) is Sh.3.7
4. The number of issued ordinary shares are 5 million shares.

Additional information:
1. It is estimated that the shareholders of Duet Restaurant Ltd. require a rate of return of 10% higher than
that of Rona Ltd. owing to the higher level of risk associated with Duet Restaurant Ltd.’s operations.
2. Rona Restaurant Ltd. estimates that the free cash flows from Duet Restaurant Ltd. at the end of the first
year will be Sh.2.5 million and these will grow at an annual rate of 5% for the first 4 years after which
the growth rate will revert to the historical earnings/dividend growth rate in perpetuity.
3. Rona Ltd. expects to raise Sh.5 million at the end of year 2 by selling off hotels of Duet Ltd. that are
surplus of its needs.

Required:
Estimate values of Duet Restaurant Ltd. using the following valuation approaches:
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(i) Price/earnings ratio model. (2 marks)
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(ii) Dividend growth model. (3 marks)
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(iii) Discounted free cash flow basis. (5 marks)

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(c) Discuss Modigliani and Miller’s proposition in a real estate finance context clearly stating the assumptions of the
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theory. (4 marks)
(Total: 20 marks)
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QUESTION THREE
(a) Evaluate five benefits of a currency swap. (5 marks)

(b) A United States (US) company buys goods worth 1,440,000 Euros (€) from a German company payable in 30
days. The US company wants to hedge against the Euro (€) strengthening against the United States dollar ($).

The following exchange rates are provided:

Current spot rate: $/€ 0.9215 – 0.9221

Futures exchange rate: $/€ 0.9245.

The standard size of a 3 month € futures contract is €125,000. In 30 days time, the spot rate is 0.9345 – 0.9351
$/€ and closing futures price will be 0.9367 $/€.

Required:
Determine the net outcome of the futures currency hedge. (5 marks)

(c) Bezo Construction Company Ltd. made a Sh.20 million bond issue 5 years ago when interest rates were
substantially high. The interest rates have now fallen and the firm wishes to retire this old debt and replace it with
a new and cheaper one. Given below are details about the two bond issue:

Old Bond: The outstanding Sh.20 million bond has a nominal value of Sh.1,000 and a coupon rate of 20%. They
were issued 5 years ago with a 25-year maturity. They were initially sold at 5% discount to attract investors and
the firm incurred a floatation cost of Sh.450,000. The bond is callable at Sh.1,150 per unit.
New Bond: The new bond issue of Sh.20 million would have Sh.1,000 nominal value per unit and 18% coupon
rate. They would have a 20-year maturity and will be sold at 10% discount to attract investors. Floatation cost on
the new bond are estimated at Sh.550,000.
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 Assume two months overlapping period and corporation tax rate of 30%.

Required:
(i) Determine the incremental initial cash outlay required to issue the new bond. (4 marks)

(ii) Calculate the annual cash flow saving (if any), expected from the bond refinancing. (3 marks)

(iii) Determine the net present value (NPV) of the bond refinancing and hence advise the company
accordingly. (3 marks)
(Total: 20 marks)
QUESTION FOUR
(a) Assess four circumstances under which a company would consider reorganising its operations rather than
liquidating. (4 marks)

(b) In relation to corporate restructuring and reorganisation, discuss the potential advantages for a company
undertaking the divestment of one of its division by means of:

(i) A sell off. (2 marks)

(ii) A demerger. (2 marks)

(iii) A divestment. (2 marks)

(c) Ngao Ltd. is considering investing in two capital investment projects; X and Y. The projects cash flows are
provided as shown below:
Project
Year X Y
Cash flow Sh.“000” Cash flow Sh.“000”
0 (40,000) (80,000)
1 (80,000) (40,000)

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2 (120,000) -

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3 400,000 240,000

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The funds available for investment in both projects are restricted as follows:

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Year Amount Sh.“000”
0 100,000
1 80,000
2 60,000

Additional information:
1. None of the projects will delay, that is, both investments will start in year 0.
2. The funds not utilised in one year shall not be available for investment in the subsequent years.
3. Both projects are divisible, that is, a project can be undertaken in part or in whole.
4. The cost of capital is 13%.

Required:
(i) Formulate a linear programming model to solve the problem. (4 marks)

(ii) Using the graphical approach, solve the linear programming model and hence determine the proportion
of each project to be undertaken to maximise net present value (NPV). (6 marks)
(Total: 20 marks)
QUESTION FIVE
(a) Summarise four objectives of the International Monetary Fund (IMF). (4 marks)

(b) Discuss four advantages of Foreign Direct Investment (FDI). (8 marks)

(c) The following information relates to the performance of three portfolios; A, B and C during the year ended
30 June 2022:

Portfolio Average return (%) Standard deviation (%) Covariance of portfolio

return with market returns
A 17.55 30 0.0088
B 13.26 34 0.0750
C 9.34 28 0.0021

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 Additional information:
1. The market return and the risk-free rate averaged 14% and 7% respectively during the year ended
30 June 2022.
2. The standard deviation of the market is 10%.

Required:
Evaluate the performance of the three portfolios using:

(i) Sharpe’s performance measure. (4 marks)

(ii) Treynor’s performance measure. (4 marks)

(Total: 20 marks)
...............................................................................................................

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 CPA ADVANCED LEVEL

PILOT PAPER

ADVANCED FINANCIAL MANAGEMENT

December 2021. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.

QUESTION ONE
(a) GLD Building Group is contemplating a takeover of Diarim Enterprise Ltd., a manufacturer of earthmoving
equipment.
The following information is available about the two companies.
GLD Diarim
Number of shares in issue 6,000,000 4,000,000
Dividend per share Sh.0.30 Sh.0.09
Price per price Sh.8.91 Sh.3.20
Additional information.
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1. The cost of equity capital for both firms is 10%.
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2. From a level of Sh.0.06 per share 6 years ago, GLD’s dividends has grown to the current level of Sh. 0.09 per share.
3. GLD’S management is confident that managerial synergies arising as a result of proposed takeover will enable them
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to increase Diarim Ltd’s past dividends growth rate by a further 1%.

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4. The merger will involve transactions cost of Sh.500000.

Required:
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Based on the approximate dividend growth rate, estimate the post-acquisition value of Diarims Ltd. using the dividend growth
model, and evaluate the value gain arising as a result of the takeover. (7 marks)
(b) (i) Discuss the main economic and financial justification advanced for mergers and acquisitions. (4 marks)

(ii) According to evidence, to what extent do the shareholders of the companies tend to benefit from such an
activity? (2 marks)
(iii) According to the evidence, to what extent do the managers of companies tend to benefit from such activity?
(2 marks)
(iv) Explain what are referred to as “managerial” motives for mergers and acquisitions (M&A). (5 marks)
(Total: 20 marks)
QUESTION TWO
Arkard, an investment specialist has been entrusted with Sh.10 million by a collective investment scheme (unit trust) and
instructed to invest the money optimally over a two-year period.
Parts of the instruction are that:
1. The funds be invested in one or more of four specified projects and the money market.
2. The four projects are not divisible and cannot be postponed.
3. The unit requires a return of 24% over the two years. The following are details of the investment in the projects and
the money market.

CA33 Page 1
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 Initial Cost Return over Expected Standard deviation
two years of returns over the two years
Sh.”000” % %
Project 1(p1) 6,000 22 7
Project 2(p2) 4,000 26 9
Project 3(p3) 6,000 28 15
Project 4(p4) 6,000 34 13
Money market (MM) 1,000 (minimum) 18 5

The correlation coefficients of returns over the two years are as follows:
Between Between projects Between projects Between money
Projects &market portfolio and the money market and market
(MP) market (mm) portfolio
P1&p2=0.70 p1&mp=0.68 p1&mm=0.40 MM&MP=0.4
P2&p3=0.0 p2&mp=0.65 p2&mm=0.45
P1&p3=0.62 p3&mp=0.75 p3&mm=0.55
P1&p4=0.56 p4&mp=0.88
P2&p4=0.57
P3&p4=0

Over the two year period, the risk free rate is estimated to be 16%, the market portfolio return is 27% and the variance of the
return on the market 100%.
By analyzing the two assets portfolios:

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(a) Use the mean variance dominance rule to evaluate how Arkard should invest the Sh.10 million. (8 marks)

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(b) Determine the betas and required rates of return for the portfolios then use the capital assets pricing model to evaluate

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how Arkard should invest the Sh.10 million. (8 marks)

(c) Examine four criticisms of the Modigliani and Miller (MM) hypothesis without taxes. (4 marks)
(Total: 20 marks)
QUESTION THREE
An investor is considering introducing a new product code named super pad into the market. This would involve purchasing
a plant costing Sh.300 million.
Additional information:
1. The plant has a useful life of five years and is to be depreciated on a straight line basis.
2. The salvage value is nil.
3. Due to market uncertainties, the sale price, variable cost and sales volume of the super pad have been
estimated stochastically as follows:
Selling price Variable Cost Sales Volume
Value Probability Value Probability Value Probability
Sh. Sh. units
30 0.20 10 0.20 4 million 0.20
40 0.60 20 0.50 6 million 0.50
50 0.20 30 0.30 8 million 0.30

CA33 Page 2
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 4. The company’s cost of capital is 12% and the corporate tax rate is 30%.
Required:
(a) The expected net present value (NPV) of the new product using expected values for each variable. (4 marks)

(b) The expected NPV by performing ten runs using the following random numbers for each variable.
Selling price: 76 64 02 53 16 16 55 54 23 36
Variable cost: 20 82 74 08 01 69 36 35 52 99
Sales volume: 55 50 29 58 51 14 86 24 39 47
Required:
Determine the expected NPV as simulated. (10 marks)

(c) The probability that this product will be a success. (1 mark)

(d) Discuss the advantage (merits) and disadvantages (limitations) of simulation analysis. (5 marks)
(Total: 20 marks)
QUESTION FOUR
(a) Unbundling is the process of selling off incidental non-core businesses to release funds, to reduce gearing in order
to allow management to concentrate on their chosen core business.
In relation to corporate restructuring and reorganization, briefly explain the following forms of unbundling:
(i) Management buyout (MBO).
e (2 marks)
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(ii) Management buy in (MBI). (2 marks)
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(iii) Spin off or demerger. (2 marks)

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(iv) Sell off or divestment. (2 marks)

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(b) Rhinox LTD is planning to invest in an expansion plan. The company has estimated Sh.20 million as the initial
investment for the expansion.
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The plan is expected to generate Sh.5 million annual after tax cash inflow for the next 5 years. Cost of capital is
10%.
Required:
(i) The NPV of the project. (2 marks)

(i) The value of the call option to delay if the risk free rate of return is 7% and standard deviation of returns is
30%.
(6 marks)
(c) In relation to financial risk management, briefly explain four advantages of financial derivatives. (4 marks)
(Total: 20 marks)

QUESTION FIVE
(a) Alpha will receive US dollars 400,000 in 3 month’s time. The company treasurer has determined the following:
Spot rate Dollars 1.8250-Dollars 1.8361
3 months forward Dollars 1.8338-Dollars 1.8452

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 Money market rates Borrowing Deposit
US Dollars 5.1% 4.2%
Sterling 5.75% 4.5%
The money market rates are annual rates.
Required:
Determine whether a forward contract hedge or a money market hedge should be undertaken. (8 marks)

(b) Explain four advantages of investing in Real Estate Investment Trusts. (8 marks)

(c) Explain the meaning of the term crypto currency and give an example. (4 marks)

(Total: 20 marks)

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