CERTIFIED PUBLIC ACCOUNTANT
INTERMEDIATE LEVEL EXAMINATIONS
I1.1: MANAGERIAL FINANCE
DATE: THURSDAY, 26 AUGUST 2021
INSTRUCTIONS:
1. Time Allowed: 3 hours 15 minutes (15 minutes
reading and 3 hours writing).
2. This examination has two sections; A & B.
3. Section A has three Compulsory Questions while B
has three questions of which two Should be attempted.
4. In summary attempt Five questions.
5. Marks allocated to each question are shown at the end
of the question.
6. Show all your workings where necessary.
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SECTION A
QUESTION ONE
(a) Duterimbere Investment Company Ltd (DIC Ltd) is considering whether to purchase a
piece of land close to Kigali International Airport. The land will be used to provide 600 car
parking spaces. The cost of the land is Frw 60,000,000 but further expenditure of Frw
20,000,000 will be required immediately to develop the land to provide access roads and
suitable surfacing for car parking. DIC Ltd is planning to operate the car park for five years
after which the land will be sold for Frw 100,000,000 at Year 5 prices. A consultant has
prepared a report detailing projected revenues and costs.
Revenues
It is estimated that the car park will operate at 75% capacity during each year of the project.
Car parking charges will depend on the prices being charged by competitors. There is a 40%
chance that the price will be Frw 6,000 per week, a 25% chance the price will be Frw 5,000
per week and a 35% chance the price will be Frw 7,000 per week.
DIC Ltd expects that it will earn a contribution to sales ratio of 80%.
Fixed operating costs
DIC Ltd will lease a number of vehicles to be used to transport passengers to and from the
airport. It is expected that the lease costs will be Frw 5,000,000 per annum. Staff costs are
estimated to be Frw 35,000,000 per annum. The company will hire a security system at a cost
of Frw 10,000,000 per annum.
Inflation
All of the values above, other than the amount for the sale of the land at the end of the five-
year period, have been expressed in terms of current prices. The vehicle leasing costs of Frw
5,000,000 per annum will apply throughout the five years and are not subject to inflation.
Car parking charges and variable costs are expected to increase at a rate of 5% per annum
starting in Year 1.
All fixed operating costs excluding the vehicle leasing costs are expected to increase at a rate
of 4% per annum starting in Year 1.
Other information
The company uses net present value based on the expected values of cash flow when
evaluating projects of this type.DIC Ltd’s cost of capital is 8% per annum. . DIC Ltd ’s
financial director has provided the following taxation information:
• Tax depreciation is not available on either the initial cost of the land or the development
costs.
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• Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is payable in the following year. All cash flows apart from the initial
investment of Frw 80,000,000 should be assumed to occur at the end of the year.
Required:
Evaluate the project from a financial perspective. You should use Net Present Value as
the basis of your evaluation and show your workings. (14 Marks)
(b) Kagitumba Manufacturing Ltd (KM Ltd) is interested in measuring its overall cost of
capital. The firm is in the 40% tax bracket. Current investigation has gathered the following
data:
Debt
The firm can raise debt by selling Frw1,000-par-value, 10% coupon interest rate, 10-year
bonds on which annual interest payments will be made. To sell the issue, an average discount
of Frw30 per bond must be given. The firm must also pay flotation costs of Frw20 per bond.
Preferred stock
The firm can sell 11% (annual dividend) preferred stock at its Frw100-per-share par value.
The cost of issuing and selling the preferred stock is expected to be Frw4 per share.
Common stock
The firm’s common stock is currently selling for Frw80 per share. The firm expects to pay
cash dividends of Frw6 per share next year. The firm’s dividends have been growing at an
annual rate of 6%, and this rate is expected to continue in the future. The stock will have to
be underpriced by Frw4 per share, and flotation costs are expected to amount to Frw4 per
share.
Required:
i. Calculate the individual cost of each source of financing. (Round to the nearest
0.1%.) (7 Marks)
ii. Calculate the firm’s weighted average cost of capital using the weights shown in
the following table, which are based on the firm’s target capital structure
proportions. (Round to the nearest 0.1%.) (4 Marks)
Source of capital Weight
Long-term debt 40%
Preferred stock 15%
Common stock equity 45%
Total 100%
(Total: 25 Marks)
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QUESTION TWO
(a) Working capital management is essentially an accounting strategy with a focus on the
maintenance of a sufficient balance between a company’s current assets and liabilities. An
effective working capital management system helps businesses not only cover their financial
obligations but also boost their earnings.
Required:
Examine Five factors which determine a firm’s working capital needs. (5 Marks)
(b) Consider the following financial statements for Nyarugunga Company Ltd for the year
ended 31 December 2020, a Kigali based company producing and selling consumables. The
statement of financial position is accompanied by a comparative statement as at 31 December
2019:
Nyarugunga Company Ltd’s Statement of Comprehensive Income for the year ended 31
December 2020:
Particulars 2020 (Frw 'million')
Sales 4,053
Cost goods sold 2,780
Depreciation 550
Earnings before interest and taxes 723
Interest paid 502
Taxable income 221
Taxes (30%) 66
Net income 155
Nyarugunga Company Ltd’s
Statement of Financial Position as at 31 December 2020:
2020 (Frw 'million') 2019 (Frw 'million')
Assets
Non-Current Assets
Net plant and equipment 6,527 6,085
Current Assets
Cash 215 210
Accounts receivable 310 355
Inventory 328 507
Total Current assets 853 1,072
Total assets 7,380 7,157
Liabilities and Owners’ Equity
Owners’ equity
Common stock and paid-in surplus 1,000 1,000
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Retained earnings 2,347 2,248
Total Owners’ equity 3,347 3,248
Long-term debt 2,308 1,987
Current liabilities
Accounts payable 298 207
Notes payable 1,427 1,715
Total Current liabilities 1,725 1,922
Total liabilities and owners’ equity 7,380 7,157
Additional Information:
• Assume 365 days in a year.
Required:
i. Calculate the changes from 2019 to 2020 in the following items in the statement of
financial position and identify the change as either a source or use of cash:
a. Accounts receivable. (1 Mark)
b. Inventory. (1 Mark)
c. Net plant and equipment. (1 Mark)
d. Notes payable. (1 Mark)
e. Long-term debt. (1 Mark)
ii. Based on the information presented in the statement of comprehensive income for the
year ended 31 December 2020 and the statement of financial performance as at 31
December 2020, calculate the following ratios for 2020:
a. Current ratio. (1 Mark)
b. Cash ratio. (1 Mark)
c. Inventory turnover. (1 Mark)
d. Days’ sales in receivables. (1 Mark)
e. Cash coverage ratio. (1 Mark)
iii. Calculate the 2020 Return on Equity (ROE) for Nyarugunga Company Ltd and then
break down your answer into its component parts using the Du Pont identity.
(5 Marks)
(Total: 20 Marks)
I1.1 Page 5 of 9
QUESTION THREE
ISUME Ltd is a start-up company located in Special Economic Zone in Kigali. The company
specializes in the manufacture of innovative eco-friendly sanitary pads. Analysts across
Africa have predicted that ISUME Ltd’s business model is likely to be the future of
sustainable sanitary pads. The company’s investment committee has recently advised that the
company considers listing on the Rwanda Stock Exchange (RSE) in order to attract
affordable finance from the public. However, the company’s Chief Investment Officer has
instead advised that it is still too early to list the company. She advised that the company
should first source funding through venture capitalists at this stage as this route has less
regulatory scrutiny.
The Chief Executive Officer of ISUME Ltd, Mrs. Irakaza, is a University of Rwanda
graduate in technology and has little experience in finance. During the recent senior
management meeting, it was advised that the office of the Chief Investment Officer should
advise Mrs. Irakaza on sources of finance.
Required:
You are an Investment Analyst in ISUME Ltd and the Chief Investment Officer has
requested to prepare briefing notes to Mrs. Irakaza highlighting the following:
a) Explain two types of share capital clearly indicating two advantages of each.
(6 Marks)
b) Examine the following aspects relating to Venture Capital:
i. Five stages of investment by a venture capitalist. (5 Marks)
ii. Four risks associated with venture capital financing. (4 Marks)
(Total: 15 Marks)
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SECTION B
QUESTION FOUR
Gashumba Ltd is a Kayonza-based company dealing in the production and sale of fresh
flowers. The company has recently published its financial statements for the year ended 31
December 2020. During the recent Annual General Meeting held in EPIC Hotel Nyagatare,
shareholders agreed in an ordinary resolution to a dividend pay out to its shareholders.
However, the Managing Director is a University of Rwanda master’s degree holder in
agriculture and has little experience in finance.
Required:
You are the company’s Financial Analyst and the Managing Director of Gashumba Ltd has
requested you to prepare a report examining the following:
a) Practical considerations which Gashumba Ltd must take into account in setting its
particular dividend policy. (8 Marks)
b) The concept of Dividend-Irrelevance Theory that is sometimes used in determining
dividend policies and outline its limitations. (7 Marks)
c) Factors affecting dividend payouts. (5 Marks)
(Total: 20 Marks)
QUESTION FIVE
(a) As the newly appointed financial manager of Terimbere Industries, you are about to
analyze a proposal for mining and selling a small deposit of iron ore. You are given the
forecasts shown in the table below:
Year: 0 1 2 3 4 5 6
Capital investment 10,000
Working capital 1,500 4,075 4,279 4,493 4,717 3,039 -
Change in working
capital 1,500 2,575 204 214 225 (1,678) (3,039)
Revenues 15,000 15,750 16,538 17,364 18,233
Expenses 10,000 10,500 11,025 11,576 12,155
Depreciation of
mining equipment 2,000 2,000 2,000 2,000 2,000
Pretax profit - 3,000 3,250 3,513 3,788 4,078
Tax (30%) - 900 975 1,054 1,136 1,223
Profit after tax - 2,100 2,275 2,459 2,652 2,855
I1.1 Page 7 of 9
Consider the following additional information:
• All amounts are Frw ‘000’
• The project requires an investment of Frw 10 million in mining machinery. At the end of
5 years the machinery has no further value.
• The company applies straight-line depreciation to the mining equipment over 5 years.
• Assume that investors expect a return of 12% per annum from investments in the capital
market with the same risk as the iron ore project.
Required:
Using the information provided in the table and additional information, calculate the:
i. Project cash flows. (3.5 Marks)
ii. Project present values (3.5 Marks)
(b) Discuss THREE advantages and TWO disadvantages of using Discounted Cash
Flow (DCF) analysis to making investment decisions (5 Marks)
(c) Ganza Ltd is a public limited company established in 1998 in Kigali. The company’s
financial statements for subsequent years indicate that the company performed well
financially until it came to light in 2018 that Ganza Ltd’s financial statements were complex
and confusing to shareholders and analysts. In addition, it was discovered that the directors of
the company were involved in unethical practices, which they covered by misrepresenting
earnings and modifying the balance sheet to indicate favorable performance. Further, some
speculative business ventures proved disastrous. Eventually, the combination of these issues
later resulted in the bankruptcy of Ganza Ltd and its directors were sued in courts of law for
squandering shareholder’s funds. Ganza Ltd’s story unveils agency principal problem often
referred to as the Agency Theory.
Required:
i. Discuss Four reasons why actions of the managers are in conflict with the interest of
shareholders (4 Marks)
ii. Recommend Four solutions to shareholders and management conflict of interest.
(4 Marks)
(Total: 20 Marks)
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QUESTION SIX
(a) You are a financial analyst for your company, Shora Wunguke Ltd. You have been asked
for your advice in selecting a portfolio of assets by your supervisor and have been given the
following data about three assets A, B, and C:
Expected Return
Year Asset A Asset B Asset C
2018 12% 16% 12%
2019 14% 14% 14%
2020 16% 12% 16%
Additional Information:
You have been told that you can create two portfolios—one consisting of assets A and B and
the other consisting of assets A and C—by investing equal proportions (50%) in each of the
two component assets.
Required:
Using the information provided about the three assets as well as additional information:
i. Calculate the expected return for each asset over the 3-year period. (4 Marks)
ii. Compute the expected return for each of the two portfolios for the 3-year period.
(5 Marks)
iii. How would you characterize the correlations of returns of the two assets making
up each of the two portfolios identified in part (i)? (2 Marks)
iv. Compute the standard deviation for each portfolio (2 Marks)
v. Which portfolio do you recommend and why? (2 Marks)
(b) With respect to portfolio diversification, explain the following:
i. Non-diversifiable risk (2 Marks)
ii. Unsystematic risk (2 Marks)
iii. What is the primary importance in selecting assets with the most desired risk–
return characteristics? (1 Marks)
(Total: 20 Marks)
End of question paper
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