EXAMINATION : INTERMEDIATE LEVEL

SUBJECT : FINANCIAL MANAGEMENT

CODE : B1
EXAMINATION DATE : THURSDAY, 4TH MAY, 2023

TIME ALLOWED : THREE HOURS (2:00 P.M. - 5:00 P.M.)

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GENERAL INSTRUCTIONS

1. There are TWO Sections in this paper. Sections A and B which comprise a total
of SIX questions.

2. Answer question ONE in section A.

3. Answer any FOUR questions in Section B.

4. In total answer FIVE questions.

5. Marks are shown at the end of each question.

6. Calculate your answers to the nearest two decimal points unless otherwise directed.

7. Show clearly all your workings in respective answers where applicable.

8. This question paper comprises 8 printed pages.

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SECTION A
Compulsory Question
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QUESTION 1
(a) Explain the meaning of dividend stability and its value to a company and investors.
(6 marks)

(b) A shareholder of Warembo Co. is concerned about the recent performance of the
company and has collected the following financial information.

Year to 31st December 2022 2021 2020

Turnover (TZS. million) 680 680 660
Earnings per share (TZS.) 58.9 64.2 61.7
Dividend per share (TZS.) 40.0 38.5 37.0
Closing ex dividend share price (TZS.) 648.00 835.00 740.00
Return on equity predicted by Capital Asset 8% 12%
Pricing Model (CAPM)

The shareholder has learnt that one of the items discussed at a recent board meeting
of Warembo Co was the dividend payment for 2023. The finance director proposed
that, in order to conserve cash within the company, no dividend would be paid in
2023, 2024 and 2025. It is expected that improved economic conditions at the end of
these three-years period would make it possible to pay a dividend of TZS.70 per
share in 2026. The finance director expects that an annual dividend increases of 3%
per year in subsequent years could be maintained. The current cost of equity of
Warembo Co is 10% per year. Assume that dividends are paid at the end of each
year.

REQUIRED:

(i) Calculate the dividend yield, capital gain and total shareholder return for 2021
and 2022 and briefly discuss your findings with respect to the returns
predicted by the Capital Asset Pricing Model (CAPM) and the other financial
information provided. (8 marks)

(ii) Calculate and comment on the share price of Warembo Co using the dividend
growth model based on:

• the historical information provided and

• if the proposed change in dividend policy is implemented. (3 marks)

(c) Discuss the relationship between investment decisions, dividend decisions and
financing decisions in the context of financial management, illustrating your
discussion with examples where appropriate. (3 marks)
(Total: 20 marks)

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SECTION B
There are FIVE questions. Answer ANY FOUR questions
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QUESTION 2
(a) (i) Briefly discuss the relationship between short term and long-term financial
planning of a company. (2 marks)

(ii) Identify the key steps involved in the financial planning process and explain
how a company effectively utilize these steps to develop a comprehensive
financial plan that aligns with its goals and objectives. (5 marks)
(b) Tarimo Company is contemplating on whether it should finance its proposed
investment of TZS.1,000,000 using preferred shares or a term loan. Tarimo can
borrow TZS.1,000,000 at 10% annual interest rate or it can sell 10,000 preferred
shares with the total value of TZS.1,000,000. The latter alternative will require it to
pay annual preferred dividends of TZS.10 per share. The return on new investment
(i.e. earning before interest and tax divided by investment) is expected to be 11%.
The data in the income statement before executing the investment proposal is given
below.

Number of common shares 1,000

TZS.
Earning before interest and tax 800,000
Interest 0
Earning after interest 800,000
Tax rate 46% 368,000
Preferred dividends 0
Income available for common stock holders 432,000
EPS 432
Assume the tax rate will continue to be 46%.

REQUIRED:
As a financial consultant, advise the management on the best alternative it should use
to finance its new investment. (8 marks)

(c) RDC Ltd practises a strict residual dividend policy and maintains a capital structure
of 60 percent debt and 40 percent equity. Earnings for the year are TZS.500 million.

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 REQUIRED:

(i) Determine the maximum amount of capital spending possible for RDC Ltd
without issuing new equity. (2 marks)
(ii) Determine whether RDC Ltd will be able to pay dividends if its planned
investment outlays for the coming year are TZS.1,200 million. If so, how
much dividends will it pay? (3 marks)
(Total: 20 marks)

QUESTION 3
(a) Assume there are N securities in the market. The expected return of every security is
10 percent. All securities also have the same variance of 0.0144 and the covariance
between any pair of securities is 0.0064.

REQUIRED:

(i) Briefly explain the key determinants of the expected returns and variance of a
port-folio made up of several risky assets. (3 marks)

(ii) What is the expected return of an equally weighted portfolio containing all N
securities? (2 marks)

(iii) What will happen to the variance as N gets larger? (1 mark)

(iv) What security characteristics are most important in the determination of the
variance of a well-diversified portfolio? (2 marks)

(b) Mollel plc manufactures sunglasses, and therefore, its returns are best during sunny
seasons. Another company Mwani plc, manufactures umbrellas, and therefore, its
returns are best during rain seasons. The returns on the shares are shown in the table
below, together with the probability of when a particular weather ‘event’ may occur.
Event Probability Mollel plc (%) Mwani plc (%)
Sunny Weather 0.3 20 4
Sunny Spells 0.4 12 15
Wet Weather 0.3 -5 25

REQUIRED:
(i) Calculate the expected return and standard deviation of a share in Mollel plc
and Mwani plc. (6 marks)
(ii) Discuss the results from (i) with reference to risk and return, stating which
company has higher risk and which one would you choose to invest in.
(3 mark)

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 (iii) Explain how you could improve the combined risk and return received by an
investor through the use of a portfolio comprising shares in both Mollel plc
and Mwani plc. (3 marks)
(Total: 20 marks)

QUESTION 4
(a) Managers of ABC Company are focused on managing the Company’s working capital
to balance liquidity and profitability. They implement strategies to manage receivables
including a strict credit policy and offering incentives for early payment. The Manager
also use cash management techniques and Economic Order Quantity (EOQ) to
optimize inventory levels and reduce costs. They can take advantage of supplier
discounts to increase profitability while managing working capital effectively.

REQUIRED:
(i) Provide at least two (2) situations where a manager has to make decisions that
balance the competing demands of maximizing profitability and maintaining
adequate liquidity. (2 marks)

(ii) Explain three (3) ways the company can use to manage receivables to optimize
cash flow and minimize bad debts losses. (3 marks)

(b) Uyole Ltd is facing cashflow problems due to slow payments from customers. The
company is considering factoring to improve its cash flow. The company needs to
evaluate the creditworthiness of its customers before factoring and to develop a
communication plan to ensure customers understand the process and are not negatively
impacted. The company also needs to understand the financial statements impact of
factoring including the appearance of a liability on the balance sheet.

The annual sales of Uyole Ltd for year 2022 was TZS.1,440,000,000 of which 80%
was credit sales. According to the credit terms, debtors have a one-month period to
pay their dues. Due to collection problems experienced in previous years, the company
has contracted XYZ Ltd, which is an experienced debts collection firm. XYZ Ltd is
willing to offer factor services with an advance of 85% of the total credit sales for a fee
of 2% a month plus a commission of 4% on the total amount of the debts. This
arrangement is expected to save TZS.6,000,000 annually in management costs and
avoid bad debts at 1% of credit sales.

The Finance Manager of Uyole Ltd considers the factoring services to be unfavourable
and has consulted Mwananchi Bank which is ready to make an advance payment equal
to 85% of the credit sales at an interest rate of 15% per annum. The bank requires a
processing fee of 3% on the debts.

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 REQUIRED:
(i) Briefly explain how the creditworthiness of customers can be assessed when
factoring. (2 marks)
(ii) Explain ways companies can use to ensure that factoring does not negatively
impact customer relationship. (2 marks)
(iii) Explain the impact of factoring on a company’s financial statements and the key
considerations when deciding whether to use factoring as a form of financing.
(3 marks)
(iv) Evaluate the two options and advise Uyole Ltd, whether to use the services of the
factor or the advance from Mwananchi bank. (8 marks)
(Total: 20 marks)
QUESTION 5
(a) Briefly discuss the use of price-earning (P/E) ratio in stock valuation. (5 marks)
(b) Selected data from annual accounts of Mix Business Company Ltd, for the past three
years are reported below. To assist you in this assessment the following median
performance indicators have been extracted from a recent inter-firm comparison report
on the industry in which Mix Business is engaged:

Profit before tax : Net assets employed 28%

Annual sales : Stock at year-end 6.5 times
Debtors : Annual sales/12 3 months
Annual sales per employee : TZS.4,800
Average payroll cost per employee TZS.1,200

Below is the summarized financial information, all figures are in TZS.”000” except
number of employees.
Statement of Profit or Loss and other Comprehensive Income
Year ended December 31st 2020 2021 2022
Sales – Home 29,480 27,630 28,050
Export 7,100 8,020 9,850
Total 36,580 35,650 37,900
Profit before taxation 2,220 3,600 2,500

After charging;
Depreciation 750 800 780
Payroll costs 12,950 13,100 12,750
Deduct
Tax 820 1,700 1,080
Preferred share dividend 150 150 150
Ordinary share dividend 700 1,050 1,050
1,670 2,900 2,280
Retained profit 550 700 220

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 Statement of Financial Position as at 31st December
2020 2021 2022
Current assets:
Stock 5,150 6,270 6,550
Debtors 11,170 11,100 10,120
Cash and short
Term investments 2,280 4,400 4,480
TOTAL CURRENT ASSETS 18,600 21,770 21,150
Current liabilities:
Trade creditors 5,800 7,400 8,070
Others 1,900 3,250 2,330
7,700 10,650 10,400
Net current assets 10,900 11,120 10,750
Non-current assets:
Land and buildings (Revalued 13,570 13,570 13,570
1980)
Other non-current assets at cost 22,500 23,500 24,120
Less: Depreciation (19,620) (20,420) (20,970)
2,880 3,080 3,150
Total Non-current Assets 16,450 16,650 16,720
Net assets employed 27,350 27,770 27,470
Ordinary shares of TZS.10 each 14,000 14,000 14,000
Preference shares 2,500 2,500 2,500
Reserves 8,950 9,650 9,870
Deferred taxation 1,900 1,620 1,100
27,350 27,770 27,470
Average number of employees 1,387 1,415 1,310

REQUIRED:

You are asked to evaluate performance of the company over this period and to discuss
the possibilities of it becoming the target for a takeover bid. (15 marks)
(Total: 20 marks)

QUESTION 6

(a) Anderson plc is currently an all-equity firm and has an estimated unlevered beta of 1.2.
The expected annual return on the market portfolio is 12% and the annual risk-free rate is
4%. The company expects to generate earnings before taxes of TZS.17 million in
perpetuity. It distributes all its earnings as dividends at the end of each year. Anderson
has 5 million ordinary shares outstanding. The tax rate is 30%.

Anderson is considering a leveraged recapitalization to boost its share price. The firm
plans to raise a fixed amount of TZS.20 million permanent debt with a cost of debt of 8%
and will use the proceeds to repurchase shares. However, the upfront investment
banking fee associated with the recapitalization will be 2.5% of the amount of debt
raised.

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 REQUIRED:

(i) Determine the value of Anderson plc and the share price as an unlevered firm.
(4 marks)
(ii) Use the Adjusted Present Value (APV) method to calculate the company value
and the share price after the recapitalization plan is announced but before stock
repurchase happens. (3 marks)

(iii) Calculate the after-tax Weighted Average Cost of Capital (WACC) of Anderson
after the recapitalization (rounding to three decimal places) and find the value of
the levered firm using the WACC approach. (3 marks)

(iv) Use the Flow to Equity method to calculate the value of company’s equity after
the recapitalization. (3 marks)

(b) Mwandosi Corporation is growing by leaps and bounds but unfortunately, it frequently
finds itself in cash shortages. At present it is looking at alternative methods of paying for
trade credit with terms 2/10, n/60. Its bank will not allow it any further credit unless
current indebtedness is eliminated. However, a finance company will provide the
TZS.75,000,000 that Mwandosi desires at 16 percent interest.

REQUIRED:
(i) Should Mwandosi pay off the trade credit on the 10th day or allow the cash
discount to expire and pay for the accounts on the 60th day? Assume the
finance company would finance Mwandosi for 50 days. (3 marks)

(ii) If Mwandosi paid off the account on the 75th day with internally generated
funds, how much is the cost of the credit (on an annualized basis)? (2 marks)

(iii) If the payable were stretched out to 25 days beyond the original due, what
would be the cost of losing the discount (on an annualized basis)? (2 marks)
(Total: 20marks)

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