Advanced Financial May

Management 2018
We gratefully acknowledge permission to make use of past examination
papers of KASNEB. We however would want to emphasize that the
solutions given here are not in any way to be construed as obtained
Suggested
from KASNEB but are the suggested solutions by the authors of this solutions
material.

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 Advanced Financial Management

QUESTION ONE
(a) The objectives of a corporate governance system are to eliminate or mitigate conflicts of
interest among stakeholders, particularly between managers and shareholders, and to
ensure that the assets of the company are used efficiently and productively in the best
interest of the investors and other stakeholders.

Required:
In the context of the above statement, discuss four core attributes of an effective
corporate governance system. (4 marks)

(b) In relation to investment appraisal, evaluate four limitations of sensitivity analysis.

(4 marks)

(c) Tabby Ltd. has a potential investment opportunity for which the initial cash outlay and
future cash flows are uncertain. The analysis carried out provided the following
probability estimates:

Probability estimates
Cash outlay Annual cash inflows
Probability Amount Probability Amount
Sh. “000” Sh. “000”
0.40 250,000 0.20 45,000
0.25 280,000 0.40 50,000
0.25 300,000 0.40 60,000
0.10 305,000

Additional information:
1. The cost of capital is 10%
2. Life of the project is expected to be 10 years
3. Salvage value is zero.

Required:
(i) Construct a decision tree for the investment to show pay offs, probabilities and net
present value (NPV) for each alternative. (6 marks)

(ii) The expected NPV of the project. (3 marks)

(iii) If the NPV of the project is less than Sh.5 million, Tabby Ltd. would be exposed
to a hostile takeover.
Compute the probability that Tabby Ltd. will avoid a hostile takeover.
(Assume a normal distribution and that the variance of the NPV is Sh.1,861.47
million). (3 marks)
(Total: 20 marks)

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Suggested solution.
(a) Attributes of an effective corporate governance system.
1. The authority and duties of members (shareholders)
Members and shareholders shall jointly and severally protect, preserve and actively
exercise the supreme authority of the corporation in general meeting (AGM). They have
a duty to exercise that supreme authority to:
Ensure that only competent and reliable persons who can add value are elected or
appointed to the board of directors (BOD), Ensure that the BOD is constantly held
accountable and responsible for the efficient and effective governance of the corporation
so as to achieve corporate objective, prospering and sustainability and change the
composition of the BOD that does not perform to expectation or in accordance with
mandate of the corporation
2. Leadership
Every corporation should be headed by an effective BOD, which should exercise
leadership, enterprise, integrity and judgements in directing the corporation so as to
achieve continuing prosperity and to act in the best interest of the enterprise in a
manner based on transparency, accountability and responsibility.
3. Appointments to the BOD
It should be through a well-managed and effective process to ensure that a balanced mix
of proficient individuals is made and that each director appointed is able to add value
and bring independent judgment on the decision making process.
4. Strategy and Values
The BOD should determine the purpose and values of the corporation, determine
strategy to achieve that purpose and implement its values in order to ensure that the
corporation survives and thrives and that procedures and values that protect the assets
and reputation of the corporation are put in place.
5. Responsibility to stakeholders
The BOD should identify the firm’s internal and external stakeholders and agree on a
policy (ies) determining how the firm should relate to and with them, increasing wealth,
jobs and sustainability of a financially sound corporation while ensuring that the rights
of the stakeholders are respected, recognized and protected.

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 Advanced Financial Management

(b) Limitations of sensitivity analysis

 It assumes that for analysis of a particular variable all other variables will remain
constant thus univariate
 Each risk is considered independently with no attempt made to quantify their
probabilities of occurrence.
 It becomes extremely complex if uncertainties arise through interactions between a large
number of variables.
 Managers cannot see the effect of changed assumptions on the final objective.
 It will often not address the impact of non-linearities if they are present.

(c) Tabby Ltd

Steps:
1. Draw the decision tree
2. Compute the expected NPV
3. Determine the probability using normal curve

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X = Sh.5,000
µ = Sh.48,717.8
ơ = 43,144.76

Z = - 1.01

From the normal curve

0.5-0.3438 = 0.1562
Therefore
Prob of avoiding a hostile takeover = (1-0.1562)
= 0.8438 or 84.38%

QUESTION TWO
(a) The capital asset pricing model (CAPM) is subject to theoretical and practical limitations.
Theoretical limitations are inherent in the structure of the model, whereas practical
limitations arise in implementing the model.

Required:
Summarise two practical limitations of CAPM (2 marks)

(b) A portfolio manager creates the following portfolio:

Security Expected annual return (%) Expected standard deviation (%)

1 16 20
2 12 20

Required:
(i) The proportion invested in security 1, if the portfolio of the two securities has an
expected return of 15%. (1 mark)

(ii) The expected standard deviation of an equal-weighted portfolio, if the correlation

of returns between the two securities is -0.15. (2 marks)

(iii) The expected standard deviation of an equal-weighted portfolio, if the returns of

the two securities are uncorrelated. (2 marks)

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 Advanced Financial Management

(c) Kent Investment Fund (KIF) in which you plan to invest has a total capital of Sh.500
million invested in the shares of five companies as follows:
Company Amount Beta
Invested in shares coefficient
Sh. “million”
Alpha Ltd. 140 0.8
Beta Ltd. 80 1.5
Chatter Ltd 120 3.0
Dinner Ltd. 100 1.0
Eastern Ltd. 60 2.5

Additional information:
1. The beta coefficient of KIF can be determined as a weighted average of the fund’s
investment.
2. The current risk-free rate of return is 8%.
3. The market returns have the following estimated probability distribution for the
next period:

Probability Market return (%)

0.1 7
0.2 9
0.4 11
0.2 13
0.1 15

Required:
(i) The estimated equation of the security market line (SML). (3 marks)

(ii) The fund’s required rate of return for the next period. (3 marks)

(iii) Suppose Anthony Muli, the chief Investment Officer (CIO) of KIF receives a
proposal to invest in a new company. The investment needed to take a position in
the new company’s shares is Sh.50 million.

The forecasted rate of return from this investment and the probability of their
occurrence in different states of nature, are given as follows:

State of Probability Forecasted rate

Nature of return (%)
A 0.1 10
B 0.2 15
C 0.4 20
D 0.2 10
E 0.1 15

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Using the capital asset pricing model (CAPM), advise Anthony Muli on whether
to invest in the new company’s shares. (7 marks)
(Total: 20 marks)

Suggested solution
(a) Limitations of CAPM
 It is strictly a single period model and must be used with caution in the evaluation of
multi-period projects.
 The input data required in the model i.e. Rf, Bj and Rm are not easily available.
 It has been found not to perform in some instances i.e. it cannot be used for estimation
of returns given systematic risk. E.g. for securities with low beta, high price earnings
ratios, securities with strong seasonality pattern in their returns. This suggests that other
factors other than beta may influence security returns.

(b) (i) The proportion invested in security 1, if the portfolio of the two securities has an
expected return of 15%.
Let x represent the proportion invested in security 1
(1-x) represents the proportion invested in security 2
16x +(1-x)12 = 15
16x + 12 -12x =15
4x = 3
X = 0.75

(ii) Standard deviation of the portfolio

Variance =
Standard deviation is simply the square root of variance
Variance =
Variance = 170
Standard deviation = √170 = 13.04%

(iii) Standard deviation of the portfolio

Variance =

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Variance =
Variance = 200
Standard deviation = √200 = 14.14%

(b) Kent Investment Fund (KIF)

Steps:
1. Compute the expected returns of the market
2. Compute the weighted average beta of the fund
3. Determine the security market line
Expected return from the market =E Rm
E Rm = Σ pi Rmi
E Rm = Σ (0.1 x 7) + (0.2 x 9) + (0.4 x 11) + (0.2 x 13) + (0.1 x 15)
E Rm = 11%
The beta coefficient for the investment fund.
Beta = Σ wi Bi
Σ wi
Beta = Σ (140m x 0.8) + (80m x 1.5) + (120m x 3.0) + (100m x1.0) + (60m x 2.5)
Σ (140m + 80m + 120m + 100m + 60m)
Beta = Σ 842
Σ 500
Beta = 1.684

(i) The estimated equation for the security market line (SML).
Rj = Rf + Bj (Rm – Rf)
Rj = 8% + 1.684 (11% - 8%)

(ii) The investment fund’s required rate of return for the next period
Rj = 8% + 1.684 (11% - 8%)
Rj = 13.05%

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(iii)
Steps:
1. Compute the expected returns of the new company and the market
2. Compute the market variance
3. Compute the co-variance between the new company and the market
4. Determine the new company’s beta by dividing step 3 by step 2 above
5. Using the CAPM, determine the required returns and compare with expected
returns.

2
Pi Rxi Rmi Rxi - ERxi Rmi - ERmi (Rmi – ERmi) pi (Rxi – ERxi)(Rmi – ERmi)pi

0.1 10 7 -5.5 -4 1.6 2.2

0.2 15 9 -0.5 -2 0.8 0.2
0.4 20 11 4.5 0 0 0
0.2 10 13 -5.5 2 0.8 -2.2
0.1 15 15 -0.5 4 1.6 -0.2

ERxi ERmi Variance Co-variance

15.5 11 4.8 0.00

Std.dev.= 2.19

Beta of x = (co-variance between x & market)/variance of the market

Beta x = σxM
σ2M
Beta x = 0
2.19
Beta x = 0

(ii) Minimum required rate of returns using CAPM

Required returns (Rx) = Rf + Bx (Rm – Rf)
Where:
Rf is the risk free rate……………..8%
Bx is the beta on stock x………….0

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Rm is the market returns……….11%

RA = 8% + 0 (11% - 8%)
RA = 8%
Advise: Since the expected returns (15.5%) are more than the required returns (8%), Anthony
Muli should go ahead and invest in the shares

QUESTION THREE
(a) Describe the following pre-offer takeover defensive mechanisms:

(i) Poison pills. (1 mark)

(ii) Golden parachutes. (1 mark)

(ii) Fair price amendments. (1 mark)

(iv) Supermajority voting provisions. (1 marks)

(v) Restricted voting rights. (1 mark)

(b) Explain five factors that Multi Corporation (MNCs) should consider when making long-
term investment decisions.

(c) Nangina Ltd. is considering acquiring Bwiri Ltd. Nangina Ltd. is contemplating financing
of the acquisition of Bwiri Ltd. using any of the following options:

Options 1: An ordinary share for ordinary share exchange

Under the terms of acquisition, Nangina Ltd. will offer one of its ordinary share for every
two shares in Bwiri Ltd.

Options 2: Ordinary shares for debenture exchange

Nangina Ltd. expects to offer 2 units of 10% debentures for every 100 ordinary shares in
Bwiri Ltd. Each unit of debenture has a par value of Sh.100 each.

The summarized financial information relating to the two companies for the year ended
30 November 2017 was as follows:

Nangina Ltd. Bwiri Ltd.

Profit after tax (Sh.) 120 million 30 million
Number of shares 20 million 6 million
Earnings per share (EPS) (Sh.) 6 5
Market price per share (Sh.) 50 25

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Price earnings ratio 8.33 times 5 times

The corporate tax rate is 30%.

Required:
Determine the combined operating profit of the two firms and the post-acquisition
earnings per share (EPS) at the point of indifference in the firm’s earnings under
financing options (1) and (2) above. (10 marks)
(Total: 20 marks)

Suggested solution
(a) (i) Poison pills.
This is where the target undertakes an act that will make it less attractive and that can
interfere with its going concern. E.g Borrowing heavily or declaring very high dividends
(ii) Golden parachutes.
Golden parachutes are large compensation payments to executive management,
payable if they depart unexpectedly. Lump sum payments are made upon termination of
employment. The amount of compensation is usually based on annual compensation and
years of service
(ii) Fair price amendments.
A fair price amendment is a provision contained in a public company’s charter that
requires potential acquirers of the company to pay “a fair price” in order to acquire
shares held by the company’s stockholders.
(iv) Supermajority voting provisions.
A supermajority voting provision, an amendment to a company’s corporate charter, is a
provision that states that certain corporate actions require much more than a mere
majority – typically 67%-90% – approval from its shareholders to pass. In other words, a
supermajority voting provision requires greater than a majority shareholder approval for
certain corporate actions to be approved.
(v) Restricted voting rights.
A voting right is the right of shareholders to vote on matters of corporate policy,
including decisions on the makeup of the board of directors, issuing securities, initiating
corporate actions and making substantial changes in the corporation's operations.

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(b) Factors that Multi Corporation (MNCs) should consider when making long-term investment
decisions.
Tax Planning Considerations: Corporate tax rates vary among countries. When an MNC
chooses debt as a financing source, it will prefer to raise it in a country where the tax
rates are higher since interest on debt is a tax deductible expense, and this reduces tax
payable. Secondly, for a given pre-tax cost of debt, the post-tax cost of debt is lower in
the country with the higher tax rate.
Exchange rate risk: If the affiliate’s revenues are denominated in host country currency,
it makes sense for the affiliate to raise funds denominated in the same currency.
Therefore, to avoid currency mismatches (and the exchange rate risk inherent therein)
wherever possible the affiliate should consider raising funds in the same currency in
which it earns revenues
Level of development of local debt markets: An affiliate’s ability to raise debt in the
host country depends on the availability and willingness of investors to subscribe to debt.
Institutional investors are circumscribed by their internal investment guidelines that
prevent them from investing in below investment grade debt.
Foreign direct investment (FDI) restrictions: FDI ceilings vary between countries and
within a country; they can vary from sector to sector, as well as over time. Some
countries impose rules specifying that a certain percentage of the project cost must be
raised by MNC affiliate from local capital markets. FDI ceilings specify the maximum
equity holding in local companies, and also the type of debt that forms part of FDI.
Trends in currency movements: Exchange rate fluctuations cause uncertainty in future
cash flows, and influence the effective cost of borrowing. When a company decides to
borrow funds from overseas since it is cheaper to do so, it must take into account not
only the cost of financing, but also the expected exchange rate in order to calculate the
effective cost of borrowing overseas
Protection of Creditor Rights: In countries that do not have laws that protect creditor’s
rights, or where such laws exist but enforcement is poor, lenders face difficulties when
principal is not repaid. Since non-performing assets are likely to be high, lenders build
this into the cost of debt. So, interest rates on debt are likely to be higher, since default
risk is factored into the price of the loan. The differential between the cost of debt and
cost of equity narrows down, and borrowers are deterred from debt.

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Carry Forward of Losses: The tax shield on debt reduces tax liability, and increases post
tax profitability. But this is an attraction only when the company has pre-tax profits. If it
has pre-tax profits, any brought forward losses from the earlier years can be set off
against profits so that its tax liability is zero. In such a case, the tax deductibility of
interest on debt becomes irrelevant. So an MNC affiliate with carry forward losses may
not select debt financing.

(c) Nangina Ltd

Steps:
1. Develop a mathematical model which results the EPS for both options after the merger.
2. Equate the EPS of the two options using the models developed.
3. At the point of indifference determine the EBIT and EPS.

Option 1
EBIT = (combined PAT/70%) (m) 214.29
Interest 0
EBT (m) 214.29
PAT (70% 0f EBT)(m) 150
Number of ord. shares:
Nangina Ltd (m) 20
Bwiri Ltd (6m shares/2) 3
Total Shares (post-merger) (m) 23
EPS (PAT/shares) 6.52

Option 2
EBIT = (combined PAT/70%) (m) 214.29
Interest (m) (W1) (1.2)
EBT (m) 213.09
PAT (70% 0f EBT) (m) 149.16
Number of ord. shares: post-merger
Nangina Ltd (m) 20

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Bwiri Ltd (m) 0

Total Shares (m) 20
EPS (PAT/shares) 7.458

W1: Interest
Bwiri Ltd shares (m) 6
Exchange=2 debentures for every 100 shares 120,000
Interest per debenture: (10% of Sh.100) 10
Total interest (m) 1.2

Note: The above computations may not be necessary. We only presented them to assist the
student in developing the mathematical models.
At the point of indifference therefore,
EPS using option 1 should equal EPS under option 2 assuming equal EBIT. Thus
EPS 1 = EPS2
(EBIT – I) (1 – T) = (EBIT – I) (1 – T)
Number of shares Number of shares
(EBIT – 0) (0.7) = (EBIT – 1.2) (0.7)
23 20
14 EBIT = 16.1 EBIT – 19.32m
2.1 EBIT = 19.32m
EBIT = 9.2 m

EPS at 9.2m
(9.2 – 0) (0.7) = (9.2 – 1.2) (0.7)
23 20
0.28 = 0.28 ………..EPS

QUESTION FOUR
(a) In relation to derivatives markets and contracts:

(i) Highlight four characteristics that are common to both forward contracts and
futures contracts. (4 marks)

(ii) Differentiate between a “straddle” and a “Strangle” (2 marks)

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(iii) Outline three methods of terminating a swap contract. (3 marks)

(b) Lagdara Ltd., an unlevered firm, operates in the textile industry. The firm’s current
capital structure is summarized as follows:
Sh. “000”
Ordinary share capital (Sh.50 par value) 120,000
Share premium 40,000
Retained earnings 80,000
Shareholders’ funds 240,000

The firm is considering borrowing 10% debt finance of Sh.40 million in order to finance
an expansion programme making it a levered firm.

Additional information:
1. Annual earnings before interest and tax (EBIT) generated by the firm are Sh.60
million. This is expected to remain constant each year in perpetuity.
2. The firm’s ordinary shares are currently trading at a market price per share (MPS)
of Sh.200 at the securities exchange.
3. The corporate tax rate applicable is 30%.

Required:
(i) Using the Modigliani-Miller (M-M) approach and the information provided
above, analyse the financial implications of the change in capital structure of
Lagdara Ltd. (9 marks)

(ii) Justifying your answer, advise the management of Lagdara Ltd. on whether to
change its capital structure. (2 marks)
(Total: 20 marks

Suggested solution
(a) In relation to derivatives markets and contracts:
(i) Characteristics that are common to both forward contracts and futures
contracts.
 Both are used to hedge risk
 Both are bilateral (binding on each party)
 Both forward and futures contracts involve the agreement between two parties
to buy and sell an asset at a specified price by a certain date.
 Both do not involve a cost (premium) at the time of making the contract

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(ii) a “straddle” and a “Strangle”

Straddle: A straddle is a combined position created by the simultaneous purchase
(or sale) of a put and a call with the same expiration date and the same exercise
price.
Diagram

Strangle: Combining call and put at different exercise prices

A strangle is a portfolio of a put and a call with the same expiration date but with
different exercise prices.

S
(iii) Methods of terminating a swap contract
Buying out the counterparty
Just like an option or futures contract, a swap has a calculable market value, so one
party may terminate the contract by paying the other this market value.
Selling the Swap to Someone Else: Because swaps have calculable value, one party may
sell the contract to a third party. As with Strategy 1, this requires the permission of the
counterparty.
Use a Swaption: A swaption is an option on a swap. Purchasing a swaption would allow
a party to set up, but not enter into, a potentially offsetting swap at the time they
execute the original swap.
Through performance

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(b) Lagdara Ltd.

Before borrowing
Market value of the firm (120m/Sh.50 x Sh.200) Sh.480m
Cost of equity

Ke = 0.0875 or 8.75%
Wacc = 8.75%

After borrowing
Market value of the firm
VL=VU + BT
VL = 480m + (40m x 0.3)
VL = 480m + 12m
VL = 492m

Value of equity (S) = VL – B

B = value of debt
S = 492m – 40m
S = 452m

Cost of equity

Ke = 8.67%
Kd = 10% x 0.7
Kd = 7%

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( ) ( )

( ) ( )

Wacc = 8.53%

Summary
Before borrowing After borrowing
Cost of equity (ke) 8.75% 8.67%
Wacc 8.75% 8.53%
Value of the firm 480m 492m

(ii) Since the WACC declines and value increases after borrowing, the management of the company
should consider changing its capital structure.

QUESTION FIVE
(a) Assess five limitations of applying the free cash flow (FCF) approach using the weighted
average cost of capital (WACC) as a discount rate when evaluating projects with
different risks or debt capacity. (5 marks)

(b) The issue of taxation relating to international trade has become important as business
transtaction become more complicated. Transfer pricing is one such area which has come
under scrutiny by tax authorities all over the world. Transfer pricing has been of great
concern to the government as it has made the government lose huge tax revenues.

Required:
In relation to the above statement, summarise three objectives of transfer pricing other
than reducing tax liability. (3 marks)

(c) Kikumi Ltd. expects to receive 750,000 Euros from a credit customer in the European
Union in 6 Months’ time. The spot exchange rate is 2.349 Euros (EUR) per United States
Dollar (USD) and the 6-month forward rate is 2.412 Euros per USD.

The following commercial interest rates are available to kikumi Ltd.

Deposit rate per annum (%) Borrowing rate per annum (%)
EUR 4.0 8.0
USD 2.0 3.5

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Kikumi Ltd. does not have any surplus cash to use in hedging the future Euro receipt.

Required:
Evaluate whether the money market hedge or a forward hedge would be preferred.
(7 marks)

(d) Kisima Ltd. expects free cash flows of Sh.7.36 million this year and a future growth rate
of 4% per annum. Currently, the firm has Sh.30 million in debt outstanding. This
leverage will remain fixed during the year but at the end of each year, kisima Ltd. is
expected to increase or decrease its debt to maintain a constant debt/equity ratio.

Kisima Ltd. pays 5% interest on its debt and has an unlevered cost of capital of 12%.

The corporate tax rate is 40%.

Required:
Compute the value of Kisima Ltd. (5 marks)
(Total: 20 marks)

Suggested solution
(a) Limitations of applying the free cash flow (FCF) approach using the weighted average cost of
capital (WACC) as a discount rate when evaluating projects with different risks or debt
capacity.
 It fails to use the riskiness of the project in valuation. This means that it applies the
company’s riskiness in assessing new projects which might carry different risks.
 It fails to recognize the financing effect of the new project but instead assumes that this
new project will be financed in the same way as the company.
 It assumes that the cost for the new project is the same as that of the company and that
the new project is similar to the company.
 It makes an assumption that the new project is always in the same industry and that the
systematic risk is always the same.
 It fails to recognize fully the tax benefits associated with different financing

(b) Objectives of transfer pricing other than reducing tax liability.

Performance evaluation

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When different affiliates within a multinational are treated as standalone profit centres, transfer
prices are needed internally by the multinational to determine profitability of the individual
divisions. Transfer prices which deviate too much from the actual prices will make it difficult to
properly monitor the performance of an affiliated unit.
Management incentives
If transfer prices used for internal measures of performance by individual affiliates deviate from
the true economic prices, and managers are evaluated and rewarded on the basis of the
distorted profitability, then it may result in corporate managers behaving in an irresponsible
way.
Cost allocation
When units within the multinational are run as cost centres, subsidiaries are charged a share of
the costs of providing the group service function so that the service provider covers its costs plus
a small mark-up. Lower or higher transfer prices may result in a subsidiary bearing less or more
of the overheads.
Tariffs
Border taxes, such as tariffs and export taxes, are often levied on cross-border trade. Where the
tax is levied on an ad valorem basis, the higher the transfer price, the larger the tax paid per unit.
Whether an MNC will follow high transfer price strategy or not may depend on its impact on the
tax burden. When border taxes are levied on a per-unit basis (ie specific taxes), the transfer price
is irrelevant for tax purposes.
Exchange control and quotas
Transfer pricing can be used to avoid currency controls in the host country. For example, a
constraint in profit repatriation could be avoided by the parent company charging higher prices
for raw materials, or higher fees for services provided to the subsidiary. The parent company will
have higher profits and a higher tax liability and the subsidiary will have lower profitability and a
lower tax liability. When the host country restricts the amount of foreign exchange that can be
used to import goods, then a lower transfer price allows a greater quantity of goods to be
imported.

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(c) Kikumi ltd

(i) Using forward contract.
Steps
Since the 6-months forward is given, convert the EUROS receivable at this rate.
EUR750,000 / 2.412 = USD310,945.27

(ii) Money market hedge.

Notes:
(i) The company will need to borrow EUROS today.
(ii) Convert (Sell) the EUROS immediately to USD
(iii) Place the USD received on deposit.
(iv) After six months when the EUROS are received, repay the foreign currency loan
and thus withdraw from the home currency deposit account.
(v) Borrowing rate for EUROS in six months equals 8% / 2 = 4%.
(vi) Deposit (Investing rate) for USD in six months equals 2% / 2 =1% .

Steps
(i) What the company borrows in EUR today should mature to the exact amount
the company expects to receive after six months. In this case,
Borrow EUR.750,000/1.04 =EUR.721,153.85 today
(ii) Convert by selling to the bank today at 1 US$ =EUR.2.349 and receive
USD.307,004.62.
(iii) Invest the USD.307,004.62 in USA
(iv) This investment matures to USD.307,004.62 (1.01) = USD.310,074.66 in six
months time.
(v) This is the money in USD. that the company will receive under the money market
explained above.

(iii) Advise:
Based on the above computations,the company should consider using the foward hedge
since it would receive more.

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(d) Kisima Ltd

Steps:
1. Compute the firm’s wacc
2. Using the normal growth model compute the value of the firm
Cost of equity (Ke) = 12%
Cost of debt (kd) [5%(1-0.4)] = 3%
Wacc on assumption that leverage is 30%
Wacc = Ke we + Kd wd
Wacc = (12% x 0.7) + (3% x 0.3)
Wacc = 9.3%
Value of the firm

V=Sh.138.87m

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