EXAMINATION : INTERMEDIATE LEVEL

SUBJECT : FINANCIAL MANAGEMENT

CODE : B1
EXAMINATION DATE : MONDAY, 20TH FEBRUARY, 2023

TIME ALLOWED : THREE HOURS (09:00 A.M. - 12:00 NOON)

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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 7 printed pages.

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SECTION A
Compulsory Question
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QUESTION 1
(a) Evaluate the usefulness of the following measures in the context of an individual security
and a portfolio:
(i) Expected return
(ii) Standard deviation
(iii) Coefficient of variation (6 marks)

(b) A division of Bawaba Company has been allocated a fixed capital sum by the main Board
of Directors for its capital investment during the next year. The division’s management
has identified three capital investment projects, each potentially successful and of similar
size. However, it has only been allocated enough funds to undertake two projects. Projects
are not divisible and cannot be postponed until a later date.

The division’s management proposed to use portfolio theory to determine which two
projects should be undertaken, based on an analysis of the projects’ risk and return. The
success of the projects will depend on the growth rate of the economy. Estimate of project
returns at different levels of economic growth are as follows:

Economic Growth Probability of Estimate Return (%)

(Annual Average) Occurrence
Project 1 Project 2 Project 3
Zero 0.2 5 5 10
2 Percent 0.3 10 10 10
4 Percent 0.3 10 10 10
6 Percent 0.2 5 20 10

The company is contemplating on whether to invest in Portfolio 1 or Portfolio 2. Portfolio

1 is made up of Projects 1 and 2 while Portfolio 2 is made up of Projects 1 and 3. The
projects in each portfolio are equally weighted.

REQUIRED:

Use the above information to evaluate which of the two portfolios the division of Bawaba
Company is likely to undertake. All relevant information must be shown.
(9 marks)

(c) Based on your understanding of business and financial risks, discuss the dangers to a
company of a high level of gearing. (5 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) From a financial standpoint, the value of money changes with time so a
TZS.5,000,000 now and a TZS.5,000,000 three years later is not the same. It is a concept
known as the time value of money. The implication is that, lapse of time comes along with
many economic factors which affect value attached to money.

REQUIRED:

(i) Explain any three (3) importance of the time value of money concept. (6 marks)

(ii) Describe any three (3) features of future value. (6 marks)

(b) Zangie Real Estate Co. is considering selling an apartment property that it owns. A buyer
is willing to pay TZS.200 million for the property, all of which would be paid to Zangie
upfront (today). Given the unpredictable market conditions, besides selling the property,
Zangie is considering the following other three alternatives:

I. The property can generate a constant cash inflow stream of TZS.15 million per year
forever with the first receipt occurring one year from now.

II. The property can generate a cash inflow of TZS.15 million one year from today and
thereafter, this amount will continue growing at a constant rate of 3% per year
forever.

III. The property can generate a constant cash inflow of TZS.15 million per year for ten
years with the first receipt occurring one year from now. Thereafter it will generate
TZS.30 million per year forever.

Zangie’s cost of capital is 10%.

REQUIRED:

Advise Zangie Real Estate Co. on the best course of action to take given the three
alternatives relative to selling the property today. (8 marks)
(Total: 20 marks)

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QUESTION 3
(a) Financial markets are considered the main source of funds in any modern market
economy.

REQUIRED:

With practical examples, briefly explain any four (4) roles of financial markets in an
economy. (8 marks)

(b) Tujenge Limited (TULI) is considering factoring its accounts receivables. A factoring
company has proposed a one-year agreement to both manage its receivables and advance
80% of the credit sales value when invoiced. Existing invoices will be eligible for an
immediate 80% cash payment.

The annual sales on credit are TZS.600 million spread evenly throughout the year, and the
average delay in payment from the invoice date is 90 days. The factoring company is
confident of reducing this delay to only 60 days, and will pay the remaining 20% of
invoice value to TULI immediately on receipt from the customer.

The charge for receivables management will be 1.7% of annual credit turnover payable at
the year-end. For the advance payment on the invoices a commission of 1% will be
charged plus interest applied at 10% per annum on the gross funds advanced.

TULI will be able to save TZS.8,000,000 of administration costs if the factoring company
takes over the management of the receivables. Currently, the company finances trade
credit through an overdraft facility with an annual interest rate of 11%.

REQUIRED:

Prepare a Report to the Management of TULI advising them on whether to enter into the
agreement. The report should include detailed computations and a brief discussion of the
relative advantages and disadvantages of overdraft and factoring financing to TULI.
(12 marks)
(Total: 20 marks)

QUESTION 4
(a) Your company is considering a large new investment which is a major diversification into
a new industry. Typically, this new industry has an average equity beta of 1.5 and an average
industry gearing (debt to equity) by market value of 1.3.

Your company’s gearing level (by market value) is 1:2 debt to equity, and after-tax earnings
available to ordinary shareholders in the most recent year were TZS.5,400,000,000 of which
TZS.2,140,000,000 was distributed as ordinary dividends. The company has 10 million
issued ordinary shares, which are currently trading on the Stock Exchange at TZS.3,210.

While gathering information to estimate the discount rate to be used in appraising the new
investment, you have obtained some working notes by a former employee who was working

B1, February 2023 Page 4 of 53

 on the proposal for the new investment but has since left the company. The employee had
estimated the following items for the next five years (annual averages).

Stock market total return on equity 16%

Company dividend yield 7%
Company share price rise 14%
Company equity Beta 1.4
Growth rate of company earnings 12%
Growth rate of company dividends 11%
Growth rate of company sales 13%
Treasury bill yield 12%

Corporate debt may be assumed to be risk-free. The company pays tax at 35% and personal
taxation may be ignored.

REQUIRED:
(i) Estimate the company’s Weighted Average Cost of Capital (WACC) using the
Dividend Valuation Model (DVM) and the Capital Assets Pricing Model (CAPM).
(4 marks)

(ii) Explain, why your results in (i) above are similar or different. (2 marks)

(iii) Using any relevant information from part (i) above and supporting computations,
recommend which cost of equity should be used for the new investment. (6 marks)

(b) Investment appraisal is a planning process to identify, analyze and select long term,
investment of an asset or item that is purchased with the hope that it will generate income
or appropriate value at some point in the future, beyond one year.

REQUIRED:
(i) Explain the different between risk and uncertainty in relation to investment appraisal.
(4 marks)

(ii) Discuss any four (4) reasons why Net Present Value (NPV) is regarded as superior to
the Internal Rate of Return (IRR) as an investment appraisal technique.
(4 marks)
(Total: 20 marks)

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QUESTION 5

(a) Sama limited and Raha Limited are companies listed at the local stock market. The
following figures are from their current Statements of Financial Position:

Sama Ltd. Raha Ltd.

Millions of TZS. Millions of TZS.
Authorized Ordinary Share Capital
2,000,000 shares of TZS.100 200 200
Market Value of Equity 100 80
5% Perpetual Debt 40
Total Market Capitalization 100 120
Cost of Equity Capital 10% 15%

Each company earns an annual profit before charging debenture interest of TZS.10 million
which is expected to remain constant for the indefinite future. The profits of both companies
before charging debenture, are generally regarded as being subject to identical levels of risk.
It is the policy of both companies to distribute all available profits as dividends at the end
of each year. Raha Ltd has just made annual dividend and interest payments on the ordinary
shares and on its debentures respectively.

Mr. Hashim owns 10% ordinary shares in Raha Ltd. He is wondering whether he could
increase his annual income without incurring any extra risk by selling his shares in Raha
Limited and buying some of the ordinary shares in Sama Limited.

REQUIRED:

(i) Assuming that Mr. Hashim can borrow and lend at 5%, prepare calculations to
demonstrate how he might improve his position the way he has suggested.
(6 marks)

(ii) Explain with reasons as to why the cost of equity of Sama Ltd differ from that of Raha
Ltd. (2 marks)

(b) An investor has a portfolio of shares in four (4) listed companies as detailed below:

Company Number of Market Price Beta Expected

Shares Held per Share Factor Return during
the Next Year
Ace Ltd 5,000 TZS.500 1.5 19.5%
Black Ltd 7,000 TZS.600 2.0 22%
Club Ltd 8,000 TZS.700 1.7 20%
Diamond Ltd 9,000 TZS.800 0.7 13%

At present, the risk-free rate of return is 7% while the return on market is 15%.

B1, February 2023 Page 6 of 53

 REQUIRED:
(i) Calculate the beta for the portfolio and the required return on the portfolio.
(4 marks)
(ii) Assess the performance of the individual share in the portfolio and state whether the
portfolio investment is financially viable. (4 marks)

(c) Explain the nature of a stock (script) dividend and discuss the advantages and
disadvantages of using stock dividends to reward shareholders of a company.
(4 marks)
(Total: 20 marks)

QUESTION 6

(a) Describe any four (4) possible approaches or strategies to create a firm’s value that will
ultimately maximize the shareholders’ wealth. (8 marks)

(b) Risk Governors Ltd (RGL) is considering two mutually exclusive proposals both having
an initial outlay of TZS.900 million. The proposals, denoted as A and B, have uncertain
cash inflows depending on the market conditions. There are four possible market scenarios
having probabilities of 20%, 40%, 20% and 20%. The cash inflows of A and B under the
four possible market conditions are forecasted as below (Cash flows in TZS. million).

Market Scenario Probability Cash Flows in A Cash Flows in B

I 0.20 200 220
II 0.40 250 240
III 0.20 280 265
IV 0.20 300 280

RGL recognizes the fact that project appraisal must take into account the riskiness of the
cash flows. To objectively decide upon the appropriate discount rate, the firm’s
management has devised a formula for arriving at the Risk Adjusted Discount Rate
(RADR) based on co-efficient of variation (CV) as follows:

RADR = 8% + CV x 25%

Assume that each proposal lasts for 5 years and RADR is used to evaluate the proposals.

REQUIRED:

With supporting computations, recommend the proposal to be implemented by RGL.

(12 marks)
(Total: 20 marks)

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