Safaricom AND Shelter Afrique are examples of companies that have in the recent past issued floating rate bonds.


a) Briefly explain the meaning of a “floating rate” bond. (4 marks)

b) From the point of view of company’s financial manager, outline the merits and demerits, to the company, of issuing floating rate debt as a means of raising capital. (16 marks)

(Total: 20 marks)


Swale Ltd. wants to raise Sh.15,000,000 in additional funds through a rights offering. The following statements were prepared just before the planned rights offerings.

Balance Sheet as at 31 March 1994





Current assets

Fixed assets






Current liabilities

Long-term debt (25%)

Ordinary shares (sh.10 par)

Retained Earnings






Income Statement for the year ended 31 March 1994


Earnings before interest and taxes 13,500

Interest 4,500

Earnings before tax 9,000

Taxation (40%) 3,600

Net Income 5,400

Additional information:

  1. The company had a price-earnings ratio of 7.5 at the time of the rights offering. Its dividend payout ratio is 40%.

  2. The proposed rights offering subscription price per share is Sh.15.

  3. No change is expected in the return on total assets or dividend payout ratio after the rights offering.


a) How many rights are required to buy one new share? (3 marks)

b) Calculate the return on total assets. (2 marks)

Calculate the following immediately before the rights issue:

- Dividend per share; (2 marks)

- Market price per share. (2 marks)

d) Calculate the dividend per share and market price per share one year after the rights of offering and state whether you would recommend the rights offering. (Give reasons) (8 marks)

e) Prepare the company’s balance sheet immediately after the rights offering under (c) above. (7 marks)


a) A firm may adopt a conservative policy or an aggressive policy in financing its

working capital needs.

Clearly distinguish between:

  • A conservative policy and (3 marks)

  • An aggressive policy. (3 marks)

b) The following information relates to the current trading operations of Maji Mazuri Enterprises (MME) Ltd:

- Level of annual sales (uniform per month) - Sh.600 million

- Contribution to sales ratio - 15%

- Debtors recovery period:

Percentage Average collection  of debtors period (days)

25    32

60    50

15    80

- Credit sales as a percentage of total sales - 60%

- Required return on investments - 15%

- Level of bad debts (2% of credit sales) - Sh.7,200,000

The management of the company is in the process of reviewing the company’s credit management system with the objectives of reducing the operating cycle and improving the firm’s liquidity. Two alternative strategies, now being considered by management are detailed as follows:

Alternative A: change of credit terms

The proposal requires the introduction of a 2% cash discount which is expected to have the following effects:

  1. 50 per cent of the credit customers (and all cash customers) will take advantage of the 2 per cent cash discount.

  2. There will be no change in the level of annual sales, the percentage of credit sales and the contribution of sales ratio.

  3. There will be savings in collection expenses of Sh.2,750,000 per month.

  4. Bad debts will remain at 2 per cent of total credit sales.

  5. The average collection period will be reduced to 32 days.

Alternative B: contracting the services of a factor

The factor would charge a fee of 2% of total credit sales and advance MME Ltd. 90% of total credit sales invoiced by the end of each month at an interest rate of 1.5% per month.

The effects of this alternative are expected to be as follows:

  • No change is expected in the level of annual sales, proportion of credit sales and contributions margin ratio.

  • Savings on debt administration expenses of Sh.1,400,000 per month will result

  • All bad debt losses will be eliminated

  • The average collection period will drop to 20 days.


i) Evaluate the annual financial benefits and costs of each alternative (Assume 360–day year) (8 marks)

ii) Advise MME Ltd. management on the alternative to implement (2 marks)

iii) Explain briefly other factors that should be considered in reaching the decision in (ii). above (4 marks)

(Total: 20 marks)


Love Ltd is considering acquiring Beautiful Ltd. For the past six years, the profits of Beautiful Ltd. has been as follows:








Profits Sh.’M’








Love Ltd expects to pay a DPS of Sh.3.20. The current MPS is Sh.40. The growth in dividends will be matched with the growth in earnings of Beautiful Ltd. once acquired. The future expected profits p.a. (equal to the average of past profits) will also grow a rate equal to past profits growth rate. Love Ltd is an all equity firm. Beautiful Ltd has 50 million ordinary shares.


a) Compute the cost of equity of Love Ltd. (6 marks)

b) Using the cost of equity computed in (a) above, determine the maximum

price with Love Ltd should pay for each share of Beautiful Ltd to acquire it. (10 marks)

c) What is the significance of valuation of securities. (4 marks)

5. Prime Shoes Ltd. manufactures various types of shoes. The company is now considering its working capital policy for 1994. Fixed assets are projected at Sh.30 million and current liabilities at Sh.27 million. Sales and Earnings before interest and taxes (EBIT) are partially a function of the company’s investment in working capital particularly its investment in stocks and debtors. Prime Shoe Ltd. is considering the following three different working capital investment policies:

Aggressive policy - small investment in current assets

Conservative policy - large investment in current assets

Moderate policy - moderate investment in current assets.

The following information relates to three policies:

Aggressive Moderate Conservative

Sh.’000’ Sh.’000’ Sh.’000’

Investment in

Current Assets 42,000 45,000 48,000

Projected Sales 88,500 90,000 91,500

EBIT 8,500 9,000 9,150


a) Determine the working capital investment policies for each of the following:

i) Rate of return on total assets. (3 marks)

ii) Net working capital (3 marks)

iii) Current ratio (3 marks)

iv) Operating margin (3 marks)

v) Current assets turnover (3 marks)

b) Describe the profitability – risk trade offs of these three policies.

(6 marks)