THE PUBLIC ACCOUNTANTS EXAMINATIONS BOARD

A Committee of the Council of ICPAU

CPA(U) EXAMINATIONS

LEVEL TWO

FINANCIAL MANAGEMENT - PAPER 10

WEDNESDAY 28 NOVEMBER, 2018

INSTRUCTIONS TO CANDIDATES:
1. Time allowed: 3 hours 15 minutes.

The first 15 minutes of this examination have been designated for reading
time. You may not start to write your answer during this time.

2. Section A has one compulsory question carrying 40 marks.

3. Section B has four questions and only three are to be attempted. Each
question carries 20 marks.

4. Relevant formulae and tables are provided on pages 8 - 10.

5. Write your answer to each question on a fresh page in your answer

booklet.
6. Please, read further instructions on the answer booklet, before attempting
any question.

© 2018 Public Accountants Examinations Board

 Financial Management – Paper 10

SECTION A
This section has one compulsory question to be attempted
Question 1
SAMOTA Uganda Ltd (SUL) is a well-known manufacturer of cosmetics since its
incorporation in 1998. SUL has been financed through bonds and ordinary
shares over the years.
The Board of Directors (BOD) recently decided that more funds should be raised
to finance one of the viable projects. The company treasurer was later tasked by
management to ascertain the actual cost of those additional funds to be raised.
The funding options under consideration include:
1. An issue of 10% irredeemable debentures of Shs 1,000 and incur 4%
floatation costs.
2. An issue of new ordinary shares with a market value of Shs 2,000 per
share and expect to pay an initial dividend of Shs 100 per share. The
dividends are expected to grow at a rate of 10% per annum and also 4%
floatation costs will be incurred.
The funds will be used to finance either of the two projects, namely: ‘MBUSH’
which is a product that eliminates gray hair, or ‘PIHU’, another new product to
bleach women’s body skin. The two projects require the same initial outlay of
Shs 122 million. MBUSH is expected to generate cash inflows of Shs 32 million
per annum in the first two years and a 50% increment per year in the last two
years. PIHU on the other hand is expected to generate annual cash inflows of
Shs 41 million per year for the first two years and Shs 11 million per year for the
subsequent two years. The minimum required rate of return is 15% per year.
Required:
(a) Determine the cost of debt, if debentures were issued at:
(i) par (3 marks)
(ii) a 10% discount (3 marks)
(iii) a 10% premium (3 marks)
(b) Determine the cost of equity using the Gordon growth model. (3 marks)
(c) As the treasurer of SUL, advise management on which project to
undertake, using the:
(i) net present value method. (10 marks)
(ii) internal rate of return method. (8 marks)
(d) Explain to the management of SUL the meaning of the following terms:
(i) Financial analysis. (2 marks)
(ii) Different methods of financial analysis. (5 marks)
(iii) Merits of trend analysis. (3 marks)
(Total 40 marks)

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 Financial Management – Paper 10

SECTION B
Attempt any three of the four questions in this section
Question 2
Mango (U) Ltd (MUL) is a manufacturer of fast moving consumer goods
(FMCGs). The raw materials required to manufacture these unique products are
imported from overseas and they are sourced from different countries. Because
of the long time lag between purchase and delivery of raw materials and
movements in foreign exchange rates between the shilling and major currencies
like the US dollar, Japanese yen, euro and British pound, MUL usually
experiences stock-outs. The fluctuation in foreign exchange rates also affects
the company’s profit margin.
In order to avoid these problems the finance director decided to purchase raw
materials in bulk which has created the problem of storage, security and safety
of the raw materials. On the other hand, there is increased demand in the
region for the company’s products which are unique. This demand has
necessitated expansion of their operation in the whole of the East African region
and beyond. Due to this expansion, more raw materials and finances are
required to support it.
In the process of financing the expansion, the finance director advised
management to use short-term finances like overdrafts since they are dealing in
FMCGs which will pay back faster. He has also suggested that MUL should delay
payment to suppliers of raw materials as a way of accessing funds which are
interest free and also as a way of hedging against foreign exchange rate
movements.
This form of funding has, however, caused the company a lot of problems and
when the company’s managing director consulted finance experts, he was
informed that the cause of all the problems is overtrading. He does not know
how to tackle the problem and he has sought your advice as an expert in
financial management.
Required:
Advise the managing director on the:
(a) causes of overtrading. (5 marks)
(b) symptoms of overtrading and suggest to him how it can be avoided.
(6 marks)
(c) determinants of working capital requirements for an organisation like MUL.
(5 marks)
(d) internal factors that may affect an organisation in achieving its objectives.
(4 marks)
(Total 20 marks)

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 Financial Management – Paper 10

Question 3
Sendi Uganda Ltd (SUL) deals in the importation and installation of solar
equipment in areas where the national electricity grid does not reach. The
company won a tender to supply and install solar power in the 10 districts in
west Nile region. To effectively carry out this work, SUL requires additional
funds worth Shs 1 billion and the directors intend to raise the required funds
from an issue of ordinary shares either to the general public or by using rights
issue offering.
The finance director advised the directors to raise the funds required through a
rights issue offer, reasoning that issuing shares to the general public dilutes
control, and the directors seem to be in agreement.
SUL has in issue 1 million ordinary shares currently selling at Shs 2,000 per
share. The company requires Shs 1 billion to be raised from a rights issue
offering. For the process to be successful, shares will be issued at a discount of
20% of their market price.
Required:
(a) Calculate the:
(i) theoretical ex-rights price. (5 marks)
(ii) value of a right. (2 marks)
(iii) new market value of the company. (3 marks)
(b) Explain to the Board of SUL the following:
(i) Pre-emptive rights. (2 marks)
(ii) Subscription rights. (2 marks)
(iii) Initial public offering (IPO). (2 marks)
(iv) The importance of the underwriter in issuing shares to the general
public. (4 marks)
(Total 20 marks)

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 Financial Management – Paper 10

Question 4
According to the Management Letter issued by the auditors for the year ending
31 December, 2016 the financial controller of KWATA Ltd was found not to have
complied with some international financial reporting standards.
The report revealed the following:
1. Outstanding bills were apparently inflated.
2. Stores ledger books were not up to date, and stationery seemed to have
been misappropriated.
3. Payments to suppliers were delayed without justifiable reasons. It was
found that the financial controller wanted a kickbacks before payments
were made.
4. The shareholders had not been paid dividends although the dividends
were declared two years ago. The shareholders were complaining about
the loss of value due to delayed payment.
5. The financial statements were not prepared according to international
financial reporting standards.
Following the auditors’ recommendations, the comparative statements of
financial position and comprehensive income for KWATA Ltd were adjusted and
are presented below.
Statement of financial position as at 31 December:
2016 2017
Assets: Shs ‘000’ Shs ‘000’
Non-current assets:
Property, plant & equipment 12,000 15,200
Current assets:
Cash & bank 6,000 6,400
Receivables 8,000 8,800
Inventories 800 1,200
14,800 16,400
Total assets 26,800 31,600
Liabilities:
Share capital 9,600 9,600
Reserves 2,400 4,640
12,000 14,240
Long-term liabilities:
Long-term debt 4,800 5,600
Current liabilities:
Short-term bank borrowings 4,800 5,200
Payables 5,200 6,560
10,000 11,760
Total equity & liabilities 26,800 31,600
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 Financial Management – Paper 10

Statement of comprehensive income for the year ended 31 December:

2016 2017
Shs ‘000 Shs ‘000
Net sales 16,000 24,400
Cost of sales (12,800) (18,800)
Gross profit 3,200 5,600
Operating expenses (1,600) (2,000)
Operating profit 1,600 3,600
Other income 400 800
Profit before interest and tax 2,000 4,400
Interest (800) (1,200)
Profit before tax 1,200 3,200
Tax (30%) (360) (960)
Profit after tax (PAT) 840 2,240
Required:
(a) In reference to the above scenario, discuss any three types of unethical
issues faced by finance managers. (6 marks)
(b) Explain to the shareholders of KWATA Ltd the meaning of the term ‘time
value of money’. (2 marks)
(c) Using trend analysis, comment on the financial strength and operating
performance of KWATA Ltd using the following ratios:
(i) Total assets turnover. (3 marks)
(ii) Return on equity. (3 marks)
(iii) Debt-equity. (3 marks)
(iv) Earning power. (3 marks)
(Total 20 marks)

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 Financial Management – Paper 10

Question 5
Bank of Uganda (BOU) through its policy of optimal cash management to
commercial banks recently pinned the managing director of Dicey Bank Ltd (DBL)
for failure to make compulsory deposits on its reserve account for the month of
January 2018.
The managing director in his defense said that DBL opened up two branches in
that month and spent a lot of money such that the balance remaining was to pay
suppliers and to meet the demands of the clients.
At a meeting to address those related issues, BOU official played a video that
was recently featured on a popular TV program ‘dust-free news’. This video
revealed information that DBL had opted to undertake a cross listing instead of
listing on the Uganda Securities Exchange (USE) and that it was the major
reason why they were not compliant with BOU rules and regulations. This left
the managing director speechless as another high profile customer at the press
conference revealed that he had earlier made a withdraw request of Shs 166
million but the teller failed to effectively serve him as the former had less than
what was requested.
Required:
(a) (i) Distinguish between listing and cross listing on securities exchange
(2 marks)
(ii) Explain the requirements for listing on the Main Investment Markets
(MIMs) of the Uganda Securities Exchange (4 marks)
(b) Advise the managing director of DBL on the reasons for holding cash.
(8 marks)
(c) Describe the costs of holding too little cash. (6 marks)
(Total 20 marks)

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 Financial Management – Paper 10

FINANCIAL FORMULAE

The capital asset pricing model Eri  Rf   i Rrm  Rf 

 Ve   Vd 1  T  
The asset beta formula a =  . e  +  . d 
 Ve  Vd 1  T    Ve  Vd 1  T  
Cov x , y 
Correlation coefficient   x , y  
 x y

Covariance Cov x , y     x  x  y  y 
CovR A , R M )
Beta of a security A = = (r jm  j ) /  m
 2 ( RM )

D0 1  g 
The Gordon model P0 =

rg  g 
Gordon’s growth approximation g = bre
(1  g )
Terminal value TV = FCFt
(k  g )

 1  ic   1  rc 
Purchasing power parity and interest rate parity S1 = So  S = So  
 1  i  1
 b   1  rb 
The Fisher formula (1 + m) = (1 + r) (1 + i)

2C 0 D
Economic order quantity (EOQ) =
CH

 Ve   Vd 
Weighted Average Cost of Capital (WACC) = V  V  k e
 V  V  k d (1  T )
 e d   e d 

Modigliani and Miller Proposition 2 (with tax) 

k e  k ei  1  T  k ei  k d VV d

Two-asset portfolio S p  wa2 s a2  wb2 sb2  2 wa wb rab sa sb

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 Financial Management – Paper 10
n
Present value interest factor of Shs 1 per period at r% for n periods 1  r 
Period 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 0.901 0.893
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 0.812 0.797
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 0.731 0.712
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 0.659 0.636
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 0.593 0.567
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564 0.535 0.507
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 0.482 0.452
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 0.434 0.404
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 0.391 0.361
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 0.352 0.322
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350 0.317 0.287
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319 0.286 0.257
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290 0.258 0.229
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263 0.232 0.205
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239 0.209 0.183
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218 0.188 0.163
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198 0.170 0.146
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180 0.153 0.130
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164 0.138 0.116
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149 0.124 0.104

Period 13% 14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24%
1 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 0.826 0.820 0.813 0.806
2 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 0.683 0.672 0.661 0.650
3 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 0.564 0.551 0.537 0.524
4 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 0.467 0.451 0.437 0.423
5 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 0.386 0.370 0.355 0.341
6 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 0.319 0.303 0.289 0.275
7 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 0.263 0.249 0.235 0.222
8 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 0.218 0.204 0.191 0.179
9 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 0.180 0.167 0.155 0.144
10 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 0.149 0.137 0.126 0.116
11 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 0.123 0.112 0.103 0.094
12 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 0.102 0.092 0.083 0.076
13 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 0.084 0.075 0.068 0.061
14 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 0.069 0.062 0.055 0.049
15 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 0.057 0.051 0.045 0.040
16 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054 0.047 0.042 0.036 0.032
17 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045 0.039 0.034 0.030 0.026
18 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038 0.032 0.028 0.024 0.021
19 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 0.027 0.023 0.020 0.017
20 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026 0.022 0.019 0.016 0.014

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 Financial Management – Paper 10

Present value interest factor of an (ordinary) annuity of Shs 1 per period at r% for n periods  1  1  r  
n

 r 
 
Period 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 0.901 0.893
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 1.713 1.690
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 2.444 2.402
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 3.102 3.037
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 3.696 3.605
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355 4.231 4.111
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868 4.712 4.564
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335 5.146 4.968
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759 5.537 5.328
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145 5.889 5.650
11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495 6.207 5.938
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814 6.492 6.194
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103 6.750 6.424
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367 6.982 6.628
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606 7.191 6.811
16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824 7.379 6.974
17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022 7.549 7.120
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201 7.702 7.250
19 17.226 15.678 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365 7.839 7.366
20 18.046 16.351 14.877 13.590 12.462 11.470 10.594 9.818 9.129 8.514 7.963 7.469

Period 13% 14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24%
1 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 0.826 0.820 0.813 0.806
2 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 1.509 1.492 1.474 1.457
3 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 2.074 2.042 2.011 1.981
4 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 2.540 2.494 2.448 2.404
5 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 2.926 2.864 2.803 2.745
6 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 3.245 3.167 3.092 3.020
7 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 3.508 3.416 3.327 3.242
8 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 3.726 3.619 3.518 3.421
9 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 3.905 3.786 3.673 3.566
10 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 4.054 3.923 3.799 3.682
11 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327 4.177 4.035 3.902 3.776
12 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439 4.278 4.127 3.985 3.851
13 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 4.362 4.203 4.053 3.912
14 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 4.432 4.265 4.108 3.962
15 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 4.489 4.315 4.153 4.001
16 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730 4.536 4.357 4.189 4.033
17 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775 4.576 4.391 4.219 4.059
18 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812 4.608 4.419 4.243 4.080
19 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843 4.635 4.442 4.263 4.097
20 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870 4.657 4.460 4.279 4.110

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