SUGGESTED SOLUTION

B1 – FINANCIAL MANAGEMENT
NOVEMBER 2022

ANSWER 1

(a) Public Sector Objective of ‘value for money’

Public sector organizations are generally set up with a prime objective which is not related to
making profits. These organizations exist to pursue no-financial aims, such as providing a
service to the community. However, there will be financial constraints which limit what any
such organization can do. A not-for-profit organization needs finance to pay for its operations,
and the major financial constraints is the amount of funds that it can obtain. Having obtained
funs, a not-for-profit organization should seek to get value for money from use of the funds:
• Economy: not spending TZS.2m when the same thing can be bought for TZS.1m.
• Efficiency: getting the best use out of what money is spent on
• Effectiveness: spending fund so as to achieve the organization’s objectives.

Since managing government (for example) is different from managing a company, a different
framework is needed in planning and control. This can be achieved by:
• Setting objectives for each
• Careful planning of public expenditure proposals
• Emphasis on getting value for money.

Private Sector Objective of Wealth Maximization.

A private sector organization has as its primary objective the making of sufficient profits to
provide return for its owners and to keep the business operating. So, it is job of senior
management to maximize the market value of the company. Specifically, the main financial
objective of a company should be to maximize the wealth of its investments earn a return, for
the benefit of shareholders. Part of this job will involve attracting funds from the market, such
as new investors, but as with public sector organizations it is also important that the operations
of the company are run economically and efficiently.

(b) The role of financial intermediaries

A financial intermediary is an institution that links lenders with borrowers, by obtaining
deposits from lenders and then relending them to borrowers. Financial intermediaries include:
Commercial banks, Financia houses, Insurance companies, Pension Funds, Unit trust
companies, Investment trust companies, etc. Private investor benefits from financial
intermediaries in the following ways:

Reduction of risk through pooling

Since financial intermediaries lend to a large number of individuals and organizations, any
losses suffered through default by borrowers or through capital losses are effectively pooled
and borne as costs by the intermediary. Provided that the intermediary is itself financially
sound, the lender should not run the risk of losing his investment. Bad debts are borne by the
financial intermediary in its relending operation.

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Maturity transformation
Financial Intermediaries can allow depositors to have immediate access to their savings while
lending to mortgage holders for many years. The intermediary takes advantage of the
continual turnover of cash between borrowers and investors to achieve this.

Convenience
They provide a simple way for the lender to invest, without him having personally to find a
suitable borrower directly. All the investor has to decide is for how long the money is to be
deposited and what sort of return is required; all he then has to do is to choose an appropriate
intermediary and form of deposit.

Information
Intermediaries can offer a wide range of specialist expert advice on the various investment
opportunities that is not directly available to the private investor.
(Any 4 points @ 1 mark)

(c) Evaluation of the company performance in relation to the industry performance from 2020
to 2021 based on the given ratio: (2020 to 2021)
i. Current ratio
Performance of the company from year 2020 to 2021 in terms of current ratio
increased from 0.84:1 to 0.91:1 while of industry decreases from 1.72:1 to 1.63:1. This
shows that the firm is exposing to high risk of liquidity though by having such ratios it
shows that resources are not idle i.e., high profit policy followed.

ii. Quick ratio

Performance of the company from year 2020 to 2021 in terms of quick ratio decreased
from 0.44:1 to 0.21:1 while of industry also decreases from 1.88:1 to 0.71:1. The firm
is not able to pay maturing obligations from quick assets. This may lead to bad
reputation of the company.

iii. Dept ratio

Performance of the company from year 2020 to 2021 in terms of debt ratio decreased
from 63.3 to 61% while of industry decreases from 50%. This shows that the firm is
too geared and depends on debts in running the company. This implies that in the
future the company may face problems in raising addition funs through loans.

iv. Interest cover

Performance of the company from year 2020 to 2021 in terms of interest cover
decreased from 34.6 times to 32.5 times while of industry increased from 7.2 times to
8.5 times. The company is having enough profit to cover financing costs from the
available profit. This is a good strength compared to industry average.

v. Stock turnover
Performance of the company from year 2020 to 2021 in terms of stock turnover
decreased from 16.3 times to 14.2 times while of industry increased from 12.8 times to
113 times. This shows that general the performance is good in relation to that of
company though it decreased.

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vi. Return on equity
Performance of the company from year 2020 to 2021 in terms of return equity
decreased from 23.4% to 20.6% while of industry increased from 18.8% to 19.4%.
This implies that the performance is decreasing though it is good compared to that to
the industry. The company is good in utilizing its equity to generate profit and
minimize direct and indirect costs.

vii. Net income

Performance of the company from year 2020 to 2021 in terms of net income after tax
increased from 7.5% to 14% while of industry also increased from 2.6% to 4.7%. This
firm is performing well compared to industry averages and this is attributed by good
controls of direct costs and indirect costs such as selling and distribution and
borrowing and borrowing costs.

ANSWER 2
a. Percentage of sales method and computations
i. The following are assumptions to be made under percentage of sales method:
(a) All costs vary directly in proportion to sales.
(b) Net profit percentage will remain constant since costs vary directly in
proportion to sales.
(c) Dividends generally do not vary directly with sales and depend upon
management decision.
(d) All assets including noncurrent assets vary directly in proportion to sales.
(e) Equity and debt do not vary directly in proportion to sales and depend upon
management decision.
(f) Retained earning will depend upon dividend payout.

ii. Estimation of the amount of funds that the company is required to raise from
external sources to support the growth in 2022.
Data Given
Sales growth = 10%
Sales for 2022 = TZS.660,000,000
Current assets = 125% of total sales
Non-current assets = 150% of total sales
Short term debts = 35% of total sales
Profit margin on sales = 15%
Dividend payout = 30%

Formula
EFR (External Funds Requirement) = g* (current assets of current year – g * (current
liabilities of current year) – ((1 – dividend payout ratio) Return on sales) ((1+g) sales of
current year)
Computation
Sales for 2021 = 100% + 10% = 660,000,000
= 110% = 660,000,000
= TZS.600,000,000

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 Current assets = 600,000,000 * 125%
= TZS.750,000,000

Non-current assets = 600,000,000 * 150%

= TZS.900,000,000

Short term debts (Current liabilities) = 600,000,000 * 35%

= TZS.210,000,000

EFR = (0.10 * 750,000,000) – 0.10 * 210,000,000) – ((1-0.30) * 0.15)

((1 + 0.30) * 600,000,000)
= 75,000,000 – 21,000,000 – 81,900,000
= - 27,900,000

Therefore, Additional Funds needed is TZS.27,900,000

iii. Determination of the expected retained earnings for the year 2022

Formula:
Expected retained earnings = Opening Balance + Net Profit – Expected dividend

But
Opening balance of retained earnings 2022
= (600,000,000 * 15%) * 70%
= TZS.63,000,000
Net profit 2022 = 660,000,000 * 15%
= TZS.99,000,000
Dividend 2022 = TZS.99,000,000 x 30%=29,700,000
Expected retained earnings (2022) = 99,000,000 – 29,700,000 = 69,300,000
Expected retaining earning (Total) = 61,200,000 – 15,840,000
= 132,300,000

Therefore, expected retained earnings is TZS.132,300,000

iv. Determination of the amount of total assets of the company in the year 2022

Formula:
Total assets = Noncurrent assets + Current assets
= 990,000,000 + 825,000,000
= 1,815,000,000

Therefore, total assets of the company in the year 2022 is TZS 1,815,000,000

b) i. Advantages of external finance and use of external finance.

The following are the advantages of external financing:
• The organization is able to finance the expansion of projects which it cannot do from
internally generated sources.

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 • Internally generated resources can be used for some other purpose. If the company can
find out an investment that gives higher returns than the rate at which the loan is
secured by the company, then internally generated funds can be invested in that
avenue, and then internally generated funds can be invested in that avenue, and
business operations can be financed by way of external financing.

• Borrowing money to finance expansion may help a company meet market demand or
position itself better in the market. The larger – scale implies a greater market as
services and goods can now be provided to more customers.

• External sources of finance greatly help a company expend (grow at a fact rate) and
thus operate on a larger scale.

• Future higher dividends to shareholders as a return on investment will increase due to

investment.

ii. Explanations on the use of external finance for long term investments and the Firm’s
growth.
External finance and a firm’s growth are closely related. An increase in sales of an
organization leads to the need for external financing. An organization which grows at a
fast rate needs to resort to external financing since internal earnings may not be
sufficient. Assets requirements grow at a faster rate as compared to retained earnings
hence external financing is required. An increase in the sales of an organization leads
to higher investment in plant and machinery and other assets. This additional
requirement can be financed through retained earnings up to a certain extent beyond
which it is necessary to resort to external financing. External financing also helps an
organization to grow by facilitating other activities like research, advertisement leads
to high production as well as firm’s growth.

ANSWER 3

a) Systematic risk: this is also known as market risk. It arises due to the uncertainties in
the economy and cannot be reduced by diversification. Examples of systematic risk are
increase in the inflation rate, changes in tax policies, etc.

Unsystematic risk: this is also known as unique risk and arises from unique
uncertainties of individual securities. Uncertainties of individual securities in a
portfolio cancel out each other and hence this risk can be reduced through
diversification. Examples of unsystematic risk are new competitors in the market,
strikes in the company, etc.

b) As per formula studied above, present value is calculated as follows:

PP = 10,000,000 12% (1.12) = 1.762441 P = 5,674,271
11.5% (1.0095833)/60 = 1.7722715 P = 5,642,476
Monthly compounding (Alt 2) is slightly better.

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 From the above it can be concluded that Mr. Masunzu needs to invest TZS.5,642,416
for 5 years @ 11.5% so that Mr. Masunzu gets 10,000,000 at the end of 5 years.

c) Ujamaa Pls needs to create a sinking fund for the period from the issue of debentures
to maturity in order to ensure that sufficient and timely funds are available for
repayment of debentures on maturity.
A sinking fund is a fund which is created by contributing fixed amount at regular fixed
intervals so that a redecided sum is accumulated at the end of the specified period.

The sinking fund is generally created by borrowers for e.g., companied create sinking
fund to repay debentures or bonds on maturity. Borrowers may pay interest at regular
intervals during the life of the of the loan but may not have sufficient provision to
repay principle on the maturity of the loan. As such sinking funds are created to make
provision for repayment of loan on maturity.

The time value of money is taken into account to calculate the amount that needs to be
contributed to the sinking fund so that funds are available to repay the loan on
maturity. Funds contributed to the fund are so invested that amount is available at the
time of repayment of loan.

The factor that is used to calculate the equal annual contribution every year is called
the Sinking Fund Factor (SFF) and it ranges between 0 and 1.0.

d) Stock Repurchase is transaction in which a firm buys back shares of its own stock,
thereby decreasing shares outstanding, increasing EPS, and often increasing the stock
price. Situations that warrant share repurchase.
• Situation where the firm has cash available for distribution to its stakeholders
and it distributes this cash by repurchasing share rather than by paying cash
dividends,
• Situations where the firm concludes that its capital structure is too heavily
weighted with equity and it sells debt and uses the proceeds to buy back its
stock, and
• Situation where the firm has issued options to employees and it uses open
market repurchases to obtain stock for use when the options are exercised.

Stock that has been repurchased by a firm is called treasury stock. If some of the
outstanding shock is repurchased, fewer shares will remain outstanding. Assuming that
the repurchase does not adversely affect the firm’s future earnings, the earnings per
share on the remaining shares will increase, resulting in a higher market price per
share. As a result, capital gains will have been substituted for dividends (2.5 marks).

Merits of Shares Repurchase

The merits of repurchase are as follows:
1. A repurchase announcement may be viewed as a positive signal by investors
because repurchases are often motivated by managements’ belief that their firms’
shares are undervalued.

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 2. The stockholders have a choice when the firm distributes cash by repurchasing
stock-they can sell or not sell. With a cash dividend, on the other hand,
stockholders must accept a dividend payment and pay the tax.
3. A repurchase can remove a large block of stock that is “overhanging” the market
and keeping the price per share down.
4. Repurchases can be used to produce large-scale changes in capital structure.
5. Companies that use stock option as an important components of employee
compensation can repurchase share and then reissue those shares when employees
exercise their options. This avoids having to issue new shares, which dilutes
earnings per share.

Demerits of Repurchases
Demerits of repurchases include the following:
1. Stockholders may not be indifferent between dividends and capital gains, and the
price of the stock might benefit more from cash dividends than from repurchases.
2. The selling stockholders may not be fully aware of all the implications of a
repurchases, or they may not have all the pertinent information about the
corporation’s present and future activities. This is especially true in situations.
3. The corporation may pay too high a price for the repurchased stock, to the
disadvantage of remaining stockholders.

Effects of share Repurchases

Current EPS = Net Income/ Number of Share in Issue
= TZS.400m/2,500,000
= TZS.160

EPS after Repurchasing 500,000 Shares

= TZS.400M/2,000,000
= TZS.200

Effect on the Market Share Price

Share Price = P/E Ratio x EPS
The P/E Ratio = Current Share Price/ Earnings per Share
= TZS.3,200/TZS.160
= 20 times

Expected Market Price after repurchases is: = P/E Ratio x EPS after Repurchase
= 20 x TZS.200
= TZS.4,000

ANSWER 4

a. Portfolio Theory & CAPM

• Portfolio Theory and the CAPM are not the same, although portfolio theory
provides the basis of the more sophisticated CAPM approach to making
investment decisions under conditions of risk.

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 • The principal difference in this context is that the CAPM is only concerned with
systematic risk i.e., that element of risk that cannot removed by diversification.
Portfolio theory other hand is concerned with the total risk of the portfolio.
• Thus, it is unlikely that the two approaches will give the same portfolio risk
measure unless the portfolio in question is sufficiently well diversified to eliminate
fully unsystematic risk.

b.
i. Assessment of the Company’s Financial Performance
Description Amount (TZS)
Profits before tax 10,000,000
Less: Tax 40% 4,000,000
Profits after tax 6,000,000
Less preferred Dividend (8% x TZS 1,000 3,200,000
X 40,000
Earning attributable to ordinary 2,800,000
shareholders Number of Ordinary shares 20,000
in Issue
EPS 140

ii. Comment on Performance

The performance of the company has extremely deteriorated. There EPS has decreased
from TZS.400 to TZS.140, represented a decrease by 65%.

iii. Uses and limitations of the Earnings per Share as measure of Company’s
performance.

Uses:
• Earnings per share (EPS) is widely used as a measure of a company’s performance
and is of particular importance in comparing results over a period of several years.
A company must be able to sustain its earnings in order to pay dividends and
reinvest in the business so as to achieve future growth. (1 mark)
• Investors also look for growth in the EPS from one year to the nest. (1 mark)

Limitations:
EPS is a figure based on past data, and can be easily manipulated by changes in
accounting policies. (1 mark)

c. (i) Earnings Available to Common Shareholders (E)

E = Earnings After Taxes [EAT] = [EBIT] – I] (1 -T)
= [TZS.5m – TZS 20m (0.1)] (1-0.3)
= TZS.2,100,000 (1 mark)

• Market Value of the Geared Gingo Co. (V1)

VL = VU + BT
= EBIT (1-T) Keu + BT
= TZS5M (1-0.3)/0.12 + TZS 20m (0.3)

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 = TZS.29.17m + TZS.6m
= TZS.35.17m (1 mark)
• Cost of Equity Capital of the Geared Gingo Co.
Keg = Keu + [Keu – Kd] B/SL (1-T)
= 12% + [12% - 10%] 6/29.17 (1-0.3)
= 12% + 0.287%
= 12.287% (1 mark)
• Market Value of Equity
SL = VL -B
= TZS.35.17m – TZS 6m
= TZS.29.17m (1 mark)

(ii) UGINGO COMPANY

• Earnings Available to Common Shareholders [E]

E = Earnings After Taxes [EAT] = EBIT] (1-T)

= [TZS.5m] (1-0.3)
= TZS.3,500,000 (1 mark)

• Market Value of the Ungeared Ugingo Co (VU)

VU = EBIT (1-T) Keu
= TZS.5m (1-0.3)/0.12
= TZS.29.17m 1 (1 mark)

• Overall Cost of Capital of the Ungeared Ugingo Co. (WACCU)

WACCU = Keu
= 12% (1 mark)

• Market Value of Equity of the Ungeared Ugingo Co [SU)

SU = VU
= TZS 29.17m (1mark)

(iii) The value of the geared and the ungeared firm are the same proving the concept of
capital structure irrelevance as par M M.

ANSWER 5

a. Deciding on Management Renumeration Package

The objectives of manager may conflict with the objective of shareholders, so
management remuneration package is often designed to encourage goal
congruence. Remuneration committees exist in listed companies aim to reduce
managerial self interest and encourage remuneration packages that support the
achievement of shareholders wealth rather than purely managerial goals. Packages
need to motivate manager while supporting the achievement of shareholder wealth
maximization. The following factor need to be considered.
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 Performance measure
The managerial performance measure selected for use in the remuneration package
should support the achievement of the primary objective of shareholder wealth
maximization. It could be linked to share price changes or total shareholders
return. The managerial performance measure should relate to factors under a
manager’s control.

Types of reward
As cash bonus will be a powerful incentive for managers to improve their
performance and achieve targets. Share options can be used but they can encourage
risk-taking.
b.
i. Dividend per Share (2019) and Dividend Yield (2019)
Dividend per Share (DPS) = 0.4 x TZS 1,260,000/10,000= TZS 50.4
Current Dividend Yield = DPS/Po = TZS 50.4/TZS 5,040= 1%
ii. Dividend per Share (2018)
DPS = (TZS1,50,000 x 0.4)/10,000 = TZS 42

iii. Dividend Payout (2019) = Total Dividend/ Net Income

= [TZS 42 x 10,000]/1,260,000
= 33.3%

iv. The company should maintain a constant dividend payout ratio as this
will guarantee setting aside a proportion of income each year as
retained earnings to be used for the purpose.

c. The value of Baobab Company

The value of Shares can be calculated using the formula:
Value of Shares = [Total Dividends (1+ Growth Rate)]/Cost of Equity – Growth Rate]

Total Shareholder’s Wealth = Total Dividends + Value of Shares.

Retain 30%
Current Years Dividend = (0.7) (32,000,00) = TZS.22,400,000

Market Value of Shares = TZS.22,400,000 (1.08) / (0.2-0.8) = TZS.201,600,000

0.5 Marks

Total Shareholders Wealth = TZS.22, 400,000 + TZS.201,600,000 = TZS.224,000,000

0.5 marks

Retain 20%
Current Year’s Dividend = TZS.(0.80) (32,000,000) = TZS.25,600,000 (0.5 marks)

Market Value of Shares = TZS.25,600,000 (1.60))/0.2-0.06) = TZS 193,828,571.40

Total Shareholders Wealth = TZS.25,600,000 + TZS.193,828,571.40=

TZS. 219,428,571.40

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 Retain 10%
Current Years’s Dividends = TZS.(0.90) 32,000,000) = TZS.20,800,000 (0.5 marks)

Market Value of Shares = TZS.28,800,000 (1.03))/0.2- 0.03) = TZS.174,494,117.6

Total Shareholders Wealth = TZS.28,800,000 + TZS.174,494,117 = TZS.

203,294,117.6 (0.5 marks)

Therefore, the value of shares will be maximized by retaining 30% of the year
earnings and only paying 22,400,000/= in dividend (2 marks)

ANSWER 6

a. Total Sales 1,000,000 x 1,000 = 1,000,000,000

Statement of Working Capital Requirement

TZS TZS
Debtors (1,000,000,000 x 0.80x3/12) 200,000,000
Finished Goods (1,000,000,000 x 0.80 x 3/12) 200,000,000
Work – in – progress (1,000,000,000 x 0.80 x 2/12) 133,333,333
Raw Materials (1,000,000,000 x 0.40 x 3/12) 100,000,000
Total Current Assets 633,333,333
Creditors (1,000,000,000 x 0.40 x 4/12) 133,333,333
Wages (1,000,000,000 x 0.20 x 1/24) 8,333,333
Expenses (1,000,000,000 x 0.20 x 1/24) 8,333,333
Total Current Liabilities 150,000,000
Net Working Capital (NWC)= CA – CL 483,333,333
Add: 10% for contingencies 48,333,333
531,666,666
Cash 15,000,000
Working Capital Requirement 546,666,666

b. (i) If a firm’s cash inflows and outflows are variable but completely predictable the firm
can use the EOQ model of inventory control (i.e the Baumol model) to determine the
optimal level of working balance under conditions of certainty. The objective function
is cost minimization (e.i the firm attempts to minimize the sum of holding costs-
opportunity cost; and conversation costs – transaction costs)

(ii) If a firm’s cashflows and outflows are completely random the firm can use stochastic
models (e.g the Miller – Orr model). The model assumes that the firm do not use its
cash flows are uniformly and sets the upper and lower control limits while assuming
that the net cash follow is normally distributed with a zero value of mean and a
standard deviation.
c. Calculation the break – even EBIT. At any EBIT above this, the increased financial
leverage will increase EPS
Under the old capital structure, the interest bill is TZS.80 million x 0.90 = TZS
7,200,000

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 There are 10 million shares of stock, so, ignoring taxes, EPS is (EBIT – TZS.
7,200,000)/10 million.

Under the new capital structure, the interest expense will be TZS.125 million x 0.09 =
TZS.11.25 million.

Furthermore, the debt rises by TZS.45 million. This amount Is sufficient to repurchase
TZS.45 million/ TZS.45 = 1 million shares of stock, leaving 9 million outriding.

EPS is thus (EBIT – TZS.11.25 million) /9,000,000.

Setting the two scenarios equal to each other and solve for the break – even EBIT.

(EBIT – TZS.7.2 million)/10 million = (EBIT – TZS.11.25 million)/ 9,000,000

EBIT – TZS.7.2 million = 1 x (EBIT – TZS.11.25 million
EBIT = TZS.47,700,000

______________xxx____________

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