B1 – Financial
Management
MAY 2017
NBAA PAST PAPERS
The National Board of Accountants and Auditors,
EXAM-
TUESDAY, 2ND MAY 2017
EXAMINATION : INTERMEDIATE LEVEL
SUBJECT : FINANCIAL MANAGEMENT
CODE : B1
TIME ALLOWED : THREE HOURS (2:00 P.M. – 5:00 P.M.)
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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.
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)
A company should invest in all projects with a positive
net present value in order to maximize shareholders’ wealth. In some cases, a company may have various
attractive opportunities and yet not be able to undertake them.
REQUIRED:
Discuss this in
the context of investment finance. (6
marks)
(b)
In the annual Board of Directors’ meeting of the
Shengena International Hotels, it was decided that the hotel expand it
facilities by providing a gym and spa for the use of guests. The hotel’s Managing Director noted that the
move would result in an increase in the occupancy rate of the hotel and the
rates that can be charged for each room.
The cost of
refurbishing the space, which is currently used as a library for guests, and
installing the gym and spa is estimated to be TZS.100,000,000. The cost of the equipment is expected to be
TZS.50,000,000. The gym and spa will
need to be refurbished and the equipment replaced every four years. The equipment will be sold for TZS.15,000,000
cash at the end of year 4. This amount
includes the effect of inflation.
The hotel’s financial
consultants have produced a feasibility report at a cost of
TZS.10,000,000. The key finding from
their report, regarding occupancy rates and room rates are as follows:
·
Current occupancy rate: 80%
·
Number of rooms available: 40
·
Current average room rate per night: TZS.250,000
Occupancy rates,
following the opening of the gym and spa, are expected to rise to 82% and the
average room rate by 5%, excluding the effect of inflation.
The hotel is
open for 360 days per year.
Other relevant
information is as listed below:
1.
The gym will require four (4) full time employees each
with an average salary of TZS.30,000,000 per annum.
2.
The current budgeted overhead absorption rate for the
hotel is TZS.80,000 per square metre per annum.
The area required for the gym and spa is 400 square metres. The hotel’s
overheads are expected to increase by TZS.42,000,000 directly as a result of
opening the gym and spa.
3.
Inflation is expected to be at a rate of 4% per annum
and will apply to sales revenue, overhead costs and staff costs. The rate of 4%
will apply from Year 2 to each of the subsequent years of the project.
4.
The hotel’s financial consultants have provided the
following taxation information:
·
Tax depreciation is allowable on all costs of
refurbishing, installation and equipment at 25% reducing balance per annum.
·
Taxation rate is 30% of taxable profits. Half of the tax is payable in the year in
which it arises and the balance is paid the following year.
·
Any losses resulting from this investment can be
offset against taxable profits made by the company’s other business activities.
The company
uses a post-tax money cost of capital of 12% per annum to evaluate projects of
this type.
REQUIRED:
(i)
Calculate the Net Present Value (NPV) of the gym and
spa project.
(8 marks)
(ii)
Using linear interpolation estimate the post-tax money
cost of capital at which the hotel would be indifferent to accepting or
rejecting the project.
(6 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)
According to portfolio theory, a market estimates of
investors reactions to risk cannot be measured precisely, so it is impossible
to set risk adjusted discount rates for various classes of investment with a
high degree of precision.
REQUIRED:
Discuss this statement. (6
marks)
(b)
Jangala and Joseph are two famous security analysts at
the local stock market. Recently the
local stock exchange has experienced market changes due to different economical
and political factors which have affected the price and return of the security
traded in the market. As a result of the
market changes, the two analysts have selected different stocks with each
claiming that the stock selected is highly performing than the other. The expected return on the two stocks for two
particular market returns are provided in the table below:
|
|
Jangala
Selected Stock
|
Joseph Selected Stock
|
|
Return
|
19%
|
16%
|
|
Beta
|
1.5
|
1.0
|
REQUIRED:
(i)
Can you tell which investor had a better performing
stock aside from the issue of general movements in the market? Explain. (4
marks)
(ii)
If the government bond rate were 6% and the market
return during the period were 14% which investor would have a superior stock
selection? (5
marks)
(c)
Assume that there are N Securities in the market. The expected return of every security is 10%
and all securities have the same variance of 0.0144. the covariance between any pair of the
securities is 0.0064.
REQUIRED:
(i)
Compute the expected return of an equally weighted
portfolio. (3 marks)
(ii)
Explain what will happen to the variance as N gets
larger, and outline the main determinant(s) of the risk of a well-diversified
portfolio. (2
marks)
(Total: 20 marks)
QUESTION
3
(a)
Indicate whether the following events might cause the
price of equities (stocks) in general to change and whether they might cause a
bank’s share price to change.
(i)
The government announces that inflation unexpectedly
jumped by 2 per cent last month.
(ii)
The bank’s earnings report, just released, generally
fell in line with analysts’ expectations.
(iii)
The government reports that economic growth last year
was at 3 per cent, which generally agreed with most economists’ forecasts.
(iv)
The Parliament approves changes to the tax laws that
will increase the top marginal corporate tax rate. The legislation had been debated for the
previous six months.
(6 marks)
(b)
Amazon Company Ltd. and Zodiac Company Ltd, are in the
same risk class. Shareholders expect
Amazon to pay a TZS.400 per share dividend next year when the stock will sell
for TZS.2,000 per share. Zodiac Co. has
a no-dividends policy. Currently, Zodiac
stock is selling for TZS.2,000 per share.
Zodiac shareholders expect a TZS.400 capital gain over the next
year. Capital gains are not taxed, but
dividends are taxed at 25 percent.
REQUIRED:
(i)
What is the current price of Amazon stock? (4
marks)
(ii)
If capital gains are also taxed at 25 percent, what is
the price of Amazon stock? (3
marks)
(iii)
Explain the result you found in part (b) (ii) above. (2
marks)
(c)
The net income of GGM Corporation, which has 10,000
outstanding shares and a 100% dividend payout policy, is TZS.32,000. The expected value of the firm one year hence
is TZS.1,545,600. The appropriate
discount rate for Magita is 12 percent.
REQUIRED:
(i)
What is the current value of the firm? (2
marks)
(ii)
What is the ex-dividend price of Magita’s stock if the
board follows its current policy? (3
marks) (Total: 20 marks)
QUESTION 4
(a)
KOBELO Company owns an equipment that is already 5
years old and the remaining useful life is estimated at not more than three
years. It is now 31st
December 2016 and the equipment can be sold now at its residual value. The following are the net cash flows and
residual value estimates for the equipment over the next three years:
|
End of Year
|
Net Cash Flow
(Millions of TZS)
|
Residual Value
(Millions of TZS)
|
|
2016
|
-
|
14
|
|
2017
|
10
|
8
|
|
2018
|
2
|
1
|
|
2019
|
1
|
0
|
The cost of
capital for the firm is 10%.
A decision is to
be made whether to abandon the equipment at the end of year 2017, 2018 or 2019.
REQUIRED:
Evaluate and comment on the appropriate timing of abandoning the
equipment.
(6 marks)
(b)
Discuss the difference between a nominal (money terms)
approach and a real terms approach to calculating net present value. (6 marks)
(c)
Discuss any four factors to be considered in
formulating a trade receivables policy. (8
marks) (Total :20 marks)
QUESTION 5
(a)
“Retained earnings are the cheapest source of
funds. Actually they do not have
opportunity cost”.
REQUIRED:
Discuss the
statement by responding to the following:
(i)
Is retained earnings free of opportunity costs? (2
marks)
(ii)
How does the cost of retained earnings compare with
that of issuing new equity? (2
marks)
(iii)
Why do firm raise external funds rather than rely only
on retained earnings?
(4 marks)
(b)
Since the concept of Limited Liability Company was
conceived, firms have been distributing fractions of their earnings as
dividend. Of recent however,
corporations are increasingly changing their payout policy, and incorporate
stock repurchase programs as a means of distributing corporate cash flows
REQUIRED:
Explain the
concept of share repurchase and briefly explain its advantages and
disadvantages. (6
marks)
(c)
Extracts of the financing part of the Statement of
Financial Position of Keona Ltd is as follows:
TZS
Common stock
(50,000 shares at TZS.3 par) 150,000
Paid-in capital
in excess of par 250,000
Retained
earnings 450,000
Total stockholders’ equity 850,000
Keona Ltd is
considering to issue an additional 5,000 shares of common stocks as part of its
stock dividend plan. The current market
price of Keona Ltd’s common stock is TZS.20 per share.
REQUIRED:
Show how the
proposed stock dividend would affect Keona’s stockholder’s equity. (6
marks)
(Total : 20 marks)
QUESTION 6
(a)
Explain the concept of overtrading, its causes and key
ratios that signal its presence in a business. (10 marks)
(b)
The Financial Director of MAJEMBE Industries is
reviewing two alternative schemes for building and running new
laboratories. The choice is between a low
cost conventional building and a high tech building. Features of the latter option included:
optimum orientation of the Building structures; less glazing; north facing roof
lights; photo sensitive override controls for the lighting windows; double glazing;
cavit wall installation.
Estimates of the building costs and running costs (in
terms of present day prices) for the estimated 50 years life of the laboratory
are as follows:
|
|
Conventional
|
Hi-tech
|
|
|
(TZS ‘000’)
|
(TZS‘000’)
|
|
Design,
construction and installations
|
14,000
|
16,000
|
|
Annual
running costs:
|
|
|
|
Labour
|
260
|
260
|
|
Energy
|
100
|
50
|
|
Materials
|
10
|
10
|
|
Depreciation
|
280
|
320
|
|
Maintenance
costs:
|
|
|
|
Labour
|
160
|
120
|
|
Material
|
70
|
50
|
|
Demolition
and disposal costs
|
100
|
100
|
REQUIRED:
Assuming a four per cent cost of capital, which alternative is cheaper
for MAJEMBE Industries? (10
marks)
(Total: 20 marks)
________________ p _____________
SUGGESTED SOLUTIONS
BI – FINANCIAL MANAGEMENT
MAY 2017
ANSWER 1
(a)
Reason for
not investing in viable projects
·
Hard capital Rationing
-
Fund limited for reasons outside a company e.g. firm
too risky for investors, high gearing.
·
Soft capital Rationing
-
Funds limited for reasons within a company e.g. (i)
avoid consequences of external financing (ii)
control growth
(b)
(i)
Net present
value
|
|
Year 0 ‘000’
|
Year 1 ‘000’
|
Year 2 ‘000’
|
Year 3 ‘000’
|
Year 4 ‘000’
|
Year 5 ‘000’
|
|
Net cash flows
Residual value
Tax payment
|
(150,000)
-
-
|
57,600
-
(3,015)
|
59,904
-
(7,782)
|
62,300
-
(10,948)
|
64,792
15,000
(8,657)
|
(2,476)
|
|
Net cash flow after tax
Discount factor
|
(150,000)
1.000
|
54,585
0.893
|
52,122
0.797
|
51,352
0.712
|
71,135
0.636
|
(2,476)
0.567
|
|
Present value
|
(150,000)
|
48,744
|
41,541
|
36,563
|
45,242
|
(1,404)
|
Net present Value = Tshs.20, 686,000
(ii)
The Post Tax
Money Cost
The post tax
money cost of capital at which the hotel will be indifferent between
accepting/rejecting the project is where the net present value is equal to zero
i.e. the IRR of the project.
If cash flows
are discounted at 20%
|
|
Year 0 ‘000’
|
Year 1 ‘000’
|
Year 2 ‘000’
|
Year 3 ‘000’
|
Year 4 ‘000’
|
Year 5 ‘000’
|
|
Net cash flows after tax
|
(150,000)
|
54,585
|
52,122
|
51,352
|
71,135
|
(2,476)
|
|
Discount factor
|
1,000
|
0.833
|
0.694
|
0.579
|
0.482
|
0.402
|
|
Present value
|
(150,000)
|
45,469
|
36,173
|
29,732
|
34,287
|
(995)
|
Net present value = (Tshs.5,334,000)
Cost of Capital at which the Hotel would be
indifferent;
IRR
= LR +
L
= 12% NPVLR = 20,686,000
HR
= 20% NPVHR= (5,334,000)
IRR = 12 +
= 18.36%
By interpolation
12% + 8%
(20,686/(20,686 + 5,334)) = 18.36%
ANSWER 2
(a)
The statement is valid, it is precisely impossible to
measure individual attitude.
-
The individual risk differs
-
Market risk
-
Despite of its practicability, it is better to make
subjective estimates and construct imperfect set of visual adjusted discount
rules for case in evaluating assets.
( b) (i) Need to look on abnormal
return between actual return and predicted by the SML
Without
information in risk free and market rate of return it in difficult to tell
which in accurate.
(ii) Jangala
α1
= 19% - [6% +1.5(14% - 6%)]
=
19% - 18%
=
1%
Joseph
α = 16% - [6% +1
(14% - 6%)]
= 16% - 14%
= 2%
Joseph has
higher superior stock.
(c) (i) Return = (1/N)S(N*Ri)=N*0.1/N = 10%
(ii) As N increases
(approaching infinity), (it remain the same) covariance approaches 0.0064 which
is covariance between any pair of the given security.
The covariance of the
returns of the securities is the most important factor to consider when placing
security in a well diversified portfolio.
ANSWER 3
(a)
(i) The
government announces that inflation unexpectedly jumped by 2 per cent last
month.
·
The change in systematic risk has occurred.
·
An increase in inflation rate decreases the real
rate of return, assuming nominal rates remain unchanged.
·
Therefore, market prices in general will most
likely decline. Price of the bank will fall.
(ii) Bank’s earnings report,
just issued, generally fell in line with analysts’ expectations.
·
No change in unsystematic risk (risk factor)
·
The company stock price already reflects the
market valuation of the company’s earnings since it is in line with the
analysts’ expectations.
·
The price of the bank stock will mostly likely
to stay constant.
(iii) The government reports that
economic growth last year was at 3 per cent, which generally agreed with most
economists’ forecasts.
·
No change in systematic risk (risk factor)
·
Market has already priced the stocks in
expectation of economic growth.
·
Therefore, market prices in general will stay
constant and bank stock price will most likely stay constant.
(iv) Parliament approves
changes to the tax code that will increase the top marginal corporate tax
rate. The legislation had been debated
for the previous six months.
·
No change in systematic risk
·
Expectation of tax increase has been priced in
since it has been debated for 6 months.
·
General stock market prices will most likely
stay constant and the bank’s stock price will stay constant too.
(b) (i) What
is the current price of Amazon Co. stock:
The after tax
expected return (R) on Zodiac stock is 400/2000 = 20%
Since all
companies are in the same risk class, Amazon will be priced to yield the same
after-tax expected return.
R = [Dividend
(1 – tax on dividend)+ Capital Gain (1 – tax on capital gain]/Initial Price.
R = [d(1 – td)
+ (P1 – P0)(l – tgl/P0 but tg
= 0
0.2 = [400(1-
0.25) + (2,000 – P0]/ P0
P0= Tsh. 1,916.7
(ii)
If capital gains are also taxed at 25 percent, what is
the price of Amazon Co. stock?
If tax on
capital gain is 25%, the after tax expected return (R) on Zodiac stock is
400(l-0.25)/2000 = 15%
0.15 =
[400(l-0.25) + (2,000- P0)(l-0.25)]/P0
P0 = Tsh.2,000
(iii)
Explain the result you found in part (ii)
When taxes are
the same for both capital gain and dividend, then investors are indifferent of
receiving dividend and capital gain.
Hence the price will be the same.
(c) The net income of Magita Corporation,
which has 10,000 outstanding shares and 100% payout policy, is TZS 32,000. The expected value of the firm one year hence
is TZS. 1,545,600. The appropriate
discount rate for Magita is 12 percent.
(i)
What is the current
value of the firm?
Value = Present
Value of future cashflows
=
Th.32,000 + Tsh. 1,545,600/(1.12)
= Ths.1,412,000
(ii)
What is the ex-dividend price of Magita’s stock if the
board follows its current policy?
Price =
Value/Number of shares outstanding
P= Tsh.141.2
Dividend =
Earnings/number of shares
Dividend =
Tsh.3.2
On the
ex-dividend date, price will fall by an amount of dividend to Tsh. 138.
ANSWER 4
(a)
KOBELO
COMPANY
Establishing
the Appropriate Timing of Equipment Abandonment
Operating
the Equipment for One More Year (to Year 2017)
We
calculate the NPV of the project assuming the operations continue for one more
year and the firm foregoes the net salvage value receivable at the end of year
2016
|
End
of Year
|
2016
(0)
|
2017
(1)
|
2017
|
|
Net Cash Flows (millions of TZS)
Discount Factor (10%)
|
(14)
1
|
10
0.909
|
8
0.909
|
|
Present Value
|
(14)
|
9.09
|
7.272
|
NPV = TZS[9.09 +
7.272]m – TZS14m = TZS2.362m
Operating
the Equipment for Two More Years (to Year 2018)
We calculate the
NPV of the project assuming the operations continue for two more years and the
firm foregoes the net salvage value receivable at the end of year 2016.
|
End of Year
|
2016
(0)
|
2017
(1)
|
2018(2)
|
2018(2)
|
|
Net Cash Flows (millions of TZS)
Discount Factor (10%)
|
(14)
1
|
10
0.909
|
2
0.826
|
1
0.826
|
|
Present Value
|
(14)
|
9.09
|
1.652
|
0.826
|
NPV=
TZS[9.09 + 1.652 + 0.826]m – TZS 14m = -
TZS 2,432
Operating the Equipment for Three
More Years (to Year 2019)
We
calculate the NPV of the project assuming the operations continue for three
more years and the firm foregoes the net salvage value receivable at the end of
year 2016.
|
End of Year
|
2016
(0)
|
2017
(1)
|
2018(2)
|
2019(3)
|
|
Net Cash Flows (millions of TZS)
Discount Factor (10%)
|
(14)
1
|
10
0.909
|
2
0.826
|
1
0.751
|
|
Present Value
|
(14)
|
9.09
|
1.652
|
0.751
|
NPV=
TZS[9.09 + 1.652 + 0.751]m – TZS14m = -TZS2.507m
Comment: the NPV of the equipment if it is to be
operated for one more year is positive.
Thus the equipment should operate for one more year to 2017 and
abandoned.
(b) Nominal
vs. Real Money Terms Approach
A
nominal (money terms) approach to investment appraisal discounts nominal cash
flows with a nominal cost of capital.
Nominal cash flows are found by inflating forecast values from current
price estimates, for example, using specific inflation. Applying specific inflation means that
different project cash flows are inflated by different inflation rates in order
to generate nominal project cash flows.
A real terms approach to investment appraisal discounts real cash flows
with a real cost of capital. Real ash s
flows are found by deflating nominal cash flows by the general rate of
inflation. The real cost of capital is
found by deflating the nominal cost of capital by the general rate of
inflation, using the Fisher equation:
(1+
real discount rate) x (1 + inflation rate) = (1 + nominal discount rate)
The net
present value for an investment project does not depend on whether a nominal
terms approach or a real terms approach is adopted, since nominal cash flows
and the nominal discount rate are both discounted by the general rate of
inflation to give real cash flows and the real discount rate,
respectively. Both approaches give the
same net present value.
(c) Trade Receivables Policy
The factors to be
considered in formulating a trade receivables policy relate to credit analysis,
credit control and receivables collection.
Credit
analysis
In
offering credit, a company must consider that it will be exposed to the risk of
late payment and the risk of bad debts.
To reduce these risks, the company will assess the creditworthiness of its
potential customers. In order to do
this, the company needs information, which can come from a variety of sources,
such as trade references, bank references, credit reference agencies, published
accounts and so on. As a result of
assessing the creditworthiness of customers, a company can decide on the amount
of credit to offer, the credit terms to offer, or whether to offer credit at
all.
Credit control
Having
extended credit to customers, a company needs to consider ways to ensure that
the terms under which credit was granted are followed. It is important that customers settle
outstanding accounts on time and keep to agreed credit limits. Factors to consider here are, therefore, the
number of overdue accounts and the amount of outstanding cash. This information can be provided by an aged
receivables analysis.
Awareness of customers with regard to
their outstanding
Another
factor to consider is that customers need to be made aware of the amounts
outstanding on their accounts and reminded when payment is due. This can be done by providing regular
statements of account and by sending reminder letters when payment is due.
Receivables collection
Cash
received needs to be banked quickly if payment is not made electronically by
credit transfer. Overdue accounts must
be followed up in order to assess the likelihood of payment and to determine
what further action is needed. In the
worst cases, legal steps may need to be taken in order to recover outstanding
amounts. A key factor to consider here
is that the benefit gained from chasing overdue amounts must not exceed the
costs incurred.
ANSWER 5
(a)
(i) Why
retained earnings have an opportunity cost associated:
Retained
earnings belong to the existing common stockholders. If the funds are paid out instead of
reinvested, the stockholders could earn a return on them. Thus, we say retaining funds for reinvestment
carries an opportunity cost.
(ii) Why is the cost of
issuing new common stock higher than the cost of retained earnings:
In issuing
new common stock, we must earn a
slightly higher return than the normal cost of common equity in order to cover
the distribution costs of the new security.
(iii)
Why is the cost of retained earnings the equivalent of
the firm’s own required rate of return on common stock:
- Cost consideration – cost of equity is
higher than the cost of debt.
-
Tax consideration – from debts there is interest tax
benefit.
-
Insufficient of internal finance through retained
earnings are not enough.
-
Legal requirement for the public listed company.
(b)
Share repurchases
A firm
may distribute each to stockholders by repurchasing its own stock rather than
paying out cash dividends. Stock
repurchases can be used (1) somewhat routinely as an alternative to regular
dividends, (2) to dispose of excess (nonrecurring) cash that came from asset
sales or from temporarily high earnings, and (3) in connection with a capital
structure change in which debt is sold and the proceeds are used to buy back
and retire shares.
Advantages of
repurchases:
1.
A repurchase announcement may be viewed as
a positive signal that management believes the shares are undervalued.
2.
Stockholders have a choice – if they want
cash, they can tender their shares, receive the cash, and pay the taxes, or
they can keep their shares and avoid taxes.
On the other hand, one must accept a cash dividend and pay taxes on it.
3.
If the company raises the dividend to
dispose of excess cash, this higher dividend must be maintained to avoid
adverse stock price reactions. A stock
repurchase, on the other hand, does not obligate management to future
repurchases.
4.
Repurchased stock, called treasury stock,
can be used later in mergers, when employees exercise stock options, when
convertible bonds are converted, and when warrants are exercised. Treasury stock can also be resold in the open
market if the firm needs cash.
Repurchases can remove a large block of stock that is “overhanging” the
market and keeping the price per share down.
5.
Repurchases can be varied from year to
year without giving off adverse signals, while dividends may not.
6.
Repurchases can be used to produce
large-scale changes in capital structure.
Disadvantages of repurchases:
1.
A repurchase could lower the stock’s price
if it is taken as a signal that the firm has relatively few good investment
opportunities. On the other hand,
though, a repurchase can signal stockholders that managers are not engaged in
“empire building,” where they invest funds in low-return projects.
2.
If the Tax authority establishes that the
repurchase was primarily to avoid taxes on dividends, then penalties could be
imposed. Such actions have been brought
against closely-held firms, but to our knowledge charges have never been
brought against publicly-held firms.
3.
Selling shareholders may not be fully
informed about the repurchase; hence, they may make an uninformed decision and
may later sue the company. To avoid
this, firms generally announce repurchase programs in advance.
4.
The firm may bid up the stock price
resulting in the firm paying too high a price for the shares. In this situation, the selling shareholders
would gain at the expense of the remaining shareholders. This could occur if a tender offer were made
and the price was set too high, or if the repurchase was made in the open
market and buying pressure drove the price above its equilibrium level.
(c)
Stock dividend
After
the 10% stock dividend, Keona’s stockholder’s equity account is as follows:
Common
stock (55,000 shares at Tsh.3 par) = 165,000
Paid-in capital in excess of par =
335,000
Retained earnings =
350,000
Total stockholders’ equity 850,000
ANSWER 6
(a)
The concept of overtrading:
Overtrading –
is a situation in which a company is growing its sales faster than it can
finance them:
The following
may be the cause of overtrading:
(i)
Depletion of working capital: Depletion of working capital ultimately
results in depletion of cash resources.
Cash resources of the company may get depleted by premature repayment of
long term loans, excessive drawings, dividend payments, purchase of fixed
assets and excessive net trading losses etc.
(ii)
Faulty financial policy: Faulty financial policy can result in
shortage of cash and overtrading in several ways including using working capital
for purchase of fixed assets and attempting to expand the volume of the
business without raising the necessary resources, etc.
(iii)
Over expansion:
In national emergencies like war, natural calamities, etc a firm may be
required to produce goods on a larger scale.
Government may pressurize the manufacturers to increase the volume of
production without providing for adequate finances. Such pressure results in overexpansion of the
business ignoring the elementary rules of sound finance.
(iv)
Inflation and rising prices: Inflation and rising prices make renewals and
replacements of assets costlier. The
wages and material costs also rise. The
manufacturer, therefore needs more money even to maintain the existing level of
activity.
(v)
Excessive taxation:
Heavy taxes result in depletion of cash resources at a scale higher than
what is justified. The cash position is
further strained on account of efforts of the company to maintain reasonable
dividend rates for their shareholders.
(b)
Cash flow Discount
factor Present value
Year
Conventional Hi-Tech Conventional Hi Tech
(Tshs.’000’) (Tshs.’000) @4% (Tshs.’000’) (Tshs.’000’)
0 14,000 16,000 1.000
14,000 16,000
1-50 600 p.a. 490 p.a. 21.482 12,890 10,530
50
100
100
.141
14.1
14.1
Present value of lifetime costs
26,904 26,544
The hi-tech building works out a little cheaper in the long run and
subject to other considerations, should be recommended. (Note that at a discount rate of 6% the
conventional building would be slightly cheaper)
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