Financial management revision question and answer

(a) Ujuzi Limited wishes to raise finance to cater for the purchase of new fixed assets, as its sales level has greatly increased in the recent years, and the demand for its products is expected to increase for the foreseeable future. The company has 900,000 outstanding shares which are currently trading in the stock exchange at Sh.130 a share. The finance manager estimates that the fixed assets will cost Sh.22,500,000 and he has convinced the board of directors to raise the money through a rights issue. The board has set the subscription price at Sh.75 per share.

Required:
(i) The number of rights required to purchase a new share. (2 marks)
(ii) The price of one share after the rights issue. (2 marks)
(iii) The theoretical value of the rights if the shares are sold ex-right. (2 marks)
(iv) The effect on a shareholder‟s wealth if he decides neither to exercise nor sell
the right. (2 marks)

(b) PKG Ltd. maintains a minimum cash balance of Sh.500,000. The deviation of the company‟s daily cash changes is Sh.200,000. The annual interest rate is 14%. The transaction cost of buying or selling securities is Sh.150 per transaction.

Required:
Using the Miller-Orr cash management model, determine the following:
(i) Upper cash limit
(ii) Average cash balance
(iii) The return point.

(c) Explain briefly the meaning of the term “overtrading”.
ANSWER


(c) – “Overtrading” refers to an attempt the firm to achieve too much sales volume too quickly without adequate capital to support the increase in sales
– The symptoms of overtrading are.
– rapid increase in short term financing to finance sales
– high current liabilities and low liquidity ratios
– rapid increase in sales volume over the year
– increase in the gearing of the firm as equity capital remain constant.

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