Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

Summarised below are financial data in respect of Kevinko Ltd:


As a result of recent capital expansion, market analysts expect pre-tax earnings to increase at the rate of 25% for the next two years before reverting to the company‟s existing growth rate.

The company‟s overall beta is 0.763 while the beta for debt is 0.20. The risk free rate is 12% and the market return is 17%. Currently, the shares of the company are selling at Sh.21.70 on the stock exchange cum 1996 dividend. The debentures are selling at Sh.89.50 ex-interest.
The corporate tax is 35%.

Required:
a) Using the dividend growth model, estimate what a fundamental analyst might consider to be the
intrinsic value of Kevinko‟s shares. Comment on this value.

b) If interest rates were to go 5% what would be the effect of this increase on the company‟s share
price?

c) What is the difference between fundamental analysis and a chartist‟s analysis in the valuation of
shares?
answer

c) Fundamental analysis:

• This view of valuation states that the real or intrinsic value of a security is equal to the total P.V of all expected cash flows (dividends or interest) from the security. However, this is influenced some fundamentals about the company such as:
• Capital structure and level of gearing
• P/E ratio
• Dividend policy and stability of DPS
• Earnings power and volatility of Eps
• Economic conditions
• Past performance of the firm
• Recent ratio analysis
• Political stability in the country

Chartist (also called technical) analysis involves the use of historical or past price pattern to predict the future price pattern. The believe is that “History shall repeat itself”.

Chartists use graphs, and charts as their main tools of analysis. They have identified 3 types of price trends or patterns.

Primary trend – for price pattern observed over a long period of time e.g on yearly basis Secondary also called seasonal trend is related to monthly price trends
Tertiary – for price pattern observed over a very short period of time e.g on weekly or daily basis.

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