Exam 10 May 2016, questions and answers PDF

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©T h eNa t i o n a l Bo a r do f Ac c o u n t a n t sa n dAu d i t o r s , 2 0 1 6

Contents Questions B1

–

Page

Financial Management ………….….…............................... 1

B2

Financial Accounting …….......……................................

–

9 B3

–

Auditing Principles and Practice ………………………..

B4

–

Public Finance and Taxation I ………………………….. 27

B5

–

Performance Management ………………………………….

B6

–

Management, Governance and Ethics …………………. 46

Suggested Answers B1

–

20

35

Page

Financial Management ………….….…............................... 52

B2

–

Financial Accounting …….......……................................ 67

B3

–

Auditing Principles and Practice ………………………..

79

B4

–

Public Finance and Taxation I …………………………..

91

B5

–

Performance Management ………………………………….

103

B6

–

Management, Governance and Ethics ………………….

117

EXAMINATION

:

INTERMEDIATE LEVEL

SUBJECT

:

FINANCIAL MANAGEMENT

CODE

:

B1

EXAMINATION DATE

:

TUESDAY, 3TH MAY 2016

TIME ALLOWED

:

THREE HOURS (2:00 P.M. – 5:00 P.M.)

--------------------------------------------------------------------------------------------------------GENERAL INSTRUCTIONS 1.

There are TWO sections in this paper. Sections A and B which comprise SEVEN 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 7printed pages.

________________________

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

1

--------------------------------------------------------------------------------------------------------SECTION A Compulsory Question --------------------------------------------------------------------------------------------------------QUESTION 1 Explain any three ways in which the management of a corporate firm can be encouraged to achieve the objective of maximization of shareholders’ wealth. (4 marks)

(a)

(b)

Assume that you are working as an assistant investment adviser at Finance 360 Ltd. You have been approached by a client, Mr. Robert Mengison is planning to invest in a portfolio of shares for an investment advice. He has identified two shares with the following details: Share 1 – Mbuni Ltd, a company in the brewing industry whose expected annual returns are as follows: Annual Investment Return 12%

Probability of Occurrence 0.4

24%

0.6

Share 2 – Samaki Limited, a company in the oil and gas extraction industry, whose expected annual returns are as follows: Annual Investment Return 10%

Probability of Occurrence 0.3

20%

0.7

You have calculated the co-efficient of correlation between the two shares which is +0.75. Mr. Mengison plans to invest TZS.600,000,000 in Mbuni Ltd shares and TZS.400,000,000 in Samaki Limited’s shares. The following additional information is also known to you: 

Return on government bonds is 4%



The Return expected from the market is 10% and the risk is 6%

REQUIRED: Prepare a brief note for Mr. Mengison which covers on the following issues to advise him on his proposed investment:

2

(i)

Explanation of the terms portfolio theory, systematic and unsystematic risk. (6 marks)

(ii)

The expected return and risk as measured by standard deviation for each share and the proposed portfolio (8 marks)

(iii)

The Capital Asset Pricing Model(CAPM) on the efficiency of the proposed portfolio considering that its beta(s) is likely to be 0.843. (2 Marks) I n t e r me d i a t eL e v e l , Ma y2 0 1 6

(Total: 20 marks) --------------------------------------------------------------------------------------------------------SECTION B There are SIX questions. Answer ANY FOUR questions --------------------------------------------------------------------------------------------------------QUESTION 2 (a)

Explain any three (3) factors that determine the capital structure of a corporation. (6 marks)

(b)

Kidosho Company is planning to raise TZS 15 million as new finance for a major expansion of existing business and is considering a right issue or an issue of bonds. The corporate objective of Kidosho Company, as stated in its Annual Report, is to maximize the wealth of its shareholders and to achieve continuous growth in earnings per share. Recent financial information of Kidosho Company is as follows: Turnover (TZS million) Profit before interest and tax (TZS million) Earnings (TZS million) Dividends (TZS million) Ordinary shares (TZS million) Reserves (TZS million) 8% Bonds, redeemable 2022 (TZS million) Share price (TZS)

2012 2013 16.8 19.1 6.8 7.5 3.6 4.1 1.6 1.6 5.5 5.5 5.1 7.6 20 20 2.67 3.35

2014 2015 24 28 8.5 9.8 4.7 5.5 1.9 2.2 5.5 5.5 10.4 13.7 20 20 5.74 8.64

The par value of the shares of Kidosho Company is TZS 1 per share. The general level of inflation is on average 4% per year in the period under consideration. The bonds of Kidosho Company are currently trading at their par value of TZS 100. The following values for the business sector of Kidosho Company are available:     

Average return on capital employed Average return on shareholders’ funds Average interest coverage ratio Average debt/equity ratio (market value basis) Equity Return predicted by the capital asset pricing model

25% 20% 20 times 50% 14%

REQUIRED: (i)

Evaluate the financial performance of Kidosho Company.

(ii)

Analyze and discuss the extent to which the company has achieved its stated corporate objectives of maximizing the wealth of its shareholders and achieving continuous growth in earnings per share. (6 marks)

(iii)

If the new finance is raised using a right issue priced at TZS.7.50 per share and the expansion has not yet started, calculate and comment on the effect of the right issue on the share price, the earning per share and the debt equity ratio. (8 marks)

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

3

(Total: 20 marks) QUESTION 3 (a)

IDOFE Company Ltd is a company listed on a major stock exchange. The company has struggled to maintain profitability in the last two years due to poor economic conditions in its home country and as a consequence it has decided not to pay a dividend in the current year. However, there are clear signs of economic recovery and IDOFE Company Ltd is optimistic that payment of dividends can be resumed in the future. Forecast financial information relating to the company is as follows: Year Earnings (TZS) Dividends (TZS)

1 2 300,000,000 360,000,000 NIL 50,00,000

3 430,000,000 100,000,000

The company is optimistic that earnings and dividends will increase after Year 3 at a constant annual rate of 3% per year. IDOFE Company Ltd currently has a before-tax cost of debt of 5% per year and an equity beta    of 1.6. On a market value basis, the company is currently being financed 75% by equity and 25% by debt. During the course of the last two years the company acted to reduce its gearing and was able to redeem a large amount of debt. Since there are now clear signs of economic recovery, IDOFE Company Ltd plans to raise further debt in order to modernize some of its non-current assets and to support the expected growth in business. This additional debt would mean that the capital structure of the company would change and it would be financed 60% by equity and 40% by debt on a market value basis. The before-tax cost of debt of IDOFE Company Ltd would increase to 6% per year and the equity beta(s) would increase to 2.0. The risk-free rate of return is 4% per year and the equity risk premium is 5% per year. In order to stimulate economic activity the government has reduced profit tax rate for all large companies to 20% per year. The current average price-earnings ratio of listed companies similar to IDOFE Company Ltd is 5 times. REQUIRED:

4

(i)

Estimate the value of IDOFE Company Ltd using the price-earnings ratio method and discuss the usefulness of the variables that you have used. (4 marks)

(ii)

Calculate the correct cost of equity of IDOFE Company Ltd and, using this value, calculate the value of the company using the dividend valuation model. (6 marks)

(iii)

Calculate the current weighted average after-tax cost of capital of IDOFE Company Ltd and the weighted average after-tax cost of capital following the new debt issue. Comment on the difference between the two values. (5 marks) I n t e r me d i a t eL e v e l , Ma y2 0 1 6

(b)

Identify the objectives of working capital management and discuss the central role of working capital management in financial management. (5 marks) (Total: 20 marks)

QUESTION 4 (a)

AGC Company’s capital structure on 31st December 2015, was as follows: Common stock (TZS 1 per, 100,000,000 shares) Paid-in capital on common stock Retained earnings Total stockholders’ equity

TZS 100,000,000 20,000,000 680,000,000 800,000,000

The company’s net income for 2015 was TZS.150,000,000. It paid out 40% of the earnings in dividends. The stock was selling at TZS.6 per share on December 31. REQUIRED: Assuming the company declared a 5% stock dividend on 31 st December 2015. What is the reformulated capital structure on 31st December 2015? (8 marks) (b)

XYZ Corporation has a policy of paying out 70% of its earnings dividends. REQUIRED: Evaluate this policy, assuming most stockholders are:

(c)

(i)

Senior citizens (old people) in low tax brackets.

(2 marks)

(ii)

High network individual in high tax brackets.

(2 marks)

Examine any four factors which determine a company’s dividend policy. (8 marks) (Total :20 marks)

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

5

QUESTION 5 (a)

The net working capital of a business is related to the concepts are of overtrading and undertrading. Explain the meaning of ‘undertrading’ and ‘overtrading’ and briefly discuss the major causes of each. (6 marks)

(b)

Carter Corporation’s sales are expected to increase from TZS.50 million in 2015 to TZS.60 million in 2016. Its assets totalled TZS.30 million at the end of 2015. Carter is operating at full capacity, so its assets must grow in proportion to projected sales. At the end of 2015, current liabilities were TZS.10 million, consisting of TZS.2,500,000 of accounts payable, TZS.5,000,000 of notes payable, and TZS.2,500,000 of accrued liabilities. The after-tax profit margin is forecasted to be 5%, and the forecasted earnings retention ratio is 30 percent. REQUIRED:

(c)

(i)

Calculate Carter’s additional funds needed for the year 2016.

(4 marks)

(ii)

Calculate the value of assets for the year 2016.

(1 mark)

(iii)

If the additional funds are to be raised through notes payable, what would be the amount of notes payable at the end of year 2016? (3 marks)

Assume that the cost of a four year university first degree education will be TZS.2,500,000 per year when your child enters university 10 years from now. REQUIRED:

6

(i)

If you presently have TZS.1,250,000 to invest, what rate of interest must your investment earn to pay the cost of the four year university education for your child? Assume that the entire cost of the four year university education must be paid when your child matriculates (at the start of the first year of study). (3 marks)

(ii)

Suppose in order to accumulate the sum required under (i) above you have planned to make equal payments at the end of every year into an account that pays a stated annual interest rate of 7%. What should be your annual payments? (3 marks) (Total : 20 marks)

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

QUESTION 6 (a)

The FOXITY Company purchased a special machine one year ago at a cost of TZS.12 million. At that time the machine was estimated to have a useful life of 6 years and no salvage value. The annual cash operating cost is approximately TZS.20 million. The FOXITY COMPANY is planning to replace the old machine with a new machine which has just come in the market and will do the same job but with an annual cash operating cost of only TZS.17 million. This new machine costs TZS.21 million and has an estimated life of 5 year with zero salvage value. The old machine can be sold for TZS.10 million. Straightline depreciation is used, and the company’s income tax rate is 40%. Assume a cost of capital of 8% after taxes. REQUIRED: Calculate: (i)

The cost of initial investment of the new machine

(ii)

The incremental cash inflow after taxes

(iii)

The Net Present Value (NPV) of the new investment; and

(iv)

The Internal Rate of Return (IRR) of the new investment. (8 marks)

(b)

Zahra Entertainment Company has developed a new type of digital recorder. If the firm directly goes to the market with the product, there is only a 50% chance of success. On the other hand, if the firm conducts test marketing of the recorder, it will take a year and will cost TZS.4 million. Through the test marketing, however, the firm is able to improve the product and increase the probability of success to 75%. If the new product proves successful, the present value of the payoff (at the time when the firm starts selling it) is TZS.40 million, while if it turns out to be a failure, the present value of the payoff is TZS.10 million. REQUIRED: If the discount rate is 15% should the firm conduct the test marketing or go directly to the market? (4 marks)

(c)

Discuss any FOUR ways of incorporating risk into the investment appraisal process. (8 marks) (Total: 20 marks)

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

7

QUESTION 7 (a)

Identify the problems faced when undertaking investment appraisal and explain how these problems can be overcome in the following areas: (i)

Assets with replacement cycles of different lengths;

(ii)

An investment project that has several internal rates of return;

(iii) (b)

(c)

The business risk of an investment project is significantly different from the business risk of current operations. (6 marks) Explain the effect of leverage on the value of the firm:

(i)

In a perfect market without taxes and financial distress.

(2 marks)

(ii)

In a world with taxes and financial distress.

(4 marks)

MATEM LTD a successful United Kingdom (UK) –based Multi National Corporation (MNC), is considering to raise funds for a project in Tanzania during the next year. The UK risk-free rate is 6% while the Tanzania risk-free rate is 10%. Risk premia on pound denominated debt provided by UK creditors and on Tanzanian shilling denominated debt provided by Tanzanian creditors are 3% and 5% respectively. Beta    of the project (i.e. the expected sensitivity of project returns) to UK investors in response to the UK market is 1.5 while the expected UK market return is 14%. Further the corporate tax rates are 30% in both UK and Tanzania. Debt providers are unlikely to allow more than 50% of the financing to be in the form of debt. REQUIRED: Establish the best option for the company to raise finance. Compute the resulting average cost of capital. (8 marks) (Total: 20 marks) ________________  _____________

8

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

EXAMINATION

:

INTERMEDIATE LEVEL

SUBJECT

:

FINANCIAL ACCOUNTING000000

CODE

:

B2

EXAMINATION DATE :

WEDNESDAY, 4TH MAY, 2016

TIME ALLOWED

THREE HOURS (2:00 P.M. – 5:00 P.M.)

:

--------------------------------------------------------------------------------------------------------GENERAL INSTRUCTIONS 1.

There are TWO sections in this paper. Sections A and B which comprise of SEVEN 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 where necessary.

7.

Show clearly all your workings in respective answers where applicable.

8.

This question paper comprises 10 printed pages.

_________________

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

9

--------------------------------------------------------------------------------------------------------SECTION A Compulsory Question --------------------------------------------------------------------------------------------------------QUESTION 1 The group accounts of Swan have already been prepared with the exception of consolidating the parent’s interest in the new joint venture of Gabo. Gabo was incorporated three months ago by Swan and another company each of whom contributed cash of TZS.500 million in return for being issued with 50% of the share capital of Gabo. Swan wishes to consolidate the financial statements of Gabo using proportionate consolidation on a line by line basis. Financial statements of the Swan group and Gabo are as follows: Statements of Financial Position Swan TZS. million Non-current assets Goodwill Tangible Investment in Gabo Current assets Inventory Receivables Cash at bank Total Assets: Equity Share capital (TZS.1 per share) Share premium Accumulated profits Non-controlling interest Liabilities: Non-current liabilities Current liabilities Total Equity and Liabilities

10

Gabo TZS. million

8,000 12,000 500

Nil 800 Nil

6,000 8,400 12,500 47,400

250 110 130 1,290

5,000 5,000 19,400 8,000

1,000 Nil 190 Nil

4,000 6,000 47,400

60 40 1,290

I n t e r me d i a t eL e v e l , Ma y2 0 1 6

Statement of Profit or Loss & Other Comprehensive Income SWAN GABO TZS Million TZS Million Revenue 100,000 900 Cost of sales (55,000) (250) Gross profit: 45,000 650 Operating costs (20,000) (300) Profit befo...