Q1. a) Explain three disadvantages of accounting Rat of return (ARR) method in evaluating investment decisions [6mks] b) A firm is considering the following two mutual exclusive investments. Projects Yr 0 Yr 1 Yr 2 Yr 3 A -25000 15000 15000 25640 B -28000 12692 12672 12672 The cost of capital is 12% Required: i. Calculate the NPV for each project [7mks] ii. Calculate the IRR for each project [10mks] iii. Which project should be undertaken? Why? [2mks] Q2. a) Discuss the mechanisms of resolving the agency conflict between shareholders and creditors. [10mks] b) You just purchased a bond that matures in 5 years. The bond has a face value of Ksh. 50,000 and has 8% annual coupon. The required rate of return is 6%. Required: Estimate the current value of the bond [10mks] c) State 3 typesof bonds [5mks] Q3. a) Suppose you want to retire forty years from today. You determine that you need sh 50000 per year once you retire, with the first retirement funds withdrawn one year from the day you retire. You estimate you will earn 6% per year on your retirement funds and that you will need funds up to and including your 25th birthday after retirement. Required How much must you deposit in an account today so that you have enough funds for the retirement. [10mks] b) A customer has been ordering 5000 units at the rate of 1000 units per order during last year. The production cost is in sh 12 per unit. It costs sh 1500 to set up one run of 1000 units and inventory carrying cost is 20% of the production cost since the customer may buy at least 5000 units this year, the company would like to avoid making five different production runs. Required: Determine the most economic production run [15mks] Q4. a) The key company has the following capital structure 14% loan 300,000 11% preference share capital 100,000 Equity 1,600,000 2,000,000 The company’s share has a current market price of Sh.24 per share. The expected dividend per share next year is sh.2 , the dividend are expected to grow at 3% annually for the forever. Tax rate is 30%. Required: Calculate the weighted average cost of capital [19mks] b) State and explain briefly any two measures of risk [6mks]

1. a)What is the term structure of the interest rates (10 marks)
b) Describe three theories that explain the term structure of interest rates. (15 marks)

2. a)What factors cause the demand and supply of loanable funds to shift. (13 marks)
b) What role does interest rate play in the economic development of a country. (12 marks)

3. i) A bond you are evaluating has a 10% coupon rate, a face value of kshs 1000, and is 10 years from maturity.

a) If the required rate of return on the bond is 10% what is its fair present value? (6 marks)
b) If the required rate of return on the bond is 12%, what is its fair present value? (4 marks)
”c) What does your answer-to part-a) and b) say about the relation ”between required rates of return and fair values of the bond? (4 marks)
ii) How are financial intermediaries able to engage in maturity transformation? (11 marks)

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