1) Pazuri Ltd. is considering raising KSH 2 billion through a rights issue. Outline the advantages of raising finance through a rights issue as opposed to a public issue
- Shareholder preference and control: raising funds through rights issues avoids dilution of control and provides loyalty rewards through discounted shares.
- Cost-effectiveness: as opposed to a public issue, rights issue lowers costs and reduces administrative burden.
- Speed and efficiency: raising finance through rights issue is quicker and simple compared to a public issue
- Pricing efficiency: Rights issue is issued through discounted pricing and ensures price stability – there is less price volatility compared to public issue.
- Market confidence: rights issue shows signs of market confidence on the company and enhances stability of the firm.
- Flexibility: funds used through rights issue can be used for various purposes as opposed to a rights issue.
2) Outline three costs that are associated with the management of trade credit given
- Administrative costs: including expenses related to maintenance of trade credit. They include office supplies and overheads, technology, and personnel expenses.
- Financing costs: this is the cost of acquiring credit, including interest or cost of capital, opportunity cost, and cash flow payments.
- Bad debt costs: these are costs incurred as a result of customers failing to honor their invoices.
3) Explain how the following items could be used to maximize the profits of a company:
- Bank overdraft
- Taxation
Bank overdraft enables the company to maximize profits by there is sufficient cash flow and for continuity of business operations, hence covering short term liquidity shortages and meeting short term financial obligations. It also enables the company to take advantage of emerging business opportunities such as bulk buying to enjoy discounts or invest in projects with high returns.
On the other hand, taxation can be used by a company to maximize profits by utilizing tax relief, tax deductions, and deferred tax liabilities. The firm can use available tax reliefs to increase their profits or reduce costs.
4) State three reasons why money has time value
The time value of money reflects the idea that money loses value over time. What a given amount of money is worth today is not the same as what it will be worth in the future. Money has time value because:
- An investor loses out potential benefits when choosing to hold money. Money has investment potential; it can be invested in bonds, stocks and savings to earn interest, capital gains or dividends.
- Inflation erodes the value of money. Inflation reducing the purchasing power of money over time, meaning that money loses its value due to inflation.
- Rising risks and uncertainties: since the future is uncertain, money expected in the future may not be received. Default risks and market economic risks reduces the value of future earnings.
5) Explain the following terms as used at the stock exchange:
- Cum-right
- Ex-right
The term cum right means “with rights”, which means that shareholders have a right to subscribe to rights issue offered by a company at the stock exchange. Owners of cum rights shares have access or are entitled to declared rights. The price of rights issue is lower than the market value of shares, and those who have cum rights can enjoy such discounts.
Ex-rights means “without rights”, which means that shareholders who have ex-rights do not enjoy rights. Owners of ex-right shares are not entitled automatically to rights issue, and they may not enjoy the discounts that cum-right owners enjoy through reduced issue prices.
6) State three merits of investing in government bonds
investors can enjoy numerous benefits or merits for investing in government bonds. Some of the merits associated with government bonds are:
- Safety and security: government bonds are safe and secure due to the creditworthiness and low default risk of government
- Government bods also provide an avenue for stable and predictable stream of income – offer fixed payments or interest at regular intervals such as annually or semi-annually.
- Liquidity: government bonds are highly liquid and have an active secondary market where investors can easily buy and sell their government bonds. They can be easily converted into cash.
