Question

a)         Ngomongo Holdings Limited has investment interests in three companies. Kirinyaga Video Limited (KVL), Kilgoris Hauliers Limited (KHL) and Turkana Limited (TFL). The following financial data relate to these companies:

As at 31^st December 2013, the financial statements of two of the companies revealed the following information:

Company	Price of share	Earnings per share Kshs.	Dividends per share Kshs.
Kirinyaga Video Ltd	160	8	8
Kilgoris Hauliers(KHL)	270	18	9

Earnings and dividends information for Turkana Fisheries Ltd (TFL) for the past five years is given below:

Year ended 31st December	2009 Kshs.	2010 Kshs.	2011 Kshs.	2012 Kshs.	2013 Kshs.
Earnings per share	5.0	6.0	10.0	7.0	12.0
Dividend per share	3.0	3.0	5.0	3.5	5.5

The estimated return on equity before tax required by investors in Turkana Fisheries Ltd’s shares is 20%.

Required:

For Kirinyaga Video Ltd (KVL) and Kilgoris Hauliers Ltd (KHL) determine and compare:

Dividends yields.                                                                  

Price/earnings ratio                                                                

Dividends covers                                                                   

Using the dividends growth model, determine the market value of 1,000 shares held in Turkana Fisheries Ltd (TFL) as at 31^st December 2001.                                                                                                                            

b)         Distinguish between financial risk and operating risk.                                  

c)         Define the following term as used in financial management:                         (10 Mark)

Financial distress

Moral hazard

Adverse selection

Bonus issue

Stock split

Answer 1

Using the dividends growth model, determine the market value of 1,000 shares held in Turkana Fisheries Ltd (TFL) as at 31st December 2001- Wrong Question.

Operating Risk	Financial Risk
The risk of insufficient profit, to meet out the expenses is known as Operating Risk.	Financial Risk is the risk arising due to the use of debt financing in the capital structure.
Variability is EBIT	Leverage Multiplier and Debt to asset ratio.
The risk cannot be minimized.	If the firm does not use debt funds, there will be no risk.
Compliance risk, operational risk, reputation risk, financial risk, strategic risk etc.	Credit risk, Market risk, Liquidity risk, exchange rate risk, etc.
Disclosed by difference in net operating income and net cash flows.	Disclosed by difference in the return of equity shareholders.
Connected with economic Environment	Use of debt capital

Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy.

Moral hazard is the risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity. In addition, moral hazard may also mean a party has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.

Adverse selection is a term commonly used in economics, insurance, and risk management that describes a situation where market participation is affected by asymmetric information.

A bonus issue, also known as a scrip issue or a capitalization issue, is an offer of free additional shares to existing shareholders. A company may decide to distribute further shares as an alternative to increasing the dividend payout.

A stock split or stock divide increases the number of shares in a company. The price is adjusted such that the before and after market capitalization of the company remains the same and dilution does not occur.