Juma Company Ltd. Which is effectively controlled by the Juma family although they own only a minority of shares, is to undertake a substantial new project which requires external finance of about Sh.400 million, leading to a 40% increase in gross assets. The project is to develop and market a new product and is fairly risky. About 70% of the funds required will be spent on land and buildings. The resale value of the land and buildings is expected to remain equal to or greater than, the initial purchase price. Expenditure during the development period of the first 4 to 7 years will be financed from other revenue of Juma Company Ltd. This will have a consequent strain on the company's overall liquidity.
If, after the development stage, the project proves unsuccessful, then the project will be terminated and its assets sold. If, as is likely, the development is successful, the project's assets will be utilized in production and the company's profits will rise considerably. However, if the project proves to be very successful, then additional finance may be required to further expand the production facilities.
At present, Juma Company Ltd. Is all equity financed.
The financial manager is uncertain whether he should seek funds from a financial institution in the form of an equity interest, a loan (long or short term) r convertible debentures.
Required:
(a) Describe the major factors to be considered by Juma Company Ltd. In deciding on the method of financing the proposed expansion project.
(b) Briefly discuss the suitability of equity, loans and convertible debentures for the purpose of financing the project from the point of view of:
(i) Juma Company Ltd.
(ii) The provider of finance.
Clearly state and justify the type of finance recommended for Juma Company Ltd.
(c) Kengar Sugar Company Ltd. Has been enjoying a substantial net cash inflow. Before the surplus funds are needed to meet tax and dividend payments, and to finance further capital expenditure in several months' time, they are invested in a small portfolio of short-term equity investments.
Details of the portfolio, which consist of shares of four companies listed on the stock exchange are as follows:
|
Company
|
Number of shares
|
Beta equity coefficient
|
Market price per share
Sh.
|
Latest dividend yield
%
|
Expected return on equity in the next year
%
|
|
A Ltd
B Ltd
C Ltd
D Ltd
|
60,000
80,000
100,000
125,000
|
1.16
1.28
0.90
1.50
|
42.90
29.20
21.70
31.40
|
6.1
3.4
5.7
3.3
|
19.5
24.0
17.5
23.0
|
The current market return is 19% a year and treasury bill yield is 11% a year.
Required:
On the basis of the data given above, calculate the risk of Kengar Sugar Company Ltd.'s short-term investment portfolio relative to that of the market.