STRATHMORE INSTITUTE OF MATHEMATICAL SCIENCES

BBS ACTUARIAL SCIENCE

END OF SEMESTER EXAMINATION
BSA 2103: FINANCIAL STATEMENT ANALYSIS AND VALUATION IN ACTUARIAL
SCIENCE

DATE: 4 August 2020 Time: 2 Hours 30 mins

Instructions
1. This examination consists of FIVE questions.
2. Answer Question ONE (COMPULSORY) and any other TWO questions.

Question One
a) What is meant by ratio analysis? State two consideration the financial analysts
should consider before carrying out the ratio analysis. Explain two limitations of
ratios. (8 marks)
b) Common size and trend statements provide a convenient way to organize the
financial statement information. Briefly explain the benefits of using the common
size and trend statements in financial analysis. (6 marks)
c) Duke Limited, is a public company quoted on the Nairobi Securities Exchange
(NSE) that would like to acquire (100% of) a suitable private company. It has
obtained the following draft financial statements for one of the companies, Salama
Limited.
Salama Limited
Statement of comprehensive income for the years ended 31 st December
2019 2020
KShs’000 KShs’000
Turnover 1,824,410 2,272,986
Costs of sales (1,123,796) (1,049,322)
Gross profit 700,614 1,223,664
Expenses
Administration and establishment (222,660) (274,097)
Selling
expensesand distribution expenses (11,584) (10,782)
Other charges and expenses (88,043) (122,827)
Profit / (loss) from operations 378,327 815,958
Finance costs (interest) (7,483) (60,481)
Profit / (loss) before tax 370,844 755,477
Taxation (charge) / credit 29,971 (381,202)
 Profit / (loss) after tax 400,815 374,275
Salama Limited
Statement of financial position as at 31st December
Assets 2019 2020
Non-current assets KShs’000 KShs’000
Property, plant and equipment 1,176,980 2,429,918
Current assets
Inventories 96,575 173,171
Trade and other receivables 173,163 184,480
Taxation recoverable 12,309 15,136
Cash and bank balances 30,263 283,086
312,310 655,873
Total assets 1,489,290 3,085,791
Shareholders’ funds and liabilities
Capital and reserves
Share capital 228,055 250,548
Reserves 789,339 1,577,216
Non-current liabilities 1,017,394 1,827,764
Deferred tax 130,583 296,429
Bank loan 7,784 4,550
Post-employment benefits 23,281 11,206
Notes in issue - 600,000
Current liabilities 161,648 912,185
Short term portion of post-employment 2,100 1,500
Trade and other payables
benefits 308,148 344,342
310,248 345,842
Total shareholders’ funds and liabilities 1,489,290 3,085,791

Additional information:
Salama Limited has 400,000 ordinary shares outstanding and it operates on a 365
calendar-year. Assume all sales are made on credit.
Required:
a) From the information provided, compute the following ratios for Salama
Limited for the years ended 31st December 2019 and 2020.
i) Return on capital employed (2 marks)
ii) Asset turnover (2 marks)
iii) Inventory conversion period (2 marks)
iv) Accounts receivable collection period (2 marks)
v) Current ratio (2 marks)
b) Based on the ratios you have computed in (b) above, assess the relative
performance and financial position of Salama Limited for the two years
ended 31st December 2019 and 2020 to inform the directors of Duke
Limited in their acquisition decision. (6 marks)
(Total: 30 marks)
Question Two
a) One metric of particular importance to an equity investor is earnings per share
(EPS). EPS is an input into ratios such as the price/earnings ratio. Better still
presentation of EPS enables each shareholder to compute his or her share of the
company’s earnings.
Required:
Discuss the importance of EPS to both the current and potential
investors citing relevant examples. (6 marks)

b) Natto Limited is a company which deals with the manufacture of polythene papers.
As a result of a new legislation banning the use of polythene papers in country K
in 2019, Natto Limited has been experiencing cash flow problems since then. The
information provided below shows the performance of various subsidiaries of the
company for the year ended 30 June 2020:
Natto Limited
Company Working Retained EBIT Market value Liabilities Sales Total
Capital Earnings of equity Assets

Shs'000' Shs'000' Shs'000' Shs'000' Shs'000' Shs'000' Shs'000'

A Ltd 8,000 72,000 90,000 40,000 100,000 240,000 250,000

B Ltd 6,000 36,000 20,000 6,000 12,000 140,000 120,000

C Ltd 12,000 34,000 18,000 62,000 680,000 1,000,000 1,200,000

D Ltd 50,000 240,000 380,000 180,000 800,000 1,800,000 2,400,000

Required:
i) The Altman’s Z Score for each subsidiary company and a comment on
each of the results obtained (8 marks)
ii) It has been suggested that other ratios ought to be incorporated into
the Altman’s bankruptcy prediction model. What is your opinion on this?
(6 marks)
(Total: 20 marks)

Question Three
a) Financial ratios can help a firm identify its strategic and competitive capabilities and
adjust accordingly. Giving a relevant example, analyze the relevance of this
proposition. (8 marks)

b) An analyst has gathered data from two companies in the same industry, Alpha and
Beta Limited.
Alpha Limited Beta Limited
(Shs ‘millions) (Shs ‘millions)
Revenues 500 900
 Operating income 35 100
Interest expense 5 0
Income before taxes 30 100
Taxes 10 40
Net income 20 60
Total assets 250 300
Total debt 100 50
Owner’s equity (book 150 250
Required:
value)
Calculate the return on equity, (ROE) for both companies and explain the
critical factors that can lead to a higher ROE. (12 marks)
(Total: 20 marks)

Question Four
Mary is a financial analyst who is preparing to forecast cash flow for Parma limited as an
input into her valuation model. She asked you to evaluate the historical cash flow
statement of Parma limited which is presented here below. Parma limited presents its
financial statement in conformity with IFRSs.
PARMA GROUP
STATEMENT OF CASHFLOWS
FOR THE YEAR ENDED 31ST DECEMBER
2020 2019
Shs 'm' Shs 'm' Shs 'm' Shs 'm'
Cash flows from operating activities
Profit before tax 178 142
Adjustment:
Profit from associates (4) (6)
Finance cost 6 7
Depreciation 64 53
Impairment on goodwill 4 3
Amortization of patents 3 3
Amortization of trade licenses 23 18
Loss on disposal of PPE 10 9
106 106 87 87
284 230
Changes in working capital
Increase/decrease in inventory (96) 123
Increase in receivables (62) (65)
Decrease/Increase in payables 45 (158)
(113) (113) (100) (100)
171 130
Interest paid (4) (6)
Taxation paid (26) (42)
 Cash flows from operating activities 141 82
Cash flows from investing activities
Acquisition of PPE (50) (95)
Acquisition of available for sale financial assets (5) (14)
Acquisition of trade licenses (100) -
Disposal of PPE 4 15
Disposal of FV through p/l a/c 5 -
Dividends from associates 1 4
Cash flows used in investing activities (145) (145) (90) (90)
Cash flows from financing activities
Issue of shares 90 45
Issue of debentures 40 20
Redemption of bank loan (8) 25
Dividends paid: H ltd (80) (60)
: N.C.I. (1) (5)
Cash flows from financing activities 41 41 25 25
Cash and Cash equivalent during the year 37 17
Cash and Cash equivalent bal b/f (23) (40)
Cash and Cash equivalent bal c/f 14 (23)
Required:
a) What are the major sources of cash for Parma limited? (4 marks)
b) What is the relationship between the net profit before tax and cash flow
from operating activities? (6 marks)
c) Is the cash flow from operating activities sufficient to cover capital
expenditures? (2 marks)
d) Evaluate the liquidity position of Parma limited and in particular the
going concern of the entity. (8 marks)
(Total: 20 marks)

Question Five
a) Explain what is meant by the term ‘Earnings management’ (2 marks)
b) Recording the substance of transactions, rather than their legal form, is an important
principle in financial accounting. Abuse of this principle can lead to profit manipulation;
non-recognition of assets and substantial debt not being recorded on the balance
sheet.
Required:
Describe how the use of off-balance sheet financing can mislead users of
financial statements (your answer should lay emphasis on earnings
management). (6 marks)
c) According to IASs 33 (Earnings Per Share), explain why the diluted earnings per share
is more suitable for valuation purposes than the basic EPS. (4 marks)
d) Malcolm Ltd reported Sh. 100,000 in net income for 2004 on weighted average
common shares outstanding of 12,500. Malcolm Ltd has Sh. 400,000 face value of
convertible bonds outstanding with an annual coupon rate of 6%. The bonds were
issued on April,1, 2004 and can be converted into common shares at a conversion
ratio of 20 shares per 1,000 of face value. Malcolm Ltd has also had 5,000 outstanding
warrants with an exercise price of Sh. 40 that were issued on December 31, 2003.
The average share price during the year was Sh. 45, and the marginal tax rate is 35%.
Required: Compute the basic and the diluted earnings per share. (8 marks)
(Total: 20 marks)