Question two

CENTRAL DEPOSITORY SYSTEM (C.D.S)

Its a computerized ledger system that enables the holding or transfer of securities
without the need for physical movement. The ownership of security or shares is
through a book entry instead of physical exchange CDS is for security what a bank
is for cash transfer between banks.
Advantages of CDS
1. It shortens the registration process in the stock exchange i.e. high speed of
registering shareholders. 2. It improves the liquidity of stock exchange than
increase the turnover of the equity shares in the market.
3. It will lower the clearing and settlement cost e.g. no need to prepare share
certificates and seal them (putting a seal).
4. Its faster and less risky settlement of securities which make the market more
attractive for investors e.g. instances of fraud will be reduced since there is no
physical share certificate which may be forged.
5. There will be improved and timely communication between company and the
investors hence reduced delay in receiving dividends and right issues and improve
information dissemination concerning a company.
6. It will lead to an efficient and transparent securities market to adhere to
International Standards for the benefit of all stakeholders.
b) In computation of the weights or proportions of various capital components, the
following values may be used:
Market values
Book values
Replacement values
Intrinsic values
Market Value This involves determining the weights or proportions using the
current market values of the various capital components. The problems with the
use of market values are:
The market value of each security keep on changing on daily basis thus market
values can be computed only at one point in time.
The market value of each security may be incorrect due to cases of over or under
valuation in the market.

Book values This involves the use of the par value of capital as shown in the
balance sheet. The main problem with book values is that they are historical/past
values indicating the value of a security when it was originally sold in the market for
the first time.
Replacement values This involves determining the weights or proportions on the
basis of amount that can be paid to replace the existing assets. The problem with
replacement values is that assets can never be replaced at ago and replacement
values may not be objectively determined.
Intrinsic values In this case the weights are determine on the basis of the
real/intrinsic value of a given security. Intrinsic values may not be accurate since
they are computed using historical/past information and are usually estimates.
e) Weaknesses of WACC as a discounting rate
WACC/Overall cost of capital has the following problems as a discounting rate:
(a) it can only be used as a discounting rate assuming that the risk of the project
is equal to the business risk of the firm. If the project has higher risk then a
percentage premium will be added to WACC to determine the appropriate
discounting rate.
(b) It assumes that capital structure is optimal which is not achievable in real
world.
(c) It is based on market values of capital which keep on changing thus WACC
will change over time but is assumed to remain constant throughout the
economic life of the project.