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IPCC, Financial Management May2008, Question Paper

[Part 3-B: Financial Management] 5. Answer any five of the following: (i) Explain the relevance of time value of money in financial decisions. (ii) Discuss the features of Secured Premium Notes (SPNs). (iii) The following data relate to RT Ltd : Rs Earning before interest and tax (EBIT) 10,00,000 Fixed cost 20,00,000 Earning Before Tax (EBT) 8,00,000 Required : Calculate combined leverage (iv) Explain the concept of closed and open ended lease. (v) Discuss the advantages of preference share capital as an instrument of raising funds. (vi) Explain the principles of Trading on equity. The financial statement and operating results of PQR revealed the following position as on 31st march, 2006:
Equity share capital (Rs 10 fully paid share) Working capital Bank overdraft Current ratio Liquidity ratio Proprietary ratio (Net assets/Proprietary Fund) Cost of sales Debtors velocity Stock turnover based on cost of sales Gross profit ratio Net profit ratio Rs 20,00,000 Rs 6,00,000 Rs 1,00,000 2.5 : 1 1.5 : 1 .75 : 1 Rs 14,40,000 2 months 4 times 20% of sales 15% of sales

6.

Closing stock was 25% higher than the opening stock. There were also free reserves brought forward from earlier years. Current assets include stock, debtors and cash only. The current liabilities expect bank overdraft treated as creditors. Expenses include depreciation of Rs 90,000 The following information was collected from the records for the year ended31st March, 2007: Total sales for the year were 20% higher as compared to previous year. Balances as on 31st March, 2007 were : Stock Rs 5,20,000, Creditors Rs 4,15,000. Debtors Rs 4,95,000 and Cash balance Rs 3,10,000. Percentage of Gross profit on turnover has gone up from 20% to 25%and ratio of net profit to sales from 15% to 16%. A portions of Fixed assets was very old (book values Rs 1,80,0000 disposed for Rs 90,000. (No depreciations to be provided on this item). Long-term investments were purchased for Rs 2,96,000. Bank overdraft fully discharged. Percentage of depreciation to Fixed assets to be provided at the rate in the previous year. Required : (i) Prepare Balance Sheet as on 31st March, 2006 and 31st March, 2007. (ii) Prepare the fund flow statement for the year ended 31st March, 2007. 1

7. (a) ABC Ltd wishes to raise additional finance of Rs 20 lakh for meeting its investment plans. The company has Rs 4,00,000 in the form of retained earnings available for investment purposes. The following are the further details : Debt equity ratio 25 : 75 Cost of debt at the rate of 10 per cent (before tax) upto Rs 2,00,000 and 13% (before tax) beyond that Earning per share, Rs 12. Dividend payout 50% of earnings. Expected growth rate in dividend. 10% Current market price per share, Rs 60. Companys tax rate is 30% and shareholders personal tax rate is 20%. Required: (i) Calculate the post tax average cost of additional debt. (ii) Calculate the cost of retained earnings and cost of equity. (iii) Calculate the overall weighted average (after tax) cost of additional finance. (b) C Ltd is considering investing in a project. The expected original investment in the project will be Rs 2,00,000, the life of project will be 5 year with no salvage value. The expected net cash inflows after depreciation but before tax during the life of the project will be as following :
Year Rs 1 85,000 2 1,00,000 3 80,000 4 80,000 5 40,000

The project will be depreciated at the rate of 20% on original cost. The company is subjected to 30% tax rate. Required : (i) Calculate pay back period and average rate of return (ARR). (ii) Calculate net present value and net present value index, if cost of capital is 10%. (iii) Calculate internal rate of return. Note : The P.V. factors are :
Year 1 2 3 4 5 P.V at 10% .909 .826 .751 .683 .621 P.V. at 37% .730 .533 .389 .284 .207 P.V. At 38% .725 .525 .381 .276 .200 P.V. at 40% .714 .510 .364 .260 .186

8.

Answer any three of the following : (i) Explain the concept of Debt securitization. (ii) Explain briefly the functions of Treasury Department. (iv) Explain briefly the features of External Commercial Borrowings. (ECB) (v) The Sales Manager of AB Limited suggests that if credit period is given for 1.5 months then sales may likely to increase by Rs 1,20,000 per annum. Cost of sales amounted to 90% of sales. The risk of non-payment is 5%. Income tax rate is 30%. The expected return on investment is Rs 3,375 (after tax). Should the company accept the suggestion of Sale Manager ?

November2008 Answer all Questions


[Part 3-B : Financial Management] 2

5.

Answer any five of (i) Write a short note on Deep Discount Bonds. (ii) What is meant by Venture Capital Financing? (iii) Discuss the concept of Optimal Capital Structure. (iv) Name the various financial instruments dealt with in the international market. (v) How is return on capital employed calculated? What is its significance? (vi) What is quick ratio? What does it signify? Balance Sheets of a company as on 31st March, 2007 and 2008 were as follows :
31.3.07 Rs 10,00,000 2,00,000 1,20,000 2,10,000 5,00,000 1,85,000 80,000 1,36,000 24,31,000 31.3.08 Rs 10,00,000 3,00,000 1,45,000 25,000 3,00,000 3,00,000 2,15,000 1,05,000 1,44,000 25,34,000 Assets Goodwill Land and Building Plant and Machinery Investments (non-trading) Stock Debtors Cash and Bank Prepaid Expenses Premium on Redemption of Debenture 31.3.07 Rs 1,00,000 7,00,000 6,00,000 2,40,000 4,00,000 2,88,000 88,000 15,000 31.3.08 Rs 80,000 6,50,000 6,60,000 2,20,000 3,85,000 4,15,000 93,000 11,000s 20,000 25,34,000

6.

Liabilities Equity Share Capital 8% P.S. Capital General Reserve Securities Premium Profit & Loss A/c 11% Debentures Creditors Provisions for tax Proposed Dividend

24,31,000

Additional information: 1. Investments were sold during the year at a profit of Rs 15,000 2. During the year an old machine costing Rs. 80,000 was sold for Rs 36,000. Its written down value was Rs 45,000 3. Depreciation charged on Plants and Machinery @ 20 per cent on the opening balance. 4. There was no purchase or sale of Land and Building. 5. Provision for tax made during the year was Rs 96,000. 6. Preference shares were issued for consideration of cash during the year. You are required to prepare: (i) Cash flow statement as per AS-3. (ii) Schedule of changes in working capital. 7. (a) MN Ltd is commencing a new project for manufacture of electric toys. The following cost information has been ascertained for annual production of 60,000 units at full capacity:
Amount per unit (Rs) Raw materials Direct labour Manufacturing overheads: Variable Fixed Selling and Distribution overheads: Variable Fixed Total cost Profit Selling price 20 15 15 10 3 1 25 4 64 16 80

In the first year of operations expected production and sales are 40,000 units and 35,000 units respectively. To assess the need of Working capital, the following additional information is available : (i) Stock of Raw materials 3 months consumption. (ii) Credit allowable for debtors 1 months. (iii) Credit allowable by creditors 4 months. (iv) Lag in payment of wages 1 month. (v) Lag in payment of overheads 1/2 month. (vi) Cash in hand and Bank is expected to Rs 60,000. (vii) Provision for contingencies is required @ 10% of Working capital requirement including that provision. You are required to prepare a projected statement of Working capital requirement for the first year of operations. Debtors are taken at cost. (b) A company wants to invest in a machinery that would cost Rs 50,000 at the beginning of year 1. It is estimated that the net cash inflows from operations will be Rs 18,000 per annum for 3 years, if the company opts to service a part of the machine at the end of year 1 at Rs 10,000 and the scrap value at the end of year 3 will be Rs 12,5000. However, of the company decides not to services the part, it will have to be replaced at the end of year 2 at Rs 15,4000. But in this case, the machine will work for the 4th year also and get operational cash inflow of Rs 18,000 for the 4th year. It will have to be scrapped at the end of year 4 at Rs 9,000. Assuming cost of capital at 10% and ignoring taxes, will you recommended the purchase of this machine based on the net present value of its cash flows. If the supplier gives a discount of Rs 5,000 for purchase, what would be your decision? (The present value factors at the end of years 0,1,2,3,4,5 and 6 are respectively 1, 0.9091, 0.8264, 0.7513, 0.6830, 0.6209 and 0.5644). 1. Answer any three of the following : (i) A company offers a fixed deposit scheme whereby Rs 10,000 matures to Rs 12,625 after 2 years, on a half-yearly compounding basis. If the company wishes to amend the scheme by compounding interest every quarter, what will be the revised maturity value ? (ii) A company operates at a production level of 1,000 units. The contribution is Rs 60 per unit, operating leverage is 6, combined leverage is 24. If tax rate is 30%, what would be its earnings after tax? (iii) What do you mean by Stock Turnover ratio and Gearing ratio? (iv) Explain the concept of multiple Internal rate of Return.

May 2009 Answer all Questions


[Part 3-B : Financial Management] 5. Answer any five of the following : Write a short note on functions of Treasury department. Discuss the concept of American Depository Receipts. How is Debt service coverage ratio calculated? What is its significance? Discuss conflict in profit versus wealth maximization objective. Discuss the concept of Debt-Equity or EBIT-EPS indifference point, while determining the capital structure of a company. (vi) Discuss the benefits to the originator of Debt Securitisation. (i) (ii) (iii) (iv) (v) Balance Sheets of RST Limited as on March 31, 2008 and March 31, 2009 are as under : 4

6.

Liabilities Equity Share Capital (Rs 10 face value Per share) General Reserve 9% Preference Share Capital Share Premium A/c Profit & Loss A/c 8% Debentures Creditors Bills Payable Provision for Tax Proposed Dividend

31.3.2008 Rs

31.3.2009 Rs

Assets Land & Building Plant & Machinery Investments (Long-term) Stock Debtors Cash & Bank Prepaid Expenses Advance Tax Payment Preliminary Expenses

31.3.2008 Rs 6,00,000 9,00,000 2,50,000 3,60,000 3,00,000 1,00,000 15,000 80,000 40,000

31.3.2009 Rs 7,00,000 11,00,000 2,50,000 3,50,000 3,90,000 95,000 20,000 1,05,000 35,000

10,00,000 3,50,000 3,00,000 25,000 2,00,000 3,00,000 2,05,000 45,000 70,000 1,50,000 26,45,000

12,00,000 2,00,000 5,00,000 4,000 3,00,000 1,00,000 3,00,000 81,000 1,00,000 2,60,000 30,45,000

26,45,000

30,45,000

Additional information: (i) Depreciation charged on building and plant and machinery during the year 2008-09 were Rs 50,000 and Rs 1,20,000 respectively. (ii) During the year an old machine costing Rs 1,50,000 was sold or Rs 32,000. Its written down value was Rs 40,000 on date of sale. (iii) During the year, income tax for the year 2007-08 was assessed at Rs 76,000. A cheque of Rs 4,000 was received alongwith the assessment order towards refund of income tax paid in excess, by way of advance tax in earlier years. (iv) Proposed dividend for 2007-08 was paid during the year 2008-09. (v) 9% Preference share of Rs 3,00,000, which were due for redemption, were redeemed during the year 2008-09 at a premium of 5%, out of the proceeds of fresh issue of 9% Preference shares. (vi) Bonus shares were issued to the existing equity shareholders at the rate of one share for every five shares held on 31.3.2008 out of general reserves. (vii) Debentures were redeemed at the beginning of the year at a premium of 3%. (viii) Interim dividend paid during the year 2008-09 was Rs 50,000. Required: (a) Schedule of Changes in Working Capital; and (b) Fund Flow Statement for the year ended March 31, 2009. 7. (a) The capital structure of MNP Ltd is as under :
9% Debentures 11% Preference shares Equity shares (face value : Rs 10 per share) Rs 2,75,000 Rs 2,25,000 Rs 5,00,000 Rs 10,00,000

Additional information: (i) Rs 100 per debenture redeemable at par has 2% floatation cost and 10 years of maturity. The market price per debenture is Rs 105. (ii) Rs 100 per preference share redeemable at par has 3% floatation cost and 10 years of maturity. The market price per preference share is Rs106. (iii) Equity share has Rs 4 floatation cost and market price per share of Rs 24. The next year expected dividend is Rs 2 per share with annual growth of 5%. The firm has a practice of paying all earnings in the form of dividends. 5

(b)

(iv) Corporate Income-tax rate is 35%. Required: Calculate Weighted Average Cost of Capital (WACC) using market value weights. A company is required to choose between two machines A and B. The two machines are designed differently, but have indentical capacity and do exactly the same job. Machine A costs Rs 6,00,000 and will last for 3 years. It costs Rs 1,20,000 per year to run. Machine B is an economy model costing Rs 4,00,000 but will last only for two years, and cost Rs 1,80,000 per year to run. These are real cash flows. The costs are forecasted in Rupees of constant purchasing power. Opportunity cost of capital is 10%. Which machine company should buy? Ignore tax. PVIF0.10.1 = 0.9091, PVIF0.10,2 = 0.8264, PVIF0.10.1 = 0.7513.

8. Answer any three of the following : (i) A firm maintains a separate account for cash disbursement. Total disbursements are Rs 2,62,500 per month. Administrative and transaction cost of transferring cash to disbursement account is Rs 25 per transfer. Marketable securities yield is 7.5% per annum. Determine the optimum cash balance according to William J Baumol model. (ii) A firm has a total sales of Rs 12,00,000 and its average collection period is 90 days. The past experience indicates that bad debt losses are 1.5% on sales. The expenditure incurred by the firm in administering receivable collection efforts are Rs 50,000. A factor is prepared to buy the firms receivables to the firm at an interest rate of 16% p.a. after withholding 10% as reserve. Calculate effective cost of factoring to the firm. Assume 360 days in a year. (iii) Explain the concept of discounted payback period. (iv) Discuss the composition of Return on Equity (ROE) using the DuPont model.

November 2009 Answer all Questions


[Part 3-B: Financial Management] 5. Answer any five of the following: (i) Explain briefly the limitations of financial ratios. (ii) What do you understand by Business Risk and Financial Risk? (iii) Differentiate between Factoring and Bills discounting. (iv) Differentiate between Financial Management and Financial Accounting. (v) Y Ltd retains Rs 7,50,000 out of its current earning. The expected rate of return to the shareholders. If they had invested the funds elsewhere is 10%. The brokerage is 3% and the shareholders came in 30% tax bracket. Calculate the cost of retained earning. (vi) From the informations given below calculate the amount of Fixed assets and Proprietor's fund. Ratio of fixed assets to proprietors fund = 0.75 Net working capital = Rs 6,00,000 6. The Balance Sheets of a Company as on 31 March 2008 and 2009 are given below:
Liabilities 31.3.08 Rs 31.3.09 Rs Assets 31.3.08 Rs 31.3.09 Rs

Equity share capital Capital reserve General reserve Profit & Loss A/c 9% debentures Sundry creditors Bills payables Proposed dividend Provision for tax Unpaid dividend

14,40,000 8,16,000 2,88,000 9,60,000 5,50,000 26,000 1,44,000 4,32,000 46,56,000

19,20,000 48,000 9,60,000 3,60,000 6,72,000 5,90,000 34,000 1,72,800 4,08,000 19,200 51,84,000

Fixed assets Less depreciation Investment Sunder debtors Stock Cash in hand Preliminary Expenses

38,40,000 11,04,000 27,36,000 4,80,000 12,00,000 1,40,000 4,000 96,000

45,60,000 13,92,000 31,68,000 3,84,000 14,00,000 1,84,000 48,000

46,56,000

51,84,000

Additional informations: During the year ended 31 March 2009 the company: (i) Sold a machine for Rs 1,20,000; the cost of machine was Rs 2,40,000 and depreciation provided on it was Rs 84,000. (ii) Provided Rs 4,20,000 as depreciation fixed assets. (iii) Sold some investment and profit credited to capital reserve. (iv) Redeemed 30% of the debenture @ 105 (v) Decided to write off fixed assets costing Rs 60,000 on which deprecation amounting to Rs 48,000 has been provided. You are required to prepare Cash Flow Statement as per AS-3. 7. (a) From the following Financial data of Company A and Company B prepare their Income statements.
Variable cost Fixed cost Interest expenses Financial leverage Operating leverage Income tax rates Sales Company A Rs 56,000 20,000 12,000 5: 1 30% Company B Rs 60% of sales 9,000 4: 1 30% 1,05,000

(b) A hospital is considering to purchase a diagnostic machine costing Rs 80,000. The projected life of the machine is 8 years and has an expected salvage value of Rs 6,000 at the end of 8 years. The annual operating cost of the machine is Rs 7,500. It is expected to generate revenues of Rs 40,000 per year for eight years. Presently, the hospital is outsourcing the diagnostic work and is earning commission income is Rs 12,000 per annum; net of taxes. Required: Whether it would be profitable for the hospital to purchase the machine. Give your recommendation under: (i) Net Present Value method (ii) Profitability Index method. PV factors at 10% are given below:
Year l 0.909 Year 2 0.826 Year 3 0.751 Year 4 0.683 Year 5 0.621 Year 6 0.564 Year 7 0.513 Year 8 0.467

8. Answer any three of the following: (i) Explain the two basic functions of Financial Management. (ii) Explain the following terms: (a) Ploughing back of profits (b) Desirability factor. (iii) What do you understand by weighted average cost of capital? 7

(iv)

There are two firms P and Q which are identical except P does not use any debt in its capital structure while Q has Rs. 8,00,000, 9% debentures in its capital structure. Both the firms have earning before interest and tax of Rs. 2,60,000 p. a. and the capitalization rate is 10%. Assuming the corporate tax of 30%, calculate the value of these firms according to MM Hypothesis.

C.A. Final Gr. I New Course Paper-2


November 2008 Question No. 1 is compulsory. Answer any four question from the rest. 1. (a) Following information is available for X Companys shares and Call option:
Current share price Option exercise price Risk free interest rate Time of the expiry of option Standard deviation Calculate the value of option using Black-Scholes formula. Rs Rs 7% 3 years 0.18 185 170

(b)

Suppose a dealer quotes All-in-cost for a generic swap at 8% against six month libor flat. If the notional principal amount of swap is Rs 5,00,000. (i) Calculate semi-annual fixed payment. (ii) Find the first floating rate payment for (i) above if the six-month period from the effective date of swap to the settlement data comprises 181 days and that the corresponding libor was 6% on the effective date of swap. (iii) In (ii) above, if the settlement in on Net basis, how much the fixed rate payer would pay to the floating rate payer? Generic swap is based on 30/60 days basis. (c) Consider the following information on two stocks, A and B:
Year 2006 2007 Return on A (%) 10 16 Return on B (%) 12 18

You are required to determine: (i) The expected return on a portfolio containing A and B in the proportion of 40% and 60% respectively. (ii) The Standard deviation of return from each of the two stocks. (iii) The covariance of returns from the two stocks. (iv) Correlation coefficient between the returns of the two stocks. (v) The risk of a portfolio containing A and B in the proportion of 40% and 60%. 2. (a) The following is the yield structure of AAA rated debenture:
Period 3 months 6 months 1 year 2 years 3 years and above Yield (%) 8.5% 9.25 10.50 11.25 12.00

(i) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and year 3. (ii) If the interest rate increases by 50 basis points, what will be the percentage change in the price of the bond having a maturity of 5 years? Assume that the bond is fairly priced as the moment at Rs 1,000 8

(b)

RST Ltd has a capital of Rs 10,00,000 in equity shares of Rs 100 each. The shares are currently quoted at par. The company proposes to declare a dividend of Rs 10 per share at the end of the current financial year. The capitalization rate for the risk class of which the company belongs is 12%. What will be the market price of the share at the end of the year, if (i) a dividend is not cleared? (ii) a dividend is declared? (iii) assuming that the company pays the dividend and has net profits of Rs 5,00,000 and makes new investments of Rs 10,00,000 during the period, how many new shares must be issued? Use the MM model. (c) Mr X established the following spread on the Delta Corporations stock: (i) Purchased one 3-month call option with a premium of Rs 30 and an exercise price of Rs 550. (ii) Purchased one 3-month put option with a premium of Rs 5 and an exercise price of Rs 450. Delta Corporations stock is currently selling at Rs 500. Determine profit or loss, if the price of Delta Corporations: remains at Rs 500 after 3 months. falls at Rs 350 after 3 months. rises to Rs 600. Assume the size of option is 100 shares of Delta Corporation.

XL Ispat Ltd has made an issue of 14 per cent non-convertible debentures on January 1, 2007. These debentures have a face value of Rs 100 and is currently traded in the market at a price of Rs 90. Interest on these NCD will be paid through post-dated cheques dated June 30 and December 31. Interest payments for the first 3 years will be paid in advance through post-dated cheques while for the last 2 years, post-dated cheques will be issued at the third year. The bond is redeemable at par on December 31, 2011 at the end of 5 years. Required: (i) Estimate the current yield at the YTM of the bond. (ii) Calculate the duration of the NCD. (iii) Assuming that intermediate coupon payments are, not available for reinvestment calculate the realized yield on the NCD. 3. (a) A company has an old machine having book value zero, which can be sold for Rs 50,000. The company is thinking to choose one from following two alternatives: (i) To incur additional cost of Rs 10,00,000 to upgrade the old existing machine. (ii) To replace old machine with a new machine costing Rs 20,00,000 plus installation cost Rs 50,000. Both above proposals envisage useful life to be five years with salvage value to be nil. The expected after tax profits for the above three alternatives are as under:
Year 1. 2. 3. 4. 5. Old existing Machine Rs 5,00,000 5,40, 000 5,80, 000 6,20, 000 6,60, 000 Upgrade Machine Rs 5,50,000 5,90, 000 6,10, 000 6,50, 000 7,00, 000 New Machine Rs 6,00,000 6,40, 000 6,90, 000 7,40, 000 8,00, 000

(d)

The tax rate is 40 per cent. The company follows straight line method of depreciation. Assume cost of capital to be 15 per cent. P.V.F. of 15% = 0.870, 0.756, 0.658, 0.572 and 0.497. You are required to advise the company as to which alternative is to be adopted. 9

(b)

The data given below relates to a convertible bond:


Face value Coupon rate No. of shares per bond Market price of share Straight value of bond Market price of convertible bond Rs 250 12% 20 Rs 12 Rs 235 Rs 265

Calculate: (i) Stock value of blood. (ii) The percentage of downside risk. (iii) The conversion premium (iv) The conversion parity price of the stock. (c) What are the drawbacks of investments in Mutual Funds? 4. (a) An exporter is a UK-based company. Invoice amount is $ 3,50,000. Credit period is three months. Exchange rates in London are:
Spot Rate 3-month Forward Rate ($/) 1.5865 1.5905 ($/) 1.6100 1.6140 Loan 9% 8%

Rates of Interest in Money Market:


$ Deposit 7% 5%

Compute the show how a money market hedge can be put in place. Compare and contrast the outcome with a forward contract. (b) An Indian exporting firm, Rohit and Bros, would be cover itself against a likely depreciation of pound sterling. The following data is given: Receivables of Rohit and Bros: 5,00,000 Spot rate: Rs 56.00/ Payment date: 3-months 3-months interest rate: India: 12 per cent per annum UK: 5 per cent annum What should the exporter do? The closing value of Sensex for the month of October 2007 is given below:
Date 1.10.07 3.10.07 4.10.07 5.10.07 8.10.07 9.10.07 10.10.07 11.10.07 12.10.07 15.10.07 16.10.07 17.10.07 19.10.07 22.10.07 23.10.07 24.10.07 25.10.07 29.10.07 30.10.07 31.10.07 Closing Sensex Value 2800 2780 2795 2830 2760 2790 2880 2960 2990 3200 3300 3450 3360 3290 3360 3340 3290 3240 3140 3260

(c)

10

You are required to test the weak form of efficient market hypothesis by applying the run test at 5% and 10% level of significance. Following value can be used Value of t at 5% is 2.101 at 18 degrees of freedom. Value of t at 10% is 1.734 at 18 degrees of freedom. Value of t at 5% is 2.086 at 20 degrees of freedom. Value of t at 10% is 1.725 at 20 degrees of freedom. 5. The rate of inflation in USA is likely to be 3% per annum and in India it is likely to be 6.5%. The current spot rate of US $ in India is Rs 43.30. Find the expected rate of US $ in India after one year and 3 years from now using purchasing power parity theory. (ii) On April 1, 3 months interest rate in the UK and US $ are 7.5% and 3.5% per annum respectively. The UK /US $ spot rate is .7570. What would be the forward rate for US $ for delivery on 30 June? (b) K. Ltd is considering acquiring N. Ltd, the following information is available:
Company K. Ltd N. Ltd Profit after Tax 50,00,000 15,00,000 Number of Equity 10,00,000 2,50,000 Market value shares per share 20.00 160.00

(a)

(i)

6.

Exchange of equity shares for acquisition is based on current market value as above. There is no synergy advantage available: (i) Find the earning per share for company K. Ltd after merger. (ii) Find the exchange ratio so that shareholders of N. Ltd would not be at a loss. Write short notes on any four of the following: Financial restructuring Cross-border leasing Embedded derivatives Arbitrage operations Rolling settlement.

C.A. Final Gr. I New Course Paper-2


May 2009 Question No. 1 is compulsory. Answer any four question from the rest. 1. (a) Consider a two-year American call option with a strike price of Rs 50 on a stock the current price of which is also Rs 50. Assume that there are two time periods of one year and in each year the stock price can move up or down by equal percentage of 20%. The risk free interest rate is 6%. Using binomial option model, calculate the probability of price moving up and down. Also draw a two step binomial tree showing prices and payoffs at each node. Mr X owns a portfolio with the following characteristics:
Factor 1 sensitivity Factor 2 sensitivity Expected Return Security A 0.80 0.60 15% Security B 1.50 1.20 20% Risk free security 0 0 10%

(b)

It is assumed that security returns are generated by a two factor model. 11

(i) If Mr X has Rs 1,00,000 to invest and sells short Rs 50,000 of security B and purchases Rs 1,50,000 of security A what is the sensitivity of Mr Xs portfolio to the two factors? (ii) If Mr X borrows Rs 1,00,000 at the risk free rate and invests the amount he borrows along with the original amount of Rs 1,00,000 in security A and B in the same proportion as described in part (i), what is the sensitivity of the portfolio to the two factors? (iii) What is the expected return premium of factor 2? (c) The share of X Ltd is currently selling for Rs 300. Risk free interest rate is 0.8% per month. A three-month futures contract is selling for Rs 312. Develop an arbitrage strategy and show what riskless profit will be 3 months hence assuming that X Ltd will not pay any dividend in the next three months. 2. (a) An investor has two portfolios known to be on minimum variance set for a population of three securities A, B and C having below mentioned weights:
Portfolio X Portfolio Y WA 0.30 0.20 WB 0.40 0.50 WC 0.30 0.30

It is supposed that there are no restrictions on short sales. (i) What would be the weight for each stock for a portfolio constructed by investing Rs 5,000 in portfolio X and Rs 3,000 in portfolio Y? (ii) Suppose the investor invests Rs 4,000 out of Rs 8,000 in security A. How will be allocate the balance between security B and C to ensure that his portfolio is on minimum variance set? (b) Calculate the value of share from the following information:
Profit of the company Equity capital of company Par value of share Debt ratio of company Long run growth rate of the company Beta 0.1: risk free interest rate Market return Capital expenditure per share Depreciation per share Change in Working capital Year 1 2 3 4 5 6 Return on (% ) 12 15 11 2 10 12 Rs 290 crore Rs 1,300 crore Rs 40 each 27 8% 8.7% 10.3% Rs 47 Rs 39 Rs 3.45 per share Return on market portfolio (%) 12 12 11 4 9.5 2

(c) The returns on stock A and market portfolio for a period of 6 years are as follows:

You are required to determine: (i) Characteristic line for stock A (ii) The systematic and unsystematic risk of stock A. 3. (a) M/s Gama & Co. is planning of installing a power saving machine and are considering buying or alternative. The machine is subject to straight-line method of depreciation. Gama & Co. can raise debt at 14% payable in five equal annual instalments of Rs 1,78,858 each, at the beginning of the year. In case of leasing, the company would be required to pay an annual end of year rent of 25% of the cost of machine for 5 years. The Company is in 40% tax bracket. The salvage value is estimated at Rs 24,998 at the end of 5 years.

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Evaluate the two alternatives and advise the company by considering after-tax cost of debt concept under both alternatives. P.V. factors 0.9225, 0.8510, 0.7851, 0.6681 respectively for 1 to 5 years. (b) ABC Ltd has Rs 300 million, 12 per cent bonds outstanding with six years remaining to maturity. Since interest rates are falling, ABC Ltd is contemplating of refunding these bonds with a Rs 300 million issue of 6-year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bonds will be Rs 6 million and the call premium is 4 per cent. Rs 9 million being the unamortized portion of issue cost of old bonds can be written off no sooner the old bonds are called off. Marginal tax rate of ABC Ltd is 30 per cent. You are required to analyse the bond refunding decision. (c) Mr X earns 10% on his investments in equity shares. He is considering a recently floated scheme of a Mutual Fund where the initial expenses are 6% and annual recurring expenses are expected to be 2%. How much the Mutual Fund scheme should earn to provide a return of 10% to Mr X? 4. (a) Your forex dealer had entered into a cross currency deal and had sold US $ 10,00,000 against EURO at US $ 1 = EUR 1.4400 for spot delivery. However, later during the day, the market became volatile and the dealer in compliance with his managements guidelines had to square-up the position when the quotations were:
Spot US $ 1 1 month margin 2 month margin Spot US $ 1 1 month forward 2 month forward INR 31.4300/4500 25/20 45/35 Euro 1,4400/4450 1.4425/4490 1.4460/4530

What will be the gain or loss in the transaction? (b) On 19 April following are the spot rates Spot EUR/USD 1.2000 USD/INR 44.800 Following are the quotes of European Options:
Currency pair EUR/ISD EUR/USD USD/INR USD/INR Call/Put Call Put Call Put Strike price 1,2000 1,2000 44,8000 44,8000 Premium $ 0.035 $ 0.04 Rs 0.12 Rs 0.04 Expiry date July 19 July 19 Sep. 19 Sep. 19

A trader sells an at-the-money spot straddle expiring at three months (July 19). Calculate gain or loss if three months later the spot rate is EUR/USD 1,2900. (ii) Which strategy gives a profit to the dealer if five months later (Sep. 19) expected spot rate is USD/INR 45.00. Also calculate profit for a transaction USD 1.5 million. (c) You have following quotes from Bank A and Bank B:
SPOT 3 months 6 months SPOT 3 months 6 months Bank A USD/CHF 1.4650/55 5/10 10/15 GBP/USD 1.7645/60 25/20 35/25 Bank B USD/CHF 1.4653/60 GBP/USD 1.7640/50

(i)

Calculate: (i) How much minimum CHF amount you have to pay for 1 Million GBP spot? (ii) Considering the quotes from Bank A only, for GBP/CHF what are the Implied Swap points for Spot over 3 months? 5. The following information relating to the acquiring Company Abhiman Ltd and the target Company Abhishek Ltd. are available. Both the companies are promoted by multinational company, Trident Ltd. The promoters holding is 50% and 60% respectively in Abhiman Ltd and Abhishek Ltd: 13

Share Capital (Rs) Free Reserves and Surplus (Rs) Paid up Value per share (Rs) Free float Market Capitalisation (Rs) P/E Ratio (times)

Abhiman Ltd 200 lakh 800 lakh 100 400 lakh 10

Abhishek Ltd 100 lakh 500 lakh 10 128 lakh 4

Trident Ltd is interested to do justice to the shareholders of both the companies. For the swap ratio weights are assigned to different parameters by the Board of Directors as follows:
Book Value EPS (Earning per share) Market Price 25% 50% 25%

(i) What is the swap ratio based on above weights? (ii) What is the Book Value, EPS and expected Market price of Abhiman Ltd after acquisition of Abhishek Ltd (assuming P.E. ratio of Abhiman Ltd remains unchanged and all assets and liabilities of Abhishek Ltd are taken over at book value). Calculate: (a) Promoters revised holding in the Abhiman Ltd (b) Free float market capitalization. (c) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.), if acquisition of Abhishek Ltd, Abhiman Ltd decided to: (i) Issue Bonus shares in the ratio of 1: 2; and (ii) Split the stock (share) as Rs 5 each fully paid. 6. (a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both the bonds have a face value of Rs 1,000 and coupon rate of 8% (with annual interest payments) and both are selling at par. Assume that the yields of both the bonds fall to 6%, whether the price of bond will increase or decrease? What percentage of this increase/decrease comes from a change in the present value of bonds principal amount and what percentage of this increase/decrease comes from a change in the present value of bonds interest payments? Consider a bond selling at its par value of Rs 1,000, with 6 years to maturity and a 7% coupon rate (with annual interest payment), what is bonds duration? If the YTM of the bond in (b) above increases to 10%, how it affects the bonds duration? And why? Why should the duration of a coupon carrying bond always be less than the time to its maturity?

(b) (c) (d)

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