FINANCIAL MANAGEMENT

Time allowed 2 hours

Total marks 100

[N.B. The figures in the margin indicate full marks. Questions must be answered in English. Examiner will
take account of the quality of language and of the way in which the answers are presented. Different
parts, if any, of the same question must be answered in one place in order of sequence.]

Marks

1. Rahim Afroz Ltd. (RA) manufactures domestic solar panels and has a financial year end of 31
December. Its directors are now considering expanding RAs scale of operations via an initiative
called Project North.

If Project North is proceed, then RA would have to invest in new capital equipment which would
cost Tk.3 million and be purchased on 31 December 2011. Because of the fast rate of technological
change in the solar panel industry, PAs directors estimate the Project North would enjoy a
three-year period of competitive advantage (2012-2014).

RA has paid for market research which produced the following estimates for Project North.

(1) Year to 31 December 2012 (all figures expressed in December 2011 prices)
Total sales Tk.2,200,000
Total variable costs Tk.1,200,000
Total fixed costs (including interest paid of Tk.17,000) Tk.427,000
(2) Increasing sales volume in 2013 and 2014 10% pa
(3) Inflation rates: Sales prices 5% pa
All costs 8% pa
(4) Working capital
(to be in place at the start of each trading year) 10% of total annual sales
(5) Trade-in value of capital equipment (in December 2014 prices) Tk.600,000

Capital allowances

RAs machinery and equipment attracts capital allowances, but is and will be excluded from the
general pool. The equipment attracts 20% (reducing balance) capital allowances in the year of
expenditure and in every subsequent year of ownership by the company, except the final year. In
the final year, the difference between the machinerys written down value for tax purposes and its
disposal proceeds will be either:

(i) treated by the company as an additional tax relief, if the disposal proceeds are less than the
tax written down value, or
(ii) be treated as a balancing charge to the company, if the disposal proceeds are more than the
tax written down value.

Other information

RA uses a post-tax money weighted average cost of capital of 14%.
RAs directors would like to assume that the corporation tax rate will be 28% for the foreseeable
future and tax will be payable in the same year as the cash flows to which it relates.
Unless otherwise stated all cash flows occur at the end of the relevant trading year.

Requirements

(a) Calculate the net present value of the Project North initiative at 31 December 2011 and
advise RAs directors whether they should proceed with it. 13
(b) Calculate the sensitivity of the decision in part (a) to changes in the estimated volume of sales.
Ignore the impact of working capital in this calculation. 5
(c) Advise RAs directors whether Project North initiative should proceed if the trade-in value of
the capital equipment at 31 December 2014 were to be Tk.100,000 (in December 2014 prices). 5
(d) Explain briefly your treatment of RAs interest payment of Tk.17,000 in part (a). 2
(e) Explain Shareholder Value Analysis and identify the extent to which its principles are
employed in making the decision in part (a). 5
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2

2. DDS is a Bangladeshi company which manufactures and sells large-scale components for the oil
and gas industries. As the majority of its customers are international, the DDS board is considering
whether the company should be hedging its exposure to foreign exchange risk. One of its key
customers is NSDF, a Norwegian oil exploration company.

DDS and NSDF have recently agreed a contract (DDS/12/57) for the supply of a large consignment
of components. DDS will start manufacturing these at the end of December 2011 and the work
will be completed in the summer of 2012. DDS will receive the agreed contract price, 16.75 million
Norwegian Kroner (NK), on 31 December 2012.

Information regarding Bangladesh and Norwegian currencies is given in the table below:

Table

(1) Recent research paid for by DDS produced the following forecast spot rates for NK/Tk. at 31
December 2012:
Probability
9.200 9.230 10%
9.300 9.330 10%
9.400 9.430 40%
9.500 9.530 40%
(2) Spot rate (NK/Tk.) 9.300 9.325
(3) Forward rate at 31 December 2012 offered by DDS bank: 0.10 0.13 NK discount
(4) Current interest rates Borrowing Depositing
NK 6.60% pa 5.70% pa
Taka (Tk.) 5.49% pa 4.30% pa
(5) DDS bank has quoted the following twelve month currency over-the-counter options each
with a premium of Tk.25,000;
A put option on 16.75 million NK at an exercise price (NK/Tk.) of 9.300
A call option on 16.75 million NK at an exercise price (NK/Tk.) of 9.250

Looking ahead, the DDS board has also identified a surplus of funds denominated in Taka. It is
planning to invest this in June 2012 in an interest-bearing BD deposit account for a period of six
months. It would like to investigate how it might hedge against adverse interest rate movements.

Requirements

(a) Assuming the current date is 31 December 2011, calculate the sterling amount receivable by
DDS on 31 December 2012 if it uses: 12
(i) the expected spot rate in 12 months time
(ii) a forward contract
(iii) a money market hedge
(iv) an option.
(b) Making reference to your calculations in part (a) discuss the issues that should be taken into
account by the DDS board when it considers whether it should hedge the NSDF receipt. 8
(c) Advise the DDS board as to the effectiveness of employing the following methods of hedging
the companys exposure to interest rate risk on the proposed investment of the surplus funds
in June 2012: 8
(i) a Forward Rate Agreement (FRA)
(ii) an interest rate future
(iii) an interest rate option
(iv) an interest rate swap.

3. HH Ltd. is a small private company that runs a residential activity centre from a stately home,
Sundabban Hall, and its 125-acre estate in Khulna. The companys client base comprises principally
of local government bodies who send groups of disadvantaged children for residential stays at the
estate and private firms who send employees on people development programmes centred on all
aspects of leadership, team-building and management development.

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3

Since HH was established almost 15 years ago, all of its shares have been owned by members of the
Khan family. In addition, the residential courses on offer and the range of activities included in them
have been restricted by the level of accommodation available in Sundarban Hall itself and by the fact
that HH has never used long-term external finance to invest in developing the available facilities.

However, following the recent appointment of Aniq Khan as chief executive in succession to his
father, Sabur Khan, who has retired, the family is now keen to expand both the accommodation on
the estate and the range of activities on offer to clients. A recently commissioned report by a firm of
management consultants has estimated that HHs proposed expansion plans will cost Tk.2.8 million.

The most recent management accounts for HH can be summarized as follows:

Income Statement for the year ended 31 May 2011
Tk.000
Revenue 11,024
Profit from operations 1,281
Tax (359)
Profit after tax 922
Dividends (433)
Retained profit for the year 489

Balance sheet as at 31 May 2011 Tk.000

Non-current assets 4,228
Current assets 616
Current liabilities (594)
4,250

Share capital (ordinary Tk.1 shares) 2,000
Retained profits 2,250
4,250

Returns on invested funds and the proportion of profits retained are consistent with previous years.
Within its current assets HH has only a small cash balance and within its current liabilities it has no
borrowings.

Upon his retirement, the former chief executive, Sabur Khan, sold his shares to other members of
the family. At the time, the consideration paid for these shares was based on an estimated valuation
provided by HHs auditors of Tk.4 per share.

There has been much debate among the directors regarding the source of finance for the firms
proposed expansion, with some directors wishing to continue with the policy of no long-term debt
and others believing that debt finance should be the preferred option.

Requirements

(a) Calculate HHs cost of capital, stating and justifying the assumptions and methodology you
employ. 8
(b) Discuss the advantages and disadvantages of a right issue to fund the proposed expansion, and,
as an alternative to a right issue, whether a listing on the Dhaka Stock Exchange Ltd. (DSE) would
be appropriate, given HHs particular circumstances. 8
(c) If debt finance were to be used:
(i) explain the benefits that might accrue to HH if the proposed expansion was financed by
convertible loans rather than an ordinary bank loan; and
(ii) explain the implicit assumptions underlying the use of HHs resultant weighted average cost
of capital as a discount factor in appraising the proposed expansion. 8
(d) Without using calculations, identify the methods that the companys auditors might have used
to value HHs shares. 6


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4

4. You have been approached for financial advice by the management of a client, Z Ltd. a
manufacturing company. Z Ltd. was established in 1957 and formed the platform for growth. The
following information relates to the proposed financing scheme for a management buy-out of Z Ltd.

% Tk.000
Share capital held by
Management 40 100
Institutions 60 150
250
10% redeemable cumulative preference share
(redeemable in ten years time and all sold to institutions) 1,200
1,450
Clearing bank
Loans 700
Overdraft facilities (currently 12% per annum) 700
2,850

Loans are repayable over the next five years in equal annual instalments. They are secured on
various specific assets, including properties. Interest is 12% per annum.

Z Ltd. is at present part of a much larger organization, which considers this segment to be no longer
compatible with its main line of business. This is despite the fact that Z Ltd. has been experiencing
growth in revenue in excess of 10% per annum.

The assets to be acquired have a book value of Tk.2,250,000, but the agreed price was Tk.2,500,000.

Requirements

(a) What is the difference between
(i) a management by-in and a management buy-out?
(ii) a self-off and a spin-off? 4
(b) Write a report to the buy-out team of Z Ltd. appraising the financing scheme. Your report should
include inter alia, the cash flow implications of the proposed scheme. 8



The End