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FINANCIAL MANAGEMENT

Time allowed 2 hours


Total marks 100
[N.B. Questions must be answered in English. Figures in the margin indicate full marks. Examiner will take
account of the quality of language and of the manner 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. (a) Methods of exports financing include: (i) Bills of Exchange (ii) Export factoring (iii)
Documentary Credits and Export Credit insurance. Explain how these methods help the
exporters reducing the risks of bad debts in foreign trade.
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(b) Explain why the forward exchange rates are different from spot rates.

(c) T Ltd. has bought goods from US supplier and must pay US $ in three months time. The
companys Finance Director wishes to hedge against the foreign exchange risks, and the three
methods which the T Ltd. considers are : (i) forward exchange contacts (ii) money market
borrowing or lending, and (iii) making lead payments.
The following annual interest rates & exchange rates are currently available:
Period
1 month
3 months

US Dollar
Deposit rate
Borrowing rate
7%
10.25%
7%
10.75%

Bangladesh Taka
Deposit rate
Borrowing rate
10.75%
14.00%
11.00%
14.25%

Which is cheaper method for T Ltd.?

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2. (a) Businesses have an ongoing capital requirement if they are to continue to meet the
shareholders expectation. Explain how capital market helps the business in this regard?
(b) What is meant by going public? Discuss its advantages and disadvantages.

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(c) Pran Ltd. is a successful food retail company. Over the last five years it has increased its share
of the Bangladesh food retail market by 30%. It makes no use of debt and has financed its
operations entirely from retained earnings. Pran has a current price/earning ratio of 28
compared with the food retailing sector average of 19. Other financial data relating to the
company are shown below:
Figures in Taka
2008
2009
2010
2011
2012
Earning per share
16.10
19.30
24.70
30.50
35.80
Net dividend per share
4.86
5.86
7.50
9.00
11.00
Book value of equity per share 103.00
124.00
142.00
165.00
190.00
Requirements:
Estimate the cost of equity capital for Pran Ltd. using the following models:
(i) Dividend growth model
(ii) Earning retention model

6x2=12

3. (a) Why cash flow is preferred rather than profit in investment appraisal?

(b) How taxation affect the investment decision? Discuss with two examples.

(c) ABC Ltd. is considering an investment in new technology that will reduce operating costs
through increasing energy efficiency and decreasing pollution. The new technology will cost Tk.1
million and have a four-year life, at the end of which it will have a scrap value ofTk.100,000.
A licence fee of Tk.104,000 is payable at the end of the first year. This licence fee will increase by
4% per year in each subsequent year.
The new technology is expected to reduce operating costs byTk.580 per unit in current price terms.
This reduction in operating costs is before taking account of expected inflation of 5% per year.
[Please turn over]

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Forecast production volumes over the life of the new technology are expected to be as follows:
Year
Production
(units per year)

60,000

75,000

95,000

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80,000

If ABC Ltd. bought the new technology, it would finance the purchase through a four-year loan
paying interest at an annual before-tax rate of 86% per year.
Alternatively, ABC Ltd. could lease the new technology. The company would pay four annual
lease rentals of Tk.380,000 per year, payable in advance at the start of each year. The annual
lease rentals include the cost of the license fee.
If ABC Ltd. buys the new technology it can claim capital allowances on the investment on a
25% reducing balance basis. The company pays taxation one year in arrears at an annual rate
of 30%. ABC Ltd. has an after-tax weighted average cost of capital of 11% per year.
Required:
(a) Comment on whether ABC Ltd. should lease or buy the new technology.
(b) Calculate the net present value (NPV) of buying the new technology and advise
whether ABC Ltd. should undertake the proposed investment.
(c) Discuss how an optimal investment schedule can be formulated when capital is
rationed and investment projects are either: (i) divisible; or (ii) non-divisible.
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B Ltd. wishes to calculate its weighted average cost of capital and the following information
relates to the company at the current time:
Number of ordinary shares
Book value of 7% convertible debt
Book value of 8% bank loan
Market price of ordinary shares
Market value of convertible debt
Equity beta of B Ltd.
Risk-free rate of return
Equity risk premium
Rate of taxation

20 million
Tk.29 million
Tk.2 million
Tk.550 per share
Tk.10711 per Tk.100 bond
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47%
65%
30%

B Ltd. expects share prices to rise in the future at an average rate of 6% per year. The convertible
debt can be redeemed at par in eight years time, or converted in six years time into 15 shares of
B Ltd. per Tk.100 bond.
Required:
(a) Calculate the market value weighted average cost of capital of B Ltd. State clearly any
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assumptions that you make.
(b) Discuss the circumstances under which the weighted average cost of capital can be used in
investment appraisal.

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