FINANCIAL MANAGEMENT

Time allowed – 3:30 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 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) Explain the Capital Asset Pricing Model, its relationship to the SML, and the major forces
causing shifts in the SML. 2
(b) You are a portfolio manager of National Investment Company (NIC). You are examining the
investment plan for future 2020 to 2023 periods. There are three assets in your hand with
expected return for 4 years as follows:
Year Assets X Asset Y Asset Z
2020 16% 17% 14%
2021 17 16 15
2022 18 15 16
2023 19 14 17
Using these assets you have isolated the three investment alternatives shown in the following:
Alternative1: 100% of assets X
Alternative 2: 50% of Assets X and 50% of assets Y
Alternative 3: 50% of Assets X and 50% of assets Z
Requirements:
i. Calculate the expected return over the 4-year period for each of the three alternatives; 3
ii. Calculate the standard deviations of returns over the 4-year period for each of the three alternatives; 3
iii. Use your findings in parts (i) and (ii) to calculate the co-efficient of each of the three alternatives; 2
iv. On the basis of your findings, which of the three investment alternatives do you
recommend and why? 3

2. Islam Brothers Limited (IB) is a manufacturer of retail goods. It has a financial year end of 31
December. Much of IB’s trade is in India - its main suppliers are based in west part of India and a
major customer is based in east part of India.
IB has two large contracts due for settlement at the end of March 2020 and, because of the scale of
these contracts, its board is considering whether or not to hedge against the possibility of an adverse
move of taka against the Indian Rupee before the end of March 2020. Details of the two contracts
are shown below:
Receipt due from Indian customer on 31 March 2020 ₹ 300 Million.
Payment due to Indian supplier on 31 March 2020 ₹ 375 Million
You work for IB and have been asked to advise the board on the implications of hedging these two
contracts. The information below in Table 1 has been gathered on 31 December 2019:
Table 1
Spot rate (₹/৳) 0.8700- 0.8930
Relevant over the counter (OTC) currency option, exercise price (₹/৳) 0.8689
Three month forward contract – premium ₹ /৳) 0.0018-0.0015
OTC currency option cost (per Rupee converted) ৳0.018
Forward contract arrangement fee (per Rupee converted) ৳ 0.0058
Rupee interest rate (borrowing) 11.0% pa
Rupee interest rate (lending) 7.0% pa
Taka interest rate (borrowing) 8.0% pa
Taka interest rate (lending) 5.0% pa
Requirements:
(a) Using the information above, and assuming that the spot rate on 31 March 2020 will be:
1. either ₹ 0.853 - ₹ 0.876/ ৳

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 2. or ₹ 0.9049 - ₹ 0.9289/ ৳
Calculate IB’s net Taka payment if it uses the following to hedge its foreign exchange
transaction risk:
- a forward contract
- a money market hedge
- an over-the-counter currency option. 9
(b) Advise IB’s directors of the implications of hedging or not hedging its foreign exchange
transactions on 31 March 2020, showing supporting calculations. 8

3. SW is a well established retailer of gymnasium equipment. The company's key market is in Dhaka.
Extracts from the company's most recently published annual report (as at 31 December 2019) are
shown below:
BDT '000 BDT'000 BDT'000
Non-current assets 3,518
Current assets
Inventories 3,780
Trade receivables 3,668 7,448
Total assets 10,966

Ordinary shares (50p) 980

Retained earnings 1,954
Total equity 2,934
Non-current liabilities:
8% Debentures (redeemable in 2024) 2,550
Current liabilities:
Trade payables 2,870
Other payables 372
Short-term borrowings 2,240 5,482
Total liabilities 8,032
10,966
SW's finance director has calculated that the company needs to raise BDT 1,827,777 of additional
long-term funds to provide finance for the following three matters:
➢ Over the past three years, SW's annual revenue has changed very little and so its senior
management is now considering extending operations into Chattogram and Sylhet. This would
necessitate expenditure of BDT 950,000 on new buildings and vehicles at the company's
existing distribution centre.
➢ SW's short-term borrowings comprise only a bank overdraft and the company is under pressure
from its bank to reduce that overdraft (which has stayed close to its current level for the past
eighteen months) to BDT 2 million.
➢ Its trade suppliers are unhappy that they have to wait, on average, 45 days to receive payment
and would like this figure reduced by ten days.
You are a member of SW's finance team and have been asked to prepare workings that would aid
management in their decision. Other information relevant to the situation is:

SW's total revenue (2019) BDT 28.5m

SW's net margin (2019) – before interest costs 3%
Bank overdraft interest rate (fixed) 17.5%
Dividends per share (2019) 5p
Earnings per share (2019) 9.25p
Gearing using book values: debt / (debt + equity) (2019) 46.5%
SW's marketing director believes that the expansion into Chattogram and Sylhet will generate
additional revenue of BDT 6m in 2020 and, because of the impact of fixed costs, it is estimated that
the net margin on these extra sales (before interest costs) would be 5%. SW's management
estimates that the 2019 dividend per share will be maintained in 2020.

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 You have been advised that, for the additional long-term funds, senior management wishes to use either
(i) A rights issue, with the new shares priced at about 20% below the current market value of BDT
1.55 per share; or
(ii) An issue of irredeemable debentures with a coupon rate of 10%. Currently investors expect a
12% return on similar debentures in the market.
The corporation tax rate is 30%. SW's management has assumed that there will be no additional
working capital requirements associated with the additional revenue.
Requirements:
(a) Demonstrate how SW's finance director calculated the long-term funding requirement of BDT
1,827,777. 2
(b) Assuming that SW needs to raise BDT 1,827,777, calculate:
(i) Its projected earnings per share figure for 2020 if it raises those funds by (a) a rights issue
or (b) a debenture issue. 5
(ii) SW's projected gearing figure at the end of 2020 if it raises those funds by (a) a rights issue
or (b) a debenture issue. 5
(c) Based on your workings in (b) above, recommend, with reasons, which, if either, method of
long-term funding SW's senior management should choose. 3
(d) Comment on the assumption made by SW's management that there would be no additional
working capital requirements associated with the additional revenue. 3

4. In the fashion world, marketing strategies are prerequisite for success. Sam Hassan is an over
ambitious challenging entrepreneur owning a casual wear company, Yellow Fashion Wear (YFW).
During 2019, YFW rocketed to Taka 100 million in sales after 10 years in business. Its fashion line
covered the young man and woman from head to toe with shirts, trousers, hats, sweaters, dresses,
blouses, skirts, pants, sweatshirts, socks, and shoes, etc. In major big cities there are Yellow shops
in every super market and streets..
The company’s historical growth was so spectacular that no one could have predicted it. However,
securities analysts speculated that Yellow could not keep up the pace. They warned that
competition is fierce in the fashion industry and that the firm might encounter little or no growth in
the future. They estimated that stockholders also should expect no growth in future dividends.
Contrary to the conservative analysts, Sam Hassan believed that the company could maintain a
constant annual growth rate in dividends per share of 6% in the future, or possibly 8% for the next
two years and 6% thereafter. Hassan based his estimates on an established long-term expansion
plan into USA and European markets. Venturing into these markets was expected to cause the risk
of the firm, as measured by the risk premium on its stock, to increase immediately from 8.8% to
10%. Currently the risk free rate is 6%.
In preparing the long term financial plan, Yellow’s chief financial officer has assigned you to
evaluate the firm’s current stock price. He has asked you to consider the conservative productions
of the securities analysts and the aggressive predictions of the company founder, Mr. Hassan.
You have compiled the following 2019 financial data to aid your analysis.
Data items 2019 value
Earnings per share (EPS) Tk. 6.25
Price per share of common stock Tk.40.00
Book value of common stock equity Tk.60,000,000
Total common shares outstanding 2,500,000
Common stock dividend per share Tk.4.00
Requirements:
a. What is the firm’s current book value per share and P/E ratio? 2
b. What is the current required return for Yellow’s stock? 2
c. What will be the new required return for Yellow’s stock assuming that the firm expands into
foreign markets (USA and Europe) as planned? 2
d. If the securities analysts are correct and there is no growth in future dividends, what will be the
value per share of Yellow Stock? 2
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 e. If Hassan’s prediction is correct, what will be the value per share of Yellow stock should the
firm maintain a constant annual 6% growth rate in future dividends? 2
f. If Hassan’s predictions are correct, what will be the value per share of Yellow stock should the firm
maintain a constant annual 8% growth in dividend per share over the next 2 years and 6% thereafter? 3
g. Compare the price of stock values found under different methods above. Which valuation
method do you believe most clearly represents the true value of the Yellow’s stock? 4

5. Best Hotels Limited is a listed company which owns a chain of hotels around the country. The
management of Best Hotels are investigating a BDT 195 million potential investment in the real
estate business which would be a diversification from its mainstream business. The investment
would involve the construction and management of a Shopping Mall. An initial investment
payment of BDT 120 million is payable immediately and the reminder upon completion of the
Shopping Mall at the end of year one. The operations would commence immediately after
completion of the Mall. The Shopping Mall is expected to operate for a period of 13 years after
which a major investment would be required. The residual value at the end of its life cycle (after 14
years from now) is projected to be BDT 45 million after tax. The rental charges would be based on
the floor area.
Type of floor area Number of shops Monthly rent per shop
Medium 40 BDT 65,000
Large 30 BDT 180,000
It’s expected that during the first year of operation the shop occupancy will be 60% for Medium
and 40% for Large. During the subsequent years, the shop occupancy would be at full capacity.
Annual operating costs are expected to be 45% of the annual revenue.
The corporate tax rate is 37.5% per year.
Requirements:
(a) Evaluate the proposed investment in the Real Estate Business using the Net Present Value
method. Assume the cost of capital is 13% per year. 10
(b) Assuming the role of a Financial Consultant, write a brief report to the management of Best
Hotels Ltd, discussing the non-financial factors that should be considered before the decision to
diversify into the real estate business is made. 5

6. SBN, one of the largest plant wholesalers in Bangladesh, was poised for expansion. Through strong
profitability, a conservative dividend policy, and some recent realized gains in real estate, SBN has
a strong cash position and was searching for a target company to acquire. The executive members
on the acquisition search committee had agreed that they preferred to find a firm in a similar line of
business rather than one that would provide broad diversification. It would be their first acquisition,
and they preferred to stay in a familiar line of business. Abdur Rahman, Director of Marketing, had
identified the targeted lines of business through exhaustive market research.
Mr. Rahman had determined that the servicing of plants in large commercial offices, hotels, zoos,
and theme parks would complement the existing wholesale distribution business. Frequently SBN
was requested by its large clients to bid on a service contract. However, the company was neither
staffed nor equipped to enter this market. Mr. Rahman was familiar with the major plant service
companies in the places nearing Dhaka and had suggested GPC as an acquisition target because of
its significant market share and excellent reputation.
GPC had successfully commercialized a market that had been dominated by small local contractors
and in house landscaping departments. Beginning with a contract from one of the largest theme
parks in the Bangladesh. GPC’s growth in sales has compounded remarkably over the last 8
years.GPC had also been selected because of its large portfolio of long –term service contracts with
several major DSE listed companies. These contracted clients would provide a captive customers
base for the wholesale distribution of SBN plants products.
In a conference Mr. Rahman offered a proposal for merger to the GPC President. GPC President
had reacted favourably and subsequently provided financial data including GPC’s earnings records
and current balance sheet. These data are presented in Table-1 and Table-2.

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The CFO of SBN had estimated the incremental cash after taxes from the acquisition would be
Tk.18,750,000 for year 1 and 2; Tk. 20,500,000 for year 3; Tk. 21,750,000 for year 4; Tk.
24,000,000 for year 5; and Tk. 25,000,000 for years 6 through 30. He also estimated that the
company should earn a rate of return of at least16% on an investment of this type. Additional
financial data are given in Table-3.

TABLE -1
GPC Earning records
Year EPS Year EPS
2011 2.20 2015 2.85
2012 2.35 2016 3.00
2013 2.45 2017 3.10
2014 2.60 2018 3.30

TABLE-2
GPC Balance sheet (31 December, 2018) (Figures in Taka)
Assets Liabilities and equity
Cash 2,500,000 Current liabilities 5,250,000
Accounts receivable 1,500,000 Mortgage payable 3,125,000
Inventories 7,625,000 Common stock 15,625,000
Land 7,475,000 Retained earning 9,000,000
Fixed assets net 13,900,000
Total assets 33,000,000 Total liabilities and equity 33,000,000

TABLE-3
SBN and GPC Financial data (December 31, 2018)
SBN GPC
Earnings available for common stock (Tk.) 35,000,000 15,246,000
Number of shares of Common stock 10,000,000 4,620,000
Market price per share (TK.) 50 30*
*estimated by SBN
Requirements:
a. What is the maximum price SBN offer GPC for a cash acquisition? (assume relevant time
horizon for analysis is 30 years). 5
b. If SBN planned to sell bonds to finance 80% of the cash acquisition price found in part 1, how
might issuance of each of the following bonds affect the firm?. Describe pros and cons of each
bond such as: straight bond, convertible bond, bonds with stock purchase warrant attached. 3
c. What is the ratio of exchange in a stock swap acquisition if SBN pays Tk. 30 per share of GPC?
Explain why? 2
d. What effect will this swap of stock have on the EPS of the original share holders of SBN and
GPC? Explain why? 3
e. If the merger attributed to SBN’s assets grow at a much slower rate than those attributed to
SBN’s premerger assets, what effect might this growth have on the EPS of the merged firm
over the long run? 3
f. What impact would GPC, being a foreign based company, have on the foregoing analysis?
Describe the added regulations, costs, benefits, and risks that are likely to be associated with
such an international merger. 4

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