Birla Institute of Technology & Science, Pilani Hyderabad Campus

II Semester 2017-18
Comprehensive Examination (Closed Book)
Course No.: ECON F315 / FIN F315 Marks: 40. Date: 01-05-2018
Course Title: Financial Management Duration: 3 Hrs. Time: 9:00 AM to 12:00 Noon

Q:1/ On 01/04/2017, you purchased a premium car (Mercedes Benz) on a lease of Rs. 20,000 (as
lease rental) per month for 6 years from M/s Ashok Leyland Finance Ltd. You have paid lease
rental for one year ending 31/03/2018 and from 01/04/2018 onwards you have been in financial
difficulties in meeting lease rental commitments. Therefore, you approached the leasing
company to revise the terms of lease with an assumption that you will not able to pay
instalments for next one year up to 31/03/2019. However, you want to keep the total
repayment period same (2023) as before. The leasing company agreed to waive next 12
instalments (2018-19) by increasing the amount to Rs.27,500 per month for the remaining
period (4 years). If your opportunity cost of capital is 12%, should you accept the revised
payment terms from the leasing company? Justify. Also find to what revised lease rents you
could remain indifferent. [5.00]

Q:2/ You are analyzing the beta for Hewlett Packard and have broken down the company into four
broad business groups, with market values and betas for each group.

Business Group Market Value of Equity Beta

Mainframes Rs. 2.0 billion 1.1
Personal Computers Rs. 2.0 billion 1.5
Software Rs. 1.0 billion 2
Printers Rs. 3.0 billion 1

A. Estimate the beta for Hewlett Packard as a company. Is this beta going to be equal to the beta
estimated by regressing past returns on HP stock against a market index? Why or Why not?
B. If the treasury bond rate is 7.5%, estimate the cost of equity for Hewlett Packard. Estimate the
cost of equity for each division. Which cost of equity would you use to value the printer division?
Assume market premium as 5.5%.
C. Assume that HP divests itself of the mainframe business and pays the cash out as a dividend.
Estimate the beta for HP after the divestiture. (HP had Rs. 1 billion in debt outstanding). The tax
rate is 36%. [1+2+2=5]

Q:3/ Flamingo enterprise is operating at 50% capacity. The annual output of the firm at the current
capacity level is 300000 units. The increasing market size and demand for its products has made
the company management to increase its capacity level to 80% in financial year 2017-18. The
cost structure for Flamingo Ltd is as follows:

(Rs. per unit)

Materials and Stores 8
Wages 4
 Variable overheads 4
Selling price 20

The current assets and current liabilities of Flamingo Ltd stood as follows on 31.3.2017.

(units) (Rs)
Materials and stores 80,000 6,40,000
Work in process 40,000 4,80,000
Finished goods 50,000 8,00,000
Accounts receivables - 7,80,000
Accounts payable - 4,00,000
Wages payable - 3,20,000
Other expenses payable - 1,20,000
The total fixed overheads for the firm at its current capacity level amount to Rs.3.5 lakhs. Since
the firm has surplus capacity available, increasing the production level in the next financial year
will not add much to the fixed overheads. They will go up marginally by 10%. Estimate the
additional working capital requirements for Flamingo Ltd. making the following assumptions:
A. The prices of material are likely to remain unchanged in the coming year. Even the wage
rate is likely to remain unchanged.
B. Work in process is 50% complete as regards wages and variable overheads
C. The time lags in the payments made to / by the firm are likely to remain unchanged in the
coming financial year. [10.00]

Q:4/ Equifax company has sales of Rs.25,00,000. Average Collection period is 50 days, bad debt losses
are 5% of sales and collection expenses are Rs.25,000. The cost of funds is 15%. The company
has two alternative Collection programmes:

Programme I Programme II
Average Collection period reduced to 40 days 30 days
Bad debt losses reduced to 4% of sales 3% of sales
Collection expenses 50,000 80,000

Which programme should the company choose? [5.00]

Q:5/ You have been asked to analyze the capital structure of Bhushan Steel Ltd. The company has
supplied you with the following information: There are 100 million shares outstanding, trading
at $ 10 a share; The firm has debt outstanding of $ 500 million, in market value terms; The beta
for the firm currently is 1.04, the risk free rate is 5% and the market risk premium is 5.5%; The
firm’s current bond rating is A; the default spread for A rated bond’s is 1.5%; The effective tax
rate is 20%, but the marginal tax rate is 40%.
a) Estimate the current cost of capital for Bhushan Steel Ltd.
b) Now assume that you have computed the optimal debt to capital ratio to be 50%. If
the pre-tax cost of debt will rise by 0.25%, if it moves to the optimal, estimate the
new cost of capital at 50%.
c) Estimate the change in stock price from moving to the optimal debt ratio, assuming
that you are planning to borrow money and buy back stock, and that you can buy
 the stock back at an average price of $11.50.
[2+2+2=6]
Q: 6/ You have been asked to assess the implied risk premium on the NSE. The index is trading at
Rs.1050, and the dividend yield is 3%. The current long term bond rate is 6.5%, and the expected
long term nominal growth rate in the economy is 6%. Estimate the implied risk premium for
equities. Explain why Implied Equity Risk Premium (IERP) is considered to be better proposition
than equity risk premium (ERP) while calculating expected rate of return of equity shareholders.
[3.00]

Q:7/ Robotics international corporation (RIC) is considering the production of industrial robots for the
television manufacturing industry. The net investment for this project will be broken down into
3 stages. In stage one they want to conduct a $500,000 study of the market potential for using
robotics in television assembly lines. Management estimates that there is a probability of 0.8
that the marketing study will produce favorable results, and 0.2 probability that will produce
negative results. If it appears that a sizable market for television assembly robots does exist,
they want to design and fabricate several prototype robots, in stage two they want to spend
$1000,000 to design and fabricate several prototype robots. These robots would then be
evaluated by television industry engineers, and their reactions would determine whether RIC
would proceed with the project. Management estimates that there is a 60% possibility that the
television engineers will find the robot useful and a 40% probability that they will not like it. If
reaction to the prototype robots is good, in stage three, they want to build a production plant at
a net cost of $10,000,000. If this stage were reached, managers estimate that the project would
generate net cash flows over the following 4 years which depend on how well the final product
was accepted by TV manufacturers. There is a 30% chance that acceptance of robots will be
quite good and net cash flows will be $10,000,000 per year, a 40% probability that of cash flows
of $4,000,000 each year and a 30% chance of a $2,000,000 loss per year form year 3 to year 6.
The company has a cost of capital of 11.5%.

Whether the RIC should accept the project or not? (Note: Compute the NPV and riskiness of the
project with the help of decision tree analysis). [6.00]