Chapter 3

Solved Problem 1

Price in No. of outstanding

Price in shares Market capitalisation in
Share base year Price Relative
year t (Rs.) the base year (1 x 4)
(Rs.)
(in million)
1 2 3 4 5
A 40 30 75 3 120
B 60 75 125 12 720
C 20 40 200 6 120
D 75 90 120 5 375
195 235 520 1335

The price weighted index for yeat t is = 121

The equal weighted index for yeat t is = 130
The value weighted index for yeat t is = 126
Market capitalisation in
year t

(2 x 4)
6
90
900
240
450
1680
 Chapter 4
1
Stock Beginning price Dividend paid Ending pice Total return Return relative
A 30 3.4 34 24.67% 1.25
B 72 4.7 69 2.36% 1.02
C 140 4.8 146 7.71% 1.08

2
Year 3 Year 4 Year 5
Year 1 return(R1) Year 2 return(R1)
return(R1) return(R1) return(R1)
0.07 0.03 -0.09 0.06 0.1
(a) Cumulative wealth index 1.17
(b) Arithmetic Man 3.40%
(c) Geometric Mean 3.18%
(d)
The variance and standard deviation are calculated as under

Return in % Deviation Square of deviations

Period
Ri (Ri –R(mean)) (Ri – R(mean))2

1 7 3.60 12.96
2 3 -0.40 0.16
3 -9 -12.40 153.76
4 6 2.60 6.76
5 10 6.60 43.56
A.M= 340.00% Sum 217.2
=
Varince = 54.3
Standard deviation = 7.37 percent
Alternatively we may use the
Excel built-in formula STDEV : 7.37 percent

3
Probability(p) Rate of return( R)
0.2 0.05
0.4 0.1
0.1 0.08
0.3 0.11
Expected rate of
return(R') 9.10%
 Solved problem 5.1
Investment today 5,000
Interest rate 9%
No. of years of investment 75
Future value 3,205,954.47

2
Interest rate in percentage 12
Doubling period as per rule of
72 6
69 6.1

3
Nominal rate of interest 16%
No. of compoundings in a year 4
Effective rate of interest 17%

4
No. of annual deposits 15
Amount of each deposit 5,000
Rate of interest per annum 14%
Total period of deposit in years 15
Future value of the annuity 219,212

5
Period of deposit in years 5
Amount of annual deposit 6,000
Lumpsum payment at the end 44,650
Implicit interest rate 20%

6
Future value 1,000,000
Period 60
Discount rate 10%
Present value 3,284

7
No. of annuity payments 12
Amount of annuity payment 10,000

No. of years at the end of which

the first annuity payment occurs 8
Discount rate 14%
Value of the annuity at the end
of the year
8 56,603
Present value of the annuity 22,621

8
Discount rate 14%
Year 0 1 2 3 4
Cash flow 5,000 6,000 8,000 9,000 8,000
Present value 27,230

9
Amount of deposit 200,000
Interest rate 10%
No.of annual withdrawals 15
Amount of each withdrawal 26,295

10
Cost of the tour 1,000,000
Amount of annual savings 80,000
Rate of interest per annum on
savings 14%
No. of years of waiting 7.72

11
Amount of borrowal 80,000
Monthly interest rate 1.25%
No. of monthly instalments 12
Monthly instalment amount 7,221
Loan amortisation schedule
Monthly Principal Remaining
Month Beginning amount instalment Interest repayment balance
1 80,000 7,221 1000 6,221 73,779
2 73,779 7,221 922.2 6,298 67,481
3 67,481 7,221 843.5 6,377 61,104
4 61,104 7,221 763.8 6,457 54,647
5 54,647 7,221 683.1 6,538 48,109
6 48,109 7,221 601.4 6,619 41,490
7 41,490 7,221 518.6 6,702 34,788
8 34,788 7,221 434.8 6,786 28,002
9 28,002 7,221 350.0 6,871 21,132
10 21,132 7,221 264.1 6,957 14,175
11 14,175 7,221 177.2 7,043 7,132
12 7,132 7,221 89.1 7,132 0
 Solved problem 6.1
Balance Sheet of Matrix Limited for the year ended march 31,20X1
Rs. In million
20X1 20X0
Equity And Liabilities
Shareholders’ Funds 620 455
Share capital * 125 125
Reserves and surplus 495 330
Non-Current Liabilities 300 295
Long-term borrowings** 196 205
Deferred tax liabilities(net) 92 80
Long-term provisions 12 10
Current Liabilities 132 113
Short-term borrowings 90 75
Trade payables 20 24
Other current liabilities 10 8
Short-term provisions 12 6
Total 1052 863
Assets
Non-Current Assets 650 555
Fixed assets 600 495
Non-current investments 20 20
Long-term loans and advances 30 40
Current Assets 402 308
Current investments 17 5
Inventories 165 138
Trade receivables 175 115
Cash and cash equivalents 25 20
Short-term loans and advances 20 30
Total 1052 863
* Par value of share (Rs.) 10
** Out of whch
Statement payable
of Profit andin 1 year
Loss for Matrix Limited for the year ended March 31, 50
20X1
Rs.in million
Revenue from operations 1065
Other income@ 35
Total revenues 1100
Expenses
Material expenses 600
Employee benefits expenses 120
Finance costs 35
Depreciation and amortization expenses 50
Other expenses 10
Total expenses 815
Profit before exceptional and extraordinary items and tax 285
Exceptional items
Profit before extraordinary items and tax 285
Extraordinary items
Profit before tax 285
Tax expenses 95

Profit( loss for the period) 190

Dividends 25
Tax rate asumed = 30%
Note:

As per the revised balance sheet

           
format, the portion of the long term
borrowings maturing during the current
period are to be segregated and classified
under the head ‘other current liabilities’.
As such, instalments of term loans
repayable in the next 12 months should
already have been reduced from the
outstanding long term liabilities balance
and added to current liabilities. In the
problem, however, for illustrative purpose
it has been assumed that the same has not
been done.

(a) Sources and uses statement for the period 1-4-20X0 to 31-3-20X1
(

Net profit 190

Depreciation and amortisation 50

Increase in deferred tax liabilities 12

Increase in long-term provisions 2
Increase in short-term borrowings 15
Increase in other current liabilities 2
Increase in short-term provisions 6
Decrease in long-term loans and advances
10
given
Decrease in short-term loans and advances
10
given
Total sources 297
(ii)

Cash Flow Statement

Rs. in million
A. CASH FLOW FROM OPERATING ACTIVITIES
PROFIT BEFORE TAX 285
Adjustments for:
Depreciation and amortisation 50
Finance cost 35
Interest income -35
OPERATING PROFIT BEFORE WORKING
335
CAPITAL CHANGES
Adjustments for changes in working
capital:
Trade receivables and short-term loans and
-50
advances
Inventories -27
Current investments -12
Trade payables, short-term provisions, and
4
other current liabilities
CASH GENERATED FROM OPERATIONS 250
Direct taxes paid -95
NET CASH FROM OPERATING
155
ACTIVITIES
B.CASH FLOW FROM INVESTING
ACTIVITIES
Purchase of fixed assets -155
Increase in non-current investments 0
Interest income 35
NET CASH USED IN INVESTING
-120
ACTIVITIES
C.CASH FLOW FROM FINANCING
ACTIVITIES
Decrease in long- term borrowings -9
Increase in long-term loans and advances
10
given
Increase in short-term borrowings 15
Increase in deferred tax liabilities 12
Increase in long-term provisions 2
Dividend paid -25
Finance costs -35
NET CASH USED IN FINANCING
-30
ACTIVITIES
NET CASH GENERATED (A+B+C) 5
CASH AND CASH EQUIVALENTS AT THE
20
BEGINNING OF PERIOD
CASH AND CASH EQUIVALENTS AT THE
25
END OF PERIOD

2
Current assets 1,600
Current liabilities 1,000
Minimum current ratio 1.25
Maximum borrowing 1400

3
Current ratio 1.4
Acid-test ratio 1.2
Current liabilities 1,600
Inventory turnover ratio 8
Current assets 2,240
Inventories 320
Sales 2,560

4
Net profit margin ratio 4%
Current ratio 1.25
Return on net worth 15.23%
Total debt to total assets ratio 0.4
Inventory turnover ratio 25
Solution are the figures in italics in the following statements
Profit and Loss account
Sales 2535.8
Cost of goods sold 1587.9
Operating expenses 700
Profit before interest and tax 247.9
Interest 45
Profit before tax 202.9
Tax provision at 101.4
50%
Profit after tax 101.4
Balance sheet
Net worth 666 Fixed assets
Long-term debt: interest at Current assets
15% 300 Cash
Accounts payable 144 Receivables
Inventory
Total 1110 Total
(c )
Current ratio 2.21
Acid-test ratio 1.30
Cash ratio 0.23
Debt-equity ratio 0.70
Interest coverage ratio 9.14
Fixed charges coverage ratio 3.48
Inventory turnover ratio 4.95
Debtors turnover 7.34
Average collection period 49.69 days
Total assets turnover ratio 1.15
Gross profit margin 29.58%
Net profit margin 17.27%
Return on assets 19.84%
Earning power 33.42%
Return on equity 35.35%

@
Consists entirely of interest income
 Cost of goods sold(Rs.in million) 750

or the period 1-4-20X0 to 31-3-20X1

Rs. in million
Uses
Dividend payment 25

Decrease in long-term borrowings 9

Decrease in trade payables 4

Purchase of fixed assets 155

Increase in current investments 12

Increase in inventories 27

Increase in trade receivables 60

Total uses 292

Net addition to cash 5

Net addition to cash 5
930
180
18.6
60
101.4
1110
Solved problem 7.1
Return on a
portfolio of half
Return on share each of Box
Probability Return on Box's stock Cox's stock and Cox
High growth 0.3 100 150 125
Low growth 0.4 110 130 120
Stagnation 0.2 120 90 105
Recession 0.1 140 60 100
Current selling price of both the
shares 100

Portfolio
where a unit
consists of
half share
each of Box
Box Limited Cox Limited and Cox
Amount invested 1,000 1,000 1,000
No.of shares/units that can be
purchased 10 10 10
Expected return 1120 1210 1165
Standard deviation 116.62 291.38 89.58

Square of the
deviation of the
Return on
State of nature Probability Return on asset 1(%) return on asset 1
asset 2(%) from its expected
value

1 0.1 5 0 64
2 0.3 10 8 9
3 0.5 15 18 4
4 0.1 20 26 49
Expected value of the return on asset 1 = 13
Expected value of the return on asset 2 = 14
(a)Standard deviation of the return on asset 1 = 4.00
Standard deviation of the return on asset 2 = 7.27
(b )Covariance
( c) Coefficient between
of correlation the returns
between on assets
the returns 1 and 12 and
on assets = 2 29.00
= 1.00

3
Security no. 1 2 3
Proportion of the security in the
portfolio 0.3 0.5 0.2
Standard deviation of the security 6.0 9.0 10.0
Correlation coefficient between
securities 1 and 2 1 and 3 2 and 3
Correlation coefficient 0.4 0.6 0.7
Standard deviation of portfolio
return 7.13

5
Stock P Stock Q
Expected return 16% 18%
Standard deviation 25% 30%
Coefficient of correlation between
P&Q -1
Weight of P in a portfolio with 0
standard deviation 54.55%

Expected return of such portfolio 16.91%

6
Stock A Stock B
Expected return (%) 16 12
Standard deviation(%) 15 8
Coefficient of correlation between the two stocks 0.6
(a) Covariance
(b) Expected returnbetween the two
of a portfolio stocksA & B
in which 72
have weights of 0.6 & 0.4 (%) 14.40
(b) Risk of a portfolio in which A & B have
weights of 0.6 & 0.4 (%) 11.22
 Product of the
Square of the deviation of the
deviation of the return on asset 1
return on asset 2 from its mean and
from its expected the deviation of the
value. return on asset 2
from its mean
196 112
36 18
16 8
144 84
 Solved Problem 8.1

Aggressive
Market return(%) Stock(%) Defensive Stock(%)
6 2 8
20 30 16
(a) Beta of the aggressive stock 2
Beta of the defensive stock 0.571
(b)

Market Aggressive Defensive

Probability return(%) Stock(%) Stock(%)
0.5 6 2 8
0.5 20 30 16
Expected return on the aggressive stock(%) 16
Expected return on the defensive stock(%) 12
( c)
Expected return on the market portfolio(%) 13
Market risk premium (%) 6
The SML is = 7%+βix 6%
(d)
Required return of the aggressive stock (%) 19
Alpha of the aggressive stock(%) -3
Required return of the defensive stock (%) 10.429
Alpha of fhe defensive stock (%) 1.571

2
Return on
Return on stock market
Period A (%) portfolio(%)
1 22 12
2 13 14
3 17 13
4 15 10
5 14 9
6 18 13
7 16 14
8 6 7
9 (8) 1
10 13 12
11 14 (11)
12 (15) 16
13 25 8
14 9 7
15 (9) 10
 Beta 0.032
Alpha 9.71
The characteristic lin RA = 9.71+0.032RM
Solved problem 11.1
Par value of the bond 100
Coupon rate 12%
Maturity period in years 5
Discount rate 15%
Settlement date(say) 1/1/2007
Maturity date 12/31/2011
Value of the bond(Price) 89.95

2
Par value of the bond 1,000
Market price of the bond 1,050
Coupon rate 14%
Maturity period in years 5
Settlement date(say) 1/1/2007
Maturity date 12/31/2011
a) & (b) Yield to maturity 12.59%
(c ) Reinvestment rate 12%
Future value of investment 1,889.40
Realised yield to maturity 12.47%

3
Par value of the bond 100
Coupon rate 14%
Maturity period in years 5
No.of interest payments in a year 2
Required rate of return 16%
Settlement date(say) 1/1/2007
Maturity date 12/31/2011
Value of the bond 93.29
 4
Face value Interest rate Maturity( years) Current price
100,000 0 1 91,000
100,000 10.50% 2 99,000
100,000 11.00% 3 99,500
100,000 11.50% 4 99,900

Interest rate for year 1 9.89%

Current price Forward rate
99,000 12.42%
99,500 11.50%
99,900 12.78%
 Note: We have made use of the Goal Seek feature in Excel to get the forward rates above.

For this, in cell G42 only type the formula to start with even while keeping cell H42 blank. Then go to menu
DATA > What if Analysis > Goal Seek. Enter the target cell no. as G42 and varying cell as H42. Set the target cell
value to 99000 and press OKAY. The required value in cell H42 would be automatically filled in. Similarly the
forward rates for the other years may be obtained.
Solved problem 12.1
(Amounts in Rs.)
Face value of the bond 100
Coupon payable annually 12%
Years to maturity 6
Redemption value 100
Current market price 110
Settlement date(Date of purchase,say) 1/1/2016
Redemption date 12/30/2021
a) Yield to maturiry 9.72% using the actual formula
b) Duration (in years) 4.67

2
Period of the annuity in years 10
Yield p.a. 9.00%
Duration in years 4.80

3
Frequency of coupon payment per year 2
Coupon rate p.a 10%
Yield to maturity per half year 4%
Term to maturity in years 12
a) Durarion of the bond(in half years) 15.17

4 (Amounts in Rs.)
Maturity obligation to pay 215,900
Term of the obligation in years 10
Market interest rate p.a. 8%
Present value of the obligation 100,003
Term of the ZCBs to be used (in years) 6
Duration of the perpetuities to be used(in
years) 13.50
Proportion of investment in zero coupon Keep B32 blank to start with. Enter the formula given below in B3
bonds 0.467 10. The correct value will be automatically filled in B32
Term of the obligation in years 10 =B32*B30+(1-B32)*B31

Proportion of investment in perpetuities 0.533

5 (Amounts in Rs.)
Par value of the bond 100,000
Coupon rate p.a. payable annually 9%
Term to maturity in years 5
Current yield to maturiy 8%
Horizon period of the portfolio manager ( in
years) 2
Expected yield at the end of years 2 of a 3 year maturity bond=
Expected reinvestment of the coupon
income over the next 2 years is p.a
Current price of the bond 103,993
Forecast price 105,249
Future value of reinvested coupon 18,540
Return for 2 years 19.04%
The expected annualised return over the
two year period 9.10%
nter the formula given below in B33 and use the Goal Seek feature in Data>What-if-Analysis by setting the value of B33 to
tomatically filled in B32
 7%

6.00%
Solved problem 13.1
Current selling price per share 30
Dividend expected next year 2
Required rate of return 15%
Expected growth rate 8.3%

2
Growth rate in dividends 18%
Period of 18% growth rate in years 4
Subsequent growth rate 12%
Period of 12% growth rate in years 4
Growth rate after 8 years, forever 6%
Last dividend per share 2
Required rate of return on equity 15%
Year DividendPV of dividend
1 2.36 2.05
2 2.78 2.11
3 3.29 2.16
4 3.88 2.22
5 4.34 2.16
6 4.86 2.10
7 5.45 2.05
8 6.10 1.99
Price of the share at the end of 8 years 71.86
Present value of the price of the share at
the end of 8 years 23.49
Intrinsic value per share 40.33

3
Current dividend 3
Initial Supergrowth rate 40%
Period in years for the supergrowth rate 5
Consequent stable growth rate 12%
Required return 15%
Intrinsic value of the share 327.60

4
Current dividend 5
Present growth rate 50%
Linearly declining period in years 8
Stable rate after 8 years 10%
Required rate of return 18%
Intrinsic value per share 168.75
 Solved minicase 15.1
The financials of GSM Limited (Rs. In million)
20X1 20X2 20X3 20X4 20X5
Net sales 1020 1090 1210 1350 1520
C ost of goods sole 734 807 883 959 1095
Gross profit 286 283 327 391 425
Operating expenses 72 74 85 105 120
Operaing profit 214 209 242 286 305
Non-operating surplus/deficit 11 14 18 -12 -5
PBIT 225 223 260 274 300
Interest 40 45 60 66 55
Profit before tax 185 178 200 208 245
Tax 35 38 40 52 50
Profit after tax 150 140 160 156 195
Dividends 60 60 65 65 70
Retained earnings 90 80 95 91 125
Equity share capital (Rs. 10 par) 200 200 200 250 250
Reserves and surplus 400 480 575 616 741
Shareholders' funds 600 680 775 866 991
Loan funds 400 450 550 600 615
Capital employed 1000 1130 1325 1466 1606
Net fixed assets 600 650 710 850 900
Investments 50 55 60 70 80
Net current assets 350 425 555 546 626
Total assets 1000 1130 1325 1466 1606
Market price per share(year end) Rs. 60 55 65 57 75

(a)
20X1 20X2 20X3 20X4 20X5
Bonus adjustment factor 1 1 1 1.25 1.25
Adjusted EPS Rs. 7.50 7.00 8.00 7.80 9.75
PE ratio(prospective) 8.57 6.88 10.42 7.31
PE ratio(retrospective) 2.00 1.62 1.68 1.65 1.89
Retention ratio 0.60 0.57 0.59 0.58 0.64
Return on equity 25.00% 20.59% 20.65% 18.01% 19.68%
Book value per share Rs. 30.00 34.00 38.75 34.64 39.64
EPS Rs. 7.50 7.00 8.00 6.24 7.80

(b)
CAGR of Sales 10.49%
CAGR of EPS 6.78%
Volatility of ROE 33.61%

(c )
Sustainable growth rate 11.78%
(d)
ROE for 20X4 0.203 x 0.921 x 0.759
ROE for 20X5 0.197 x 0.946 x 0.817

(e )

20X5 20X6 Remarks

Net sales 1520 1702.40 Increase by 12%
Cost of goods sold 1095 1215.45 Increase by 11%
Operating expenses 120 132.00 Increase by 10%
Net operating surplus/deficit -5 0.00 Will be 0
PBIT 300 354.95
Interest 55 53.90 Decrease by 2%
Profit before tax 245 301.05
Tax 50 67.46 Increase of tax rate 2%
Profit after tax 195 233.59
EPS Rs. 9.34

(f)
Average payout ration for 20X3-20X5 0.39
Risk-free rate 0.09
Beta of GSM's stock 0.90
Market risk premium 0.08
The required rate of return 0.16
Expected growth rate in dividends 0.12
PE ratio as per the constant growth
model 8.92
(g)
Value anchor 83.37
Rs. In million)
x 0.750 x 1.693
x 0.796 x 1.621
Solved problem 17.1
(Amounts in Rs.)
S E u r d R
60 55 1.35 0.12 0.7 1.12
Cu 25.99852 ∆ 0.67 Use the Goal Seek feature in the dropd
Cd 0 B 25.00 'what-if-analysis': Holding C4 blank all
C 15.00 the formulae for Cu and Cd in their re
and that for call option(=E5*A4-E6 ) i
D7 equal to the value 15 and keep th
The stock is expected to rise by 1.35 or 35% cell C4 as variable.

2
S E u r d R
60 50 1.4 0.12 0.8 1.12
Cu 34 ∆ 0.94
Cd 0 B 40.48
C 16.19

3
S0 E rf σ t(in years)
120 110 0.12 0.4 0.5
d1 d2 N(d1) N(d2)
0.6612 0.3783 0.7458 0.6474
C0 22.42233

4
Call option Put option
Time to expiration(years) 0.25 0.25
Risk-free rate 10% 10%
Exercise price(Rs.) 50 50
Stock price(RS.) 60 60
Price (Rs.)--as given 16 2
Call option if put-call parity
were working (Rs.) 13.23
So, the parity condition is not working in this case

6 (All amounts in Rs.)

Current stock price 100
Possible rise in 1 year 60%
Possible fall in 1 year 20%
Risk-free interest rate 10%
Exercise price in an year's
time 110
Probability of rise in stock Keep B40 blank to start with. Enter the formula given below in B41 and use the G
price 0.38 B41 to 10%. The correct rate of return will be automatically filled in B40
Expected return 0.1 =B40*B36+(1-B40)*-B37
Value of the call option if the
stock price rises 50
Value of the call option if the
stock price falls 0

Expected value of the call

option under the risk neutral
method 18.75
Current value of call option 17.05
Goal Seek feature in the dropdown menu of
analysis': Holding C4 blank all along, enter
mulae for Cu and Cd in their respective cells
for call option(=E5*A4-E6 ) in cell D7. Set
l to the value 15 and keep the value of u in
cell C4 as variable.

n below in B41 and use the Goal Seek feature in Data>What-if-Analysis by setting the value of
atically filled in B40
 Solved problem 18.1
(amounts in Rs.)
Current stock price 16
Risk-free rate 9%
Maturity period (years)of the stock
futures 1/12
Current futures price 16.12

2
Current price of the stock index 3500
Risk-free rate 8%
Maturity period (years)of the stock
index futures 0.5
Expected dividend yield on the
index 2%
Current futures price 3603.47
 Solved problem 19.1

Return from own investment in equity shares 15%

Exit load of the recently announced mutual fund 1%
Recurring annual expenses of that mutual fund 2.00%
Return expected from the investment by you 15%
Return that should be earned by the mutual fund 18.53%
 Solved problem 21.1
Rate of return earned in $ terms 13%
Period in which earned(year) 1
Depreciation of USD over INR in that period 5%
Realised rate of return in INR terms 7.35%

2
Variance of USD rate of return on Berkshire Hathway shares(%) 100.00
Variance of the exchange rate change(%) 25.00
Covariance between the USD rate of return on Berkshire Hathway shares
and exchange rate change (%) -20.00
Variance of INR rate of return on Berkshire Hathway (%) 85.00
 Solved problem 23.1
(Amounts in Rs.million)
Period 1 2 3 4
Rate of return 7% 16% 10%
Beginning value of assets 100.00 117.00 137.72
Investment profit during the period 7.00 18.72 13.77
Net inflow at the end 10.00 2.00 0.00
Ending value of the assets 117.00 137.72 151.49
Period 0 1 2 3
Net cash flow -100.00 -10.00 -2.00 151.49
Rupee weighted average return (IRR) 11.05%
Arithmetic average return 11%
Time-weighted average return(GM) 10.94%

Solved Problem 23.2

Mean Standard Treynor Sharp

Fund return deviation Beta Measure Measure
A 12 18 1.1 5.455 0.333
B 10 15 0.9 4.444 0.267
C 13 20 1.2 5.833 0.350
Market Index 11 17 1 5.000 0.294
Risk-free return 6 0 0
Jensen Measure M2 Measure
0.500 0.667
-0.500 -0.467
1.000 0.950
0.000 0.000