Test Series: October, 2018

MOCK TEST PAPER –2

FINAL COURSE: GROUP – I
PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT (OLD)

SUGGESTED ANSWER / HINTS

1. (a) Number of index future to be sold by the Fund Manager is:

1.1 90,00,00,000
= 4,605
4,300  50
Justification of the answer:
11
Loss in the value of the portfolio if the index falls by 10% is Rs. x90 Crore = Rs. 9.90 Crore.
100
0.1 4,300  50  4,605
Gain by short covering of index future is: = 9.90 Crore
1,00,00,000
This justifies the answer cash is not part of the portfolio.
4
(b) βp = xβ
i1
i i

= 1.60 x 0.25 + 1.15 x 0.30 + 1.40 x 0.25 + 1.00 x 0.20

= 0.4 + 0.345 + 0.35 + 0.20 = 1.295
The Standard Deviation (Risk) of the portfolio is
= [(1.295) 2(18)2+(0.25)2(7)2+(0.30)2(11)2+(0.25)2(3)2+(0.20)2(9)2)]
= [543.36 + 3.0625 + 10.89 + 0.5625 + 3.24] = [561.115] ½ = 23.69%
Alternative Answer
The variance of Security’s Return
2 =  i2 2m + 2εi
Accordingly, variance of various securities
2 Weight(w) 2Xw
L (1.60)2 (18)2 + 72 = 878.44 0.25 219.61
M (1.15)2 (18)2 + 112 = 549.49 0.30 164.85
N (1.40)2 (18)2 + 32 = 644.04 0.25 161.01
K (1.00)2 (18)2 + 92 = 405.00 0.20 81
Variance 626.47

SD = 626.47 = 25.03
(c) (i) Returns for the year
(All changes on a Per -Unit Basis)
Change in Price: Rs.48 – Rs.45 = Rs. 3.00
Dividends received: Rs. 1.00
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 Capital gains distribution Rs. 2.00
Total reward Rs. 6.00
` 6.00
Holding period reward:  100  13.33%
` 45
(ii) When all dividends and capital gains distributions are re-invested into additional units of the
fund @ (Rs. 46/unit)
Dividend + Capital Gains per unit = Rs. 1.00 + Rs. 2.00 = Rs. 3.00
Total received from 200 units = Rs. 3.00 x 200 = Rs. 600/-.
Additional Units Acquired = Rs. 600/Rs. 46 = 13.04 Units.
Total No. of Units = 200 units + 13.04 units = 213.04 units.
Value of 213.04 units held at the end of the year
= 213.04 units x Rs.48 = Rs. 10225.92
Price Paid for 200 Units at the beginning of the year = 200 units x Rs. 45 = Rs. 9000.00
Holding Period Reward Rs. (10225.92 – 9000.00) = Rs.1225.92
`1225 .92
Holding Period Reward =  100  13.62%
` 9000
(d) Here we can assume two cases (i) If investor is US investor then there will be no impact of
appreciation in $. (ii) If investor is from any other nation other than US say Indian then there will
be impact of $ appreciation on his returns.
First we shall compute return on bond which will be common for both investors.
(Price at end - Price at begining)+Interest
Return =
Price at begining
(5250  5000)  350
=
5000
250  350
= =0.12 say 12%
5000
(i) For US investor the return shall be 12% and there will be no impact of appreciation in $.
(ii) If $ appreciate by 2% then return for non-US investor shall be:
Return x 1.02 = 0.12 x 1.02=0.1224 i.e. 12.24%
Alternatively it can also be considered that $ appreciation will be applicable to the amount of
principal as well. The answer therefore could also be
(1+0.12)(1+0.02) -1 =1.12X1.02 - 1 = 0.1424 i.e. 14.24%
2. (a) Computation of initial cash outlay
(Rs. in lakhs)
Equipment Cost (0) 120
Working Capital (0) 15
135
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 Calculation of Cash Inflows:
Year 1 2 3-5 6-8
Sales in units 80,000 1,20,000 3,00,000 2,00,000
Rs. Rs. Rs. Rs.
Contribution @ Rs. 60 p.u. 48,00,000 72,00,000 1,80,00,000 1,20,00,000
Fixed cost 16,00,000 16,00,000 16,00,000 16,00,000
Advertisement 30,00,000 15,00,000 10,00,000 4,00,000
Depreciation 15,00,000 15,00,000 16,50,000 16,50,000
Profit/(loss) (13,00,000) 26,00,000 1,37,50,000 83,50,000
Tax @ 50% (6,50,000)* 13,00,000 68,75,000 41,75,000
Profit/(loss) after tax (6,50,000) 13,00,000 68,75,000 41,75,000
Add: Depreciation 15,00,000 15,00,000 16,50,000 16,50,000
Cash Inflow 8,50,000 28,00,000 85,25,000 58,25,000
* Tax Benefit as loss shall be adjusted against taxable profit.
Computation of PV of CIF
Year CIF PV Factor @ 12%
Rs. Rs.
1 8,50,000 0.893 7,59,050
2 28,00,000 0.797 22,31,600
3 85,25,000 0.712 60,69,800
4 85,25,000 0.636 54,21,900
5 85,25,000 0.567 48,33,675
6 58,25,000 0.507 29,53,275
7 58,25,000 0.452 26,32,900
8 58,25,000 0.404 23,53,300
WC 15,00,000 0.404 6,06,000
SV 1,00,000 0.404 40,400
2,79,01,900
PV of COF 1,35,00,000
Additional Investment = Rs. 10,00,000  0.797 7,97,000
1,42,97,000
NPV 1,36,04,900
Recommendation: Accept the project in view of positive NPV.
(b) The expected rate of return on equity after 2008 = 0.0625 + 1.10(0.055) = 12.3%
The dividends from 2003 onwards can be estimated as:
Year 2003 2004 2005 2006 2007 2008 2009
Earnings Per Share (€) 2.1 2.415 2.78 3.19 3.67 4.22 4.48
Dividends Per Share (€) 0.69 0.794 0.913 1.048 1.206 1.387 2.91
a. The price as of 2008 = €2.91/(0.123- 0.06) = €46.19
b. The required rate of return upto 2008 = 0.0625 + 1.4(0.055) = 13.95%. Th e dividends upto
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 2008 are discounted using this rate as follow:
Year PV of Dividend
2004 0.794/1.1395 = 0.70
2005 0.913/(1.1395)2 = 0.70
2006 1.048/(1.1395)3 = 0.70
2007 1.206/(1.1395)4 = 0.72
2008 1.387/(1.1395)5 = 0.72
Total 3.54

The current price = €3.54 + €46.19/(1.1395) 5 = €27.58.

* Values have been rounded off.
3. (a) Initial amount borrowed = Rs. 5,00,000 – Rs. 50,000 = Rs. 4,50,000
This amount of Rs.4,50,000 is the amount which together with interest at the rate of 10% on
outstanding amount is repayable in equal installments i.e., annuities in the beginning of each of
10 years. The PVAF at the rate of 10% for 9 years is 5.759 and for the year 0 it is 1.000. So, the
annuity amount may be ascertained by dividing Rs.4,50,000 by (5.759 + 1.000).
So Annual payment = Rs.4,50,000/6.759 = Rs. 66,578
Amount owed at time 0 = Rs.4,50,000 – Rs. 66,578 = Rs.3,83,422.
Schedule of Debt Payment
End of Year Total Payment Interest Principal Amount Outstanding
Rs. Rs. Rs.
0 66,578 0 3,83,422
1 66,578 38,342 3,55,186
2 66,578 35,519 3,24,127
3 66,578 32,413 2,89,962
4 66,578 28,996 2,52,380
5 66,578 25,238 2,11,040
6 66,578 21,104 1,65,566
7 66,578 16,557 1,15,545
8 66,578 11,555 60,522
9 66,578 6,056* NIL
* Balancing Figure
Schedule of Cash Outflows: Debt Alternative
(Amount in Rs.)
(1) (2) (3) (4) (5) (6) (7) (8)
End of Debt Interest Dep Tax Shield Cash outflows PV factors PV
year Payment [(3)+(4)]0.5 (2) – (5) @ 5%

0 66,578 0 0 0 66,578 1.000 66,578

1 66,578 38,342 50,000 44,171 22,407 0.952 21,331

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 2 66,578 35,519 50,000 42,759 23,819 0.907 21,604
3. 66,578 32,413 50,000 41,206 25,372 0.864 21,921
4 66,578 28,996 50,000 39,498 27,080 0.823 22,287
5 66,578 25,238 50,000 37,619 28,959 0.784 22,704
6 66,578 21,104 50,000 35,552 31,026 0.746 23,145
7 66,578 16,557 50,000 33,279 33,299 0.711 23,676
8 66,578 11,555 50,000 30,777 35,801 0.677 24,237
9 66,578 6,056 50,000 28,028 38,550 0.645 24,865
10 - 0 50,000 25,000 (-25,000) 0.614 (-15,350)
Total present value of Outflows 2,56,998

Schedule of Cash Outflows: Leasing Alternative

(Amount in Rs.)
End of Lease Payment Tax Shield Cash Outflow PVIFA @ 5% PV
year
0 55,000 0 55,000 1.000 55,000
1-9 55,000 27,500 27,500 7.109 1,95,498
10 0 27,500 -27,500 0.614 (-16,885)
Total Present value of Outflows 2,33,613
The present values of cash outflow are Rs.2,56,998 and Rs.2,33,613 respectively under debt and
lease alternatives. As under debt alternatives the cash outflow would be more, the lease is
preferred.
Note: (i) The repayment of loan as well as payment of lease rental is made in the beginning of
the years. So, at the end of year 10, there will not be any payment in either option, but the tax
benefit of depreciation for the year 10 as well as of lease rentals paid in the beginning of year 10,
will be available only a the end of year 10.
(ii) Students may also calculate depreciation after subtracting the amount of subsidy from
original cost, however, even in this situation, lease alternative is preferable.
(b) Market price per share (MPS) = EPS X P/E ratio or P/E ratio = MPS/EPS
(i) Determination of EPS, P/E ratio, ROE and BVPS of BA Ltd. and DA Ltd.
BA Ltd. DA Ltd.
Earnings After Tax (EAT) Rs. 2,10,000 Rs. 99,000
No. of Shares (N) 100000 80000
EPS (EAT/N) Rs. 2.10 Rs. 1.2375
Market price per share (MPS) 40 15
P/E Ratio (MPS/EPS) 19.05 12.12
Equity Funds (EF) Rs. 12,00,000 Rs. 8,00,000
BVPS (EF/N) 12 10
ROE (EAT/EF) × 100 17.50% 12.37%
(ii) Estimation of growth rates in EPS for BA Ltd. and DA Ltd.
Retention Ratio (1-D/P ratio) 0.6 0.4
Growth Rate (ROE × Retention Ratio) 10.50% 4.95%

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 (iii) Justifiable equity shares exchange ratio
(a) Intrinsic value based = Rs.20 / Rs.40 = 0.5:1 (upper limit)
(b) Market price based = MPSDA/MPSBA = Rs.15 / Rs.40 = 0.375:1(lower limit)
Since, BA Ltd. has a higher EPS, ROE, P/E ratio and even higher EPS growth expectations,
the negotiable terms would be expected to be closer to the lower limit, based on the existing
share prices.
(iv) Calculation of post merger EPS and its effects
Particulars BA Ltd. DA Ltd. Combined
EAT (Rs.) (i) 2,10,000 99,000 3,09,000
Share outstanding (ii) 100000 80000 132000*
EPS (Rs.) (i) / (ii) 2.1 1.2375 2.341
EPS Accretion (Dilution) (Re.) 0.241 (0.301***)
(v) Estimation of Post merger Market price and other effects
Particulars BA Ltd. DA Ltd. Combined
EPS (Rs.) (i) 2.1 1.2375 2.341
P/E Ratio (ii) 19.05 12.12 19.05
MPS (Rs.) (i) / (ii) 40 15 44.6
MPS Accretion (Rs.) 4.6 2.84***
* Shares outstanding (combined) = 100000 shares + (.40 × 80000) = 132000 shares
** EPS claim per old share = Rs.2.34 × 0.4 Rs. 0.936
EPS dilution = Rs.1.2375 – Rs. 0.936 Rs. 0.3015
***S claim per old share (Rs. 44.60 × 0.4) Rs. 17.84
Less: MPS per old share Rs. 15.00
Rs. 2.84
4. (a) (i) Beta of the Portfolio
Security Market No. of Value β Value x β
Price Shares
A 29.40 400 11760 0.59 6938.40
B 318.70 800 254960 1.32 336547.20
C 660.20 150 99030 0.87 86156.10
D 5.20 300 1560 0.35 546.00
E 281.90 400 112760 1.16 130801.60
F 275.40 750 206550 1.24 256122.00
G 514.60 300 154380 1.05 162099.00
H 170.50 900 153450 0.76 116622.00
994450 1095832.30

10,95,832.30
Portfolio Beta = = 1.102
9,94,450

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 (ii) Theoretical Value of Future Contract Expiring in May and June
F = Sert
FMay= 8500 x e 0.20 x (2/12) = 8500 x e 0.0333
e0.0333 shall be computed using Interpolation Formula as follows:
e0.03 = 1.03045
e0.04 = 1.04081
e0.01 = 0.01036
e0.0033 = 0.00342
e0.0067 = 0.00694
e0.0333 = 1.03045 + 0.00342 = 1.03387 or 1.04081 – 0.00694 = 1.03387
According the price of the May Contract
8500 X 1.03387 = Rs. 8788
Price of the June Contract
FMay= 8500 x e 0.20 x (3/12) = 8500 x e 0.05= 8500 x 1.05127 = 8935.80
(iii) No. of NIFTY Contracts required to sell to hedge until June
Value of Position to be hedged
= 
Value of Future Contract
(A) Total portfolio
994450
 1.102 = 4.953 say 5 contracts
8850  25
(B) 50% of Portfolio
994450  0.50
 1.102 = 2.47 say 3 contracts
8850  25
(C) 120% of Portfolio
994450  1.20
 1.102 = 5.94 say 6 contracts
8850  25
(b) Market Risk Premium (A) = 14% – 7% = 7%
Share Beta Risk Premium Risk Free Return Return
(Beta x A) % Return % % Rs.
Oxy Rin Ltd. 0.45 3.15 7 10.15 8,120
Boxed Ltd. 0.35 2.45 7 9.45 14,175
Square Ltd. 1.15 8.05 7 15.05 33,863
Ellipse Ltd. 1.85 12.95 7 19.95 89,775
Total Return 1,45,933
Total Investment Rs. 9,05,000
` 1,45,933
(i) Portfolio Return =  100 = 16.13%
` 9,05,000

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 (ii) Portfolio Beta
Portfolio Return = Risk Free Rate + Risk Premium х β = 16.13%
7% + 7 = 16.13%
β = 1.30
Alternative Approach
First we shall compute Portfolio Beta using the weighted average method as follows:
0.80 1.50 2.25 4.50
BetaP = 0.45X + 0.35X + 1.15X + 1.85X
9.05 9.05 9.05 9.05
= 0.45x0.0884+ 0.35X0.1657+ 1.15X0.2486+ 1.85X0.4972 = 0.0398+ 0.058 + 0.2859 +
0.9198 = 1.3035
Accordingly,
(i) Portfolio Return using CAPM formula will be as follows:
RP= RF + BetaP(RM – RF)
= 7% + 1.3035(14% - 7%) = 7% + 1.3035(7%)
= 7% + 9.1245% = 16.1245%
(ii) Portfolio Beta
As calculated above 1.3035
5. (a)
Particulars Rs.
Estimated Receivables 46,00,000
 30 
Estimated Receivables under Factor  3,74,00,000   30,73,973
 365 
Reduction in Receivables (Rs. 46,00,000 – Rs. 30,73,973) 15,26,027
Total Savings (A)
Reduction in finance costs Rs. 15,26,027 @ 5% 76,301
Saving of Administration costs 1,00,000
Saving of Bad debts 3,50,000
Total 5,26,301
Total Cost of Factoring (B)
Interest on advances by Factor
Advances 30,73,973 @ 80% Rs. 24,59,178
Interest on Rs. 24,59,178 @ 7% Rs. 1,72,142
Overdraft Interest rate 5% (Rs. 1,22,959) 49,183
Charges payable to Factor (Rs. 3,74,00,000 @ 3%) 11,22,000
Total 11,71,183
Net Saving (A) – (B) (6,44,882)
Since Net Saving is negative the proposal is not viable and cannot be accepted

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 (b) (i) US $ required to get Rs. 25 lakhs after 2 months at the Rate of Rs. 47/$
` 25,00,000
∴ = US $ 53191.489
` 47
(ii) Rs. required to get US$ 2,00,000 now at the rate of Rs. 46.25/$
 US $ 200,000 × Rs. 46.25 = Rs. 92,50,000
(iii) Encashing US $ 69000 Now Vs 2 month later
Proceed if we can encash in open mkt $ 69000 × Rs.46 = Rs. 31,74,000
Opportunity gain
10 2
= 31,74,000   Rs. 52,900
100 12
Likely sum at end of 2 months 32,26,900
Proceeds if we can encash by forward rate:
$ 69000 × Rs.47.00 32,43,000
It is better to encash the proceeds after 2 months and get opportunity gain.
6. (a) (i) Calculation of maximum price per share at which PQR Ltd. can offer to pay for XYZ Ltd.’s
share
Market Value (10,00,000 x Rs. 24) Rs. 2,40,00,000
Synergy Gain Rs. 80,00,000
Saving of Overpayment Rs. 30,00,000
Rs. 3,50,00,000
Maximum Price (Rs. 3,50,00,000/10,00,000) Rs. 35

Alternatively, it can also be computed as follows:

Let ER be the swap ratio then,
24×10,00,000+40×15,00,000+ 80,00,000+30,00,000
40=
15,00,000+10,00,000×ER

ER = 0.875
40
MP = PE x EPS x ER = x Rs. 4 x 0.875 = Rs. 35
4
(ii) Calculation of minimum price per share at which the management of XYZ Ltd.’s will be
willing to offer their controlling interest
Value of XYZ Ltd.’s Management Holding Rs. 96,00,000
(40% of 10,00,000 x Rs. 24)
Add: PV of loss of remuneration to top management Rs. 30,00,000
Rs. 1,26,00,000
No. of Shares 4,00,000
Minimum Price (Rs. 1,26,00,000/4,00,000) Rs. 31.50

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 (b) (i) According to Dividend Discount Model approach the firm’s expected or required return on
equity is computed as follows:
D1
e 
K  g
P0
Where,
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
3.36
Therefore, K e   7.5%
146
= 0.0230 +0.075 = 0.098
Or, Ke = 9.80%
(ii) With rate of return on retained earnings (r) 10% and retention ratio (b) 60%, new growth rate
will be as follows:
g= br i.e.
= 0.10 X 0.60 = 0.06
Accordingly dividend will also get changed and to calculate this, first we shall calculate
previous retention ratio (b1) and then EPS assuming that rate of return on retained earnings
(r) is same.
With previous Growth Rate of 7.5% and r =10% the retention ratio comes out to be:
0.075 =b 1 X 0.10
b1 = 0.75 and payout ratio = 0.25
With 0.25 payout ratio the EPS will be as follows:
3.36
= 13.44
0.25
With new 0.40 (1 – 0.60) payout ratio the new dividend will be
D1 = 13.44 X 0.40 = 5.376
Accordingly new Ke will be
5.376
Ke   6.0%
146
or, Ke = 9.68%
Alternatively
EPS with 6% growth rate instead of 7.5%.
1.06
13.44× = 13.25
1.075
With new 0.40 (1 – 0.60) payout ratio the new dividend will be
D1 = 13.25 X 0.40 = 5.30
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 Accordingly new Ke will be
5.30
Ke   6.0%
146
or, Ke = 9.63%
7. (a) Advantages of Holding Securities in ‘Demat’ Form: The Depositories Act, 1996 provides the
framework for the establishment and working of depositories enabling transactions in securities in
scripless (or demat) form. With the arrival of depositories on the scene, many of the problems
previously encountered in the market due to physical handling of securities have been to a great
extent minimized. In a broad sense, therefore, it can be said that ‘dematting’ has helped to
broaden the market and make it smoother and more efficient.
From an individual investor point of view, the following are important advantages of holding
securities in demat form:
• It is speedier and avoids delay in transfer
• It avoids lot of paper work.
• It saves on stamp duty.
From the issuer-company point of view also, there are significant advantages due to dematting,
some of which are:
• Savings in printing certificates, postage expenses.
• Stamp duty waiver.
• Easy monitoring of buying/selling patterns in securities, increasing ability to spot takeover
attempts and attempts at price rigging.
(b) The following factors may particularly be kept in mind while assessing the factors relating to an
industry :
(a) Product Life-Cycle;
(b) Demand Supply Gap;
(c) Barriers to Entry;
(d) Government Attitude;
(e) State of Competition in the Industry;
(f) Cost Conditions and Profitability and
(g) Technology and Research.
(c) Inefficiencies of Money Market:
(i) Markets not integrated,
(ii) High volatility,
(iii) Interest rates not properly aligned,
(iv) Players restricted,
(v) Supply based-sources influence uses,
(vi) Not many instruments,
(vii) Players do not alternate between borrowing and lending,
(viii) Reserve requirements,

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 (ix) Lack of transparency,
(x) Inefficient Payment Systems,
(xi) Seasonal shortage of funds,
(xii) Commercial transactions are mainly in cash, and
(xiii) Heavy Stamp duty limiting use of exchange bills
(d) The various financial instruments dealt with in the international market are briefly described
below :
• Euro Bonds: Denominated in a currency issued outside the country of that currency.
• Foreign Bonds: Example a British firm placing dollar denominated bonds in U.S.A.
• Fully Hedged Bonds: Currency risk eliminated by selling in forward market entire stream of
interest and principal payments.
• Floating Rate Notes: Interests are adjusted to reflect the prevailing exchange rate, Not so
popular.
• Euro Commercial Papers: Designated in US Dollar, they are short-term instruments.
• Foreign Currency Options: Provide hedge against financial and economic risk.
• Foreign Currency Futures: Obligation to buy or sell a specified currency in the present for
settlement at a future dates.
(e) Due to the prevailing guidelines, the target company without the approval of the shareholder
cannot resort to any issuance of fresh capital or sale of assets etc., and also due to the necessity
of getting approvals from various authorities. Thus, the target company cannot refuse transfer of
shares without the consent of shareholders in a general meeting.
A target company can adopt a number of tactics to defend itself from hostile takeover through a
tender offer.
• Divestiture;
• Crown jewels;
• Poison pill;
• Poison Put;
• Greenmail;
• White knight;
• White squire;
• Golden parachutes; and
• Pac-man defense.

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