Model Solution: 1

Financial Management

1. Solution
a) No. of new share to be issued = 500000 /10=50,000 Shares
b) No. Of right = 100,000/50,000=2:1

c) The individual shareholders position (Assume one shareholder holds 2 share)

Before Right issue After Right issue

20X2= 40
Market Price per share x No of share
1X10= 10
= 20X2= Tk. 40
Total = 50
Per Share Price tk. 20
Total 3 Shares value tk. 50
So, Per Share Value = 50/3= tk. 16.67.

From the above table the value of right is = 20-16.67= tk. 3.33
Since The induvial has option to sell the right by tk. 3.33 and share price fall
down to tk. 16.67. which is equal to current market price tk. 20

So right offer does not carry any value to shareholder.

d) Value of the firm:
Before right issue After right issue
Common stock 1,000,000 Common stock 1,500,000
Retain earning 1.000,000 Retain earning 1.000,000
2,000,000 2,500,000

e) Shown in req. C

2. Solution
We need to know what the investor paid for a bond in order to produce a yield of 10%. That's
easy: P0 = 120(PVIFa-10%-20) + 1000/(1.10)20 = 1,170.27
NSV= 1170.21-70.27=1100

Cost of Debt = 𝑰𝑵𝑻 + ( 𝑭𝑽 − 𝑵𝑺𝑽)/𝑵 ÷ (FV+NSV)/2

= 120 + (1000-1100)/20 ÷ (1000+1100)/2
= 10.95%
After tax = 10.95(1-.35) =7.11%

If the firm needs to sell more than TK24,000,000 of new bonds, the cost of the incremental bonds
is gotten the same way. The yield to the investor is 14% a year and flotation costs are 67.54. This
information should produce a P0 = 867.54, net proceeds, I0 of 800, a before-tax cost of 14.44% and
an after-tax cost of 14.44%(1-.35)=9.38%

So, the cost of selling the first TK24 million of new bonds is ki1=7.11%. Any additional bonds would
cost ki2=9.38%.
 Model Solution: 1
Financial Management

Preferred Stock

The investor's return or yield is 16%. So, we know that .16 = D/P0 and kp = D/I0. We also know that
I0=P0 - flotation costs. If flotation costs = .20*P0, then I0=P0 - .20P0 = .8P0. Substituting, we know kp
= D/.8P0 or (D/P0)/.8 or .16/.8 = .20. The cost of issuing any new preferred stock, kp, is 20%.

Common Stock

G= (7/5.545)^4-1= 6%

Current Ke= 18% + 6%= 24%

Current Market Price = D1/Dividend yield= 7(1.06)/.18=tk. 41.22

If the firm sells up to TK7.5 million of new common stock, there is underpricing and flotation
costs equal to 20% of the current price or .20(41.22) = 8.24. This leaves I0 of 41.22 - 8.24 =
32.98. Substituting this for I0 gives the cost of new common stock as kn1 = 7.42/32.98 + .06
= 28.50%. If the company sells more than TK7.5 million of new common stock, the flotation
costs rise to 30% of the current price and the net proceeds fall to 41.22 - .3(41.22) or 28.85.
This makes the cost of the marginal shares beyond TK7.5 million kn2 = 7.42/28.85 + .06 =
31.72%.

Slab For MCC

Debt 0-40 million & 40 million above. [If the current weight is maintained debt
carries 120/200= .6 weight so total fund will be 24/.6= 40 million.]
Preference debt no slab

Equity 4.5 million internal fund already exist. If the current weight is maintained
common equity carries 60/200=0.30 weight. So total fund will be =
4.5/.3= 15 million.

The following table may be highlighted:

0 - 15 15 - 40 40 +
Source WT. MCC1 MCC2 MCC3
Debt .60 7.11 7.11 9.38
Pf'D .10 20.00 20.00 20.00
Equity .30 24.00 28.50 31.72

Marginal cost of capital for 0 to TK15 million, the MCC is .60 x 7.11 + .10 x 20.00 + .30 x
24.00 = 13.46%. Do the same for the other two columns and result are 14.66% and 17.14%
 Model Solution: 1
Financial Management

PROJECT OUTLAY IRR RANKED

A 8,000,000 14.0% 4

B 8,000,000 21.0% 1

C 10,000,000 19.0% 2

D 12,000,000 13.5% 5

E 12,000,000 16.0% 3

IF we take the project ranking we clearly see that project B, C, & D first three and their
cumulative investment is = 8+10+12=30 million which is fall under slab 2 of Marginal
cost of capital table and cost of capital = 14.66%.
Since IRR higher than cost of capital of B, C& D project these three should be selected.

b). To find the cost of raising TK30 million, we just need to see where it comes from. The first TK15
million comes from sources up to the first break point. Therefore it costs 13.46%. The second TK15
million comes from the middle segment of the MCC schedule and, therefore, costs 14.66%. Just take
a weighted-average of these two costs. (15/30) x 13.46 + (15/30) x 14.66 = 14.08%. The average
cost of raising TK30 million is 14.06%.

3. Solution

Particular Option -1 Option -2 Option -3 Option -4

EBIT 1,000,000 1,000,000 1,000,000 1,000,000
Interest Expense (W-
1) (120,000) (240,000) (240,000) (192,000)

EBT 880,000 760,000 760,000 808,000

TAX @ 40% (352,000) (304,000) (304,000) (323,200)

EAT 528,000 456,000 456,000 484,800

PD (100,000) - (100,000) (40,000)

EAT 428,000 456,000 356,000 444,800

No. of Share 30,000 30,000 20,000 30,000

EPS 14.27 15.20 17.80 14.83

 Model Solution: 1
Financial Management

WORKINGS

Interest Option -1 Option -2 Option -3 Option -4

Current Interest 120,000.00 120,000.00 120,000.00 120,000.00
New - 120,000.00 120,000.00 72,000.00
Total 120,000.00 240,000.00 240,000.00 192,000.00
Preference Dividend
Current - - - -
New 100,000.00 - 100,000.00 40,000.00
No. Of Share
Current 20,000.00 20,000.00 20,000.00 20,000.00
New 10,000.00 10,000.00 - 10,000.00
Total 30,000.00 30,000.00 20,000.00 30,000.00

4. Solution

Events The market is The market is The market is The market is

not weak form weak but not semi-strong strong form
efficient the semi-strong form but not the efficient.
form efficient strong form
efficient
The stock price has This information The information is fully impounded in the current price
risen steadily each could be acted and no abnormal profit opportunity exists
day for the past 30 on and profit can
days be earned
following price
trend.
The financial This information could be used to The information is fully impounded in
statement of a buy stocks cheap before rest of the the current price and no abnormal
company were market discovers the anomaly, profit opportunity exists
released 3 days ago profit opportunity exist.
and you believe you
have uncovered
some anomalies in
the company's
inventory and cost
control reporting
techniques that are
causing the firm's
true liquidity
strength to be
understated.

You observe that This information could be used as a profitable trading The information
the senior strategy, by noting the buying activity of the insiders is fully
management of a as a signal that the stocks is underpriced or good news impounded in the
company has been is imminent. current price and
buying a lot of the no abnormal
company's stock on profit
the open market opportunity
over the past week. exists
 Model Solution: 1
Financial Management

5. Solution
• DSE risk premium= 11%-3.5% = 7.50%
• Equity risk premium of the company = 1.30 x 7.50% = 9.75%
• Cost of equity = Rf+Risk premium = 3.50%+9.75% = 13.25%
• Cost of capital = 7%x .5/1.5 +13.25%x1/1.5= 11.21% [ As there is tax rate is given, we
used before tax cost of debt]

Assuming 40% tax rate, cost of capital will be = 7%x(1-.4) x .5/1.5 +13.25%x1/1.5=10.26%.

i. NPV = (20) +5.5 /.1121-0.04 = 56.28. as NPV is positive we should accept the project.

Assuming 40% tax rate, cost of capital will be = 7%x(1-.4) x .5/1.5

+13.25%x1/1.5=10.26%. NPV will be 67.86. project should be accepted.

6. Solution

The minimum convertible bond value is the greater of the conversion price or the straight bond
price. To find the conversion price, we need to determine the conversion ratio. Which is = bond
price/conversion price = 1000/130 = 7.69

Each bond can be exchanged for 7.69 no’s stocks. This means conversion price of the bond is

Conversion price = 26 x 7.69 = 200

And straight bond value is: 60x [1-1/1.11^30]/.11 +1000/1.11^30 = 521.63 +43.69 = 565.32.

So minimum price is 565.32.

b.
let years be n
1100 = 26 (1.13) ^
n x7.69
or 1.13^n = 5.5
or N Log 1.13 = log 5.5
or N= 13.95 years

7. Solution

The current operating cycle is the sum of the current inventory days and trade receivables days,
less the current trade payables days.

Current inventory days = (473,400/2,160,000) x 365 = 80 days

Current trade receivables days = (1,331,500/5,400,000) x 365 = 90 days
Current trade payables days = (177,500/2,160,000) x 365 = 30 days
Current operating cycle = 80 + 90 – 30 = 140 days
Operating cycle after policy changes = 50 + 62 – 45 = 67 days
The change in the operating cycle is therefore a decrease of 73 days.
 Model Solution: 1
Financial Management

(ii) At present, the current ratio is 1,804,900/1,504,100 = 1·20 times.

The current net working capital is $300,800.

The revised figures for inventory, trade receivables, trade payables and overdraft must be
calculated in order to find the current ratio after the planned working capital policy changes.
Revised inventory = 2,160,000 x 50/365 =$295,890
Revised trade receivables = 5,400,000 x 62/365 = $917,260
Revised trade payables = $2,160,000 x 45/365 = $266,301
Revised overdraft level = 295,890 + 917,260 – 266,301 – 300,800 = $646,049
Revised current assets = 295,890 + 917,260 = $1,213,150
Revised current liabilities = 266,301 + 646,049 = $912,350
Revised current ratio = 1,213,150/912,350 = 1·33 times
The effect on the current ratio is to increase it from 1·20 to 1·33 times.
(iii) The finance cost saving arises from the decrease in the overdraft from $1,326,600 to
$646,049, a reduction of $680,551, with a saving of 5% per year or $34,028 per year.

8. Solution
a. Here A limited shareholders is considering buying of b limited. Cost of capital of A limited
will be used to discount dividend streams of B limited.

Ke= 8 (1.1)/60 +.10 = 24.67%

Present value of B Limited Dividend can be found by = D1/ke-g

10 (1.08) /.2467- 0.08 = tk. 64.79

As per dividend discount model, price should be Tk. 64.79 or lower

As per market multipliers, P/E of A limited is = 60/20 = 3.

As such price of A limited should be = EPSx P/E = 15 x 3 = Tk. 45

As per NAV of A limited is = 30000/2000 = 15 Taka

So, P/NAV = 60/15 = 4
By using this P/NAV of A limited, we can find price of B limited P/NAV x NAV = 4x 13.33 =
Tk. 53.33

So, three probable prices are:

As per DDM Tk.64.79
As per P/E = 45
 Model Solution: 1
Financial Management

as per P/NAV = 53.33

average may be used.

b.
First, we need to calculate free cash flows:

Year Profit After Capital Expenditures Depreciation Free cash flows

Tax (Tk.000) (Tk.000) A – B +C
(Tk.000) (B) (C)
(A)
1 2500 2000 700 1200
2 3000 1500 800 2300
3 3500 2500 1000 2000
4 4000 1400 1100 3700
Each year 4500 1400 1200 4300
beyond

Terminal value = 4300 / .1 = 43000

Years Free cash flows PV factor Discounted value

1 1200 0.909 1090.8
2 2300 0.826 1899.8
3 2000 0.751 1502
4 3700 0.683 2527.1
4 43000 0.683 29369
Total 36388.7

Price per shares = 36388.70/ 1500 =Tk. 24.26 per share