Masters of Business Administration- MBA Semester 2 MB0045 – Financial Management - 4 Credits (Book ID: B1134) Assignment Set- 1 (60 Marks

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Note: Each question carries 10 Marks. Answer all the questions. Q1. A company has issued a bond with face value of Rs.1000 , with 10% pa coupon rate payable annually and a tenure of 10 years to maturity. At the end of 10 years, the bond will be redeemed at a premium of 10% to face value . a) At what price would you buy the bond if the prevailing interest rate is 12% pa on investments of similar risk? b) What is the YTM of the bond if the prevailing price is same as calculated in a) above. c) What is the current yield of the bond at the given price? d) If the coupon rate is paid semi-annually, at what price would you buy the bond at the 12% pa prevailing interest rate? Answer: a. PVIFA(Kd,n) = [(1 + Kd)n - 1 ] / [Kd (1 + Kd) n] PVIFA(12%,10) = [(1+0.12)10 -1] / [0.12(1+0.12) 10] = [(1.12) 10 -1] / [0.12(1.12) 10] = 2.11 / 0.37 = 5.70 coupan rate I = 10% face value = 1000 So, I = 1000 * 10 % = Rs 100 Value of Bond Vo =

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Q2. Given the following details for a company: Net operating income 200,000 Overall cost of capital 20% Value of the firm 1000,000 Cost of debt 15%

Interest 75,000 Market value of debt 500,000 Market value of equity 500,000 a) Given the assumptions of the net operating income approach, what will be the cost of equity, if the market value of debt is 200,000. b) Given the assumptions of the net income approach, what will be the overall cost of capital with Market value of debt of 200,000. Answer: Net operating income Overall cost of capital Value of the firm Cost of debt Interest Market value of debt Market value of equity a. Net operating income 200,000 Overall cost of capital Ko 20% Value of the firm V 1000,000 Cost of debt Kd 15% Interest 75,000 Market value of debt B = 200,000 I/Kd Market value of equity S = V 800,000 –B Leverage B/S 0.25 Cost of equity Ke =

200,000 20% 1000,000 15% 75,000 500,000 500,000

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Q3. Given the following projects , rank them on the basis of NPV and Payback period if the cost of capital is 10% pa. Project A Year Cash flow 0 -10000 1 5000 2 7000 3 8000 4 15000 Project B Year Cash flow 0 -10000 1 5000 2 8000 3 6500 4 11000 Project C Year Cash flow 0 -10000 1 5000 2 8500 3 9000 4 12000

Answer: PV factor = cost of capitol =10% Project A Year Cash PV PV of flow A factor cash 10% flow B 0 10000 1/(1-pv) n (10000) =0 1 5000 1/(1.1) 1 4545 = 0.909

Project B Cash flow 10000 5000

Project C PV of Cash cash flow flow (10000) 4545 10000 5000 PV of cash flow (10000) 4545

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Q4. Given the following information, calculate Degree of operating leverage, Degree of Financial leverage, Degree of total leverage. Quantity sold 100,000 units Variable cost per unit 200 Selling price 800 Fixed cost 10,000 Number of equity shares 50,000 Debt 1000,000 @ 15%pa Preference shares 10,000 of Rs.100 each @ 10% Tax rate 30% Answer: Quantity sold Variable cost per unit V Var cost = cost * Qty Selling price S Seles Revenue = selling price * Qty Fixed cost F Number of equity shares Debt 1000,000 @ Preference shares 10,000 of Rs.100 each 100,000 units 200 200,00,000 800 800,00,000 10,000 50,000 15%pa @ 10%

Tax rate T EBIT = Q(S-V)-F DOL = Q(S-V)/ Q(S-V)-F I = 15% of Debt 1000,000 = 150000

30% 100000*(800-200)-10000 = 5,99,90,000 1

D = 10% of Preference shares 10,000 of Rs.100 each = 10% * 10000 * 100 = 100000 DTL =

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Q5. Explain the following concepts : a) Operating cycle b) Total inventory cost c) Price earnings ratio d) Financial risk Answer: a)Operating Cycle The time gap between acquisition of resources and collection of cash from customers is known as the operating cycle. Operating cycle of a firm involves the following elements. •Acquisition of resources from suppliers •Making payments to suppliers •Conversion of raw materials into finished products •Sale of finished products to customers •Collection of cash from customers for the goods sold The five phases of the operating cycle occur on a continuous basis. There is no synchronisation between the activities in the operating cycle. Cash outflows occur before the occurrences of cash inflows in operating cycle.

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6. Explain the Net operating income approach to capital structure theories. Answer: Net operating income approach (NOI) Net operating income approach is propounded by Durand and is totally opposite of the Net Income Approach. Durand says that any change in leverage will not lead to any

change in the total value of the firm, market price of shares and overall cost of capital. The overall capitalisation rate is the same for all degrees of leverage. We know that: K0 =

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Masters of Business Administration- MBA Semester 2 MB0045 – Financial Management - 4 Credits (Book ID: B1134) Assignment Set- 2 (60 Marks)
Note: Each question carries 10 Marks. Answer all the questions. Q1. Given the following information, prepare a cash budget: Month Sales Purchases Wages Production overheads Jan 100000 40000 10000 6000 Feb 120000 45000 15000 6500 March 150000 35000 18000 7000 April 160000 30000 20000 7700 May 175000 25000 22000 8000 June 200000 20000 24000 8500 Selling overheads 6000 6500 6600 6800 6200 6300

The company has a policy of selling its goods at 50% cash and the balance on credit. On credit sales, 50% is paid in the following month and balance 50% two months from the sale. Purchases are paid one month from the month of purchase. Wages are paid in the following month and overheads are also paid in the following month. The company plans a capital expenditure, in the month of April, for Rs. 25,000. The company has a opening balance of cash of Rs. 40,000 on 1st Jan 2010. Prepare a cash budget for Jan to June. Answer: Jan Opening Cash Bal 40000 Cash sales 50000 Credit sales Total Cash 90000 Available Cash Payments Materials Wages Feb 65000 60000 50000 175000 40000 10000 March 113000 75000 60000 248000 45000 15000 April 175000 80000 75000 330000 35000 18000 May 263400 87500 80000 430900 30000 20000 Jun 366400 100000 87500 553900 25000 22000

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Q2. Given the following information in terms of per unit costs, prepare a statement showing the working capital requirement. Raw material 60 Direct labour 22 Overheads 44 Total cost 126 Profit 18 Selling price 140 The following additional information is available: Average raw material in stock one month Average materials in process 15 days Credit allowed by suppliers one month Credit allowed to debtors two months Time lag in payment of wages 15 days Time lag in payment of overheads one month Sales on cash basis 20% Cash balance to be maintained 80,000 You are required to prepare a statement showing the working capital required to finance a level of activity of 100,000 units of output. You may assume production is carried out evenly throughout the year and payments occur similarly. Assume 360 days in a year. Answer: Estimation of Working Capital a. Investment in inventory 1. Raw material RMC / 360 *RMCP = 1,00,000 *60 / 360 = 16666.67 2. Work – in process inventory COP/360*WIIPCP = 1,00,000 * 126 / 360 = 35000 3. Finished goods inventory

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Q3. Given the following information, calculate the weighted average cost of capital. Capital structure in millions Equity capital ( Rs.10 par value) 2 14% preference share capital Rs.100 each 1.5 Retained earnings 2 12% Debentures Rs.100 each 4 8% term loan 0.5 Total 10 The market price per equity share is Rs. 45. The company is expected to declare a dividend per share of Rs.5 and dividends are expected to grow at 15% pa. The preference shares are redeemable at Rs. 115 after 5 years and are currently traded at Rs. 90 in the market. Debentures will be redeemed after 5 years at Rs.110. The corporate tax rate is 30%. Calculate the Weighted average cost of capital. Answer: Capital millions Equity capital ( Rs.10 par value) 2 14% preference share capital 1.5 Rs.100 each Retained earnings 2 12% Debentures Rs.100 each 4 8% term loan 0.5 Total 10 Po = 45 D1 = 5 g = 10% Step I is to determine the cost of each component. Ke =( D1/P0) + g structure in

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Q4. Calculate the present value of the following options: a) Rs. 10,000 to be received after 5 years if the prevailing rate of interest is 10%pa b) Rs. 10,000 to be received after 5 years if the prevailing rate of interest is 10%pa payable semi annually c) Rs. 5000 to be received every year for 5 years if the prevailing interest rate is 10% pa

d) Rs. 5000 to be received after 5 years and Rs. 10,000 to be received after 10 years Answer: a) 10000*PVIFA (10%, 5y) =

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Q5. Explain each of the following: a) Operating cycle b) Shareholders wealth maximisation c) Capital rationing d) Economic order quantity Answer: a)Operating Cycle The time gap between acquisition of resources and collection of cash from customers is known as the operating cycle. Operating cycle of a firm involves the following elements. •Acquisition of resources from suppliers •Making payments to suppliers •Conversion of raw materials into finished products •Sale of finished products to customers •Collection of cash from customers for the goods sold The five phases of the operating cycle occur on a continuous basis. There is no synchronisation between the activities in the operating cycle. Cash outflows occur before the occurrences of cash inflows in operating cycle. Cash outflows are certain. However, cash inflows are uncertain because of uncertainties associated with effecting sales as per the sales forecast and ultimate timely collection of amount due from the customers to whom the firm has sold its goods. Since cash inflows do not match with cash out flows, firm has to invest in various current assets to ensure smooth conduct of day to day business operations. Therefore, the firm has to assess the operating cycle time of its operation for providing adequately

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Q6. a) Discuss the advantages of ordering Economic order quantity of inventory. b) Discuss the Dividend discount model of measuring cost of equity Answer:

a) Advantages of ordering Economic order quantity refers to the optimal order size that will result in the lowest ordering and carrying costs for an item of inventory based on its expected usage. The order quantity that minimises the total cost associated with inventory management. The Advantages are: •Constant or uniform demand: The demand or usage is even through-out the period •Known demand or usage: Demand or usage for a given period is known i.e. deterministic •Constant unit price: Per unit price of material does not change and is constant irrespective of the order size •Constant Carrying Costs: The cost of carrying is a fixed percentage of the average value of inventory

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