BFD Final Mock

3 hrs. 30 min

Q1. Dutch Automobile Ltd (DAL) is a large, listed company based in Germany with Euro as its
currency. It exports automobile parts to various customers in USA. It is 1st Jan 2023, and the
company is expecting a major receipt amounting to USD 7.2 million by end of April 2023.
The current Spot rate US$ 1 = Euro 0.80. Inter-bank interest rates in USA & Germany are 12% & 6%
per annum, respectively. Commercial Banks in USA & Germany are offering following rates:

Borrowing Rate Deposit Rate

USA 14% 10%
Germany 7% 5%
The CFO of (DAL) is concerned about possible depreciation of USD and is considering to use
following derivatives:
Exchange traded currency futures

Contract size = Euro 125,000, price in US$ per Euro

March 2020 1.2620
June 2020 1.2740
US$ 8,000 is required to be paid upfront as initial margin per contract. The requirement for any
additional margin can be ignored.
It can be assumed that futures contracts are settled at the end of each month. Basis can be assumed to
diminish to zero at contract maturity at a constant rate, based on monthly time intervals.
Exchange traded currency options
Contract size = Euro 50,000
Call option Put option

Premium in USD cents per Euro

Exercise price March June March June

US$ per Euro

1.26 1.52 2.10 1.96 2.80
1.28 0.58 1.16 2.60 3.04
Over the counter Forward contract
Volks Bank GmbH is willing to offer forward rate contract and quoted 4-month forward rate
assuming that interest rate parity theory (based on inter-bank rates) will hold during next 4 months.
 It can be assumed that option contracts expire at the end of the month. On 30th April 2023,
spot rate moves to US$ 1 = Euro 0.7660
Required:
Compute net receipt of Star Company in Euro under each derivative. (15 marks)
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Q.2 a) Beta Ltd (BL) needs to borrow Rs.80 million on May 31, 2023, to pay security deposit in
a Government tender. The amount will be recovered in full on Nov 30, 2023.
Beta can normally borrow at KIBOR + 2%. The current rate of KIBOR is 12%. The treasury
department of (BL) is expecting that KIBOR can be increased within next two months by 4%
and will then remain same till December 2023. The CEO is concerned and has asked treasury
department to find suitable method of hedging the risk for this transaction.
It is 1st April 2023 and following information and quotes are available. The margin
requirement for futures contracts can be ignored.
Three-month Rupee Futures, Rs.2.5 million contract size with following prices:
June 2023 87.40
Sept 2023 86.8
Options on three-month Rupee Futures, Rs.2.5 million contract size. Option premiums in
annual % and strike price are given below:

Calls Strike price Put

June Sept June Sept

0.20 0.40 87.80 0.28 0·32
0.40 0.60 87.10 0.12 0.16

It can be assumed that futures and options contracts are settled at the end of each month. Basis
can be assumed to diminish to zero at contract maturity at a constant rate, based on monthly
time intervals. It can also be assumed that there are no margin requirements.

Habib Bank Ltd has offered the following FRA to Beta Ltd, to exchange nominal KIBOR by
paying following fixed rate
o 1–7 : 13.8%
o 2–8 : 14%
o 3–9 : 14.5%

Required:
Compute the interest cost of Beta for the 6 months borrowing under each method and also
compute expected effective rate of interest for FRA and hedge efficiency for Futures contracts.
 b) Company A currently has a 12-month loan at a fixed rate of 10% but would like to swap to
variable. It can currently borrow at LIBOR + 200 basis points.
Company B has a 12-month loan at a LIBOR + 250 basis points but, due to fears over
interest rate rises, would like to swap to a fixed rate. It can currently borrow at fixed rate of
12.5%.
A bank is currently quoting 12-month LIBOR swap rates as follows:

Buying rate 9% (Bank to pay 9% on receiving LIBOR)

Selling rate 9.5% (Bank to receive 9.5% against paying LIBOR)

Required
i) Show how each company can enter into swap with the bank. What will be the effective
interest rate for each company?
ii) Compute saving from swap arrangement to each company. (20 Marks)
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Q.3 Zee Electronic Ltd (ZEL) has 50 million shares outstanding of face value Rs.10 each, currently trading
in the market at Rs.50 per share. It also has 5 million irredeemable debentures in issue trading in
market at Rs.100 each, paying annual interest of 8%. ZEL pays its all after tax profits as dividends.

Presently ZEL has identified an opportunity to invest in a project which has same business risk as all
existing projects of ZEL.

ZEL immediately needs Rs 500 million for this project. This project will provide annual after-tax profit
of Rs 72 million if the project is financed by all equity capital. However, ZEL wants to finance Rs 300
million by issuing irredeemable debentures paying 8% markup per annum and balance amount will be
arranged by issue of right shares. Issue price of right shares will be at 20% discount to current market
price of ZEL shares.

Tax rate applicable to ZEL is 40% and tax is paid in same year in which the income is earned. Current
cost of equity for ZEL shares is 12.48%.

Required

Assume market is semi-strong form of efficient.

 Compute total value of ZEL after undertaking this project, and also compute theoretical ex- right
market price of ZEL shares.
 Compute revised cost of equity for ZEL shares (12 Marks)
(Note: For both requirements Use MM Theory with Tax)

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Q.4 The Board of Directors of Premier Petroleum Ltd (PPL) is considering acquiring the entire
shareholdingof Karachi Power Limited (KPL) and Islamabad Power Ltd (IPL).

Salient features of proposed acquisitions are as follows:

KPL
 3 shares in PPL to be offered to KPL shareholders holding 5 shares in KPL
 Debt holders of KPL will receive new TFCs in PPL against cancellation of their existing TFCs
in KPL. PPL will issue TFCs of Rs 100 each paying interest rate of 12% per annum which are
redeemable in 5 years’ time. TFCs issued will be sufficient to cover market value of KPL debts
 KPL shareholders will agree to this acquisition if they receive at least 25% premium over their
current market price

IPL
 IPL shareholders will receive cash against their entire shareholding. Sufficient cash amount to
be paid to IPL shareholders to enable them to receive 15% premium
 Debt holders of IPL will receive new TFCs in PPL against cancellation of their existing TFCs
in IPL. PPL will issue TFCs of Rs 100 each paying interest rate of 12% per annum which are
redeemable in 5 years’ time. TFCs issued will be sufficient to cover market value of IPL debts

Board is of the opinion that the proposed acquisition would enable PPL to:

(i) immediately increase the combined PBIT of the three companies by Rs 80 million;
(ii) sell KPL’s & IPL’s surplus fixed assets. These assets can be sold for Rs 120 million; and
(iii) reduce PPL’s risk factor as perceived by its shareholders, which would result in increase
in PPL P/E ratio by 20%.

Following information has been extracted from the financial statements of all three companies for
the year ended 31 Dec 2022:

PPL Rupees in million

90 million shares of Rs10 each 900
Retained Earnings 200
Long term bank loan paying annual interest @10% 1,500
Current liabilities 50
Profit after tax 450

Current P/E ratio of PPL is 15

KPL Rupees in million

50 million shares of Rs10 each 500
Profit Before Interest and Tax 600
Depreciation 60
Annual Capital Expenditure 80

Debt-Equity ratio of KPL by market value is 30:70. Weighted average cost of capital 20% and annual
expected growth rate in free cash flows is 8%.
 IPL Rupees in million
18 million shares of Rs10 each 180
Profit After Tax 150
Interest for the year 12.6

IPL pays 60% of its profit after tax as dividend and annual expected growth rate is 12%. Current
cost ofequity of IPL is 28% and it maintains debt-equity ratio by market value of 20:80.

PPL shareholders will agree for these acquisitions only if they expect to earn at least 30% premium
over their current market value of shares.

Applicable income tax rate for all the companies is 40%. PPL existing bank borrowing will also
continue after acquisition.

Required:
Advise to the Board of Directors to PPL whether above acquisition proposal would be acceptable
from the perspective of shareholders of all companies by computing premium over their current
market values. (20 Marks)
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Q.5 Star Airline (SL) is planning to launch new route Karachi - Frankfurt - Karachi. Before launching
flight on the new route, the Board of directors would like to see whether this flight on new route
will be financially feasible or not.

The following information has been gathered for this purpose.

The flight No. ST-605 proposed for this route has capacity of 500 passenger seats, from which
10% seats are First Class, 20% seats are Business Class and remaining seats are Economy Class.
It is expected that during each journey all first class seats will be fully booked but only 70% &
80% seats of business class and economy class will be booked respectively. It is further expected
that each day flight will complete one return journey of Karachi – Frankfurt – Karachi, and total
200 return journeys will be completed per annum.

The distance between Karachi to Frankfurt is 6500 km. The fuel cost is Rs.200 per km.

Baggage

For complete return journey baggage is allowed 60, 50 and 40 kg respectively to first class, business
class and economy class passengers. Any excess baggage is charged @ Rs. 500 per kg. It is expected
that only 50% of economy class passengers will carry excess baggage of average 5 kg each in
complete return journey. The variable cost of handling all baggage is Rs.200 per kg.

Meal & other refreshment

The variable cost of serving meal and other refreshment to each first class, business class and
economy class passenger for complete return journey is Rs 2000, Rs 1,500 and Rs 1,000
respectively.
 Airport tax

SL has to pay Rs.30,000 per passenger as airport tax for complete return journey.

In-Flight duty-free shopping

80% of first class passengers, 50% of business class passengers & 30% of economy class
passengers make In-Flight purchases of Rs. 10,000, Rs,5,000 and Rs. 4,000 per passenger
respectively. The variable cost of products sold to them is 50% of sale price.

Prices of return ticket (inclusive airport tax)

First class Rs 120,000

Business class Rs 100,000
Economy class Rs 80,000

Annual fixed costs are as under:

Rupees in million
Advertising 50
Repair and maintenance 75
Staff salaries 375
Other expenses 1,245

Company will have to buy immediately a new plane for this route for Rs.4,500 million. Besides this
new plane, the company has to pay immediately route permit fees for Rs.1,000 million (this permit
covers 5-year period only). Tax allowable depreciation for new plane is 20% on reducing balance
method. After 5 years, the realizable value of the plane would be Rs 400 million. Also route permit
fees is allowable tax expense and company can amortize it for tax purpose in 5 years (@ Rs 200
million each year)

Applicable tax rate for the company is 35% and tax is paid in same year in which income is earned.
All above amount except depreciation and amortization are in real terms and subject to inflate each
year at general inflation rate of 8% per annum.

Suitable nominal discount rate is 25%.

Required

a) Compute NPV and advise to the company whether they should launch the flight on new
route.
b) Compute IRR and MIRR for this project. (18 Marks)

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Q.6 World Star Ltd (WSL) wants to invest in a new project for manufacturing environment-friendly
Generators which requires immediate outflow of Rs 500 million to purchase plant & equipment and
Rs 100 million for working capital. This project will generate sales & profit as follows:

 Sales Revenue for first year will be Rs 300 million & will increase by 20% per annum for years
2, 3 & 4 after then sales will grow @ constant rate of 5% in perpetuity.
 Variable cost will be 40% of sales revenue
 Fixed cost other than depreciation will be Rs 10 million in first year; thereafter Rs 20 million
fixed cost per annum will be incurred in perpetuity
 Company can claim tax allowable depreciation of 20 million each year in perpetuity
 There will be no capital expenditure other than Rs 500 million for first 4 years. From year 5 &
onwards, fixed capital expenditure each year would be Rs 25 million in perpetuity
 Company’s weighted average cost of capital is 14.88% (with debt/equity ratio of 40%:60% by
market values). Company has debt capital in the form of irredeemable debentures. At present
similar debentures earn 12% yield.
 Above project has similar business risk as existing products of Seven Star

This project will be financed as follows:

 Rs 300 million by a subsidized loan. Markup of subsidized loan will be 8% but this loan is
available only for first 4 years. Thereafter this loan will be replaced by normal loan paying
annual interest 12%
 Rs 100 million loan with annual interest of 12%
 Balance Rs 200 million by issue of right shares

All loans can be assumed to be irredeemable except subsidized loan which is available only for first
4 years. Interest/Mark-up on all loans is tax admissible.
Applicable tax rate is 30% payable in same year in which profit is earned & will remain same forthe
foreseeable future.
There will be no issue cost of financing .

Required
Determine the feasibility of the project for Seven Star by computing its APV. (15 Marks)

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