End Term CFII 2020-22

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Q.
Question 2 Time taken: 37s Marks Scored: 0/1
2
[Mark: 1] Modigliani and Miller's Proposition II indicates that with risk free debt:
Response:
OPTIONS RESPONSE ANSWER
All the other options are correct
The risk to equity increases with leverage
The expected return on equity is a linear function of the firm's debt to equity ratio
The expected return on equity is positively related to leverage
Q.
3
[Mark: 1] A company has 30 crore equity shares outstanding, each with a face value of Rs. 10. It raises fresh capital to fund new projects from a new
shareholder who invests Rs. 40 crore for a 12.5 per cent equity stake in the company. The post-money valuation of the company’s equity is:
Response:
Rs. 340 crore
Rs. 300 crore
Rs. 320 crore
Rs. 360 crore

Q.
Question 4 Time taken: 2m 4s Marks Scored: 0/1
4
[Mark: 1] Which of these will not be affected by a bonus issue of equity shares?
Response:
Debt/ Equity Ratio
Market Price per Share
Dividends per Share
Earnings per Share
Q.
5
[Mark: 1] Degree of financial leverage represents:
Response:
The percentage change in EBIT for a 1% change in sales
The percentage change in EPS for a 1% change in EBIT
The percentage change in sales for a 1% change in EBIT
The percentage change in EPS for a 1% change in sales

Q.
6
[Mark: 1] A company has just paid a dividend of Rs. 3 per share, and the ex-dividend price of the stock is Rs. 30. The dividends are expected to grow at a
constant rate of 5% per year forever. Estimate the cost of equity of the company.
Response:
10.5%
15.0%
15.5%
10.0%
Q.
7
[Mark: 1] The trade-off theory of capital structure predicts that:
Response:
rapidly growing firms should borrow more than mature firms.
increasing leverage increases firm value, especially at high debt ratios.
unprofitable firms should borrow more than profitable ones.
firms in safe businesses should borrow more than those in risky ones.

Q.
8
[Mark: 1] Which of the following actions by an acquiring firm signals its belief that post-merger gains will be substantially larger than expected?
Response:
Acquiring firm makes an offer with the condition that management must be replaced.
Acquiring firm attempts to gain majority ownership, but not complete ownership.
Acquiring firm makes a cash offer, since this allows the acquirer to solely benefit from
gains not yet reflected in the market.
Acquiring firm makes a stock offer, since its stock value is priced lower than it will be
post-merger.
Q.
9
[Mark: 1] A levered firm has fixed assets worth Rs. 20 crore and net working capital worth Rs. 10 crore. The company’s debt comprises (i) term loans of
Rs. 24 crore which are secured by fixed assets, and (ii) subordinated debt of Rs. 12 crore. If all the company’s debt were due today, how much would
each debtholder be entitled to receive?
Response:
Senior debenture holder – Rs. 20 crore; Subordinated debt holder – Rs. 10 crore

Q.
10
[Mark: 1] A company needs to raise Rs. 100 crores to finance a project. The NPV of the project assuming all-equity financing is Rs. 40 crores. If the
company plans to finance part of the project with debt and the brokerage payable for raising the debt amounts to Rs. 1 crore, what is the APV of the
project?
Response:
Rs. 41 crore
Rs. 139 crore
Rs. 141 crore
Rs. 39 crore
Q.
11
[Marks: 3] Despite what Modigliani and Miller theorized, the value of a levered firm could be different from that of an otherwise similar but fully-equity
financed firm. Why/ Why not? Argue based on your learnings from the course. Limit your answer to 200 words. Shorter answers are welcome; good
arguments are more important.
Response:
The value of a levered firm can be different from that of an otherwise similar but full equity financed firm as certain factors affect the value of a
levered firm. Factures such as Distress cost, agency cost, and tax shield which is not the case with an all equity financing firm.
Also, the capital structure of an all-equity financed firm has no debt component which is present in a levered firm.
The beta debt value is 0 for an all equity-financed firm.
Words : 82
Word Limit : 200

Q.
12
[Marks: 3] A company has earnings before interest and taxes of Rs. 5 crores.
(a) It is financed by a combination of equity shares and Rs. 20 crore of debt. The debt carries an interest rate of 12%. and the corporate tax rate is 35%.
How much profit is available for the equity shareholders?
(b) If instead, the company is financed by a combination of equity shares and Rs. 20 crore of preference shares. The dividend rate on the preferred
shares is 10% and the corporate tax rate is still 35%. How much profit is now available for equity shareholders?
(c) If the company is financed entirely by equity, how much profit is available for the equity shareholders?
Response:
Words : 0
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Q.
13
12. [Marks: 3] The stock of a company has a beta of 1.15, and its cost of equity is 15%. During the period used to measure the beta, the market value of
the company’s debt was about 2 times the market value of its equity. The debt issued by the company had a beta of 0.2. Now the firm decides to move to
a debt-equity ratio of 1:2 and maintain the same thereafter. With the new capital structure, the debt becomes risk-free, and the risk-free rate is 8%.
Assuming Modigliani and Miller are correct, calculate
(i) the cost of equity, after the change in the capital structure, and
(ii) the stock’s beta, after the change in the capital structure.
Response:
Words : 0
Cf13.pdf

Q.
14
[Marks: 3] Edited extracts from a news item from the Economic Times dated Nov 2, 2018. relating to an equity financing by Airtel Africa Ltd. (AAL) are
given below:
“Airtel Africa Ltd is raising $1.25 billion by issuing fresh shares to six global investors.”
“Bharti Airtel currently holds 93% in Airtel Africa.”
“After the share issue, Bharti Airtel's stake in AAL will dip to 65%.
Based on the above, estimate (i) the post-money equity valuation of AAL, and (ii) the combined shareholding percentage of the six global investors in AAL
after the issue. (Assume that the six global investors were not existing shareholders of AAL.)
Response:
Words : 0
IMG_4697.jpg

Q.
15
[Marks: 3] A company has issued optionally and fully convertible debentures (face value = Rs. 100; current market price = Rs. 125). Each debenture is
convertible into two equity shares. The conversion option is exercisable one year from today. In case debenture holders do not exercise the conversion
option, the debentures will be redeemed one year after the conversion date. The debentures bear a coupon of 8% p.a. payable annually. The next coupon
payment is due just before the option exercise date. YTMs of non-convertible debentures issued by companies with similar ratings and for similar
maturities are in the region of 9% p.a.
(a) What is the value attributed by investors to the conversion option embedded in each debenture?
(b) What is the minimum price of equity shares of the company that should prevail one year from today if an investor should exercise the conversion
option?
Response:
Words : 0
IMG_4698.jpg

Q.
16
[Marks: 3] Consider a project to produce lunar water coolers. It requires an upfront investment of Rs. 100 crores and offers a level after-tax cash flow
(FCFF) of Rs. 40 crores per year for 4 years. The opportunity cost of capital is 12%, which reflects the project’s business risk.
Suppose the project is financed with Rs. 50 crores of debt and Rs. 50 crores of equity. The interest rate is 8% and the marginal tax rate is 35%. The
principal of the loan will be paid off in equal instalments of Rs. 12.5 crores each over the project’s 4-year life. Interest is to be paid each year on the loan
outstanding at the beginning of the relevant year. What is the adjusted present value (APV) of the project?
Response:
Words : 0
Cf 16.pdf

Q.
17
[Marks: 3] Company A has an equity value of Rs. 100 crore, and Company T has an equity value of Rs. 50 crore. Merging the two would allow cost
savings with a present value of Rs. 20 crore. Company A purchases 100% of the equity of Company T for a cash consideration of Rs. 55 crore.
(a) How much do Company A's shareholders gain from this merger?
(b) If a consideration of Rs. 55 crore were to be offered by way of issue of stock of Company A, what would be the percentage shareholding of the original
shareholders of Company T in Company A after the transaction is completed?
Response:
Words : 0
IMG_4699.jpg

Q.
18
Virgin Hyperloop is an American transportation technology company that works to commercialize the high-speed technology concept called the Hyperloop,
a variant of the vacuum train. Hyperloop systems are intended to move passengers and/ or cargo at airline speeds at a fraction of the cost of air travel. On
May 12, 2017, the company held its first full-scale Hyperloop test. The test combined Hyperloop components including vacuum, propulsion, levitation,
sled, control systems, tube and structures. On November 8, 2020, after more than 400 unmanned tests, Virgin Hyperloop conducted the first human trial.
(Source: Wikipedia)
The company is now “working with the Punjab Government to explore a transformational hyperloop infrastructure project in the region. Starting with
Amritsar, Ludhiana, and Chandigarh, a hyperloop system could connect some of Punjab’s largest cities in minutes and launch a wider network across
northern India.” (Source: Company website)
[Marks: 3] Assume that the company is considering two broad capital structure options for its Punjab project: (i) Debt-equity ratio of 2:1; (ii) Debt-equity
ratio of 1:2. Using arguments based on the trade-off theory and/ or the pecking order theory, which of the two options would you recommend? Limit your
answer to 200 words. Shorter answers are welcome; good arguments are more important.
[Marks: 3] For the debt component of the financing, what kind(s) of debt would you recommend? Consider aspects like the repayment schedule to be
sought, currency of financing, advisability of building in options, collateral, fixed vs. floating rate, etc. Apart from other things, you may want to rely on your
learnings from the A2 Motorway case. Limit your answer to 200 words. Shorter answers are welcome; good arguments are more important.
Response:
(i) I would recommend option 1 that is the debt-equity ratio of 2:1

This project includes a large number of tests as the trial itself took 400 tests and now it is ready for its human trial. Vast projects need huge capital
amount.
Hence, a large amount of equity financing would be used. Issuing a large number of shares gives multiple shareholders a stake in your firm which is
not a good course of action.
(ii) For debt financing, they should take debt on a floating rate and the repayment schedule should be taken long with smaller amounts of
installments. Collateral should be considered for taking a loan and there should be built-in options present as they will be feasible in the longer run,
keeping in mind that the repayment schedule is a long one and this is a long-term loan.
Words : 141
Word Limit : 400

Q.
19
[Marks: 6] A zero-debt firm is prepared to pay a dividend of Rs. 10 million this year and Rs. 11 million next year. Thereafter, dividends are expected to
grow every year by 10% in perpetuity. The cost of equity of the company is 15%. The firm has 2 million shares outstanding. There are no taxes on
dividends.
(a) What would the market price per share be immediately before the payment of the current year’s dividend?
(b) What would the market price per share be immediately after the payment of the current year’s dividend?
Unexpectedly, just before paying out the current year’s dividend, the firm receives a bonanza in the form of a Rs. 2 million grant from the government as
recognition for its efforts towards preservation of the environment. The firm decides to distribute the entire Rs.2 million as a ‘special dividend’.
(c) How much would the total dividend (planned plus special) per share for the current year be?
(d) What would be the market price per share be immediately after the payment of the planned plus special dividend?
If, after the unexpected receipt of the Rs.2 million grant from the government, the firm decides not to distribute the entire Rs.2 million as a ‘special
dividend’, but instead to use it to buy back shares just before the other (planned) dividend for the current year is paid out.
(e) How much would the dividend per share for the current year be?
(f) What would be the market price per share be immediately after the payment of the dividend?
Response:
Words : 0
Cf 19.pdf

Q.
20
[Marks: 6] A company has 30 crore equity shares outstanding. Its stock price is Rs. 80 per share.
(a) The company now makes a bonus issue of 1 shares for every three shares held. What would the stock price be after the bonus issue? What would the
market capitalization be immediately after the bonus issue?
(b) A year later, the company buys back 10% of its outstanding shares at the market price? What would the stock price be after the buyback? What would
the market capitalization of the company be immediately after the buyback?
(c) Another year later, the company pays out a dividend of Rs. 3.60 per share. What would the stock price be after the dividend? What would the market
capitalization of the company be immediately after the dividend?
(d) Immediately thereafter, the company makes a rights issue of 1 share for every 1 share held at an issue price of Rs. 50. What would the stock price be
after the rights issue? What would the market capitalization of the company be immediately after the rights issue?
Disregard impact of taxes, if any. Assume that there is no additional information communicated to investors by any of the actions indicated above. The
expected return on the company’s equity is 10%.
Response:
Words : 0
Cf 20.pdf

Q.
21
[Marks: 6] At end of Year 0, the projected Free Cash Flows (FCFs) of a firm for the next three years are as follow.
After Year 3, the FCFs are expected to grow in perpetuity at a rate of 6% p.a. The tax rate is 25%. The details related to the financing of the firm are as
follow.
(a) Compute the Enterprise Value of the firm.

(b) If instead, the firm were to target an all equity capital structure, what would the Enterprise Value be?
Response:
Words : 0
IMG_4700.jpg

Q.
Question 22 Not Attempted
22
[Marks: 6] Company A and Company B are in the business of manufacturing whatchamacallits. The two companies plan to merge in an all-stock
transaction. Details of the two companies are given below.
In addition to its operating assets, Company A holds land which is estimated to have a market value of Rs. 40 crores. Company B holds surplus cash and
cash equivalents of Rs. 20 crores.
The industry average EV/ EBITDA ratio for whatchamacallit manufacturers (who do not have any non-operating assets or surplus cash) is 10, while the
industry average P/E ratio is 20.
(a) Assuming there are no merger gains or merger costs, estimate a suitable share exchange ratio for the merger using (i) EV/ EBITDA ratio; (ii) P/E
ratio.
(b) If the exchange ratios you obtain from the two methods above are different, explain why. Answer in less than 50 words.
Response:
Words : 0

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End Term CFII 2020-22

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OPTIONS RESPONSE ANSWER

All the other options are correct

The risk to equity increases with leverage

The expected return on equity is positively related to leverage

OPTIONS RESPONSE ANSWER

Rs. 340 crore

Rs. 300 crore

Rs. 320 crore

Rs. 360 crore

Mercer-Mettl | Vasundhara Page 7 / 24

OPTIONS RESPONSE ANSWER

Debt/ Equity Ratio

Market Price per Share

Dividends per Share

Earnings per Share

[Mark: 1] Degree of financial leverage represents:

OPTIONS RESPONSE ANSWER

The percentage change in EBIT for a 1% change in sales

The percentage change in EPS for a 1% change in EBIT

The percentage change in sales for a 1% change in EBIT

The percentage change in EPS for a 1% change in sales

Mercer-Mettl | Vasundhara Page 8 / 24

OPTIONS RESPONSE ANSWER

[Mark: 1] The trade-off theory of capital structure predicts that:

OPTIONS RESPONSE ANSWER

rapidly growing firms should borrow more than mature firms.

increasing leverage increases firm value, especially at high debt ratios.

unprofitable firms should borrow more than profitable ones.

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OPTIONS RESPONSE ANSWER

OPTIONS RESPONSE ANSWER

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OPTIONS RESPONSE ANSWER

Rs. 139 crore

Rs. 141 crore

Word Limit : 200

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