Indian Institute of Management Kozhikode

EPGP 13 Section A, Financial Management – I, End-Term Exam

Max Time – 2 Hours Max Marks – 40.

Instructions:

I. Answer all questions

II. Each question carries 5 marks each
III. You can use excel for this exam
IV. Upload your hand written answer sheet alongside excel working
V. Ensure you write the steps and answers in the written sheet – excel is just
for your computational purpose
1. The following table gives a set of investment opportunities that a firm can take.
In the table, you have data of the investment needed in a project, the cash flows
for the first three years, the NPV and IRR. All the projects’ cash flows extend
beyond 3 years and continue longer. Some projects may close sooner, some
later. The cost of capital for all projects is 10%. Further data: projects A and B
are mutually exclusive, all projects are discrete i.e. you cannot make partial
investments in any project. (all cash flows in table in millions) (4 marks)

Project Investment CF1 CF2 CF3 NPV IRR

A 80 14 16 20 45 16.1
B 150 10 40 35 56 13
C 45 20 25 0 41 37.8
D 30 -5 -10 25 -4 10
E 30 -5 10 10 3 12
F 25 6 9 10 10 22

a. If the firm only accepts projects with pay back period of 3 years or lesser.
What is the total NPV with this policy?
b. Between A and B which project would you choose?
c. Suppose the firm identifies a new project A* whose cash flows, NPV and
IRR mirror that of project A, what would you choose between A*, A and B
if they are all mutually exclusive?
d. If the firm has a capital constraint of $ 150 million, which projects would
you suggest?

2. You just received a bonus of ₹ 1 million from your firm. You are looking to invest
it in a good business to enhance your wealth. Because you do not know where to
invest your money, you hire a consulting organization that helps you identify the
best business to invest. For this service, the firm charges you ₹ 100, 000 up
front. After the firm gives you the recommendation, you choose to invest in a
business for 3 years. Sales in this business is expected to be ₹ 600, 000 in year 1
and expected to grow at the rate of 10% for the remaining years. Cost of running
the business is 30% of sales. Each year, the firm also has to invest 20% of the
sales in working capital. However, the initial cost can be depreciated over the
life of the business in a straight line method with no salvage value. The
applicable tax rate for this business is 40% and the discounting rate is 10%.
Given all this information, is this worth while to invest your bonus?

3. (a) Mitra Associates is planning to earn perpetual cash flows of ₹1 lakh every
year from a new business idea. The only investment it requires to implement
this, is an office building and luckily it already owns an unused space which can
be used for this purpose without any additional investment. This office space
 was bought by Mitra ten years back for ₹10,000 and is now worth approx. ₹5
lakhs. What is the NPV of this proposal using a discount rate of 25%?
(b) A and B are one year projects with A being the smaller project. A has an IRR
of 20%. B requires 50% additional investment than A and the incremental IRR of
B over A is also 20%. What will be project B’s IRR?

4. The auctions for the next set of t-bills (zero coupon government bonds) are due
in 10 days. The bond has a life of 180 days and face value of ₹ 100. One of your
friends has also suggested an investment idea to you – loan me ₹ 1 and I will pay
you back ₹ 1.4 in 18 months. On the day of t-bills bidding, what would be the
maximum price you would bid for per bond that makes you indifferent between
investing in the bonds and loaning money to your friend?

5. In 2011, Beta Corporation earned gross profits of ₹760,000

a. Suppose it is financed by a combination of common stock and ₹1 million

of debt. The interest rate on the debt is 10%, corporate tax rate is 35%.
What is the profit available for common stockholders?
b. Now, suppose if the firm decides to not issue debt, rather finance itself by
a combination of common stock and ₹1 million of preferred stock. The
dividend on the preferred stock being 8% and the tax rate at 35%, what is
the profit available for common stock holders? Assume the firm pays off
dividend to preferred stock holders immediately.

6. Your firm is contemplating investing in a machine as a new investment. There

are two machines in the market A and B and the investment decision is a
mutually exclusive decision. Machine A costs ₹ 100 while machine B costs ₹ 120.
The following table outlines the future cash flows of each machine.

Machine Year 1 Year 2 Year 3

A 110 121 0
B 110 121 25

If the cost of capital (discounting rate) is 10%, which machine should your firm
choose?

7. (a) You are keen to obtain a helicopter pilot’s licence. A club offers you lessons
over two
years, with a choice between the following payment terms:

• you can either pay the full fees (Rs100, 000) immediately with a 5% discount;
or
• you can make two equal annual payments, the first one due immediately.
At what interest rate would these two options work out at the same cost?
 (b) You have found your dream house and you have the choice between renting
it with a lease in perpetuity (for Rs100 000 for first year and the rent increases
by 3% per year) or buying it. At what purchase price would you be better off
renting if the loan you needed to buy the house costs you 7%?

8. Fijisawa, Inc., is considering a major expansion of its top-selling product line and
has estimated the following cash flows associated with the expansion. The initial
outlay will be Rs 10,00,000, and the project will generate cash flows of Rs
2,00,000 per year for 10 years. The appropriate discount rate is 10 percent.
i. Calculate the NPV.
ii. Calculate the PI.
iii. Calculate the IRR.
iv. Should this project be accepted? Why or why not?