CWA/ICWA Final :: Advanced Financial Management and International Finance : June 2003

*F-14(AFM)* *Revised Syllabus*
Time Allowed : 3 Hours		Full Marks : 100
Part A is compulsory and answer another five questions from Part B.
PART A Attempt all the ten questions, each carrying 2 marks
Questions No. 1 to 5 — There is an incorrect statement. Indicate it by the small alphabet (a,b,c, or d)
Questions No. 6 to 10 — There is a correct answer. Indicate it by the small alphabet (a,b,c, or d)
In all cases, give your working or reasons for your answer.
Marks

Variance analysis is a control technique involving study of comparison of actual costs with standard costs and as a control device it is studied to assign responsibility for deviations and thus, to control cost. The key ratios relating to variance analysis are:

(a)	Solvency ratio	(b)	Material price variance ratio
(c)	Labour efficiency variance ratio	(d)	Capacity utilisation ratio.

2x10

Variable rate borrowers use interest rate caps:

(a)	To retain the ability to benefit from any favourable interest rate movements
(b)	To obtain certainly about maximum interest rate
(c)	To reduce the burden of interest contracted at
(d)	To obtain peace in mind disturbed by rising rate of interest.

Internal strategies to reduce or eliminate currency exposure include:

(a)	Currency invoicing	(b)	Currency option contract
(c)	Netting and Offsetting	(d)	Leading and lagging.

The Modigliani-Miller approach to capital structure theory is based on certain simplified assumptions. They include:

(a)	Capital markets are imperfect	(b)	Investors are rational
(c)	No corporate income tax	(d)	Investors have homogeneous expectations.

The basic elements of a budget are:

(a)	It defines the responsibility of each employee
(b)	It is a comprehensive and coordinated plan
(c)	It is expressed in financial terms for a profit organization
(d)	It is a future plan for a specified period.

X Ltd has earned contribution of Rs. 2,00,000 and net profit of Rs. 1,50,000 on sales of Rs. 8,00,000. What is the margin of safety

(a)	Rs. 5,75,000	(b)	Rs. 4,00,000
(c)	Rs. 7,00,000	(d)	Rs. 6,00,000.

X and Y purchased a secondhand machine for Rs. 8,000 on April 1, 1999 and spent Rs. 3,500 on overhauling and installation. Depreciation is written off 10% p.a. on original cost. On June 30, 2002, the machine was found to be unsuitable and sold for Rs. 6,500. What is the loss to be written off?

(a)	Rs. 1,265.80	(b)	Rs. 1,262.50
(c)	Rs. 1,309.80	(d)	Rs. 1,350.05.

An option dealer took short positions in a call and a put options on dollar at the strike price of Rs. 47.00. He received premiums of Rs. 2.50 for each option. For the dealer to make a gain in this option strategy, price should remain in the range of

(a)	Rs. 44.50 to Rs. 47.00	(b)	Rs. 47.00 to Rs. 49.50
(c)	Rs. 44.50 to Rs. 49.50	(d)	Rs. 42.00 to Rs. 52.00

Assume CAPM is correct. You are holding a stock, which has a beta (β) of 1.5 and is currently in equilibrium. The required return on the stock is 12% and the expected return on the market is 10%. Suddenly due to economic conditions, the expected return on the market increases by 20%. If nothing else changes, how much will this affect your required return?

(a)	+ 20%	(b)	+ 25%
(c)	- 25%	(d)	+ 30%

10.

According to the second method of lending by a bank as per Tandon Committee suggestion, the maximum permissible bank borrowings - based on the following information is:

Total current assets	Rs. 40,000
Current liabilities other than bank borrowings	10,000
Core current assets	5,000

(a)

Rs. 22,500

(b)

Rs. 20,000

(c)

Rs. 16,250

(d)

None of the above.

Please turn over

( 2 )

F-14(AFM)
Revised syllabus

Marks

PART B

11.

M/s. Smart India Ltd. has been expanding rapidly during the last two years. The overdraft facility has been fully utilized. The trend of expansion calls for an additional working capital of Rs. 80 lacs. The bank refused to accommodate the company with increased working capital limit. The following information is available from the latest published accounts.

(1)	Total assets (Rs. 100 lacs) financed by— (i) Equity with the retained earnings (ii) Overdraft.	Rs. 30 lacs Rs. 70 lacs
(2)	Sales	Rs. 200 lacs
(3)	Cost of Sales	Rs. 180 lacs
(4)	Interest	Rs. 3 lacs
(5)	Taxes (average)	50%
(6)	No. of shares	20,000 of Rs. 100 each
(7)	Market price per share	Rs. 800

The Board of directors together with their associates are holding 68% of the shares while the remaining has been issued as fully paid up stock. The Board wants to retain absolute control over the company. But it is not in a position to take up any new shares.
Two alternatives have been given to the Board:

(1)

Issue just enough shares at the present market price to maintain absolute control.

(2)

Restructure the capital with a gearing ratio 1:3. Half the debts will be financed by the bank through term loans, the other half being issued as convertible debentures.
You are required to —
(a) Comment on alternative financing proposals.
(b) Work out a conversion formula for convertible debentures.

12.

(a)

During a year the price of British Gilts (face value £ 100) rose from £ 105 to £ 110, while paying a coupon of £ 8. At the same time the exchange rate removed from $/£ 1.80 to 1.70. What is the total return to an investor in USA who invested in this security?

(b)

(i)

Young Limited last paid a dividend of Rs. 2 per share. Its earnings and dividends are expected to grow @ 8% p.a. The beta of the company is 1.3. It risk free-return is 6% p.a. and the return on market portfolio is 10% p.a., what is the price per share of the equity stock?

(ii)

What will be the effect on the price per share of Young Limited if the following changes take place together?

—	There is a decrease in the inflation premium by 2% p.a.
—	The expected growth rate increases by 1% p.a.

Give reasons for your advice.

5+(5+6)=16

13.

New Style Ltd. is considering the replacement of one of its moulding machines. The existing machine is in good operating condition, but is smaller than required if the firm is to expand its operations. The old machine is 5 years old, and has remaining depreciable life of 10 years. The machine was originally purchased for Rs. 1,50,000 and is being depreciated at Rs. 10,000 per year for tax purposes.

The new machine will cost Rs. 2,20,000 or Rs. 1,70,000 if exchanged with the existing machine. It will be depreciated on a straight line basis for 10 years, with no salvage value. The management anticipates that, with the increased operations, there will be need for an additional net working capital of Rs. 30,000. The new machine will allow the company to expand current operations, thereby increasing annual revenue by Rs. 60,000 and variable operating costs from Rs. 2,00,000 to Rs. 2,20,000.
The company's tax rate is 35% and its cost of capital is 10%.
Should the company replace its existing machine? Assume that the loss on exchange of existing machine can be claimed as short-term capital loss in the current year itself.

14.

(a)

(i)	Beauty Ltd. has an excess cash of Rs. 16,00,000 which it wants to invest in short-term marketable securities. Expenses relating to investment will be Rs. 40,000. The securities invested will have an annual yield of 8%. The company seeks your advice as to the period of investment so as to earn a pre-tax income of 4%.
(ii)	Also, find the minimum period for the company to break-even its investment expenditure. Ignore time value of money.

6+2=8

(b)

ABC Finance Ltd. is a hire-purchase and leasing company. It has been approached by a small business firm interested in acquiring a machine through leasing. The quoted price of the machine is Rs. 5,00,000. 10% sale tax is extra. The lease will be for a primary lease period of 5 years.

The finance company wants 8% post-tax return on the outlay. Its effective tax rate is 35%. The income tax rate of depreciation on the machine is 25% (W.D.V.). Lease rents are payable in arrear at the end of each year.
Calculate the annual rent to be charged by ABC Finance Ltd.

15.

(a)

Company X and Company Y belong to the same industry. Some of their financial statistics are given below:

	X	Y
Net tangible assets backing for equity shares	300%	200%
Profit earned to profit distributed as dividend	200%	125%
Dividend per equity share	Rs. 50	Rs. 66

If the market value of a share in Company X (considered representative of industry) is Rs. 250, what should, in your opinion, be the value placed on a share in Company Y? Give reasons for your answer. Ignore corporate dividend tax.

(b)

Trust Ltd. is deciding whether to payout Rs. 4,80,000 in excess cash in the form of an extra dividend or go for a share repurchase. Current earnings are Rs. 2.40 per share and the stock sells for Rs. 24. The market value balance sheet currently is as follows:

Balance Sheet (in Rs. '000)
Equity	2,400	Assets other than cash	2,560
Debt	640 3,040	Cash	480 3,040

Evaluate the two alternatives in terms of the effect on the price per share of the stock, the EPS and the P/E ratio.
Which alternative do you recommend? Give reasons.

16.

Explain with examples the following terms:
(a) Forward Rate Agreement;
(b) Marking to Market;
(c) Interest Rate Cap;
(d) Profitability Index.

4x4=16

17.

The following information are available for Sunshine Ltd:

8+8=16

A/S = 0.8, Δ S = Rs. 60 lacs. L/S = 0.5

m = 0.04, S₁ = Rs. 500 lacs. d = 0.6

Where A/S = current and fixed assets as a proportion of sales.

Δ S = expected increase in sales

L/S = current liabilities, provisions and bank borrowings as a proportion of sales

m = net profit margin

S₁ = projected sales for the next year

d = dividend payout ratio.

There will be no change in the level of investments and no repayment of the term loans in the next year.

(a)

Estimate the external funds requirement for the next year.

(b)

Suppose the growth rate of net profit margin is 10% for Sunshine Ltd. for the next year in the above case, what then will be the external funds requirement?

__________