CWA ICWA Final Stage III : Advanced Financial Management and International Finance - December 2007

CWA ICWA - Final Stage III • Advanced Financial Management and International Finance • December 2007

This Paper has 30 answerable questions with 0 answered.

F—14(AFM) Revised Syllabus
Time Allowed : 3 Hours	Full Marks : 100

The figures in the margin on the right side indicate full marks
Answer Question No. 1 from Part A which is compulsory and another five questions from Part B.
Please answer all the bits of a question at one place.
Working Notes should form part of the answer.
PART A Attempt all the questions
Marks

The figures in the margin on the right side indicate full marks

Answer Question No. 1 from Part A which is compulsory and
another five questions from Part B.

Please answer all the bits of a question at one place.

Working Notes should form part of the answer.

PART A
Attempt all the questions

Marks

(a)

In each of the cases given below one out of four answers is correct. Indicate the correct answer (= 1 mark) and give your working/reasons briefly (= 1 mark).

2x7

(i)

MEGATRON LTD. paid a dividend of Rs. 2.60 during the last year and growth rate in the dividends is expected to be 8%. The current market price of the stock is Rs. 30.00. This beta of the stock is 1.60 and the return on the market index is 13%. If the risk–free rate of return is 8%, by how much should the price of the stock be raised in percentage terms so that it is at equilibrium?

(A)

11.5%

(B)

13.5%

(C)

17.0%

(D)

Data insufficient

(0)

(ii)

On September 30, 2007, the BSE Sensex was 17060 points, With the expectation of a bullish trend in the near future, an analyst projected the expected value of Sensex by the end of next six months as:

Sensex	18342	19195	20048
Probability	0.30	0.40	0.30

What is the expected annualized return from the market? (Rounded off your answer.)

(A)

15%

(B)

20%

(C)

25%

(D)

30%

(0)

(iii)

The value of a share of MORTON LTD. after right issue was found to be Rs. 75.00. The theoretical value of the right is Rs. 5. The number of existing shares required for a rights share is 2. The subscription price at which rights were issued is

(A)

Rs. 22.50

(B)

Rs. 40.00

(C)

Rs. 65.00

(D)

Rs. 82.00

(0)

(iv)

In June 30, 2007, a six–month call on ROYAL LTD.'s stock with an exercise price of Rs. 50.00 sold for Rs. 4.00. The stock price was Rs. 40.00. The risk–free rate was 5% per annum. How much would you be willing to pay for a put on Royal Ltd.'s stock with the same maturity and exercise price? [Given: e^–n = e^{–0.05 x 0.5} = 0.9753]

(A)

Rs. 8.76

(B)

Rs. 12.76

(C)

14.00

(D)

None of A, B and C

(0)

(v)

A fund manager is contemplating payment of dividend for his scheme in six months time. He has cash but wants to park in T–Bills. He needs at least 8% return over a period of 6 months (180 days) from now. At what price he can purchase a T–Bill (face value of Rs. 100.00) from the secondary market?

(A)

Rs. 96.20

(B)

Rs. 95.48

(C)

91.35

(D)

None of A, B and C

(0)

(vi)

The spot and 6 months forward rates of US $ in relation to the rupee (Re/$) are Rs. 40.9542/41.1255 and Rs. 41.8550/9650 respectively. What will be the annualised forward margin (premium with respect to Bid Price)?

(A)

4.10%

(B)

4.40%

(C)

4.50%

(D)

None of A, B and C

(0)

(vii)

VIKAS INDUSTRIES LTD. is considering offering credit to the customer. The probability that a customer pays for the first order is 0.75. In case the customer pays for the first order, the probability of default in case of a repeat order is likely to be 0.20. If the revenue from each order is Rs. 1,50,000.00 and the associated cost is Rs. 1,00,000.00, what would be the total net weighted benefit from the order to the company?

(A)

Rs. 16,250.00

(B)

Rs. 27,500.00

(C)

Rs. 32,500.00

(D)

Data insufficient

(0)

(b)

Choose the most appropriate one from the stated options and write it down.(Onlyindicate A, B, C, D as you think correct.)

6x1

(i)

In capital asset pricing model approach, to know the cost of equity we require

(A)	The expected dividends
(B)	The current market price of the stock
(C)	Growth rate of the firm
(D)	Rate of return on market portfolio.

(0)

(ii)

Product of beta square of the project and market variance gives us the

(A)	Correlation between two projects
(B)	Standard deviation of a project
(C)	Unsystematic risk of a project
(D)	Systematic risk of a project

(0)

(iii)

How is Days of Sales Outstanding (DSO) different from Average Collection Period (ACP)?

(A)	ACP measures the number of days it takes to collect a receivable, whereas DSO measures outstanding sales.
(B)	ACP takes total sales in the collection whereas DSO takes only the credit sales.
(C)	ACP is affected by the seasonality of sales whereas DSO is not.
(D)	None of A, B and C.

(0)

(iv)

Which of the following statements is/are true regarding Earnings Price Ratio approach?

(A)	The ratio assume that the growth in EPS is constant.
(B)	The results are accurate when the dividend pay–out ratio is 100 per cent.
(C)	The results are accurate when the retained earnings are expected to earn a rate of return more than cost of equity.
(D)	None of A, B and C.

(0)

(v)

If expected earning per share is EPS equity capitalization rate is Ke, dividend pay–out ratio is 100% and growth rate is nil, then the value of share is equal to

(A)	EPS/Ke
(B)	EPS x Ke
(C)	Ke/EPS
(D)	EPS/(1 + Ke).

(0)

(vi)

Which of the following tools for managing the risk is used in case of an interest rate swap?

(A)	Avoidance
(B)	Loss control.
(C)	Separation.
(D)	Transfer.

(0)

PART B Attempt any five questions, each carrying 16 marks.

PART B
Attempt any five questions, each carrying 16 marks.

(a)

NOVELTY LTD., a consumer durable manufacturer, reported earnings per share of Rs. 3.20 in 2007 and paid dividends per share of Rs. 1.70 in that year. The firm reported depreciation of Rs. 350 lakh in 2007 and capital expenditures of Rs. 475 lakh. There were 160 lakh outstanding shares traded at Rs. 51 per share. The ratio of capital expenditure to depreciation is expected to be maintained in the long term. The working capital needs are negligible. Novelty had a debt outstanding of Rs. 1600 lakh and intends to maintain its current financing mix of debt and equity to finance future investment needs. The firm is in the steady state, and earnings are expected to grow at 7% per year. The stock had a Beta of 1.05, the Treasury bill rate is 6.25% and the market premium is 5.5%.

Requirements:

(i)	Estimate the value per share using the dividend discount model.
(ii)	Estimate the value per share, using the FCFE model (Free Cash Flow to Equity).
(iii)	How would you explain the difference between the two models, and which one would you use as a benchmark to compare with the market price?

3+5+2

(0)

(b)

Amol Ltd. makes a rights issue at Rs. 5 a share of one of the new share for every 4 shares hold. Before the issue, there were 10 million shares outstanding and the share price was Rs. 6. Based on the above information. You are required to compute:

(i)	The total amount of new money raised.
(ii)	How many rights are required to buy one new share?
(iii)	What is the value one right?
(iv)	What is the prospective ex–rights price?
(v)	How far could the total value of the company fall before shareholders would be unwilling to take up their rights?
(vi)	Whether the company's shareholders are just as well as off, if right shares are issued at Rs. 4 rather than a rights issue at Rs. 5?

1+1+1+1+1+1

(0)

(a)

An investor is holding 1000 shares of Rishabh Company. Presently, the rate of dividend being paid by the company is Rs. 2 per share and the share is being sold at Rs. 25 per share in the market. However, several factors are likely to change during the course of the year as indicated below:'

	Existing	Revised
Risk – Free Rate	12%	10%
Market Risk Premium	6%	4%
Beta Value	1.4	1.25
Expected Growth Rate	5%	9%

In the view of the above factors whether the investor should buy, hold or sell the shares? And why?

1+1
+1+1+2

(0)

(b)

DARK LTD. has an expected return of 22% and standard deviation of 40%. PENGUIN LTD. has an expected return of 24% and standard deviation of 38%. Dark Ltd. has a Beta of 0.86 and Penguin Ltd., a Beta of 1.24. The correlation coefficient between the return of Dark Ltd. and Penguin Ltd. is 0.72. The standard deviation of the market return is 20%.
Requirements:

(i)	Is investing in Penguin Ltd. better than investing in Dark Ltd.?
(ii)	If you invest 30% in Penguin Ltd.,and 70% in Dark Ltd., what is your expected rate of return and portfolio standard deviation?
(iii)	What is the market portfolios expected rate of return and how much is the risk free rate?
(iv)	What is the Beta of portfolio if Dark Ltd.'s weight is 70% and Penguin Ltd.'s weight is 30%?

2+2
+4+2

(0)

(a)

What are the salient features of Financial and Operating Lease?

3+2

(0)

(b)

TITANIC INSTRUMENTS LTD. is in the business of manufacturing bearings. Some more product lines are being planned to be added to the existing system. The company has decided to acquire a machine costing Rs. 10,00,000 having a useful life of 5 years with the salvage value of Rs. 2,00,000 (consider short–term capital loss/gain for the income tax). The full purchase value of machine can be financed by bank loan at the rate of 10% interest p.a. repayable in five equal installments falling due at the end of each year. Alternatively the machine can be procured on a 5 years lease, year end lease rentals being Rs. 2,50,000 per annum. The company follows the written down value method of depreciation at the rate of 25 per cent. The company is in the 30 per cent tax bracket.

Requirements:

(i)	What is the present value (PV) of cash outflow for each of these financing alternatives using the after–tax cost of Debt?
(ii)	Which of the two alternatives is preferable?
Note: Extracted from the TABLE of PV:
(i)	PVIF at 7% for 0 to 5 years are : 1.000, 0.9346, 0.8734, 0.8163, 0.7629, 0.7130.
(ii)	PVIF at 10% for 0 to 5 years are : 1.0000, 0.9091, 0.8264, 0.7513, 0.6830, 0.6209.
(iii)	PVIFA for 5 years at 10% = 3.7908.
(iv)	PVIFA for 5 years at 7% = 4.1002.

4+2
+3+2

(0)

(a)

An analyst intends to value INFORTECH LTD., an IT company in terms of the future cash generating capacity. He has projected the following after–tax cash flows:

year	1	2	3	4	5
Cash flows (Rs. million)	176	48	64	86	117

It is further estimated that beyond 5th year, cash flows will perpetaute at a constant growth rate of 7% per annum, mainly on account of inflation. The perpetual cash flow is estimated to be Rs. 1026 million at the end of an 5th year.

(i)	What is the value of the company in terms of expected future cash flows? You may assume a cost of capital of 20% for your calculation.
(ii)	The company has outstanding debt of Rs. 362 million and cash/balance of Rs. 271 million. Calculate shareholder value, if the number of outstanding shares is 15.15 million.
(iii)	The company has received a take over bid of Rs. 201 per share. It is good offer? [Given: PVIF at 20% for Yr 1 to Yr 5: 0.833, 0.694, 0.579, 0.482, 0.402].

5+2+2

(0)

(b)

ASHIKA TEXT LTD., manufacturing company producing Textile products, has a sales of Rs. 9.60 crore, variable cost Rs. 5.60 crore and Fixed costs of Rs. 1.04 crore. The company has debt and equity resources worth Rs. 11.20 crore and Rs. 16.00 crore respectively. The cost of debt is 10%. With the date given, you are required to calculate:

(i)	The company‘s ROI.

(ii)	EBT if sales decline to Rs. 6 crore.

(iii)

The percentage change in EPS if the sales increase by 5%. Ignore Taxation.

2+2+3

(0)

(a)

A forex trader wants to earn arbitrage gain. He receives the following data and quotes from forex and the money marker.

Spot rate of US $
6 month forward rate of US $
Annualised interest rate for six months – US $
Annualised interest rate for six months – Rupees

:
:
:
:

Rs. 43.30/$
Rs. 43.70/$
4%
8%

What are the transactions the trader will execute to receive arbitrage gain if he is willing to borrow Rs. 43.30 million or US $ 1 million, assuming that no transaction cost or taxes exist?

(0)

(b)

FRESNO CORPORATION LTD., a US company will need $200,000 in 180 days. It considers using (1) a forward hedge, (2) a money market hedge, (3) and option hedge, or (4) no hedge. Its analysts develop the following information, which can be used to assess the alternative approaches to hedging:

•	Spot rate of pound as of today = $ 1.50
•	180 – days forward rate of pound as of today = $ 1.47
•	Interest rates per annum are as follows:

	UK	US
180–day deposit rate	4.5%	4.5%
180–day borrowing rate	5.0%	5.0%

•

A call option on pounds that expires in 180 days has an exercise price of $ 1.48 and a premium of $ 0.03.

•

Fresno Corporation forecasted the future spot rate in 180 days as follows:

Possible Outcome	Probability
$ 1.43 1.46 1.52	20% 70% 10%z

Evaluate each alternative with necessary calculations and give your recommendations. (Assume 360 days in a year.) – Ignore Transaction Cost or Taxes.

2+3+2+2+1

(0)

MILTON THERMOPLASTIC LTD., a US based plastic manufacturer is considering a proposal to produce of high quality plastic glasses in India. The necessary equipment to manufacture the glasses would cost Rs. 10 million in India and it would last 5 years. The tax relevant rate of depreciation is 25 per cent on written down value. The expected salvage value is Rs. 1 million (consider short–term capital gain/loss for the Income tax). The glasses will be sold at Rs. 4 each. Fixed cost will be Rs. 2.5 million each year and Variable cost Rs. 2 per glass.

The company estimates, it will sell 7.5 million glasses per year; tax rate in India is 35 per cent. MILTON Thermoplastics Ltd. assumes 20 per cent cost of capital for such a project. Additional working capital requirement will be Rs. 5 million. The company (manufacturer) will be allowed 100 per cent repatriation each year with a withholding tax rate of 10 per cent. It is forecasted that the Rupee will depreciate in relation to US dollar @ 2 per cent per annum, with an initial exchange rate of Rs. 42/$. Accordingly the exchange rates for the relevant 5–year period of the project will be as follows:

Year
Exchange rate

0
Rs. 42/$

1
Rs. 42.84/$

2
Rs. 43.70/$

3
Rs. 44.57/$

4
Rs. 45.46/$

5
Rs. 46.37/$

Assume that no depreciation will be charged in the Terminal Year. Advise Milton Thermoplastic Ltd. regarding the financial viability of the proposal.
Note: Extracted from the table of PV of Re. 1:

Year
PVIF at 20%

0
1.000

1
0.833

2
0.694

3
0.579

4
0.482

5
0.402

(0)

Write short notes on any four out of the following:

4x4

(a)

Green shoe option.

(0)

(b)

Forward as hedge instrument.

(0)

(c)

Economic value added (EVA)

(0)

(d)

Consortium lending

(0)

(e)

Financial Engineering

(0)

(f)

Leveraged and Management Buy–outs..

(0)

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