| 1. | (a) | “Profit maximisation is pre–requisite for shareholders’ wealth maximisation.” Do you agree ? Give a brief account of the advantages and disadvantages of these goals. | 5 | (0) |
| | (b) | Discuss the advantages of investing in mutual funds. | 5 | (0) |
| | (c) | Length of operating cycle is the major determinant of working capital needs of a business firm. Explain. | 5 | (0) |
| | (d) | Write a note on ‘depository system in India’. | 5 | (0) |
| 2. | (a) | A dealer having annual sales of Rs.50 lakh extends 30 days credit period to its debtors. The variable cost is estimated at 80% on sales and fixed costs are Rs.6,00,000. The dealer intends to change the credit policy for which the following information is given : | | Average Collection | Annual Sales | | Credit Policy | Period (Days) | (Rs.in Lakhs) | A
B
C | 45
60
75 | 56
60
62 |
Rate of return (pre–tax) required on investment is 20%. You are required to assess the most profitable policy with the help of incremental approach. Calculations may be restricted to two decimal places. | 10 | (0) |
| | (b) | A closely–held toys manufacturing company has been following a dividend policy, which can maximise the market value of the company as per Walter’s Model. Accordingly, each year at dividend time, the capital budget is reviewed in conjunction with the earnings for the period and alternative investment opportunities for the shareholders. In the current year, the company reports net profits of Rs.10,00,000. It is estimated that the company can earn Rs.2,50,000 if such profits are retained. The investors have alternative investment opportunities that will yield them 12%. The company has 1,00,000 shares outstanding. What would be the dividend payout ratio of the company, if it wishes to maximise the wealth of the shareholders ? | 10 | (0) |
| 3. | (a) | Two companies –– P Ltd. and Q Ltd. belong to the equivalent risk group. The two companies are identical in every respect except that Q Ltd. is levered, while P Ltd. is unlevered. The outstanding amount of debt of the levered company is Rs.6,00,000 in 10% debentures. The other information for the two companies are as follows : | | P Ltd. | Q Ltd. | Net operating income (EBIT) (Rs.)
Interest (Rs.)
Earnings to equity–holders (Rs.)
Equity capitalisation rate, ke
Market value of equity (Rs.)
Market value of debt (Rs.)
Total value of firm (Rs.)
Overall capitalisation rate, ko=EBIT/V
Debt–equity ratio | 1,50,000
—
1,50,000
0.15
10,00,000
—
10,00,000
15.0%
0 | 1,50,000
60,000
90,000
0.20
4,50,000
6,00,000
10,50,000
14.3%
1.33 |
An investor owns 5% equity shares of Q Ltd. Show the process and the amount by which he could reduce his outlay through use of the arbitrage process. Is there any limit to the ‘process’ ? | 10 | (0) |
| | (b) | Soni Ltd. and Toni Ltd. face the following interest | Rate: | | Soni Ltd. | Toni Ltd. | | US Dollar (Floating rate) | LIBOR +0.25% | LIBOR +2.25% | | Japanese Yen (Fixed rate) | 1.75% | 2% |
Toni Ltd. wants to borrow US Dollars at a floating rate of interest and Soni Ltd. wants to borrow Japanese Yen at a fixed rate of interest. A financial institution is planning to arrange a swap and requires a 100 basis point spread. If the swap is equally attractive to Soni Ltd. and Toni Ltd., what rate of interest will they end up paying ? | 6 | (0) |
| | (c) | The following information is available in respect of Security–X and Security–Y : Security
X
Y | B
1.8
1.6 | Expected Rate of Return
22.00%
20.40% |
Rate of return of market portfolio is 15.3%. If risk–free rate of return is 7%, are these securities correctly priced ? What would be the risk–free rate of return, if they are correctly priced ? | 4 | (0) |
| 4. | (a) | “The cash flow approach of measuring future benefits of a project is superior to the accounting approach.” Discuss. | 5 | (0) |
| | (b) | Describe the main features of the gilt edged primary market. | 5 | (0) |
| | (c) | Briefly explain the services offered by merchant bankers to an issue. | 5 | (0) |
| | (d) | Describe the reasons for internationalisation of business and investment. | 5 | (0) |
|
| 5. | A firm has an investment proposal, requiring an outlay of Rs.40,000. The investment proposal is expected to have 2 years‘ economic life with no salvage value. In Year–1, there is a 0.4 probability that cash flow after tax (CFAT) will be Rs.25,000 and 0.6 probability that CFAT will be Rs.30,000. The probabilities assigned to CFAT for the Year–2 are as follows : | If CFAT = Rs.25,000 | If CFAT = Rs.30,000 | Amount
(Rs.) | Probability | Amount
(Rs.) | Probability | 12,000
16,000
22,000 | 0.2
0.3
0.5 | 20,000
25,000
30,000 | 0.4
0.5
0.1 |
The firm uses a 10% discount rate for this type of investment. You are required to– | (i) | Present the above information in the form of a decision tree. |
| (ii) | Find out the NPV under (a) the worst outcome; and (b) under the best outcome. |
| (iii) | Find out the profitability or otherwise of the above investment proposal. |
| 6+7+7 | (0) |
| 6. | (a) | A company is planning to raise Rs.20,00,000 additional long–term funds to finance its additional capital budget of the current year. The debentures of the company to be sold on a 14% net yield basis to the company, and equity shares to be sold at Rs.50 per share net to the company, are the alternatives being considered by the company. The company expects to pay dividend of Rs.5 per share at the end of coming year. The expansion is expected to carry the company into a new–higher risk class. The required rate of return expected from the point of view of the investment community is 16%. | (i) | Determine the growth rate of the company, which the market is anticipating. | | (ii) | Management is anticipating 8% growth rate. On this basis, at what price should the equity share be sold by the company ? | | (iii) | Assuming that management is anticipating growth rate of only 4% per year, what form of financing would you recommend ? |
| 6 | (0) |
| | (b) | Indigo Ltd. is planning to import a multi-purpose machine from Japan at a cost of 7,200 lakh Yen.The company can avail loans at 15% interest per annum with quarterly rests with which it can import the machine. However, there is an offer from Tokyo branch of an India based bank extending credit of 180 days at 2% per annum against opening of an irrevocable letter of credit.
Other information :
Present exchange rate Rs.100=360 Yen
180 Days forward rate Rs.100=365 Yen
Commission charges for letter of credit at 2% per 12 months.
Will you accept the bank’s offer and why ? | 4 | (0) |
| | (c) | Evaluate the feasibility or otherwise of a project keeping in view the following data : | (i) | The nominal rate of return is 14%. | | (ii) | The expected rate of inflation over life is 7%. | | (iii) | Cash flows of the project are as under : |
| Year | 0 | 1 | 2 | 3 | 4 | | Cash flows (Rs.) | (10,000) | 3,000 | 3,000 | 3,000 | 3,000 |
Also find out the real rate of return. | 10 | (0) |
| 7. | Write short notes on the following : | 5each | |
| | (i) | Leveraged lease | | (0) |
| | (ii) | Considerations in dividend policy | | (0) |
| | (iii) | Dow theory | | (0) |
| | (iv) | Securitisation of mortgages. | | (0) |
