CWA/ICWA Final :: Advanced Financial Management and International Finance : June 2006

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 which is compulsory and any five from the rest.
Please answer all the bits of a question at one place.
PART A
Attempt all the questions
Marks
1. (a) In each of the cases given below one out of four answers is correct. Indicate the correct answer and give your working/reasons briefly. 2x5=10
(i)ANKUR Ltd. intends to invest Rs. 50 lacs in commercial paper (C.P.) and has received the following quotes from a primary dealer:
Bid: 5.30%
Ask: 5.00%
If the maturity period of the C.P. is 45 days, the investment amount (rounded up to nearest rupee) will be (assume day count basis as "actual/365")
(A)Rs. 4967541(B)Rs. 4968454
(C)Rs. 4969467(D)none of (A), (B), (C)
(ii)A share of STAR Ltd. is currently quoted at Rs. 55. The retained earning per share being 40% is Rs. 4 per share. If the investors expect annual growth rate of 10%, what would be the cost of equity of STAR Ltd?
(A)20.5%(B)21.0%
(C)22.0%(D)23.5%
(iii)

A company has obtained quotes from two different manufactures for an equipment. The details are as follows:
 Cost (Rs. million)Estimated life (years)
Make X4.510
Make Y6.0015

Ignoring operation and maintenance cost, which one would be cheaper? The company's cost of capital is 10 per cent.
[Given: PVIFA (10%, 10 yrs.) = 6.1446 and PVIFA (10%, 15 yrs.) = 7.6061]
(A)Make X will be cheaper(B)Make Y will be cheaper
(C)Cost will be the same(D)None of (A), (B), (C)
(iv)The United States Dollar is selling in India at Rs. 45.20. If the interest rate for a 6 months borrowing in India is 10% and the corresponding rate in USA is 4%, what would be the rate of forward premium/(discount)?
(A)5.93%(B)5.88%(C)(5.71%)(D)(5.52%)
(v)If the share of BA Ltd. (F.V.Rs. 10) quotes Rs. 920 on NSE, and the 3 months futures price quotes at Rs. 950, and the borrowing rate is given as 8% and the expected annual dividend yield is 15% p.a. payable before expiry, then the price of 3 months BA Ltd. futures would be
(A)Rs. 948.40(B)Rs. 939.90(C)Rs. 936.90(D)Rs. 928.40
(b) From the following, choose the most appropriate answer (only indicate A, B, C, D, as you think correct): 1x5=5
(i)Free cash flow means
(A)Cash is available for financing incremental working capital
(B)Cash is available for financing additional investment in plant and machinery.
(C)Cash is available for meeting financial flows like debt servicing, dividend payment etc
(D)None of (A), (B), (C).
(ii)The following are the characteristics of GDR
(A)1 GDR = n shares, where n must be an integer;
(B)It is a fixed income security;
(C)The issuing Company has no foreign exchange liabilities;
(D)It is subject to two-way fungibility.
(iii)In the real world, Corporate finance managers have the following goals in mind while declaring dividends;
(A)Projects with positive NPV are not to be cut to pay dividends
(B)Maintain a long-term target debt-equity ratio;
(C)Resort to dividend cuts as and when needed;
(D)Avoid the need to raise fresh equity.
(iv)Factor that is irrelevant in determining the choice of debt-equity mix:
(A)Taxation;(B)The nature of asset-base;
(C)Industry norm;(D)Variability of cash flows.
(v)Select the wrong statement:
Butterfly spread is created in any one of the four ways namely—
(A)Buy 2 calls at mid-strike price; write one call above and one call below;
(B)Buy 2 puts— one above mid-strike price and one below mid-strike price;
(C)Write 2 calls at mid-strike price; buy one call above and one call below;
(D)Write 2 puts at-mid-strike price; buy one put above and one put below.
(c) Fill in the blanks by filling the appropriate word given in the brackets: 1x5
(i)Higher the beta of a stock as compared with the market beta ________ is the risk. (greater/lesser)
(ii)Companies usually prefer to issue inverse floater to make the bond attractive under ________ scenario. (raising interest rate/falling interest rate).
(iii)An enterprise, a bank, or an investor is said to have a ________ position in the case of increase in the rate of interest. (long/short)
(iv)To an investor holding a well-diversified portfolio, the risk that is relevant, is ________ . (systematic risk/diversifiable risk)
(v)Increase in interest rates ________ call value but ________ put value (increases/decreases; decreases/increases; decreases/decreases)
Please turn over

( 2 )

F-14(AFM)
Revised syllabus		 Marks
2. (a) Explain the differences between Operating leverage and Financial leverage: 16
(b) The following key information pertains to EXEL Ltd. for the year 2005-06;
Rs. in lakh
Sales
Variable Costs
Fixed Costs
9% Debentures
Equity Shares (Rs. 100 each)
Corporate Tax		 82.50
46.20
6.60
50.00
60.000
35%
You are required to work out:
(i)What is the Company's ROI?
(ii)Does it have favourable financial leverage?
(iii)If the company belongs to an industry whose asset Turnover is 3, does it have high or low asset leverage?
(iv)What are the Opening, Financial and Combined Leverages of the Company (Exel Ltd.)?
(v)What is the Compay's EPS?
(vi)What will be the expected EPS if the Sales of Excel Ltd. increase by 10 per cent in the next year and Cost Structure as well as financial structure remains the same?
3. (a) The Shares of Bangaluree Corporation Limited are selling at Rs. 105 each. Chandrasekhar wants to chip in with buying a three months call option at a premium of Rs. 10 per option. The exercise price is Rs. 110. Five possible prices per share on the expiration date ranging from Rs. 100 to Rs. 140, with intervals of Rs. 10 are taken into consideration by him. What is Chandrasekhar's pay-off as call option holder on expiration? 16
(b)
(i)If beta (β) is 1.50; Rf (risk-free returns) is 6.00%; and Rm (market return) is 12.00%, what should be the return on the share (Rj) with the beta as given above?
(ii)If the alpha value is + 1.5, 1, 0 (zero), or -2.40, what would be the corresponding current expected return from the stock in (i)?
(iii)What investment action would you suggest for each of the four different situation is (ii)
(c) What is the significance of Alpha in the investment market?
4. (a) From the following details of HPL Ltd. calculate the Cost of Capital. (4+3)+(3+4+2)
DebtAmountsNominal interest
Foreign Loan

Local Currency Loan
 US $ 100
million
Rs. 2200
million		 5%

12%
Expected depreciation of rupee: 3% per annum
Current exchange rate : Rs. 45 per US $
Bank/FI guarantee for raising foreign capital : 1%
Equity Capital
Unlevered Beta
Risk-free Rate
Market Premium		 :
:
:
:		 Rs. 3,000 million
0.6
6%
8%
The project is expected to have all effective tax rate of 30 per cent.
(b) MB LEASING COMPANY has been approached by a client to write a 5- year lease on an equipment. The equipment is eligible for depreciation at 25 per cent for Income Tax purpose, In the terminal year, the client will be required to pay 1 per cent of the equipment cost to acquire the ownership of the asset. The post-tax rate of return of the leasing company is 12 per cent. Assuming that the lessor is subject to a Corporate tax rate of 35 per cent, calculate pre-tax annual lease rental payable in arrear, and express the same in terms of standard lease quotation i.e rupees per THOUSAND per month.
Note: Extracted from the table:
(i)

The present value factors at 12% discount rate for 0 to 5 years are: 1,000, 0.8928, 0.7972, 0.7118, 0.6355 and 0.5674.

(ii)

The present value factor of an annuity of Re. 1 for 60 months at 12%

 [Using the formula:
1 - (1 + r)-n
r
] = 44.9550.
5. (a) Briefly explain the following concepts:
(i)Economic value added,
(ii)Shareholder value,
(iii)Marking to market.
 (3x3)+7
(b) What is a Foreign Exchange Risk?
Briefly explain the major types of Foreign Exchange Exposures.
Please turn over

( 3 )

F-14(AFM)
Revised syllabus
Marks
6. (a) ELECTRONICS LTD. your customer has imported 5000 cartridges at landed cost in Mumbai, of US $ 20 each. The company has the choice for paying for the goods immediately or in 3 months time. It has a clean overdraft limit with you where 14% p.a. rate of interest is charged.
Calculate which of the following methods would be cheaper to your customer.
(i)Pay in 3 months time with interest @ 10% and cover risk forward for 3 months.
(ii)Settle now at a current spot rate and pay interest of the overdraft for 3 months.
The rates are as follows:]
Mumbai Rs./$ spot :43.25 — 43.55
3 months swap :35/25
(b) The finance director of MOLSON Ltd. has been studying exchange rates and interest rates relevant in India and USA Molson Ltd. has purchased goods from the US Co. at a cost of $ 40.50 lakhs payable in $ in 3 months time. In order to maintain profit margins the finance director wishes to adopt, if possible a risk-free strategy that will ensure that the cost of goods to Molson Ltd. is no more than Rs. 18 crores.
Rs./$ spot
Rs./$ (1 month forward)
Rs./$ (3 months forward)		 41/43
42/44
43/46

Interest rates available of Molson Ltd:
 India (Rates in %)India (Rates in %)
 DepositBorrowingDepositBorrowing
1 month9.0012.004.007.00
3 months9.0013.005.008.00
Calculate whether it is possible for Molson Ltd. to achieve a cost directly associated with transaction not more than Rs. 18 crores, by means of a forward market hedge or money market hedge. Ignore transaction costs.
(5+2+1)+(2+4+2)
7. The LOVING CANDY Co. has been studying an investment project calling for the manufacture and introduction of a new candy bar called Yuppie Nougat, targeted (you guessed it ) for the yuppie market. As a consequence, Loving Candy expects to use the finest foreign chocolate and to price the candy very high relative to its cost; otherwise no self-respecting yuppie would even think of buying it. Part of the expense will consist of a vast marketing program, complete with endoresements by yuppie heroes. 14+2
The project is expected to last eight years, after which time yuppies will be more interested in dentures than candy bars. The introduction of the candy bar requires 400 new machines costing $ 10,000 each. Installing each machine costs $ 100. The machines will be depreciated on a straight-line basis over five years. The production facility will be located at a site the company already owns. The company could rent the space that the candy facility will occupy for $ 500,000 per year.
Loving Candy expects to sell 2 million bars per year for the entire life of the project. The price will be $ 2.50 per candy bar, with a production cost of $ 0.50. The plan schedules the marketing expense per candy bar at $ 1.00. Outlets for the candy bar have been chosen with yuppies in mind. The firm expects to maintain an average inventory of about 500,000 bars, and expects no other increase in working capital. The appropriate after-tax discount rate for Yuppie Nougat is 18 per cent.
Calculate NPV of the projects cash flows.
You may consider the following while doing your calculations:
(a)For tax purpose, depreciate the machine, including installation cost, using straight-line method.
(b)Estimate working capital in terms of production costs, and consider the amount as investment in the zero year.
(c)Assume salvage value equal to recovery of working capital.
(d)Assume tax rate of 34 per cent.
Should Loving Candy help sweeten the world with Yuppie Nougat?
Note: Extracted from the table.
P.V. factors at 18% discount rate for 0-8 years are:
1.0000, 0.8475, 0.7182, 0.6086, 0.5158, 0.4371, 0.3704, 0.3139, 0.2660.
8. (a) Write a short note on Index futures.
(b) On Aug. 2, Mr. Tandon buys 5 contracts of December Reliance futures at 840. Each contract covers 50 shares. Initial margin was set at Rs. 2400 per contract while maintenance margin was fixed at Rs. 2000 per contract. Daily settlement prices are as follows:
Aug. 2
Aug. 3
Aug. 4
Aug. 5		 818
866
830
846

Mr. Tandon meet all margin calls. Whenever he is allowed to withdraw money from the Margin Account, he withdraws half the maximum amount allowed.
Compute for each day:
(i)Margin call;
(ii) Profit & (Loss) on the contracts;
(iii)The balance in the Account at the end of the day.
(c) A multinational company has paid out 75 per cent of its earnings as dividend in the current period. The company's present ROE is 30 per cent, and it expects to maintain both ROE and dividend payout ratio in the long run.
The company's share is currently trading at Rs. 150. Do you think that the share is overvalued? Give reasons. You may further consider the following information:
Current EPS
Share Beta
Risk-free Rate
Market Premium		 :
:
:
:		 Rs. 10
0.75
6%
8%
3+(2+2+3)+6

__________

 

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