CWA/ICWA Final :: Advanced Financial Management and International Finance : June 2007

You are required to determine:

(i)	The price at which the shares can be re-purchased if the market capitalization of the company should be Rs. 230 lakhs after buyback;
(ii)	The number of shares that can be re-purchased;
(iii)	The impact of shares re-purchase on the EPS, assuming the net income is same.

Required:

(i)	Calculate the Mark to Market Cash Flows and daily closing balances in the account of (A) an investor who has gone long at 4585 (B) an investor who has gone short at 4585
(ii)	Calculate the net profit/(loss) on each of the contracts.

Yearwise Investments in Fixed Assets:

Year Investment in Fixed Assets Post-tax non-operating cash flows

1 20 10

2 0 0

3 10 5

4 15 20

5 0 0

Note: You may use the formula:

1 (1 + r)n

for determining PVIF at r (rate for cost of capital)

(i) expansion of existing capacity, and (ii) setting up a new project not related with the present business. The company's shares are regularly traded in stock exchanges, the recent estimate of share beta is 1.2. The debtequity ratio of the company at present is 2 : 1. However, the new project, if undertaken can be financed with a debt-equity ratio of 1 : 1, since the company has adequate internal accruals. To assess business/financial risk of the proposed new project, the GT LTD. has identified a comparable company with debt-equity ratio of 1.5 : 1 and estimated share beta of 1.5. The comparable company is subject to an effective tax rate of 20 per cent, whereas effective tax rate of Gesco Textiles Ltd. is 30 per cent.

You are required to estimate (with necessary calculations) the following:

(i)	Cost of capital to be used as cut-off rate to evaluate the expansion project, assuming that its debt-equity ratio will be 2 : 1.
(ii)	Cost of capital to be used as cut-off rate to evaluate the new project.
(iii)	Based on your calculations in (i) and (ii) above, would you recommend different cut-off rates or single cut-off rate for the expansion and new projects? Give reasons.

You may further like to consider the following information while answering the above questions:

(a)	The company will be able to negotiate loan at 12 per cent;
(b)	The present vield on long-dated government securities is around 7 per cent;
(c)	Expected spread between return on stock index and government securities (i.e., market premium 6 per cent;
(d)	Estimated liquidity premium in the government securities is 1 per cent;
(e)	Effective corporate tax rate of Gesco Textiles Ltd. will continue to be 30 per cent even after the projects being undertaken.

Following market information is available:

	Exchange Rates
£ spot rate Six month £ forward rate	$ 1.5617—1.5773 $ 1.5455—1.5609

 

Country	Money Market Rates
	Borrow%	Deposit%
US$	6	4.5
UK£	7	5.5

Foreign currency option prices:

Execise price Call option (June) Put option (June)

: : :

$ 1.70 $ 0.037 $ 0.096

Contract size (1 unit is £ 12500)

Evaluate the following hedging alternatives with necessary calculations and decide which of the same is the most attractive to Carlhams Corporation Ltd.

Huron River Salt Company wishes to finance exports to Britain with £ 3 million of pound denominated fixed rate debt for six months. Huron is unable to obtain a fixed interest rate in London for less than 13.5% interest because of its lack of credit history in the UK. However, Lloyds Bank is willing to extend a floating rate British pound Loan at LIBOR + 2%. Huron, however, cannot afford to pay more than 12%. How can Yorkshire and Huron help one another via an interest rate swap? Assume that Yorkshire is in a strong bargaining position and can negotiate the best deal possible, but Huron will not pay over 12%. Assume further that transaction costs are 0.5% and exchange rates do not change. Illustrate the effective post-swap interest rates of each party with boxes and arrows. What are the interest savings by each party overy the six months period of the swap?

The average price per unit of the product is expected to be Rs. 200 netting a contribution of 40 per cent. The annual fixed costs, excluding depreciation, are estimated to be Rs. 480 lakh per annum from the third year onwards; for the first and second year, it would be Rs. 240 lakh and Rs. 360 lakh respectively. The average rate of depreciation for tax purpose is 33.33 per cent on the capital assets. The rate of income tax may be taken at 35 per cent. The cost of capital is 15 per cent.

At end of the third year, an additional investment of Rs. 100 lakh would be required for working capital. Terminal value for the fixed assets may be taken at 10 per cent and for the current assets at 100 per cent. For the purpose of your calculations, the recent amendments to tax laws with regard to balancing charge may be ignored.

As a financial consultant what recommendation on the financial viability of the project would you make to the TRYTONIC LTD.?

Note: Extracted from the table:

Year PVIF at 15%

1 0.870

2 0.756

3 0.653

4 0.571

5 0.497

6 0.432