Scanner Appendix. CS Professional Programme Module - II (New Syllabus) (Solution of December )

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1 Solved Scanner Appendix CS Professional Programme Module - II (New Syllabus) (Solution of December ) Paper - 5 : Financial, Treasury and Forex Management Chapter - 1: Nature, Significance and Scope of Financial Management Dec [1] (a) In any economy, the financial sector plays a major role in the mobilization and channelising of saving. Financial institutions, instruments and markets constitute the financial sector. They act as conduit for the transfer of financial resources from net savers to net borrowers. Financial sector performs this basic economic function of intermediation essentially through four transformation mechanisms: 1. Liability-asset transformation (i.e. accepting deposits as a liability and converting them into assets such as loans); 2. Size-transformation (i.e. providing large loans on the basis of numerous small deposits); 3. Maturity transformation (i.e. offering savers alternate forms of deposits according to their liquidity preferences while providing borrowers with loans of desired maturities); and 4. Risk transformation (i.e. distributing risks through diversification which substantially reduces risks for savers which would prevail while directly in the absence of financial intermediation). Chapter - 2: Capital Budgeting Dec [2A] (Or) (i) Risk and uncertainty are quite inherent in capital budgeting decision. Capital budgeting involves various elements which have uncertainties. This is so because capital budgeting are actions of today which bears 1

2 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 2 fruits in future which is unforeseen. Future is uncertain and involve risk. The estimations of cash inflows may not hold true. The cost of capital which offers cut-off rates may also be inflated or deflated under business cycle conditions. Besides all these, technological developments are other factors that enhance the degree of risk and uncertainty by rendering plant & equipments obsolete and the projects out of date Dec [3] (a), (b) (a) (A) Petrol Truck Calculation of present value of outflow: P.V. of purchase cost = 1,50,000 + P.V. of operating cost = 64,996 W.N. 1 Less: Depreciation Tax benefit = (40,905) (1,50, ) Net P.V. of cash outflow = 1,74,091 Working Note: 1 Year Operating cost Outflow after tax P.V. factor P.V. 1 24,000 16, , ,000 23, , ,000 20, , ,000 21, ,821 64,996 (B) Battery powered Truck Calculation of present value of outflow: P.V. of purchase cost = 2,50,000 P.V. of operating cost = {12,000 (1-0.3) 3.79} Less: Depreciation Tax Benefit= (68,175) (2,50, ) Net P.V. of cash outflow = 2,13,661 ABC Chemicals Ltd. should option for purchase of petrol truck.

3 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 3 (b) Total fund required = 22 crores Debt = 11 crores Equity = 11 crores Cost of debt Amt. (in crores) Rate K d Amount K d = = 8% K e = 12% Weighted average cost of capital: = (8 0.5) + (12 0.5) = = 10% Risk adjusted discount rate = 10% + 2% = 12% Dec [5] (a), (b) (a) (A) Machine A P.V. of cash outflow = 25,00,000 P.V. of cash inflow: Year Cash Pv Factor inflow P.V. of cash inflow ,00, ,78, ,00, ,16, ,00, ,00, ,00, ,95,800 31,90,600 NPV = 31,90,600-25,00,000

4 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 4 NPV = ` 6,90,600 (B) Machine B P.V. of cost outflow = ` 40,00,000 P.V. of cash inflow: Year Cash inflow P.V. Factor P.V. of cash inflow 1 10,00, ,70, ,00, ,58, ,00, ,52, ,00, ,72, ,00, ,45,500 NPV = 46,99,100-40,00,000 = ` 6,99,100 NPV of Machine B is higher. (b) Calculation of existing profit: Sales = ( ) = 15,00,000 Less: Variable cost = 10,50,000 Contribution ( ) = 4,50,000 Less: Fixed cost = 3,00,000 Profit = 1,50,000 (A) In case market share is increased by 25% Current market share = 15% Current volume = units New market share will be 15% + 25% = 40% New volume = units. New fixed cost will be: Year Fixed cost 1 4,30,000 46,99,100

5 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 5 2 4,05, ,80,000. (B) In case market share is increase by 20% New market share will be 15% + 20% = 35% New volume = 35,000 units Fixed cost will be as under: Year Fixed cost 1 4,30, ,05, ,80,000 Based on this information, profitability of 3 years needs to be calculated. Chapter - 3: Capital Structure Dec [2A] (Or) (ii) The pecking order hypothesis is a perspective based upon repeated observations of how corporations seem to raise funds over time. Financing comes from three sources, internal funds, debt and new equity. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a last resort. Hence: internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required Dec [3A] (Or) (ii) ABC Ltd. XYZ Ltd. Sales 40,00,000 50,00,000 Variable cost 16,00,000 15,00,000 Contribution 24,00,000 35,00,000

6 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 6 Less: Fixed cost 10,00,000 20,00,000 EBIT 14,00,000 15,00,000 Operating leverage = = ABC Ltd. has a lower operating leverage compared to XYZ Ltd. Chapter - 4: Cost of Capital Dec [4] (d) Calculation of cost of debentures = 12 (1-0.3) = 8.4% Calculation of cost of short term loan = 10 (1-0.3) = 7% Calculation of WACC: Particulars Amount Weight Cost Cost Equity 70, Debentures 10, Loan 20, WACC = 16.24% Chapter - 6: Project Planning Dec [1] (b) Project review is a very important aspect of entire project life. Even projects that are well designed, comprehensively planned, fully resourced and meticulously executed will face challenges. These challenges can take place at any point in the life of the project and the project team must work to continually revisit the design, planning and implementation of the project to confirm they are valid and to determine whether corrective actions need to be taken when the project s performance deviates significantly from its design and its plan.

7 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 7 Purpose of the project control is to Monitor, Evaluate and Control the project. Project review involves: 1. Project Monitoring: Project Monitoring tracks the operational work of the project 2. Project Evaluation: Project Evaluation tends to focus on tracking progress at the higher levels of the logical framework i.e. project outcomes. 3. Project Control: Project Control involves establishing the systems and decision-making process to manage variances between the project plans Dec [2] (b) Net Lease: In a commercial real estate, a net lease requires the tenant to pay, in addition to rent, some or all of the property expenses that normally would be paid by the property owner (known as the "landlord" or "lessor"). These include expenses such as real estate taxes, insurance, maintenance, repairs, utilities, and other items. The precise items that are to be paid by the tenant are usually specified in a written lease. Chapter - 7: Dividend Policy Dec [3A] (Or) (iv) (A) When dividend is paid: As per Miller-Modigliani dividend model P o = Where, P 0 = Current Market Price D 1 = Dividend in year 1 P 1 = Price at the end of year 1 K(e) = Capitalisation rate P 0 = 150 D 1 = ` 8 K e1 = 12%

8 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) = P 1 = 160 (B) When dividend is not declared: P 0 = 150 = P 1 = ` 168. Chapter - 8: Working Capital Dec [1] (c) There is a myth that a firm having a high current ratio is treated as favourably placed as regards payment of its current liabilities. Holding of current assets is always in proportion to the turnover of the company. If the company has high current assets, then there might be a case where company s current assets age is increasing. As the current assets, particularly inventory and receivables, get older the chances of their easy and complete conversion into cash reduces. Moreover the firm is paying a huge cost for the higher build up of current assets. Thus, a firm having a high current ratio may not necessary be treated as being favourably placed as regards payment of its current liabilities Dec [2] (a) Some of the differences between forfaiting and export factoring is as under: 1. A forfeiter discounts the entire value of the note/bill but the factor finances between 75-85% and retains a factor reserve which is paid after maturity. 2. The avalling bank which provides an unconditional and irrevocable guarantee is a critical element in the forfaiting arrangement wheras in a facoring deal, particularly non-recourse type, the export factor bases his credit decision on the credit standards of the exporter.

9 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 9 3. Forfaiting is a pure financing arrangement while factoring also includes ledger administration, collection etc. 4. Factoring is essentially a short-term financing deal. Forfaiting finances notes/bills arising out of deferred credit transaction spread over three to five years. 5. A factor does not guard against exchange rate fluctuations; a forfeiter charges a premium for such risk Dec [2A] (Or) (iv) In finance, a reverse stock split or reverse split is a process by which shares of corporate stock are effectively merged to form a smaller number of proportionally more valuable shares. A reverse stock split may be used to reduce the number of shareholders. A reverse split is conducted out of a need to remain listed on an exchange, rather than solely to prop up the share price Dec [3] (d) Increase in sales = 1,20,000 Increase in bad debts (10% of non-payment risk) = 12,000 Net sales revenue = 1,08,000 Less: Production expenses (80%) = 96,000 12,000 Less: Income 30% = 3,600 Profit after tax = 8,400 Average collection period (ACP) = So, DTR (Debtors Turnover Ratio) = DTR = DTR = 8 Also, DTR = 8 = Average Debtors = 15,000

10 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 10 x + x = 15,000 x = 10,714 Thus, the company should earn ` 4,285 since the minimum required rate of return is 40%. Since, company is earning ` 8,400, new business connection should be established Dec [4] (a) There are various sources of working capital. Some of them are as under: 1. Owner s funds are the main source. Sale of equity stock or preference stock could provide a permanent working capital to the business with no burden of repayment particularly during short period. These funds can be retained in the business permanently. 2. Another source of permanent working capital is bond financing but it has a fixed maturity period and ultimately repayment has to be made. For repayment of this source, company provides sinking funds for retirement of bonds issued for permanent working capital. 3. Term loan from banks or financial institutions has the same characteristics as the bond financing of permanent working capital. 4. Short-term borrowing is also a source of working capital finance on permanent basis Dec [4] (c) Net Assets = Current Assets + Fixed Assets - Current Liabilities Policy Total Assets (cr) PBIT (cr) Return Conservative % Moderate % Aggressive % Chapter - 9: Security Analysis and Portfolio Management Dec [1] (d) Sharpe Index model was developed by William Sharpe. It expresses the relationship between return of a particular security with that of index such as

11 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 11 Nifty, Sensex, Nasdaq etc. It is also known one factor model or single index model. Thus, this model reflects how the prices of shares get influenced by market index and the same can be used to estimate the return on securities. The Sharpe ratio is a risk-adjusted measure of return that is often used to evaluate the performance of a portfolio. The ratio helps to make the performance of one portfolio comparable to that of another portfolio by making an adjustment for risk. The idea of the ratio is to see how much additional return you are receiving for the additional volatility of holding the risky asset over a risk-free asset Dec [3] (c ) There are various tools that helps to evaluate the performance of companies. Economic value added is one of such tool. It means cash flow after tax of a business less the cost of capital. Now a days EVA is used in determining the value of a firm since it is a true indicator as against earnings. EVA = Net operating profit after tax (NOPAT) ( ) Capital Employed Cost of Capital. Thus, there are two components of EVA, being NOPAT and capital charge where capital charge refers to the product of capital employed and cost of capital Dec [4] (b) Expected return of portfolio: Asset Amount Return X 2,00, % 17,00,000 Y 2,80, % 28,56,000 Z 3,20,000 12% 38,40,000 Return = Return = %. 8,00,000 83,96,000 Chapter - 10: Derivatives and Commodity Exchanges - An Overview

12 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) Dec [2] (d) Some of the differences of call premium and put premium are as under: Particulars Call Premium Put Premium Exchange rate A s e xchang e r a t e As exchange rate increases call premium increases put premium also increases decreases. Strike Price As strike rate increases call premium decreases Risk Free Interest Rate As the interest rate in the economy increases, value of call option increases Rate Volatility As strike rate increases put premiu m a lso increases As the interest rate in the economy increases, value of put option decreases The owner of the call The owner of the call benefits from the rate benefits from the rate increase decrease Chapter - 11: Treasury Management Dec [3A] (Or) (i) Treasury management is the science of managing treasury operations of a firm. The main function of treasury management is the management of funds. Treasury management has both macro and micro aspects. Treasury management is different from financial management. Some of the tools of treasury management are as follows: (i) Zero Base Budgeting: It is a method of budgeting which requires each cost element to be specifically justified. It requires each budget to be prepared & justified from zero, instead of simply using last year s budget as base. (ii) Financial Statement Analysis: Financial statement analysis helps to know the soundness & intrinsic worth of the company. It plays an important role in deciding whether to invest in the company or not to invest in the company. (iii) Analytical & planning tools:

13 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 13 Analytic & planning tools are necessary for planning & budgeting. Planning & budgeting are important to achieve the targets of treasury function. Chapter - 12: Forex Management Dec [2] (c) Interest rate parity: According to this parity, the high interest rate on a currency is offset by forward discount and low interest rate is offset by forward premium. In other words, it states that difference in interest rates between two countries is equal to the difference between the forward and spot exchange rates. Purchasing power parity: This approach states that the exchange rate between the currencies of two countries equals the ratio between the prices of goods in these countries, further the exchange rate must change to adjust to change in prices of goods. Thus purchasing power parity states that exchange rate between countries will adjust to change in inflation rates Dec [2A] (Or) (iii) Pegging of currency refers to a method of stabilizing a country s currency by fixing its exchange rate to that of another country. Different countries follow different methods for pegging of their currencies. The foreign exchange value is established according to the practice being followed by a country. There are many intermediate arrangements for determination of exchange values. These arrangements are being listed below: Domestic currency pegged to one foreign currency A currency pegged to a basket of currencies Flexibility limited in terms of a single currency Pegged to some indicators Managed Float Independent float Dec [3A] (Or) (iii) Current exposure 1$ = ` $ =

14 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 14 = = 1 = ` Current exposure in ` = = ` 50,98,200. In December end, currency rate will be: 1$ = ` 65 1$ = 144 = = 1 = ` Lakh = ` 45,13,900 Expected Loss = 50,98,200-45,13,900 = ` 5,84,300. Shuchita Prakashan (P) Ltd. 25/19, L.I.C. Colony, Tagore Town, Allahabad Visit us :

15 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 15 FOR NOTES

16 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 16 FOR NOTES

Roll No : 1 : Time allowed : 3 hours Maximum marks : 100. Total number of questions : 6 Total number of printed pages : 8

NEW SYLLABUS 335 Roll No : 1 : Time allowed : 3 hours Maximum marks : 100 Total number of questions : 6 Total number of printed pages : 8 NOTE : 1. Answer ALL Questions. 2. Tables showing the present value