Question Paper Financial Management (CFA540): October 2007

Transcription

1 Question Paper Financial Management (CFA540): October 2007 Answer all questions. Marks are indicated against each question. 1. The rate of return on common stock of FTC Ltd. over the coming year is normally distributed with an expected value of 20% and a standard deviation of 25%. What is the probability of earning a negative rate of return? 3.59% 21.19% 16.49% 22.13% 40.13%. 2. Which of the following implies the significant advantage of a public limited company over a proprietorship firm? Fewer government regulations Limited life Inability to mobilize a lot of funds Limited liability Difficulty of transfer of ownership interest. 3. The term divestiture involves which of the following activities? I. Distribution of shares to the existing shareholders of the parent company. II. Sale of a portion of the firm through an equity offering. III. Sale of a portion of the firm s shares to an outside third party in consideration of cash or equivalent thereof. Only (I) above Only (II) above Only (III) above Both (I) and (III) above All (I), (II) and (III) above. 4. A dealer has taken long position in Euro against dollar when the market rates for $/Euro are /47. Later the rates moved to /44. If the dealer liquidates his long position, it results into a Profit of $ per Euro Profit of $ per Euro Loss of $ per Euro Profit of $ per Euro Loss of $ per Euro. 5. A quote is called as American quote, if the exchange rate is expressed In terms of number of units of any other currency per unit of US dollar In terms of US dollars per unit of any other currency In terms of number of units of any other currency per unit of British pound In terms of number of units of any other currency per unit of any other currency excluding British In terms of number of units of any other currency per unit of euro. 1

2 6. Which of the following is/are true regarding a company following a conservative working capital policy? I. The technical insolvency of the company will be high. II. The company will finance it s current assets more from long-term source. III. The company will have a higher current ratio than one following an aggressive working capital policy. IV. The company will have a lower current assets turnover ratio than the one following an aggressive working capital policy. Only (I) above Both (II) and (III) above Both (III) and (IV) above (I), (II) and (III) above (II), (III) and (IV) above. 7. Leontief paradox is associated with which of the following theories of international trade? Theory of absolute advantage Heckscher-ohlin model Imitation Gap theory International product lifecycle theory Theory of comparative advantage. 8. In balance of payments statement, current account deficits are offset by Merchandise trade deficits Merchandise trade surpluses Capital account surpluses Capital account deficits Official reserves. 9. The present value interest factor of annuity is/are equal to FVIFA (k, n) I. FVIF (k, n). II. III. IV. n (l k) 1 k(l k) n. FVIFA (k, n) (l k) n. Reciprocal of sinking fund factor for k% and n years PVIF (k, n). Only (I) above Only (II) above Both (I) and (III) above (I), (II) and (III) above All (I), (II), (III) and (IV) above. 10. Which of the following may be considered as the correct reason(s) for money having time value? I. In India, it is guaranteed by the union government. II. Money can be productively invested to generate real returns over a period of time. III. Its purchasing power increases with the passage of time due to inflation. IV. It is the legal tender for carrying out any type of transaction. Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (III) and (IV) above. 2

3 11. The shares of SMS Ltd. are presently trading at a price of Rs.10 per share. The expected dividend by the end of the year is Re.1.00 per share while the appreciations of the share price of SMS vis-à-vis the Market Index(presently at 3,800) are projected by the analysts as follows: What is the beta value for the shares of SMS Ltd.? Consider the following data of M/s. Global InfoTech Ltd.: Price (Rs.) Market Index Probability Market Value of Debt Rs.6,00,000 Interest Rs.45,000 Net Operating income Rs.1,50,000 Cost of Equity Capital 12% If debt-equity ratio changes to 4:5, the revised equity capitalization rate according to net operating income approach is 10.15% 11.25% 12.31% 14.35% 15.45%. 13. If the tax rate on stock income is 15%, the tax rate on debt income is 20% and the corporate tax rate is 32%, the tax advantage associated with the total assets of Rs.200,00,000 out of which 40% has been contributed by the promoters, is Rs.22,50,000 Rs.35,00,000 Rs.33,30,000 Rs.34,00,000 Rs.25,00, Which of the following will not cause a change in the bid-ask spread? I. High market volatility. II. Trading volume. III. Decrease in forward maturity. Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (I) and (III) above. 3

4 15. Consider the following information for three stocks, Stock A, Stock B, and Stock C. The returns on each of the three stocks are positively correlated, but they are not perfectly correlated. Stock Expected Return Standard Deviation Beta A 10% 20% 1.0 B 10% 20% 1.0 C 12% 20% 1.4 Portfolio P has half of its funds invested in Stock A and half invested in Stock B. Portfolio Q has invested its funds equally in each of the three stocks. The risk-free rate is 5 percent, and the market is in equilibrium. Which of the following statements is correct? Portfolio P has a standard deviation of 20 percent Portfolio P s coefficient of variation is greater than 2.0 Portfolio Q s expected return is percent Portfolio Q has a standard deviation of 20 percent Portfolio P s required return is greater than the required return on Stock A. 16. The market rates are as under: Rs/ 82.45/50 1 m 30/20 paise 2 m 60/50 paise If a bank has to quote for sale of British pounds to a customer for 2 months forward contract with option over second month, the quote will be As per the given information: Spot rate : Rs.46.37/$ 3 month forward rate : Rs.46.45/$ The inflation rate in India is 5.5%, calculate the inflation rate in the USA assuming that the PPP holds good even for the short run 5.52% 4.82% 4.52% 4.88% 5.88%. 18. Which of the following is a part of the financial control function of the finance manager? Negotiating with the banks and financial institutions for loans Negotiating with the merchant banks for issue of shares and debentures Deciding on the manner of deployment of funds in various assets Appraisal of investment proposals given by various departments Reporting on the financial performance of individual departments within the organization. 4

5 19. Regular Suppliers Ltd. targets to limit its average collection period to 25 days. For the financial year 2007, it targets a sales turnover of Rs.2880 lakh. What should be the maximum amount of average receivables? (Assume that one year is equal to 360 days and all sales are on credit basis). Rs.125 lakh Rs.150 lakh Rs.175 lakh Rs.200 lakh Rs.250 lakh. 20. According to CAPM, a security s required return is equal to risk free rate of return plus a premium which will be Equal to security s beta Based on total risk of the security Based on unsystematic risk of the security Based on systematic risk of the security Based on security s market value. 21. Which of the following defensive strategies is most effective in foiling a takeover bid, when the target company has the financial resources to make a legitimate bid for the bidder? Greenmail Pac Man Defense White Knight White Squire Recapitalization. 22. Sonex Ltd. common stock is currently selling for Rs.20 per share. Security analysts at Karvy have assigned the following probability distribution to the price of (and rate of return on) Sonex Ltd. stock one year from now: Price Rate of Return Probability Rs.16 20% 0.25 Rs.20 0% 0.30 Rs % 0.25 Rs % 0.20 Assuming that Sonex is not expected to pay any dividends during the coming year, determine the coefficient of variation for the rate of return on the stock of Sonex Ltd The correlation coefficient between returns on stock of M/s. X Ltd. and the market returns is 0.3. The variance of returns on M/s. X Ltd. is 225(%) 2 and that for the market returns is 100(%) 2. The risk-free rate of return is 5% and the market return is 15%. The last paid dividend is Rs.2 and the current purchase price is Rs.30. The growth rate for the company is 10%. The required rate of return on the security as per the Capital Asset Pricing Model is 9.50% 10.00% 11.30% 12.50% 13.50%. 5

6 24. Which of the following is not considered as a capital component for the purpose of calculating the Weighted Average Cost of Capital (WACC) in capital budgeting? Accounts payable and accruals Common stock Preferred stock Long-term debt Convertible bonds. 25. Mr. Ashish borrowed an amount of Rs.7,00,000 from M/s. Paywell Finance Ltd. As per the loan agreement, he has to repay Rs.8 lakhs at the end of 7 th year, Rs.10 lakhs at the end of 8 th year, Rs.5 lakhs at the end of 9 th year and Rs.4 lakh at the end of 10 th year from now. In order to meet these payments, he wants to deposit money in a bank scheme that offers an interest rate of 10% p.a. The approximate amount that Mr. Ashish should invest at the end of every year for a period of 6 years, so that he can repay the loan as per the agreement is Rs.1,50,253 Rs.3,00,000 Rs.2,85,525 Rs.1,45,000 Rs.1,55, Which of the following statement is true? Retained earnings represent the profits ploughed back into the business Retained earnings are given lesser importance, when a firm follows a residual dividend policy Retained earnings represent the extent to which the firm has invested in liquid assets out of its profits Retained earnings is the only principal source of finance for growing firms Retained earnings cannot be utilized by a firm to buy-back its shares. 27. Which of the following is not an assumption underlying the Modigliani and Miller approach to capital structure? There is no corporate or personal income tax The transaction cost is constant irrespective of the value of the transactions in securities Information is freely available to investors and securities traded in the market are infinitely divisible Investors make rational investment decisions Firms can be divided into classes in such a way that all the firms falling within one class have the same degree of business risk. 28. In the presence of floatation costs, the cost of external equity is Less than the cost of existing equity capital More than the cost of existing equity capital Equal to the cost of short-term debt Equal to the cost of existing equity capital Equal to the cost of long-term debt. 6

7 29. Mr. Jaswant has planned to purchase a flat, whose present cost is Rs.20 lakh. He has approached City Home Finance, which has agreed to finance 80% of the cost of the flat. As he, presently, has Rs.1.5 lakh only which is not sufficient to purchase the flat, he deferred his plan of purchase for three years and deposited the amount he had in a bank. Mr. Jaswant planned to save annually for the next three years and purchase the flat with the bank finance of 80%, at the end of three years. The rate of interest that can be earned on the bank deposits is 8% p.a. and the cost of the flat is expected to escalate by 5% p.a. The amount that Mr. Jaswant has to save annually, the first deposit being made today, is Rs.78,200 Rs.81,350 Rs.85,250 Rs.87,500 Rs.91, The probability distribution of returns of stock of M/s. BDPL Ltd. and the returns on market are given below: Probability (P) Returns of stock of M/s. BDPL Ltd. (in %) Market returns (in %) The risk-free rate of return is 5%. According to CAPM, the risk premium for the stock of M/s. BDPL Ltd. is The value of a share after the rights issue was found to be Rs.70. The theoretical value of the right is Rs.8. The number of existing shares required for a rights share is 2. The subscription price at which rights were issued is Rs.54 Rs.60 Rs.65 Rs.70 Rs Consider the following information about the debentures issued by M/s. Lalit Industries Ltd.: Face Value = Rs.100 Coupon rate = 11% p.a. Amount realized per debenture = Rs.95 Corporate tax rate = 40% Debenture is redeemable at a premium of 5% after 8 years. The difference between the redemption price and the net amount realized can be written off over the life of the debenture and the amount so written off is tax-deductible. The cost of debenture capital is 7.05% 7.15% 7.25% 7.35% 7.45%. 7

8 33. Mr. Sanjay Kothari who is now 40 years old, plans to retire in 20 years and he expects to live for another 25 years after he retires, that is, until he is 85. He wants a fixed retirement income that has the same purchasing power at the time he retires as Rs.75,000 has today. His retirement income will begin the day he retires, 20 years from today, and he will then get 24 additional annual payments. Inflation is expected to be 4 percent per year from today forward; he currently has Rs.2,00,000 savings; and he expects to earn a return on his savings of 7 percent per year, annual compounding. To the nearest rupee, how much must he save during each of the next 20 years (with deposits being made at the end of each year) to meet his retirement goal? Rs.31, Rs.35, Rs.54, Rs.41, Rs.62, The following details are available regarding the long term sources of finance of M/s. VK Ltd.: Source of finance Range of new financing from the source Post tax cost (%) (Rs. crore) Equity & above 16 Preference & above 14 Debt & above 10 (3 marks) The company is considering expanding its operations and requires funds in the range of Rs.60 crore Rs.70 crore for the same. The present capital structure of the company is as follows: (Rs. in crore) Equity capital 200 Reserves and Surplus 100 Debt 400 Preference shares 100 It is planning to maintain the present capital structure even in future. The weighted marginal cost of capital of new financing in the range of Rs.60 crore Rs.70 crore is 9.475% % % % %. 35. Techno industries Ltd., has 80,000 shares outstanding. The current market price of each share is Rs.75. The company expects a net profit of Rs.12,00,000 during the year and it belongs to a risk class for which the approximate capitalization rate has been estimated to be 20%. The company is considering dividend of Rs.10 per share for the current year. According to the Modigliani Miller model, how many new shares must the company issue if the dividend is paid and the company needs Rs.28,00,000 for an approved investment expenditure during the year? 12,000 shares 18,000 shares 20,000 shares 24,000 shares 30,000 shares. 8

9 36. Deccan Paints Ltd. had 10 lakh equity shares outstanding at the beginning of July 2007 and these shares were traded in NSE at Rs.150 each. The rate of capitalization appropriate to the risk class to which the firm belongs is 12%. The net income for the year is Rs.2 crore and the investment budget is Rs.4 crore. Assume that no dividend is declared and the additional fund requirement is financed by new issue of equity shares. If Modigliani-Miller hypothesis holds good, the number of equity shares to be issued by the company is 1,09,048 1,09,248 1,19,048 1,19,248 1,29, The following information regarding the equity shares of M/s. Venus Ltd. is given: Market price per share Rs.25 DPS Rs. 5 Multiplier 2 According to the traditional approach to the dividend policy, the EPS for M/s. Venus Ltd., is Rs Rs Rs Rs Rs Shunt Technology will spend Rs.24,00,000 on a piece of equipment that will manufacture fine wire for the electronics industries. The shipping and installation charges will be Rs.10,00,000 and net working capital will increase by Rs.2,50,000.The equipment will replace an existing machine that has a salvage value of Rs.7,50,000 and a book value of Rs.10,25,000. If Shunt has a current marginal tax rate of 36 percent, the net investment is Rs.32,50,000 Rs.28,01,000 Rs.35,20,000 Rs.28,50,000 Rs.27,45, Aniruddh Textiles Ltd, is considering a new piece of equipment, which is expected to cost Rs.6,00,000 and will produce cash flows of Rs.1,00,000 every year for the next 12 years (the first cash flow will be exactly one year from today). If the company is able to invest in an upgrade, which would cost Rs.1,20,000 in year 5, it would increase the annual cash flows from 6 th year onwards to Rs.2,00,000. If the discount rate appropriate for the company is 15%, the NPV of the investment approximately is Rs.78,765 Rs.80,674 Rs.89,247 Rs.99,544 Rs.99,604. 9

10 40. Consider the following information regarding a project: Initial investment Rs.10 lakh Required rate of return on the project 12% Required payback period 3 years In which of the following cases can the project be accepted? Present value of inflows is less than Rs.10 lakh Internal rate of return is less than 12% Benefit cost ratio is between 0 and 1 Payback period is less than 3 years Net benefit cost ratio is less than Mrs. Lalitha, who just completed 65 years of her age has currently Rs.100,000 in her savings bank account on which she earns an interest of 9 p.a. She is planning to join an old age home, immediately after she completes 85 years of her age. Before joining old age home, she wants to utilize all her savings, by withdrawing a constant amount each year. If her first withdrawal is after one year from today, the constant amount, she can withdraw each year is Rs.14,250 Rs.11,000 Rs.11,458 Rs.13,500 Rs.10, The following information relates to the sources of long term finance used by Pioneer Industries Ltd.: Source Book value Market value (Rs. in lakh) (Rs. in lakh) Paid-up equity share capital Reserves and surplus 400 Preference shares Debentures Cost of equity share capital = 20 Cost of preference share capital = 15 Post tax cost of debenture capital = 8% The difference between the weighted average cost using book value weights and market value weights would be % 0.33% 0.30% 0.34% 0.45%. 43. Port Stadium Inc. has annual sales of Rs.4,00,00,000 and keeps average inventory of Rs.1,00,00,000. On average, the firm has accounts receivable of Rs.80,00,000. The firm buys all raw materials on credit, its trade credit terms are net 35 days and it pays on time. The firm s managers are searching for ways to shorten the net operating cycle. If sales can be maintained at existing levels but inventory can be lowered by Rs.20,00,000 and accounts receivable lowered by Rs.10,00,000, what will be the net change in the net operating cycle? (Assume 365-day year and round off your answer to the closest whole day) +105 days 105 days + 27 days 27 days 3 days. 10

11 44. The projected returns from the equity shares of Suburban Traders Ltd. for the next one year are as follows: Probability Projected Returns 10 % 16 % 20 % What is the expected risk (in terms of standard deviation) for the equity shares of Suburban Traders Ltd.? 3.16 percent 3.36 percent 3.96 percent percent 3.56 percent. 45. A reputed TV set manufacturer, plans to manufacture 20,000 sets of washing machines for the next year. The cost components are as follows: Item Raw Material Manufacturing Expenses Selling, administrative and financial expenses Unit Cost (Rs.) 8,000 5,000 3,000 The selling price per unit is Rs.20,000 and sales may be assumed to be uniform throughout the year, while the manufacturing expenses are expected to be incurred evenly throughout the month. The durations at various stages of the operating cycle are given below: Raw material stage Work in process stage Finished goods stage Debtors stage 1.5 months 1 month 1 month 2 months If the minimum cash balance required is Rs.50,00,000, what is the estimate for the working capital requirement of the company? Rs.1, lakh Rs.1, lakh Rs.1, lakh Rs.1, lakh Rs.1, lakh. (3 marks) 46. Lakshya Corp. is a retailer that can finance its purchases with trade credit under the terms: 1/10, net 30 days. The company plans to take advantage of the trade credit that is offered. After all the trade credit is used, the company can either finance the purchases with a bank loan at the rate of 10 percent (on a 365-day year), or the firm can continue to use trade credit. The company has an understanding with its suppliers to stretch out its payments beyond 30 days without facing any additional financing costs. Therefore, the longer it takes the company to pay its suppliers, the lower the cost of trade credit. How many days from the date of purchase would the firm wait to pay its suppliers in order for the cost of the trade credit to equal the cost of the bank loan? (Round off the figure to the nearest integer) 30 days 36 days 40 days 44 days 47 days. 47. Which of the following functions is/are served by the primary capital market of an economy? It offers a market to trade for the outstanding short term securities It allows the corporate houses to raise the long term capital by issuing new securities It offers a market to trade for the outstanding long term securities It allows the corporate houses to raise short and long term capital It offers an excellent exit route for the venture capital funding companies. 11

12 48. The following figures are collected from annual report of Hyderabad Ceramics Ltd.: Particulars Raw materials inventory Closing Balance Work in process inventory Closing Balance Finished Goods inventory Closing Balance Purchases of raw materials during the year Manufacturing expenses during the year Depreciation Selling, administration and financial expenses during the year Excise Duty paid during the year 2006 (in Rs. 000s) (in Rs.000s) Assuming 360 days in a year, what should be the average finished goods storage period of Hyderabad Ceramics Ltd. for the year 2007? 2 days 3 days 4 days 5 days 6 days. 49. The following sales forecasts have been made for Navdeep Electronics for the period January to April Additional Information: (Rs.) Particulars January February March April Sales 1,50,000 2,10,000 3,60,000 2,10,000 Raw materials 1,40,000 2,00,000 1,60,000 1,70,000 Manufacturing expenses 20,000 40,000 58,000 32,000 Loan installment 2,000 22,000 42,000 42,000 (i) All sales are made on credit basis. 2/3 of the debtors are collected in the same month and balance in the next month. There is no expected bad debt. The debtors on January 1, 2007 were Rs.60,000. (ii) The minimum cash balance, the firm must have is estimated to be Rs.10,000. However, the cash balance on January 1, 2007 was Rs.13,000. (iii) Borrowing can be done only in multiples of Rs.100. (3 marks) What is the cash balance at the end of February 2007? How much should the firm borrow/refund to maintain the minimum cash balance at the end of February 2007? Rs.61,000; Refund Rs.51,000 Rs.61,000; Borrow Rs.71,000 Rs.65,000; Borrow Rs.75,000 Rs.71,000; Borrow Rs.61,000 Rs.71,000; Refund Rs.61, Which of the following statements is/are true? (3 marks) I. Commercial paper can be issued by high credit worthy firms with good credit rating. II. The company following a conservative policy will have a more percentage of operating profitability compared to its counter party following an aggressive approach. III. The firm financing its permanent working capital with short-term credit faces more risk than the firm financing with long-term credit. Only (I) above Only (II) above Only (III) above Both (I) and (III) above Both (II) and (III) above. 12

13 51. The following are the details regarding the operation of a firm during a period of 12 months: Sales Selling price per unit Variable cost per unit Total cost per unit Credit period allowed to customers Rs.48,00,000 Rs.20 Rs.14 Rs.18 One month The firm is considering a proposal for a more liberal credit by increasing the credit period from one month to two months. This relaxation is expected to increase the sales by 25%. What is the return on additional investment in receivables? 62% 68% 72% 77% 79%. 52. Swathi must decide whether her firm should relax its credit standards. The proposed change would increase sales by 10,000 units. The cost of the increased investment in accounts receivable would be Rs.9,345, with a cost of increased bad debts of Rs.23,495. Swathi s company sells its product for Rs.10 per unit, with variable costs per unit of Rs.6, fixed costs of Rs.1,25,000 per year, and a required return of 10 percent on investments of equal risk. Swathi 's firm should Relax its credit standards, because the change would provide Rs.27,160 net profit Relax its credit standards, because the change would provide Rs.7,160 net profit Maintain its current credit standards, because the change does not meet the 10 percent required rate of return Maintain its current credit standards, because the change would cost Rs.5,340 Maintain its current credit standards, because the change would cost Rs.32, Which of the following is not a relevant factor in cash management? Availing of term loans to the maximum possible limit Branch wise collection of receivables Prompt billing and mailing the same to the customers Prompt depositing of the cheques received from customers in the bank Centralized purchases and payments to the suppliers. 54. The Midtown Company keeps excess cash on hand in case of an industrial accident in the manufacturing of it s fertilizer. This is an example of Compensating need for holding cash Precautionary need for holding cash Speculative need for holding cash Deterministic need for holding cash Transactions need for holding cash. 55. Which of the following is a disadvantage of bought-out-deals? It is more expensive than public issue It involves a time consuming procedure It is difficult to convince a wholesale investor Promoters are not assured of immediate funds Sponsor may misuse its power. 13

14 56. Which of the following is not an assumption of theory of comparative advantage? Perfect competition Full employment Perfect mobility of labor between sectors and perfect immobility between countries Continuous technological innovation Average and marginal product of labor is constant. 57. Which of the following is/are a non-tariff barrier in international trade? I. Embargo. II. Export duty. III Import duty. IV. Specific duty. Only (I) above Only (II) above Both (I) and (II) above (I), (II) and (III) above All (I), (II), (III) and (IV) above. 58. Which of the following assumptions underlie the definition of cost of capital as a measure for appraising new investments? I. The risk characterizing the new project under consideration is not significantly different from the risk characterizing the existing investments of the firm. II. The firm will finance new investments without resorting to external financing. III. There will be no deviation from the debt-equity mix presently adopted by the firm. Only (I) above Only (II) above Both (I) and (II) above Both (I) and (III) above All (I), (II) and (III) above. 59. Short-term portfolio investments are recorded in which type of Balance of Payments (BOP) account? Investment income Unilateral transfers Current Accounts Capital Accounts Reserves. 60. Which of the following may be termed as Limited Discretionary Order? An order that is to be executed by the broker any time at the discretion of the customer An order limited by a fixed price as decided solely by the broker An order that is to be executed by the broker any time at his discretion An order to be executed by a broker at a price that is very near to the price set by the customer An order limited by a fixed price as decided solely by the customer. 14

15 61. The role of is to direct one nation s savings into investments of another nation. I. Merchandise trade flows. II. Services flows. III. Current account flows. IV. Capital flows. Only (I) above Only (IV) above Both (I) and (II) above Both (II) and (III) above All (I), (II), (III) and (IV) above 62. Which of the following exchange rate forecasting approaches is also known as the balance of payment approach? Monetary approach Portfolio balance approach Asset approach Demand-supply approach Mundell-Fleming approach. 63. A Foreign Institutional Investor borrowed Euro 1 million at 3% p.a. for 6 months and invested in India at 6% p.a. for 6 months. The current spot rate is Rs.51 per Euro. In order to get a positive spread the six months Rs./Euro forward rate should be > Rs < Rs > Rs Rs >Rs The Eurodollar interest rates in London are as under: 1 month 3.00% p.a. 2 months 3.60% p.a. 3 months 4.00% p.a. The one month interest rate after 2 months is expected to be 4.44% p.a. 4.55% p.a. 4.66% p.a. 4.77% p.a. 4.88% p.a. 65. Which of the following is not a type of bank finance for working capital? Cash credit Overdraft Commercial paper Purchasing and discounting of bills Note lending. 15

16 66. The pound sterling quote of a bank is Rs / 84. If the banker agrees to quote a better rate by 2 paise to an Exporter, who is buying , the rate quoted is Rs Rs Rs Rs Rs If the rates of return from a security are not at all related to the market returns, then the beta for that security will be 1 0 Between 0 and 1 Greater than 1 Less than If the risk free rate of return is expected to increase in future and the investors become more risk averse, then the Security Market Line (SML) will Shift up and the slope will increase Shift up and the slope will decrease Shift down and the slope will increase Shift down and the slope will decrease Remain unchanged. 69. Which of the following is not a feature of certificate of deposit issued by a bank? It is transferable by endorsement and delivery The maximum maturity period is one year It is not subject to the reserve requirement of the bank There is no lock-in period for transferring it to others It is a document of title to a time deposit. 70. Which of the following is not a part of the money market? Stock market Call money market Certificate of deposits market Treasury bills market Commercial paper market. 71. Stanban AG, an integrated steel producer in Switzerland, is worst hit by recession wave. In 2007, the entire company was broken into eight new entities and Stanban ceased to exist. This technique of restructuring is called Spin off Divestiture Split up Split off Equity carve out. 72. The discount rate used in the APV method to calculate savings due to concessionary loans is Risk free rate of interest in home country Competitive borrowing rate in home country Risk free rate of interest in host country Competitive borrowing rate in host country The cost of capital for the parent company.

17 73. Consolidation of financial statement(s) of an MNC gives rise to I. Economic exposure. II. Translation exposure. III. Transaction exposure. Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above. 74. Which of the following instruments are fixed-income securities having a maturity of over one year? American Depository Receipts Commercial Papers Medium-Term Notes Global Depository Receipts Treasury Bills. 17

18 Suggested Answers Financial Management (CFA540): October Answer : Reason : 0-20 z P = or 21.19% 2. Answer : Reason : A public limited company is said to be in a significant advantage owing to its limited liability. If the company turned to an insolvent one, the members don t have any further liability to bail out whereas in a proprietorship firm, the liability of the owner is unlimited. However, for a public limited company, the ownership can be easily transferred and resources can be mobilized with unlimited life. But for a proprietorship company, these advantages are not available to a proprietorship company. 3. Answer : Reason : Divestiture involves the sale of a portion of the firm to an outside third party. Cash or equivalent consideration is received by the divesting firm. Distribution of shares to the existing shareholders of the parent company is spin off and sale of a portion of the firm through an equity offering is equity carve out. 4. Answer : Reason : The dealer will book loss as his long position is created at $/Euro and it is liquidated at $/Euro Loss = = per Euro. 5. Answer : Reason : A quote in terms of U.S. dollars per unit of any other currency is called an American quote. 6. Answer : Reason : As a conservative working capital policy involves financing of current assets more from long-term sources, the company will have a lower debt-servicing cost compared to an aggressive policy and consequently a lower degree of the risk of technical insolvency. Hence statement (I) is incorrect. Under a conservative working capital policy, the financing mix will consist of a higher proportion of long-term sources of finance like equity and to some extent debentures also. Hence statement (II) is correct. A company following a conservative working capital policy will invest more in current assets than a company following an aggressive working capital policy. Hence, it will have a higher current ratio than the one following an aggressive working capital policy. So statement (III) is correct. Under a conservative working capital policy, a firm invests more in current assets than a firm following an aggressive policy. Therefore the current assets turnover ratio computed as Sales Current assets will be lower incase of a conservative working capital policy. So statement (IV) is also correct. Hence option is the correct choice as statements (II), (III) and (IV) are correct. 7. Answer : Reason : Wassily Leontief paradox is associated with Heckscher-ohlin model of international trade theories. 8. Answer : Reason : In balance of payments statement, current account deficits are offset by capital account surplus 9. Answer : Reason : Present value interest factor of annuity = = n (1 k) 1 k 1 (1 k) n (1 k) n k(1 k) 1 n 18

19 = FVIFA(k, n) (1 k) n FVIFA(k, n) = FVIF(k, n) 1 = Reciprocal of sinking fund factor for k% and n years FVIF(k, n) = Reciprocal of sinking fund factor for k% and n years PVIF(k,n) Sinking fund factor = 1 FVIFA(k, n) 10. Answer : Reason : Being a legal tender and having the government guarantee do not have any role in relation to the time value of money. The purchasing power of money gradually decreases due to inflation and so the individuals prefer to spend money, rather than saving the same without any suitable incentives. But money may be productively invested to generate higher returns in future. Hence the option is the correct one. 11. Answer : Reason : Return from each of the given scenarios may be obtained as Price (Rs.) Return = 10 percent = 20 percent = 30 percent Probability So, the expected return is = =20 percent. Expected return from the shares of SMS Ltd is = 20 percent Returns from the market under various scenarios can be estimated as Market index Return = 15 percent = 25 percent = 35 percent Probability Hence, the expected return = = 25 percent. And the expected return from market index is = 25 percent So, the variance on the market return can be calculated as m Now, the covariance between the return from the share and return form the market can be calculated as = 0.30 (10-20)(15-25) (20-20)(25-25) + 0.3(30-20)(35-25) = = 60 = Hence, the beta value for the shares of SMS Ltd is = = covariance between the returns from the shares and market var iance on the market returns

20 12. Answer : Reason : As per Net Operating Income Approach k e = NOI INT S where symbols are in their standard use 1,50, , 000 Rs.8, 75, 000 S = 0.12 Market value of Debt = Rs.6,00,000 (given) Value of the firm = Rs.14,75,000 Overall cost of capital k o NOI 1, 50, 000 V 14,75, = 10.17% 45, 000 K d = 6,00, = 7.5% As per NOI approach, overall cost of capital will remain constant even if the debt-equity ratio changes. k k k k e o o d D E k 4 e = = = %~12.31% 13. Answer : Reason : The amount of borrowed capital = Rs. 200,00,000(1-0.4) = Rs.120,00,000 Tax advantage associated with debt capital = = ( )( ) 1 120, 00, 000 ( ) = Rs (1 tc)(1 tps) 1 B (1 tpd ) 14. Answer : Reason : Options in, and can cause a change in the bid-ask spread. Market downturn will cause rates to fall but not necessarily the spread. Correct answer is. 15. Answer : Reason : Standard deviation of portfolio P will be less than 20% since the correlation coefficients are between 0 and 1. Expected return from portfolio P = 0.5 x x 10 = 10% Portfolio P s coefficient of variation will be less than 2.0 since S.D. is less than 20% and expected return is 10%. Expected return from portfolio Q = 1/3( ) = 10.67% Standard deviation of portfolio Q will be less than 20% since the correlation coefficients are between 0 and Answer : Reason : Since the currency is at discount, one month discount only is to be deducted assuming that the delivery of foreign currency is taken up by the customer on the first day of the option period. Hence the rate is minus 0.20 that is Answer : Reason : Applying PPP, we can state that Rs and $1 can buy same basket of goods today Let the inflation rate in the USA be i After 3 months, the price of the basket willl be as follows : in India ( /4) = Rs in USA, 1(1+ i/4) = S(1 + i/4) Expected Spot rate after three months is then / (1 + i/4) 20

21 But the expected spot rate is nothing but the forward rate So, we can write / (1 + i/4) =46.45 i = 4.82% 18. Answer : Reason : The management of an organization exercises its control on the overall performance of the organization on the basis of the reports sent by the finance manager on the performance of the individual departments. Since this function of the finance manager helps the management to exercise control over the overall performance of the organization it is considered to be a part of the control function of the finance manager. 19. Answer : Reason : The average collection period is defined as: Average Accounts Re ceivable = Average daily credit sales Here, the average daily credit sales, as targeted, is Rs2880/360 = Rs lakh Hence, the maximum amount of average accounts receivable for the year 2007 will be = Rs.8.00 lakh 25 days = Rs.200 lakh 20. Answer : Reason : As per CAPM, security s required rate of return is equal to risk free rate plus a premium based on the systematic risk of the security. Hence, option is the answer. 21. Answer : Reason : Pac man defense is one of the more extreme anti takeover defense. It refers to the situation in which a target makes counter offer for the bidder. Pac Man defense strategy can only be effective if the target company has the financial resources to make legitimate bid for the bidder. 22. Answer : Reason : Expected return, R = -20%(0.25) + 0%(0.30) + 20%(0.25) + 40%(0.20) = 8% S.D., = [(-20% - 8%) 2 (0.25) + (0% - 8%) 2 (0.30) + (20% - 8%) 2 (0.25) + (40% -8%) 2 (0.20)] 0.5 = 21.4% Coefficient of variation = 21.4% / 8% = Answer : Reason : The expected rate of return as per the Capital Asset Pricing Model can be computed as: k x = R f + β x (k m - R f ) Where k x is the required rate of return on the security, k m is the return on market portfolio, R f is the risk free rate of return Cov(k jk m ) ρ β x = Var(k m ) = σ σ xm x m Var(k m ) = = 0.45 Therefore, k x = R f + β x (k m - R f ) = x ( ) = 9.5% Hence, the required rate of return as per CAPM = 9.5%. 24. Answer : Reason : The WACC includes all investor supplied capital which includes long-term debt, preferred stock, and common stock. It is due to the fact that capital budgeting decision is long term in nature where as accounts payable and accruals are short term in nature. Hence, they will not be considered. 25. Answer : Reason : At the end of 6 years, the future value of the amount that Ashish deposits each year for a period of 6 years, should be equal to the present value of the payments that he has to make under the loan agreement in the 7th, 8th, 9th and 10th years. The discounted value of the payments to be made at the end of 7th, 8th, 9th and 10th years, as at the 21

22 Rs lakh end of the 6th year = 1.10 (1.10) (1.10) (1.10) Future value of the deposits made at the end of every year, for a period of 6 years = X. FVIFA(10%, 6 years) (where X is the amount to be invested at the end of every period till 6 years). X. FVIFA(10%, 6 years) = Rs lakh lakh lakh Rs.2,85,525 X = FVIFA(10%,6 years) Hence Ashish has to deposit Rs.2,85,525 at the end of every period for 6 years so as to be able to make the payments under the loan agreement. 26. Answer : Reason : Retained earnings represent the profits ploughed back into the business. Retained earnings are given more importance, when a firm follows a residual dividend policy. Retained earnings can be utilized by a firm to buy-back its shares. Growing firms use not only retained earnings, other sources of finance also. Hence, alternative is answer. 27. Answer : Reason : The MM approach to capital structure assumes that information is freely available to all the investors, that firms can be classified in such a way that firms falling within a class have the same degree of business risk, that there are no corporate or personal income taxes, that investors make rational investment decisions and that there are no transaction costs. 28. Answer : Reason : In the presence of floatation costs, the cost of external equity will always be more than the cost of existing equity capital. It has no logical connection with cost of long-term or short-term debt. Hence,, and are incorrect. 29. Answer : Reason : 1.5(1.08) 3 + x FVIFA 8%,3 (1.08) = 20(1.05) 3 0.2= x = Answer : Rs lakhs x = or Rs Reason : Risk premium = (R m R f ) (k Prob. k A k m (ka - k A ) (km - k m - k m ) (k - k m m ) m ) (k A - k A ) (k A - k A ). P k k AP = Cov(kAk m ) β A =. Var(k m ) = A k m kmp = P.(kA k A )(km k m ) 2 P(km k m ) = Risk premium =.1798(9.05-5) = Hence, option is the correct choice Answer : Reason : Value of a share after the rights issue = where symbols are in standard use Po S Theoretical value of a right = N 1 NPo S N 1 22

23 In the question V t = Rs.8, V 0 = Rs.70 N=2 = 2Po S 70 3 =2P+S = 210 Po S 3 8 = 24 Po S 24 S Po S S 48 3S S Answer : Reason : Cost of debt capital when the difference between the redemption price and the net amount realized can be written off over the life of the debenture and the amount so written off is tax deductible is given by: k d F P i(1 t) (1 t) n ( F P) 2 = (1 0.4) (1 0.4) 8 (105 95) = 7.35% Answer : : Reason: Future Value of Rs 75,000 after 20 years at the rate of inflation of 4% 34. Answer : Reason : FV = 75,000 FVIF (4, 20) = Rs 1,64,334 Future value of Rs 2,00,00 after 20 FV = 2,00,000 FVIF (7, 20) = Rs 7,73,937 He wants to withdraw, or have payments of Rs.1,64,334 per year for 25 years, with the first payment made at the beginning of the first retirement year. So, we have a 25-year annuity due with A= Rs1,64,334, at an interest rate of 7 percent. Present value of this annuity on his retirement = 1,64,334 PVIFA (7,25) x (1+ k) = Rs 2,049,138 He must save enough to accumulate 20,49,138 7,73,937 = Rs 12,75,201 Then Rs.12,75,201 is the FV of a 20-year ordinary annuity. The payments will be deposited in the bank and it will earn 7 percent interest. A FVIFA (7,20) = 12,75,201 A = Rs Type of finance Rs. in crore Proportion Networth (Equity + R&S) Debt capital Preference share capital Calculation of breaking point: Source of finance Cost Range of new Range of total Breaking point (%) financing new financing (Rs. in crore) (Rs. in crore) (Rs. in crore) Equity /0.375 = /0.375 = and above and above 23

24 Preference /0.125 = and above 32 and above Debt /0.5 = /0.5 = and above 72 and above If the new financing is in the range of Rs crore Cost of equity = 15% Cost of preference = 14% Cost of debt = 9% Weighted marginal cost of capital in the above range = 0.15 x x x 0.5 = % Hence, answer is. 35. Answer : Reason : As per MM model, the current market price of the share, P 0 is 1 P ( D P ) k e Step 1:Since the firm pays a dividend of Rs.10, the price at the end of year 1, P 1 is 1 75 (10 P ) P (75x1.2) 10 1 P Rs.80 1 Step 2: Amount to be raised by the issue of new shares: n P I ( E nd ) n x80 28, 00, 000 (12,00,000-80,000x10) 1 80n 24, 00, n 24, 00, 000 / 80 30, 000 The company has to issue 30,000 new shares. 36. Answer : Reason : The market price per share is given by p o P D ke where symbols are in standard use. If no dividends are declared p P 1 = Rs.168 Net Income = Rs.2 crore Investments budget = Rs.4 crore Amount to be raised by issue of new shares = Rs.2 crore Number of shares to be issued = 2, 00, 00, ,19,048 shares. 37. Answer : Reason : The traditional approach to dividend policy establishes a relationship between the market price and the dividends in the following manner: P = m(d+e/3) where, m is a multiplier, D is the Dividend Per Share (DPS) and E is the Earnings Per Share (EPS). Hence, 25 = 2 (5+E/3) 24

25 So EPS = Rs Hence, option is the correct choice. 38. Answer : Reason : Net investment = Cost of equipment + Shipping and installation charges + Net working capital Salvage value Tax saving on loss of sale of machine Rs Rs Rs Rs.750,000 - Rs.99,000* = Rs (Rs.10,25,000 - Rs.750,000)(0.36) = Rs tax saving on loss. 39. Answer : Reason : In the scenario given, the cash flows would look like this: Year Rs.( 000s) (1.15) 2 (1.15) 3 (1.15) 4 (1.15) 5 (1.15) (1.15) 7 (1.15) 8 (1.15) 9 (1.15) 10 (1.15) 11 (1.15) Rs thousands = Rs.89,247 Hence is the answer. 40. Answer : Reason : The project cannot be accepted when the present value of inflows is less than Rs.10 lakh, the initial investment. The project cannot be accepted, when the IRR is less than 12%, the required rate of return. The project cannot be accepted when the benefit cost ratio is less than The project can be accepted when the payback period is less than 3 years, the required payback period. The project cannot be accepted, when net benefit cost ratio is less than Answer : Reason : The value of a loan today is given, and you are required to find out the amount of payments. In a PV problem, PV = Cash flow x PVIFA (i,n) Cash flow = Payment = PV of loan / PVIFA (i,n) = 100,000 / PVIFA (9%,20) = 100,000 / = Rs10955 Hence is the answer. 42. Answer : Reason : Weighted Average Cost of Capital (WACC) using book value weights Sum of book values of all sources of capital used is = 1075 Weight for equity capital (w e ) = Weight for reserves and surplus (w r ) = Weight for preference capital (w p ) = Weight for debenture capital (w d ) = WACC = w e k e + w r k r + w p k p + w d k d = % % % % = 16.62% (approx.) Weighted average cost of capital (WACC) using market value weights Sum of market values of all sources of capital used = =1190 Weight of equity capital = Weight of preference capital =

26 Weight of debenture capital = WAC = = 16.92% (approx.) The difference between the WACC using book value weights and market value weights = ( )%= -0.30% 43. Answer : Reason : Old With Change 44. Answer : ICP = ACP = 365 Rs.4,00, 00, Rs.4,00, 00, Rs.1,00,00,000 = 4 = Rs.80, 00,000 = 5 = Rs.80,00,000 Rs.4,00,00, = Rs.70,00,000 Rs.4,00,00, = APP = 35 days Net operating cycle = days New NOC = days Change in net operating cycle = = days -27 days. Net change is 27 days (net operating cycle is 27 days shorter). Reason : Expected return from that equity share = = = percent. Expected risk may be calculated as: P R R i i = = = = = (approximately) So, the expected risk = Answer : Reason : Input Raw Material In raw material In W I P In finished Goods In debtors Period (months) Raw materials Work in Process Finished Goods (in Rs. Lakh) Debtors Total Manufacturing Expenses In WIP 1/ In finished goods In debtors Selling, Administrative and financial expenses In finished goods 1 50 In debtors Profit 26