Scanner Appendix. CS Professional Programme Module - II (New Syllabus) (Solution of June ) Paper - 5 : Financial, Treasury and Forex Management

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1 Solved Scanner Appendix CS Professional Programme Module - II (New Syllabus) (Solution of June ) Paper - 5 : Financial, Treasury and Forex Management Chapter - 2 : Capital Budgeting June [2] (c) Answer: Net Present Value (NPV) measures the difference between the present value of future cash inflows and present value of future cash outflow. Internal rate of return on the other hand, is the discount rate at which N.P. V is zero i.e. present value of cash inflows is equal to the value of investment made. While in the IRR method, the intermediate cash flows will be reinvested at IRR itself, in case of NPV method the investment is made at cut off rate which proves out to be a better presumption June [3A] (Or) (i) Calculation of NPV Years CFAT in ` PV Annuity 10% Total PV in ` A B A B ,000 58, ,70,586 2,19,866 As per NPV criterion, Project B Will be selected. Less: cash outlay (1,60,000) (1,80,000) NPV 10,586 39,866 1

2 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 2 Chapter - 3 : Capital Structure June [2] (a) Capital structure relates to deployment of funds for creation of long term asset whereas financial structure involves creation of both long term and short term assets. Capital structure is the main source of financial structure. Capital structure refers to the funds for the long term. Where the firm has no current liabilities, the capital structure of the firm is equal to the financial structure. Capital structure can be considered as one of the major component of financial structure. So capital structure is narrower in sense as compared to financial structure which is broader and includes current liabilities also. The balanced financial structure arises in case the amount of current liabilities is less than capital structure. Capital structure & its component can be deployed in acquisition of fixed assets as well as current assets but the current liabilities should not be used to finance acquisition of fixed asset. Chapter - 4 : Cost of Capital June [3] (b) (i) Calculation of WACC using book value weights Source of capital Amount (W) Cost (X) Weighted cost (XW) Debentures 4,00, ,000 Preference shares 1,00, ,000 Equity shares 6,00, ,000 Retained earnings 2,00, ,000 W 13,00,000 X W 1,24,000 WACC=XW/W* 100 = 9.54% (ii) Calculation of WACC using market value weights Source of capital Amount (W) Cost (X) Weighted cost (XW) Debentures 3,80, ,000 Preference shares 1,10, ,800 Equity shares 9,00, ,17,000 Retained earnings 3,00, ,000 W 16,90,000 X W 1,71,800

3 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 3 WACC = XW/W * 100 = 10.17% Chapter - 5 : Financial Services June [2A] (Or) (iii) Merchant banker means any person engaged in the business of issue management by making arrangements regarding selling, buying and subscribing to securities or acting as manager/consultant/advisor in relation to issue management. Merchant bankers constitute an important segment of capital market intermediaries. Following are the activities, undertaken by the merchant bankers:- Managing of public issue Managing international issues in form of ADRs, GDRs and Euro bonds. Private placement of securities Underwriting Stock broking Advisory services related to diverse issues such as mergers & acquisitions. The activities of Merchant Bankers are regulated by SEBI (Merchant Bankers) Rules,1992 and SEBI (Merchant Bankers) Regulations, Chapter - 6 : Project Planning June [4] (d) Financial variability takes into account whether the project is financially variable /feasible taking into consideration profitability aspects and fixed expenses including interest. It takes in its preview cost of project, projected cast forecast of profits etc. Financial aspects of the project are analysed under the following head: Amount of resources required to bring the project into operation and the Sources from which finance will be obtained. Debt equity ratio Profitability and cash flow Security: Chapter - 7 : Dividend Policy June [1] (c) Both dividend and growth are desirable but are conflicting goals to each

4 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 4 other. Higher dividend means less retained earnings and vice versa. This position is quite challenging for the finance manager and necessitates the need to establish a dividend policy in the firm which will evolve a pattern of dividend payments having no adverse effects on future actions of the firm. Dividend policy determines what portion of earnings will be paid out to stock holders and what portion will be retained in the business to finance long-term growth. Dividend constitutes the cash flow that accrues to equity holders whereas retained earnings are one of the most significant sources of funds for financing the corporate growth June [3] (a) Net profit Before tax 17,50,000 Less: 30% 5,25,000 Profit after tax 12,25,000 Earnings per share (EPS) = ` 12,25,000/1,00,000 = ` Market price per share (MPS) = ` 85 P/E Ratio = MPS/EPS = ` 85/ ` = June [3] (d) Using Walter Model: ` P = Where P is price per share D is dividend per share E is earnings per share r is internal rate of return k is capitalization rate

5 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 5 Applying the above formula for two companies Beauty Ltd. Pretty Ltd. P = P = ` 80 P = ` June [3A] (Or) (ii) Using Modigliani-Miller Dividend Irrelevancy Model P 0 = Where, P 0 is prevailing market price of the share P 1 is the market price of the share at the end of period one D 1 is the dividend to be received at the end of period one K e is the capitalization rate 100 = P 1 = ` June [4] (c) Considerations/determinants/ factors affecting the dividend policy are as follows: (i) Legal Considerations:- Sections 123 and 124 of the Companies Act, 2013, deals with the provisions relating to dividend. The legal framework within which dividend policy needs to be formulated is provided by virtue of this section only. Due consideration to dividend tax liability also needs to be kept in mind. (ii) Opportunities available for utilisation of funds:- The decisions regarding dividend payout ratio and retention ratio depends upon the opportunities available to the company. If it has some projects where such financial sources can be deployed which can consequently fetch high return it will declare low dividend. However, if a company has no immediate requirement for funds, it may decide to declare high dividends. (iii) Quantum of cash available:- Before declaring dividend cash

6 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 6 availability needs to be ensured. Since declaration and payment of dividend leads to outflow of cash, liquidity position needs to be well analysed. (iv) Stability of earning:- A company with stable income / earning can have high dividend payout ratio while an organisation with in stable earnings cannot do so. Thus, stability of earnings is directly proportional to the dividend payout ratio and consequently with dividend also. (v) Impact on market price:- Dividend decision has a direct impact on the market price as the latter reflects the present value of future dividend. Chapter - 8 : Working Capital June [1] (b) Operating Cycle refers to the length of time between the enterprise paying cash for raw material, conversion of raw material into goods and finally realising cash from the debtors. Operating cycle = Raw Material Storage Period + Work-in-Progress holding period + Finished goods storage period + Debtors / Receivables Collection period Creditors Payment period Diagrammatically, operating cycle can be represented in the following manner:- Operating Cycle reflects the time frame within which the funds once

7 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 7 employed for production can be re-occupied back. Smaller the operating cycle, better it is, since it indicates lesser blockage of funds in working capital. Thus, operating cycle is an important tool in working capital management. It can rightly be said that the length of operating cycle is the major determinant of working capital needs of a business firm June [3A] (Or) (iii) Average level of receivables = ` 360 lakh * 30/360 = 30 lakh Evaluation of the offer Factoring 1% of 30 lakh 30,000 10% of 30 lakh 3,00,000 Total (i) 3,30,000 Thus the amount available for advance is Average level of receivables 30,00,000 Less: total (i) above (3,30,000) ` 26,70,000 Less: 15% p.a. for 30 days (26,70,000 * 15% * 30/360) (33,375) Net amount of advance available 26,36,625 Evaluation of Factoring proposal Cost to the firm: Factoring commission 30,00,000 * 1/100 * 360/30 3,60,000 Interest charges 33,375 * 360/30 4,00,500 Total cost 7,60,500 Firm s savings on taking factoring services: Cost of credit administration 1,40,000 Cost of bad debts losses 0.02 * 360 lakh 7,20,000 Total savings 8,60,000 Net benefit to the firm = savings cost = ` 8,60,000 ` 7,60,500 = ` 99,500.

8 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 8 The firm should accept the factoring proposal June [4] (a) Item No. Units Units Cost (`) Cost Ranking , , ,

9 June [5] (a) Credit policy Present A B C Period (days) Annual sales Variable cost (80% on sales) Fixed cost Total cost Profit (annual sales-total cost) Incremental profit (A) Average Investment in 72*30/ *45/365 80*60/ *75/365 Debtors = 5.92 = 9.47 = = Incremental investment in debtors as compared to present level % of incremental investment (B) Excess return i.e. (A-B) Policy B having average collection period of 60 days yields the maximum profit and thus is most profitable. 9

10 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) June [6] Calculation of monthly consumption or raw material, monthly sales and monthly cost of production Raw material Opening stock + purchases (1,80, ,35,000) 11,15,00 0 Less: Closing stock 1,55,000 Annual consumption 9,60,000 Monthly consumption i.e. 9,60,000/12 80,000 Monthly sales 18,00,000/12 1,50,000 Monthly cost of production 14,40,000/12 1,20,000 Calculation of working capital required by Himalaya Ltd. Raw material - 2 months consumption: 80,000*2 1,60,000 Work in progress - 15 days of cost of production 1,20,000/2 60,000 Finished goods - 1 month cost of production 1,20,000 Sundry debtors - 1 month sales 1,50,000 Expenditure for 1 month 50,000 Total working capital 5,40,000 Less: Creditors - 15 days purchases: 9,35,000/12*0.5 (38,958) Less: Advance received on sales order (2,50,000) Net working capital required by the company 2,51,042 Working capital limits set by bankers Raw material - 2 months consumption 1,60,000 Less: 18% margin (28,800) 1,31,200 Work in progress - 15 days cost of production 60,000 ` ` ` `

11 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 11 Less: 30% margin (18,000) 42,000 Finished goods - 1 month cost of production 1,20,000 Less: 20% margin (24,000) 96,000 Sundry debtors - 1 month sales 1,50,000 Less: 10% margin (15,000) 1,35,000 For expenses Nil Nil Total limit likely to be approved by the bank 4,04,200 Chapter - 9 : Security Analysis and Portfolio Management June [2] (b) Systematic Risks Unsystematic Risks 1. Systematic risk are also known as Unsystematic risk can also be called market risk or non diversifiable risk. specific risk or diversifiable risk. 2. These risk are beyond the control of management of the entity. Such risk are within the purview and control of the management. 3. Such risk affect all companies. Only a particular security gets hit by it. 4. Systematic risk cannot be removed by diversification. Diversification can surely act as a means to combat unsystematic risk. 5. Taxation policies, inflation, interest Increase in competition, industrial rates are examples of systematic dispute, change in management are risk. illustrations of unsystematic risk June [2A] (Or) (i) The CAPM is based on a list of critical assumptions: 1. Investors are risk averse and use the expected rate of return and standard deviation of return as appropriate measures of risk and return for their portfolio. 2. Investors make their investments decisions based on a single period horizon which is the immediate next time period. 3. Transaction costs are either absent or so low that these can be ignored. 4. Assets can be bought and sold in any desired unit.

12 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) The investor is limited by his wealth and the price of the asset only. 6. Taxes do not affect the choice of buying assets. 7. All individuals assume that they can buy the assets at the going market price and they all agree on the nature of the return and risk associated with each investment June [4] (b) (i) Calculation of Beta 1.40 (120 lakh/540 lakh) (160 lakh/ 540 lakh) x (260 lakh/540 lakh) = = 1.35 (ii) If firm divests itself of software business and pay out cash in form of dividend: Beta = 1.40 (120 lakh/380 lakh) (260 lakh/ 380 lakh) = = 1.12 If they keep the cash in the firm then Beta = 1.40 (120 lakh/540 lakh)+ 0 (160 lakh/540 lakh) (260 lakh/ 540 lakh) = = 0.79 (iii) To value the software business for the divestiture use 1.90, the beta for the software division. Chapter - 10 : Derivatives and Commodity Exchanges - An Overview June [2] (d) Answer: The term derivatives refers to those instruments which derive their value from the underlying asset. The two main types of derivatives are: Forwards and futures Options In forward and future contract the seller enters into an agreement with the buyer to purchase the specified asset at pre-determined price on a specified future date. An option contract is one which gives the buyer the right to buy or sell the

13 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 13 underlying asset at pre-determined price at some future point of time. L.C. Gupta committee was appointed by Security & Exchange Board of India. The objective of the committee was to suggest proper framework for introduction of trading in derivatives. This committee recommended for starting up with the financial derivatives in the first go. It also provided for prompt collection of mark to market/maintenance margin. It stipulated stringency for the derivative market. It advocated for the removal of restrictions earlier imposed on trading mutual funds in derivative sector. Derivative is a financial instrument or contract which derives its value from some underlying asset. derivatives reveal a relationship June [3] (c ) A straddle position means that the investor will buy the call option as well as the put options and pay the premium on both options. The net pay off position may be found as follows: Total premium paid = ` 15 + ` 10 = ` 25 If share price happens to be ` 450 then call option will not be exercised Net pay off = Pay off on put option Premium paid = (` ) 25 = ` 10 If share price happens to be ` 525 then put option will not be exercised Net pay off = pay off on call option premium paid = (` 525 ` 448) 25 = ` 15 So the investor will be benefitted whether price is less than or more than the strike price on the expiry of date. Chapter - 11 : Treasury Management June [1] (a) The treasury function is concerned with management of funds at the micro level. Once the funds have been arranged and investments identified, handling of the funds generated from the activities of the firm should be monitored

14 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 14 with a view to carry out the operations smoothly. Since funds or cash is the lubricant of all business activity, availability of funds on day to day basis is to be ensured by the treasury manager. The role of treasury management is to manage funds in an efficient manner, so that the operations in the area of finance are facilitated in relation to the business profile of the firm. Management of funds is the domain of the treasury function June [2A] (Or) (iv) The major role the information technology is playing in effective treasury management is as follows: 1. Automate repetitive tasks: Technology today is being leveraged to automate repetitive tasks such as data gathering, accounting, bank polling, portfolio tracking and reporting. Automating these processes enable to focus on more value added tasks, critical to providing effective decision support to management team. 2. Implement internal controls: To ensure compliance with rule and regulations, sound and effective internal controls must be implemented. In treasury workstation, sophisticated rules must be implemented to ensure policy compliance. 3. Time saver and fraud & error detection Methodology: Through the treasury management system, all repetitive transactions are automatically tagged with the correct instructions. Most companies using a treasury management system get 90-95% of their transactions automatically tagged accurately without any manual intervention. 4. Forecast cash flows: Effective forecasting helps manage financial risk by enabling to predict a cash shortfall or liquidity crisis, taking into account interest rate changes and foreign exchange fluctuations. Forecasting also helps to enhance financial returns, enabling to make more effective decisions regarding investments and borrowing needs. 5. Communicate with operating units: Operating units must be involved while building your forecasts to ensure incorporation of all the necessary and up-to-date information. The treasury forecast performance matters must be compared to forecasts generated by other groups and/ or divisions. Significant variances may be indicators that treasury is not yet aware of all the information that should be included in the forecast. 6. Choose a Web-based treasury management system: The full benefits of

15 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) 15 technology without unnecessary costs or delays may be achieved by selecting a web-based treasury management system. Web-based solutions significantly reduce implementation costs and timeframes, and enable to access the system from anywhere at any time. Furthermore, any enhancements to the system are automatically deployed to all users, thus eliminating the need to spend internal resources on hardware or software acquisition, testing or downloads. To ensure the security of your information, select a system with two factor authentication and encryption technology must be selected. 7. Rethink treasury processes: There should be reassessing of the treasury workstation at transparent intervals to evaluate processes and identify how they can/should be revised to maximize efficiencies. While re-evaluating treasury management system, the focus should not only be on data, but on experience and knowledge. The proper and effective use of information technology in treasury operation increases the efficiency and effectiveness of corporate officers across the treasury, investor relations, corporate finance and corporate communication function. Chapter - 12 : Forex Management June [1] (d) It is rightly said that speculation or the anticipation of the market participants many a times is the prime reason for exchange rate movements. The total foreign exchange turnover worldwide is many a times the actual goods and services related turnover indicating the grip of speculators over the market. Those speculators anticipate the events even before the actual data is out and position themselves accordingly to take advantage when the actual data confirms the anticipations. The initial positioning and final profit taking make exchange rates volatile. These speculators many a times concentrate only on one factor affecting the exchange rate and as a result the market psychology tends to concentrate only on that factor neglecting all other factors that have equal bearing on the exchange rate movement. Under these circumstances even when all other factors may indicate negative impact on the exchange rate of the currency if the one factor that the market is concentrating comes out positive the currency strengthens.

16 Solved Scanner Appendix CSPP M-II Paper - 5 (New Syllabus) June [5] (b) Option :- 1 Receive after 4 months Amount to be received = $ 1,00,000 Forward Rate (after 4 months) = Amount received after 4 months = 56,84,000 Option:- 2 Receive immediately and provide discount of 2% Amount to be received = $ 1,00,000 Discount (2%) = 2,000 Net Amount to be received = $ 98,000 Current spot rate = Amount received today = 98, = ` 56,52,640 8% for 4 months = 56,52,640 = 1,50,737 Total amount received after 4 months = 58,03,377 Thus, it is advisable to after 2% discount. Shuchita Prakashan (P) Ltd. 25/19, L.I.C. Colony, Tagore Town, Allahabad Visit us :

CS Professional Programme Module - II (New Syllabus) (Solution of June ) Paper - 5: Financial, Treasury and Forex Management

Solved Scanner Appendix CS Professional Programme Module - II (New Syllabus) (Solution of June - 2015) Paper - 5: Financial, Treasury and Forex Management Chapter - 1: Nature, Significance and Scope of