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1 Gurukripa s Guideline Answers for Nov 2016 Exam Questions CA Final Strategic Financial Management Question No.1 is compulsory. Answer any 5 Questions from the remaining 6 Questions. Answer any 4 out of 5 in Q.7. Note: Page Number References are from Padhuka s Students Referencer on Strategic Financial Management Question 1(a): International Finance Swap Points On 3 rd April 2016, a Bank quotes the following Spot Exchange Rate (US $1) INR INR months Swap Points month s Swap Points In a spot transaction, delivery is made after two days. Assuming Spot Date as 5 th April 2016, and assuming 1 Swap Point = , you are required to (a) Ascertain Swap Points for 2 months and 15 days. (For 20 th June 2016), (b) Determine Foreign Exchange Rate for 20 th June 2016, and (c) Compute the Annual Rate of Premium / Discount of US$ on INR, on an Average Rate. Solution: Refer Principles and various Illustrations in Chapter 16 5 Marks (a) Swap Points for 3 rd Month = = 96 (b) Swap Points for 15 days = (a) (c) Swap points for 2 Months and 15 days = = 138 (d) Foreign Exchange Rate for 2 Months and 15 days = = (e) Annual rate of Premium / Discount [Taking 3 Month Ask Swap Points as Base] = Forward Rate - Spot Rate 12 Months 100 Spot Rate Forward Period = Months 100 = 0.11% 3 Months Question 1(b): Portfolio Management Risk Reverse Working 5 Marks The following information is available in respect of Security A: Equilibrium Return 12% Co Variance of Market Return and Security Return 196% Market Return 12% Coefficient of Correlation % Treasury Bond trading at ` 120 Determine the Standard Deviation of (a) Market Return, and (b) Security Return. Solution: Similar to Page 7.25, Q.No Computation of Beta of the Security: Coupon Payment ` 100 6% 1. Risk Free Rate = = = 5% Current Market Price ` Assuming Equilibrium Return = CAPM Return, we have 12% = R F + β A (R M R F ) 12% = 5% + β A (12% 5%) β A = 1 2. Computation of Market and Security Risk Market Risk Security Risk Computation σ A Cov AM β A = ρ AM β A = 2 σm σm σ A 196% 1 = = 2 14% σ M 14% σ M = 14% (Market Risk) σ A = = 17.50% 0.80 Nov

2 Question 1(c): Mutual Fund Effective Yield Mr. A has invested in three Mutual Fund (MF) schemes as per the details given below MF A MF B MF C Date of Investment Amount of Investment (`) 1,00,000 2,00,000 2,00,000 Net Asset Value (NAV) at Entry Date (`) Dividend Received upto (`) 2,850 4,500 NIL NAV as on (`) Marks Find out the Effective Yield (upto three decimal points) on per annum basis in respect of each of the above three Mutual Fund (MF) Schemes upto [Assume 1 year = 365 days. Show the amount of Rupees upto 2 decimal points.] Solution: Similar to Page 8.18, Q. No. 11 [RTP, N 04, N 09, M 13] MF (a) Invt. (b) Opg. NAV (c) Units (d) = (b c) Clg. NAV (e) Total NAV (`) (f) = (d e) Cap Gain (g) = (f b) Dividend Received (h) Total Yield (i) = (g + h) No. of Days A 1,00, , , (485.41) 2,850 2, B 2,00, , ,03, ,000 4,500 7, C 2,00, , ,98, (1,980.20) 0 (1,980.20) 31 (11.658) Total Yield 365 Note: Effective Yield (%) = 100. Opening Investment No.of days of holdings Question 1(d): Bond Valuation Conversion Decision and Duration 5 Marks A Ltd has issued Convertible Bonds, which carried a Coupon Rate of 14%. Each Bond is convertible into 20 Equity Shares of the Company A Ltd. The prevailing Interest Rate for similar credit rating Bond is 8%. The Convertible Bond has 5 years maturity. It is redeemable at par at ` 100. You are required to estimate (Calculations be made upto 3 decimal places) (a) Current Market Price of the Bond, assuming it being equal to its fundamental value, (b) Minimum Market Price of Equity Share at which Bondholder should exercise Conversion Option, and (c) Duration of the Bond. The Relevant Present Value Table is as follows Present Values T1 T2 T3 T4 T5 PVIF 0.14, t PVIF 0.08, t Solution: Similar to Page 11.15, Q. No. 20 and Page 11.23, Q. No. 35 [N 09] Yield p.a. (%) 1. Current Market Price of Bond = Intrinsic Value, computed as below Nature Yr Cash Flow PVF 8% DCF Interest (100 14%) Maturity Intrinsic Value Minimum Price at which Bond holder should exercise Conversion Option = =` 6.20 Per Share 20 Shares 3. Duration of Bond (Formula Method) = 1 + y y (1 + y) + Period(c y) c[(1 + y) Period 1] + y ( ) + 5( ) = [( ) 5 1] = = = Years (approx.) Nov

3 Question 2(a): International Finance LMN Ltd is an export oriented business house based in Mumbai. The Company invoices in Customer s Currency. The receipt of US $ 6,00,000 is due on 1 st September Market Information as at 1 st June 2015 is Exchange Rate US $ / ` Exchange Rates US $ / ` Contract Size Spot Currency Future 1 Month Forward June ` 30,00,000 3 Months Forward September Initial Margin (`) Interest Rates in India % June 12, p.a. September 16, p.a. On 1 st September 2016, the Spot Rate US $ / ` is and Currency Futures Rate is US $ / ` It may be assumed that Variation in Margin would be settled on the maturity of the Futures Contract. Which of the following methods would be most and advantageous for LMN Ltd? (a) Using Forward Contract, (b) Using Currency Futures, and (c) Not hedging Currency Risks. Show the calculations and comment. Solution: Similar to Page 17.80, Q. No. 76 [N 06] 1. Forward Contract Hedge Amount Amount receivable in US Dollars USD 6,00,000 Forward Rate USD per ` Cash Inflow in ` (USD 6,00,000 USD / `) ` 4,11,52, Hedging using Currency Futures Facts: USD 6,00,000 is receivable in 3 Months time. USD should be encashed into Rupees. Therefore, USD should be sold and Rupee should be bought. Therefore, the Company should BUY Rupee Futures Contract Cash Flows: June 1 (Now) Payment of Initial Margin in by borrowing in Rupees Sept 1 (3 Mths Later) Sept 1 (3 Mths Later) Sept 1 (3 Mths Later) Settlement of Variable Margin based on Contracted Futures Rate and Futures Rate on Settlement Date for September Futures Purchase of Rupee by paying in US Dollars (received from the Overseas customer) based on Spot Rate on the date of settlement. Settlement of money borrowed in Rupees for payment of Margin along with interest (a) No. of Futures Contracts Required and Margin Money Result Amount receivable in USD USD 6,00,000 Exchange Rate for September Futures [USD / `] USD Total Value Receivable in Rupees = Rupees to be bought [Amt Receivable USD 6,00,000 Futures Exchange Rate USD / `] ` 4,14,07,867 Contract Size ` 30,00,000 No. of Contracts Required [Rupee required ` 4,14,07,867 Contract Size ` 30,00, Margin Money per September Rupee Futures Contract ` 16,000 Therefore, Total Margin Money payable [` 16,000 per Contract 14 Contracts] = Amount Borrowed ` 2,24,000 Nov

4 (b) Settlement of Variable Margin Money Amount Total Value of Rupee Futures Bought [30,00,000 14] ` 4,20,00,000 Contracted Futures Rate [USD payable per Rupee] USD Total USD Payable for buying Rupees under Futures Contract based on contracted Sep Futures Rate [` 4,20,00,000 Contracted Futures Rate ] [A] USD 6,08,580 Futures Rate on date of settlement or expiry [USD payable per Rupee] USD Total USD Payable for buying Rupees under Futures Contract based on Sep Futures Rate on the date of settlement [` 4,20,00,000 Futures Rate on Settlement Date USD ] Amount of Gain [Amount Payable under Contracted Futures Rate Less Amount Payable under Futures Rate on Expiry Date] [B] [A] [B] USD 6,14,040 [C] USD 5,460 Exchange Rate for Settlement of Amount of Gain [Spot Rate on the Settlement Date= USD per `] [D] USD Amount Receivable in Rupees [Amount of Gain Exch. Rate] [C] [D] ` 3,73,717 (c) Settlement of Futures Contract i.e. Computation of USD Payable Amount Rupees to be bought = Amount receivable in Rupees [A] `4,20,00,000 Exchange Rate [Spot Rate prevailing on date of settlement] USD USD Required for buying Rupees [Rupees to be bought Exch. Rate] USD 6,13,620 Less: USD Received from Overseas Custmer USD 6,00,000 USD to be bought in Spot Market for settling Futures Contract USD 13,620 Rate at which USD can be bought [Spot Rate prevailing on date of settlement] USD Rupees Payable for buying USD [USD 13,620 Exch. Rate ] [B] USD9,32,238 (d) Total Amount Receivable in Rupees [Cash Flows on Settlement Date] Amount Receivable on Settlement of Futures Contract 4,20,00,000 Add: Amount Receivable on Settlement of Gain on account of Variable Margin 3,73,717 Less: Amount payable to buy US Dollars for settlement of Futures Contract (9,32,238) Less: Int Payable on money borrowed for payment of Initial Margin [` 2,24, % p.a. 3 / 12] (4,760) Net Inflow under Futures Contract 4,14,36,719 Note: Initial Margin of ` 2,24,000 and the corresponding borrowing is not considered above since the sum borrowed and paid on 1 st June will be received back on 1 st September and used for settlement of the borrowing. 3. No Hedge Situation Amount Amount receivable in US Dollars USD 6,00,000 Exchange Rate on the date of settlement [Spot Rate] [USD per `] Cash Inflow in ` (USD 6,00,000 USD / `) 4,10,67, Evaluation of Alternatives Alternative Cash Inflow Ranking Forward Market Hedge 4,11,52,263 2 Futures Contract 4,14,36,719 1 No Hedging 4,10,67,761 3 Conclusion: Expected Cash Inflows under Futures Contract Hedge is maximum and hence the most advantageous. ` Question 2(b): Forward Swap, Cancellation, etc. On 10 th July, an Importer entered into a Forward Contract with a Bank for US$ 50,000 due on 10 th September at an Exchange Rate of ` The Bank covered its position in the Inter Bank Market at ` How the Bank would react if the customer requests on 20 th September Nov

5 (i) To cancel the contract? (ii) To execute the contract? (iii) To extend the contract with due date to fall on 10 th November? The Exchange Rates of US$ in the Inter Bank Market were as below: 10 th September 20 th September Spot US$1 = / /9900 Spot/September / /1800 Spot/October / /3300 Spot/November / /4900 Exchange Margin was 0.1% on buying and selling. Interest on Outlay of Funds was 12% p.a. You are required to show the calculations to (a) cancel the Contract, (b) execute the Contract, and (c) extend the Contract as above. Solution: Similar to Page A.34, Q. No.50 [M 15] 1. Calculation of Cancellation Rate Importer = Will Pay USD = He would have entered into Forward Purchase Contract = To cancel it on 20 th September, he has to enter into Spot Sale Contract = So, Spot Bid Rate is relevant. Spot Bid Rate Less: Exchange 0.10% Cancellation Rate per USD Amount Payable on $ 50,000 for Cancellation Contract Rate Less: Cancellation Rate Amount Payable per $ Amount Payable on $ 50,000 [ $ 50,000] 47, Interest on Outlay of Funds Actual Cost for purchase of USD under Forward Contract Less: Spot Selling Rate Loss on Sale of one USD Loss on Sale of USD 50,000 26,500 12% for 10 Days 87 Total Cost =Cancellation Charges + Loss on Sale + Interest thereon = 47, , = ` 73, New Contract Rate New Contract Rate entered on 20 th September (for the Importer, buy USD on 10 th November) (+) 0.10% Margin Net Amount to Pay Situation To cancel the Contract 4. Summary Pay ` 73,887 and cancel the contract. Action To execute the Contract (a) Pay Loss on Sale & Interest = ` 26,587 (b) Execute by buying $ 50,000 & pay $ 50, = ` 33,42,000 To extend the Contract Pay ` 73,887 & enter into New Contract at ` Question 3(a): Portfolio Management and Futures Details about Portfolio of Shares of an Investor are as below Nov

6 Shares No. of Shares (Lakh) Price per Share Beta A Ltd 3.00 ` B Ltd 4.00 ` C Ltd 2.00 ` The Investor thinks that the risk of portfolio is very high and wants to reduce the Portfolio Beta to He is considering the two below mentioned alternative strategies (a) Dispose off a part of his existing portfolio to acquire Risk Free Securities, or (b) Take appropriate position on Nifty Futures which are currently traded at ` 8125 and each Nifty points is worth ` 200. You are required to determine 1. Portfolio Beta, 2. Value of Risk Free Securities to be acquired. 3. Number of Shares of each Company to be disposed off, 4. Number of Nifty Contracts to be bought/sold, and 5. Value of Portfolio Beta for 2% rise in Nifty. Solution: Similar to Page 7.50, Q.No.36 [N 11], Page A.27, Q. No. 40 [N 15] & Page 14.39, Q.No Computation of Portfolio Beta Security Shares MPS Total Value Beta Product [1] [2] [3] [4](in Lakhs) [5] [6] =[5] [4] A Ltd 3,00, , ,100 B Ltd 4,00, , ,600 C Ltd 2,00, Product 6,500 Present Portfolio Beta = = = 1.3. Market Value 5,000 5,000 6, Value of Risk Free Securities to be acquired to reduce Beta to 0.91 Security Beta Proportion (Amt. Invested) Product Risk Free Investments 0 X 0 Risky Securities Present X x Product Portfolio Beta = = Amount Invested x = 0.91 (Required Beta) x On solving, 1.3x = x = 0.39 x = 0.3 or 30% for Risk Free Invts, and hence 70% for Risky Invts. Amt to be invested in Risk Free Invts = 30% of ` 5,000 Lakhs = ` 1,500 Lakhs. [=Value of Risky Investments Sold.] 3. Number of Shares of each Company to be disposed off Security Market Value of Investments Value of 30% MPS No. of Shares sold A Ltd ` 15,00,00,000 ` 4,50,00,000 ` ,000 B Ltd ` 30,00,00,000 ` 9,00,00,000 ` 750 1,20,000 C Ltd ` 5,00,00,000 ` 1,50,00,000 ` , No. of Nifty Futures Contract to be traded [ Desired Value of Beta - Beta of the Portfolio] No. of Contracts = Portfolio Value Value of a Futures Contract = ` 5,000 Lakhs , = 1,950 Lakhs 16,25,000 = 120 Contracts to be sold. Nov

7 5. Portfolio Beta after 2% rise in Nifty Note: If Nifty increases by 2%, Stock having 1.40 Beta will increase by 2.8% [i.e. 2% 1.40] Security Shares Original Value Beta Rise in MPS Total Value (in Lakhs) Product [1] [2] [3] (in Lakhs) [4] [5] = 2% Beta [6] = [3] + Rise [7] =[4] [6] A Ltd 3,00,000 1, % 1, = 1,542 2,158.8 B Ltd 4,00,000 3, % 3, = 3,072 3,686.4 C Ltd 2,00, % = Beta if Nifty rises by 2% = Get More Updates From 5,000 5,130 6, , = 1.3. [Note: Alternative assumptions exist for computation of Beta in this case.] 5,130 Question 3(b): Portfolio Management Characteristic Line and Risk The Returns and Market Portfolio for a period of four years are as under: Year % Return of Stock B % Return on Market Portfolio For Stock B, you are required to determine (a) Characteristic Line, and (b) The Systematic and Unsystematic Risk. Solution: Similar to Page 7.30, Q. No. 12 [M 09] 1. Computation of Beta of Stock Year R M R B D M = (R M R ) D M B = (R B R ) 2 B D M D B 2 D M D B (1) (2) (3) (4) = [(2) 6.5] (5) = [(3) 8.5] (6) = (4) 2 (7) = (5) 2 (8) = (4) (5) Mean Variance Standard Deviation Market Portfolio Σ R M 26 Σ R = = = 6.5 R M B = n 4 2 σ M = Σ D M = = σ = n 4 B R A n Stock B 34 = = Σ D A 45 = = n 4 σ M = = σ B = = Combination Market and Stock B Combination Market and Stock B Covariance Beta of Stock B = [ D D ] M Cov B 57 = = = Correlation ρ M, B = M,B n 4 Cov M,B 2 σ M = = Cov M,B σ M 2. Computation of Characteristic Line for Stock B = = σ B Basic Values: y = R B = 8.5 Β= 0.74 x = R M (Expected Return on Market Index) = 6.5 For computing a using Securities Market Line, Y = a + β R m So, 8.5 = a , So, a = 8.5 ( ) = 3.69 Characteristic Line for Stock B= Y = a + β R m = R M Nov

8 3. Analysis of Risk into Systematic Risk and Unsystematic Risk Standard Deviation Approach Variance Approach (a) Total Risk 3.354% 11.25% (b) Systematic Risk: Method 1: (using ρ M, B ) Method 2: (using σ m ) Get More Updates From Total Risk ρ MA = = 3.247% (or) β σ m = = 3.247% Total Risk ρ MA 2 = = 10.54% (or) β 2 σ m 2 = = 10.54% (c) Unsystematic Risk [a b] = = % = = 0.71% Question 4(a): Portfolio Management & Mutual Fund Mr. Abhishek is interested in investing ` 2,00,000 for which he is considering following three alternatives: (a) Invest ` 2,00,000 in Mutual Fund X (MFX) (b) Invest ` 2,00,000 in Mutual Fund Y (MFY) (c) Invest `1,20,0000 in Mutual Fund X (MFX) and ` 80,000 in Mutual Fund Y (MFY) Average Annual Return earned by MFX and MFY is 15% and 14% respectively. Risk Free Rate of Return is 10% and Market Rate of Return is 12%. Covariance of Returns of MFX, MFY and Market Portfolio Mix are as follows: MFX MFY Mix MFX MFY M You are required to calculate: 1. Variance of Return from MFX, MFY and Market Return. 2. Portfolio Return, Beta, Portfolio Variance and Portfolio Standard Deviation. 3. Expected Return, Systematic Risk and Unsystematic Risk, and 4. Sharpe Ratio, Treynor Ratio and Alpha of MFX, MFY and Portfolio Mix. Solution: Refer Principles and various Illustrations / Computations in Chapter 7 & Computation of Values MFX MFY Mix (Market) (a) Covariance between same stock = Variance Var MFX = Var MFY = Var Mix = (b) Standard Deviation = Variance = a (c) Beta = Covariance of Fund with Market Variance of Market β MFX = = βmfy = = β Mix (Market) = (d) Total Risk = Variance (Variance Approach) = (a) β σ (e) Systematic Risk ( P M ) = = (f) Unsystematic Risk (Total Systematic Risk) (g) Sharpe Ratio = (h) Treynor Ratio = RP - R σ P P F RP R β F = = = = = = (i) CAPM Return = R f + β (R m R f ) 12.17% 11.81% (j) Jenson s Alpha = Actual Return CAPM = 2.83% = 2.19% (k) Alpha using Securities Market Line (SML) R s = α + β R m 15 = α + ( ) α = 1.96% 14 = α + ( ) α = 3.16% Nov

9 2. Computation of Portfolio Return, Expected Return and Beta Portfolio Portfolio Return Expected Return Portfolio Beta Variance 100% in MFX 15% 15% 2,00,000 = 30, % in MFY 14% 14% 2,00,000 = 28, % in MFX 40% in MFY (15% 60%) + (14% 40%) = 14.60% 14.60% 2,00,000 = 29,200 ( %) + ( %) = (σ A A B B A A B B AB Note: SD of Portfolio having Stock A& B (σ AB ) = W ) + (σ W ) + 2(σ W σ W ρ ) Correlation Coefficient, i.e. ρ AB in this case, of MFX & MFY= CovMFX MFY σmfx σmfy = 4.30 = σ MFX MFY = ( ) + ( ) + 2( ) = = Question 4(b): Capital Budgeting Net Present Value KLM Ltd requires ` 15,00,000 for a new project. Useful Life of Project is 3 years. Salvage Value Nil. Depreciation is ` 5,00,000 p.a. Note Given below are the projected Revenues and Costs (excluding Depreciation) ignoring inflation: Year Revenues ` 10,00,000 13,00,000 14,00,000 Costs in ` 5,00,000 6,00,000 6,50,000 Applicable Tax Rate is 35%. Assume Cost of Capital to be 14% (after tax). Inflation Rates for Revenues and Costs are as under: Year Revenue % Costs % PVF at 14%, for 3 years = 0.877, and Show amount to the nearest rupee in calculations. You are required to calculate Net Present Value of the Project. Solution: Refer Principles and various Illustrations / Computations in in Chapter 2 Year Revenue (Real) 1. Computation of Nominal Cash Flows i.e. after Inflation Note: Nominal Cash Flow = Real Cash Flow (1 + Inflation Rate) Inflation Factor Revenue Cost Inflation Factor (Nominal) (Real) Cost (Nominal) 1 10,00, = ,90,000 5,00, = ,50, ,00, = ,30,360 6,00, = ,19, ,00, = ,46,965 6,50, = ,33, Computation of Net Present Value Year Revenue Cost Depn. PBT 35% PAT CFAT PVIF 14% DCF 1 10,90,000 5,50,000 5,00,000 40,000 14,000 26,000 5,26, ,61, ,30,360 7,19,400 5,00,000 3,10,960 1,08,836 2,02,124 7,02, ,39, ,46,965 8,33,905 5,00,000 4,13,060 1,44,591 2,68,489 7,68, ,18,730 Total Discounted Cash Inflow 15,19,965 Less: Initial Investments 15,00,000 Net Present Value 19,965 Note: It is assumed that the Cost of Capital is after Inflation. Nov

10 Question 5(a): Factoring vs Own Management of Receivables with / without Recourse Projected Sales for the next year of Z Ltd is ` 1,000 Crores. The Company manages its Accounts Receivables internally. Its present annual Cost of Sales Ledger Administration is ` 11 Crores. The Company finances its Investment on Debtors through a mix of Bank Credit and own Long Term Funds in the ratio of 60:40. Current Cost of Bank Credit and Long Term Funds are 10% and 12% respectively. The past experience indicates that Bad Debts Losses are 1.5% on Total Sales. The Company has a credit policy of 2/10, net 30. On an average, 40% of Receivables are collected within the discount period and rest are collected 70 days after the invoice date. Over the years, Gross Profit is maintained at 20% and the same is expected to be continued in future. To enable the Management focus on promotional activities and get rid of escalating cost associated with In House Management of Debtors, the Company is considering the possibility of availing the services of Fairgrowth Factors Ltd for managing the Receivables of the Company. According to the proposal of the Factor, it would pay advance to the tune of 85% of Receivables with 20% interest and 81% of Receivables with 21% interest for the recourse and non recourse agreements respectively. The proposal provides for guaranteed payment within 30 days from the date of invoice. The Factoring Commission would be 4% without recourse and 2% with recourse. If the Company goes for the factoring arrangement, the staff would be under burdened and concentrate more on promotional activities and consequently additional sales of ` 100 Crores would be achieved. Assume that all Sales of the Company are credit sales and the year is of 360 days. You are required to: (a) Calculate Cost of In House Management of Receivables. (b) Compute Cost of Fairgrowth Factors Ltd proposal (with recourse and without recourse) (c) Calculate Net Benefits under Recourse Factoring and Non Recourse Factoring, and (d) Decide the best option for the Company. Solution: Similar to Page A.11, Q. No. 13 [N 14] 1. Cost of In House Management ` Crores (a) Bad Debts (`1,000 Crores 1.50%) (b) Cash Discount (` 1,000 Crores 40% 2%) 8.00 (c) Avoidable Administrative Cost (d) Cost of Investment in Receivables (`1,000 Crores 10.8%) Total Cost (including Bad Debts ` 15 Crores) Note: K o = Cost of Funds = ( % %) = 10.8% Average Collection Period = (40% 10 days + 60% 70 days) = 46 days. 2.Fairgrowth Proposal (` Crores) With Recourse Without Recourse (a) Factoring Commission Sales1100 2% = Sales1100 4% = (b) Amount lent by Factor (1,100 Commission 22.00) 85% = (1,100 Commission 44.00) 81% = (c) Interest Charges on Amount lent % = % = (d) Cost of Own Funds blocked in Drs i.e. (Sales Amt lent by Factor) [Note] (1, ) 12% = (1, ) 12% = (e) Total Cost of Factoring (a+c+d) Note: Long Term Funds Cost of 12% is considered for this purpose. Nov

11 3. Cost Comparison (` Crores) With Recourse Without Recourse Present Own Cost [Note] = Cost of Factoring Proposal Difference = Cost Saved / (Excess Cost) 8.69 (28.62) Note: Bad Debts `15 Crores not avoidable in case of With Recourse Factoring. Conclusion: Fairgrowth Proposal with Recourse is most beneficial. Question 5(b): International Finance Hedging Profit / Loss A Company is considering hedging its Foreign Exchange Risk. It has made a purchase on 1 st July 2016, for which it has to make a payment of US$ 60,000 on 31 st December The present Exchange Rate is 1 US$ = ` 65. It can purchase forward 1 $ at ` 64. The Company will have to make an upfront premium at 2% of the Forward Amount purchased. The Cost of Funds to the Company is 12% per annum. In the following situations, compute the Profit/ Loss the Company will make if it hedges its Foreign Exchange Risk with the Exchange Rate on 31 st December 2016 as (a)` 68 per US$, (b) ` 62 per US$, (c) ` 70 per US$, (d) ` 65 per US$. Solution: Similar to Page 17.55, Q. No. 44 [M 08] 1. Cash Flow in case of Forward Contract Value USD to be purchased in Forward Market USD 60,000 Forward Contract Purchase Price per USD ` 64 Total Value of Forward Contract [USD 60,000 ` 64 per USD] 38,40,000 Upfront Premium at 2% of Contract Value [` 38,40,000 2%] 76,800 Interest on Upfront Premium for a period of 6 Months [` 76,800 12% p.a. 6/12] 4,608 Total Cash Outgo on under Forward Contract Route 39,21,408 Note: Upfront premium on Forward Contract is a transaction cost for entering into Forward Contract payable to the Foreign Currency Seller in the Forward Contract. It is assumed that this amount will be borrowed at 12% p.a. by the Company. 2. Notional Gain or Loss on If Exchange Rate on is (`/USD) ` 68 ` 62 ` 70 ` 65 Cash Outflow on ($ 60,000 `68 or `62 or `70 or `65) [Based on Spot Rate as at ] 40,80,000 37,20,000 42,00,000 39,00,000 Less: Cash Outflow under Forward Contract (39,21,408) (39,21,408) (39,21,408) (39,21,408) Profit / (Loss) on entering into Forward Contract 1,58,592 (2,01,408) 2,78,592 (21,408) Question 6(a): Valuation of Business& Shares XN Ltd reported a Profit of ` Lakhs after 34% tax for the Financial Year An analysis of the accounts reveals that the Income included Extraordinary Items of ` 15 Lakhs and an Extraordinary Loss of ` 5 Lakhs. The existing operations, except for the Extraordinary Items, are expected to continue in future. Further, a new product is launched and the expectations are as under: `Lakhs `Lakhs Sales 70 Labour Costs 16 Material Costs 20 Fixed Costs 10 The Company has 50,00,000 Equity Shares of ` 10 each and 80,000, 9% Preference Shares of ` 100 each with P/E Ratio being 6 times. You are required to: (a) Compute the Value of the Business. Assume Cost of Capital to be 12% (after tax) and (b) Determine the Market Price per Equity Share. Solution: Similar to Page 18.34, Q. No. 13 [M 09, N 12] Nov

12 1.Computation of Value of Business Earnings After Tax of 34% for the last year = ` Lakhs. So EBT is % ` Lakhs Less: Extra Ordinary Income Not to recur in the future (15) Add: Extra Ordinary Loss Not to recur in the future 5 Add: Additional Income from New Launch = ( ) 24 Future Expected Earnings Before Tax 166 Less: Taxes at 34% thereon Future Expected Earnings After Tax Less: Preference Dividend (9% of ` 80 Lakhs) (7.20) Valuation: Equity Earnings (a) Value of Whole Business assuming overall Capitalisation Rate = 12% = 1 1 (b) Equity Expectations = K e = = = 16.67% PE Ratio % (i) Value of Equity (Equity Earnings ) % (ii) Value of Pref. Capital (Face Value, in the absence of an identified Preference Expectation Rate) Value of Business = Total under (b) Note: Alternatively, Equity Expectations may also be assumed at given K o =12%. 2. Value of Market Price Per Equity Share Based on Projected Earnings Past Year s Earnings (a) Equity Earnings (`Lakhs) Pref. Dividend = (b) No. of Equity Shares (Lakhs) (c) Earnings Per Share (a b) ` ` (d) PE Multiple 6 6 (e) Market Price Per Equity Share = [c d] ` ` Question 6(b): Capital Budgeting Social Costs / Benefits The Municipal Corporation of a city with mass population is planning to construct a Flyover that will replace the intersection of two busy Highways X and Y. Average Traffic per day is 10,000 Vehicles on Highway X and 8,000 Vehicles on Highway Y. 70% of the Vehicles are private and rest are commercial vehicles. The flow to traffic across and between aforesaid Highways is controlled by traffic lights. Due to heavy flow, 50% of traffic on each of the highways is delayed. Average Loss of Time due to delay is 1.3 minute in Highway X and 1.2 minute in Highway Y. The Cost of time delayed is estimated to be ` 80 per hour for Commercial Vehicles and ` 30 for Private Vehicle. The cost of stop and start is estimated to be ` 1.20 for Commercial Vehicles and ` 0.80 for Private Vehicle. The cost of operating the traffic lights is ` 80,000 a year. One Policeman is required to be posted for 3 hours a day at the crossing which costs ` 150 per hour. Due to failure to obey traffic signals, eight fatal accidents and sixty non fatal accidents occurred in last 4 years. On an average, Insurance Settlements per fatal and non fatal accidents are ` 5,00,000 and ` 15,000 respectively. To eliminate the delay of traffic and the accidents caused due to traffic light violations, the Flyover has been designed. It will add a quarter of kilometer to the distance of 20% of total traffic. No posting of Policeman will be required at the Flyover. The Flyover will require investment of ` 3 Crores. Extra Maintenance Cost would be ` 70,000 a year. The incremental Operating Cost for Commercial Vehicle will be ` 5 per km and ` 2 for Non Commercial Vehicle. Expected Economic Life of the Flyover is 30 years having no salvage value. The Cost of Capital for the Project is 8%. (Corresponding Capital Recovery is ). You are required to calculate: 1. Total Net Benefits to Users, 2. Annual Cost to the State, and 3. Benefit Cost Ratio. Nov

13 Get More Updates From Solution: Refer Principles in Chapter 1 1.Total Net Benefits to Users (or Cost Saved) Private Vehicles Commercial Vehicles (a) Delayed Vehicles per day in Highway X 10,000 70% 50% = 3,500 10,000 30% 50%= 1,500 (b) Average Time delay in Highway X 1.3 Minutes 1.3 Minutes (c) Delayed Vehicles per day in Highway Y 8,000 70% 50% = 2,800 8,000 30% 50% = 1,200 (d) Average Time delay in Highway Y 1.2 Minutes 1.2 Minutes (e) Total Time delay (in Minutes) (3, ) + (2, ) = 7,910 (1, ) + (1, ) = 3,390 (f) Total Time Delay (in Hours) = (e) Hours 56.5 Hours (g) Cost of Time Delay per hour ` 30 ` 80 (h) Cost of Time Delay p.a. = (f) (g) 365 ` 14,43,575 ` 16,49,800 (i) Cost of Stop and Start per Vehicle ` 0.80 ` 1.20 (j) Total Delayed Vehicles = (a) + (c) 6,300 2,700 (k) Cost of stop and start = (j) (i) 365 ` 18,39,600 ` 11,82,600 (l) Total Benefits p.a.=delay + Stop / Start Costs saved (h + k) = ` 32,83,175 (h + k) = ` 28,32,400 (m) IncrementalOperating Cost (7, ,600) 20% 0.25 Km ` = ` 4,59,900 (3, ,400) 20% 0.25 Km ` = ` 4,92,750 (n) Total Net Benefits to Users per annum ` 28,23,275 ` 23,39, Annual Net Cost to the State ` 51,62,925 A. Costs (a) Annual Cost of Capital ` 3,00,00, = 26,64,000 (b) Extra Maintenance Cost 70,000 Sub Total Costs p.a. [A] 27,34,000 B. Benefits to State = Cost Saved (a) Insurance Settlements p.a. ( ` 5,00,000 8) + ( ` 15,000 60) = 12,25,000 4 Years (b) Salary to Policemen= (150 per hour 3 Hrs 365) 1,64,250 (c) Cost of Operating Traffic Lights 80,000 Sub Total Benefits p.a. [B] 14,69,250 C. Net Cost to State p.a. = [A] [B] 12,64,750 51,62, Benefit Cost Ratio = = ,64,750 Note: Alternatively, Benefit Cost Ratio may also be computed using the principles of Profitability Index. Question 7(a): Answer any four of the following ` 4 4 Marks = 16 Marks Question Answer Reference 1. What is Cross Border Leasing? State its advantages. See Page No. 3.4, Q.No.7 2. What are the rigidities in the Indian Money Market? See Page No. 12.4, Q.No.7 3. What is Exchange Traded Fund? What are its advantages? See Page No. 8.5, Q.No What are the problems for Mergers and Acquisitions in India? See Page No. 18.4, Q.No.7 5. What makes an Organization sustainable? State the specific steps. See Page No , Q.No.40 Nov

14 Padhuka s Publications For CA Inter Ready Referencer on Accounting Group I Law, Ethics and Communication A Referencer Students' Handbook on Cost Accounting and Financial Management Cost Accounting and Financial Management A Practical Guide Handbook on Taxation Question Bank for Taxation Students' Handbook on Advanced Accounting Group II A Students' Handbook on Auditing and Assurance Auditing and Assurance A Ready Referencer Students' Handbook on Information Technology and Strategic Management Question Bank Information Technology and Strategic Management Students' Referencer on Standards on Auditing For CA CPT Basics of Accounting Mercantile Law Guide Basics of General Economics Practical Guide on Quantitative Aptitude MCQ Bank for CA CPT Complete Guide for CA CPT For Attractive Discounts with Special Combo Offers *, visit * Subject to availability of Offer at the time of order. Terms and Conditions apply. Nov

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