No. of Pages: 7 Total Marks: 100

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1 LG No. of Pages: 7 Total Marks: 100 No of Questions: 7 Time Allowed: 3 Hrs Question No. 1 is compulsory Answer any five questions from the remaining six questions. Wherever necessary, suitable assumption(s) may be made by the candidates. Working notes should form part of the answer 1 (a) From the following information, determine the possible value of brand as per potential earning model: ` In Lakhs (i) Profit After Tax (PAT) `2,500 (ii) Tangible fixed assets `10,000 (iii) Identifiable intangilble other than brand `1,500 (iv) Weighted average cost of capital (%) 14% (v) Expected normal return on tangible assets weighted average cost (14%) + normal spread 4% 18% (vi) Appropriate capitalisation factor for intangibles 25% 1 (b) Certain callable convertible debentures are issued at ` 60. The value of similar debentures without call or equity conversion option is ` 57. The value of call as determined using Black and Scholes model for option pricing is ` 2. Determine values of liability and equity component. 1 (c) Primus Hospitals Ltd. had acquired 40 units of Doppler Scan machines from Holiver USA at a cost of US $ 165,100 per unit in the beginning of financial year The prevailing rate of exchange was ` 50 to 1 US $. The acquisition was partly funded out of a government grant of `5 crores. The grant relating to such machines was given with a rider that in the event of a change in management, the entity is bound to return the grant. In April 2011, 51% control in the company was taken over by an overseas investor. The expected productive period of such an asset is normally reckoned as 5 year. The depreciation rate adopted was 20% p.a. on S.L.M. basis. The company had incurred expenditure of US $ 4000 towards bank charges and ` 7500 per unit as sea freight. You are also informed that neither capital reserve nor deferred income account has been maintained by the company. You are required to suggest the accounting treatment as a result of the return of the grant, in the light of the relevant AS. 1 (d) Antarbadi Limited reported a Profit Before Tax (PBT) of 4 lakhs for the third quarter ending On enquiry you observe the following, give the treatment required under AS 25: (i) Dividend income of `4 lakhs received during the quarter has been recognized to the extent of `1 lakh only. (ii) 80% of sales promotion expenses ` 15 lakhs incurred in the third quarter has been deferred to the fourth quarter as the sales in the last quarter is high. (iii) In the third quarter, the company changed depreciation method from WDV to SLM, which resulted in excess depreciation of `12 lakhs. The entire amount has been debited in the third quarter, though the share of the third quarter is only ` 3 lakhs. (iv) (v) `2 lakhs extra-ordinary gain received in third quarter was allocated equally to the third and fourth quarter. Cumulative loss resulting from change in method of inventory valuation was recognized in the third quarter of `3 lakhs. Out of this loss `1 lakh relates to previous quarter. PRIME/ME36/Final 1

2 (vi) Sale of investment in the first quarter resulted in a gain of ` 20 lakhs. The company had apportioned this equally to the four quarter. Prepare the adjusted profit before tax for the third quarter. (4 x 5 = 20 Marks) 2 The draft Balance Sheet of three companies, W, H, 0, as at is as under: ` In Thousands Assets W H O Fixed assets Investments 1,60,000 shares in H ,000 shares in O 184 Cash at bank Trade receivables Inventory Total Liabilities Share capital (Nominal value Re.1 per share) Reserves Trade payables Debentures Total You are given the following information: (a) (b) (c) (d) W purchased the shares in H on when the balance in reserves was `500 thousands. The shares in O were purchased on when the balance in reserves was `242 thousands. The following dividend have been declared but not accounted for before the accounting year end. W - ` 65 thousands H - ` 30 thousands O - ` 15 thousands Included in inventory figure of O is inventory valued at `20 thousands which had been purchased from W at cost plus 25%. (e) Goodwill in respect of the acquisition of H has been fully written off. (f) On H made bonus issue of one share for every share held. This had not been accounted in the balance sheet as on (g) Included in trade payables of W is ` 18 thousands to O, which is included in trade receivables of O. Prepare Consolidated Balance Sheet of W as at (16 Marks) PRIME/ME36/Final 2

3 3 (a) Samvedan Limited is a non-banking finance company. It accepts public deposit and also deals in hire purchase business. It provides you with the following information regarding major hire purchase deals as on Few machines were sold on hire purchase basis. The hire purchase price was set as ` 100 lakhs as against the cash price of ` 80 lakhs. The amount was payable as ` 20 lakhs down payment and balance in 5 equal instalments. The hire vendor collected first instalment as on , but could not collect the second instalment which was due on The company was finalizing accounts for the year ending Till , the date on which the Board of Directors signed the accounts, the second instalment was not collected. Presume IRR to be 10.42%. Required : (i) What should be the principal outstanding on ? Should the company recognize finance charge for the year as income? (ii) What should be the net book value of assets as on so far Samvedan Ltd. is concerned as per NBFC prudential norms requirement for provisioning? (iii) What should be the amount of provision to be made as per prudential norms for NBFC laid down by RBI? (8 Marks) 3 (b) 4 Ramesh Goyal has invested in three mutual funds. From the details given below, find out effective yield on per annum basis in respect of each of the schemes to Ramesh Goyal upto Mutual Fund X Y Z Date of Investment Amount of investment (`) 1,00,000 2,00,000 1,00,000 NAV at the date of investment (`) Dividend received upto (`) 1,900 3,000 Nil NAV as on (`) (8 Marks) A Ltd. and B Ltd. were amalgamated on and from 1 st April, A new company C Ltd. was formed to take over the business of the existing companies. The Balance Sheets of A Ltd., and B Ltd., as on 31 st March, 2010 are given below: (` in lakhs) Liabilities A Ltd. B Ltd. Assets A Ltd. B Ltd. Share capital: Equity shares of ` 100 Each 12% Preference shares of F 100 each Fixed Assets: Land and Building Plant and Machinery Reserves and surplus: Investments: Revaluation Reserve General Reserve Current Assets, Loans and Advances: PRIME/ME36/Final 3

4 Investment Allowance Stock Reserve Sundry Debtors Profit & Loss account Bills Receivable Secured Loans: 10% Debentures (` 100 each) Current Liabilities and Provisions: Cash and Bank Sundry Creditors Bills Payable Additional Information: 2,000 1,500 2,000 1,500 (1) 10% Debenture holders of A Ltd., and B Ltd., are discharged by C Ltd., issuing such number of its 15% Debentures of ` 100 each, so as to maintain the same amount of interest. (2) Preference shareholders of the two companies are issued equivalent number of 15% Preference shares of C Ltd., at a price of ` 150 per share (face value of ` 100). (3) C Ltd., will issue 5 equity shares for each equity share of A Ltd. and 4 equity shares for each share of B Ltd. The shares are to be ` 30 each, having a face value of ` 10 per share. (4) Investment allowance reserve to be maintained for 4 more years. Prepare the Balance Sheet of C Ltd., as on 1st April, 2010 after the amalgamation has been carried out on the basis of amalgamation in the nature of purchase. (16 Marks) 5 (a) Prosperous Bank has a criterion that it will give loans to companies that have an Economic Value Added greater than zero for the past three years on an average. The bank is considering lending money to a small company that has the economic value characteristics shown below. The data relating to the company is as follows: (i) Average operating income after tax equals ` 25,00,000 per year for the last three year (ii) Average total assets over the last three years equals ` 75,00,000. (iii) Weighted average cost of capital appropriate for the company is 10% which is applicable for all three year. (iv) The company s average current liabilities over the last three years are ` 15,00,000. Does the company meet the bank s criterion for a positive economic value added? (8 Marks) PRIME/ME36/Final 4

5 5 (b) Sparrow Holdings is a SEBI Registered Mutual Fund which made its maiden N.F.O (New Fund Offer) on 10th April, 2010 ` 10 face value per unit. Subscription was received for 90 lakhs units. An underwriting arrangement was also entered into with Affinity Capital Markets Ltd., that agreed to underwrite the entire NFO of 100 lakhs units on a commission of 1.5%. Out of the monies received ` lakhs was invested in various capital market instruments. The marketing expenses for the N.F.O amounted to ` lakhs. During the financial year ended March 2011 the Fund sold securities having cost of ` lakhs (FV ` lakhs) for ` lakhs. The fund in turn purchased securities for `130 lakhs. The management expenses of the fund are regulated by SEBI stipulations which state that the same shall not exceed 0.25% of the average funds invested during the year. The actual amount spent towards management expenses was ` 2.47 lakhs of which ` 47,000 was in arrear. The dividends earned on the investments held amounted to ` 2.51 lakhs of which a sum of ` 25,000 is yet to be collected. The fund distributed 80% of realized earnings. The closing market value of the portfolio was ` lakhs You are required to determine the closing per unit NAV of the fund. (8 Marks) 6 (a) Life Industries Ltd (LIL) furnishes the following information from which you are required to calculate the prevailing Economic Value Added of the company and also explain the reason for the difference, if any, between the EVA as calculated by you and the MVA (Market Value Added) of LIL amounting to ` crores. Common shares of ` 1,000 face value 1,58,200 units 12% Debentures ` 10 face value 50,00,000 units Current tax rate 30% Financial Leverage 1.1 times Securities Premium Account (Rupees in lakhs) 155 Free Reserves (Rupees in lakhs) 154 Capital Reserve (Rupees in lakhs) (b) It is a prevailing practice for companies in the industry to which LIL belongs to pay at least a dividend of 15% p.a. to its common shareholder. (8 Marks) Hindusthan Corporation Limited (HCL) has been consistently preparing Value Added Statement (VAS) as part of Financial Reporting. The Human Resource department of the Company has come up with a new scheme to link employee incentive with Value Added as per VAS. As per the scheme an Annual Index of Employee cost to Value Added annually (% of employee cost to Value Added rounded off to nearest whole number) shall be prepared for the last 5 years and the best index out of results of the last 5 years shall be selected as the Target Index. The Target Index percentage shall be applied to the figure of Value Added for a given year to ascertain the target employee cost. Any saving in the actual employee cost for the given year compared to the target employee cost will be rewarded as Variable incentive to the extent of 70% of the savings. From the given data, you are requested to ascertain the eligibility of Variable Incentive for the year for the employees of the HCL. PRIME/ME36/Final 5

6 Value added statement of HCL for last 5 years (` lakhs) Year Sales 3,200 3,250 2,900 3,800 4,900 Less: Bought out goods and services 2,100 2,080 1,940 2,510 3,200 Value added 1,100 1, ,290 1,700 Application of Value Added Year To Pay Employees To Providers of Capital To Government Tax For Maintenance and expansion Summarized Profit and Loss Account of the HCL for (` in lakhs) Sales 5,970 Less: Material consumed 1,950 Wages 400 Production salaries 130 Production expenses 500 Production depreciation 150 Administrative salaries 150 Administrative expenses 200 Administrative depreciation 100 Interest 150 Selling and distribution salaries 120 Selling expenses 350 Selling depreciation 120 4,320 Profit 1,650 7 (a) (8 Marks) Assam Ltd. purchased an oil well for $ 100 million. It estimates that the well contains 250 million barrels of oil. The oil well has no salvage value. If the company extracts and sells 10,000 barrels of oil during the first year, how much depletion expense should be recognized as per IFRS 6? (5 Marks) PRIME/ME36/Final 6

7 7 (b) From the information furnished you are required to compute the Basic and Diluted EPS (earnings per share) for accounting year to and adjusted EPS for the year to Net profit for year ended ` 75,50,000 Net profit for year ended ` 1,00,25,000 No. of equity shares as on ,00,250 Bonus issue on share for every 2 held No. of 12% Convertible Debentures of ` 100 each issued on ,00,000 Conversion ratio of Debentures Tax rate 10 shares per debenture 30 percent (6 Marks) 7 (c) X Limited was making provisions up to for non-moving stocks based on no issues for the last 12 months. Based on a technical evaluation the company wants to make provisions during the year in the following manner: Total value of stock ` 3 crores. Provision required based on 12 months ` 8 lakhs. Provision required based on technical evaluation `7.50 lakhs. Does this amount to change in accounting policy? Can the company change the method of provision? ( 5 Marks ) PRIME/ME36/Final 7

8 PRIME ACADEMY 36 th SESSION MODEL EXAM - FINAL Financial Reporting SUGGESTED ANSWERS 1. (a) Calculation of Possible Value of Brand ` In Lakhs Profit after Tax 2,500 Less : Profit allocated to tangible assets ( 18% of `10000) 1,800 Profit allocated to intangible assets including brand 700 Capitalisation factor 25% Capitalised value of intangibles including brand ( 700/25*100) 2800 Less : Indentifiable intangibles other than brand 1500 Brand Value (b) A callable convertible debenture is one that gives the issuer a right to buy a convertible debenture from the debenture holder at a specified price. This feature in effect is a call option written by the debenture holder. The value of call (i.e. option premium) is payable by the issuer. 1. (c) Liability component of non-convertible debentures (disregarding the call value) = ` 57 Less: Value of call payable by the issuer ` 2 Net liability component of non-convertible debentures ` 55 Equity component in callable convertible debentures = ` 60 ` 55 = ` 5 Calculation of Revised Book Value of machine as on 1st April 2011 Particulars (`) Acquisition of 40 Doppler Scan machines [US $ 165,100 x ` 50 x 40 machines] 330,200,000 Add: Bank charges paid ($ 4,000 x ` 50) 200,000 Add: Sea Freight on the above machines (` 7,500 per unit x 40 machines) 300,000 Total landed cost as on 1st April, ,700,000 Less: Government grant (50,000,000) Value of 40 Doppler Scan machines 280,700,000 Less: 20% for 3 years on SLM basis (i.e ` 28,07,00,000 x 20% x 3 years) (168,420,000) WDV at the beginning of the year ,280,000 Add: Refund of government grant on 1st April, ,000,000 Revised book value of machine as on 1st April, ,280,000 PRIME/ME36/Final 8

9 Note: As per para 16 of AS 6 'Depreciation Accounting', where the historical cost of a depreciable asset has undergone a change due to increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors, the depreciation on the revised unamortized depreciable amount should be provided prospectively over the residual useful life of the asset. In this case, on 1 st April, 2011, the remaining useful life is only two years i.e & Hence, the WDV of ` 16,22,80,000 is to be written off under 50% each year i.e. ` 8,11,40,000 per year. The government grant of ` 5 crores that becomes refundable should be accounted for as an extraordinary item as per AS 12 'Government Grants', with related disclosure of the increased depreciation of ` 2.5 crores (i.e. ` 8,11,40,000 ` 5,61,40,000) consequent to the return of such grant. 1. (d) As per para 36 of AS 25 "Interim Financial Reporting", seasonal or occasional revenue and cost within a financial year should not be deferred as of interim date un till it is appropriate to defer at the end of the enterprise's financial year. Therefore dividend income, extra-ordinary gain, and gain on sale of investment received during 3 rd quarter should be recognized in the 3 rd quarter only. Similarly, sales promotion expenses incurred in the 3 rd quarter should also be charged in the 3 rd quarter only. Further, as per the standard, if there is change in the accounting policy within the current financial year, then such a change should be applied retrospectively by restating the financial statements of prior interim periods of the current financial year. The change in the method of depreciation or inventory valuation is a change in the accounting policy. Therefore, the prior interim periods' financial statements should be restated by applying the change in the method of valuation retrospectively. Accordingly, the adjusted profit before tax for the 3 rd quarter will be as follows: Statement showing Adjusted Profit before Tax for the third quarter ( `in lakhs) Profit before tax (as reported) 4 Add: Dividend income ` (4-1) lakhs 3 Excess depreciation charged in the 3 rd quarter, due to change in the method, should be applied retrospectively ` (12-3) lakhs 9 Extra ordinary gain ` (2-1) lakhs 1 Cumulative loss due to change in the method of inventory valuation should be applied retrospectively ` (3-2) lakhs 1 18 Less: Sales promotion expenses (80% of ` 15 lakhs) (12) Gain on sale of investment (occasional gain should not be deferred) (5) Adjusted Profit before tax for the third quarter 1 PRIME/ME36/Final 9

10 2. Consolidated Balance Sheet of W and its subsidiary H As at 31st March, 2010 Assets (` in thousands) Fixed assets ( ) 1, Investment in Associate (W.N.5) (including goodwill `7.20 thousand) Add: Accumulated reserves Cash at bank ( ) Trade receivables ( ) Inventory ( ) Dividend receivable from O 6.00 Liabilities Total 3, Share capital (Nominal value Re.1 per share) Minority Interest (W.N.3) Reserves (W.N.4) 1, Trade payables ( ) Debentures ( ) Proposed Dividend (W.N.6) Total 3, Working Notes: 1.Analysis of profits of H ( ` In Thousands) Pre Acquisition Profits Post Acquisition Profits Reserves on the date of acquisition Less: Bonus issue Less: Dividend declared on Less: Minority interest (20%) W s share (80%) It is assumed that bonus issue had been made out of pre-acquisition reserves. 2. Cost of control/goodwill ( ` In Thousands) Amount paid for investment 562 Less: Paid up value of shares including bonus (80% of 400) 320 Share in pre acquisition profits of H Goodwill 2 PRIME/ME36/Final 10

11 3. Minority Interest ( ` In Thousands) Paid up value of share including bonus issue (400 20%) 80 Share in pre acquisition profits of H 60 Share in post acquisition profits of H Consolidated Reserves ( ` In Thousands) ( ` In Thousands) Balance as per W s Balance Sheet 1, Add: Share in post acquisition profits of H Dividend from H Share of profit from Associate O Add: Dividend from O , Less: Dividend payable Goodwill written off , Investment in Associate O as on (As per AS 23) ( ` In Thousands) Amount paid for investment Less: Paid up value of shares Share in pre acquisition reserves (40% of 242) Goodwill (Identified at the time of purchase) 7.20 Initial cost Add: Increase in equity reserves [40% of ( )] Less: Unrealized profit ((20X25/125)X40%) (1.60) Investment in Associate O as on Share of profit from Associate O ( ) Proposed Dividend ( ` In Thousands) W Minority Interest (30 24) (a) (i) Since, the hire-purchaser paid the first installment due on , the notional principal outstanding on was `50.25 lakhs (refer W.N.). In the year ended , the installment due of `16 lakhs has not been received. However, it was due on i.e. on the balance sheet date, and therefore, it will be classified as standard asset. Samvedan Ltd. will recognize `5.24 lakhs as interest income included in that due installment as this should be treated as finance charge. PRIME/ME36/Final 11

12 (ii) The net book value of the assets as on `. in lakhs Overdue installment Installments not due (` 16 lakhs x 3) Less: Finance charge not matured and hence not credited to Profit and loss account ( ) (8.51) Less: Provision as per para 9(2)(i) of NBFC prudential norms (Refer point (iii)) 7.49 Net book value of assets for Samvedan Ltd (iii) Amount of Provision ( ` In Thousands) Overdue installment Installments not due (` 16 lakhs x 3) Less: Finance charge not matured and hence not credited to Profit and loss account ( ) (8.51) Less: Depreciated value (cash price less depreciation for two years on 20% ) (48.00) Provision to be created as per para 9(2)(i) of NBFC prudential norms 7.49 Since, the installment of ` 16 lakhs not paid, was due on only, the asset is classified as standard asset. Therefore, no additional provision has been made for it. Working Notes: It is necessary to segregate the installments into principal outstanding and interest components by using 10.42%. ( `. in lakhs) Time Opening outstanding amount (a) Cash flow (b) 10.42% (c) = (a x 10.42%) Principal repayment (d) = (b c) Closing outstanding (e) = (a d) (60) PRIME/ME36/Final 12

13 3.(b) Calculation of effective yield on per annum basis in respect of three mutual fund schemes of Ramesh Goyal upto X Y Z 1 Amount of Investment (`) 1,00,000 2,00,000 1,00,000 2 Date of investment NAV at the date of investment (`) No. of units on date of investment [1/3] 9, ,000 10,000 5 NAV per unit on (`) Total NAV of mutual fund investments on [4 x 5] 99, ,02,000 98,000 7 Increase/ decrease of NAV [6-1] (952.39) 2,000 (2,000) 8 Dividend received upto ,900 3,000 Nil 9 Total yield [7+8] ,000 (2,000) 10 Yield % [9/1] x % 2.5% (2%) 11 Number of days Effective yield p.a. [10/11]x 366 days 2.85% 10.05% (23.61%) February was of 29 days in the year Balance Sheet of C Ltd. as on 1st April, 2010 (` In Lakhs) (` In Lakhs) Liabilities Amount Assets Amount Share Capital: Fixed Assets: 70,00,000, Equity Shares of `10 each (W.N.4) 700 Goodwill (W.N. 2) 20 5,00,000, 15% Preference Shares of ` 100 each (all the above 500 Land and Building ( ) 950 shares are allotted for consideration other than cash) Plant and Machinery ( ) 600 Reserves and Surplus: Investments (150+50) 200 Current Assets, Loans and Securities Premium Account (W.N.4) 1650 Advances Investment Allowance Reserve (50+50) 100 Stock ( ) 600 Secured Loans: Sundry Debtors ( ) % Debentures (40+20) (W.N.5) 60 Cash and Bank ( ) 500 Unsecured Loans 0 Bills Receivable (50+50) 100 Current liabilities and provisions: Miscellaneous Expenditure: Sundry Creditors ( ) 390 Amalgamation Adjustment Account 100 Bills Payable (150+70) PRIME/ME36/Final 13

14 Working Notes: 1. Computation of Purchase Consideration (a) Preference Shareholders A Ltd. (3,00,00, ) ie. 3,00,000 Shares x ` 150 each 450 ( `. in lakhs) (2,00,00, ) ie 2,00,000 Shares x ` 150 each 300 (b) Equity Shareholders: [(8,00,00, ) x 5] ie 40,00,000 Shares x ` 30 each 1200 B Ltd. [(7,50,00, ) x 4] ie. 30,00,000 Shares x ` 30 each 900 Amount of purchase consideration 2. Net Assets taken over ` In Lakhs A Ltd B Ltd Assets taken over: Land and Building Plant and Machinery Investments Stock Sundry Debtors Bills Receivable Cash and Bank ,000 1,500 Less: Liabilities taken over Debentures Sundry Creditors Bills Payable 150 (460) 70 (210) Net Assets taken over 1,540 1,290 1,650 1, Goodwill / Capital Reserve PRIME/ME36/Final 14 A Ltd. `. in lakhs B Ltd. Purchase Consideration 1,650 1,200 Less: Net Assets taken over (1,540) (1,290) Goodwill Capital Reserve - (90) Net Goodwill = 20

15 4. Share Capital / Securities Premium Share Capital Securities Particulars Equity Preference Premiun ` In Lakhs ` In Lakhs ` In Lakhs A Ltd. Equity shares (8,00,000 shares x 5 x ` 10) 400 Securities premium (8,00,000 sharesx5 x ` 20) 800 Preference shares (3,00,000 shares x ` 100) 300 Securities premium (3,00,000 shares x ` 50) 150 B Ltd. Equity shares (7,50,000 shares x 4 x ` 10) 300 Securities premium (7,50,000 shares x 4 x`20) 600 Preference shares (2,00,000 shares x ` 100) 200 Securities premium (2,00,000 shares x ` 50) Debentures ` In Lakhs A Ltd B Ltd Interest on 10% = 60 х 10% = 6 Number of 15% debentures to maintain same amount of interest (6 / 15 X 100) 40 Interest on 10% = 30 х 10% = 3 Number of 15% debentures to maintain same amount of interest ( 3/15 X 100) (a) Calculation of Economic Value Added Net Operating Profit After Tax 25,00,000 Less: Cost of capital employed (Refer W.N.) (6,00,000) Economic Value Added 19,00,000 Economic value added is greater than zero. Therefore, the company qualifies for the loan. PRIME/ME36/Final 15

16 Working Note: Calculation of Cost of Capital employed Average total assets 75,00,000 Less: Average current liabilities (15,00,000) Capital employed 60,00,000 Cost of capital = Capital employed x Weighted average cost of capital = 60,00,000 x10/100 = 6,00,000 ` 5.(b) Calculation of Closing per unit of NAV of the fund Net Assets of Sparrow holding PRIME/ME36/Final 16 `. in lakhs Closing cash balance (W.N.2) Closing Market Value of Investments 1, Accrued Dividends (collectable) , Less: Current Liabilities Outstanding Management Fee (payable) (0.47) Closing Net Assets (A) 1, Units outstanding (in lakhs) (B) NAV per unit (A/B) Working Notes: (` In Lakhs) 1. Computation of opening cash balance Proceeds of NFO in full including underwriters commitment 1, Less: Initial Purchase of Securities Less: Underwriting Commission Marketing Expenses Computation of Closing cash balance Opening bank balance (W.N.1) Add: Proceeds from sale of securities Dividends received on investment Less: Cost of Securities purchased Management Expenses (W.N.3) 1.76 Capital Gains Distributed ` ( x 80%) Dividends Distributed ` (2.26 x 80%) Closing cash balance 79.99

17 3. Computation of Management Expenses Chargeable Actual Expense Incurred [A] 2.47 Opening Investment Made Closing Funds Invested ( ) Total 1, Average Funds Invested (1,787.75/2) % of Average Funds Invested [B] 2.23 Lower of A or B 2.23 Less: Amount unpaid (0.47) Management expenses paid (a) Computation of Economic Value Added `. in lakhs Profit after tax 420 Add: Interest net of tax = 60 x ( / 100 ) 42 Return to providers of funds 462 Less: Cost of Capital (342) Economic Value Added 120 MVA of ` crore: The MVA of ` crore is the difference between the current Market Value of LIL and the capital contributed by the fund providers. While EVA measures current earning efficiency of the company, MVA takes into consideration the EVA from not only the assets in place but also from the future projects/activities of the company. The difference between MVA over EVA thus represents the value attributed to the future potential of the company & may change from time to time based on market sentiments. In short the MVA is the net present value of all future EVA s. 1. Calculation of Net Profit after interest and tax Interest on Debentures = 50,00,000 units x 10 x 12% = ` 60,00,000 Therefore, Financial Leverage = Profit before Interest & taxes (PBIT) / PBIT less Interest 1.10 =000,00,60PBITPBIT ` 1.10 (PBIT ` 60,00,000) = PBIT 1.10 PBIT ` 66,00,000 = PBIT 1.10 PBIT PBIT = ` 66,00, PBIT = ` 66,00,000 PBIT = ` 6,60,00,000 Profit after interest but before tax = ` 6,60,00,000 ` 60,00,000 = ` 6,00,00,000 Less: Income 30% (` 1,80,00,000) Profit After Interest & Tax ` 4,20,00,000 PRIME/ME36/Final 17

18 2. Calculation of Weighted Average Cost of Capital (WACC) ` In Lakhs Amount (`) (1) Weight (2) Cost % (3) WACC% (4) = 2X3 Equity Shareholders fund Common Shares 1582 Securities Premium 155 Free Reserves 154 Capital Reserves Debenture holders fund * Cost of Capital = Capital Employed x WACC% = ` 2,500 lakhs x 13.68% = ` 342 lakhs * Rate of Interest on debentures is taken net of tax 30% 6.(b) 1. Calculation of Target index (` in lakhs) Year Employees cost Value added 1,100 1, ,290 1,700 Percentage of Employee cost to Value added (to the nearest whole number) 47% 41% 47% 47% 44% Target index percentage is taken as least of the above from companies viewpoint on conservative basis i.e. 41%. 2. Value Added Statement for the year ` In Lakhs ` In Lakhs Sales 5970 Less : Cost of bought in goods & services Material consumed 1950 Production expenses 500 Administrative expenses 200 Selling expenses Added value 2970 PRIME/ME36/Final 18

19 3. Employee cost for (` in lakhs) Wages 400 Production salaries 130 Administrative salaries 150 Selling salaries Calculation of target employee cost = Target Index Percentage x Value added = 41% x ` 2,970 lakhs = ` lakhs 5. Calculation of savings Target employee cost = ` 1, lakhs Less: Actual Cost = ` 800 lakhs Saving = ` lakhs 6. Calculation of Variable incentive for the year : 70% of saving is variable incentive = 70% x ` lakhs = ` lakhs (a) As per IFRS 6 Exploration for and Evaluation of Mineral Resources, depletion rate and depletion expense can be computed as: Depletion rate = Current period production/total barrels of production = 10,000 barrels/250,000,000 barrels = Depletion expense for the first year = Purchase price x Depletion rate = $100,000,000 x = $ 4, (b) No. of Bonus shares issued as on On existing shares (50,00,250 x ½) 25,00,125 shares On convertible debentures as per SEBI Guidelines on Bonus Issue (1,00,000 debentures x 10 shares x ½) 5,00,000 shares Basic Earnings per share for the year = Net profit for the year ended / Weighted average number of equity share as on ` 1,00,25,000 / (50,00,250+25,00, ,000) = ` 1.25 Adjusted earnings per share for the year = `75,50,000 / (50,00,250+25,00,125+5,00,000)=`0.94 For Diluted EPS Interest expense for the current year = ` 12,00,000 Tax relating to interest expense (30%) = ` 3,60,000 Adjusted net profit for the current year = ` 1,00,25,000 + (12,00,000-3,60,000) x3/12 = ` 1,02,35,000 PRIME/ME36/Final 19

20 No. of equity shares resulting from conversion of debentures = 1,00,000 x 10 shares = 10,00,000 No. of equity shares used to compute diluted earnings per share = 50,00, ,00, ,00,000 + (10,00,000 x 3/12) = 50,00, ,00, ,00, ,50,000 = 82,50,375 shares Diluted earnings per share = 1,02,35,000/82,50,375 = ` 1.24 Note: As per AS 20, bonus shares issued to existing shareholders and to convertible debenture holders (on conversion of debentures into shares) are an issue without consideration. Therefore, it is treated as if it had occurred prior to the beginning of the year , the earliest period reported. 7.(c) Basis of provisioning whether on no issues or on technical evaluation is the basis of making estimates and cannot be considered as Accounting Policy. As per AS 5, due to uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. The estimation process involves judgments based on the latest information available. An estimate may have to be revised if changes occur regarding the circumstances on which the estimate was based, or as a result of new information, more experience or subsequent developments. The basis of change in provisioning is a guideline and the better way of estimating the provision for nonmoving stock on account of change. Hence, it is not a change in accounting policy. Accounting policy is the valuation of inventory on cost or on net realizable value or on lower of cost or net realizable value. Any interchange of this valuation base would have constituted change in accounting policy. Further, the company should be able to demonstrate satisfactorily that having regard to circumstances provision made on the basis of technical evaluation provides more satisfactory results than provision based on 12 months issue. If that is the case, then the company can change the method of provision. PRIME/ME36/Final 20

21 CT No. of Pages: 5 Total Marks: 100 No of Questions: 7 Time Allowed: 3 Hrs Question No. 1 is compulsory Answer any five questions from the remaining six questions Working notes should form part of the answer 1. Answer the following (a). Shashi Co. Ltd. has projected the following cash flows from a project under evaluation: Year `(in lakhs) The above cash flows have been made at expected prices after recognizing inflation. The firm s real cost of capital is 10%. The expected annual rate of inflation is 5%. Evaluate the viability of the project. (b) The share of X Ltd. is currently selling for ` 900. Risk free interest rate is 0.8% per month. A three months futures contract is selling for ` 936. Develop an arbitrage strategy and show what your riskless profit will be 3 month hence assuming that X Ltd. will not pay any dividend in the next three months. (c) Calculate Market Price of: (i) 10% Government of India security currently quoted at `110, but interest rate is expected to go up by 1%. (ii) A bond with 7.5% coupon interest, Face Value `10,000 & term to maturity of 2 years, presently yielding 6%. Interest payable half yearly. (d) Suppose that there is a future contract on a share presently trading at `1000. The life of future contract is 90 days and during this time the company will pay dividends of `7.50 in 30 days, `8.50 in 60 days and `9.00 in 90 days. Assuming that the Compounded Continuously Risk free Rate of Interest (CCRRI) is 12% p.a. you are required to find out Fair Value of the contract if no arbitrage opportunity exists. (4 x5=20 Marks) 2. (a) Following Financial data are available for PQR Ltd. for the year 2012 : (` in lakh) 8% debentures % bonds (2007) 50 Equity shares (` 10 each) 100 Reserves and Surplus 300 Total Assets 600 Assets Turnovers ratio 1.1 Effective interest rate 8% Effective tax rate 40% Operating margin 10% Dividend payout ratio 16.67% Current market Price of Share 14 PRIME/ME36/Final 1

22 Required rate of return of investors 15% You are required to: (i) (ii) (iii) (iv) Draw income statement for the year Calculate its sustainable growth rate Calculate the fair price of the Company s share using dividend discount model, and What is your opinion on investment in the company s share at current price? (8 Marks) (b). MK Ltd. is considering acquiring NN Ltd. The following information is available: Earnings No. of Company after Equity Market Value tax (`) Shares Per Share(`) MK Ltd. 60,00,000 12,00, NN Ltd. 18,00,000 3,00, Exchange of equity shares for acquisition is based on current market value as above. There is no synergy advantage available. (i) Find the earning per share for company MK Ltd. after merger, and (ii) Find the exchange ratio so that shareholders of NN Ltd. would not be at a loss. (8 Marks) 3. (a) A Mutual Fund Co. has the following assets under it on the close of business as on: Company No. of Shares 1 st February nd February 2012 Market price per share ` Market price per share ` L Ltd 20, M Ltd 30, N Ltd 20, P Ltd 60, Total No. of Units 6,00,000 (i) (ii) Calculate Net Assets Value (NAV) of the Fund. Following information is given: Assuming one Mr. A, submits a cheque of ` 30,00,000 to the Mutual Fund and the Fund manager of this company purchases 8,000 shares of M Ltd; and the balance amount is held in Bank. In such a case, what would be the position of the Fund? (iii) Find new NAV of the Fund as on 2nd February 2012 (8 Marks) PRIME/ME36/Final 2

23 (b) Fair finance, a leasing company, has been approached by a prospective customer intending to acquire a machine whose Cash Down price is ` 3 crores. The customer, in order to leverage his tax position, has requested a quote for a three year lease with rentals payable at the end of each year but in a diminishing manner such that they are in the ratio of 3:2:1. Depreciation can be assumed to be on straight line basis and Fair Finance s marginal tax rate is 35%. The target rate of return for Fair Finance on the transaction is 10%. Required: Calculate the lease rents to be quoted for the lease for three year. (8 Marks) 4 (a) ABC Ltd. has ` 300 million, 12 percent bonds outstanding with six years remaining to maturity. Since interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a ` 300 million issue of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bond will be ` 6 million and the call premium is 4 per cent. ` 9 million being the unamortized portion of issue cost of old bonds can be written off no sooner the old bonds are called off. Marginal tax rate of ABC Ltd. is 30 per cent. You are required to analyse the bond refunding decision. (8 Marks) (b) Given below is the Balance Sheet of S Ltd. as on : ` ` Liabilities (in lakhs) Assets (in lakhs) Share capital Land and building 40 (share of ` 10) 100 Plant and 80 machinery Reserves and 40 Investments 10 surplus Creditors 30 Stock 20 Debtors 15 Cash at bank You are required to work out the value of the Company s, shares on the basis of Net Assets method and Profit earning capacity (capitalization) method and arrive at the fair price of the shares, by considering the following information: (i) Profit for the current year ` 64 lakhs includes ` 4 lakhs extraordinary income and ` 1 lakh income from investments of surplus funds; such surplus funds are unlikely to recur. (ii) In subsequent years, additional advertisement expenses of `5 lakhs are expected to be incurred each year. PRIME/ME36/Final 3

24 (iii) Market value of Land and Building and Plant and Machinery has been ascertained at ` 96 lakhs and ` 100 lakhs respectively. This will entail additional depreciation of ` 6 lakhs each year. (iv) Effective Income tax rate is 30%. (v) The capitalization rate applicable to similar business is 15%. (8 Marks) 5. (a) Expected returns on two stocks for particular market returns are given in the following table: Market Return Aggressive Stock Defensive Stock 7% 4% 9% 25% 40% 18% You are required to calculate: (i) The Betas of the two stocks. (ii) Expected return of each stock, if the market return is equally likely to be 7% or 25%. (iii) Return as per CAPM if the risk free rate is 7.5% and market return is equally likely to be 7% or 25%. (iv) The Alphas of the two stocks. (8 Marks) (b) A call and put exist on the same stock each of which is exercisable at ` 60. They now trade for: Market price of Stock or stock index ` 55 Market price of call ` 9 Market price of put Re. 1 Calculate the expiration date cash flow, investment value, and net profit from: for expiration date stock prices of ` 50, ` 55, ` 60, ` 65, ` 70. (i) Buy 1.0 call (ii) Write 1.0 call (iii) Buy 1.0 put (iv) Write 1.0 put (8 Marks) 6. (a) The earnings per share of a company is `10 and the rate of capitalization applicable to it is 10 per cent. The company has three options of paying dividend i.e. (i) 50%, (ii) 75% and (iii) 100%. Calculate the market price of the share as per WALTER s model if it can earn a return of (a) 15, (b) 10 and (c) 5 per cent on its retained earnings. (6 Marks) (b) An importer requests his bank to extend the forward contract for US $ 20,000 which is due for maturity on 30th October, 2012, for a further period of 3 months. He agrees to pay the required margin money for such extension of the contract. Contracted Rate - US $ 1 = `42.32 The US Dollar quoted on : Spot months Premium 0.87% / 0.93% PRIME/ME36/Final 4

25 Margin money for buying and selling rate is 0.075% and 0.20% respectively. Compute: (i) The cost to the importer in respect of the extension of the forward contract, and (ii) The rate of new forward contract. (5 Marks) (c) The following 2 way quotes appear in the foreign exchange market: 2 months Spot forward RS/US $ `46.00/`46.25 `47.00/`47.50 Required: (i) How many US dollars should a firm sell to get `25 lakhs after 2 months? (ii) How many Rupees is the firm required to pay to obtain US $ 2,00,000 in the spot market? (iii) Assume the firm has US $ 69,000 in current account earning no interest. ROI on Rupee investment is 10% p.a. Should the firm en cash the US $ now or 2 months later? (5 Marks) 7. Write short notes on any four of the following: (a) Commercial Paper (b) Global Depository Receipts (c) Debt securitisation (d) Leading and Lagging (e) Zero Coupon Bonds (4 x4=16 Marks) PRIME/ME36/Final 5

26 PRIME ACADEMY 36 TH SESSION MODEL EXAM --STRATEGIC FINANCIAL MANAGEMENT SUGGESTED ANSWERS 1. (a) Cash flows given are money cash flows, Assuming Discount rate given is Real Discount rate (RDR). We need to compute money discount rate (MDR) for discounting cash flows (1 + MDR) = (1 + RDR) x (1 +Inflation rate) (1 + MDR) = (1 +.10) x (1 +.05) MDR = i.e. 15.5% Computation of NPV Discounted Year Cash flows `. (In Lakhs) Pvf@15.5% Cash flows `. (In Lakhs) NPV 3.42 Since NPV is Positive, the project is viable. 1 (b) Computation of Fair future price: S 0 = 900 r=0.8% p.m. t=3 months F = S0 *(1 + r) n F = 900 *( ) 3 F= 900(1.008) 3 F = i.e`.922 Actual Future price is`.936, so sell future, buy spot Arbitrage strategy 1. risk free rate 0.8% p.m 2. Buy Share at spot price and enter future sale contract 3. After 3 months sell future for` Settle liability { 900(1.008)3}i.e` Arbitrage gain`.14 ( ) 1 (c) (i) Current yield = (Coupon Interest / Market Price) X 100 = (10/110) X 100 = 9.09% If current yield go up by 1% i.e the market price would be = 10/Market Price X 100 PRIME/ME36/Final 6

27 1 (d) 2. (a)(i) Market Price =` (ii) Market Price of Bond = P.V. of Interest + P.V. of Principal =`. 1,394 +`. 8,885 =`. 10,279 Step 1: PV of Cash Income Time Income t (years) r rt PVF: e -rt PV 1 month 7.5 1/12 12% month 8.5 2/12 12% month 9 3/12 12% Step 2: Adjusted S0 = S - Step 1 = = Step 3: Fair Value of future contract Step 2 x e rt = x e (0.12 x 3/12) = x e (0.03) = x = Income statement Sales Less: Operating costs EBIT Less: Interest EBT Less 40% Earnings after tax Less: dividend 5.20 Retained Earnings Total Assets : 600 Assets Turnovers ratio : 1.1 Turnover = 1.1 x 600 : 660 Operating expenses (90%) : 594 EBIT(10% of sales) : 66 Effective interest rate : 8% Interest Total liabilities Interest = 8% ( ) Interest = 8%(175) = = 8% 14 PRIME/ME36/Final 7

28 (ii) Sustainable growth rate (g): g = b x r b (retention ratio) = % = 83.33% r (ROE) = EAT Net Worth r = ( ) = 7.80 % g = 83.33%(7.8) = 6.50 % (iii) Fair price of the share using dividend discount model Dividend per share (div/10) = 0.52`. per share d1 = d0 (1 + g) =.520(1+.065) = D0 Po = D1 = = `.6.52 ke-g (iv) Current market price is`.14, which is greater than the fair price, hence investment should not be made. 2 (b) (i) Step 1: Computing total earnings of the merged entity: Earnings of MK as an independent entity 6,000,000 Earnings of NN as an independent entity 1,800,000 Total earnings after Merger 7,800,000 Step 2: Computing No: of shares after merger: No: of shares(existing) of MK Ltd. 1,200,000 New shares issued to NN- Market value basis: Existing number of equity shares of NN-3Lakhs Market value issue (160/200 x 3Lacs) 240,000 Total shares of merged entity 1,440,000 PRIME/ME36/Final 8

29 Step 3: EPS of the merged entity Total earnings after Merger (step 1) 7,800,000 Total shares of merged entity (step 2) 1,440,000 EPS of the merged entity (a) (ii) Exchange ratio so that the shareholders of NN Ltd would not be at a loss: The exchange ratio should be based of EPS of the companies. EPS of MK Ltd. = 60Lacs/ 12 lakhs = 5 EPS of NN Ltd. = 18Lacs/ 3 lakhs = 6 So exchange ratio should be 6 shares of MK Ltd for every 5 shares of NN Ltd. (i) Computation of NAV of the fund Company No. of shares Market price Value `. `. L Ltd 20, ,000 M Ltd 30, ,372,000 N Ltd 20, ,224,000 P Ltd 60, ,306,000 47,302,000 No: of units NAV (ii) Increase in no: of units of mutual fund due to A's investment = /78.84 =38053 units Company No. of shares Market price Value `. `. L Ltd 20, ,000 M Ltd 38, ,871,200 N Ltd 20, ,224,000 P Ltd 60, ,306,000 49,801,200 cash in hand {30 lakhs - (8K x )} 500,800 Total assets 50,302,000 No: of units NAV PRIME/ME36/Final 9

30 (iii) Computation of NAV of the fund on 2nd February Company No. of Market shares price Value `. `. L Ltd 20, ,000 M Ltd 38, ,680,000 N Ltd 20, ,662,000 P Ltd 60, ,000 51,986,000 cash in hand 500,800 Total assets 52,486,800 No: of units 638,053 NAV (b) If the lease rent in the 3rd year is x, that of years 1 & 2 would be 3x and 2x. Computation of Present value of Cash inflows from lease: `. In lakhs year 1 year 2 year 3 Lease rent received 3x 2x x Less: 1.05x 0.7x 0.35x Lease rent net of tax 1.95x 1.3x.65x 10% Discounted cash flows x x x Total x Present value of tax shield on depreciation Depreciation (year 1-3) = `.100Lakhs Present value of tax shield on depreciation (100 x 0.35x 2.486) =`.87.01Lakhs. At 10%, the benefits from leasing = cash down price x = 300 Lakhs x =` Lakhs year 1 year 2 year 3 Lease rental (`. In Lakhs) PRIME/ME36/Final 10

31 4. (a) Analysis of Bond refund decision: Initial outflow (year 0) Cost of new bonds (Face value premium4%) Add: issue costs 6.00 Less: Value of old bonds (300.00) Less: Tax savings on unamortized issue cost of old bonds (2.70) (9Million x 30%) In-between flows (Years 1-6) Savings in interest Interest on old bonds Interest on new bonds Savings in interest net of tax shield [int saved x (1-0.30)] 4.20 Amortization difference Issue costs of new bond 6.00 Premium on new bonds Less: unamortized issue cost of old bonds (9.00) Net amortization for 6 years 9.00 per year (amortization/6 years) 1.5 Tax shield on amortization p.a 0.45 Total benefit (a + b) 4.65 PVAF (6 years, 7%) Present value of inflows Less: Initial outflow NPV of refunding decision 6.86 Since NPV is positive, the bonds should be refunded. 4 (b) Net assets method: `.(in lakhs) Land and building 96 Plant and machinery 100 Investments 10 Stock 20 PRIME/ME36/Final 11

32 Debtors 15 Cash at bank 5 Creditors (30) Net assets 216 No: of shares (100/10) 10 Value per share `.21.6 Price earning capacity method: Future maintainable profits `.(in lakhs) Current year profits Less: Extra ordinary items (4.00) Income form surplus funds (1.00) Additional Advertisement (5.00) Extra depreciation (6.00) Future maintainable profits Less: FMP after tax Capitalization rate 15% Capitalized value Less: creditors (30) Total value No: of shares 10 Value per share 19.4 Fair price of share= ( )/2 =` (a) i. Beta of the stocks Aggressive stock Beta = change in stock return = 40-4 change in market return 25-7 =2 Defensive stock = 18-9 = ii. Expected returns of the two stocks: Aggressive stock: x 4% x 40% = 22% Defensive stock: x 9% x 18% = 13.5% PRIME/ME36/Final 12

33 iii. Expected return of market portfolio = 0.5 x 7% + 0.5% x 25% = 16% Market risk prem. = 16% - 7.5% = 8.5% CAPM return (required return) = Risk free rate + β (Market risk premium) = 7.5% + β8.5% Aggressive stock: - 7.5% + (2) x8.5%= 24.5% Defensive stock: - 7.5% + (0.5) x8.5% = 11.75% iv. Alpha for stock A =22% % = (-)2.5% Alpha for stock B = 13.5% % = 1.75% 5 (b) Buy Call (Strike Price`.60) Buy Put (Strike Price`.60) Expiry Date Stock Price Expiry Date Cash Flows Initial Investment Net Profit Expiry Date Stock Price Expiry Date Cash Flows Initial Investment Net Profit Write Call (Strike Price`.60) Expiry Date Cash Flows Expiry Date Stock Price Initial Investment Net Profit Write Put (Strike Price`.60) Expiry Expiry Date Date Stock Cash Initial Price Flows Investment Net Profit PRIME/ME36/Final 13