Gurukripa s Guideline Answers for May 2016 Exam Questions CA Final Strategic Financial Management

Gurukripa s Guideline Answers for May 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): Reward to Variability / Volatility Ratio 5 Marks The following are the data on five Mutual Funds: [Assume the Risk Free Rate is 6%] Fund A B C D E Return 15 18 14 12 16 Standard Deviation 7 10 5 6 9 Beta 1.25 0.75 1.40 0.98 1.50 You are required to compute Reward to Volatility Ratio and Rank these portfolio using Sharpe Method, and Treynor s Method. Solution: Same Pg. 8.27 Qn. 21 of Padhuka s Students Referencer on Strategic Financial Management [RTP] Note: Reward to Variability Ratio Sharpe s Ratio and Reward To Volatility Ratio Treynor Ratio Particulars Fund A Fund B Fund C Fund D Fund E Sharpe s Ratio RP RF 15 6 18 6 14 6 12 6 16 6 σ 1.29 1.20 1.60 1.00 1.11 P 7 10 5 6 9 Rank based on Sharpe s Ratio 3 2 1 5 4 Treynor Ratio RP RF 15 6 18 6 14 6 12 6 16 6 7.20 16.00 5.71 6.12 6.67 βp 1.25 0.75 1.40 0.98 1.5 Rank based on Treynor Ratio 2 1 5 4 3 Question 1(b): Bond Valuation 5 Marks Bright Computers Ltd is planning to issue a Debenture series with a Face Value of ` 1,000 each for a term of 10 years with the following Coupon Rates: Years 1 4 5 8 9 10 Rates 8% 9% 13% The Current Market Rate on similar Debenture is 15% p.a. The Company proposes to price the Issue in such a way that a yield of 16% Compounded Rate of Return is received by the Investors. The Redeemable Price of the Debenture will be at 10% Premium on maturity. What should be the Issue Price of Debenture? Solution: Same Pg. 11.11 Q. 15 of Padhuka s Students Referencer on Strategic Financial Management [M 03] Year Nature ` Disc. Factor @ 16% Disc. Cash Flow 1 4 Interest 8% ` 1,000 ` 80 0.862 + 0.743 + 0.641 + 0.552 2.798 ` 223.84 5 8 Interest 9% ` 1,000 ` 90 0.476 + 0.410 + 0.354 + 0.305 1.545 ` 139.05 9 10 Interest 13% ` 1,000 ` 130 0.263 + 0.227 0.490 ` 63.70 10 Maturity Proceeds ` 1,000 + 10% ` 1,100 0.227 ` 249.70 Total ` 676.29 Question 1(c): Growth Model Variant Free Cash Flows Current Market Price Calculate the Value of Share of Average Ltd from the following information: Equity Capital of Company ` 1,200 Crores Beta 0.1, Risk Free Interest Rate 8.7% Profit of the Company ` 300 Crores Market Returns 10.3% Par Value of Share ` 40 each Change in Working Capital per Share ` 4 Debt Ratio of Company 25 Depreciation per Share ` 40 Long Run Growth Rate of the Company 8% Capital Expenditure per Share ` 48 5 Marks Solution: Same Pg. 10.20 Q. 17 of Padhuka s Students Referencer on Strategic Financial Management [M 09] May 2016.1

Number of Shares 1. Computation of EPS 1200 30 Crores Earnings Per Share 40 PAT Number of Shares 300 ` 10 30 2. Computation of Free Cash Flows to Equity Holders (FCFE) and Share Valuation Particulars Principle Computation ` (a) Earnings Per Share (WN 1) 10 (b) Change in WC per Share (assumed increase) Change (1 Debt Ratio) 4 (1 0.25) 3 (c) Depreciation attributable per Share Depreciation (1 Debt Ratio) 40 (1 0.25) 30 (d) Cash Flow attributable per Share EPS Working Capital Increase + Depn. 10 3 + 30 37 (e) Capital Expenditure Per Share Total Capex (1 Debt Ratio) 48 (1 0.25) 36 (f) Free Cash Flow per Equity Share Cash Flow Capital Expenditure 37 36 1 3. Computation of Value of Share (a) Cost of Equity K e Fair Return under CAPM computed as follows R f + ß (R m R f ) 8.7 + 0.1 (10.3 8.7) 8.86% FCFE(1 + g) 1(1.08) 1.08 (b) P 0 Current Expected Price of Share ` 125.58 K e g 0.0886 0.08 0.0086 Question 1(d): Pay Off Computation Effect of Tie up on Options 5 Marks Fresh Bakery Ltd s Share price has suddenly started moving both upward and downward on a rumour that the Company is going to have a Collaboration Agreement with a Multinational Company in Bakery Business. If the rumour turns to be true, then the Stock Price will go up but if the rumour turns to be false, then the Market Price of the Share will crash. To protect from this, an Investor has purchased the following Call and Put Option: (i) One 3 Months Call with a Striking Price of ` 52 for ` 2 Premium per Share. (ii) One 3 Months Put with a Striking Price of ` 50 for ` 1 Premium per Share. Assuming a lot size of 50 Shares, determine the followings: 1. The Investor s position, if the Collaboration Agreement push the Share Price to ` 53 in 3 months. 2. The Investor s ending position, if the Collaboration Agreement fails and the price crashes to ` 46 in 3 months time. Solution: Same Pg. 15.20 Q. 7 of Padhuka s Students Referencer on Strategic Financial Management [M 06] Position if Price increases to ` 53 Position if Price falls to ` 46 Particulars Time ` Particulars Time ` Cost of Call & Put Options T 0 ` 2 + ` 1 ` 3 Cost of Options T 0 ` 2 + ` 1 ` 3 Action on Options T 1 Put Lapse, Call Exercise Action on Options T 1 Call Lapse, Put Exercise Gain on Call T 1 ` 53 ` 52 ` 1 Gain on Put T 1 ` 50 ` 46 ` 4 Net Loss on Options T 1 ` 3 ` 1 ` 2 Net Gain on Options T 1 ` 4 ` 3 ` 1 Question 2(a): Risk Adjusted Discount Rate 10 Marks MNL Ltd is considering investment in one of three mutually exclusive projects: AB, BC, CD. Company s Cost of Capital is 15%. Risk Free Rate is 10%. Tax Rate is 34%. MNL has gathered the following basic Cash Flows & Risk Index data for each project: Projects AB BC CD Initial Investment 12,00,000 10,00,000 15,00,000 Year 1 4 Yr 1 Yr 2 Yr 3 Yr 4 Yr 1 Yr 2 Yr 3 Yr 4 Cash Inflows 5,00,000 5,00,000 4,00,000 5,00,000 3,00,000 4,00,000 5,00,000 6,00,000 10,00,000 Using Risk Adjusted Discount Rate, determine risk adjusted NPV for each of the project. Which project should be accepted? Solution: Same Pg. 2.55 Qn. 42 of Padhuka s Students Referencer on Strategic Financial Management [N 09] Under CAPM, 1. Computation of Market Return and Risk Adjusted Discount Rate based on CAPM Expected Return Risk Adjusted Discount Rate Market Return + (Risk Index Risk Premium) Risk Premium Cost of Capital of the Company Risk Free Rate of Return 15% 10% 5% Project AB BC CD Risk Adjusted Discount Rate 10% + (1.8 5%) 19% 10% + (1.0 5%) 5% 10% + (0.6 5%) 3% May 2016.2

2. Computation of NPV of the Projects Project P AB Project P BC Project P CD Year PVAF @ Cash PVF @ Cash PVF @ Cash DCF Year DCF Year 19% Flows 15% Flows 13% Flows DCF 1 4 2.6385 5,00,000 13,19,250 1 0.8696 5,00,000 4,34,800 1 0.8849 4,00,000 3,53,960 2 0.7561 4,00,000 3,02,440 2 0.7831 5,00,000 3,91,550 3 0.6575 5,00,000 3,28,750 3 0.6931 6,00,000 4,15,860 4 0.5718 3,00,000 1,71,540 4 0.6134 10,00,000 6,13,400 PV of Cash Inflows 13,19,250 12,37,530 17,74,770 Less: Initial Investment 12,00,000 10,00,000 15,00,000 Net Present Value 1,19,250 2,37,530 2,74,770 Conclusion: Since the NPV of Project CD is greater than that of the other projects, it is the best. Question 2(b): Computation of NAV 16 Marks Calculate NAV of a Regular Income Scheme on per unit basis of Red Bull Mutual Fund from the following information: Particulars ` in Crores Particulars ` in Crores Listed Shares at Cost (ex dividend) 30 Expenditure accrued 1.00 Cash in Hand 0.75 Value of Listed Bonds & Debenture at NAV date 10 Bonds & Debentures at cost (ex interest) 2.30 Number of Units (` 10 Face Value) 30 Lakhs Of these, Bonds not listed & not quoted 1.0 Current Realizable Value of Fixed Income 106.50 Other Fixed Interest Securities at Cost 2.50 Securities of Face Value of ` 100 Dividend Accrued 0.8 Listed Shares were purchased when Index was 7100 Amount payable on Shares 8.32 Present Index is 9000 Unlisted Bonds and Debentures are at cost. Other Fixed Interest Securities are also at cost. Solution: Same Pg. 8.12 Qn. 2 of Padhuka s Students Referencer on Strategic Financial Management [M 10] 1. Listed Shares (Cost 30.00 Particulars `Crores Present Index 9,000 ) 38.02 Previous Index 7,100 2. Cash in Hand 0.75 3. Bonds and Debentures (a) Unlisted / Unquoted Bonds (at Cost) 1.00 (b) Listed Bonds and Debentures (at Market Value) 10.00 (c) Other Fixed Interest Securities (Cost ` 2.50 Cr. Current Realizable Value 106.50 FV `100.00) 2.66 4. Dividend Accrued 0.80 Total of Assets 53.23 1. Amount Payable on Shares 8.32 2. Expenditure Accrued 1.00 Total of Liabilities 9.32 Net Asset Value (` Crores) 43.91 No. of Units Outstanding (in Crores) 0.30 NAV Per Unit Net Assets of the Scheme Number of Units outstanding 43.91 ` 146.37 0.30 Question 3(a): Sale & Lease Back vs Purchase New Asset Hi Tech Software Ltd (HSL) has a complete Software Developing Unit costing ` 70 Lakhs. It is this type of block of Assets that have no Book Value as at 31 st March 2016 as it entitled to 100% Rate of Depreciation under Income Tax Act, 1961. The Company is facing acute Fund Crunch as it lacks order from Middle East and was toying with the idea of taking Term Loan. Eastern Financier (EF), a reputed Finance Company, gave the idea of Buy & Lease Back to tide over the Fund Crunch. EF agreed to buy the Software Developing Unit at ` 50 Lakhs and lease it back to HSL for Lease Rental of ` 9 Lakhs p.a. for a period of 5 years. HSL decides to put the entire Net Proceeds in a Fixed Deposit at a Nationalized Bank at yearly Interest of 8.75% for 5 years to generate Cash Flow much needed for day to day operation. May 2016.3

Central Financier (CF), another Financier, gave a proposal of selling a similar Software Developing Unit at ` 30 Lakhs to HSL and they will buy back after 5 years at a price of ` 5 Lakhs provided the Annual Maintenance Contract (AMC) @ ` 1.50 Lakhs p.a. is entrusted to them. New Machine is also entitled to 100% rate of Depreciation under Income Tax Act, 1961. CF also agreed to buy the existing Software Developing Unit at ` 50 Lakhs. HSL would utilize the Net Sale Proceeds to finance this Machine. Marginal Rate of Tax of HSL is 34% and its Weighted Average Cost of Capital is 12%. Which offer HSL should accept? Solution: Similar Pg. 3.32 Q. 22 of Padhuka s Students Referencer on Strategic Financial Management [M 11] Option I Sell the Asset to EF, Invest the Proceeds in Risk Free Deposit, and take the asset back on Lease. Option II Sell the Asset in the Open Market. Purchase a New Asset from CF. Option I Nature Cash Flow Cash Flow Years DF @ 12% DCF 1. Sale of Machine: Proceeds (Inflow) 50,00,000 Less: Taxes at 34% (Book Value Nil) (17,00,000) Net Cash Flow 33,00,000 0 1.000 33,00,000 2. Investment in Risk Free Deposit (Outflow) (33,00,000) 0 1.000 (33,00,000) 3. Interest from Risk Free Deposit [33,00,000 8.75%] 2,88,750 Less: Taxes (2,88,750 34%) (98,175) 1,90,575 1 to 5 3.605 6,87,022 4. Lease Rentals (Outflow) 9,00,000 Less: Tax Shield (9,00,000 34%) (3,06,000) (5,94,000) 1 to 5 3.605 (21,41,370) 5. Maturity Proceeds of Deposit (Inflow) 33,00,000 5 0.567 18,71,100 Net Present Benefit 4,16,752 Option II Nature Cash Flow Cash Flow Years DF @ 12% DCF 1. Sale of Machine: Proceeds (Inflow) 50,00,000 Less: Taxes at 34% (Book Value Nil) (17,00,000) Net Cash Flow 33,00,000 0 1.000 33,00,000 2. Investment in New Machine (Outflow) (30,00,000) 0 1.000 (30,00,000) 3. Tax Savings on Depn. (30,00,000 34%) (Inflow) 100% in 1 st Yr 10,20,000 1 0.893 9,10,860 4. Maintenance Cost (Outflow) 1,50,000 Less: Taxes (1,50,000 34%) (51,000) (99,000) 1 to 5 3.605 (3,56,895) 5. Sale Proceeds (Inflow) 5,00,000 5 0.567 2,83,500 Net Present Benefit 11,37,465 Conclusion: Net Present Benefit under Option II is higher, and hence, HSL should accept the Offer of CF. Question 3(b): Valuation of Securities Dividend Growth Model SAM Ltd has just paid a Dividend of ` 2 per share and it is expected to grow @ 6% p.a. After paying dividend, the Board declared to take up a project by retaining the next three annual Dividends. It is expected that this Project is of same risk as the existing Projects. The Results of this Project will start coming from the 4 th year onward from now. The Dividends will then be ` 2.50 per Share and will grow @ 7% p.a. An Investor has 1,000 Shares in SAM Ltd and wants a receipt of atleast ` 2,000 p.a. from this Investment. Show that the Market Value of the Share is affected by the decision of the Board. Also show as to how the Investor can maintain his target receipt from the Investment for first 3 years and improved Income thereafter, given that the Cost of Capital of the Firm is 8%. Solution: Similar Pg. 2.81 Q. 64 of Padhuka s Students Referencer on Strategic Financial Management [M 12] Effect on Market Price of the Share Market Price if Project is Chosen Nature Year Cash Flow DF @ 8% DCF Dividend 1 3 0 0 0 Dividend 4 2.5 0.735 1.84 Terminal Value (P 4 ) 4 D 5 ` 2.50 (1.07) Ke g 8% - 7% 267.50 0.735 196.61 Market Price if it is not Chosen P 0 D 1 Ke g ` 2 ` 106.00 (1.06) 8% - 6% Market Price (Assumed to be Intrinsic Value) 198.45 So, Increase of ` 92.45 May 2016.4

If the Project is accepted, the Company will not declare Dividend for the next 3 Years. Hence, the Investor should sell the Shares now and invest in Risk Free Securities to maintain his target receipt for first 3 years. Thereafter, he can sell the Risk Free Securities and purchase these Shares to earn improved income. Sale Proceeds 1,000 ` 106 ` 1,06,000. Required Rate of ` 2,000 Return of the Investor 1.89%, which is very less when compared to Risk Free Rate (in general). `1,06,000 Question 4(a): Calculation of Beta & Expected Return XYZ Ltd paid a Dividend of ` 2 for the current year. Dividend is expected to grow at 40% for the next 5 years and at 15% per annum thereafter. The Return on 182 days T Bills is 11% per annum and the Market Return is expected to be around 18% with a Variance of 24%. The Co Variance of XYZ s Return with that of the Market is 30%. You are required to calculate the required Rate of Return and Intrinsic Value of the Stock. Solution: Refer Pg. 7.25 & 10.16, Q. 6 of Padhuka s Students Referencer on Strategic Financial Management 1. Computation of Required Rate of Return Cov 30% 1. Computation of Beta (β) AM 2 1.25 βxyz 1.25 σm 24% 2. Required Rate of Return CAPM Return, [Risk Free Return Return on 182 days T Bills 11%] R XYZ R F + β A (R M R F ) R XYZ 11% + 1.25 (18% 11%) R XYZ 19.75% 2. Computation of Intrinsic Value of the Stock Year Nature Cash Flow PVF @ 19.75% DCF 1 Dividend (` 2 + 40%) 2.80 0.835 2.34 2 Dividend (` 2.80 + 40%) 3.92 0.697 2.73 3 Dividend (` 3.92 + 40%) 5.48 0.582 3.20 4 Dividend (` 5.48 + 40%) 7.68 0.486 3.74 5 Dividend (` 7.68 + 40%) 10.76 0.406 4.37 6 MP at end of Y 6 D 7 ` 10.76 (1.15) Ke g 19.75% - 15% 260.51 0.339 88.31 Intrinsic Value ` 104.68 Question 4(b): CAPM Investing Decisions Abinash is holding 5,000 Shares of Future Group Limited Presently the rate of Dividend being paid by the Company is ` 5 per Share and the Share is being Sold at ` 50 per Share in the Market. However, several factors are likely to change during the course of the year as indicated below: Risk Free Rate Market Risk Premium Expected Growth Rate Beta Value Existing 12.50% 6% 5% 1.5 Revised 10% 4.8% 8% 1.25 In view of the above factors whether Abinash should buy, hold or sell the Shares? Narrate the reason for the decision to be taken. Solution: Same as Pg. 7.55, Q. 42 of Padhuka s Students Referencer on Strategic Financial Management [M 03] Particulars Existing Revised Rate of Return R f + β (R m R f ) 12.50% + 1.5 (6%) 21.50% 10% + 1.25 (4.8%) 16% Price of Share P 0 D0 (1 + g) Ke g 5 (1.05) 5.25 ` 31.82 0.215 0.05 0.165 5 (1.08) 5.40 ` 67.50 0.16 0.08 0.08 Current Market Price ` 50 ` 50 Inference Over Priced Under Priced Decision Sell Buy May 2016.5

Question 5(a): Interest Rate Parity Arbitrage Information on rates: Exchange Rate Canadian Dollar 0.666 per DM (Spot): Canadian Dollar 0.671 per DM (3 months) Interest Rates: DM 7.5% p.a. Canadian Dollar 9.5% p.a. To take the possible arbitrage gains, what operations would be carried out? Solution: Same as Pg. 17.30, Q. 11 of Padhuka s Students Referencer on Strategic Financial Management [N 10] Forward Rate (Can $ / DM) Spot Rate 1 + Canadian Dollar Interest Rate 0.666 1 + DM Interest Rate 3 Months 1 + 0.095 12 Months 3 Months 1 + 0.075 12 Months 0.669 Actual Forward Rate 0.671 > Theoretical Forward Rate 0.669. Hence, for arbitrage gain Buy Spot, Sell Forward as follows Now (Action at T 0 ) Later (Action at T 3 ) (a) Borrow in Canadian Dollars at 9.5% p.a. for 3 months (b) Convert Canadian Dollars into DM at Spot Rate (c) Invest DM at 7.5% p.a. for 3 Months (d) Enter into forward at T 0 for selling DM into Canadian Dollars at T 3. (a) Realize Maturity Proceeds of DM Deposits (b) Sell / Convert DM into Canadian Dollars under Forward Contract (c) Repay Canadian Dollar Liability (d) Balance in Hand would be profit. (Arbitrage Gain) Question 5(b): Hedging of Risk using Forward Contract ABC Ltd of UK has exported Goods worth Can $ 5,00,000, receivable in 6 months. The Exporter wants to hedge the receipt in the Forward Market. The following information is available: (a) Spot Exchange Rate Can $ 2.5/ (b) Interest Rate in UK 12% (c) Interest Rate in Canada 15% The Forward Rates truly reflect the Interest Rates differential. Find out the Gain / Loss to UK Exporter if Can $ Spot Rates (i) declines 2%, (ii) gains 4%, or (iii) remains unchanged over next 6 months. Solution: Same as Pg. 17.41, Q. 29 of Padhuka s Students Referencer on Strategic Financial Management [RTP] Forward Rate Spot Rate 1 + Canadian Dollar Interest Rate 2.5 1 + GBP Interest Rate 6 Months 1 + 0.12 12 Months 6 Months 1 + 0.15 12 Months 2.5 1.06 Can $ 2.4651 1.075 Particulars Spot Rate declines by 2% Spot Rate gains by 4% Spot Rate remains Stable Amount Receivable based on Forward Rate [A] Exchange Rate on the date of receipt of Invoice Value Amount Receivable on conversion on the date of receipt [B] GBP 2,02,831.53 (Can $ 5,00,000 2.4651) Can $ 2.45 [Can $ 2.5 (100 2)%] GBP 2,04,081.63 [Can $ 5,00,000 2.45] GBP 2,02,831.53 (Can $ 5,00,000 2.4651) Can $ 2.6 [Can $ 2.5 (100 + 4)%] GBP 1,92,307.69 [Can $ 5,00,000 2.6] GBP 2,02,831.53 (Can $ 5,00,000 2.4651) Can $ 2.5 GBP 2,00,000 [Can $ 5,00,000 2.5] Gain / (Loss) on Hedging [A B] (GBP 1,250.10) GBP 10,523.84 GBP 2,831.53 Question 6(a): Effect of New Marketing Strategy on the Value of Business Kanpur Shoe Ltd is having sluggish Sales during the last few years resulting in drastic fall in market share and Profit. The Marketing Consultant has drawn out a New Marketing Strategy that will be valid for next four years. If the new strategy is adopted, it is expected that Sales will grow @ 20% per year over the previous year for the coming two years and @ 30% from the third year. Other parameters like Gross Profit Margin, Asset Turnover Ratio, the Capital structure and the Rate of Income Tax @ 30% will remain unchanged. Depreciation would be 10% of Net Fixed Assets at the beginning of the year. The Targeted Return of the Company is 15%. The Financials of the Company for the just concluded FY 2015 2016 are given below May 2016.6

Income Statement Amount (`) Balance Sheet Information Amount (`) Turnover 2,00,000 Fixed Assets 80,000 Gross margin (20%) 40,000 Current Assets 40,000 Admin, Selling & Distribution Expenses (10%) 20,000 Equity Share Capital 1,20,000 PBT 20,000 Tax (30%) 6,000 PAT 14,000 Assess the Incremental Value that will accrue subsequent to the adoption of the new Strategy & advise the Board accordingly. Solution: Same as Pg. 2.25, Q. 12 of Padhuka s Students Referencer on Strategic Financial Management [N 11] (a) Sales 1. Computation of PAT Particulars Year 1 Year 2 Year 3 Year 4 Year 5 2,00,000 + 20% 2,40,000 2,40,000 + 20% 2,88,000 2,88,000 + 30% 3,74,400 3,74,400 + 30% 4,86,720 4,86,720 (b) Profit Before Tax 10% of Sales 24,000 28,800 37,440 48,672 48,672 (c) Profit After Tax 70% of PBT 16,800 20,160 26,208 34,070 34,070 (d) Fixed Assets: (i) Closing Balance 40% of Sales 40% of (a) 2,40,000 40% 96,000 2,88,000 40% 1,15,200 3,74,400 40% 1,49,760 4,86,720 40% 1,94,688 4,86,720 40% 1,94,688 (ii) Opening Balance 80,000 96,000 1,15,200 1,49,760 1,94,688 (iii) Depreciation 10% of Opg. Bal. (8,000) (9,600) (11,520) (14,976) (19,469) (iv) Balance before Purchase (ii) (iii) 72,000 86,400 1,03,680 1,34,784 1,75,219 (v) Assets Purchased (i) (iv) 24,000 28,800 46,080 59,904 19,468 (e) Current Assets: (i) Closing Balance 20% of Sales 20% of (a) 2,40,000 20% 48,000 2,88,000 20% 57,600 3,74,400 20% 74,880 4,86,720 20% 97,344 4,86,720 20% 97,344 (ii) Opening Balance (40,000) (48,000) (57,600) (74,880) 97,344 (iii) Invest. in Current Assets (i) (ii) 8,000 9,600 17,280 22,464 0 (f) Total Investment in Assets during the year (d) + (e) 24,000 + 8,000 32,000 28,800 + 9,600 38,400 46,080 + 17,280 63,360 59,904 + 22,464 82,368 19,468 Note: Present Asset Turnover Ratio, i.e. Assets as % of Sales is computed as under Fixed Asset ` 80,000 Fixed Assets: 40% Current Assets: Turnover ` 2,00,000 Current As set ` 40,000 Turnover ` 2,00,000 20% 2. Computation of Present Value of the Strategy Net Cash Particulars Years PAT Depn. Invt. In Assets Flow Disc. Factor Disc. Cash Flow Cash Flow for the year 1 16,800 8,000 (32,000) (7,200) 0.870 (6,264) 2 20,160 9,600 (38,400) (8,640) 0.756 (6,532) 3 26,208 11,520 (63,360) (25,632) 0.658 (16,866) 4 30,070 14,976 (82,368) (37,322) 0.572 (21,348) Residual Value (Note) 4 30,070 0.15 2,00,467 19,469 0.15 1,29,793 19,468 0.15 (1,29,793) 2,00,467 0.572 1,14,667 Present Value of the Strategy 63,657 Less: Value of Existing Strategy (PAT ` 14,000 Expected Return 0.15) (93,333) Incremental Value (29,676) May 2016.7

Note: Residual Value is computed as Year 5 Values Cost of Capital 15% Advise: Incremental Value due to adoption of strategy is negative. So, the Company should not opt for the new strategy. Question 6(b): M&A Maximum Buying Price to maintain EPS The CEO of a Company thinks that shareholders always look for EPS. Therefore he considers maximization of EPS as his Company s objective. His Company s current Net Profit are ` 80.00 Lakhs and P/E multiple is 10.5. He wants to buy another firm which has current income of ` 15.75 Lakhs & P/E multiple of 10. What is the maximum exchange ratio which the CEO should offer so that he could keep EPS at the current level, given that the Current Market Price of both the Acquirer and the Target Company are ` 42 and ` 105 respectively? If the CEO borrows funds at 15% and buys out Target Company by paying Cash, how much should he offer to maintain his EPS? Assume tax rate of 30%. Solution: Refer Pg. 18.42, Q. 22 of Padhuka s Students Referencer on Strategic Financial Management [M 12] 1. Computation of Present EPS Particulars Acquirer Company Target Company (a) Market Price per Share (given) ` 42 ` 105 (b) PE Ratio MPS EPS (given) 10.5 10 (c) Earnings Per Share MPS PE Ratio ` 42 10.5 ` 4 ` 105 10 ` 10.5 (d) Total Earnings, i.e. Net Profit ` 80 Lakhs ` 15.75 Lakhs (e) Number of Shares Net Profit EPS ` 80 Lakhs ` 4 20 Lakhs ` 15.75 Lakhs ` 10.5 1.5 Lakhs 2. Exchange Ratio to retain Acquirer Company s Pre Merger EPS EPS of Selling Co. 10.50 (a) EPS based Exchange Ratio 2.625 Share for 1 Share EPS of Buying Co. 4 (b) No. of Shares Issued in such case 2.625 1,50,000 Shares 3,93,750 Shares ` 80,00,000 + ` 15,75,000 (c) Acquirer s Post Merger EPS in such case ` 4 per Share (20,00,000 + 3,93,750) 3. Cash Consideration to maintain Pre Merger EPS Particulars Result (a) Post Merger Net Profit (80 Lakhs + 15.75 Lakhs) ` 95,75,000 (b) After Tax Cost of Borrowing (Let the Cash Consideration offered be X) 0.15X (1 30%) 0.105X (c) Net Profit after considering Additional Cost of Borrowing ` 95,75,000 0.105X (d) Post Merger Number of Shares if Consideration is paid by way of Cash 20,00,000 (e) Post Merger EPS ( Pre Merger EPS) ` 4 (f) So, Cash Consideration that can be offered [See Note] ` 1,50,00,000 ` 95,75,000 0.105X Note: ` 4, ` 95,75,000 0.105X ` 80,00,000, 0.105X ` 15,75,000, X 1,50,00,000. 20,00,000 Question 7: Write short notes on any four of the following: Question (a) Distinguish between Investment Bank and Commercial Bank. (b) Horizontal Merger and Vertical Merger. (c) Distinguish between Money Market and Capital Market. (d) Operations in Foreign Exchange Market are exposed to number of risks. (e) Interface of Financial Policy and Strategic Management. 4 4 16 Marks Reference Page No. 5.11, Qn. No.18 Page No. 18.1, Qn. No.2 Page No. 12.2, Qn. No.4 Page No. 17.8, Qn. No.16 Page No. 1.4, Qn. No.9 May 2016.8