Solutions of Dec - 2013 Paper -3 of Professional Programme Financial, Treasury and Forex Management Answer 1(i): Financial gearing is a fair weather friend. Please refer to 2010 Dec [1] {C} (v) under the head Descriptive Question of chapter - 3 Capital Structure. (ii) Deferred payment of taxes is a source of working capital. Answer: C Deferred payment of taxes is one of the source of working capital requirement of a company. C Taxes are not paid from day-to-day, but estimated liability for taxes is indicated in Balance Sheet. C Company collect taxes by way of tax payable on salaries of staff deducted at source, excise taxes, sales taxes, etc & retain them for some period which the company uses it as a source of its working capital requirements. C Thus, deferred payment of taxes is also a source of working capital. (v) Intrinsic value of a security is valid for a given set of conditions. C Intrinsic value of a security is valid for a given set of conditions. C Intrinsic value is the actual value of a security as opposed to its market price or bookvalue. C The intrinsic value includes other variables such as brend name, trademarks, and copyrights. C Different investors use different techniques to calculate the intrinsic value of a security with a give set of conditions like dividend per share, growth factor, required rate of return, etc. C Analyses employ these methods to see whether the intrinsic value of a security is higher or lower than its current market price allowing them to categorise it as overvalued or under valued. C Thus, it can be said that the intrinsic value of a security is valid for a given set of conditions. (iii) The device of capital rationing is adopted to control capital expenditure. Answer: C The device of capital rationing is adopted to control capital expenditure. C Finance manager has to match the demand schedule for the capital for the company and the supply of capital from different sources. C This establishes the need for capital rationing to impose constrains on capital expenditure under prevailing market conditions and place self 1
imposed constraints to check the funds being raised from outside agencies like borrowings. C Thus the device of capital rationing is adopted to control the capital expenditure. + C Please refer to 2000 Dec [1] {C} (iii) under the head Short Notes of chapter - 2 Capital Budgeting Decisions. (iv) A stable dividend policy is always preferable to a fluctuating dividend policy. Answer: Please refer to 2002-June [6] (b) under the head Descriptive Questions of chapter - 5 Dividend Policy. Answer: 2 (a) (I) Weighted average cost of capital of X Ltd: Ke = 18% Since X Ltd. has only equity share capital therefore its WACC = 18% (II) Weighted average cost of capital of Y Ltd.:. Ke =20% Kd =Int. (1-Tax) Kd =7% Calculation of WACC: Particulars Amount Cost Weight (%) Weighted cost (%) Equity Share Capital 50,00,000 0.20 0.286 0.057 Debentures 1,25,00,000 0.07 0.714 0.05 Hence, WACC = 10.7% 1,75,00,000 0.107 2
(III) Weighted average cost of capital of Z Ltd.: Ke = 24% Kd = Int. (1- Tax) = 8 (1-0.3) = 5.6% Calculation of WACC Particulars Amount Cost Weight (%) E q u i t y Capital S h a r e Weighted cost (%) 60,00,000 0.24 0.231 0.055 Debentures 2,00,00,000 0.056 0.769 0.043 Hence, WACC = 9.8% Answer: [3] (b) Evaluation of options: Option 1: Financing Import by borrowing @ 12% p.a. Cost of machine 2,60,00,000 0.098 (` in lakhs) 2460 lakhs yen in [@ ` 100 = 246 yen] 1000 + Interest at 3% for quarter 30 Total outflow in ` = 1030 Option 2: Offer from foreign branch Offer from foreign branch Cost of Letter of Credit (Commission) at 1% (for quarter) on 2460 lakhs yen (` in lakhs) @ ` 100 = 246 yen = 10.00 + Interest for quarter (3% of 10 lakhs) = 0.30 10.30 - (A) 3
Payment at the end of 90 days Cost of machine = 2460 lakh yen Interest @ 2% p.a. (2460x2/100x90/365) = 12.13 lakh yen Conversion cost at ` 100 = 250 yen = = ` 988.85 lakhs - (B) 2472.13 lakh yen Total Cost = A + B = 10.30 + 988.85 lakhs = ` 999.15 lakhs Thus, option II i.e. offer from foreign branch is cheaper & hence better. Therefore it should be accepted. Answer: [5] (a) I Price of shares if dividend is paid P 1 = 110-5 P 1 = 105 New shares to be issued n = 25000 P 0 = 100 P 1 = 105 I = 5,00,000 E = 2,50,000 m = 3571 shares Value of Firm = (25000 + 3571) x 105 = ` 30,00,000 (approx) 4
II Price of shares if dividend is not paid P 1 = 110 New shares to be issued where, n = 25000 m =? P 0 = 100 P 1 = 110 I = 5,00,000 E = 2,50,000 m = 2272.72 M = 2273 Shares Value of firm = (25000 + 2273) x 110 = ` 30,00,000 (Approx) Thus under Modigliani & Miller (mm) assumptions the payment of dividend does not affect the value of a company. Answer: [5] (b) Where, A = Annual requirment O = Cost of per purchase order C = Inventory carrying cost per unit per annum = Inventory carrying cost per unit per annum = 10% of 20 = ` 2 Annual requirement = 4000 x 12 = 48000 units Thus, EOQ = 2400 units Total cost incurred in case lot size is 2400 units: 5
Cost of Material = 48000 x 20 = 9,60,000 Ordering Cost = = 2400 Inventory carrying cost = = 2400 ` 964800 Total cost incurred in case lot size is 4000 units: Cost of material = 48000 x 20 = 9,60,000 Ordering cost = = 1440 Inventory carrying cost = = 4000 ` 9,65,440 Thus, if the minimum lot size to be supplied is 4000 units, the company has to incur extra cost of = (965440-964800) = ` 640 Answer: 4 (i) Liquidity management and treasury management Please refer to 2009 June [4] (v) under the head Distinguish Between of Chapter - 11 Treasury Management. (ii) Financial aspects and economic aspects of project appraisal. (iii) Current account and capital account in balance of payment. Please refer to 2008 Dec [3] (v) under the head Distinguish Between of Chapter - 12 Forex Management. (iv) Capital Structure and financial structure Please refer to 2006 Dec [4] (iii) under the head Distinguish Between of Chapter - 3 Capital Structure Decision. (v) De materialisation and immoblisation Some of the differences between the dematerialisationa & immobilisation are as under: (i) In dematerailisation, no physical scrip is in existence whereas in immobilisation physical shares are kept in vaults with the depository for safe custody. (ii) In dematerialisation, only electronic records is maintained by depository whereas in case of immobilisation, all subsequent transactions in the securities take place in book entry form. 6
(iii) Dematerialisation is cost effective as compared to immobilisation. (iv) Dematerialisation takes less time in transaction as compared to immobilisation. Answer: 6 Sales = 46,80,000 Cash Sales = 25% of Total sales = 25% of = 11,70,000 Credit Sales = 35,10,000 Sales price per unit = = = ` 60 Raw material cost = 60% of 60 = ` 36 Calculation of working capital requirement: Raw - material = = 1,62,000 Work in progress = = 59,250 Finished Goods = = 1,29,000 Debtors = = 2,70,000 Cash = 50,000 (-) Outstanding wages = (-) Outstanding overheads = = 15000 (-) creditors = = 2,16,000 Net working capital requirement = ` 4,25,750 Answer: 7 (i) Sensitivity analysis in capital budgeting. C Sensitivity analysis is helpful in capital budgeting C Sensitivity analysis has been evolved to treat risk & uncertainity in 7
captial budgeting decisions C It comproses of the following steps: Identification of variables Evaluation of possibilities for these variables Selection & combination of variables to calculate NPV or rate of return of the project. Substituting different values for each variable in turn while holding all other constant to discover the effect on the rate of return. Comparision of original rate of return with this adjusted rate to indicate the degree of sensitivity of the rate to change in variables. Subjective evaluation of the risk involved in the project. C The objective of sensitivity analysis is to determine how varying assumptions will effect the measures of investment worth. C A sensitivity analysis is particularly helpful in large projects that would have a substantial impact on the company s operations. Answer: 7 (ii) Stock index futures C Stock index futures are financial derivatives which have a stock index as the underlying. C Stock index is a particular kind of index that represents changes in the market values of a number of securities contained in that index. C Examples of stock index include BSE - 30 (Sensex), BSE - 100, BSE - 200, S & P Mid cap C Stock indices, being representative in character act as an effective barometer of the national economy & the market sentiments. C Both BSE & the NSE have introduced trading in index futures. C Any eligible investors who can trade in the cash market, can trade in the futures market. C Both the major stock exchange of India i.e. Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) have created a number of indices. (iii) secured premium notes. Please refer to 2010 - Dec [7] (i) under the head Short Notes of Chapter - 4 Sources of Finance. (iv) Internal treasury control Please refer to 2005 Dec [1] {C} (a) under the head Descriptive Question of Chapter - 11 Treasury Management. (v) Benefits of depository system Please refer to 2011 June [7] (ii) under the head Short Notes of chapter - 8 Financial Services. 8