CWA ICWA Exam Papers Final Group III
Financial Management and International Finance December 2010
This Paper has 32 answerable questions with 2 answered.
Time Allowed : 3 Hours Full Marks : 100
The figures in the margin on the right side indicate full marks.
Answer Question No.1 from Part A which is compulsory and five questions from Part B.
Working notes should form part of the answer.
Please (i) answer all bits of a question at one place.
(ii) open a new page for answer to a new question.
PART A (25 Marks)
1. (a) In each of the cases given below, one out of four answers is correct. Indicate the correct answer (= 1 mark) and give workings/reasons briefly in support of your answer (= 1 mark): 2×7=14
(i) The computed financial leverage based on the given data below
Operating profit Rs.25,00,000
(ii) The following information relates to Suraj Chemicals Ltd.–
Earnings per share, Rs.4
Dividend payout ratio, 45%
Rate of return required by shareholders, 15%.
Assuming that the Gordon Valuation model holds, the rate of return that should be earned on investments by Suraj Chemicals to ensure that the market price stays at Rs.60 is
(iii) The following market quotes are available. Assume there are no transaction costs be possible, arbitrage gains on Rs.10,00,000 from the middle rates given below:
Rs.76.200 = £ 1 in London
Rs.46.600 = $ 1 in Delhi
$ 1.5820 = £ l in New York
(iv) Durga Farm Supplies has an 8 per cent return on total assets of Rs.3,00,000 and a net profit margin of 5 per cent. Its sales are then
(v) The face value of a 364–day T–bill is Rs.100. If the purchase price is Rs.86, then the yield on such a bill is
(vi) Zed Ltd. has a Beta of 1.15. Return on market portfolio is 14%. Return on Zed is 15%.Risk free rate is 5%. The value of Alpha for Zed is, then
A. – 3.48% B. – 0.30% C. + 0.50% D. + 1.22%
(vii) If back orders can be taken (at an added cost per item back ordered),
A. EOQ will decrease
B. EOQ will increase
C. Lead time will decrease
D. No change will occur. Back orders do not affect the EOQ model.
(b) Write if each of the following sentences is T (true) or F (false): 1×11=11
(i) For a Company, Inventory values in the Financial Statement are certified by the Statutory Auditor. (0)
(ii) Sensitivity Analysis not only measures a risk but also helps in reducing it while appraising a project. (0)
(iii) Because of tax advantage, the cost of equity capital varies directly with the proportion of debt capital. (0)
(iv) While designing the capital structure of a business the earnings capacity becomes a less important factor than the each flow ability. (0)
(v) The size of spread for a given currency decreases as the period of maturity increases in forward exchange rate contracts. (0)
(vi) In import transactions, it is preferable to accept invoices in home currency only where the rupee is likely to depreciate against the foreign currency. (0)
(vii) Swapping from fixed to floating may save the original borrower if interest rates decline. (0)
(viii) An operating lease is one where a significant part of risk–bearing burden is on the lessee. (0)
(ix) Median is not a measure of dispersion of a random variable. (0)
(x) In linear programming, the shadow price refers to the unused capacity available once the optimum solution is obtained. (0)
(xi) A management decision may be beneficial for a given project center but not for the entire company. From the overall company viewpoint, this decision leads to sub–optimization. (0)
PART B (75 Marks)
2. (a) What is appreciation and depreciation of currency? Explain with suitable examples. 5 (0)
(b) C. Ltd.’s current operating income is Rs.4 lakh. The firm has Rs.10 lakh of 10 per cent debt outstanding. Its cost of equity capital is estimated to be 15 per cent.
(i) Determine the current value of the firm, using traditional valuation approach.
(ii) Calculate the overall capitalization rate as well as both types of leverage ratio:
(a) B/S [Debt/Equity ratio]; (b) B/V [Debt/Value ratio].
(iii) The firm is considering increasing its leverage by raising an additional Rs.5,00,000 debt and using the proceeds to retire that amount of equity. As a result of increased financial risk, kt is likely to go up to 12 per cent and ke to 18 per cent. Would you recommend the plan?
3. (a) Sarvesh Ltd. is planning to start a major restructuring plan. If the restructuring plan is undertaken, it will reduce the EPS of the company to Rs.6.50, but will enhance the payout rate to 75%. The restructuring plan will enable the company to pay dividend that is expected to grow at the rate of 22% for the next 4 years and decline to 11 % and remain at that level forever.
The risk free rate of return is 5% per annum and the market return is expected to be 12% with a standard deviation of 12.5%. The covariance of Sarvesh’s stock with that of market is 175%.
You are required to calculate the price of the stock, if the restructuring is undertaken by the company.
(b) State the means to enhance Economic Value Added (EVA) of a company. 5 (0)
4. (a) Wonder Limited’s balance sheets as at March 31, year 1, year 2, year 3 are given below (Rs. in lakh):
As at March 31
Year 1 Year 2 Year 3
Paid–up equity capital
Profit and Loss Account
(i) Prepare a statement of net sources and uses of funds for the year ended March 31, Year 2 and the Year ended March 31, Year 3.
(ii) Give your comment on the finding in (i)
(b) How does ‘Risk Adjusted Discount Rate’ differ from ‘Certainty Equivalents Approach’ as techniques of risk analysis in capital budgeting? 5 (0)
5. (a) The following particulars are available about two firms:
Firm A Firm B
Market price per share
Number of shares
Market value of the firm Rs.75
Firm A is planning to acquire Firm B. The merger is expected to bring gains, which have present value of Rs.1.5 crore. Firm A offers 2,50,000 shares in exchange for 5 lakh shares to the shareholders of Firm B.
Based on the above information, you are required to determine:
(i) total value of Firm AB (Present value AB) after merger;
(ii) gains to the shareholders of Finn A; and
(iii) true cost of acquiring Firm B and net present value of the merger to Firm B.
(b) ‘Business is about taking risk and earning return. Higher the risk in a project higher would have to be the adjustment in cut off rate and vice versa.’
You are the Chief Financial Manager of Road Transport Limited. The company has a fleet of 100 long–haul vehicles, transporting goods across India. The company’s cost of capital is 9%. The Board of Directors are considering the following four options:
(i) Replacement, with minor upgradation, of 50% of existing fleet,
(ii) Adding 50 vehicles to existing fleet,
(iii) Outright purchase of another company engaged in body-building, repairs and maintenance of various models of trucks,
(iv) Investment for controlling a company engaged in movie–production.
Present a Note to the Board on the discount rate to be used for each of these independent projects. State your assumptions.
6. (a) Bahadur Ltd. have been engaged in the business of importing commodities and selling the items locally to a net work of retail dealers. Of late, Bahadur’s business has increased and credit collection is posing a problem. Current monthly billing is Rs. 2,00,00,000. Average credit period extended to buyers is 2 months. Bahadur is considering whether it could put in place a full factoring arrangement for collection of debts without recourse, on the following terms:
• A service charge computed at 1.5% of total annual sales.
• Factor will advance a sum equivalent to 80% of debts outstanding, for an interest charge of 14% p.a.
• It is estimated that there would be savings of at least Rs.25,00,000 in administration costs plus Rs.60,000 as debt collection costs per annum if factor services are availed.
• At present the company is able to raise fresh borrowings at 12% p.a. from the bank.
Would you recommend bank borrowings?
(b) Enumerate, in general terms five main functions of a factor in the matter of trade debts. 5 (0)
7. (a) Hindusthan Glasswares have a sum of D. Kr. 69,000 due from Danish buyer, three months from now (December 1, 2010). Spot rate Re/D. Kr. 8.00 – 8.20. The company concluded a forward contract with ICICI Mumbai when swap points for February Kroners were quoted by it at 20–50.
(i) Show the rate concluded under Forward Contract;
(ii) Present your views, if on maturity date of contract Spot Kroners were traded at 7.90 – 8.10.
(b) The ITC stock is selling at Rs.4,000. Mr. X has a negative view about the stock. He decides to go through the option route to take advantage of the situation. He buys an option from Mr. A which will entitle him to sell 100 shares on or before 30th December at Rs.3,500 per share for which he has to pay Rs.200 per share today.
You are required to identify:
(i) Type of option
(ii) Exercise price
(iii) Expiry date
(iv) Option premium
(v) Buyer of the option
(vi) Writer of the option
(vii) Underlying asset
(viii) Current market price
8. (a) Suppose affiliate A sells 10,000 chips monthly to affiliate B at a unit price of $ 15. Affiliate A’s tax rate is 45%, and affiliate B’s tax rate is 55%. In addition, affiliate B must pay an ad valorem tariff of 12% on its imports. If the transfer price on chips can be set anywhere between $ 11 and $ 18, how much can the total monthly cash flow of A and B be increased by switching to the optimal transfer price? 6 (0)
(b) Suppose that covered after–tax lending and borrowing rates for three units of Eastman Kodak – located in the United States, France and Germany – are:
Currently, the French and the German units owe $ 3 million and $ 2 million, respectively to their U.S. parent. The German unit also has $ million in payables outstanding to its French affiliate. The timing of these payments can be changed by up to 90 days in either direction. Assume that Kodak U.S. is borrowing funds while both the French and the German subsidiaries have excess cash available.
(i) What is Kodak’s optimal leading and lagging strategy?
(ii) What is the net profit impact of these adjustments?