ICSI Last year question papers Financial Treasury and Forex Management

ICSI Last year question papers

Final Group 2

Financial Treasury and Forex Management

June 2005

 

NOTE:  1.  Answer FIVE questions including Question No. 1 which is COMPULSORY. All working notes should be shown distinctly.

2.  Tables showing the present value of Re. 1 and the present value of an annuity of Re. 1 for 15 years are annexed.

Question 1

(a)   “Internal treasury control is a process of self-improvement.” Explain.

(b)   List out the benefits of public deposits to the company as well as to the depositors.

(c)   “For the lessor, lease decision is akin to a capital budgeting exercise.” Examine the statement and explain its implications.

(d)   “Economic value added (EVA) concept is in conformity with the objective of wealth maximisation.” Explain.         (5 marks each)

Question 2

(a)   Mention any four tools available to cover exchange rate risk.           (4 marks)

(b)   A firm has total credit sales of Rs. 80 lakh and its average collection period is 80 days. The past experience indicates that bad debt losses are around 1% of the credit sales. The firm spends Rs. 1,20,000 per year on administering its credit sales. This cost includes salary of one officer and two clerks who handle the credit checking, collection, etc., telephone and telefax charges. These are avoidable costs. A factor is prepared to buy the firm’s receivables.

He will charge 2% commission. He will advance against receivables to the firm at 18% after withholding 10% as reserve. What is the cost of factoring? Should the firm avail factoring service?    (6 marks)

(c)   Following information is available in respect of EPS and DPS of Intelligent Ltd. for the last five years:

Year                     2004           2003           2002           2001           2000

EPS (Rs.)            14.10          13.60          13.10          12.70          12.20

DPS (Rs.)              8.20            8.10            7.90            7.80            7.70

Dividends for a particular year are paid in the same calendar year. If the same dividend policy is maintained, it is expected that the annual growth rate of earnings will be no better than the average of last four years. The risk-free rate is 6% and the market risk premium is 4%. With reference to the market rate of return, the equity shares of the company have a b of 1.5 and is not expected to change in near future.

The company has received a proposal from Smart Ltd. to acquire its operations by paying the value of shares. You are required to value the equity shares of the company using (i) dividend growth model; (ii) earnings growth model; and (iii) capital asset pricing model (CAPM).                                 (10 marks)

Question 3

(a)   Rex of Mumbai intends to set-up a plant involving a cost outlay of Rs. 20 lakh. After vigorous persuasion, the bankers agree to finance the project and allow a moratorium period of 3 years, i.e., repayment will start from the end of third year with the condition that the loan as such will be squared up by Rex in three equal yearly installments along with interest @ 6% per annum. You are required to find out the amount of the yearly installment and also the amount to be paid on account of interest.                                                   (4 marks)

(b)   The market portfolio has a historically based expected return of 0.10 and a standard deviation of 0.04 during a period when risk-free assets yielded 0.03. The 0.07 risk premium is thought to be constant through time. Riskless investments may now be purchased to yield 0.09. A security has a standard deviation of 0.08 and a co-efficient of correlation with the market portfolio is 0.85. The market portfolio is now expected to have a standard deviation of 0.04. You are required to find —

(i)  market’s return-risk trade-off;

(ii)  security beta; and

(iii)  equilibrium required expected return of the security.                   (6 marks)

(c)   DIGI Computers Ltd. is a manufacturer of computer systems. The company is marketing its products in domestic as well as global markets. It has a total sales of Rs. 1 crore. Its variable and fixed costs amount to Rs. 60 lakh and Rs. 10 lakh respectively. It has borrowed Rs. 60 lakh @ 10% per annum and has an equity capital of Rs. 75 lakh.

(i)  What is company’s return on investment?

(ii)  Does it have favourable financial leverage?

(iii)  If the firm belongs to an industry whose asset turnover is 1, does it have a high or low asset leverage?

(iv)  What are the operating, financial arid combined leverages of the firm?

(v)  If sales drop to Rs. 50 lakh, what will be the new EBIT?             (10 marks)

Question 4

Differentiate between the following:

(i)   ‘Factoring’ and ‘bill discounting’.

(ii)   ‘NPV’ and ‘IRR’ methods of capital budgeting.

(iii)   ‘Bonus issue of shares’ and ‘stock split’.

(iv)   ‘Stock future’ and ‘index future’.

(v)   ‘Futures contracts’ and ‘forward contracts’.                             (4 marks each)

Question 5

(a)   Write a short note on ‘credit rating’.                                                (4 marks)

(b)   Following are the extracts from financial statements of Zipway Ltd.:

(Rs. in Lakhs)

Earnings before interest and tax                                                            250

Less: Interest on debentures                                                                   50

Earnings before tax                                                                              200

Less: Income-tax (40%)                                                                           80

Net profit                                                                                              120

Equity share capital (shares of Rs. 10 each)                                           500

Reserve and surplus                                                                             250

10% Non-convertible debentures                                                           500

1,250

The market price per equity share is Rs. 15 and per debenture is Rs. 95. Calculate the following:

(i)  earnings per share; and

(ii)  percentage of cost of capital to the company for the debenture fund and the equity.   (8 marks)

(c)   Madhuri Ltd. is evaluating a project for which the initial investment required is Rs. 50 lakh to be met by internally generated funds of Rs. 10 lakh, from a rights issue of Rs. 15 lakh and the rest from a term loan @ 12% per annum. Rights issue will involve flotation cost of 5% and the term loan processing will cost 1%. Corporate tax rate is 40%. The risk-free rate of interest is 6.5%, market return is 15% and the relevant asset beta for the investment is estimated to be 1.5. Net operating cash inflows after tax from the project are:

Year-1: Rs. 15 lakh; Year-2: Rs. 35 lakh; and Year-3: Rs. 15 lakh.

Besides these cash inflows, residual value of Rs. 5 lakh (net of taxes) is also expected at the end of third year. Should the project be taken up?                                                     (8 marks)

Question 6

(a)   Syntex Ltd. has to make a US $5 million payment in three months’ time. The required amount in dollars is available with Syntex Ltd. The management of the company decides to invest them for three months and following information is available in this context:

—   The US $ deposit rate is 9% per annum.

—   The sterling pound deposit rate is 11% per annum.

—   The spot exchange rate is $1.82/pound.

—   The three month forward rate is $1.80/pound.

Answer the following questions —

(i)  Where should the company invest for better returns?

(ii)  Assuming that the interest rates and the spot exchange rate remain as above, what forward rate would yield an equilibrium situation?

(iii)  Assuming that the US interest rate and the spot and forward rates remain as above, where should the company invest if the sterling pound deposit rate were 15% per annum?

(iv)  With the originally stated spot and forward rates and the same dollar deposit rate, what is the equilibrium sterling pound deposit rate?                                                                (15 marks)

(b)   The following quotes are available for 3-months options in respect of a share currently traded at Rs. 31:

Strike price                                                         Rs. 30

Call option                                                         Rs.   3

Put option                                                          Rs.   2

An investor devises a strategy of buying a call and selling the share and a put option. Draw his profit/loss profile if it is given that the rate of interest is 10% per annum. What would be the position if the strategy adopted is selling a call and buying the put and the share?                                                  (5 marks)

Question 7

Daisy Ltd.. is being floated with a project to manufacture a new product called ‘Novo Fresh’. Currently it is being imported at a landed cost of Rs. 8,500 per ton. Following data has been collected relating to the project:

Rs.

(a)  Investment in land                                            1,00,000

Investment in building                                       8,00,000

Investment in plant                                              12,00,000

(b)  Cost of production — per annum:

Imported raw material                                 6,50,000

Local raw material                                          6,26,000

Salary                                                                   1,35,000

Administrative expenses                              50,000

Power                                                                     60,000

Repairs and maintenance                               5% of plant cost; and

2% of building cost.

Depreciation                                                      7% of plant cost; and

2.5% of building cost.

Steam                                                                     7,000 ton @ Rs. 16/ton

Packing drums                                                        Rs. 30/500 kgs.

(c)  Working capital requirements:

Imported raw material                                          6 months

Local raw material                                                    3 months

Packing drums stock                                               3 months

Finished goods stock                                              1 month

Credit to customers                                                 1 month

Credit from suppliers                                               1 month

Cash expenses                                                       1 month

(d)  Expected production: 250 ton per annum. You are required to —

(i)   calculate the total capital needed for the project;                           (14 marks)

(ii)   assume that entire production can be sold at import rate, calculate percentage yield on investment and profit on sales; and                                                                                     (3 marks)

(iii)   calculate rate of cash generation per year.                                      (3 marks)

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