Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
Gurukripa’s Guideline Answers to May2013 Exam CA Final
Strategic Financial Management
Question 1 is compulsory (4 × 5 = 20 Marks)
Answer any five questions from the remaining six questions (16 × 5 = 80 Marks). [Answer any 4 out of 5 in Q.7]
1(a): Computation of Gain – Cross Currency Rate
M13 (5 Marks)
You sold Hong Kong Dollar 40,00,000 value spot to your customer at ` 7.15 and covered itself in London Market on the same
day, when the Exchange Rates were – US $ 1 = HK $ 7.9250 – 7.9290
Local Inter–Bank Market Rates for US $ were – Spot US $ = ` 55.00 – 55.20
Calculate Cover Rate and ascertain the Profit or Loss in the transaction. Ignore Brokerage.
Solution:
Facts:
The Bank has sold HKD to its customer. Therefore, to cover itself, the Bank would have bought HKD from London
Market. Therefore, Bid Rate is relevant. Relevant rate for Banks opposite position is Ask Rate.
` / HKD Ask Rate
` / HKD Ask Rate
Therefore, ` /HKD
Less:
1. Computation of Buy Rate for the Bank
= ` / US $ [Ask Rate] × US $ / HK $ [Ask Rate]
= ` / US $ [Ask Rate] × 1 ÷ HKD / US $ [Ask Rate]
= ` 55.20 / US $ × 1 ÷ 7.9250
= ` 6.9653 per HKD
2. Computation of Gain / Loss to Bank
Particulars
Rate at which Bank has sold HKD to the customer
Rate at which Bank has bought HKD from London Market
Value
` 7.1500
(` 6.9653)
Gain per HKD Sold
` 0.1847
HKD Sold
40 Lakhs
Total Gain to Bank
[HKD 40 Lakhs × ` 0.1847 per HKD]
` 7.388 Lakhs
1(b): Discounted Cash Flow Approach
M13 (5 Marks)
ABC Ltd is considering acquisition of DEF Ltd, which has 3.10Crores Shares outstanding and issued. The Market Price per
Share is ` 440 at present. ABC’s Average Cost of Capital is 12%. Available information from DEF indicates its expected cash
accruals for the next three years as follows: Year 1 – `460Crores; Year 2 – `600 Crores; Year 3 – `740Crores. Calculate the
range of valuation that ABC Ltd has to consider. (PV Factors at 12% for years 1 to 3 respectively: 0.893, 0.797, and 0.712).
Solution:
1. Computation of Present Value of Future Cash Inflows (`Crores)
Year
Cash Inflow
Discount Factor at 12%
Discounted Cash Inflow
1
460
0.893
410.78
2
600
0.797
478.20
3
740
0.712
526.88
Value of the Business = Present Value of Future Cash Flows
1415.86
Note: Assumed that –
(a) Project has a useful life of only 3 years and not more, or it is proposed to be abandoned at the end of such 3 years.
(b) Project does not have any terminal Cash Flows, or such Terminal Cash Flows are incorporated in Year 3 Cash Inflows.
2. Computation of Market Capitalisation
Particulars
Value of Business
Number of Shares outstanding
Value per Share = Value of Business ÷ No. of Shares outstanding
Market Capitalization
Market Price Per Share =
` 1364 Crores
Result
` 1415.86 Crores
3.10
`456.73 per Share
`1364Crores
` 440
3.10 Crores
May 2013.1
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
Conclusions:
1.
Range of Valuation of DEF Ltd that can be considered by ABC Ltd is `1364Crores to `1415.86Crores, i.e. the range
between its Present Market Value and the Value as determined based on Expected Cash Flows.
2.
Range of Valuation that can be considered by ABC Ltd for the shares of DEF Ltd is ` 440 to `456.73 per Share.
1(c): Decision on Construction – Option Evaluation
M13 (5 Marks)
Ramesh owns a plot of Land on which he intends to construct apartment units for sale. Number of apartment units to be
constructed may be either 10 or 15. Total Construction Costs for these alternatives are estimated to be ` 600 Lakhs or ` 1025
Lakhs respectively. Current Market Price for each apartment is ` 80 Lakhs. The Market Price after a year will depend upon the
conditions of the market. If the market is buoyant, each apartment unit will be sold for ` 91 Lakhs and if it is sluggish, the Sale
Price for the same will be ` 75 Lakhs. Determine the Current Value of Vacant Plot of Land. Should Ramesh start construction
now or keep the Land vacant? The yearly Rental per Apartment Unit is ` 7 Lakhs and the Risk Free Interest Rate is 10% p.a.
Assume that the Construction Cost will remain unchanged.
Solution:
Computation of Value of Best Option and Value of Land at T0
Sell Now (10× ` 80 – 600 = 200 Lakhs)
A
Construct 10
Prob.
0.5
[10×(` 91+` 7) =
980 Lakhs)
Sell 1 Year
Later
B
Prob.
0.5
[10×(` 75+` 7) =
820 Lakhs)
Construct Now
Sell Now (15× ` 80 – 1025 = 175 Lakhs)
C
Decision
Construct 15
Prob.
0.5
[15×(` 91+` 7) =
1470 Lakhs)
Sell 1 Year
Later
D
Prob.
0.5
[15×(` 75+` 7) =
1230 Lakhs)
Construct 10 (10× ` 91 – 600 = 310 Lakhs)
Prob. 0.5
Value is 91
Construct 15 (15× ` 91 – 1025 = 340 Lakhs)
Construct 1 Year later
Construct 10 (10× ` 75 – 600 = 150 Lakhs)
Prob. 0.5
E
Value is 75
Construct 15 (15× ` 75 – 1025 = 100 Lakhs)
Option
A
B
C
D
E
Net Present Value of Options –
Value from Table
Net Present Value at T0
200 Lakhs
980 + 820 = 1,800 Lakhs
175 Lakhs
1,470 + 1,230 = 2,700 Lakhs
340 + 150 = 490 Lakhs
200 Lakhs
(1,800 Lakhs × 0.5 × 0.9091) – 600 Lakhs = 218.19 Lakhs
175 Lakhs
(2,700 Lakhs × 0.5 × 0.9091) – 1,025 Lakhs = 202.29 Lakhs
(490 Lakhs × 0.5 × 0.9091) = 222.73 Lakhs
Notes:
1. The Value of options arising in T1 is discounted at 10% for 1 year (0.9091) to arrive at the value at T0.
2.
In Case of Option E above (i.e. Construct one year later and sell at T1), the Price of the Apartment Unit will be known even before
starting construction (since at T1, T1 price will be known). Hence, the choice of construction will be based on the price at T1. If the
Price is ` 91 Lakhs, the construction should be 15 units and if the ` 75 Lakhs, the construction should be 10 units, since it yields
higher Profit. Therefore, probability should be applied only for these two alternatives which are uncertain at T0.
May 2013.2
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
3.
Whenever there is a case of decision, the option which is most beneficial is chosen. However, if the result / outcome is not
certain, equal weightage (i.e. Probability) is assigned for the choices available to ascertain the value of option.
Alternatively: To determine the value of Vacant Plot, Risk Neutral Method of Option Valuation as follows:
If market is buoyant, then possible outcome = ` 91 lakh + ` 7 lakh = ` 98 Lakhs
If market is sluggish, then possible outcome = ` 75 lakh + ` 7 lakh = ` 82 Lakhs
Let “x” be the probability of buoyant condition, then with the given risk-free rate of interest of 10% the following condition
should be satisfied:
[( x × ` 98 Lakhs ) + (1 − x ) × ` 82 Lakhs ]
1.10
`80 lakhs × 1.10 = [(x × `98 Lakhs) + (1–x) × `82 Lakhs]
3
i.e. 0.375
x=
8
Thus 1-x = 0.625
`80 lakhs =
Expected cash flow next year:
0.375 × ` 340 Lakhs + 0.625 × ` 150 Lakhs = ` 221.25 Lakhs
Present Value of expected cash flow:
` 221.25 lakhs × 0.909 = ` 201.12 Lakhs
Thus the value of vacant plot is =` 201.12 Lakhs
Recommendation: Based on the Net Present Value analysis of the Options available, Option E (i.e. Construct one year
later and sell at T1) is preferable. Current Value of Land = Value of Option available on Land = ` 222.73 Lakhs.
Assumption: If the Apartment is constructed now, the Company has to sell the units at T0 or at T1 mandatorily irrespective
of the Price prevailing on the Sale date, and there is no significant delay in Construction.
1(d): Interest Rate Cap
M13 (5 Marks)
XYZ Ltd borrows £ 15 million of 6 months LIBOR + 10.00% for a period of two years. The Company anticipates a rise in LIBOR,
hence proposed to buy a Cap Option from ABC Bank at Strike Rate of 8%. The lump sum premium is 1% for the whole of the
three resets period and the Fixed Rate of Interest is 7% p.a. The actual position of LIBOR during the forth coming reset period
is as follows –
Reset Period
LIBOR
1
9.00%
2
9.50%
3
10.00%
You are required to show how far Interest Rate Risk is hedged through Cap Option.
Solution:
Premium Payable =
Where
=
1. Computation of Premium Payable
A
1
1
−
R × T R × T × (1 + R × T) Y
× Underlying Principal
A = Premium Rate
= 1% or 0.01
R = Fixed Interest Rate for the Period under Consideration
= 7% or 0.07
T = Reset Period i.e. frequency of changing the Floating Rates
= 6 Months or 0.5 Years
Y = Total Number of Reset Periods for the Period under Consideration
= 4 Times (2 Years / Reset Period 0.5)
0.01
× £ 15,000,000 = £ 40,861
1
1
−
0.035 0.035 × 1.035 4
May 2013.3
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
2. Effectiveness of Hedge Using Interest Rate Cap
Reset
Period
Addl. Int. Rate
(Actual Less Cap)
Add. Int. Amt. = Recd from
Bank (Int. Rate × Principal)
Premium
Net Amt. received from bank
paid to bank
1
19% – 8% = 11%
150L × 11% = £ 16,50,000
£ 40,861
£ 16,09,139
2
19.5% – 8% =11.5 %
150L × 11.5% = £ 17,25,000
£ 40,861
£ 16,84,139
3
20% – 8% = 12%
150L × 12% = £ 18,00,000
£ 40,861
£ 17,59,139
£ 51,75,000
£1,22,583
£ 50,52,417
TOTAL
Interest Rate Cap has reduced the additional interest cost from £ 51,75,000 to £ 50,52,417.
2(a): Expected NPV and Risk
M13 (8Marks)
XYZ Ltd, is planning to procure a machine at an investment of `40 Lakhs. The Expected Cash Flow after Tax for next three
years is as follows –
(` in Lakhs)
Year 1
Year 2
Year 3
CFAT
Profitability
CFAT
Profitability
CFAT
Profitability
12
0.1
12
0.1
18
0.2
15
0.2
18
0.3
20
0.5
18
0.4
30
0.4
32
0.2
32
0.3
40
0.2
45
0.1
The Company wishes to consider all possible risks factors relating to the Machine. The Company wants to know –
1.
Expected NPV of this proposal, assuming independent probability distribution with 7% Risk Free Rate of Interest.
2.
Possible Deviations on Expected Values.
Solution:
1. Computation of Expected Cash Flow & Standard deviation – Year 1:
Probability (P)
Px
CFAT (x) (`)
12
15
18
32
0.1
0.2
0.4
0.3
Expected Cash Flow After Taxes
2
Px
14.40
45.00
129.60
307.20
496.20
1.20
3.00
7.20
9.60
21.00
Expected Cash Inflow for Year 1 = ` 21.00 Lakhs
Standard Deviation of Cash Inflow =
X
Σpx 2 - (Σpx)2 =
496.20 - (21.00) 2 = ` 7.43 Lakhs
2. Computation of Expected Cash Flow and Standard deviation – Year 2:
2
P
Px
Px
12
0.10
18
0.30
30
0.40
40
0.20
Expected Cash Flow After Taxes
1.20
5.40
12.00
8.00
26.60
14.40
97.20
360.00
320.00
791.60
Expected Cash Inflow for Year 2 = ` 26.60 Lakhs
Standard Deviation of Cash Inflow for Year 2 =
Σpx 2 - (Σpx)2 =
791.60 - (26.60) 2 = ` 9.17 Lakhs
3. Computation of Expected Cash Flow & Standard deviation – Year 3:
2
P
Px
Px
18
0.20
3.60
64.80
20
0.50
10.00
200.00
32
0.20
6.40
204.80
45
0.10
4.50
202.50
Expected Cash Flow After Taxes
24.50
672.10
X
May 2013.4
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
Expected Cash Inflow for Year 3 = ` 24.50 Lakhs
Standard Deviation of Cash Inflow for Year 3 =
Σpx 2 - (Σpx)2 =
672.10 - (24.50) 2 = ` 8.48 Lakhs
4. Computation of Expected NPV: (Amount in ` Lakhs)
Cash Flow
P.V.F. @ 7%
P.V. of Cash Flow
P.V. of Std. dev. (A)
Year
1
21.00
2
26.60
3
24.50
P.V. of Expected Cash Inflows
Less: Initial Investment
Net Present Value
0.9346
0.8734
0.8163
19.6266
23.2324
19.9994
62.8584
(40.0000)
22.8584
6.9441
8.0091
6.9222
21.8754
A
2
48.2205
64.1457
47.9169
160.2831
Expected NPV of Project = ` 22.86 Lakhs (approx.)
Standard Deviation of Project = (Sum of Squares of Std. Deviation) =
1.
2.
3.
4.
160.2831 = ` 12.66 Lakhs
2(b): Portfolio Beta and Hedging with Index Futures
M13 (8 Marks)
On 1st January an Investor has a Portfolio of 5 Shares as given below –
Security
Price
No. of Shares
Beta
A
349.30
5,000
1.15
B
480.50
7,000
0.40
C
593.52
8,000
0.90
D
734.70
10,000
0.95
E
824.85
2,000
0.85
The cost of the capital to the investor is 10.50% per annum. You are required to calculate –
The Beta of his Portfolio.
The Theoretical Value of the NIFTY futures for February 2013.
The number of contracts of NIFTY the investor needs to sell to get a full hedge until February for his Portfolio if the current
value of NIFTY is 5900 and NIFTY futures have a minimum trade lot requirement of 200 units. Assume that the Futures are
trading at their Fair Value.
The number of Future Contracts the investor should trade if he desires to reduce the Beta of his Portfolio to 0.6.
No. of Days in a year be treated as 365.
Solution:
Security
(1)
A
B
C
D
E
Price
(2)
349.30
480.50
593.52
734.70
824.85
1. Computation of Portfolio Beta
No. of Shares
Total Investment
Share Beta
(3)
(4)
(5)
5,000
17,46,500
1.15
7,000
33,63,500
0.40
8,000
47,48,160
0.90
10,000
73,47,000
0.95
2,000
16,49,700
0.85
Portfolio Beta
(6) = (4) × (5)
20,08,475
13,45,400
42,73,344
69,79,650
14,02,245
=
1,88,54,860
1,60,09,11 4
=0.85
1,88,54,8 60
2. Computation of Theoretical Value of Futures Contract
Securities of
R Ltd
` 5,900
Spot Price [SX]
Tenor / Time Period [t] in Years
Cost of Capital [r]
58 days or 0.1589 Year
10.50% or 0.105
0.105× 0.1589
= ` 5,900 × e
Price of Futures Contract [TFPX]
r×t
TFPX = SX × e
0.017
= ` 5,900 × e
May 2013.5
= ` 5,900 × 1.0171 = ` 6,000.89
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
Therefore, Theoretical Value of the Futures Contract is ` 6,000.89
3. No. of Contracts to be Hedged
Beta of the Portfolio
0.85
=
= 0.85
Hedge Ratio =
Beta of the Index
1
Hedge Ratio
Value of a Futures Contract
No. of Futures Contract to be traded = Portfolio Value ×
= VP ×
0.85
Hedge Ratio
= 13.85 i.e. 14 Contracts
= ` 1,88,54,860 ×
` 5,900 × 200 Units
VF
4. Activity to Reduce Portfolio Beta to 0.60
Object: Reduce Portfolio Beta
No. of Futures Contract to be sold = Portfolio Value ×
= VP ×
[Beta of the Portfolio - Desired Value of Beta]
Value of a Futures Contract
0.85 - 0.60
β1 - βN
= 4 Contracts
= ` 1,88,54,860 ×
` 5,900 × 200 Units
VF
3(a): Effective Yield
A has invested in three mutual fund schemes as per details below:
M13 (10 Marks)
MF A
MF B
Date of Investment
01.04.2011
01.05.2011
Amount of Investment
` 4,00,000
` 12,00,000
Net Asset Value (NAV) at entry date
` 10.15
` 10.25
Dividend received upto 31.07.2011
` 6,000
` 23,000
NAV as at 31.07.2011
` 10.25
` 10.20
What is the Effective Yield on per annum basis in respect of each of the three schemes to Mr. Aupto 31.07.2011?
Take one year = 365 days. Show calculations up to two decimal points.
Solution:
Schemes
•
•
MF C
0.1.07.2011
` 2,50,000
` 10.00
Nil
` 9.90
1. Computation of Net Value Added during the year ended 31.03.2013
NAV as at
NAV as at
Total NAV
Capital
Units No.
entry date
31.03.2013 (`)
31.03.2013 (`) Appreciation (`)
Opening NAV
(`)
[1]
[2]
[3]
[4]=[2]÷[3]
[5]
[6] = [4]×[5]
[7]=[2]–[6]
MF A
12,00,000
` 10.25
1,17,073.17
10.20
11,94,146.33
(–)5853.67
MF B
4,00,000
` 10.15
39408.87
10.25
4,03,940.92
(+)3,940.92
MF C
2,50,000
` 10.00
25,000
9.90
2,47,500
(–)2,500
(2) Effective Yield in %
Total Yield = Capital Appreciation + Dividend
Effective Yield in % = (Total Yield ÷ Opening NAV) × (365 ÷ No. of days of holding)
Schemes
Dividend Received (`)
MF A
MF B
MF C
Net NAV (`)
Total Yield
No. of days
Effective yield % p.a
23,000
(–)5853.67
17,146.33
122
4.275%
6,000
(+)3,940.92
9,940.92
92
9.86%
––
(–)2,500
(–)2,500
31
(–)11.77%
May 2013.6
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
3(b): MM Approach – Present Value of Firm
M13 (6 Marks)
ABC Ltd has a capital of ` 10,00,000 in equity shares of ` 100 each. The shares are currently quoted at par. The Company
proposes to declare a dividend of ` 15 per share at the end of the current financial year. The capitalization rate for the risk
class of which the Company belongs is 10%. What will be the market price of the share at the end of the year, if
(i) Dividend is not declared?
(ii) Dividend is declared?
(iii) Assuming that the Company pays the dividend and has net profits of ` 6,00,000 and makes new investments of `
12,00,000 during the period, how many new shares must be issued? Use the MM model.
Solution:
1. Computation of Price if Dividend is declared / not declared
Market Price per Share at the beginning of the year / period i.e. at Time–0 (now)
Market Price per Share at the end of the year / period
P0
P1
100
To Be
Ascertained
Dividend per Share at the end of the year / period
D1
` 0 / 15
Cost of Equity
Ke
10%
Value of the Share under Modigliani and Miller Approach = P0 =
Particulars
P0
Future Value of P0 = P0 ×1.10
D1
P1 = Future Value of P0 –D1
(D + P )
1
1
1 + Ke
Dividend Not Declared
100
110
0
110
Computation of New Shares to be issued
Factor
Number of Shares Outstanding at the beginning of the period
Number of Shares issued at the end of the year at P1
Dividend Declared
100
110
15
95
2.
Notation
n
m
Market Price per Share at the beginning of the year / period i.e. at Time–0 (now)
Market Price per Share at the end of the year / period
P0
P1
Dividend per Share at the end of the year / period
Investment at the end of the year / period
Net Earnings after Tax for the year / period
Cost of Equity
Dividend Paid [D1]
D1
I1
X1
Ke
Less:
Equity Earnings [X1]
Dividend Outgo [nD1]
Value
10,000
To be
Ascertained
100
To be
Ascertained
15
12,00,000
6,00,000
10%
` 15
6,00,000
1,50,000
[10,000× ` 15]
Retained Earnings
[A]
Investment
[I1]
Further Equity Raised [mP1]
[I1 – A]
Price at Year End
[P0 × (1 + Ke) – D1]
[P1]
Number of Shares Issued
[mP1 ÷ P1]
[m]
` 4,50,000
` 12,00,000
` 7,50,000
` 95
[100 × (1 + 0.10) – 15]
7,895 shares
[7,50,000 ÷ 95]
4(a): Valuation of Securities – Dividend Growth Model
M13 (8 Marks)
X Limited just declared a Dividend of ` 14 per Share. Mr. B is planning to purchase the Share of X Limited, anticipating
increase in growth rate from 8% to 9%, which will continue for three years. He also expects the Market Price of this Share to be
` 360 after three years.
May 2013.7
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
You are required to determine –
(a) The maximum amount Mr. B should pay for the Shares, if he requires a rate of return of 13% per annum.
(b) The maximum price Mr. B will be willing to pay for Share, if he is of the opinion that the 9% Growth Rate can be maintained
indefinitely and requires 13% Rate of Return per annum.
(c) The price of Share At the end of three years, if 9% Growth Rate is achieved, and assuming other conditions remaining
same as in (b) above.
Calculate Rupee amount up to two decimal points. The following factors may be used for computation –
Factors
Year – 1
Year – 2
FVIF at 9%
1.090
1.188
FVIF at 13%
1.130
1.277
PVIF at 13%
0.885
0.783
Solution:
Case A: Maximum Price payable at T0 if the Required Rate is 13% (Growth Rate for 3 years)
Year
Nature
Cash Flow
PVIF at 13.00%
0.885
1
Dividend
(` 14.00 + 9%) = 15.26
0.783
2
Dividend
(` 15.26 + 9%) = 16.63
0.693
3
Dividend
(` 16.63 + 9%) = 18.13
3
Market Price at end of Year 3
360.00
0.693
[Given]
Market Price at T0 (Ex–Dividend)
Market Price at T0 (Cum–Dividend) (288.57 + 14.00)
Case B: Maximum Price payable at T0 if the required rate is 13% (Growth Rate till perpetuity)
Year
Nature
Cash Flow
PVIF at 13.00%
0.885
1
Dividend
(` 14.00 + 9%) = 15.26
0.783
2
Dividend
(` 15.26 + 9%) = 16.63
0.693
3
Dividend
(` 16.63 + 9%) = 18.13
` 18.13 + 9%
Market Price at end of Year 3
= 494.04
3
0.693
[D4 ÷ (Ke – g)]
13% - 9%
Market Price at T0 (Ex–Dividend)
Market Price at T0 (Cum–Dividend) (381.46 + 14.00)
Year – 3
1.295
1.443
0.693
DCF
13.51
13.02
12.56
249.48
` 288.57
` 302.57
DCF
13.51
13.02
12.56
342.37
` 381.46
` 395.46
Case C: Price at T3 if the required rate is 13% (Growth Rate till perpetuity):` 494.04 (as computed above)
4(b): Computation of NAV
M13 (8 Marks)
On 1st April, ABC Mutual Fund issued 20 Lakh Units at ` 10 per unit. Relevant Initial Expenses involved were ` 12 Lakhs. It
invested the fund so raised in Capital Market Instruments to build a Portfolio of ` 185 Lakhs. During the month of April, it
disposed off some of the instruments costing ` 60 Lakhs for ` 63 Lakhs and used the proceeds in purchasing Securities for
` 56 Lakhs. Fund Management Expenses for the month of April were ` 8 Lakhs of which 10% was in arrears. In April, the
Fund earned Dividends amounting to ` 2 Lakhs and it distributed 80% of the realized earnings. On 30th April, the Market
Value of the Portfolio was ` 198 Lakhs.
Mr. Akash, an Investor, subscribed to 100 units on 1st April and disposed off the same at Closing NAV on 30th April. What was
his Annual Rate of Earning?
Solution:
Given the Total Initial Investments is ` 185 Lakhs, out of Issue Proceeds of ` 200 Lakhs. So, the balance of ` 15 Lakhs is
attributed towards to Initial Issue Expenses (` 12 Lakhs) and Opening Cash Balance (` 3 Lakhs).
Receipts
To Opening Balance
To Dividends Received
To Sale Proceeds of Investments
Total
1.Computation of Closing Cash Balance
Payments
`Lakhs
3.00
2.00
63.00
68.00
By Purchase of Securities
By Management Expenses (8.00 less 10% payable)
By Earnings Distributed (Note) (` 5 Lakhs × 80%)
By Closing Balance (balancing figure)
Total
May 2013.8
`Lakhs
56.00
7.20
4.00
0.80
68.00
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
Note: Realised Earnings = Gain on Sale of Securities + Dividends Received = (63 – 60) + 2 = ` 5 Lakhs
2.Computation of Closing NAV
Particulars
1.
2.
`Lakhs
Market Value of Capital Market Instruments (Given)
Cash in Hand (WN 1)
Total of Assets
198.00
0.80
198.80
0.80
Liabilities: Outstanding Expenses (` 8 Lakhs × 10%)
Net Asset Value (`Lakhs)
No. of Units Outstanding (In Lakhs)
NAV Per Unit =
(a)
(b)
(c)
Net Assets of the Scheme
= 198.00
Number of Units outs tan ding
20.00
198.00
20.00
= ` 9.90
3.Computation of Annual Rate of Earning
Realised Dividend and Capital Gains
= ` 4 Lakhs ÷ 20 Lakh units = 0.20
D1 + CG1 + (NAV1
NAV0
Annual Return
Return =
NAV0 )
0 .20 + ( 9 .90 10 .00 )
× 100 =
× 100
10 .00
= 1% p.m.
= Monthly Return × 12 = 1 × 12 = 12.00% p.a.
5(a): Re–Issue vs. Continue — Evaluation
M13 (6 Marks)
M/s. Earth Limited has 11% bond worth of ` 2 crores outstanding with 10 years remaining to maturity. The company is
contemplating the issue of a ` 2 crores 10 year bond carring the coupon rate of 9% and use the proceeds to liquidate the old
bonds. The unamortized portion of issue cost on the old bonds is ` 3 lakhs which can be written off no sooner the old bonds
are called. The company is paying 30% tax and it's after tax cost of debt is 7%. Should Earth Limited liquidate the old
bonds? You may assume that the issue cost of the new bonds will be ` 2.5 lakhs and the call premium is 5%.
Solution:
Evaluation of Redemption of existing Bonds and Issue of New Bonds
`
Nature of Cash Flow
Lakhs
Net Cash
Flow
Period /
Time
DF @
7%
Disc. Cash
Flow
Summary of Inflows:
1.
Savings on Interest Outgo
22.00
Interest on Existing Bond [` 200Lakhs × 11%]
18.00
Less: Interest on New Bonds [` 200 Lakhs × 9%]
Pre Tax Interest Savings
4.00
(1.20)
Less: Tax on Interest Savings [30% × ` 4 Lakhs]
2.80
2.
Tax Savings on Amortisation of Issue Cost
0.30
On Existing Bonds ` 3 Lakhs ÷ 10 Yrs
Less: Amortisationp.a for New Issue Cost [` 2.5 Lakhs ÷
10 Yrs]
(0.25)
Reduction in Amortisation Amt. every year
0.050
Tax savings on the above [` 0.05 × 30%]
0.015
After Tax Interest Savings
3.
2.785
2.785 1 – 10 Yrs
7.024
19.5619
1.000
0.90
Tax Savings on writing off Unamortized Floatation
cost on Old Issue, immediately
Unamortized Floatation Cost – Written Off Immediately
3.00
Tax Saving on Above [30% × ` 3 Lakhs]
0.90
Present Value of Savings and Inflows:
May 2013.9
0.90
0
20.4619
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
`
Nature of Cash Flow
Net Cash
Flow
Lakhs
Period /
Time
DF @
7%
Disc. Cash
Flow
Summary of Outflows:
4.
Floatation Cost for New Issue
2.50
5.
Premium Payable on Redemption of Existing Bonds
2.50
0
1.000
2.5000
7.00
0
1.000
7.0000
10.00
Premium Payable on Redemption [5% on ` 200 Lakhs]
Less: Tax saving on writing–off premium on redemption
[30% of ` 10.00 Lakhs]
3.00
Net Additional Outgo on account of redemption
7.00
Present Value of Cost and Outflows
9.5000
Net Present Value
10.9619
Conclusion: By redeeming existing bonds and issuing bonds afresh, the Company stands to gain by ` 10.9619 Lakhs.
Therefore, Company should refund the outstanding debt.
Note:
Appropriate Discount Rate for evaluating the replacement of bond outstanding, is the After Tax Interest Rate of the
new bonds, since such interest rate represents the current yield.
5(b): Evaluation of Overseas Investment Policy
M13 (10 Marks)
XY Limited is engaged in large Retail Business in India. It is contemplating for the expansion into a country of Africa by
acquiring a group of stores having the same line of operation as that of India.
The Exchange Rate for the Currency of the proposed African Country is extremely volatile. Rate of Inflation is presently 40% in
a year. Inflation in India is currently 10% a year. Management of XY Limited expects these rates likely to continue for the
foreseeable future. Estimated Projected Cash Flows, in real terms, in India as well as African Country for the first three years of
the project are as follows –
Particulars
Cash Flow in Indian `(000)
Cash Flows in African Rands (000)
Year 0
– 50,000
– 2,00,000
Year 1
– 1,500
+ 50,000
Year 2
– 2,000
+ 70,000
Year 3
– 2,500
+ 90,000
XY Ltd assumes the year 3 Nominal Cash Flows will continue to be earned each year indefinitely. It evaluates all Investments
using Normal Cash Flows and a Nominal Discounting Rate. The present exchange rate is African Rand 6 to ` 1.
You are required to calculate the Net Present Value of the Proposed Investment considering the following –
1. African Rand Cash Flows are converted into Rupees and discounted at a Risk Adjusted Rate.
2. All Cash Flows for these Projects will be discounted at a rate of 20% to reflect it’s high risk.
Ignore taxation.
Solution:
1. Inflation Adjusted Cash Flows (in 000)
Year
Real Cash
Flow (`)
Inflation Factor at
10%
0
–50,000
1.0000 (No Inflation)
–50,000
0
1
–1,500
1.1000
–1,650
2
–2,000
1.100 × 1.10 = 1.2100
3
–2,500
1.210 × 1.10 = 1.3310
Future Spot Rate
Real Cash
Adjusted
Year
Flow (Rand)
Cash Flows
Inflation Factor at
40%
Adjusted
Cash Flows
–2,00,000
1.0000 (No Inflation)
–2,00,000
1
+50,000
1.4000
+70,000
–2,420
2
+70,000
1.400 × 1.40 = 1.9600
+1,37,200
–3,328
3
+90,000
1.960 × 1.40 = 2.7440
+2,46,960
2. Expected Future Spot Rates (under Interest Rate Parity Theory)
= Opening Spot Rate × (1 + Foreign Currency Rate i.e. Rand Rate)
(1 + Home Currency Rate i.e. India Rate)
May 2013.10
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
Year
0
RRAND 6.0000 per INR
Closing Spot Rate
1
2
3
RAND 6.0000 × (1 + 0.40) / (1 + 0.10) = RAND 7.6364
RAND 4.7143 × (1 + 0.40) / (1 + 0.10) = RAND 9.7190
RAND 3.7041 × (1 + 0.40) / (1 + 0.10) = RAND 12.3696
Year
Cash Flow
(Rand)
Conversion
Rate
0
(2,00,000)
` 6.0000
` 7.6364
` 9.7190
` 12.3696
1
70,000
2
1,37,200
3
2,46,960
3. Evaluation of Project (in 000)
INR Cash
Total Cash
Cash Flow
Flows
Flows
(`)
(33,333.33)
(50,000)
PV Factor @
20%
Discounted Cash
Flow (`)
(83,333.33)
1.000
(83,333.33)
9,166.62
(1,650)
7,516.62
0.833
6,261.34
14,166.68
(2,420)
11,746.68
0.694
8,152.20
19,965.08
(3,328)
16,637.08
0.579
Net Present Value
9,632.87
(59,286.92)
0.579
= ` 48,164
0.20
Total NPV of the Project = (` 59,287) + ` 48164 = (` 11,156)
NPV of terminal value = 16,637×
Conclusion: Since the NPV is Negative, investment in African Country shall not be proceeded with.
6(a): Merger – Computation of Exchange Ratio
M13 (8 Marks)
Longitude Ltd is in the process of acquiring Latitude Ltd on share exchange basis. Following data are available –
Particulars
Longitude Limited
Latitude Limited
Profit After Tax (PAT)
` 140 Lakhs
`60 Lakhs
Number of Shares
15 Lakhs
16 Lakhs
Earnings Per Share (EPS)
`8
`5
Price Earnings Ratio (PE Ratio)
15 times
10 times
You are required to determine:
1. Pre–Merger Market Value per Share, and
2. Maximum Exchange Ratio Longitude Limited can offer without the dilution of –
(a) EPS and
(b) Market Value per Share
Calculate Ratio up to four decimal points, and amounts and number of shares up to two decimal points (Ignore Synergy).
Solution:
1. Pre–Merger Market Value per Share(MPS = EPS × PE Ratio)
For Longitude Ltd: ` 8× 15 times =` 120, For Latitude Ltd: ` 5× 10 times = ` 50.
2. Exchange Ratio based on Market Price
MPS of Selling Co.
50
=
= 0.416 + Shares of Longitude Ltd for every Share of Latitude Ltd.
(a) Exchange Ratio =
MPS of Buying Co.
120
(b) No. of Shares Issued = 0.4167 × 16,00,000 Shares = 6,66,720 Shares in Longitude Ltd
3. Exchange Ratio based on Earnings Per Share
(a) Basis of Exchange: Shares should be issued on the basis of Earnings Per Share before merger of the two companies.
EPS of Selling Co.
5
=
= 0.6250 Shares of Longitude Ltd for every Share of Latitude Ltd.
(b) Exchange Ratio =
EPS of Buying Co.
8
(c) No. of Shares Issued in this case = 0.6250 × 16,00,000 Shares = 10,00,000 Shares in Longitude Ltd.
May 2013.11
Gurukripa’s Guideline Answers for May2013 CA Final Strategic Financial Management
6(b): Forward Rate Agreement – Final Settlement
M13 (8 Marks)
M/s Parker & Company is contemplating to borrow an amount of ` 60 Crores for a period of 3 months in the coming 6 month’s
time from now. The current rate of Interest is 9% p.a. but it may go up in 6 months’ time. The Company wants to hedge itself
against the likely increase in Interest Rate. The Company’ Bankers quoted an FRA (Forward Rate Agreement) at 9.30% p.a.
What will be the effect of FRA and actual rate of Interest Cost to the Company, if the actual rate of Interest after 6 months
happens to be (i) 9.60% p.a. and (ii) 8.80% p.a.?
Solution:
Particulars
Forward
Rate
quoted by Bank
Profit / (Loss)
Profit / (Loss) on
Settlement (See
Note Below)
If Actual Rate is 9.60%
9.30%
If Actual Rate is 8.80%
9.30%
Since the Actual Rate is higher than the FRA, the
profit is 9.60 – 9.30 = 0.30
Since the Actual Rate is lower than the FRA, the
Loss is 8.80 – 9.30 = (0.50)
⎛ 3 ⎞
(0.096 − 0.093) × ⎜ ⎟
⎝ 12 ⎠
60 Crores ×
⎛ 3 ⎞
1 + 0.096 ⎜ ⎟
⎝ 12 ⎠
= 60 Crores × (0.00075 ÷ 1.024) = 4,39,453
⎛ 3 ⎞
(0.088 − 0.093) × ⎜ ⎟
⎝ 12 ⎠
60 Crores ×
⎛ 3 ⎞
1 + 0.080 ⎜ ⎟
⎝ 12 ⎠
= 60 Crores × (0.00125 ÷ 1.02) = (7,35,294)
Note: Profit / (Loss) on Settlement is identified using the following –
⎛ Period ⎞
(Actual Rate − Forward Rate) × ⎜⎜
⎟⎟
⎝ 12 ⎠
Profit / (Loss) = Principal ×
⎛ Period ⎞
1 + Actual Rate ⎜⎜
⎟⎟
⎝ 12 ⎠
7(a):
Write short notes on Credit Rating.
M13 (4 Marks)
Solution: Refer Page 5.14, Q.no.22
7(b):
Write short notes on Asset Securitisation.
M13 (4 Marks)
Solution: Refer Page 5.8, Q.no.13
7(c):
Write short notes on Call Money.
M13 (4 Marks)
Solution: Refer Page 12.7, Q.no.40
7(d):
Write short notes on Euro Convertible Bonds.
M13 (4 Marks)
Solution: Refer Page 17.22, Q.no.40
7(e):
Write short notes on Financial Restructuring.
M13 (4 Marks)
Solution: Refer Page 18.16, Q.no.36
May 2013.12