# CWA/ICWA Final :: Advanced Financial Management and International Finance : June 2005

 F-14(AFM)Revised Syllabus Time Allowed : 3 Hours Full Marks : 100 The figures in the margin on the right side indicate full marks Part A is compulsory and answer another five from part B. . PART AAttempt all questions, each carrying 2 marks. Marks
1. (a) In the cases below, one of the answer is correct. Choose the correct answer and give your workings/reasons briefly. 2x7=14
(i)The shares of BBA Company are selling at Rs. 30 per share. The firm had paid dividend @ 2 per share last year. If the estimated growth of the company is approximately 8 per cent per year, the cost of equity capital of the company will be
 (A) 15.50 per cent (B) 15.20 per cent (C) 16.00 per cent (D) none of (A), (B), (C).
(ii)A chemical company has net sales of Rs. 50 million, cash expenses (including Taxes) of Rs. 35 million and Depreciation expenses of Rs. 5 million. If Debtors decrease over the period by Rs. 6 million, cash from operation will be
 (A) Rs. 21 million (B) Rs. 25 million (C) Rs. 28 million (D) Rs. 35 million
(iii)

Consider the following of Target Ltd.:
 Standard deviation of shareThe correlation co-efficient for the share with the marketMarket standard deviation ::: 4%0.82.5%

Based on CAPM, the Beta Co-efficient of the company's share (which is traded in the stock market) is equal to
 (A) 1.5 (B) 1.28 (C) 1 (D) 0.5
(iv)HP Leasing Company expects a minimum yield of 10% on its investment in the leasing business. It proposes to lease a machine costing Rs. 5,00,000 for ten years. If yearly lease payments are received in advance, the lease rental to be charged by the company for the lease will be
 (A) Rs. 81,372 (B) Rs. 73,975 (C) Rs. 72,370 (D) none of (A), (B), (C).
(v)An Indian company is planning to invest in US. The US inflation rate is expected to be 3% and that of India is expected to be 8% annually. If the spot rate currently is Rs. 45/US \$, what spot rate can you expect after 5 years?
 (A) Rs. 56.09/US \$ (B) Rs. 57.00/US \$ (C) Rs. 57.04/US \$ (D) Rs. 57.13/US \$.
(vi)A company issue commercial paper for Rs. 3 crore with a maturity period of 90 days. The interest rate is 11% p.a. The net amount received by the company will be
 (A) 2.94 crore (B) 2.92 crore (C) 2.85 crore (D) D. none of (A), (B), (C).
(vii)The spot and 6 months forward rates of £ in relation to the rupee (Re/ £): are Rs. 77.9542/78.1255 and Rs. 78.8550/9650. respectively. What will be the annualised forward margin (Premium with respect to Ask Price)?
 (A) 2.31% (B) 2.15% (C) 1.80% (D) 1.59%
(b) From the following choose the most appropriate answer (only indicate A, B, C, D as you think correct): 1x6=6
(i)March Eurodollar future is now quoted at 97.98 in CMI. The implied interest rate is
 (A) 2.06% (B) 2.02% (C) 2.00% (D) none of above.
(ii)It is quite common for Banks to go in for issuing 'sub-ordinated debt'. The reasons are
 (A) Bank needs to raise funds for on lending (B) Sub-ordinated debt does not increase debt-equity (C) Sub-ordinated debt does not increase debt-equity ratio (D) Sub-ordinated debt is included under Tier-II capital for the purpose of determining capital adequacy of the bank.
 (A) one call, one put, same security, same strike price and same period (B) one call, one put, same security, different strike price and same period (C) one call, two puts, same security, same strike price and same period (D) none of (A), (B), (C).
(iv)If the amount and timing of a foreign currency outflow are both uncertain, then the best heading technique will be to
 (A) buy a put option (B) buy a call option (C) sell a call option (D) buy a forward contract.
(v)When the payment due on a draft is made upon the presentation of the draft it is a
 (A) clean draft (B) payment draft (C) sight draft (D) documentary draft.
(vi)_____ requires various marketing, production and financial management strategies to cope with the risks. (Fill in the gap from below)
 (A) Transaction Exposure (B) Accounting Exposure (C) Transaction Exposure (D) Economic Exposure.

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 F-14(AFM)Revised syllabus Marks
PART B
2. (a) What is "covered interest arbitrage"?
Assuming that no transaction cost or taxes exist, do the following data offers arbitrage profit opportunity? If so, how will the arbitrage transaction be carried out? Assume that arbitrageur can borrow up to \$ 1 million.
2+8+6
 Three-month interest rate in the United SatesThree-month interest rate in GermanyCurrent spot exchange rateThree-month forward exchange rate ::: : 8% per annum5% per annum€ 1.014/\$€ 1.0101/\$
(b) Explain the term "Swaps". Outline the possible benefits to a Company of undertaking an Interest rate Swap.
3. (a) Briefly explain the following concepts:
 (i) Sustainable growth rate (ii) Shareholder value.
6+4=10
(b) During the year 2000-01, Gulf Oil India made a sales of lubricants and greases worth Rs. 257 crores, which was down by 7.4 per cent compared to previous year's sales. While the company could reduce its overheads, its variable input (base oil and additives) cost went up significantly. As a result, variable cost-to-sales ratio in 2000-01 stood at 55.8 per cent as opposed to 48.5 per cent in the previous year. The financial highlights of the company for the year 2000-01 are as given under:
 (Rs. Crores) Sales 257.0 Overheads (excluding depreciation & interest) 103.5 Depreciation 2.7 Interest 6.5 Earnings before Tax (excluding other income) 0.7
 (i) Calculate operating leverage. The company is expecting a decline in sales by 1 per cent in the next year. If the cost structure remains the same, what will be the expected EBIT? Show necessary calculations. (ii) Calculate financial leverage. What would be the impact of financial leverge if company's sales decline by 1 per cent in the next year? Assume that financial structure will remain the same.
4. The following data are furnished by the SIGMA LEASING LTD. (SLL): 4x4
 Investment costPrimary lease termResidual valuePre-tax required rate of Annual Return :::: Rs. 99 lakhs3 yearsNIL22 per cent
The lease can be renewed for an additional period of 3 years (secondary lease period). The lease rental for the secondary period will be 5 per cent of the rental charged during the primary period.
The SLL seeks your advise in determining the annual lease rental under the following rental structures:
 (a) Equated (b) Stepped (annual increase of 12 per cent) (c) Ballooned (annual rental of Rs. 15 lakhs for year 1 and 2) (d) Deferred (deferment period of 1 year) You are required to compute the annual rental under four rental structures. Show your workings.
5. (a) The turnover of Bharat Ltd. is Rs. 240 crores of which 80 per cent is on credit. Debtors are allowed 90 days to clear off the dues. The company's annual cost of administering credit sales is Rs. 90 lakhs. It is possible to save Rs. 66 lakhs out of the sales administering costs and avoid bad debts at 1 per cent on credit sales (dues) if the company avails of full-factor service from a factor company. The company has approached Indbank Factors Ltd. (factor company) and got the following terms: 8+8=16
 Advance paymentDiscount rateCommission for service ::: 90 per cent15 per cent per annuam1.0 per cent (to be paid up-front)
A bank has come forward to make an advance equal to 90 per cent of the debts at an annual interest rate of 13 per cent.
Should the company avail of the factoring service or the offer of the bank? Give reasons (Assume 360 days in a year).
(b) HPL Ltd. is a growing company. Its Free cash flows for equity holders (FCFE) have been growing at a rate of 25 per cent in recent years. The abnormal growth rate is expected to continue for another 5 years, then these FCFE are likely to grow at the normal rate of 8 per cent. The required rate of return on these shares, by the investing community is 15 per cent, the firm's weighted average cost of Capital is 12 per cent.
The amount of FCFE per share at the beginning of the current year is Rs. 30.
Determine the maximum price an investor should be willing to pay now, based on Free cash flow approach.
The issue price of share is Rs. 500.
P.V. factors at 15% discount rate are:
 YearP.V. 10.87 20.756 30.658 40.572 50.497

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 F-14(AFM)Revised syllabus Marks
6. (a) Using suitable structural relationship, explain the impact of financial leverage. 4+12=16
(b) XYZ company is contemplating to undertake the following investment proposals: (i) expansion of existing capacity, and (ii) setting up a new project not related with the present business. The company's shares are regularly traded in stock exchanges, the recent estimate of share beta is 1.2. The debt-equity ratio of the company at present is 2 : 1. However, the new project, if undertaken, can be financed with a debt-equity ratio of 1 : 1, since the company has adequate internal accruals. To assess business/financial risk of the proposed new project, the XYZ company has identified a comparable company with debt-equity ratio of 1.5 : 1 and estimated share beta of 1.5. The comparable company is subject to an effective tax rate of 20 per cent, whereas effective tax rate of XYZ company is 30 per cent.
You are required to estimate (with necessary calculations) the following:
 (i) Cost of capital to be used as cut-off rate to evaluate the expansion project, assuming that its debt-equity ratio will be 2 : 1. (ii) Cost of capital to be used as cut-off rate to evaluage the new project. (iii) Based on your calculations in (i) and (ii) above, would you recommend different cut-off rates or single cut-off rate for the expansion and new projects? Give reasons. You may further like to consider the following information while answering the above questions: (a) The company will be able to negotiate loan at 15 per cent: (b) The present yield on long-dated government securities is around 7 per cent: (c) Expected spread between return on stock index and government securities (i.e., market premium) 6 per cent: (d) Estimated liquidity premium in the government securities is 1 per cent. (e) Effective corporate tax rate of XYZ company will continue to be 30n per cent even after the projects being undertaken.
7. (a) Define exposure differentiating between accounting and economic exposure. 6+10=16
(b) A proposed foreign investment involves a plant whose entire output of 1 million units per annum is to be exported. With a selling price of \$ 10 unit, the yearly revenue from this investment equals \$ 10 million. At present rate of exchange, dollar costs of local production equal to \$ 6 per unit. A 10% devaluation is expected to lower unit costs by \$ 0.30, while a 15% devaluation will reduce these costs by an additional \$ 0.15. Suppose a devaluation of either 10% or 15% is likely, with respective probabilities of 0.4 and 0.2 (the probability of no currency change is 0.4). Depreciation at the current exchange rate equals \$ 1 million annually, while the local tax rate is 40%.
 (i) What will annual dollar cash flows (after-tax) be under each exchange rate scenario? (ii) What is the expected value of annual after-tax dollar cash flows assuming no repatriation of profits to the United States? (iii) Considering that the project involves a total investment of \$ 25 million on plant and working capital, would you recommend the investment? Answer this question assuming that expected annual dollar cash flows, as worked out in (ii) above, would continue in perpetuity and dollar cash flows grow at an inflation rate of ever 2 percent. Also assumed that the minimum required return on investment is 12 per cent.
8. (a) An Indian exporter has sold handicrafts items to an American business house. The exporter will be receiving US \$ 1,00,000 in 90 days. Premium for a dollar put option with a strike price of Rs. 48 and a 90 days settlements is Re. 1. The exporter anticipates the spot rate after 90 days to be Rs. 46.50. 5+11
 (i) Should the exporter hedge its account receivable in the option market? (ii) If the exporter is anticipating the spot rate to be Rs. 47.50 or Rs. 48.50 after 90 days, how would it effect the exporter's decision.
(b) 'Just Born' is a newly formed firm providing garments for babies and children. It has forecast its total fund requirements for the coming year as follows:
 Month Total fundsrequirementsRs. (lakh) PermanentrequirementsRs. (lakh) SeasonalrequirementsRs. (lakh) JanuaryFebruaryMarchAprilMayJuneJulyAugustSeptemberOctoberNovemberDecember 8,5008,0007,5007,0006,9007,1508,0008,3508,5009,0008,0007,500 6,9006,9006,9006,9006,9006,9006,9006,9006,9006,9006,9006,900 1,6001,10060010002501,1001,4501,6002,1001,100600 11,600
The firm's cost of short-term and long-term financing is expected to be 10% and 15% respectively.
Calculate the cost of financing, using
 (i) hedging approach, (ii) conservative approach, and (iii) trade-off approach.

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