CWA ICWA Final Stage III : Advanced Financial Management and International Finance - June 2007

CWA ICWA - Final Stage III • Advanced Financial Management and International Finance • June 2007

This Paper has 28 answerable questions with 0 answered.

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 questions from part B.
Please answer all the bits of a question at one place.
Working Notes should form part of the answer.
PART A Attempt all the questions
Marks

The figures in the margin on the right side indicate full marks

Part A is compulsory and answer another five questions from part B.

Please answer all the bits of a question at one place.

Working Notes should form part of the answer.

PART A
Attempt all the questions

Marks

(a)

In each of the cases given below one out of four answers is correct. Indicate the correct answer and give your workings/reasons briefly.

2x7=14

(i)

VINTEX LTD. has a target ROE of 20 per cent. The debt equity ratio of the company is 1.2 and its pre–tax cost of debt is 12 per cent. What ROI should the company plan to earn if its tax rate is 35 per cent?

19.53%

20.53%

21.15%

None of the above.

(0)

(ii)

BRIGHT METALS LTD. currently pays a dividend of Rs. 2 per share that is expected to grow at a rate 15% per annum for the next three years, after which it is expected to grow at a rate of 10% forever. What value would you place on the stock of this company if an 18% rate of return is required? (Rounded off your answer to the nearest integer) [Given: PVIF (18%, 3 yrs.) = 0.8474, 0.7182, 0.6086]

41.20

31.15

22.64

Data Insufficient

(0)

(iii)

Stock—A has a beta of 1.3 and an expected return of 20%. Stock—B has a beta of 0.8 and an expected return of 14%. Assume these stocks are correctly priced. Based on CAPM what is the expected return on the market?

15.10%

16.40%

17.50%

None of the above.

(0)

(iv)

An Indian Bank wants to found their NOSTRO A/c with a US correspondent by US $ 10,00,000 against INRS when inter–Bank rate is US $ 1 = Rs. 47.20/50. The deal is struck and the Overseas Bank's VOSTRO A/c that is being maintained with the Indian Bank will be credited by

Rs. 476,00,000

Rs. 475,00,000

Rs. 472,00,000

None of the above.

(0)

(v)

The degree of operating leverage and degree of financial leverage of VIVEK LTD, are 2.5 and 1.6 respectively. What will be the percentage change in EPS, if the sales increases by 5%

2% increase

0.20% increase

20% increase

10% increase.

(0)

(vi)

MR. BROWN is bearish about the Index. Spot Nifty stands at Rs. 1150. He decide to sell one three – month Nifty call option contract (having a market lot of 200) with a strike price of Rs. 1175 for a premium of Rs. 28.90. Three months later, the Index closes at Rs. 1195. What is his net pay off on the position?

A.	Profit Rs. 1780	B.	Loss Rs. 1780
C.	Profit Rs. 3220	D.	Loss Rs. 780

(0)

(vii)

The following various currency quotes are available from a leading Indian Bank:

Rs./£
£/$
$/¥

75.31/75.33
0.6391/0.6398
0.01048/0.01052

The rate at which yen (¥) can be purchased with rupees will be

A.	Re. 0.5070	B.	Rs. 1.5030
C.	Rs. 1.7230	D.	None of the above.

(0)

(b)

From the following, choose the most appropriate answer [only indicate A, B, C, D as you think correct]:

1x6=6

(i)

The upper bound and lower bound for the value of put option are

A.	Zero and Stock price
B.	Zero and Exercise price
C.	Stock price and Zero
D.	None of the above.

(0)

(ii)

Hedging through forwards, futures, swaps etc. is an example of

A.	Risk Avoidance
B.	Risk Sharing
C.	Risk Transfer
D.	None of the above.

(0)

(iii)

Exchange rate system where Central Bank intervenes to smoothen out exchange rate fluctuations is known as

A.	Free float
B.	Managed float
C.	Fixed rate system
D.	Floating rate system.

(0)

(iv)

Locate the false statement:

Mentioned below are three derivatives with their relative features:

Feature/Derivative
A. Standardization
B. Liquidity
C. Margin
D. Guarantor

Forward
No
No
None
Bank

Futures
Yes
Yes
Yes
Clearing house

Option
Yes
Yes
Yes
Clearing house

(0)

(v)

Locate the correct statement:

Pay – off in a forward contract refers to

A.	The delivery price
B.	The estimated spot price on the date of settlement
C.	The difference between the delivery price and the spot price on the date of settlement
D.	The penalty payable by the party to the contract on default.

(0)

(vi)

The slope of the security market line (SML) denotes

A.	Market volatility
B.	Beta of the security
C.	The influence of unsystematic risk
D.	The risk premium required.

(0)

PART B Attempt any five questions, each carrying 16 marks.

PART B
Attempt any five questions, each carrying 16 marks.

(a)

ZENITH LTD. has a surplus cash of Rs. 100 lakhs and wants to distribute 35% of it to the shareholders. The company decides to buyback shares. The General Manager (F & A) of the company estimates that its share price after re–purchase is likely to be 15% above the buyback price, if the buyback route is taken. The number of shares outstanding at present is 10 lakhs and the current EPS is Rs. 4.

You are required to determine:

(i)	The price at which the shares can be re–purchased if the market capitalization of the company should be Rs. 230 lakhs after buyback;

(ii)	The number of shares that can be re-purchased;

(iii)

The impact of shares re–purchase on the EPS, assuming the net income is same.

4+1+2=7

(0)

(b)

The settlement price of JUNE NIFTY Futures contract on a particular day was 4585. The minimum trading lot on Nifty futures is 100. The initial margin is 8% and the maintenance margin is 6%. The index closed at the following levels on next five days:

Day
1
2
3
4
5

Settlement Price (Rs.)
4690
4760
4550
4480
4570

Required:

(i) Calculate the Mark to Market Cash Flows and daily closing balances in the account of

(A)	an investor who has gone long at 4585

(B)	an investor who has gone short at 4585

(ii) Calculate the net profit/(loss) on each of the contracts.

1+(3+1)
+(3+1)=9

(0)

(a)

Explain what is meant by Free Cash Flow to Equity.

(0)

(b)

NEEL ENTERPRISES LTD. is in Hospitality Services business. The company financials are as follows:

	(Rs. in lakhs)
Sales EBDIT Depreciation Tax rate Net Fixed Assets Net Current Assets (will remain at 10% of Net Fixed Assets in next 5 years) Sales Growth estimated in next 5 years Operating Expenses grow by Depreciation Post-tax cost of debt Market value of debt Cost of Equity Market value of Equity Estimated Growth of free cash flow from 6th year	100 60 10 40% 80 10 10% p.a. 8% p.a 10% 8% 40 15% 110 10% p.a

Yearwise Investments in Fixed Assets:

Year
Investment in Fixed Assets
Post–tax non–operating cash flows

1
20
10

2
0
0

3
10
5

4
15
20

5
0
0

You are required to find out the value of Neel Enterprises Ltd.

Note: You may use the formula:

(1 + r)ⁿ

for determining PVIF at r (rate for cost of capital)

6+4
+2+1=13

(0)

(a)

What is financial leverage? How does financial leverage increase the potential reward to the shareholders.

2+4

(0)

(b)

Briefly explain the following concepts:

3+4+3

(i)

Debt securitization,

(0)

(ii)

Forfaiting

(0)

(iii)

Marking to market.

(0)

(a)

What is interest rate swap and what are the principal features of an interest rate swap?

(0)

(b)

GESCO TEXTILES LTD. (GTL) 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 debtequity 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 GT LTD. 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 Gesco Textiles Ltd. 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 evaluate 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 12 per cent;
(b)	The present vield 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 Gesco Textiles Ltd. will continue to be 30 per cent even after the projects being undertaken.

4+3
+3+2=12

(0)

(a)

CARLHAMS CORPORATION LTD. in U.K. will need to make a payment of $ 250000 in six months time. It is currently 1^st January. The company is considering the various choices it has, in order to hedge its transaction exposure.

Following market information is available:

	Exchange Rates
£ spot rate Six month £ forward rate	$ 1.5617—1.5773 $ 1.5455—1.5609

Country	Money Market Rates
Country	Borrow%	Deposit%
US$	6	4.5
UK£	7	5.5

Foreign currency option prices:

Execise price Call option (June) Put option (June)	: :	$ 1.70 $ 0.037 $ 0.096
Contract size (1 unit is £ 12500)

Evaluate the following hedging alternatives with necessary calculations and decide which of the same is the most attractive to Carlhams Corporation Ltd.

2+3
+4+1=10

(0)

(b)

Yorkshire Industries, a British Industries firm with a US subsidiary, seeks to refinance some of its existing British pound debt to include floating rate obligations. The best floating rate it can obtain in London is LIBOR + 2.0%. Its current debts are as follows:

(i)	$ 10 million owed to Citibank at 9.5% (fixed annually); and
(ii)	£ 5 million owned to Midland Bank at 9.5% (fixed) annually.

Huron River Salt Company wishes to finance exports to Britain with £ 3 million of pound denominated fixed rate debt for six months. Huron is unable to obtain a fixed interest rate in London for less than 13.5% interest because of its lack of credit history in the UK. However, Lloyds Bank is willing to extend a floating rate British pound Loan at LIBOR + 2%. Huron, however, cannot afford to pay more than 12%. How can Yorkshire and Huron help one another via an interest rate swap? Assume that Yorkshire is in a strong bargaining position and can negotiate the best deal possible, but Huron will not pay over 12%. Assume further that transaction costs are 0.5% and exchange rates do not change. Illustrate the effective post-swap interest rates of each party with boxes and arrows. What are the interest savings by each party overy the six months period of the swap?

3+3=6

(0)

(a)

The rates of return on the security of Company P and market portfolio for 10 periods are given below:

Period	Return of Security–P (%)	Return on Market Portfolio (%)
1 2 3 4 5 6 7 8 9 10	20 22 25 21 18 —5 17 19 —7 20	22 20 18 16 20 8 —6 5 6 11

(i)	What is the beta of Security P?
(ii)	What is the characteristic line for Security P?

(2+2)+3=7

(0)

(b)

VIBGYOR LIMITED has sales of Rs. 250 million a year, with 80 per cent being the credit sales. The present credit terms of the company are '2/15, net 45'. At present the average collection period is 30 days. The proportion of sales on which customers currently take discount is 0.50. Vibgyor Ltd. is considering relaxing its discount terms to '3/15, net 45'. Such a relaxation is expected to increase current credit sales by Rs. 10 million, reduce the average collection period to 27 days and increase the proportion of discount sales to 0.60. The average selling price of the company's product is Rs. 1000 per unit and variable cost per unit works out to be Rs. 800. Vibgyor Ltd. is subject to a tax rate of 40 per cent, and its, before tax, rate of borrowing for working capital is 12 per cent. Should the company change its credit terms to '3/15, net 45'? Support your answer by calculating the expected change in net profit (assume 360 days in a year).

4+4+1=9

(0)

TRYTONIC LTD. is considering a new project for manufacture of pocket video games involving a capital expenditure of Rs. 600 lakh and working capital of Rs. 150 lakh. The capacity of the plant is for an annual production of 12 lakh units and capacity utilisation during the 6-year working life of the project is expected to be as indicated below:

Year
1
2
3
4−6

Capacity utilisation (per cent)
33.33
66.67
90
100

The average price per unit of the product is expected to be Rs. 200 netting a contribution of 40 per cent. The annual fixed costs, excluding depreciation, are estimated to be Rs. 480 lakh per annum from the third year onwards; for the first and second year, it would be Rs. 240 lakh and Rs. 360 lakh respectively. The average rate of depreciation for tax purpose is 33.33 per cent on the capital assets. The rate of income tax may be taken at 35 per cent. The cost of capital is 15 per cent.

At end of the third year, an additional investment of Rs. 100 lakh would be required for working capital. Terminal value for the fixed assets may be taken at 10 per cent and for the current assets at 100 per cent. For the purpose of your calculations, the recent amendments to tax laws with regard to balancing charge may be ignored.

As a financial consultant what recommendation on the financial viability of the project would you make to the TRYTONIC LTD.?

Note: Extracted from the table:

Year
PVIF at 15%

1
0.870

2
0.756

3
0.653

4
0.571

5
0.497

6
0.432

2+10
+3+1=16

(0)

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