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The Institute of Chartered Accountants of India
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
Question No.1 is compulsory.
Attempt any five out of the remaining six questions.
Wherever appropriate, suitable assumptions should be made and indicated in the answer by
the candidate.
Working notes should form part of the answer.
Question 1
(a) EFD Ltd. is an export business house. The company prepares invoice in customers'
currency. Its debtors of US$. 10,000,000 is due on April 1, 2015.
Market information as at January 1, 2015 is:
Exchange rates US$/INR
Currency Futures US$/INR
Spot
0.016667
Contract size: ` 24,816,975
1-month forward
0.016529
1-month
0.016519
3-months forward
0.016129
3-month
0.016118
1-Month
3-Months
Initial Margin
Interest rates in India
` 17,500
` 22,500
6.5%
7%
On April 1, 2015 the spot rate US$/INR is 0.016136 and currency future rate is 0.016134.
Which of the following methods would be most advantageous to EFD Ltd?
(i)
Using forward contract
(ii) Using currency futures
(iii) Not hedging the currency risk
(6 Marks)
(b) TUV Ltd. has invested in three Mutual Fund schemes as per the details given below:
Date of Investment
Amount of Investment (`)
Net Asset value at entry date
Dividend received upto March 31, 2015
Net Asset value as at March 31, 2015
Scheme X
Scheme Y
Scheme Z
1-10-2014
15,00,000
1-1-2015
7,50,000
1-3-2015
2,50,000
` 12.50
` 36.25
` 12,500
` 36.45
` 27.75
` 45,000
` 12.25
Nil
` 27.55
What will be the effective yield (per annum basis) for each of the above three schemes
upto 31st March 2015?
(4 Marks)
The Institute of Chartered Accountants of India
FINAL EXAMINATION: MAY, 2015
(c) PQR Ltd. has credit sales of ` 165 crores during the financial year 2014-15 and its average
collection period is 65 days. The past experience suggests that bad debt losses are 4.28%
of credit sales.
Administration cost incurred in collection of its receivables is ` 12,35,000 p.a. A factor is
prepared to buy the company's receivables by charging 1.95% commission. The factor will
pay advance on receivables to the company at an interest rate of 16% p.a. after withholding
15% as reserve.
Estimate the effective cost of factoring to the company assuming 360 days in a year.
(6 Marks)
(d) The following information is collected from the annual reports of J Ltd:
Profit before tax
` 2.50 crore
Tax rate
Retention ratio
40 percent
40 percent
Number of outstanding shares
Equity capitalization rate
50,00,000
12 percent
Rate of return on investment
15 percent
What should be the market price per share according to Gordon's model of dividend policy?
(4 Marks)
Answer
(a) Receipts using a forward contract = $10,000,000/0.016129
620,001,240
Receipts using currency futures
The number of contracts needed is ($10,000,000/0.016118)/24,816,975 = 25
Initial margin payable is 25 contracts x ` 22,500
5,62,500
619,732,276
OR (0.000016 x 25 x 24,816,975)/.016136 = 9926.79/0.016136 =
615,195
Less: Interest Cost ` 5,62,500 x 0.07 x 3/12
9,844
620,337,627
Forward contract
620,001,240
Futures
620,337,627
On April 1,2015 Close at 0.016134
Receipts = US$10,000,000/0.016136
Variation Margin =
[(0.016134 0.016118) x 25 x 24,816,975/-]/0.016136
Net Receipts
Receipts under different methods of hedging
The Institute of Chartered Accountants of India
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
No hedge (US$ 10,000,000/0.016136)
619,732,276
The most advantageous option would have been to hedge with futures.
(b) Calculation of effective yield on per annum basis in respect of three mutual fund schemes
to TUV Ltd. up to 31-03-2015:
PARTICULARS
MFX
(a) Investments
(b) Opening NAV
(c) No. of units
(a / b)
(f)
(c x d)
` 7,50,000
` 36.25
20,689.66
` 2,50,000
` 27.75
9,009
` 12.25
` 36.45
` 27.55
` 14,70,000
` 7,54,138
` 2,48,198
(` 30,000)
` 4,138
(` 1,802)
` 45,000
` 12,500
Nil
` 15,000
` 16,638
(` 1,802)
182
90
31
2.00%
9.00%
(-) 8.49%
Increase / Decrease of NAV ( a e)
(g) Dividend Received
(h) Total yield
(f + g)
(i)
Number of Days
(j)
Effective yield p.a. ( h/a x 365/i x 100)
MFZ
` 15,00,000
` 12.50
1,20,000
(d) Unit NAV ON 31-3-2015
(e) Total NAV on 31-3-2015
MFY
(c)
Particulars
` crore
Average level of Receivables = 165 crore 65/360
29.7916
Factoring commission = 29.7916crore1.95/100
0.5809
Factoring reserve = 29.7916crore 15/100
4.4687
Amount available for advance = ` 29.7916 (0.5809 + 4.4687)
24.742
Factor will deduct his interest @ 16%:-
24.742
16
65
100 360
Advance to be paid = (` 24.742` 0.7148)
` 0.7148
24.0272
Annual Cost of Factoring to the Firm:
` crore
Factoring commission (` 0.5809 crore 360/65)
3.2173
Interest charges (` 0.7148 crore 360/65)
3.9589
Total
7.1760
Firms Savings on taking Factoring Service:
`
0.1235
Cost of credit administration saved
The Institute of Chartered Accountants of India
FINAL EXAMINATION: MAY, 2015
Cost of Bad Debts (` 165 crore 4.28/100) avoided
7.0620
Total
7.1855
-0.0095
Net cost to the Firm (` 7.1760 ` 7.1855)
-0.0095 100
Effective cost of factoring to the firm =
-0.0395%
24.0272
(d) Gordons Formula
P0
E(1 b)
K br
P0
Market price per share
Earnings per share (` 1.50 crore/ 50,00,000) = ` 3
Cost of Capital = 12%
Retention Ratio (%) = 40%
IRR = 15%
br
Growth Rate (0.40X15%) = 6%
P0
1.80
Rs. 1.80
=
0.06
0.12-0.06
` 30.00
3(1-0.40)
0.12-0.06
Question 2
(a) Mr. Shyam is holding the following securities:
Particulars
Securities
of
Cost `
Dividend Interest
Market Price
Beta
Equity shares:
Gold Ltd.
10,000
1,725
9,800
0.6
Silver Ltd.
15,000
1,000
16,200
0.8
Bronze Ltd.
14,000
700
20,000
0.6
36,000
3,600
34,500
1.0
GOI Bonds
Average return of the portfolio is 15.7%.
Using Average Beta, Calculate:
The Institute of Chartered Accountants of India
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
(i)
Expected rate of return in each case, using the Capital Asset Pricing Model (CAPM)
(ii) Risk free rate of return
(b) On
31st
(8 Marks)
March, 2013, the following information about Bonds is available:
Name of Security
Face
Value `
Zero coupon
T-Bill
10,000
Maturity Date
Coupon
Rate
31st March, 2023
N.A.
1,00,000
20th
N.A.
100
31st
100
31st
10.71% GOI 2023
10 % GOI 2018
June, 2013
March, 2023
March, 2018
10.71
10.00
Coupon
Date(s)
N.A.
N.A.
31st
March
31st
March &
31st October
Calculate:
(i)
If 10 years yield is 7.5% p.a. what price the Zero Coupon Bond would fetch on 31 st
March, 2013?
(ii) What will be the annualized yield if the T-Bill is traded @ 98500?
(iii) If 10.71% GOI 2023 Bond having yield to maturity is 8%, what price would it fetch on
April 1, 2013 (after coupon payment on 31 st March)?
(iv) If 10% GOI 2018 Bond having yield to maturity is 8%, what price would it fetch on
April 1, 2013 (after coupon payment on 31 st March)?
(8 Marks)
Answer
(a)
Particulars of Securities
Cost (`) Dividend (`) Capital gain (`)
Gold Ltd.
10,000
1,725
200
Silver Ltd.
Bronze Ltd.
15,000
14,000
1,000
700
1,200
6,000
GOI Bonds
36,000
3,600
1,500
Total
75,000
7,025
5,500
Expected rate of return on market portfolio
Dividend Earned Capital appreciation
Initial investment
` 7,025 ` 5,500
100 16.7%
` 75,000
The Institute of Chartered Accountants of India
100
FINAL EXAMINATION: MAY, 2015
Risk free return
Average of Betas
0.6 0.8 0.6 1.0
4
Average of Betas = 0.75
Average return = Risk free return + Average Betas (Expected return Risk free return)
15.7 = Risk free return + 0.75 (16.7 Risk free return)
Risk free return = 12.7%
Expected Rate of Return for each security is
Rate of Return
= Rf + (Rm Rf)
Gold Ltd.
= 12.7 + 0.6 (16.7 12.7) = 15.10%
Silver Ltd.
= 12.7 + 0.8 (16.7 12.7) = 15.90%
Bronz Ltd.
= 12.7+ 0.6 (16.7 12.7) = 15.10%
GOI Bonds
= 12.7 + 1.0 (16.7 12.7) = 16.70%
Alternatively by using Market Risk Premium
Gold Ltd.
= 12.7 + 0.6 x 4%
= 15.10%
Silver Ltd.
= 12.7 + 0.8 x 4%
= 15.90%
Bronz Ltd.
= 12.7+ 0.6 x 4%
= 15.10%
GOI Bonds
= 12.7 + 1.0x 4%
= 16.70%
(b) (i)
Rate used for discounting shall be yield. Accordingly ZCB shall fetch:
=
10000
= ` 4,852
(1 0.075)10
(ii) The day count basis is actual number days / 365. Accordingly annualized yield shall
be:
Yield
FV-Price
365
100000-98500 365
=
= 6.86%
Price
No. of days
98500
81
Note: Alternatively, it can also computed on 360 days a year.
(iii) Price GOI 2023 would fetch
= ` 10.71 PVAF(8%, 10) + ` 100 PVF (8%, 10)
= ` 10.71 x 6.71 + ` 100 x 0.4632
= ` 71.86 + ` 46.32 = ` 118.18
The Institute of Chartered Accountants of India
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
(iv) Price GOI 2018 Bond would fetch:
= ` 5 PVAF (4%, 10) + ` 100 PVF (4%, 10)
= ` 5 x 8.11 + ` 100 x 0.6756
= 40.55 + 67.56 = 108.11
Question 3
(a) R Ltd. and S Ltd. are companies that operate in the same industry. The financial statements
of both the companies for the current financial year are as follows:
Balance Sheet
Particulars
R. Ltd. (` )
S. Ltd (` )
20,00,000
16,00,000
Retained earnings
Non-current Liabilities
4,00,000
16% Long term Debt
Current Liabilities
10,00,000
14,00,000
6,00,000
8,00,000
Total
Assets
48,00,000
30,00,000
Non-current Assets
Current Assets
20,00,000
28,00,000
10,00,000
20,00,000
Total
48,00,000
30,00,000
R. Ltd. (` )
S. Ltd. (` )
Equity & Liabilities
Shareholders Fund
Equity Capital (` 10 each)
Income Statement
Particulars
A.
B.
Net Sales
Cost of Goods sold
69,00,000
55,20,000
34,00,000
27,20,000
C.
Gross Profit (A-B)
13,80,000
6,80,00
D.
Operating Expenses
4,00,000
2,00,000
E.
Interest
1,60,000
96,000
F.
Earnings before taxes [C-(D+E)]
8,20,000
3,84,000
G.
Taxes @ 35%
2,87,000
1,34,400
H.
Earnings After Tax (EAT)
5,33,000
2,49,600
The Institute of Chartered Accountants of India
FINAL EXAMINATION: MAY, 2015
Additional Information:
No. of equity shares
2,00,000
1,60,000
20%
30%
` 50
` 20
Dividend payment Ratio (D/P)
Market price per share
Assume that both companies are in the process of negotiating a merger through exchange
of Equity shares:
You are required to:
(i)
Decompose the share price of both the companies into EPS & P/E components. Also
segregate their EPS figures into Return On Equity (ROE) and Book Value/Intrinsic
Value per share components.
(ii) Estimate future EPS growth rates for both the companies.
(iii) Based on expected operating synergies, R Ltd. estimated that the intrinsic value of S
Ltd. Equity share would be ` 25 per share on its acquisition. You are required to
develop a range of justifiable Equity Share Exchange ratios that can be offered by R
Ltd. to the shareholders of S Ltd. Based on your analysis on parts (i) and (ii), would
you expect the negotiated terms to be closer to the upper or the lower exchange ratio
limits and why?
(8 Marks)
(b) Following are the details of a portfolio consisting of three shares:
Share
Portfolio weight
Beta
Expected return in %
Total variance
A
B
0.20
0.50
0.40
0.50
14
15
0.015
0.025
0.30
1.10
21
0.100
Standard Deviation of Market Portfolio Returns = 10%
You are given the following additional data:
Covariance (A, B)
= 0.030
Covariance (A, C)
= 0.020
Covariance (B, C)
= 0.040
Calculate the following:
(i)
The Portfolio Beta
(ii) Residual variance of each of the three shares
(iii) Portfolio variance using Sharpe Index Model
(iv) Portfolio variance (on the basis of modern portfolio theory given by Markowitz)
Marks)
The Institute of Chartered Accountants of India
(8
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
Answer
(a) (i)
Determination of EPS, P/E Ratio, ROE and BVPS of R Ltd.& S Ltd.
R Ltd.
S Ltd.
5,33,000
2,49,600
200000
160000
2.665
1.56
50
20
18.76
12.82
2400000
1600000
12
10
ROE (EAT EF) or
0.2221
0.156
ROE (EAT EF)
22.21%
15.60%
EAT (`)
N
EPS (EATN)
Market Price Per Share
PE Ratio (MPS/EPS)
Equity Fund (Equity Value)
BVPS (Equity Value N)
(ii) Determination of Growth Rate of EPS of R Ltd.& S Ltd.
R Ltd.
S Ltd.
0.80
0.70
0.1777
17.77%
0.1092
10.92%
Retention Ratio (1-D/P Ratio)
Growth Rate (ROE x Retention Ratio) or
Growth Rate (ROE x Retention Ratio)
(iii) Justifiable equity share exchange ratio
(a) Market Price Based = MPS S/MPSR = ` 20/ ` 50 = 0.40:1 (lower limit)
(b) Intrinsic Value Based = ` 25/ ` 50 = 0.50:1 (max. limit)
Since R Ltd. has higher EPS, PE, ROE and higher growth expectations the negotiated term
would be expected to be closer to the lower limit, based on existing share price.
(b) (i)
Portfolio Beta
0.20 x 0.40 + 0.50 x 0.50 + 0.30 x 1.10 = 0.66
(ii) Residual Variance
To determine Residual Variance first of all we shall compute the Systematic Risk as
follows:
2
2A M
= (0.40)2(0.01) = 0.0016
2
B2 M
= (0.50)2(0.01) = 0.0025
2
2C M
= (1.10)2(0.01) = 0.0121
The Institute of Chartered Accountants of India
10
FINAL EXAMINATION: MAY, 2015
Residual Variance
A
0.015 0.0016 = 0.0134
0.025 0.0025 = 0.0225
0.100 0.0121 = 0.0879
(iii) Portfolio variance using Sharpe Index Model
Systematic Variance of Portfolio = (0.10) 2 x (0.66)2 = 0.004356
Unsystematic Variance of Portfolio = 0.0134 x (0.20) 2 + 0.0225 x (0.50) 2 + 0.0879 x (0.30) 2
= 0.014072
Total Variance = 0.004356 + 0.014072 = 0.018428
(iii) Portfolio variance on the basis of Markowitz Theory
= (wA x wAx 2A ) + (wA x wBx CovAB) + (wA x wCx CovAC) + (wB x wAx Cov AB) + (wB x wBx
B2 ) + (wB x wCx CovBC) + (wC x wAx CovCA) + (wC x wBx CovCB) + (wC x wCx 2c )
= (0.20 x 0.20 x 0.015) + (0.20 x 0.50 x 0.030) + (0.20 x 0.30 x 0.020) + (0.20 x 0.50 x
0.030) + (0.50 x 0.50 x 0.025) + (0.50 x 0.30 x 0.040) + (0.30 x 0.20 x 0.020) + (0.30
x 0.50 x 0.040) + (0.30 x 0.30 x 0.10)
= 0.0006 + 0.0030 + 0.0012 + 0.0030 + 0.00625 + 0.0060 + 0.0012 + 0.0060 + 0.0090
= 0.0363
Question 4
(a) A manufacturing unit engaged in the production of automobile parts is considering a
proposal of purchasing one of the two plants, details of which are given below:
Particulars
Plant A
Plant B
` 20,00,000
` 4,00,000
` 38,00,000
` 2,00,000
20 years
15 years
Scrap value after full life
` 4,00,000
` 4,00,000
Output per minute (units)
200
400
Cost
Installation charges
Life
The annual costs of the two plants are as follows:
Particulars
Running hours per annum
Costs:
Wages
The Institute of Chartered Accountants of India
Plant A
Plant B
2,500
2,500
(In ` )
1,00,000
(In ` )
1,40,000
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
11
Indirect materials
4,80,000
6,00,000
Repairs
Power
80,000
2,40,000
1,00,000
2,80,000
60,000
80,000
Fixed Costs
Will it be advantageous to buy Plant A or Plant B? Substantiate your answer with the help
of comparative unit cost of the plants. Assume interest on capital at 10 percent. Make other
relevant assumptions:
Note: 10 percent interest tables
20 Years
15 Years
Present value of ` 1
0.1486
0.2394
Annuity of ` 1 (capital recovery factor with 10% interest)
0.1175
0.1315
(7 Marks)
(b) An importer booked a forward contract with his bank on
April for USD 2,00,000 due on
10th June @ ` 64.4000. The bank covered its position in the market at ` 64.2800.
10 th
The exchange rates for dollar in the interbank market on 10 th June and 20 th June were:
10th June
Spot USD 1=
Sport/June
July
August
September
`
`
`
`
`
63.8000/8200
63.9200/9500
64.0500/0900
64.3000/3500
64.6000/6600
20th June
` 63.6800/7200
` 63.8000/8500
` 63.9300/9900
` 64.1800/2500
` 64.4800/5600
Exchange Margin 0.10% and interest on outlay of funds @ 12%. The importer requested
on 20th June for extension of contract with due date on 10 th August.
Rates rounded to 4 decimal in multiples of 0.0025.
On 10th June, Bank Swaps by selling spot and buying one month forward.
Calculate:
(i)
Cancellation rate
(ii) Amount payable on $ 2,00,000
(iii) Swap loss
(iv) Interest on outlay of funds, if any
(v) New contract rate
(vi) Total Cost
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(9 Marks)
12
FINAL EXAMINATION: MAY, 2015
Answer
(a) Working Notes:
Calculation of Equivalent Annual Cost
Cash Outlay
Less:
Machine A
Machine B
` 24,00,000
` 40,00,000
PV of Salvage Value
4,00,000 x 0.1486
` 59,440
4,00,000 x 0.2394
` 95,760
Annuity Factor
0.1175
0.1315
` 2,75,016
` 5,13,408
Computation of Cost Per Unit
Machine A
Machine B
2500 x 60 x 200
2500 x 60 x 400
= 3,00,00,000
= 6,00,00,000
Wages
Indirect Material
`
1,00,000
4,80,000
`
1,40,000
6,00,000
Repairs
Powers
80,000
2,40,000
1,00,000
2,80,000
Fixed Cost
Equivalent Annual Cost
60,000
2,75,016
80,000
5,13,408
Total
12,35,016
17,13,408
Cost Per Unit (b)/(a)
0.041167
0.02860
Annual Output (a)
Annual Cost (b)
Decision: As the unit cost is less in proposed Plant B, it may be recommended that it is
advantageous to acquire Plant B.
(b) (i)
Cancellation Rate:
The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing on the
date of cancellation as follows:
$/ ` Market Buying Rate
The Institute of Chartered Accountants of India
` 63.6800
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
13
Less: Exchange Margin @ 0.10%
` 0.0636
` 63.6163
Rounded off to ` 63.6175
(ii) Amount payable on $ 2,00,000
Bank sells $2,00,000 @ ` 64.4000
` 1,28,80,000
Bank buys $2,00,000 @ ` 63.6163
` 1,27,23,260
Amount payable by customer
1,56,740
(iii) Swap Loss
On 10th June the bank does a swap sale of $ at market buying rate of ` 63.8300 and
forward purchase for June at market selling rate of ` 63.9500.
Bank buys at
` 63.9500
Bank sells at
` 63.8000
Amount payable by customer
` 0.1500
Swap Loss for $ 2,00,000 in ` = ` 30,000
(iv) Interest on Outlay of Funds
On 10thApril, the bank receives delivery under cover contract at ` 64.2800 and sell spot at
` 63.8000.
Bank buys at
` 64.2800
Bank sells at
` 63.8000
Amount payable by customer
` 0.4800
Outlay for $ 2,00,000 in ` 96,000
Interest on ` 96,000 @ 12% for 10 days
` 320
(v) New Contract Rate
The contract will be extended at current rate
$/ ` Market forward selling Rate for August
Add: Exchange Margin @ 0.10%
` 64.2500
` 0.0643
` 64.3143
Rounded off to Rs. 64.3150
(vi) Total Cost
Cancellation Charges
The Institute of Chartered Accountants of India
` 1,56,740.00
14
FINAL EXAMINATION: MAY, 2015
Swap Loss
` 30,000.00
Interest
` 320.00
` 1,87,060.00
Question 5
(a) Bank 'R' was established in 2005 and doing banking in India. The bank is facing DO OR
DIE situation. There are problems of Gross NPA (Non Performing Assets) at 40% &
CAR/CRAR (Capital Adequacy Ratio/ Capital Risk Weight Asset Ratio) at 4%. The net
worth of the bank is not good. Shares are not traded regularly. Last week, it was traded
@` 8 per share.
RBI Audit suggested that bank has either to liquidate or to merge with other bank.
Bank 'P' is professionally managed bank with low gross NPA of 5%.It has Net NPA as 0%
and CAR at 16%. Its share is quoted in the market @ ` 128 per share. The board of
directors of bank 'P' has submitted a proposal to RBI for take over of bank 'R' on the basis
of share exchange ratio.
The Balance Sheet details of both the banks are as follows:
Bank R
Amt. in ` lacs
Bank P
Amt. In ` lacs
Paid up share capital
140
500
Reserves & Surplus
70
5,500
4,000
40,000
890
2,500
5,100
48,500
Cash in hand & with RBI
400
2,500
Balance with other banks
2,000
Investments
1,100
15,000
Advances
3,500
27,000
Other Assets
100
2,000
Total Assets
5,100
48,500
Deposits
Other liabilities
Total Liabilities
It was decided to issue shares at Book Value of Bank 'P' to the shareholders of Bank 'R'.
All assets and liabilities are to be taken over at Book Value.
For the swap ratio, weights assigned to different parameters are as follows:
Gross NPA
The Institute of Chartered Accountants of India
30%
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
15
CAR
20%
Market price
40%
Book value
10%
(a)
What is the swap ratio based on above weights?
(b)
How many shares are to be issued?
(c)
Prepare Balance Sheet after merger.
(d)
Calculate CAR & Gross NPA % of Bank 'P' after merger.
(11 Marks)
(b) DEF Ltd. has imported goods to the extent of US$ 1 crore. The payment terms are 60 days
interest-free credit. For additional credit of 30 days, interest at the rate of 7.75% p.a. will
be charged.
The banker of DEF Ltd. has offered a 30 days loan at the rate of 9.5% p.a. Their quote for
the foreign exchange is as follows:
Spot rate INR/US$
62.50
60 days forward rate INR/US$
63.15
90 days forward rate INR/US$
63.45
Which one of the following options would be better?
(i)
Pay the supplier on 60 th day and avail bank loan for 30 days.
(ii) Avail the supplier's offer of 90 days credit.
(5 Marks)
Answer
(a) (a) Swap Ratio
Gross NPA
5 : 40
i.e.
5/40 x 30% =
0.0375
CAR
4 : 16
i.e.
4/16 x 20% =
0.0500
Market Price
8 : 128
i.e.
8/128 x 40% =
0.025
Book Value
15 : 120
15/120 x 10% =
0.0125
i.e.
0.125
Thus for every share of Bank R 0.125 share of Bank P shall be issued.
(b) No. of equity shares to be issued:
Rs. 140 lac
Rs. 10
0.125 1.75 lac shares
(c) Balance Sheet after Merger
Calculation of Capital Reserve
The Institute of Chartered Accountants of India
16
FINAL EXAMINATION: MAY, 2015
Book Value of Shares
` 210.00 lac
Value of Shares issued
` 17.50 lac
Capital Reserve
` 192.50 lac
Balance Sheet
` lac
Paid up Share Capital
` lac
517.50 Cash in Hand & RBI
Reserves & Surplus
2900.00
5500.00 Balance with other banks
Capital Reserve
192.50 Investment
Deposits
16100.00
44000.00 Advances
Other Liabilities
2000.00
30500.00
3390.00 Other Assets
2100.00
53600.00
53600.00
(d) Calculation CAR & Gross NPA % of Bank P after merger
CAR/CRWAR
Total Capital
Risky Weighted Assets
Total Capital
Risky Weighted Assets
CAR
Rs.6210 lac
Rs.42750 lac
GNPA Ratio
Bank R
Bank P
Merged
4%
16%
` 210 lac
` 6000 lac
` 6210 lac
` 5250 lac
` 37500 lac
` 42750 lac
14.53%
Gross NPA
100
Gross Deposits
GNPA (Given)
0.40
Bank R
Bank P
0.40
0.05
GNPA R
Rs. 3500 lac
The Institute of Chartered Accountants of India
0.05
GNPA S
Rs. 27000 lac
Merged
` 6210 lac
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
Gross NPA
(b) (I)
` 1400 lac
17
` 1350 lac
` 2750 lac
Pay the supplier in 60 days
If the payment is made to supplier in 60 days the applicable forward
rate for 1 USD
Payment Due
` 63.15
USD 1 crore
Outflow in Rupees (USD 1 crore ` 63.15)
` 63.15 crore
Add: Interest on loan for 30 [email protected]% p.a.
` 0.50 crore
Total Outflow in `
` 63.65 crore
(II) Availing suppliers offer of 90 days credit
Amount Payable
USD 1.00000crore
Add: Interest on credit period for 30 [email protected]% p.a.
USD 0.00646 crore
Total Outflow in USD
USD 1.00646 crore
Applicable forward rate for 1 USD
Total Outflow in ` (USD 1.00646 crore ` 63.45)
` 63.45
` 63.86 crore
Alternative 1 is better as it entails lower cash outflow.
Question 6
(a) R Ltd., requires a machine for 5 years. There are two alternatives either to take it on lease
or buy. The company is reluctant to invest initial amount for the project and approaches
their bankers. Bankers are ready to finance 100% of its initial required amount at 15% rate
of interest for any of the alternatives.
Under lease option, upfront Security deposit of ` 5,00,000/- is payable to lessor which is
equal to cost of machine. Out of which, 40% shall be adjusted equally against annual lease
rent. At the end of life of the machine, expected scrap value will be at book value after
providing, depreciation @ 20% on written down value basis.
Under buying option, loan repayment is in equal annual installments of principal amount,
which is equal to annual lease rent charges. However in case of bank finance for lease
option, repayment of principal amount equal to lease rent is adjusted every year, and the
balance at the end of 5th year.
Assume Income tax rate is 30%, interest is payable at the end of every year and discount
rate is @ 15% p.a. The following discounting factors are given:
The Institute of Chartered Accountants of India
18
FINAL EXAMINATION: MAY, 2015
Year
Factor
0.8696
0.7562
0.6576
0.5718
0.4972
Which option would you suggest on the basis of net present values?
(8 Marks)
(b) There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having
close ended equity schemes.
NAV as on 31-12-2014 of equity schemes of D Mutual Fund Ltd. is ` 70.71 (consisting
99% equity and remaining cash balance) and that of K Mutual Fund Ltd. is 62.50 (consisting
96% equity and balance in cash).
Following is the other information:
Equity Schemes
Particular
D Mutual Fund Ltd.
K Mutual Fund Ltd.
Sharpe Ratio
3.3
Treynor Ratio
15
15
11.25
Standard deviation
There is no change in portfolios during the next month and annual average cost is ` 3 per
unit for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month
for the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular
month.
(8 Marks)
Answer
(a) Cash outflow under borrow and buy option
Working Notes:
1.
Calculation of Interest Amount
Year
Repayment of
Principal (`)
Principal
Outstanding (`)
Interest (`)
Closing
Balance (`)
1,00,000
5,00,000
75,000
4,00,000
1,00,000
4,00,000
60,000
3,00,000
1,00,000
3,00,000
45,000
2,00,000
1,00,000
2,00,000
30,000
1,00,000
1,00,000
1,00,000
15,000
The Institute of Chartered Accountants of India
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
2.
Depreciation Schedule
Year
3.
19
Opening Balance
(`)
Depreciation (`)
Closing Balance (`)
5,00,000
1,00,000
4,00,000
4,00,000
80,000
3,20,000
3,20,000
64,000
2,56,000
2,56,000
51,200
2,04,800
2,04,800
40,960
1,63,840
Tax Benefit on Depreciation and Interest
Year
Interest (`)
Depreciation (`)
Total (`)
Tax Benefit @
30% (`)
1
2
75,000
60,000
1,00,000
80,000
1,75,000
1,40,000
52,500
42,000
3
4
45,000
30,000
64,000
51,200
1,09,000
81,200
32,700
24,360
15,000
40,960
55,960
16,788
PV of Cash Outflow in Borrow and Buying Option
Year
Cash outflow
(`)
Tax Benefit
(`)
Net Cash
Outflow (`)
PVF@15%
PV (`)
1,75,000
52,500
1,22,500
0.8696
1,06,526
1,60,000
42,000
1,18,000
0.7562
89,232
3
4
1,45,000
1,30,000
32,700
24,360
1,12,300
1,05,640
0.6576
0.5718
73,848
60,405
1,15,000
16,788
98,212
0.4972
48,831
(1,63,840)
(1,63,840)
0.4972
(81,461)
2,97,381
Cash outflow under borrow and lease option
Cash payment to Lessor/ Tax Benefits on Lease Payment (Annual Lease Rent
= `1,00,000)
Year
Net Lease
Rent(`)
The Institute of Chartered Accountants of India
Security Deposit
(`)
Tax Benefit on
Gross Lease
Rent (`)
Net Cash Outflow
(RS.)
20
FINAL EXAMINATION: MAY, 2015
60,000*
30,000
30,000
60,000
30,000
30,000
60,000
30,000
30,000
4
5
60,000
60,000
30,000
30,000
30,000
(2,70,000)
(3,00,000)
* ` 1,00,000 ` 40,000 = ` 60,000
Cash payment to Bank/ Tax Benefits on Interest Payment
Year
Principal
Payment (`)
Interest (`)
Total (`)
Tax Benefit
on Interest
(`)
Net Outflow
(`)
40,000
75,000
1,15,000
22,500
92,500
2
3
40,000
40,000
69,000
63,000
1,09,000
1,03,000
20,700
18,900
88,300
84,100
4
5
40,000
3,40,000
57,000
51,000
97,000
3,91,000
17,100
15,300
79,900
3,75,700
PV of Cash Outflow in Borrow and Leasing Option
Year
Cash outflow
to Bank(`)
Cash Outflow
under Lease
(RS.)
Total (`)
PVF@15%
PV (`)
1
2
92,500
88,300
30,000
30,000
1,22,500
1,18,300
0.8696
0.7562
1,06,526
89,458
84,100
30,000
1,14,100
0.6576
75,032
4
5
79,900
3,75,700
30,000
(2,70,000)
1,09,900
1,05,700
0.5718
0.4972
62,841
52,554
3,86,411
Since PV of cash outflow is least in case of borrow and buying option it should be opted
for.
(b) Working Notes:
(i)
Decomposition of Funds in Equity and Cash Components
NAV on 31.12.14
The Institute of Chartered Accountants of India
D Mutual Fund Ltd.
K Mutual Fund Ltd.
` 70.71
` 62.50
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
21
% of Equity
99%
96%
Equity element in NAV
` 70
` 60
` 0.71
` 2.50
Cash element in NAV
(ii) Calculation of Beta
(a) D Mutual Fund Ltd.
Sharpe Ratio = 2 =
E(R) - R f E(R) - Rf
=
11.25
D
E(R) - Rf = 22.50
Treynor Ratio = 15 =
E(R) - R f 22.50
=
D
D
D = 22.50/15= 1.50
(b) K Mutual Fund Ltd.
Sharpe Ratio = 3.3 =
E(R) - R f E(R) - Rf
=
5
K
E(R) - Rf = 16.50
Treynor Ratio = 15 =
E(R) - R f 22.50
=
K
K
K = 16.50/15= 1.10
(iii) Decrease in the Value of Equity
D Mutual Fund Ltd.
K Mutual Fund Ltd.
5.00%
5.00%
1.50
1.10
7.50%
5.50%
D Mutual Fund Ltd.
K Mutual Fund Ltd.
Cash in Hand on 31.12.14
` 0.71
` 2.50
Less: Exp. Per month
` 0.25
` 0.25
Balance after 1 month
` 0.46
` 2.25
Market goes down by
Beta
Equity component goes down
(iv) Balance of Cash after 1 month
NAV after 1 month
The Institute of Chartered Accountants of India
22
FINAL EXAMINATION: MAY, 2015
D Mutual Fund Ltd.
K Mutual Fund Ltd.
70 x (1 - 0.075)
` 64.75
60 x (1 - 0.055)
` 56.70
Cash Balance
0.46
2.25
65.21
58.95
Value of Equity after 1 month
Question 7
Write short notes on any four of the following:
(a) Explain the meaning of the following relating to Swap transactions:
(i) Plain Vanila Swaps
(ii) Basis Rate Swaps
(iii) Asset Swaps
(iv) Amortising Swaps
(b) Distinction between Open ended schemes and Closed ended schemes
(c) State any four assumptions of Black Scholes Model
(d) Give the meaning of Caps, Floors and Collar options with respect to Interest.
(e) Global depository receipts
(4 x 4 = 16 Marks)
Answer
(a) (i)
Plain Vanilla Swap: Also called generic swap andit involves the exchange of a fixed
rate loan to a floating rate loan. Floating rate basis can be LIBOR, MIBOR, Prime
Lending Rate etc.
(ii) Basis Rate Swap: Similar to plain vanilla swap with the difference payments based
on the difference between two different variable rates. For example one rate may be
1 month LIBOR and other may be 3-month LIBOR. In other words two legs of swap
are floating but measured against different benchmarks.
(iii) Asset Swap: Similar to plain vanilla swaps with the difference that it is the exchange
fixed rate investments such as bonds which pay a guaranteed coupon rate with
floating rate investments such as an index.
(iv) Amortising Swap: An interest rate swap in which the notional principal for the interest
payments declines during the life of the swap. They are particularly useful for
borrowers who have issued redeemable bonds or debentures. It enables them to
interest rate hedging with redemption profile of bonds or debentures.
The Institute of Chartered Accountants of India
PAPER 2 : STRATEGIC FINANCIAL MANAGEMENT
23
(b) Open Ended Scheme do not have maturity period. These schemes are available for
subscription and repurchase on a continuous basis. Investor can conveniently buy and sell
unit. The price is calculated and declared on daily basis. The calculated price is termed as
NAV. The buying price and selling price is calculated with certain adjustment to NAV. The
key future of the scheme is liquidity.
Close Ended Scheme has a stipulated maturity period normally 5 to 10 years. The Scheme
is open for subscription only during the specified period at the time of launch of the scheme.
Investor can invest at the time of initial issue and thereafter they can buy or sell from stock
exchange where the scheme is listed. To provide an exit rout some close -ended schemes
give an option of selling bank (repurchase) on the basis of NAV. The NAV is generally
declared on weekly basis.
(c) The model is based on a normal distribution of underlying asset returns. The following
assumptions accompany the model:
1.
European Options are considered,
2.
No transaction costs,
3.
Short term interest rates are known and are constant,
4.
Stocks do not pay dividend,
5.
Stock price movement is similar to a random walk,
6.
Stock returns are normally distributed over a period of time, and
7.
The variance of the return is constant over the life of an Option.
(d) Cap Option: It is a series of call options on interest rate covering a medium-to-long term
floating rate liability. Purchase of a Cap enables the a borrowers to fix in advance a
maximum borrowing rate for a specified amount and for a specified duration, while allowing
him to avail benefit of a fall in rates. The buyer of Cap pays a premium to the seller of Cap.
Floor Option: It is a put option on interest rate. Purchase of a Floor enables a lender to
fix in advance, a minimal rate for placing a specified amount for a specified duration, while
allowing him to avail benefit of a rise in rates. The buyer of the floor pays the premium to
the seller.
Collars Option: It is a combination of a Cap and Floor. The purchaser of a Collar buys a
Cap and simultaneously sells a Floor. A Collar has the effect of locking its purchases into
a floating rate of interest that is bound on both high side and the low side.
(e) Global Depository Receipt: It is an instrument in the form of a depository receipt or
certificate created by the Overseas Depository Bank outside India denominated in dollar
and issued to non-resident investors against the issue of ordinary shares or FCCBs of the
issuing company. It is traded in stock exchange in Europe or USA or both. A GDR usually
represents one or more shares or convertible bonds of the issuing company.
The Institute of Chartered Accountants of India
24
FINAL EXAMINATION: MAY, 2015
A holder of a GDR is given an option to convert it into number of shares/bonds that it
represents after 45 days from the date of allotment. The shares or bonds which a holder
of GDR is entitled to get are traded in Indian Stock Exchanges. Till conversion, the GDR
does not carry any voting right. There is no lock-in-period for GDR.
The Institute of Chartered Accountants of India
