‘Name of participa Roll No. PART A Instructions: Each Question in this part carries 1 mark unless otherwise stated. Some questions camry penalty marks (mentioned clearly for each question). Question A-1 [1 mark; No negative marks] ‘Why is the goal of financial management to maximize the current value of the company’s stock? In other words, why isn’t the goal to maximize the future value? Maximizing the current share price is the same 2 maximizing the future share price at any future period. The value of a share of stock depends on all of the future cash flows of company. Another way to look at this is that, barring large cash payments to shareholders, the expected price of the stock must be higher in the Future than it is today. Who would buy a stock for $100 today when the share price in one year is expected to be $80? Question A-2 [1 mark; No negative marks] AB Limited is a zero-debt company and has 150 million shares outstanding with curent market price at 100 per share. Management of AB Limited has identified an investment opportunity that requires one-time initial capital outlay of £300 Crores that is to be raised from new investors by issuing new equity shares. The equity share price went up by 212 as soon as this mews released into the market. Assuming that the markets are efficient, how much is the value created by the said investment proposal? ‘Yes, this investment proposal has a positive NPV of 21800 million as the market capitalization is up by this amount as soon as this news is released to the market Question A-3 [2 marks; No negative marks] ‘You own equity shares in XZ Limited that are trading at 2250 per share. Salmon Sisters, another company, has just announced that it wants to buy XZ Limited and will pay %350 per share to acquire all the outstanding shares. Your company’s management immediately begins fighting off this hostile bid. Is management acting in the shareholders’ best interests? Why or why not? ‘The goal of management should be to maximize the share price for the current shareholders. If management believes that it can improve the profitability of the firm so that the share price will exceed 7350, then they should fight the offer from Salmon Sisters. If management believes that this bidder or other unidentified bidders vwill actually pay more than £350 per share to acquire the company, then they should still fight the offer. However, if the curent management cannot increase the value of the firm beyond the bid price, and no other higher bids come in, then management is not acting in the interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation is acquired, poorly monitored managers have ‘an incentive to fight corporate takeovers in situations such as this. Question A-4 [1 mark; No negative marks] Looking at the accounting statement of cash flows, what does the bottom line mumber mean? How useful is this number for analyzing a company? The bottom line number shows the change in the cash balance on the balance sheet. As such, itis not a useful ‘umber for analyzing a oompany Question A-5 [1 mark; No negative marks] Why is it not necessarily bad for the free cash flow to be negative for a particular period?Fora successfill company that is rapidly expanding, for example, capital outlays will be large, possibly leading to negative cash flow trom assets. In general, what matters is whether the money is spent wisely, not whether cash flow from assets is positive or negative Question A.6 [1 mark; Penalty of 1 mark for incorrect answer] Negative Cash Conversion Cyele (CCC) indicates that firm is financing its working capital from. Suppliers’ money/ Payables Question A-7 [1 mark; Penalty of 1 mark for incorrect answer] uses forecasts of cash inflows, outflows, and ending cash balances to predict loan needs and funds available for temporary investment Cash budget Question AB [1 mark; Penalty of 1 mark for incorrect answer] Another name of “/een-and-mean” policy of current assets management is Restricted policy Question A.9 [1 mark; Penalty of 1 mark for incorrect answer] An. ‘breaks down a firm's receivables by age of account. Aging schedule Question ALO [1 mark; Penalty of | mark for incorrect answer] A fimancial instrument issued by a financially sound corporate firm, is unsecured, isa short-term debt is Commercial paper Question A-l1 [1 mark; Penalty of 1 mark for incorrect answer] ‘The underwriter guarantees the sale of the issued stock at the agreed upon price. Which underwriting contract is this? Fim commitment contract Question A-12 [1 mark; Penalty of 1 mark for incorrect answer] According to the prices are always correct since they reflect all available ‘information. Efficient Markets hypothesisQuestion A-13 Ol mark] A firm can obtain capital from and before it can proceed to the primary market. Angel investors and Venture capitalists Question A-14 {0 mark; Penalty of 1 mark for incorrect answer] “T give you something and then take it back: the net transaction leaves you worse off” The above statement reflects a phenomenon in behavioural finance that is referred to as Loss aversion Question A-15 1 mark; Penalty of ] mark if all options are not mentioned] ‘Which ofthe four altematives are not common between these three financial instruments? Certificate of Deposit, Treasury Bills, Commercial Paper A. Highly liquid: Low risk. B. Unsecured instruments; Not negotiable C. Maturity period <1 year; Issued at par D. Zero coupon instrument B,CandD Question A-16 [1 mark; Penalty of 0.25 marks for each incorrect answer] In the equity market in USA, it was observed that an IPO was issued at $100 and was listed at $15. In the Indian. market, it was observed that another IPO was issued at 250 and was listed at 230. In the latter case, itis an instance of, by an amount of, ‘and in the former, it indicates by___% Answer Fomer case ~ Underpricing by 50% Latter case — Overpricing by 40% Question A-17 [1 mark; Penalty of | mark for incorrect answer] Hemant has just obtained news ftom one of the Board of Directors of a firm ‘Omega’. Based on this information, he feels that the stock is worth buying and has gone ahead. Hemant has not gained anything substantially based on this information. In this case, the market is deemed to be efficient in the fom. Strong formIf. market is efficient in the strong form, then one can't benefit from insider information to make any gains. Question A-18 [1 mark; Penalty of | mark for incorrect answer] ‘The regulator of primary markets in India is ‘while in the USA this role is performed by - (Write the full fom, Acronym will be considered as incorrect answer). Securities and Exchange Board of India (SEBD) Securities and Exchange Commission (SEC) Question A19 [1 mark; Penalty of 1 markif all options are not mentioned] In the case relating to the IPO of Netscape, which of the following are True? ‘A. Netscape had an increase in the offering price due to over-subscription B. Theroad show before the public issue was effective C. Netscape opted for the IPO to generate funds for its future growth and for potential acquisitions. D. Netscape had generated profit before bringing out its public issue BandC Question A-20 [1 mark; Penalty of 0.50 marks for each incorrect answer] Risk and time preference for consumption are two of the factors that affect the cost of money. The other two are and Production opportunities; inflationPartB: Answer all questions. Show all your calculations. ‘Name of participant: Roll No.: Question B-1 [Penalty of | mark per partif detailed steps/caleulations are not provided] (4 marks) Abhi Agro Limited has sales of 20,000 lakhs, costs (excluding depreciation) of 11,100 lakhs, depreciation expense of 22,100 lakhs, and interest expense of 21,300 laks. The tax rate is 30%. The 2020 balance sheet showed net operating working capital (NOWC) of 29,400 lakhs, and the 2021 balance sheet showed NOWC of 211,300 lakhs. Likewise, the 2020 balance sheet showed net fixed assets of [14,200 lakhs, and the 2021 balance sheet showed net fixed assets of £17,100 lakhs. ‘2. How much was the free cash flow during the year 2021? [2.5 marks] '. Suppose the company paid out £2,000 lakhs as dividend for the year 2021. How much was the increase in debt during year 20217 LS marks] Solution: 2. NOPAT for the year 2021 = (20000 ~ 11100-2100) x (1-0.3) = 24,760 lakchs Capital used in year 2021 = ANOWC 1,900 ~ ANFA 2,900 = &4,800 lakhs FCFF for year 2021 = 4,760 — 4800 = -40 lakhs b. FCF to lenders = -40— 2000=-2,040 lakhs Increase in level of debt = 2,040 + 0.7 x 1300 = 22,950 lakhs Question B2 [Penalty of 1 mark per part if detailed steps/ealeulations are not provided] (4 marks) ‘The management of Agni Dust Tea Limited (ADTL) is carrying a financial planing exercise for Year 2022 using the percentage of sales approach (AFN method). The following ratios for year 2021 provided: ‘Assets to sales = 1.42 Spontaneous liabilities to sales = 0.228 Profit margin = 18% Retention ratio = Sales for the year 2021 is 75,000 lakhs. The management anticipated 30% growth in sales for year 2022 and is considering the following operating strategies and fimancing strategies. (@) No change in any policy variable (b) Increase spontaneous liabilities to sales to 0.30 and retain 70% of the earnings (©) Reduces Asset to sales ratio to 1.30 and raise the profit margin to 20% Estimate the amount of external financing in each of the above scenarios. (@+1+1=4 marks) Sok (a) Increase in. Assets = 1.42 x 5,000 x 0.3 = 2,130 Increase in spontaneous liabilities = 0.228 x 5,000 x 0.3=342 Increase in retained earnings = $000 x 1.3.x 0.18 x 0.6= 702 EFN = 2,130 342-702 = 1,086 361 928 (b) EFN = 1086 — (0.3 — 0.228) x 1500-1170 x 0. (©) EFN= 1086 — 1,500 x 0.12 — 6,500 x 0.02 x 0.Question BS [Penalty of | mark per partif detailed steps/calculations are not provided] marks) (@) Mindware limited has a DSO of 25 days. The company averages £345,000 in credit sales each day. What is the company’s average accounts receivable investment? (1 mark) Given: Days of Sales Outstanding (DSO) = 25; Credit Sales/Day = 34 DSO= Accounts Receivables / Sales per day 25 = AR/ 345000 AR=25 x 3,45,000= 286,25,000 Answer= 286,25,000 0 (®) Asha Marriot Corporation needs to raise £1,000,000 for 1 year to supply working capital to a new store in Bengaluru. Asha Marriot buys from its suppliers on terms of 2/10, net 60, and it currently pays on the 10th day and takes discounts. However, it could forgo the discounts, pay on the 60th day, and thereby obtain the needed 71,000,000 in the form of costly trade credit 1. How much is the nominal cost of trade credit? 2. How much is the effective cost of trade credit? (@ marks) Given: 2/10 Net 60; Total amount: 21,000,000 Stop 1: Compute the nominal cost ‘Annual Nomizal cost = (Discount 1- discount rate’) X (365/credit period - discount period) Annual Normal cost = (2/98) x (365/50) .0204 x 7.3 = 14.892% ‘Step 2- Compute the EAR EAR=(1 + Periodic rate)"—1 EAR =(1.0204)-1= 0.158842154 Answer = 15.88% (© Following information is from Dell's 2013 income statement and balance sheet (number are in $ million). Use it to compute Dell's operating cycle and cash conversion cycle. (1+1 = 02 marks) Parca mount Sales 36510 Cost oF goods sold ase counts receivable oa Tveatory Ta Page 7 of 22‘Accounts payable T Operating cycle = DIO+ DSO Operating cycle = 11.27+ 63.09 = 74.36 ‘Step 2: Compute the cash conversion cyele (CCC) CCC = DIO+DSO-DPO (Or Operating cycle - DPO) DPO=AP/Average daily COGS DPO = 15,223/122.61 = 124.16 CCC = 74,36-124,16 =-49,80Question B4 [Penalty of 1 mark per part if detailed steps/calculations are not provided] (6 marks) Selected ratios and other information of Suresh pharmaceutical limited (SPL) are given below: Ratio Suresh Pharma Limited Industry Current 35 450 Quick 232 TLAssets ‘Tumover of Cash 32.22 DSO (365-day year) 90.63 64.00 Inv. Tumover 31.60 50.00 FA. Tumover 715 13.22 TA. Tumover 2.60 3.00 Profit Margin ROE Payables deferral period 63.00 L.__ Based on the data, SPL seem to be following what iype of working capital policy? IT Assume SPL buys Rs 300,000 of materials net, on terms of 1/10, net 40 but pays om Day 50. Findjfee cand costly trade credit TI. _IESPL matches with industry standard what will be the impact on its financial positions and shareholder value. (@+2+2=6marks) Solution: I SPL is following a relaxed policy (refer the CCC for SPL and Industry) ig Net Daily purchase (Total purchases/365) =300000/365= 821.92 Amnual Gross Purchase ~300000/(1-0.01) = 303030.30 Free and Costly Trade Credit Payables level for equipment if take discount: 821.92 x10 = 8219 (Free credit) Payables level for equipment if does not take discount: = $21.92 x 40 = 328768 Total Costly credit = 32876.80- 8219 = 24657.80 (Costly credit) TI IfSPL matches with the industry it will (a) Cash will increase as inventory purchases decline. (b) cash ‘will also increase as it tighten its credit policy Cleading) the receivables. (c) cash can be used to expand cher productive assets or invest in short term assets (d) ROE will improve as sales will increase (¢) All ‘these will likely to have a positive impact on the value of the firm,‘Question BS [Penalty of 1 mark per part if detailed steps/calculations are not provided] (4 marks) ‘Waleed just purchased a new house for 120,000. He was able to make a down payment equal to 25% of the ‘value of the house; the balance was mortgaged. The rate by the bank is 10% compounded annually. The mortgage has a 20 year amortization period. Given the above information, fill the blanks below: (@ Equal Annual Instalment to be paid at the end of every year (©) The principal component in the first EAI (equated annual instalment) (©) The interest component in the last (20* year) EAI (@ The principal component in the last (20* year) EAI (1+ 1#1+1=4marks) Solution: (@) Down Payment 120,000 ~ 30,000 EAT =PMT(0.1,20,90000) = 10,571.32 (p) Interest paid during the first year: 90000*0.1 = 9000 Principal component in first EAI = 10571 - 9000= 1571 (©) Interest component in the last EAI= 10571 -PV of EAI by one year= 10571.3 96103 = 2961 (@ Principal component in the last EAI = PV of EAI by one year = 9610.3Question B-6 [Penalty of | mark per par if detailed steps/caleulations are not provided] (marks) Mukesh Enterprises (ME) had a fee cash flow of Z 100 million at the end of most recent year and it's FCFs are expected to grow at a rate of 20% for the next 4 years, after that growth rate in FCF will fall to zero, ie., g=0. Further the firm’s cost of debt is 9% and maintains a 40% debt in its operating capital. The firm's beta is 120, the market risk premium is 5.50%, and the risk-free rate is 3.00%. The firm's recent balance sheet shows 280 rillion in accounts receivable, 260 million in inventory, and 2100 million in short-term investments that are ‘unrelated to operations. The balance sheet also shows 290 million in accounts payable, 7120 million in notes payable, 2300 million in long-term debt, 225 million in preferred stock, 215 million in retained eamings, and 2400 million in total common equity. If Mukesh Enterprises has 20 million shares of stock outstanding, find the best estimate of the stock's price per share? With the above information, calculate the following: Mukesh Enterprises cost of equity is ME's WACCis Present value of expected FOF during the first four years: Present value of terminal / horizon value (expected FCF ffom year 5 to infinity)__ Operating value of the ME Total value of the ME MB's equity value per share is, (7x1 mark=7 marks) Solution Firm’s cost of equity, applying CAPM, 3+1.2*5.5=9. Firm's WACC = 0.69.6% + 0.49% = 9.36% PV of Exp FCF during the first four years: 109.7+120.4+132.12+145 PV of terminal value ={ 207.36)0.0936]/(1.0936)'4 = 21548.87 mins Operating value ofthe firm: 507.23 + 1548.87 = 22056.1 mins Total value ofthe firm : 22056.1 + 2100 = 2216.1 mins Firm's equity value per share Equity value =residual claim = (2156.1 ~ 120-300-25 )/ 20 mln=280.555/- 507.23 mins 1 2 3 4 120 144-128 20736 109.729 120405 132.419 144.974 3 3 9 3 Exp Future FCFs first four years PV of Future FCFs ‘Terminal value = 207.36 / 0.0936: 215.385 PV of terminal value =2215.385 / (1.0936)'4= Rs1548.87 mins Book values and other balance sheet items are either irelevant or already accounted in FCF calculation. Equity Value is the residual claim, after debt repayment and pref shareholders claim,Question B-7 [Penalty of | mark per partif detailed steps/calculations are not provided] (4 marks) DHF Company has a beta of 1.5 and the required rate of return on the stack is 12.00% versus a required return on market index is 10.00%. Now assume that the required retum on market index increases by 30.0%. Neither betas nor the risk-free rate change. Then find the following: Risk free rate of return is -_ 6%. Old / present market risk premium: 4%6 New / revised market risk premium = 7%. New / revised required rate of retu on the DHF stock __16.5%. (4x1 mark= 4 marks) poop DEF's beta 150 DEF's initial required retum. 12.00% Percentage increase in required market return 30.0% Initial required return on the market 10.00" ‘New required retum on the market 13.00% ‘Now for the algebra Toot “Tae + DRPy) = Tye + LSP) Toutes = Tap + RP \) = tye + LO(RP\) ‘Now insert known data and transpose: 12% = yp + 1 S(RPy) >> 12% - Typ = LRP y) 10% = yp + (RPy) >> 10% -ryp= LORPy, Now solve for RPy: RP,, = 2940.5 4.00% Now find the risk-free rate: typ = Initial tyua..-RPy=10%-4%= 6.00% New RP,, = New required retum on the market -1,, 7.00% Now find the new return on stock =1,, + b(new RP.) = 16.50%Question BS [Penalty of 1 mark per part if detailed steps/calculations are not provided] (marks) Given the information about stocks X, Y, and Z below (X,Y, and Z are positively but not perfectly correlated), assuming stock market equilibrium: Expected Standard return deviation Beta % 15% 08 y 10.75% = 18% 1.2 Zz 12.50% 15% 1.6 Fund Q has one-third ofits funds invested in each of the three stocks; Return on risk-free asset is 5. find the following: a. Whatis the market risk premium? __ 4.375%, ‘Market risk premium => 9% =5.5%+0.8*MRP=3.5/0.8= 4.375% b. What is the beta of Fund Q? _0.3340.3 +0.33*1.240.3341. c. What is the expected (required) rate of retum on Fund Q? 4. What would be the standard deviation of Fund Q (15* 2%, oF <15%) and why? Less than 15% as the stocks are not perfectly positively correlated. Ams: a. What is the market risk premium? Applying CAPM to stock X and use the formula 7RF WRF fr Or 0 (0 r)b 9.00% = 5.50% + (7M rRF)*O8, solve for rM-rRF = 4.375% . What is the beta of Fund Q? 4Q = (1/38) + (1/3)*.2) + 0.37.6 = 1.20 . What is the expected (required) rate of return on Fund Q? Applying CAPM to Fund Q, 79 = 5.50% + (4.375%)"1.2 4. What would be the standard deviation of Fund Q (>15 It should be less than 15% due to diversification (Positive but not perfect)Question BS [Penalty of 1 mark per part if detailed steps/calculations are not provided] (3 marks) A General Motors.£1000 face value, bond carries a coupon rate of 8 percent, has 9 years until maturity, and sells ata yield to maturity of 9 percent ‘2. What interest payments do bondholders receive each year? : £80 ». At what price does the bond sell? (Assume annual interest payments.) € 940/- (=pv([Link],1000)) ¢. What will happen to the bond price ifthe yield to maturity falls to 7 percent? Will become a premium bond, bond price will be above face value. Question B-10 @ marks) Categorise markets on the basis of 2) Nature of Claims b) Seasoning of claims ©) Maturity of claims @) Timing of delivery Answer a) Debt; Equity b) Unseasoned Offerings (IPOs); Seasoned Offerings ©) Money markets; Capital markets 4) Spot market; Derivative market