SFM Test 2 - Question Paper

CA (FINAL)
STRATEGIC FINANCIAL MANAGEMENT
TEST PAPER-2
QUESTION PAPER CHAPTER: 12 & 13
MARKS – 50
DURATION – 90 mins
INSTRUCTIONS:
1. All the questions are compulsory.

2. Properly mention Test no. on First Page and Page no. on every answer sheet.
3. In case of multiple choice questions, mention option number only.
4. Working Notes are compulsory wherever required in support of your solution.

5. Do not copy any solution from material.
6. Attempt as much as you know to fairly judge your performance.
7. Please upload your Answer Sheet Horizontally.
8. Copy once get evaluated by Evaluator cannot be re-uploaded by the student.
9. Always check correct Test No. of your subject while uploading answer sheet.
10 Handwriting should be clean.
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WWW.CAEXAMS.IN 1
ANSWER ALL QUESTIONS
Question 1:
Herbal World is a small, but profitable producer of beauty cosmetics using the plant Aloe
Vera. Though it is not a high-tech business, yet Herbal's earnings have averaged around Rs.
18.5 lakh after tax, mainly on the strength of its patented beauty cream to remove the
pimples. The patent has nine years to run, and Herbal has been offered Rs. 50 lakhs for the
patent rights. Herbal's assets include Rs. 50 lakhs of property, plant and equipment and Rs.
25 lakhs of working capital. However, the patent is not shown in the books of Herbal World.
Assuming Herbal's cost of capital being 14 percent, calculate its Economic Value Added (EVA).
(5 marks)
Question 2:
The shares of Day Ltd. and Night Ltd. trade at 20 and 15 times their respective P/E ratios. Day
Ltd. considers taking over Night Ltd. By paying Rs. 55 crores considering that the market price
of Night Ltd. reflects its true value. It is considering both the following options:
I. Takeover is funded entirely in cash.

II. Takeover is funded entirely in stock.
You are required to calculate the cost of the takeover and advise Day Ltd. on the best
Alternative. (8 marks)
Question 3:
a) Eagle Ltd. reported a profit of ₹ 77 lakhs after 30% tax for the financial year 2011-12.
An analysis of the accounts revealed that the income included extraordinary items of
₹ 8 lakhs and an extraordinary loss of ₹10 lakhs. The existing operations, except for
the extraordinary items, are expected to continue in the future. In addition, the results
of the launch of a new product are expected to be as follows:
You are required to:

(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Eagle Ltd.‘s share capital
being comprised of 1,00,000 13% preference shares of ₹ 100 each and 50,00,000
equity shares of ₹ 10 each and the P/E ratio being 10 times. (6 marks)
WWW.CAEXAMS.IN 2
(b) The following information is provided related to the acquiring Firm Mark Limited and
the target Firm Mask Limited:
Required:
(i) What is the Swap Ratio based on current market prices?
(ii) What is the EPS of Mark Limited after acquisition?
(iii) What is the expected market price per share of Mark Limited after acquisition,
assuming P/E ratio of Mark Limited remains unchanged?
(iv) Determine the market value of the merged firm.
(v) Calculate gain/loss for shareholders of the two independent companies after acquisition.
(7 marks)
Question 4
a) A valuation done of an established company by a well-known analyst has estimated
a value of Rs. 500 lakhs, based on the expected free cash flow for next year of Rs. 20
lakhs and an expected growth rate of 5% While going through the valuation procedure,
you found that the analyst has made the mistake of using the book values of debt and
equity in his calculation. While you do not know the book value weights he used, you
have been provided with the following information:
(i) Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,
(iii) The market value of equity is three times the book value of equity, while the
market value of debt is equal to the book value of debt. You are required to estimate
the correct value of the company (5 marks)
b) Longitude Limited is in the process of acquiring Latitude Limited on a share

exchange basis. Following relevant data are available:
You are required to determine:

(i) Pre-merger Market Value per Share, and
(ii) The maximum exchange ratio Longitude Limited can offer without the dilution of
WWW.CAEXAMS.IN 3
(1) EPS and
(2) Market Value per Share
Calculate Ratio/s up to four decimal points and amounts and number of shares up to two
decimal points. (10 marks)
Question 5:
a) B Ltd. is a highly successful company and wishes to expand by acquiring other firms.
Its expected high growth in earnings and dividends is reflected in its PE ratio of 17.
The Board of Directors of B Ltd. has been advised that if it were to take over firms with a
lower PE ratio than it own, using a share- for-share exchange, then it could increase its
reported earnings per share. C Ltd. has been suggested as a possible target for takeover,
which has a PE ratio of 10 and 1,00,000 shares in issue with a share price
of Rs. 15. B Ltd. has 5,00,000 shares in issue with a share price of Rs. 12. Calculate the
change in earnings per share of B Ltd. if it acquires the whole of C Ltd. by issuing
hares at its market price of Rs. 12. Assume the price of B Ltd. shares remains constant.
(5 marks)
b) Tender Ltd has earned a net profit of ₹ 15 lacs after tax at 30%. Interest cost charged
by financial institutions was ₹ 10 lacs. The invested capital is ₹ 95 lacs of which 55% is
debt. The company maintains a weighted average cost of capital of 13%. Required,
Compute the operating income. Compute the Economic Value Added (EVA). Tender Ltd.
has 6 lac equity shares outstanding. How much dividend can the company pay before the
value of the entity starts declining? (4 marks)
WWW.CAEXAMS.IN 4

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CA (FINAL)

STRATEGIC FINANCIAL MANAGEMENT

1. All the questions are compulsory.

3. In case of multiple choice questions, mention option number only.

4. Working Notes are compulsory wherever required in support of your solution.

I. Takeover is funded entirely in cash.

You are required to:

b) Longitude Limited is in the process of acquiring Latitude Limited on a share

You are required to determine:

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