BFD Merged Q Tahapopatia +923453086312

Final Examinations
Module F
The Institute of 8 June 2016
Chartered Accountants 3 hours – 100 marks
of Pakistan Additional reading time – 15 minutes
Business Finance Decisions

Q.1 The Board of Directors of Golden Industries Limited (GIL), in its recent meeting have
expressed concern that no dividends have been paid for the preceding three years in spite
of the fact that GIL has been earning good profits. The directors were of the opinion that
GIL’s existing capital structure is not being managed at optimal level.
Summarized versions of GIL’s income statement and balance sheet are presented below:
SUMMARIZED INCOME STATEMENT

Projected – Actual –
next year current year
Rs. in million
Revenue 10,500 9,200
Cost of sales (5,500) (4,500)
Gross profit 5,000 4,700
Operating expense (1,100) (900)
Financial charges (673) (800)
Net profit before tax 3,227 3,000
Tax @ 30% (968) (900)
Profit after tax 2,259 2,100
SUMMARIZED BALANCE SHEET

Fixed assets 28,285 23,778
Current assets 15,000 14,000
43,285 37,778
Current liabilities (19,500) (15,000)
Net assets 23,785 22,778
Financed by:
Share capital (Rs. 10 each) 13,000 13,000
Reserves 2,698 439
15,698 13,439
9% long term debt 8,087 9,339
23,785 22,778
Summarised cash flow projection for the next year is as follows:
Rs. in million
Cash generations from operations 5,535
Cash to be used in investing activities (7,110)
Cash to be used in financing activities (1,925)
Net cash deficit (3,500)
Cash and cash equivalents at the beginning of year 3,000
Cash and cash equivalents at the end of year (500)
The price of GIL’s share hovered around Rs. 25 during the current year. GIL’s equity
beta has gradually risen over the last two years from 1.1 to 1.3 primarily due to the
uncertainty among the investors on account of company’s future profitability and
liquidity. The present 12-month treasury bill rate is 6% whereas the current market rate of
return is 12%.
Taha Popatia +923453086312
Business Finance Decisions Page 2 of 4
Required:
Write a report for presentation to the board of directors covering the following matters:
(a) Analysis of GIL’s policy with respect to cash flow management and its impact on
GIL’s cost of capital and its ability to pay dividend. (06)
(b) Revised value of net assets, profit after tax and cash flows if GIL increases its debt
equity ratio to:
60:40 which is the maximum limit allowed by GIL’s banks.
50:50 which is the prevailing industry norm in which GIL operates. (12)
(c) Suggestions and recommendations regarding anticipated cash flows and future
dividend prospects. (05)
Marks to be awarded for analytical clarity and logical presentation of the report (02)
Q.2 Violet Telecom Ltd. (VTL) and Blue Telecom Ltd. (BTL) are competitors in the telecom
industry which has been witnessing fierce competition in the domestic market.
Following information has been extracted from the latest annual reports of the two
companies:
VTL BTL
Customers (in million) 20 10
Average revenue per customer per month (Rs.) 250 180
Number of shares issued (in million) 1,500 1,250
Earnings per share (Rs.) 5.5 (0.5)
Book value per share (Rs.) 33 24
VTL is considering to acquire BTL. It is estimated that after this acquisition:

(i) the combined infrastructure of the two companies will create enough space to
accommodate expected growth in customer base without incurring any additional
capital expenditure.
(ii) due to growth in customer base, overall revenues of the merged entity would
increase by 10% per annum whereas the total costs would increase by 3% only.
(iii) VTL will be able to utilize BTL’s tax assessed carried forward losses of Rs. 3,300
million.
(iv) the price earnings ratio of the merged entity would be 8.
VTL intends to offer its own shares to shareholders of BTL as bid price for the
transaction. It is expected that VTL’s shareholders would accept a share exchange ratio
which would not dilute their existing earnings per share whereas BTL’s shareholders
would accept any offer which is at least equivalent to the existing book value of BTL’s
shares.
Applicable tax rate is 30% of profit before tax or 1% of revenues whichever is higher.
Required:
(a) Determine the ratio of share exchange which must be offered to shareholders of
BTL to gain their acceptance and assess whether this ratio would be acceptable to
shareholders of VTL also. (12)
(b) Discuss five other relevant factors that the directors/shareholders of both
companies may consider in evaluating the proposed merger. (05)

Q.3 White Garments Limited (WGL) is considering the replacement cycle for its specialized
cutting machines. The cost of a machine is Rs. 20 million with useful life of 5 years.
Considering the heavy usage, the choice is between replacing every three years or every
four years. Details of maintenance costs and resale value at current prices are as follows:
Years 1–2 3 4
Maintenance costs (Rs.) 600,000 1,000,000 1,400,000
Resale value (Rs.) - 4,000,000 2,000,000
It is expected that maintenance cost will increase at 10% per annum and machine
replacement cost and resale values will increase at 5% per annum.
Tax rate applicable to WGL is 30%. It can claim deprecation at 25% under reducing
balance method. WGL earns sufficient profits to adjust the claim arising out from the
depreciation of the machine.
The weighted average cost of capital of the company is 15%.
Required:
Determine the preferred replacement policy for the cutting machine. (17)
Q.4 Modern Vehicles Limited (MVL) has a wholly owned subsidiary in USA namely Stylish
Vehicles Inc. (SVI), which requires additional financing of USD 45 million for the
expansion of its operations in USA. MVL is considering the following options to raise the
finance:
(I) A US bank has agreed to provide a loan of USD 45 million to SVI for a period of
three years at the rate of 3.25% per annum.
(II) MVL can obtain a long term finance of Rs. 4,725 million from a consortium of
banks at 12-months KIBOR plus 1% and remit it to SVI, for a period of three years.
Under both the options, interest on bank loans would be payable on an annual basis and
the principal amount would be redeemed in three equal annual instalments.
Following information are available:
(i) The exchange rate and KIBOR over the three years are projected as follows:
1-Jul-16 30-Jun-17 30-Jun-18 30-Jun-19
Exchange rate (per USD) Rs. 105.0 Rs.107.5 Rs.108.8 Rs. 110.1
12-months KIBOR 6.50% 7.00% 7.25% 7.50%
(ii) It is forecasted that profit before tax and interest (PBIT) of SVI for the year ending
30 June 2017 would be USD 40 million which is expected to increase by 10% per
annum thereafter.
(iii) If finance is provided by MVL, it would charge interest at the rate of 4.25% from
SVI which would be payable annually whereas principal repayment will be made at
30 June 2019.
(iv) SVI remits 50% of its profit as dividend net of tax thereon. This policy would
continue.
(v) Tax rate applicable to MVL is 30%. Remittances on account of dividend and
interest from SVI are treated as income from foreign operations and are subject to
applicable tax in Pakistan. However, there is a bilateral tax treaty between Pakistan
and USA under which any income tax paid in USA on income remitted to
Pakistan is allowed as tax credit in Pakistan.
(vi) In USA, the corporate income tax rate and tax on dividend is 25% and 5%
respectively. Tax on dividend is to be paid at the time of remittance.
(vii) Cost of capital of MVL is 11%.
Required:
Analyse both the financing options and recommend which financing option should be
selected. (Assume that amount is required on 1 July 2016) (24)
Q.5 SilverLine Rental Services (SRS) has been in the car rental business since the past ten
years. Presently it has a fleet of 30 cars. With the expansion of business, SRS is
considering to purchase 10 more cars. In this regard, the management has gathered the
following information:
(i) Revenue from each car is estimated at Rs. 3,500 per day.
(ii) Cost of each vehicle is Rs. 1.6 million.
(iii) Each vehicle is expected to ply an average of 10 trips per day with an aggregate
running of approximately 200 kilometres. Average fuel consumption of vehicles
would be 10 kilometres per litre. The cost of fuel is estimated at Rs. 65 per litre.
(iv) The average maintenance cost would be Rs. 2 per km.
(v) Estimated realisable value of the vehicle at the end of Years 3, 4 and 5 would be
50%, 45% and 40% respectively of the original cost of the car.
(vi) The salary of each driver would be Rs. 22,000 per month.
In order to finance the purchase of new vehicles, SRS has obtained the following
quotations from Bank A and Bank B:
Bank A Bank B
Lease term 3 years 5 years
Effective rate of interest on lease 9% 9%
Down payment 0% 10%
Residual value at the end of lease term 30% 15%
Insurance premium per month 0.30% 0.25%
SRS’s cost of capital is 12%. SRS plans to sell the vehicles on completion of lease.
Assume that all cash flows arise at the end of month unless specified otherwise.
Required:
Recommend whether it would be advisable for SRS to purchase the cars. (17)
(Ignore taxation)
(THE END)

Final Examinations
Module F
The Institute of 9 December 2015

Q.1 As part of a strategic plan, the Federal Government has decided to privatize National
Airline Limited (NAL) and is offering management control for a 40% stake in the company.
Summarized income statement of NAL for the year ended 30 June 2015 is as follows:
Income Statement
Rs. in million
Operating revenue 144,342
Cost of services (147,119)
Gross loss (2,777)
Operating expenses (10,217)
Financial charges (9,793)
Other income 1,501
Net loss (21,286)
The following additional information is available from the annual report of the company:
(i) 4.3 million passengers travelled during 2014-15.
(ii) The planes used by NAL have average capacity of 300 passengers. However, due to
flights operating on unprofitable routes, the existing utilisation is 180 passengers per
flight.
(iii) Discounted tickets are provided to the government departments. Approximately
20 passengers from government departments travel on each flight and the average
discount rate is 50%.
(iv) Cost of services includes cost of fuel amounting to Rs. 69,284 million.
(v) 20% of operating expenses comprise of depreciation.
A local group is interested in bidding for NAL. Initial planning of the group is as follows:
(i) Capital expenditure of Rs. 15,000 million and Rs. 25,000 million would be made in
2016 and 2017 respectively.
(ii) NAL’s operations would be restructured which are expected to have the following
impact:
Year 2016 2017 2018 2019 2020

Increase in number of flights due to new
4% 4% 5% 5% 5%
routes and new aircrafts
Increase in average number of passengers
per flight due to new routes and 6% 6% 6% - -
discontinuance of unprofitable routes
Increase in average revenue and fuel cost
2% 2% 2% 2% 2%
due to inflation
Discount to be offered to Government
35% 25% 25% 25% 25%
departments
(iii) The ratio of Government passengers to other passengers would remain the same
during the next 5 years.
(iv) Cost of services (excluding fuel) and operating expenses (excluding depreciation) are
expected to grow at 8% per annum.
(v) Other income mainly comprises of income from courier and freight services and is
expected to grow in line with the operating revenue.
(vi) Increase in working capital is forecasted as follows:
Year 2016 2017 2018 2019 2020

Working capital (Rs. in million) 5,350 3,450 2,500 1,500 1,500
(vii) Due to carried forward tax losses and future capital expenditures, NPL is not expected
to pay any tax for the next 5 years.
(viii) Free cash flows are expected to grow by 5% after year 2020.
(ix) The cost of capital of the local group is 16%.
Required:
Based on an analysis of Free Cash Flows, calculate the bid price that the local group may
offer for the acquisition of 40% stake in NAL. (All cash flows are assumed to arise at the end of
the year) (21)
Q.2 Ryan Group (RG) is planning to divest investment in one of its fully owned subsidiary
‘Imperial Pakistan Limited’ (IPL) which is peripheral to the group’s mainstream activities
and no longer fit in with the group’s overall strategy. The management of IPL has shown
interest to acquire IPL through a management buy-out. They have planned to form a new
company, Nobel Pakistan Limited (NPL), which would acquire all the assets of IPL. RG
has offered to sell IPL at a value of Rs. 500 million. RG would pay off all its existing debts.
Members of the management of IPL plan to raise Rs. 75 million by subscribing ordinary
shares at par value of Rs. 10 each in NPL. For arranging the balance amount, the
management is considering the following sources:
(i) RG is willing to finance Rs. 25 million by subscribing ordinary shares in NPL at a par
value of Rs. 10 each.
(ii) A loan of Rs. 350 million offered by a local bank at a mark-up of 11% per annum. The
principal amount of loan would be repayable in equal annual amounts over 5 years.
Under the terms of the loan, NPL will have to comply with following debt equity
ratios:
At the end of year 1 2 3 4 5

Debt/equity ratio at book value 65% 60% 55% 50% 50%
In case of failure to comply with the debt equity ratio, NPL would have to repay the
entire outstanding amount within a period of 30 days of non-compliance.
(iii) Issue of 15% convertible preference shares amounting to Rs. 50 million to a local
group of investors. It is estimated that all preference shareholders will exercise the
conversion option at the beginning of fourth year at a price of Rs. 15 per share.
Following information is also available:

(i) IPL earned a revenue of Rs. 575 million in the latest financial year. It is expected that
revenue will grow at a rate of 5% per annum.
(ii) Earnings before interest, taxes, depreciation and amortization (EBITDA) will remain
constant at 20% of revenues.
(iii) Projected annual capital expenditure is 8% of revenues which is expected to be equal
to the annual accounting and tax depreciation.
(iv) Income tax rate applicable to NPL would be 30%.
Required:
Prepare a report for management covering the following matters:
(a) Analyze and comment whether NPL would be able to comply with debt-equity
covenant imposed by the bank over the five-year period. (12)
(b) Briefly discuss the difficulties that may be encountered by management of NPL after
the buy-out. (03)
Q.3 Wonder Limited (WL) is a Pakistan based multinational company. Marvel Enterprise (ME)
is a wholly owned subsidiary of WL in UAE. WL and ME carryout frequent transactions
among themselves as well as with an independent company Prosperity Systems (PS) which
is based in USA.WL and ME follow a centralised hedging strategy. Projected receipts and
payments in one month’s time are as follows:
Paying Company
Receiving Company
WL ME PS
WL (Pak) - AED 1,775,000 USD 2,742,000
ME (UAE) AED 915,000 - AED 740,000
PS (USA) USD 1,145,000 AED 2,690,000 -
The quoted exchange rates and interest rates are as follows:
Exchange Rates
PKR/USD PKR/AED
Buy Sell Buy Sell
Spot 105.25 105.50 28.10 28.35
1 month forward 105.75 105.95 28.50 28.80
Interest Rates
Borrowing Lending
WL (Pak) 9.50% 7.50%
ME (UAE) 6.20% 5.40%
PS (USA) 5.50% 4.90%
Required:
Analyse and devise a hedging strategy for WL and ME. (10)
Q.4 Akhtar has an equity portfolio currently worth Rs. 50 million. He has invested in good
quality stocks that are spread over diversified industries with an average beta of 1.3; a risk
profile he is happy with.
He is presently considering investing a further amount of Rs. 20 million in equity market.

He has done some research himself and wants to invest in Ravi Limited and Jhelum Limited
in equal proportions. Details of his research are as follows:
Ravi Limited (RL)

(i) RL’s current share price is Rs. 16 whereas its equity beta is 1.2.
(ii) RL is planning a 20% right issue at Rs. 12 each.
Jhelum Limited (JL)

(i) JL’s current share price is Rs. 17.40 whereas expected return on this share is 16.5%
(ii) JL has a plan to expand its present line of business. The company wants to finance the
expansion by reducing its dividend payout for the next three years from 30% to 10%.
The risk free rate is 6% and the return on the market is 12%. These rates are not expected to
change in the foreseeable future. Transaction charges are 2% of the amount transacted.
Required:
(a) Briefly discuss the difference between systematic risk and unsystematic risk. (02)
(b) Determine the systematic risk and expected return of Akhtar’s equity investment
portfolio if he goes ahead with his proposed investments. Also discuss briefly the
impact of revised systematic risk on Akhtar’s investment decision. (07)
(c) Evaluate the implication of Ravi Limited and Jhelum Limited’s proposed financial
strategies and advise Akhtar on how these strategies might affect his investment
decisions. (08)
Q.5 Impression Home Furnishing Limited (IHFL) is engaged in the business of designing and
manufacturing of furniture. After a successful endeavour in Islamabad, management has
decided to inaugurate showrooms in other parts of country which would require an
investment of Rs. 2,500 million. The following information has been extracted from IHFL’s
latest financial statements:
Rs. in million
Ordinary share capital (Rs. 10 each) 3,500
Retained earnings 2,200
14% Term finance certificates (Rs. 100 each) 5,000
Profit before interest and tax 2,150
Presently, IHFL’s shares are trading at P/E multiple of 6. The yield to maturity of current
TFCs is 12%. TFCs were issued three years ago at nominal value and are redeemable at a
premium of 10% in two years from now. The required amount for the investment is planned
to be raised as follows:
(i) Issue of further TFCs carrying coupon rate of 12% while remaining terms would
remain the same.
(ii) Issue of right shares.
The company strives to maintain a debt equity ratio of 50:50 based on market value.
The tax rate applicable to the company is 30%.
The effect of amortization of premium on TFC’s may be ignored in the computation of

profit before interest and tax.
Required:
(a) Advise the management regarding the amount to be raised in terms of debt and
equity. (08)
(b) In a recent report, treasurer of the company has forecasted that in one year’s time,
yield to maturity of both TFCs would decline to 10% and company’s PE ratio would
increase to 6.3. Assuming that the treasurer’s predictions hold true, determine the
increase in profit before interest and tax during the next year, to ensure that desired
debt equity ratio is maintained. (07)
Q.6 The management of Sandra Limited (SL) is considering to assemble a vehicle under the
brand name ‘Ferris’ by setting up a plant which would require an immediate investment of
Rs. 3,500 million. Ferris will compete with imported reconditioned vehicle ‘Ferro’. Existing
annual demand for Ferro is 15,000 vehicles and it is expected to remain the same during the
next five years. Current price of Ferro is Rs. 1.22 million and it is expected to increase by 8%
per annum.
The following information in relation to assembling of Ferris is available:

(i) CKD kits will be imported from Japan at a price of JPY 510,000 per kit. CKD kits are
subject to 40% import duty. Other variable costs of assembling a Ferris are estimated
as follows:
Rupees
Other materials and accessories 150,000
Labour and overheads 175,000
(ii) Import price of CKD kits is expected to increase by 5% per annum. All other
assembling costs are expected to increase by 8% per annum.
(iii) Tax depreciation on plant is allowed @ 15% on reducing balance method. Plant can
be disposed of for Rs. 1,500 million at the end of five years.
(iv) SL plans to price Ferris at variable costs plus 20%.

(v) Recent market survey indicates that out of total demand of Ferro:
40% will shift to Ferris if price is not more than 10% of Ferro.
Only 10% consumers will buy Ferris if price is more than 15% of Ferro.
Other information
(i) SL has share capital of 2 million shares of Rs. 10 each having market value of Rs. 250
per share. Two years back, SL issued 5 million term finance certificates (TFCs) at
nominal value of Rs. 100 each carrying a coupon rate of 14% per annum payable
quarterly. These TFCs are redeemable in three years’ time at nominal value. TFCs are
currently trading at Rs. 105 each.
(ii) Ungeared beta of automobile sector in Pakistan is 1.1 whereas SL’s debt beta is
assumed to be zero. Annualized market return on KSE 100 index is 14% and equity
risk premium is 8%.
(iii) Current conversion rate is Rs. 1.16 per JPY. Existing interest rates in Japan and
Pakistan are 4% and 6% respectively. The interest rates are not expected to change in
the next five years.
(iv) SL does not hedge foreign currency exposure.
(v) Applicable tax rate is 30%.
Required:
Recommend whether it is feasible for SL to assemble Ferris. (Assume that all cash flows arise
at the end of the year except otherwise specified) (22)
(THE END)

Final Examinations
Module F
The Institute of 3 June 2015

Q.1 Kamyab Mart (KM), a large departmental store, was inaugurated two years ago in
Peshawar with high financial prospects. However, in a recently concluded meeting, sponsors
have shown concerns over its actual performance. Following information is available in this
regard:
(i) The sponsors had appraised the investment in KM over a period of 5 years by using
discount rate of 17%.
(ii) Store set-up cost (mainly comprised of furniture and fixtures) was Rs. 5 million with
no realizable value.
(iii) Annual sales were estimated at Rs. 22 million in first year and expected to grow at
18% per annum. However, only 70% of the estimated sale was achieved in the first
year. Growth in year 2 was 10% which is expected to continue in future.
(iv) Margin on sales was estimated at 18%. However, actual margin on sales is only 12%.
(v) Administrative costs were estimated at Rs. 1.20 million and expected to rise by 15%
per annum.
(vi) Working capital is primarily comprised of inventory which forms 25% of annual
sales.
(vii) Tax depreciation is allowed at 25% on reducing balance method.
(viii) If at any time the sponsors decide to close down KM, working capital would be
realized at 80% of its value.
(ix) Applicable tax rate is 35%.
Required:
(a) Advise whether sponsors should continue to operate KM over a period of three more
years or close it down now. (10)
(b) Besides the computations carried out in (a) above, highlight the matters that may be
considered by sponsors before taking the above decision. (06)
Q.2 The directors of Ajar Cement (Pvt.) Limited (ACL) are considering listing of the company
on Karachi and Lahore stock exchanges. They wish to know the price range at which they
may launch the initial public offering. The following information is based on financial
statements for the year ended 31 March 2015:
Rs. in ‘000
Revenue for the year 275,000
Share capital (Rs.10 each) 100,000
Fair value of net assets 250,000
Additional information:
(i) Revenue is expected to grow at 15% each year for next 3 years. From year 4 onwards,
it will grow at a constant rate of 9%.
(ii) Operating costs are 80% of revenue and this ratio is expected to continue in future as
well.
(iii) Applicable tax rate is 28%.
(iv) Debt equity ratio of ACL is 1:2. A competitor with similar size of business has an
equity beta of 1.30 and debt equity ratio of 1:3. Debt beta of both companies is zero.
(v) Price Earning (P/E) ratios of listed companies in cement industry range between 15
and 19.
(vi) Annualized return of KSE 100 index is 14% whereas 12 months’ government treasury
bills are yielding 8%.
Required:
Prepare a report for the board of directors of ACL covering the following matters:
(a) Range of market values of ACL’s share under different valuation methods along with
relevance and limitation of each method. (17)
(b) Most suitable price that could be used for initial public offering. (03)
(c) Other matters that ACL should consider before deciding to list the company. (04)
Q.3 Azad Textile Limited (ATL) has been maintaining an employees’ provident fund for past
few years. Provident fund trustees meet quarterly to take investment decisions for the fund.
Till investment decisions are taken, all contributions and maturities are deposited in savings
account.
The existing portfolio of provident fund is summarized below:
Investment Rate of
Rs. in ‘000 Return
Government securities 50,145 12%
Corporate TFCs 20,342 10%
Term deposits with different banks 35,450 9%
Deposit in savings account 10,520 5%
Total 116,457
The employees of ATL have raised concerns over inadequate return on provident fund. The
trustees in a recently concluded meeting have decided to benchmark the fund’s performance
with voluntary pension funds being managed by asset management companies. The trustees
have also decided to adopt less volatile investment mix which comprises of 25% investment
in listed securities, 60% investment in debt securities and remaining in money market
securities. Detailed rules have been framed in this regard, which are summarized below:
(i) Investment in listed securities:

One security from each of the following sectors should be selected and the amount of
investment in each sector should not exceed the weightages defined by the trustees:
Forecasted
Beta Current
Sector Weightage Security Dividend fair value
factor Price
after one year
Oil and gas 40% A 1.10 45% 120 140
B 1.30 66% 150 160
Cement 30% C 0.90 14% 25 30
D 1.10 0% 35 45
Fertilizer 30% E 1.05 29% 85 100
F 1.25 36% 110 125
Par value of all shares is Rs. 10. The KSE 100 index annual return is 14%. The one-
year treasury bills are yielding 8% per annum.
(ii) Investment in debt securities:
50% of such investment would be in one of the government backed sukuks and 50%
in one of the AA rated corporate securities. Following government backed sukuk and
AA rated corporate securities are available in the market:
Par value Market *Coupon Redemption Redemption
Type Security
(Rs.) value (Rs.) rate period (Years) value (Rs.)
AA rated TFC – A 100 102 10% 4 104
corporate
securities TFC – B 100 100 9% 6 100
Govt. backed Sukuk – Y 1,000 1,000 11.25% 7 1,000
sukuk Sukuk – Z 1,000 1,075 12% 3 980
*The profit is payable annually
(iii) Money market securities:

Fund will continue to invest in term deposits with different banks.
Required:
(a) Prepare the revised portfolio of provident fund and its expected return. (15)
(b) Briefly discuss the risk and return of restructured portfolio with the existing portfolio
of the provident fund. (03)
Q.4 Target Company Limited (TCL) has been the sole supplier of a specialised computer chip
for the past several years. TCL has achieved high rate of growth during the last three years in
its single product line. TCL does not have any plans for diversifying into new product lines
and seeks to consolidate its competitive advantage by developing improved versions of the
current product and expanding its share of the growing market.
Board meeting of TCL is scheduled to be held next week to consider the draft accounts for
the year ended 31 March 2015 and declaration of dividend. A summary of the financial
statements prepared by the finance department for review of the board of directors is
presented below:
Summarised Income Statement

2016 2015 2014
(Projected) (Draft) (Audited)
------------- Rs. in million -------------
Revenue 2,305 2,095 1,760
Operating profit 884 836 754

Financial expenses (28) (36) (36)
Profit before tax 856 800 718
Income tax (30%) (257) (240) (215)
Profit for the period 599 560 503
Summarised Statement of Financial Position

2016 2015 2014 2016 2015 2014
(Projected) (Draft) (Audited) (Projected) (Draft) (Audited)
---------- Rs. in million ---------- ---------- Rs. in million ----------
Equity and liabilities Non-current assets
Share capital 296 296 240 Fixed assets less acc.
1,344 928 768
Retained earnings 1,735 1,136 800 depreciation
2,031 1,432 1,040
Non-current liabilities
Loans 280 360 360
Deferred tax 165 136 101 Current assets
Inventories 26 30 18
Current liabilities Trade receivables 205 233 157
Trade payables 70 63 51 Cash 1,214 1,022 813
Tax payables 228 204 186
Interest payable 15 18 18
2,789 2,213 1,756 2,789 2,213 1,756
The final dividend for 2014 amounted to Rs. 224 million which was paid during the year
ended 31 March 2015. In view of the company’s sound financial position, the directors had
shown their inclination to increase the dividend pay-out, in the last meeting of the Board.
Financial projections for the year ending 31 March 2016 include repayment of loans
amounting to Rs. 80 million (2015: Nil) and capital expenditure of Rs. 640 million
(2015: Rs. 320 million).
Required:
Discuss if the company’s decision in respect of dividend for 2014 was correct. Also comment
on directors’ plan to increase the payment of dividend. (15)

Q.5 Ultra Comfort Footwear (UCF) is a manufacturer of high quality footwear in Karachi. It
serves a wide network of customers through retail outlets across the city. Its revenue and
gross profit for the latest accounting year amount to Rs. 2,400 million and Rs. 960 million
respectively.
The management of UCF is considering launching of its products in other parts of the
country as well. The project would require estimated cash outflows of Rs. 630 million and be
operative in one year’s time.
The sponsors have agreed to inject capital amounting to Rs. 200 million to finance the
project. The remaining amount is proposed to be raised by restructuring the existing working
capital. Further shortfall, if any, would be met through the short-term finance. Bankers of
UCF have offered a short-term finance limit amounting to Rs. 280 million.
At present, UCF follows a conservative working capital strategy. The impact of changes in
working capital policy is estimated as under:
Conservative Proposed working capital strategy

policy Moderate policy Aggressive policy
(Rs. in million) Increase/(Decrease) Increase/(Decrease)
Trade debtors 400 (8%) (20%)
Stock in trade 250 (10%) (25%)
Cash and bank 40 (30%) (70%)
Trade creditors 300 15% 35%
Required
Analyze and recommend the most appropriate proposed working capital strategy and
discuss the significance of adopting such strategy. (10)
Q.6 On 25 May 2015, Zain Exporters Enterprise (ZEE) received an order from Windmill Inc.
(WI), a USA based company for supply of 7,500 tons of cotton yarn. The price was agreed
at USD 2,500 per ton. Payment is to be made within 30 days of shipment.
On 27 May 2015, due to fire in warehouse, stock of cotton yarn was completely destroyed.
Since, ZEE was unable to get the required quantity locally, it offered to supply cotton yarn
from Egypt, which was accepted by WI. It was agreed that the quantity and price per ton
would remain the same. However, the order would be dispatched in two shipments as
follows:
4,000 tons on 30 June 2015
3,500 tons on 31 July 2015
It was agreed between the Egyptian company and ZEE that payments would be made on
shipment, at the rate of Egyptian Pound (EGP) 18,000 per ton.
ZEE has a policy to hedge all foreign currency transactions by obtaining forward cover.
ZEE’s bank has arranged the forward cover and advised the following exchange rates on
31 May 2015:
Egyptian Pound (EGP) USD

Buy Sell Buy Sell
Spot Rs. 13.36 Rs. 13.56 Rs. 101.95 Rs. 102.10
1 month forward Rs. 13.45 Rs. 13.65 Rs. 101.70 Rs. 101.85
2 months forward Rs. 13.60 Rs. 13.80 Rs. 101.55 Rs. 101.70
The bank charges a commission of 0.01% on the transactions.

Required:
(a) Determine the profit or loss on the above transactions, if shipments are made as per
the agreed schedule. (05)
(b) On 31 July 2015, Egyptian company informed ZEE that second shipment would not
be made until 30 September 2015. ZEE is considering either delaying the second
shipment for two months or cancelling it altogether with mutual consent of all the
parties. Advise the most appropriate action that may be taken by ZEE. The exchange
rates prevailing on 31 July 2015 are as follows:
Egyptian Pound (EGP) USD

Buy Sell Buy Sell
Spot Rs. 13.75 Rs. 13.95 Rs. 101.60 Rs. 101.75
3 months forward Rs. 14.25 Rs. 14.45 Rs. 101.00 Rs. 101.15 (12)
(THE END)

Final Examinations
Module F

Q.1 As part of a strategic plan, the Federal Government has decided to privatize National
Airline Limited (NAL) and is offering management control for a 40% stake in the company.
Summarized income statement of NAL for the year ended 30 June 2015 is as follows:
Income Statement
Rs. in million
Operating revenue 144,342
Cost of services (147,119)
Gross loss (2,777)
Operating expenses (10,217)
Financial charges (9,793)
Other income 1,501
Net loss (21,286)
The following additional information is available from the annual report of the company:
(i) 4.3 million passengers travelled during 2014-15.
(ii) The planes used by NAL have average capacity of 300 passengers. However, due to
flights operating on unprofitable routes, the existing utilisation is 180 passengers per
flight.
(iii) Discounted tickets are provided to the government departments. Approximately
20 passengers from government departments travel on each flight and the average
discount rate is 50%.
(iv) Cost of services includes cost of fuel amounting to Rs. 69,284 million.
(v) 20% of operating expenses comprise of depreciation.
A local group is interested in bidding for NAL. Initial planning of the group is as follows:
(i) Capital expenditure of Rs. 15,000 million and Rs. 25,000 million would be made in
2016 and 2017 respectively.
(ii) NAL’s operations would be restructured which are expected to have the following
impact:
Year 2016 2017 2018 2019 2020

Increase in number of flights due to new
4% 4% 5% 5% 5%
routes and new aircrafts
Increase in average number of passengers
per flight due to new routes and 6% 6% 6% - -
discontinuance of unprofitable routes
Increase in average revenue and fuel cost
2% 2% 2% 2% 2%
due to inflation
Discount to be offered to Government
35% 25% 25% 25% 25%
departments
(iii) The ratio of Government passengers to other passengers would remain the same
during the next 5 years.
(iv) Cost of services (excluding fuel) and operating expenses (excluding depreciation) are
expected to grow at 8% per annum.
(v) Other income mainly comprises of income from courier and freight services and is
expected to grow in line with the operating revenue.
(vi) Increase in working capital is forecasted as follows:
Year 2016 2017 2018 2019 2020

Working capital (Rs. in million) 5,350 3,450 2,500 1,500 1,500
(vii) Due to carried forward tax losses and future capital expenditures, NPL is not expected
to pay any tax for the next 5 years.
(viii) Free cash flows are expected to grow by 5% after year 2020.
(ix) The cost of capital of the local group is 16%.
Required:
Based on an analysis of Free Cash Flows, calculate the bid price that the local group may
offer for the acquisition of 40% stake in NAL. (All cash flows are assumed to arise at the end of
the year) (21)
Q.2 Ryan Group (RG) is planning to divest investment in one of its fully owned subsidiary
‘Imperial Pakistan Limited’ (IPL) which is peripheral to the group’s mainstream activities
and no longer fit in with the group’s overall strategy. The management of IPL has shown
interest to acquire IPL through a management buy-out. They have planned to form a new
company, Nobel Pakistan Limited (NPL), which would acquire all the assets of IPL. RG
has offered to sell IPL at a value of Rs. 500 million. RG would pay off all its existing debts.
Members of the management of IPL plan to raise Rs. 75 million by subscribing ordinary
shares at par value of Rs. 10 each in NPL. For arranging the balance amount, the
management is considering the following sources:
(i) RG is willing to finance Rs. 25 million by subscribing ordinary shares in NPL at a par
value of Rs. 10 each.
(ii) A loan of Rs. 350 million offered by a local bank at a mark-up of 11% per annum. The
principal amount of loan would be repayable in equal annual amounts over 5 years.
Under the terms of the loan, NPL will have to comply with following debt equity
ratios:
At the end of year 1 2 3 4 5

Debt/equity ratio at book value 65% 60% 55% 50% 50%
In case of failure to comply with the debt equity ratio, NPL would have to repay the
entire outstanding amount within a period of 30 days of non-compliance.
(iii) Issue of 15% convertible preference shares amounting to Rs. 50 million to a local
group of investors. It is estimated that all preference shareholders will exercise the
conversion option at the beginning of fourth year at a price of Rs. 15 per share.

(i) IPL earned a revenue of Rs. 575 million in the latest financial year. It is expected that
revenue will grow at a rate of 5% per annum.
(ii) Earnings before interest, taxes, depreciation and amortization (EBITDA) will remain
constant at 20% of revenues.
(iii) Projected annual capital expenditure is 8% of revenues which is expected to be equal
to the annual accounting and tax depreciation.
(iv) Income tax rate applicable to NPL would be 30%.
Required:
Prepare a report for management covering the following matters:
(a) Analyze and comment whether NPL would be able to comply with debt-equity
covenant imposed by the bank over the five-year period. (12)
(b) Briefly discuss the difficulties that may be encountered by management of NPL after
the buy-out. (03)
Q.3 Wonder Limited (WL) is a Pakistan based multinational company. Marvel Enterprise (ME)
is a wholly owned subsidiary of WL in UAE. WL and ME carryout frequent transactions
among themselves as well as with an independent company Prosperity Systems (PS) which
is based in USA.WL and ME follow a centralised hedging strategy. Projected receipts and
payments in one month’s time are as follows:
Paying Company
Receiving Company
WL ME PS
WL (Pak) - AED 1,775,000 USD 2,742,000
ME (UAE) AED 915,000 - AED 740,000
PS (USA) USD 1,145,000 AED 2,690,000 -
The quoted exchange rates and interest rates are as follows:
Exchange Rates
PKR/USD PKR/AED
Buy Sell Buy Sell
Spot 105.25 105.50 28.10 28.35
1 month forward 105.75 105.95 28.50 28.80
Interest Rates
Borrowing Lending
WL (Pak) 9.50% 7.50%
ME (UAE) 6.20% 5.40%
PS (USA) 5.50% 4.90%
Required:
Analyse and devise a hedging strategy for WL and ME. (10)
Q.4 Akhtar has an equity portfolio currently worth Rs. 50 million. He has invested in good
quality stocks that are spread over diversified industries with an average beta of 1.3; a risk
profile he is happy with.
He is presently considering investing a further amount of Rs. 20 million in equity market.

He has done some research himself and wants to invest in Ravi Limited and Jhelum Limited
in equal proportions. Details of his research are as follows:
Ravi Limited (RL)

(i) RL’s current share price is Rs. 16 whereas its equity beta is 1.2.
(ii) RL is planning a 20% right issue at Rs. 12 each.
Jhelum Limited (JL)

(i) JL’s current share price is Rs. 17.40 whereas expected return on this share is 16.5%
(ii) JL has a plan to expand its present line of business. The company wants to finance the
expansion by reducing its dividend payout for the next three years from 30% to 10%.
The risk free rate is 6% and the return on the market is 12%. These rates are not expected to
change in the foreseeable future. Transaction charges are 2% of the amount transacted.
Required:
(a) Briefly discuss the difference between systematic risk and unsystematic risk. (02)
(b) Determine the systematic risk and expected return of Akhtar’s equity investment
portfolio if he goes ahead with his proposed investments. Also discuss briefly the
impact of revised systematic risk on Akhtar’s investment decision. (07)
(c) Evaluate the implication of Ravi Limited and Jhelum Limited’s proposed financial
strategies and advise Akhtar on how these strategies might affect his investment
decisions. (08)
Q.5 Impression Home Furnishing Limited (IHFL) is engaged in the business of designing and
manufacturing of furniture. After a successful endeavour in Islamabad, management has
decided to inaugurate showrooms in other parts of country which would require an
investment of Rs. 2,500 million. The following information has been extracted from IHFL’s
latest financial statements:
Rs. in million
14% Term finance certificates (Rs. 100 each) 5,000
Presently, IHFL’s shares are trading at P/E multiple of 6. The yield to maturity of current
TFCs is 12%. TFCs were issued three years ago at nominal value and are redeemable at a
premium of 10% in two years from now. The required amount for the investment is planned
to be raised as follows:
(i) Issue of further TFCs carrying coupon rate of 12% while remaining terms would
remain the same.
(ii) Issue of right shares.
The company strives to maintain a debt equity ratio of 50:50 based on market value.
The effect of amortization of premium on TFC’s may be ignored in the computation of

profit before interest and tax.
Required:
(a) Advise the management regarding the amount to be raised in terms of debt and
equity. (08)
(b) In a recent report, treasurer of the company has forecasted that in one year’s time,
yield to maturity of both TFCs would decline to 10% and company’s PE ratio would
increase to 6.3. Assuming that the treasurer’s predictions hold true, determine the
increase in profit before interest and tax during the next year, to ensure that desired
debt equity ratio is maintained. (07)
Q.6 The management of Sandra Limited (SL) is considering to assemble a vehicle under the
brand name ‘Ferris’ by setting up a plant which would require an immediate investment of
Rs. 3,500 million. Ferris will compete with imported reconditioned vehicle ‘Ferro’. Existing
annual demand for Ferro is 15,000 vehicles and it is expected to remain the same during the
next five years. Current price of Ferro is Rs. 1.22 million and it is expected to increase by 8%
per annum.
The following information in relation to assembling of Ferris is available:

(i) CKD kits will be imported from Japan at a price of JPY 510,000 per kit. CKD kits are
subject to 40% import duty. Other variable costs of assembling a Ferris are estimated
as follows:
Rupees
Other materials and accessories 150,000
Labour and overheads 175,000
(ii) Import price of CKD kits is expected to increase by 5% per annum. All other
assembling costs are expected to increase by 8% per annum.
(iii) Tax depreciation on plant is allowed @ 15% on reducing balance method. Plant can
be disposed of for Rs. 1,500 million at the end of five years.
(iv) SL plans to price Ferris at variable costs plus 20%.

(v) Recent market survey indicates that out of total demand of Ferro:
Only 10% consumers will buy Ferris if price is more than 15% of Ferro.
Other information
(i) SL has share capital of 2 million shares of Rs. 10 each having market value of Rs. 250
per share. Two years back, SL issued 5 million term finance certificates (TFCs) at
nominal value of Rs. 100 each carrying a coupon rate of 14% per annum payable
quarterly. These TFCs are redeemable in three years’ time at nominal value. TFCs are
currently trading at Rs. 105 each.
(ii) Ungeared beta of automobile sector in Pakistan is 1.1 whereas SL’s debt beta is
assumed to be zero. Annualized market return on KSE 100 index is 14% and equity
risk premium is 8%.
(iii) Current conversion rate is Rs. 1.16 per JPY. Existing interest rates in Japan and
Pakistan are 4% and 6% respectively. The interest rates are not expected to change in
the next five years.
(iv) SL does not hedge foreign currency exposure.
(v) Applicable tax rate is 30%.
Required:
Recommend whether it is feasible for SL to assemble Ferris. (Assume that all cash flows arise
at the end of the year except otherwise specified) (22)
(THE END)

Final Examination
Module F

Q.1 Kailash Limited has recently disposed of one of its long-term investments for Rs. 1.5 billion.
The treasurer of the company has come up with various projects for investment of the said
amount. Details of the projects are as follows:
----------------- Projects -----------------

A B C D E
Initial investment (Rs. in million) (400) (450) (600) (550) (800)
Expected annual cash inflows (Rs. in million) 200 180 220 175 500
Discount rate
11% 10% 15% 12% 22%
(based on risk involved in the project)
Project duration (years) 4 5 6 7 10
Year from which net cash flows would
1 1 1 2 5
commence (arise at the end of year)
Other relevant information is as follows:

(i) Project A and B are mutually exclusive.
(ii) Project C and E can be scaled up by 20% and scaled down by 50%.
(iii) Project A, B and D cannot be scaled up but can be scaled down.
Required:
Determine the most beneficial investment mix. (14)
Q.2 ARQ (Private) Limited is a small size company whose shares are held by three directors.
ARQ manufactures and sells garments for children. There is considerable demand for its
products. The main hurdle in fulfilling the market demand is the working capital constraint.
It is anticipated that measures to increase sales would require additional financing as
follows:
Debtors Stock Creditors
Expected increase in working capital (% of sales) 80% 100% 40%
Following information has been extracted from ARQ’s latest financial statements:
Rs. in million
Fixed assets 105
Current assets 91
Long term liabilities (75)
Current liabilities (64)
Sales 60
Profit after tax 15
60% of profit after tax is distributed as dividends. The company’s bankers have agreed to
provide finance subject to a debt equity ratio of 60:40 or lower.
Required:
(a) Determine the maximum growth in sales which could be achieved in the above
situation. (08)
(b) Calculate the financing requirements in the event the sales are projected to increase to
Rs. 100 million. (04)
Q.3 ZC Limited (ZCL) manufactures metal containers for the paints industry. Presently, ZCL
has eight machines which were purchased 3 years ago at a cost of Rs. 1.8 million each
having useful life of 8 years with zero salvage value. The production capacity of these
machines is 300,000 containers per annum which is sufficient to meet the existing demand.
ZCL anticipates that the demand would increase to 540,000 containers next year and would
remain stable in the foreseeable future. The new demand can be met by replacing all the
existing machines with 3 hi-tech machines that are available in the market at a cost of
Rs. 10 million each. The new machines will have an estimated useful life of 5 years with
salvage value of Rs. 2 million each.
The following information is also available:

(i) Selling price of each container is Rs. 50 which is expected to increase by 10% per
annum from year 2 onwards.
(ii) Existing raw material cost is 45% of sales which is anticipated to reduce to 42% of
sales by using the new machines.
(iii) The introduction of new machines would reduce the monthly labour cost by
Rs. 146,000 but would increase the overhead expenses, excluding depreciation by
Rs. 2 million per annum.
(iv) All expenses are expected to increase by 8% from year 2 onwards.
(v) The existing machines can be sold at Rs. 1.2 million each excluding disposal costs of
Rs. 60,000 per machine.
(vi) The increased production capacity will require additional working capital of
Rs. 3 million.
(vii) ZCL follows a policy of charging depreciation using straight line method.
(viii) It evaluates cost of investment by applying the discount rate of 20%.
(ix) Applicable tax rate for ZCL is 35%.
Required:
(a) Calculate the Net Present Value (NPV) if the existing machines are replaced with the
new hi-tech machines. (10)
(b) Assume that the NPV of the incremental cash flows is negative and the management
is considering to shelve the plan of replacing the machines. Discuss other financial and
non-financial factors which should be taken into consideration before management
takes a final decision. (05)
Q.4 (a) Discuss the situations under which adjusted present value (APV) might be a better
method of evaluating a capital investment than net present value (NPV) method. (03)
(b) SSG Limited is engaged in the manufacturing and marketing of product X23 in
Pakistan. SSG is on course to install new plant costing Rs. 600 million which is
expected to increase its production by 15,000 tonnes per annum. SSG intends to
finance new plant by issuing new term finance certificates (TFCs). The management
of the company believes that the new issue will not alter the company’s credit rating.
Following information has been extracted from the company’s latest statement of
financial position:
Rs. in million
Paid up Capital (Rs. 10 each) 300
Retained Earnings 1,200
1,500
Term Finance Certificates (TFCs) (Rs. 1,000 each) 1,500
3,000
TFCs are due to be redeemed at par in three years and carry mark-up at the rate of
12% payable quarterly and are being traded at Rs. 950 each.

(i) SSG earns contribution margin of Rs. 45,000 per tonne of product X23.
(ii) It is expected that only 50% of new plant capacity will be utilized in the first
year of operation which will be increased by 10% in each subsequent year
subject to maximum of 80% capacity.
(iii) Incremental fixed costs other than plant depreciation are estimated at Rs. 300
million per annum.
(iv) At the end of fifth year, the plant will have a salvage value of Rs. 180 million.
(v) Company’s shares are presently being traded at Rs. 47.50 each. Equity beta of
the company is 1.3 and equity risk premium is 5%.
(vi) Cost associated with the issuance of TFCs is estimated at 2.5%.
(vii) Applicable tax rate is 35%. SSG can claim initial and normal depreciation at
50% and 10% respectively under the reducing balance method.
(viii) Yield on one year treasury bills is 8%.
Required:
Evaluate the above investment by using APV method. (16)
Q.5 Energy Gen Limited (EGL), an independent power producer, has obtained a foreign
currency loan of USD 100 million to meet the cost of expansion of its generation capacity.
The principal is repayable equally in quarterly installments along with interest for the
quarter. Further details of the loan are as follows:
Number of Installment due

Loan Amount
Pricing quarterly
(US $) First Last
installments
Tranche A 45 million 3-month Libor + 2.85% 29 30-Sep-10 30-Sep-17
Tranche B 55 million 3-month Libor + 4.25% 22 30-Jun-12 30-Sep-17
EGL had hedged the FCY loan on the date each tranche was received on the following
terms:
Hedge Pak Rupee Floating Termination
Hedge @
Amount (US $) Rate Date
Tranche A 45 million Rs. 72.11 3-month Kibor + 0.10% 15-Oct-17
Tranche B 55 million Rs. 85.40 3-month Kibor + 0.10% 15-Oct-17
However, the hedging covers the principal repayment and Libor portion of interest rate
only. The interest portion consisting of margin over Libor was not hedged.
EGL has recently issued 5-year bonds at a fixed rate of 13%. The mark up is payable at the
end of each quarter whereas the principal amount will be repaid in lump sum at the end of
loan period. The par value and current market price of each bond is Rs. 100 and Rs. 103.70
respectively.
After the successful issue of the bonds, EGL is presently considering an option to pay off the
entire foreign currency loan by issuing a new series of bonds. Due to the envisaged decline
in interest rates, EGL plans to offer new bonds whose interest rate would be linked to
3-month Kibor and in line with the current market price. In case of early termination of
foreign currency loan, EGL will be required to pay 1.5% of outstanding principal amount as
penalty.
Existing Libor and Kibor rates are 2.3% and 11.3% respectively and it may be assumed that
these rates would not change in the year 2015. The spot rate of Pak Rupee/US $ is Rs. 102.
Exchange rate is expected to change in line with interest rate parity.
It may be assumed that today is 1 January 2015.
Required:
Analyse the loan substitution option and give appropriate recommendations. For the
purpose of simplicity, you may restrict your calculations to the calendar year 2015. (20)
Q.6 The Board of Directors of Insaaf Chemicals Limited (ICL) is considering to acquire the
entire shareholdings of Mustehkam Chemicals Limited (MCL) in a share exchange
arrangement. The expected share exchange arrangement envisages exchange of 8 shares of
ICL for every 7 shares of MCL.
Summarized statements of financial position and extract of income statements for the latest
year are presented below:
Summarized statements of financial position

ICL MCL
Rs. in million
Non-current assets 12,660 593
Current assets less current liabilities (1,940) 129
Long term liabilities (6,280) -
4,440 722
Share capital (Rs. 10 each) 1,500 200

Reserves 2,940 522
4,440 722
Income statements
Turnover 22,600 1,810
Earnings before interest and tax 2,300 280
Interest (800) (40)
Profit before tax 1,500 240
Taxation (500) (80)
Profit after tax 1,000 160
Dividend to ordinary shareholders (480) (100)
Retained earnings 520 60
Following additional information is also available:
ICL MCL
Expected dividend growth 9% 7%
Current market value of share Rs. 80 Rs. 84
Weighted average cost of capital 12.5% -
Cost of equity 15.5% 13.5%
ICL’s Board is of the opinion that the proposed acquisition would enable ICL to dispose of
surplus buildings for Rs. 110 million and also reduce the staff costs by Rs. 23 million per
year over a period of four years. However, ICL would have to pay Rs. 35 million
immediately to the outgoing staff.
The shares of chemical companies are presently trading at an average multiple of 12 times in
the stock market. The stock market is assumed to be semi-strong form efficient.
Required:
Evaluate the factors that would influence the decisions of the respective shareholders and
discuss the response of the respective shareholders to the offer of acquisition. Substantiate
your answers with relevant financial calculations. (20)
(THE END)

Final Examination 3 June 2014
Summer 2014 100 marks - 3 hours
Module F Additional reading time - 15 minutes
Q.1 Modern Garments Limited (MGL) operates in Country A whose functional currency is
CA$. MGL is evaluating a proposal to acquire the entire shareholding (consisting of 100
million shares) of Elegant Textile Mills Limited (ETML) in Country B in view of the
upsurge in demand for its products in Country B. The functional currency of Country B is
CB¥.
Following information is available relating to the proposed acquisition:
(i) ETML has a rated capacity to manufacture 8 million garment pieces per annum.
However, MGL would need to spend CB¥ 2 million on the balancing and
modernisation of plant. Subsequent to the modernisation, the plant would have a
remaining useful life of 5 years.
(ii) Projections for the first year of ETML’s operations after MGL’s takeover are as
follows:
CB¥ in million
Sales (CB¥ 100 per piece) 500
Less: Variable costs (CB¥ 25 per piece) (125)
Less: Fixed costs (include depreciation of CB¥ 18 million) (30)
Profit before tax 345
Less: Taxes @ 20% (69)
Profit after tax 276
(iii) Contribution margins are expected to increase by 10% per annum, whereas fixed
costs other than depreciation would increase by 5% per annum.
(iv) ETML would be allowed to repatriate only 60% of profit after tax every year. At the
end of year 5, ETML would be allowed to repatriate the entire amount of profit after
tax including the amount of profit withheld during the past four years. The
withholding tax on repatriation is 10%.
It is planned to invest the excess funds in a deposit account at 6% per annum. The
interest would be paid annually after deduction of 10% income tax which would be
treated as final tax.
(v) Tax rate applicable to MGL is 40%. Since there is no double taxation treaty between
Country A and Country B, the amount received from ETML would be subject to the
applicable tax rate. However, MGL would be allowed a tax credit by applying
ETML’s average rate of tax on the amount repatriated plus tax deducted at the time
of repatriation.
(vi) The current exchange rate is CA$ 5 per CB¥ and the CA$ is expected to depreciate
by 3% per annum.
(vii) Additional working capital requirements are estimated at CB¥ 10 million.
(viii) In Country B, accounting depreciation is allowed for tax purposes also.
(ix) MGL has a five year time horizon for investment appraisal and required rate of
return from the project is 25%.
Required:
Suggest the maximum price that MGL may offer for the acquisition of entire shareholdings
of ETML. (18)

Q.2 Innovative Builders & Developers (IBD) is planning to launch its new residential project
which would offer three different categories of apartments to the prospective customers. The
project is estimated to be completed in four years. Details of the project are as follows:
(i) Plot of land measuring 5000 square yards has been purchased at the rate of Rs.
50,000 per square yard.
(ii) Documentation fees for transfer of the plot, land levelling costs and architect’s fees
are estimated at Rs. 20 million, Rs. 40 million and Rs. 15 million respectively.
(iii) Details of different categories of apartments are as follows:
Apartment No. of Covered area No. of

Categories rooms (sq. feet) apartments
A 6 1,800 20
B 5 1,250 32
C 4 900 50
(iv) The common amenities for the above three categories would be equivalent to 20%,
18% and 16% respectively, of the covered area of the apartments.
(v) The aggregate cost of the project would be apportioned on the basis of covered area
of each category of the apartments including the common amenities.
(vi) Down payment on booking of the apartment would be 10% of the price. The balance
would be payable in 16 equal quarterly instalments.
(vii) The estimated construction cost at the prevailing prices is Rs. 3,000 per square feet of
the aggregate covered area which is envisaged to increase by 15% per annum.
(viii) The construction work is expected to be completed as per the following schedule:
Year 1 20%
Year 2 30%
Year 3 35%
Year 4 15%
(ix) IBD’s target IRR for such projects is 18%.
(x) It may be assumed that all payments against construction works would be made at
the beginning of the year.
Required:
Suggest the target price for each apartment in categories A, B and C which IBD should
recover to earn the target IRR on its investment in the project. (17)
Q.3 Grand Power Limited (GPL), an independent power project, is planning to expand its
installed capacity by establishing a 250 megawatt coal-based power plant. The project is
expected to become operational in three years. The plant would be set up by a foreign
company at a cost of Rs. 12 billion which would be payable in 3 equal instalments at the
end of each year.
GPL is considering the following two alternatives to meet the financing needs of the
expansion project:
Alternative I : Withholding dividends for 3 years;
Alternative II : Borrowings from market to the extent of debt equity ratio of 60:40.
Following information has been obtained from the latest audited financial statements:
Shareholders’ equity Rs. 20 billion
Borrowings Rs. 22 billion
Profit before interest and tax (PBIT) Rs. 6 billion
Depreciation Rs. 1 billion
Dividend payout ratio 80% of profit after tax
Effective tax rate 25%

GPL anticipates PBIT of Rs. 6 million per megawatt per annum from this project whereas
PBIT from existing operations would increase by 10% per annum. It is also anticipated that
the amount of borrowing for the existing business operations will continue to remain the
same.
Cost of borrowings would depend on the debt equity ratio, as follows:
Debt /equity Cost of borrowing

Less than 50:50 9%
More than 50:50 10%
The current price of the GPL’s stock is Rs. 30 per share. The directors envisage that if
Alternative I is adopted, the price earnings ratio of GPL’s shares would decline to 8 times.
Required:
Analyze the two alternatives and give appropriate recommendation to the management. (17)
Q.4 Pioneer Steel Mills Limited (PSML), a listed company, owns and operates a steel re-rolling
plant located in an industrial zone. The plant is situated at a distance of 75 kilometres from
the main city and remains operational on 24 × 7 basis during the entire year.
PSML has made arrangements with a transport service provider for pick and drop of its
staff. The daily rentals agreed with the transport provider are as follows:
Vehicle No. of Rental per vehicle per day
category vehicles (inclusive of fuel cost)
24-Seat Coasters 10 Rs. 8,200
Cars 8 Rs. 3,000
The transport service provider has recently demanded that PSML should increase the
rentals by 15% because of increase in fuel prices and other operating costs.
The CEO of PSML has directed Manager Administration to explore other options available
to the company. PSML has received a proposal from another transport service provider in
which the same number of vehicles would be provided. However, the fuel costs under this
proposal would be borne by PSML. The details of monthly rentals per vehicle are as
follows:
24-Seat Coasters Rs. 160,000 per month

Cars Rs. 70,000 per month

(i) Both the transport service providers offer credit period of 60 days. Credit period
allowed by the fuel supplier would be 15 days.
(ii) The Manager Administration has determined that the fuel efficiency and average
running based on last six months data are as follows:
Average running
Vehicle category Fuel efficiency per day per
vehicle
24-Seat Coasters 7 km per litre 250 km
Cars 12 km per litre 130 km
(iii) Fuel rate per litre is Rs. 108, including 17% general sales tax. PSML is allowed to
adjust the sales tax paid on fuel against the output tax of the company.
(iv) PSML purchases fuel through Fuel Cards which entail a service fee of 2%.
(v) PSML obtains financing facilities @ 9% per annum.
(vi) The vehicle rentals under the existing as well as proposed arrangement would be
valid for one year.

Required:
(a) Make a comparative analysis of existing and proposed options for each vehicle
category and give appropriate recommendations. (Assume a 30 day month) (14)
(b) Calculate and comment upon the sensitivity of the feasibility of the
recommended model to a change in each of the following:
Average running per day
Fuel efficiency
Fuel price (09)
Q.5 Salient Engineering Limited (SEL) is a leading supplier of auto parts in the country. Its
financial year ends on 31 May. Extracts from financial statements for the year ended 31
May 2014 are as follows:
Statement of financial position
Rs. in million
Retained earnings 952
8% Term Finance Certificates (TFCs) (Rs. 100 each) 960
(redeemable at Rs. 101 in May 2018)
11% non-redeemable debentures (Rs. 100 each) 640
Income statement
Rs. in million
Profit before interest and tax 757
Less: Interest on TFCs and debentures (125)
Less: Tax @ 30% (190)
Less: Dividends (114)
Transfer to retained earnings 328
The market prices of SEL’s shares and debt instruments on 31 May 2014 were as follows :
Ordinary shares Rs. 18.4 each, cum-dividend

TFCs Rs. 97.5 each, ex-interest
Non-redeemable debentures Rs. 99.0 each, cum-interest
The dividend paid for the year ended 31 May 2013 was 4.4%. It is anticipated that dividend
rate would continue to increase in the foreseeable future at the same rate, year on year.
Required:
(a) Calculate SEL’s weighted average cost of capital on 31 May 2014. (09)
(b) The Board of Directors of SEL are considering an investment of Rs. 450 million
in new production facilities which would increase the profit before interest and
tax by 15%. Following financing options are available:
Option I : 1 for 8 right issue at a premium of Rs. 5 per share.
Option II : Issue of 11% non-redeemable debentures at a discount of 2 percent.
Required:
Evaluate the investment and discuss the implications on SEL of selecting the equity
vis-à-vis the debt option of financing. (11)
(c) Explain how quickly the markets would adjust the effect of the above investment
on SEL’s share price under each of three types of market hypothesis. (05)
(THE END)

Final Examination 4 December 2013
Winter 2013 100 marks - 3 hours
Q.1 Premier Airline Company Limited (PACL) has incurred losses during the past several
years. Recently, a new management team has taken over the operations of PACL. The
new management has observed that there is substantial over-staffing in the non-core
functions. The excess staff is also being paid overtime under the union's pressure. The
preliminary findings have revealed the following information about employees engaged
in non-core functions:
Average annual staff cost Departmental

No. of
Non-core functions per head (including 25% overheads
staff
overtime allowance) *1 (variable)
(Rs.) (Rs.)
Flight kitchen staff 100 390,000 30,356,097
Janitorial staff 120 240,000 -
Van drivers 80 360,000 12,000,000
Other support staff 150*2 270,000 -
*1 basic salary constitutes 75% of gross salary excluding overtime
*2 number of other support staff is 3 times of the actual requirements
In order to resolve the problem, a committee consisting of HR and finance professionals

has proposed the following scheme of restructuring :
Flight kitchen may be outsourced to a leading hotel chain which would provide
in-flight meals at an average cost of Rs 350 per meal. About 150,000 meal servings
are required annually.
The required support staff may be provided by an independent human resource
management company at a rate equivalent to existing gross salaries plus 15%.
Janitorial services may be outsourced to a firm at an annual contract price of
Rs. 12,000,000.
A transport service provider may be engaged to provide the required number of
vehicles with drivers at monthly rental of Rs. 45,000 per vehicle. The present fleet
which comprises of 40 vehicles, would be disposed of.
Golden Handshake Plan (GHP) in the form of 36 basic salaries would be offered to
the redundant staff.
The committee has indicated that the labour union may agitate strongly against the
restructuring proposal which may create difficulties in the implementation of the scheme.
Therefore, only 20% of the staff is expected to avail the GHP facility when the scheme
becomes effective. The remaining 80% staff is expected to opt for GHP at the end of first
year (40% probability) or at the end of 2nd year (60% probability). On the commencement
of the scheme, such staff would be transferred to a surplus pool.
Company's cost of capital is 15%.
Required:
Evaluate the financial feasibility of the above restructuring scheme in terms of net present
value. (23)

Q.2 After the increase in tax rates for salaried individuals in the Finance Act, 2013, the
executives of Supreme Group of Companies (SGC) has requested the management to
provide them with company maintained cars in lieu of car allowances to reduce the tax
burden.
The relevant information regarding the staff in management cadre is as follows:
Management cadre Head count Car allowance (Rs.)
Senior Manager 80 40,000
DGM 16 65,000
GM 8 90,000
A survey of similar companies has revealed that on average, their car policies involve the
following:
Maximum Monthly Monthly
Management Car value of estimated fuel maintenance
cadre entitlement car reimbursement allowance
(Rs.) (Rs.) (Rs.)
Senior Manager 1000cc 1,000,000 15,000 5000
DGM 1300cc 1,500,000 20,000 7000
GM 1800cc 2,000,000 25,000 10000
The finance department has informed that the cars can be obtained from a leasing
company under the following terms and conditions:
IRR 12%
Lease period 5 years, rent payable on monthly basis
Insurance 3% annually on cost of vehicle payable in equal
monthly installments
Down payment 10% of cost
Residual value 20% of cost at which employee would be able to
purchase the car at the end of the lease period
SGC can obtain financing from the bank at the rate of 13% per annum.
Required:
Advise whether it would be worthwhile for the company to adopt the proposed vehicle
policy. Substantiate your answer with all necessary calculations. (15)
Q.3 Finest Holding Company Limited (FHCL) carries out a number of inter-group
transactions with its three foreign subsidiaries FAL, FBL and FCL which are located in
Saudi Arabia, UAE and UK respectively. Details of receipts and payments which are due
after approximately three months are as follows.
Receiving Company
Paying
FHCL (Pak) FAL (SA) FBL (UAE) FCL (UK)
Company
------------------------in million------------------------
FHCL (Pak) - SAR 4.21 AED 3.15 UK£ 0.98
FAL (SA) Rs. 225.30 - US$ 2.86 UK£ 1.64
FBL (UAE) Rs. 105.80 US$ 1.85 - -
FCL (UK) UK£ 1.32 UK£ 2.10 - -
The current spot exchange rates for each unit of foreign currency in equivalent Rupees
are as follows:
Currency Buy Sell
US$ 107.00 107.20
UK£ 171.09 171.41
SAR 28.53 28.58
AED 29.13 29.19
Required:
Demonstrate how multilateral netting might be of benefit to FHCL. (07)
Q.4 The board of directors of Prime Automobile Limited (PAL) intends to raise Rs. 1,500
million for the company’s expansion project which is expected to generate profit before
interest and tax amounting to Rs. 325 million. Following options are under consideration
of the Board:
Option I – 100% debt financing
Option II – debt and equity financing in the proportion of 50:50
Financial information from PAL’s latest audited financial statements is presented below
in a summarised form:
Summarized Statement of Financial Position

Rs. in million
Non-current assets 2,358
Current assets 353
Total assets 2,711
Share capital (Rs. 10 each) 750

Reserves 913
14% term finance certificates (Rs. 100 each) 526
Current liabilities 522
Capital and liabilities 2,711
Summarized income statement

Rs. in million
Sales 1,544
Cost of goods sold (949)
Gross profit 595
Admin. & selling expense (63)
Operating profit 532
Interest expense (80)
Tax (155)
Profit on TFCs are payable on half yearly basis. TFCs are currently being traded at
Rs. 98 each and are to be redeemed at the end of 3rd year.
PAL has proposed a cash dividend of 30% and issuance of 10% bonus shares to its
shareholders. PAL’s shares are currently being traded at Rs. 30 (cum dividend).
The average ungeared beta of companies associated with similar business is 1.20. KSE
100 Index can be considered as a representative of market return which has moved from
15530 to 18325 points during the last year. 1-year treasury bills are currently being
offered at 11% per annum.
Tax rate applicable to the company is 30%.
Required:
(a) Determine whether PAL has the borrowing capacity to raise the entire investment
through debt sources as per the Prudential Regulations which requires a minimum
debt equity ratio of 60:40. (03)
(b) Compute the existing weighted average cost of capital of PAL. (05)
(c) Compute the revised weighted average cost of capital of PAL under each of the two
financing options, assuming that the effective cost of existing and new debt would
increase as follows:
Option I – by 200 basis points (05)
Option II – by 100 basis points (05)
(d) Advise which of the above options would maximize the shareholders’ value. (04)
Q.5 (a) Differentiate between conservative and aggressive strategies for financing the
working capital requirements. What actions should a company take if it decides to
follow aggressive working capital strategy? (07)
(b) Top Generators Pakistan Limited (TGPL) is a medium size company which
imports and sells a leading brand of generators. Presently, TGPL’s board of
directors is considering to acquire a plant from China to manufacture a different
brand of generators. The acquisition, installation and commissioning of the plant
would result in estimated cash outflows of Rs. 600 million. The plant is expected to
become operational in 6- 8 months.
TGPL’s bankers have agreed to provide long-term financing for the acquisition of
plant, to the extent of Rs. 300 million. The balance amount is proposed to be raised
by revising its working capital strategy.
TGPL presently follows a conservative policy in the management of its working
capital. Projected assets and liabilities at the end of the current year are as follows:
Rs in 000
Property, plant and equipment 187,500
Trade debtors 375,000
Stock in trade 300,000
Cash and bank 75,000
Trade creditors (210,000)
Short-term borrowings (127,500)
The effect of adopting the proposed working capital strategy, would be as follows:
Decrease in trade debtors 20%
Decrease in stock in trade 30%
Decrease in cash and bank 75%
Increase in trade creditors 40%
Increase in short-term borrowings 30%
The short-term borrowings limit available to the company is Rs. 200 million. The
bankers have informed that they would consider increasing this facility after the
new plant would commence operations.
Required
Being the CFO of the company, prepare a report for the board of directors
analyzing and discussing the proposed financing strategy and its consequences on
the business prospects of the company. (12)
Marks for analytical clarity and logical presentation of the report (02)
Q.6 Paramount Industries Limited (PIL) has identified three projects for investment
purposes. Due to shortage of funds, PIL can opt for only one of the identified projects.
Details of returns and standard deviation of returns from existing operations and
proposed investments are as follows:
Co-relation of Ratio of existing
Average Standard
returns with operations with
Description annual deviation
existing proposed
returns of returns
operations investment
Existing operations 17% 25% - -
Project A 11% 17% 0.20 85:15
Project B 20% 30% 0.10 80:20
Project C 14% 28% 0.30 90:10
Market returns are 12% with a standard deviation of 19%.
Required:
Determine the most beneficial project for investment. (12)
(THE END)
FB.COM/GCAOFFICIAL

Q.1 Haala Car Rental Service (HCRS) owns and operates a large fleet of vehicles. It is
considering whether to dispose of the five cars which were purchased two years ago or to
retain them for a further period of two years as these cars are not popular among the
customers.
Following further information is available:
(i) HCRS had acquired these cars under lease financing arrangements on the following
terms and conditions:
Lease period 4 years

Security deposit 10% of cost
Interest rate implicit in the lease 1-year KIBOR + 2%
Payment of lease rentals Annually (payable in arrears)
Early termination penalty 5% of principal outstanding
KIBOR rates in Year 1 and Year 2 were 12% and 11% respectively. In Year 3, KIBOR
is expected to be 10% and is likely to remain at the same level for the next two years.
(ii) At the time of acquisition, HCRS had estimated that the cars would be rented out for
approximately 180 days in a year and had fixed the rental amount to achieve an IRR
of 20%. However, the cars were rented out for an average of 120 days per year in each
of the first two years. HCRS expects the demand to remain at the same level during
the following two years.
Actual/estimated annual maintenance expenditures on each car are as follows:

Actual Estimated
Year 1 2 3 4
Annual maintenance expenditures (Rs.) 60,000 80,000 100,000 120,000
(iii) The cars are estimated to have a residual value of 50% of cost at the end of their useful
life of 4 years. Depreciation is charged on straight line basis.
(iv) The cost of each car is Rs. 1,850,000 and their present realisable values are as follows:
Cars A B C D E
Realizable value (Rs.) 1,200,000 1,300,000 1,150,000 1,350,000 1,250,000
(v) Applicable tax rate for the company is 35%.
Required:
Advise HCRS about the cars which need to be disposed of. (20)

Q.2 (a) Briefly explain any seven factors that are considered for establishing the credit rating of
a debt instrument. (07)
(b) Harappa Pakistan Limited (HPL) wishes to invest Rs. 400 million in a project which
would be financed by issuing debentures of Rs. 250 million and the balance amount
would be financed through excess cash available with the company. HPL anticipates
that the project itself will generate sufficient cash flows to be able to redeem the
debentures in five years. The directors are considering the following three alternatives
for raising the finance:
(i) Issuance of debentures at a discount with fixed interest rate of 8%.
(ii) Issuance of zero coupon debentures which would be redeemed at the end of
year 5 at face value.
(iii) Issuance of debentures at face value at market interest rate.
HPL had also issued debentures amounting to Rs. 150 million previously. These are
due to be redeemed in three years and carry mark up at the rate of 10% payable
annually and are being traded at Rs. 94.80. The face value of existing as well as
proposed debentures is Rs. 100 each.
The credit rating of existing debentures is ‘A+’. The directors anticipate that after the
new issue, the credit rating for both debentures would be ‘A’.
The investors are expected to invest in the debentures if the following rates are offered:
Credit rating Year 1 Year 2 Year 3 Year 4 Year 5

A+ 7.45% 8.62% 9.78% 11.13% 11.84%
A 7.70% 8.92% 10.14% 11.60% 12.34%
Required:
Analyse each of the above three alternatives relating to issuance of debentures and
discuss the circumstances under which each alternative would be advisable. (13)
Q.3 Shahriq Holdings Limited (SHL) is a subsidiary of a UK based company. It entered into an
agreement to acquire 60% shareholding in a local company for which it received an advance
of GBP 2.5 million from its parent company. The advance is repayable on 30 September
2013.
SHL is exploring various options to hedge against any adverse movements in foreign
exchange rates, for which the following data is available:
(i) Exchange rates on 1 June 2013
GBP 1
Buy Sell
Spot Rs. 153.65 Rs. 153.90
4-months forward contract Rs. 157.49 Rs. 157.75
(ii) Currency futures (GBP) on 1 June 2013
Futures have a contract size of GBP 5,000 and the margin required is Rs. 7,500 per
contract. Contract prices (Rupee per GBP) are as follows:
GBP 1
June 2013 Rs. 154.67
September 2013 Rs. 157.36
The contracts can mature at the end of the above months only. It is expected that the
difference between futures and spot prices would continue to remain the same.
SHL’s incremental rate of borrowing is 10% per annum.

Required:
SHL estimates that on 30 September 2013, GBP 1 would either be equal to Rs. 154 or Rs.
155 or Rs. 156. Under each of the three possibilities, determine which method should be
selected by SHL. (11)
Q.4 Katkhair Engineering Limited (KEL) is a 100% equity-financed company. The company
designs and assembles a wide range of made-to-specification mechanical appliances for
industrial customers. The actual manufacturing of the components used in appliances is
usually outsourced but KEL ensures that the components conform to its specifications in
terms of design and metallurgy. The individual components are finally assembled and
tested at KEL’s own facilities.
KEL has recently developed a new appliance ‘EN-43’ and is in the process of deciding as to
whether it would be financially feasible to produce EN-43 on commercial basis. The
following information is available:
Sales revenue and marketing expenses

(i) EN-43 would generate cash flows for five years. It is estimated that each EN-43 will
be sold for Rs. 9,000 and annual production and sales of the appliance will be 1,500
units in each of the five years.
(ii) An expenditure of Rs. 3 million was incurred on the designing, testing and market
research of EN-43. It includes amount of Rs 1.2 million incurred on materials and
services.
Outsourcing costs
(iii) Manufacturing of components would be outsourced at a total cost of Rs. 4,000 for
each EN-43. It includes Rs. 1,200 for component L-17.
KEL already has 1,000 units of L-17 in stock. These were acquired for Rs. 800 each.
If EN-43 is not produced, the existing units of L-17 would be returned to the vendor
at Rs. 700 each.
Assembling costs
(iv) Assembly of EN-43 would require separate premises whose rent is estimated at Rs.
450,000 per annum, payable in advance.
(v) Assembly of each EN-43 would require 15 and 35 man hours of skilled and unskilled
workers respectively. The rate of wages is Rs. 100 per hour for skilled workers and
Rs. 60 per hour for unskilled workers. KEL pays 50% for idle hours. If EN-43 is not
produced, 5,000 hours of unskilled workers would remain idle in years 1 and 2.
(vi) Incremental overheads excluding depreciation are estimated at Rs. 500,000 per year.
(vii) The assembling of EN-43 would require machines which would cost Rs. 4,400,000.
The machines would have a useful life of five years after which these may be sold at
20% of their original cost.
Other information
(viii) Tax rate applicable to the company is 35% and tax is payable in the same year.
Allowable initial and tax depreciation on the machine is 40% and 20% respectively.
(ix) KEL evaluates its investment using a nominal discount rate of 15%.
(x) The rate of inflation is estimated at 10% per annum and would affect all costs and
revenues.
Required:
(a) Recommend whether or not KEL should proceed with the EN-43 project. Assume
that working capital requirements are immaterial and all cash flows arise at the end of the
year unless specified otherwise. (17)
(b) Carry out a sensitivity analysis to assess and compare the sensitivity of the project, to
the following variables:
Sales price
Nominal discount rate (07)

Q.5 The Board of Directors of Taxila Power Limited (TPL) is considering to acquire the entire
shareholding of Digari Power Limited (DPL) in a share exchange arrangement. TPL’s
Board is of the opinion that the proposed acquisition would enable TPL to:
(i) immediately increase the combined profits of the two companies by Rs. 12 million;
(ii) sell DPL’s surplus fixed assets. These assets can be sold for Rs. 20 million; and
(iii) reduce TPL’s risk factor as perceived by its shareholders which would result in decline
in their annual return expectations by 2%.
DPL has maintained a steady level of profitability and dividend performance in the
preceding years and its existing shareholders expect that this trend would continue in the
future. Current market value of DPL’s ordinary shares is Rs. 25.60 per share.
Following information has been extracted from the financial statements of both the
companies for the year ended 31 May 2013:
TPL DPL
Rs. in million
Non-current assets 600 100
Current assets, less current liabilities 200 20
Share capital (Rs. 10 each) 100 50
Reserves 700 70
Net profit for the year 80 16
Dividend for the year (paid on 31 May 2013) 40 16
The current market value of TPL’s ordinary shares is Rs. 56 per share. At present, the
expected growth rate in net profits is 12% per annum which is expected to be maintained
after acquisition. The Board intends to continue to maintain the same dividend payout ratio.
Required:
(a) Calculate the maximum price that TPL may pay for the acquisition of DPL. (08)
(b) The financial consultant of TPL is of the opinion that DPL’s shareholders may be
persuaded to sell the entire shareholding at a premium of 20% over the current market
price. Based on this assumption:
(i) Calculate the number of shares which TPL would be required to issue to the
shareholders of DPL as price consideration. (04)
(ii) What benefits, if any, would accrue to the existing shareholders of TPL and
DPL through the proposed acquisition? (03)
(iii) Discuss other relevant factors that the directors/shareholders of both companies
may consider in assessing the proposed acquisition. (10)
Ignore taxation.
(THE END)

The Institute of Chartered Accountants of Pakistan

Winter 2012 100 marks - 3 hours
Q.1 ABM Limited is contemplating a major capacity expansion project that will require an investment
of Rs. 6,000 million. It plans to raise this amount on 01 January 2013 from a combination of debt
and equity in such a way as to arrive at a debt equity ratio of 60:40 in terms of market value.
The projected capital structure of ABM on 31 December 2012 is as follows:
Rs. in million
4,500
Term finance certificates (Rs. 100 each) 5,000
Earnings per share of the company for the year ending 31 December 2012 is projected at Rs. 3.50
per share whereas the price of its shares on the above date is expected to be Rs. 19.55 per share.
ABM plans to offer shares at 80% of their market value.
Existing TFCs were issued on 01 July 2009 and carry a coupon rate of 12% payable semi-annually.
Principal repayment is due on 30 June 2014. Due to increase in market interest rates, the TFCs are
currently trading at a discount providing an yield to maturity of 14%. Consequently, the new debt
would be offered at a coupon rate of 14% per annum. All other terms and conditions would remain
the same.
Required:
(a) Calculate the amount to be raised by issue of debt and equity. (08)
(b) Compute the number of right shares to be issued and the ex-right price. (03)
(c) Assess whether the debt equity ratio would remain within the threshold, on 30 June 2013, if:
• the yield to maturity comes down to 13%; and
• the net profit and P/E ratio increase by 15% and 5% respectively. (07)
(Ignore taxation)
Q.2 (a) Discuss any five limitations of NPV technique when applied generally to investment appraisal. (05)
(b) CDN Limited uses a machine for manufacturing some of its products. The machine is
replaced every three years. Considering the high maintenance costs in the third year, CDN is
considering to revise its replacement policy from three years to two years. Details of purchase
price, maintenance costs and net realizable value at current prices are as follows:
Year 0 Year 1 Year 2 Year 3

Purchase price (Rs.) 3,200,000 - - -
Maintenance costs (Rs.) - 130,000 245,000 480,000
Net realizable value (Rs.) - - 1,280,000 700,000
Annual increase in purchase price, maintenance costs and net realizable value is estimated at
10%, 15% and 8% respectively. The weighted average cost of capital of the company is 18%.
Required:
Determine whether CDN should revise its replacement policy. (15)

Q.3 (a) GHP Limited is a fast growing business which operates a chain of petrol pumps across the
country. The company is committed to an aggressive strategy of expansion through
acquisition. It is considering to acquire 100 percent shareholding in IJQ Limited that operates
a chain of CNG stations on the highways. GHP is contemplating to offer 1 share for every 3
shares held in IJQ.
Latest financial data of GHP and IJQ are summarised below:
Statement of Financial Position

GHP IJQ
Rs. in million
Non-current assets 5,220 2,340
Current assets minus current liabilities 1,640 900
6,860 3,240
Less: Non-current liabilities 1,240 120
5,620 3,120
Ordinary share capital (Rs. 10 each) 3,000 2,000

Retained earnings 2,620 1,120
5,620 3,120
Statement of Comprehensive Income

GHP IJQ
Rs. in million
Revenue 11,280 4,840
Net profit after taxation 6,580 3,760
Dividend 1,316 1,880
Average share price for each company in recent years has been as follows:
2009 2010 2011 2012

--------------------Rupees---------------------
GHP 70 96 138 186
IJQ 48 64 68 58
GHP’s board of directors feel that there is a strong synergy between the two businesses which
will lead to an increase of Rs. 300 million per year in combined after tax profit, following the
acquisition. Both GHP and IJQ are listed companies and their cost of capital is 13% and 18%
respectively.
Required:
(i) Calculate the share price of GHP following the takeover, assuming price earnings ratio of
the company is maintained and the synergy is achieved as expected. (05)
(ii) Calculate the cost of equity of the merged entity. You may use any reasonable
assumption wherever necessary. (05)
(b) Mr. Danish, a shareholder of IJQ, has expressed concern over the bid. He claims that,
following the acquisition, the annual dividends are likely to be lower as GHP normally pays
small dividends. As he relies on dividend income to cover his living expenses, he is concerned
that he will be worse off following the acquisition. He also believes that price offered for the
shares of IJQ is too low.
Required:
Discuss the bid from the point of view of shareholders of IJQ including the concerns raised by
Mr. Danish. (08)

Q.4 KLR Limited has two operating segments viz. Paints and Chemicals. Break-up of its shareholders’
equity is as follows:
Rs. in million
Share capital (Rs. 10 each) 2,000
Latest segment-wise financial information of KLR is summarized below:
Chemicals Paints
Rs. in million
Revenue 3,150 2,500
Gross profit 378 650
Net profit after tax 220 330
Assets
Non-current assets 6,610 5,250
Current asset 7,930 6,300
Liabilities
Non-current liabilities - 12% Debentures (Rs. 100 each) 2,100 1,950
Current liabilities 4,770 3,505
KLR’s current share price is Rs. 13 per share and the market value of its debenture is Rs. 101.50.
The risk free interest rate and market return are 8% and 14% respectively. KLR’s equity beta is 1.15.
Debentures are redeemable at par in ten years.
The company is considering a demerger whereby the two segments would be listed separately on the
stock market. The existing equity would be split between the segments based on the net assets held
by each segment. The following information is relevant for the purpose of demerger:
(i) Transfers to the Paint Segment account for 25% of the revenues of the Chemicals Segment.
The transfers are made at cost. After the demerger, all transactions would be made on an ‘arms
length basis’.
(ii) Common expenses amounting to Rs. 100 million are shared by the two segments on the basis
of their revenues. After the demerger, cost of such expenses for Chemicals and the Paints
entities would be Rs. 70 million and Rs. 30 million respectively.
(iii) The average equity betas of the companies associated with the Chemicals and Paints business
is 1.2 and 1.5 respectively and the average debt equity ratios are 60:40 and 70:30 respectively.
(iv) Projected cash flows for Year 1 are as follows:
Chemicals Paints
------Rs. in million------
Pre-tax operating cash flows 280 360
Tax deprecation 70 40
From Year 2, projected cash flows and profit after tax are expected to grow at 5% per annum
in perpetuity.
Tax rate is 35%. Tax is payable in the year in which the relevant cash flows arise.
Required:
(a) Calculate the weighted average cost of capital of both companies after demerger. (10)
(b) Using cash flows, evaluate whether the demerger would be financially advantageous for
KLR’s existing shareholders. (15)

Q.5 EFO Pakistan Limited intends to make an investment of Rs. 3,000 million. Besides Pakistan, EFO
has the option to invest either in UAE or in Bangladesh. The total market value of the company’s
existing share capital is Rs. 9,000 million.
Estimates of returns on investment are presented below:
Current and Expected Return %

Economic Expected on investment in
Probability
Performance Return in
Pakistan % UAE Bangladesh
Low growth 0.3 2 5 3
Average growth 0.5 8 9 11
High growth 0.2 14 13 19
Standard deviation of expected returns are as follows:
UAE 5.12
Bangladesh 8.05
Pakistan 1.34
Co-variances of expected returns are as follows :
Pakistan/UAE 5.96
Pakistan/ Bangladesh 10.66
Directors of EFO have different viewpoints about the proposed investment which are summarised
below:
(i) Since the company does not have any prior experience of investment abroad, it should focus
exclusively on exploring opportunities within Pakistan because investment abroad carries
inherent risks.
(ii) Investment abroad will offer the company the opportunity to achieve a much better
combination of risk and return than purely domestic investments, and will open up new
opportunities.
(iii) Since expected returns are high in Bangladesh, the company should invest there and
subsequently increase the company’s investment in Bangladesh.
Required:
(a) Calculate the anticipated risks and returns on the proposed investment. (11)
(b) Briefly discuss the viewpoints of the directors about the proposed investment. (04)
(c) What other factors, in your opinion, would have a bearing on the investment decision? (04)
(THE END)


Q.1 Mac Fertilizer Limited (MFL) is a listed company and is engaged in the business of manufacturing of
phosphate fertilisers. MFL intends to diversify its operations by manufacturing and distributing steel
products. This diversification would require an investment of Rs. 3,600 million for establishing the
plant and meeting the working capital requirement. MFL plans to finance the investment as follows:
 55% of the investment would be financed by issuing Term Finance Certificate (TFCs) carrying
interest at 12% per annum and repayable in 2018.
 The balance amount would be generated by issuing right shares at Rs. 65 per share.
Extract of MFL’s statement of financial position as at 31 December 2011 is given below:
Equity and liabilities Rs. in million Assets Rs. in million

Share capital (Rs. 10 each) 7,000 Non-current assets 50,000
TFCs (Rs. 100 each) 28,000 Current assets 40,000
Current liabilities 32,000
90,000 90,000
The existing TFCs carry mark up @ 11.5% per annum and are due for redemption at par in 2016.
Currently, MFL’s shares and TFCs are traded at Rs. 80 and Rs. 102.50 respectively. Equity beta of
the company is 1.3.
The proposed investment has been evaluated at a discount rate of 17% which is based on existing cost
of equity plus a premium that takes cognisance of the risks inherent in the steel industry. However,
there are divergent views among the directors regarding the discount rate that has been used.
 Director A is of the view that the premium charged to reflect the risk in the steel industry is too
low. He is of the opinion that the company’s existing weighted average cost of capital is more
appropriate discount rate for evaluation of this investment.
 Director B suggests that the discount rate should be representative of the steel industry. He has
provided the following data pertaining to a listed company, Pepper Steel Limited (PSL).
− 900 million shares of Rs. 10 each are outstanding which are currently being traded at Rs. 35.
− Long term loan amounted to Rs. 8,000 million obtained from local banks at the average rate
of 13%.
− Equity beta of the company is 1.5.
You have been appointed as the Lead Advisor by an Investment Bank working on this transaction.
You have obtained the following information:
Interest rate for 6-months treasury bills 8%

Market return 13%
Applicable tax rate for all companies 30%
Debt beta of MFL and PSL is assumed to be zero.
Required:
Compute the discount rate based on suggestions given by Directors A and B and discuss which
suggestion is more appropriate. (19 marks)

Q.2 CB Investment Limited (CBIL) has identified various projects for investments. Details of the projects
are as follows:
Projects A B C D E F
Initial investment required now (Rs. in million) (300) (120) (240) (512) (800) (400)
Forecasted annual net cash inflows (Rs. in million) 150 50 140 256 440 300
Discount rate (based on risk involved in the project) 10% 11% 12% 11% 13% 14%
Project duration (years) 4 5 3 6 3 2
Year from which net cash inflows would commence 1 2 1 3 1 1

(i) Project A and B are mutually dependent and are non-divisible.
(ii) Project C can be scaled down but cannot be scaled up.
(iii) Project D, E and F are mutually exclusive. They cannot be scaled down but can be scaled up.
Total financing available with the company is Rs. 1,000 million. It may be assumed that all cash
flows would arise at the beginning of the year.
Required:
Determine the most beneficial investment mix. (20 marks)
Q.3 Beta Limited (BL) is engaged in the business of manufacturing and marketing of high quality plastic
products to the large departmental stores in Pakistan and United Arab Emirates. BL is presently
experiencing a decline in sales of its products. Market research carried out by the Marketing
Department suggests that sustained growth in sales and profits can be achieved by offering a wide
range of products rather than a limited range of quality products. In this regard, BL is considering the
following two mutually exclusive options:
Option I : Introduce low quality products in the market

Following information has been worked out by the Chief Financial Officer of the company:
Net present value using a nominal discount rate of 13% Rs. 82 million
Discounted payback period 3.1 years
Internal rate of return 10.5%
Modified internal rate of return 13.2% approximately
Option II : Import variety of plastic products from China

BL would buy in bulk from Chinese suppliers and sell it to the existing customers. The projected net
cash flows at current prices after acceptance of this option are as follows:
Year 0 Year 1 Year 2 Year 3 Year 4

Against import from China (US$ in million) (25.00) (20.00) (21.33) (22.33) (20.67)
From operation in UAE (US$ in million) - 22.47 24.15 25.23 23.37
From operations in Pakistan (Rs. in million) - 333 350 414 450

(i) The current spot rate is Re. 1=US$ 0.0111.
(ii) BL evaluates all its investment using nominal rupee cash flows and a nominal discount rate.
(iii) Inflation in Pakistan and USA is expected to be 10% and 3% per annum respectively.
Tax may be ignored.
Required:
Evaluate the two options using net present value, discounted payback period, internal rate of return
and modified internal rate of return. Give brief comments on each of the above methods of evaluation
and their relevance in the given situation. For the purpose of evaluation, assume that BL has a four year
time horizon for investment appraisal. (17 marks)

Q.4 FF International (FFI) is considering the opportunity to acquire CS Limited (CSL). You have been
appointed as a consultant to advise the FFI’s management on the financial aspects of the bid.
The latest summarized annual financial statements of CSL are given below:

Rs. in million
Total assets 5,000
Share capital 2,000

Accumulated profit 150
Long term loan 700
Short term loan 1,300
Other current liabilities 850
5,000
Summarized Income Statement

Rs. in million
Sales 1,000
Less: Cost of sales (430)
Gross profit 570
Selling and administration expenses (250)
Financial charges (280)
Profit before taxation 40
Taxation (14)
Profit after taxation 26
You have also gathered the following information:

(i) CSL produces a single product X-201 and has a market share of 30%. A market survey
conducted to identify the impact of increase or decrease in price has revealed the following
relationship between price of X-201 and market share:
Increase / (decrease) in price Market share

(10%) 45%
5% 23%
10% 20%
(ii) In order to increase production, CSL would have to invest Rs. 150 million in plant and
machinery which would be financed through long term loan on terms and conditions similar to
those of the existing long term loan, as specified in point (v) below.
(iii) Fixed production costs amount to Rs. 100 million which include depreciation of Rs. 75 million.
(iv) 80% of selling and administration expenses are fixed. Fixed costs include depreciation of Rs. 25
million and salaries of Rs. 160 million. After acquisition, FFI expects to reduce the staff in sales
and administration by making one-time payment of Rs. 100 million. It would reduce the
department’s salaries by 25% and the remaining fixed costs by 30%.
(v) Long term loan carries mark- up @ 15% per annum. The balance amount of principal is
repayable in five equal annual instalments payable in arrears.
(vi) Mark up on short term loan is 14% per annum. CSL has failed to meet certain debt covenants
and therefore its bankers have advised CSL to reduce the short term loan to Rs. 1,000 million.
(vii) It is the policy of the company to depreciate plant and machinery at 20% per annum using
straight line method. Accounting depreciation may be assumed to be equal to tax depreciation.
(viii) Working capital would vary at the rate of 40% of increase / decrease in sales.
(ix) Tax rate applicable to both companies is 30% and tax is payable in the same year. CSL has
unutilized carry forward tax losses of Rs. 80 million.
(x) All costs as well as sales are expected to increase by 10% per annum.
(xi) Free cash flows of CSL are expected to grow at 5% per annum after Year 5.
(xii) Based on the risk analysis of this investment, the discounting rate is estimated at 18%.

Required:
(a) Discuss any two advantages and disadvantages of growth through acquisition. (04 marks)
(b) Determine the following:
• Optimal sales level at which CSL’s profit would be maximised. (05 marks)
• Amount of cash flow gap at optimal level of sales during the first five years of acquisition.
(14 marks)
(c) Calculate the bid price that FFI may offer for the acquisition of CSL assuming that cash flow
gap identified in (b) above would have to be filled by FFI by way of an interest free loan.
(07 marks)
Q.5 Assume that the date today is 1 June 2012. Alpha Automobiles Limited (AAL) has imported CNG
kits from Japan and has to repay an amount of JPY 175 million in three months time.
AAL intends to hedge the contract against adverse movements in foreign exchange rates and its
foreign exchange exposures. The following data are available:
Exchange rates quoted on 1 June 2012

JPY 1
Buy Sell
Spot rate Rs. 1.9223 Rs. 1.9339
One month forward rate Rs. 1.9335 Rs. 1.9451
Three month forward rate Rs. 1.9410 Rs. 1.9493
Interest rates available to AAL

Borrowing Investing
Japan 5% 3%
Pakistan 8% 5%
JPY currency futures

Futures have a contract size of JPY 100,000 and the margin required is Rs. 1,000 per contract.
Contract prices (Rupee per JPY) are as follows:
JPY 1
July 2012 Rs. 1.9365
October 2012 Rs. 1.9421
January 2013 Rs. 1.9490
The contracts can mature at the end of the above months only.
Currency options
Options have a contract size of JPY 250,000. The premiums (paisa per Rupee) payable on various
options and the corresponding strike prices are shown below:
Calls Puts
Strike
price 31 July 31 October 31 July 31 October
2012 2012 2012 2012
Rs. ----------------------------Paisas----------------------------
1.90 2.88 3.55 0.15 0.28
1.91 1.59 2.32 1.00 1.85
1.92 0.96 1.15 2.05 2.95
Options are exercisable at the end of relevant month only.
Required:
Illustrate four methods by which Alpha Automobiles Limited might hedge its currency exposure.
Recommend which method should be selected. (14 marks)
(THE END)

Module F 100 marks – 3 hours
Winter 2011 Additional reading time – 15 minutes
Q.1 (a) Briefly discuss the Dividend Irrelevance Theory developed by Miller and Modigliani (MM).
State three arguments against the validity of this theory. (05 marks)
(b) Al-Ghazali Pakistan Limited (AGPL) is a listed company whose shares are currently traded at
Rs. 80 per share. AGPL’s Board has approved a proposal to invest Rs. 600 million in a project
which is expected to commence on 31 December 2012. There are no internal funds available
for this investment and the company would have to finance the project from the profit for the
year ending 31 December 2012 and through right issue.
AGPL has a share capital consisting of 20 million shares of Rs. 10 each and its profit for the
year ending 31 December 2012 is projected at Rs. 250 million.
The annual return on 1-year treasury bills, the standard deviation of returns on AGPL’s shares
and the estimated correlation of returns with market returns are 7.5%, 8% and 0.8 respectively.
The current market return is 12.9% with a standard deviation of 5%.
Required:
Using MM Theory of Dividend Irrelevance, estimate the price of AGPL’s shares as at 31
December 2012, if the company declares:
(i) 20% dividend
(ii) Nil dividend (05 marks)
(c) Justify the MM Theory of Dividend Irrelevance, based on your computation in (b) above.
(05 marks)
Q.2 The directors of Khayyam Limited (KL) are considering an investment proposal which would need
an immediate cash outflow of Rs. 500 million. The investment proposal is expected to have two
years economic life with salvage value of Rs. 50 million at the end of second year.
KL’s Budget and Planning Department anticipates that Net Cash Inflows After Tax (NCIAT) are
dependent on exchange rate of the US $ and has made the following projections:
Exchange Rate Exchange Rate Exchange Rate
Rs. 84-87 Rs. 88-91 Rs. 92-95
NCIAT Probability NCIAT Probability NCIAT Probability
Year 1 250 65% 320 35% - -
Year 2:
− If Year 1 exchange rate is Rs. 84-87 280 20% 330 65% 360 15%
− If Year 1 exchange rate is Rs. 88-91 340 5% 380 50% 400 45%
All NCIATs are in millions of rupees
KL uses a 14% discount rate for investments having similar risk levels.
Required:
(a) Draw a decision tree to depict the above possibilities. (04 marks)
(b) Determine whether it would be advisable for Khayyam Limited to undertake this project.
(10 marks)

Q.3 Ibn-Seena Limited (ISL) is a reputable unquoted company engaged in the business of
manufacturing and sale of pharmaceutical products. It is presently considering a proposal to
acquire Al-Biruni Pharmaceuticals (Private) Limited (APPL) which is a wholly owned subsidiary
of Al-Biruni International (ABI).
Summarised income statements of ISL and APPL for the latest financial year are given below:
ISL APPL
Rs. in million
Sales 2,500 1,800
Less: Cost of sales - Variable (1,350) (630)
- Fixed * (150) (190)
Gross profit 1,000 980
Selling expenses (375) (360)
Administration expenses (125) (90)
Profit before tax 500 530
Tax (35%) (175) (186)
Profit after tax 325 344
* includes depreciation of Rs. 70 million and 100 million respectively
Other Information
(i) APPL’s sales consist of Generic Medicines (40%) and Patented Products (60%). Presently,
20% of the revenue from Patented Products is contributed by a product Z-11. All patents are
owned by ABI; however, no royalty or technical fee is presently claimed by it.
(ii) The variable costs of Patented Products are 30% of the sales amount. Product Z-11 will
complete its patent period after three years and thereafter its price would have to be reduced.
Consequently, the ratio of variable costs of production to sales would fall in line with that of
Generic Medicines.
(iii) After acquisition the costs and revenues of APPL are projected as follows:
Total sales and variable costs would grow at 10% per annum except in Year 4 when the
growth rate of sales would decline on account of reduction in price of product Z-11.
Fixed costs other than depreciation would increase at the rate of 5% per annum. However,
depreciation would remain constant over the next five years.
Selling expenses and administration expenses would be reduced by 30% and 80%
respectively. However, from Year 2 onwards, selling expenses would increase at 7% per
annum whereas administration expenses would increase by 5% per annum.
ABI will charge 15% royalty on sale of Patented Products whereas 3% technical fee will be
levied on the sales of all products.
(iv) Free cash flows of APPL are expected to grow at 3% per annum after Year 5.
(v) ISL intends to finance this project through debt carrying interest at the rate of 10% per annum.
The principal would be re-payable at the end of Year 6.
(vi) ISL would discount this project at its existing weighted average cost of capital of 20%.
Required:
(a) Calculate the bid price that ISL may offer for the acquisition of APPL. (17 marks)
(b) Assess the impact of the acquisition on the wealth of ISL’s shareholders at the end of Year 5
assuming that the shares at that time would be priced at 7 times its PE ratio and ISL’s profit
after tax would increase at 8% per annum. (03 marks)

Q.4 Khaldun Corporation (KC) is a Pakistan based multinational company and has number of inter-
group transactions with its two foreign subsidiaries KA and KB, which are located in USA and UK
respectively. Details of receipts and payments which are due after approximately three months are
as follows.
Receiving Company
Paying
KC (Pak) KA (USA) KB (UK)
Company
------------in million------------
KC (Pak) - Rs. 131 £ 5.10
KA (USA) US $ 1.50 - US $ 4.50
KB (UK) £ 4.00 £ 1.80 -
The current exchange rates and interest rates are as follows:
Exchange Rates
US $ 1 UK £ 1
Buy Sell Buy Sell
Spot Rs. 86.56 Rs. 86.80 Rs. 134.79 Rs. 135.13
Interest Rates
Borrowing Lending
KC (Pak) 10.50% 8.50%
KA (USA) 5.20% 4.40%
KB (UK) 5.90% 5.00%
Required:
(a) Calculate the net rupee receipts/payment that KC (Pak) should expect from the above
transactions under each of the following alternatives:
Hedging through forward contract
Hedging through money market (08 marks)
(b) Demonstrate how multilateral netting might be of benefit to Khaldun Corporation. (06 marks)
Q.5 Ghazali Limited (GL) operates a chain of large retail stores in country X where the functional
currency is CX. The company is considering to expand its business by establishing similar retail
stores in country Y where functional currency is CY. As a policy, GL evaluates all investments
using nominal cash flows and a nominal discount rate.
The required investments and the estimated cash flows are as follows:
(i) Investment in country X
CX 7 million would be required to establish warehouse facilities which would stock
inventories for supply to the retail stores in country Y at cost. At current prices, the annual
expenditure on these facilities would amount to CX 0.5 million in Year 1 and would grow
@ 5% per annum in perpetuity.
Investment in country Y
Investment of CY 800 million would be made for establishing retail stores in country Y.
At current prices, the net cash inflows for the first three years would be CY 170 million,
250 million and 290 million respectively. After Year 3, the net cash inflows would grow at
the rate of 5% per annum, in perpetuity.
(ii) Inflation in country X and Y is 7% and 20% per annum respectively and are likely to remain
the same, in the foreseeable future. Presently, country Y is experiencing economic difficulties
and consequently GL may face problems like increase in local taxes and imposition of
exchange controls.
(iii) The current exchange rate is CX 1 = CY 45.
(iv) GL’s shareholders expect a return of 22% on their investments. GL uses this rate to evaluate
all its investment decisions.

Required:
Prepare a report to the Board of Directors evaluating the feasibility of the proposed investment.
Your report should include the following:
(a) Computation of net present value of the project and a recommendation about the viability of
the project. (12 marks)
(b) Identification of the risk and uncertainties involved. (03 marks)
(c) Brief discussions on management strategies which may be adopted to counter the risks of
increase in local taxes and imposition of exchange controls. (05 marks)
Q.6 Skill Enhancement Centre (SEC) is an established institution with a mission to impart training to
the youth by developing their job-related technical skills. It offers industry-specific one year
diploma courses to students.
In the recent past, several other institutions have started offering a wide range of new courses with
the result that the number of students enrolled in SEC’s Textile Designing Course (TDC) has
declined to 175 students per annum. SEC is developing its 5-year plan and an important
consideration is to replace TDC with Advanced Textile Graphics Course (ATGC).
The following related information is available:
(i) Several computers would need to be upgraded at a cost of Rs. 350,000. However, if ATGC is
not introduced 30 such computers may be sold at Rs. 12,000 each. The current book value of
each computer is Rs. 15,000.
(ii) ATGC would require new textile designing software which costs Rs. 1,200,000.
(iii) The new course would be taught and managed by the existing staff which receives total
remuneration of Rs. 6,000,000 per annum. However, if the enrolment in ATGC program
exceeds 225 students per annum, two new technical instructors would have to be engaged at
a cost of Rs. 1,800,000 per annum which would be payable in advance.
(iv) Details relating to income from fees and other costs are as follows:
Timing of TDC ATGC

cash flows Rupees
Course fee per student In advance 42,000 43,200
Cost of training material per student In advance 6,000 7,400
Directly attributable costs (per annum) In arrears 120,000 230,000
Apportionment of overheads excluding staff costs In arrears 2,400,000 3,000,000
Preliminary costs (including training of instructors) In advance - 750,000
(v) On an average, a new student enrolled in a course brings additional revenue of Rs. 2,400 per
annum on account of other activities.
(vi) Being an educational institution, SEC is exempted from income tax.
(vii) SEC assesses the viability of a course using a discount rate of 7%.
(viii) It is assumed that the number of students enrolled would remain constant throughout the
five-year period.
Required:
Determine the minimum annual enrolments which would make it financially viable for SEC to
introduce ATGC. (17 marks)
(THE END)


Final Examinations June 8, 2011
Reading time – 15 minutes
Module F – Summer 2011 100 marks – 3 hours
Q.1 (a) GER Auto Parts Limited is engaged in the manufacture of automobile spare parts. GER’s
summarised financial statements for the year ended December 31, 2010 are as follows:
Balance Sheet
Equity and Liabilities Rupees Assets Rupees
Share capital (Rs. 10 each) 1,250,000 Fixed assets 7,500,000
Reserves 5,250,000 Inventory 750,000
Long term debt 2,500,000 Receivables 875,000
Current liabilities 625,000 Cash 500,000
9,625,000 9,625,000
Income Statement
Rupees
Sales of 12,500 units 11,718,750
Variable costs (7,812,500)
Fixed costs (1,750,000)
Interest expense (10%) (250,000)
Profit before tax 1,906,250
Tax (35%) (667,188)
Net profit 1,239,062
Owing to competitive pressures, GER plans to reduce the prices of existing products by 6%.
However, variable and fixed costs (excluding interest) are expected to increase by 5% and 10%
respectively. Interest rate is floating and is expected to increase to 10.6% per annum.
Required:
Calculate the amount of sales that GER should achieve in the following year to enable it to
maintain its existing total leverage. Show how this change would affect the operating and
financial leverages. (07 marks)
(b) GER’s management is also considering to launch a new product. Based on market research, it
has identified the following options:
Option 1 Option 2
Product X Product Y
Investment required (Rs.) 3,000,000 7,000,000
Unit price (Rs.) 15,000 5,000
Fixed cost (Rs.) 200,000 300,000
Expected sales (units) 200 1,000
Variable costs (% of sales) 78% 73%
The management plans to invest in any one of these options. The investment would be
financed through long term debt which is available at 12% per annum.
Required:
Calculate the impact of each of the above options on GER’s operating and financial leverages
for the year ending December 31, 2011. Which option would you recommend and why? (You
may assume that implementation of the above options would have no impact on the sales of existing
products as computed in (a) above). (08 marks)

Q.2 The Trustees of FR Co-operative Housing Society are planning to invest its surplus funds in
different open end mutual funds. Details of proposed investments along with market information
gathered from a stock analyst are as follows:
Mutual Funds
A B C
 Information on proposed investment
Date of investment 1-Jul-11 1-Aug-11 1-Sep-11
Amount of investment Rs. 500,000 Rs.1,000,000 Rs. 500,000
Estimated net asset value on acquisition Rs. 10.50 Rs. 10.00 Rs. 9.70
Estimated net asset value as on December 31, 2011 Rs. 10.40 Rs. 10.00 Rs. 9.90
 Expected dividends
(during the investment holding period)
Cash dividend to be received Rs. 9,500 Rs. 15,000 -
Bonus to be received 10% 5% 5%
 Funds characteristics
Front end load (Buying load) 3.00% 2.00% 1.50%
Back end load (Selling load) 1.00% 0.00% 2.00%
Sharpe ratio 0.71 0.31 0.16
Correlation with benchmark indices 0.75 0.92 0.83
 Expected performance of benchmark indices

Benchmark index KSE 100 KSE 30 KMI 30
Total annual return % 16 17 12
Standard deviation of annual returns 0.10 0.18 0.13
The yield on 1-year treasury bills is 9%.
Required:
(a) Estimate the effective annual yield which FR would earn, from the date of investment up to
December 31, 2011.
(b) In respect of each fund, evaluate whether it would achieve the return in accordance with its
risk profile. (15 marks)
Q.3 In order to reduce the cost of electricity consumption, HIN Textile Mills Limited has decided to
install a gas generator and discontinue the power supply being obtained from a utility company.
The gas generator which would meet their requirements would cost Rs. 80 million. The following
two proposals are being considered by HIN:
Option 1: Offer from BAL Leasing Company Limited

BAL has offered a three year lease at a quarterly rent of Rs. 7.46 million payable in arrears. In
addition, HIN would be required to pay a security deposit of Rs. 10 million at the time of signing
the lease agreement. Generator will be transferred to HIN at the end of the lease term, against the
security deposit.
The fair value of the generator, at the end of lease period is estimated at Rs. 20 million.
Operating and maintenance costs of the generator are estimated as follows:
Costs Frequency Rs. in million

Staff salary Monthly 0.50
Lubricants and filters Quarterly 1.00
Parts replacement Half yearly 3.00
Overhaul At the end of 2nd year 15.00

Option 2 : Offer from PUS Rental Services

PUS has also offered to sign a three year contract according to which HIN would pay quarterly
rent of Rs. 11 million in arrears, with a 10% increase in each subsequent year. The lease rental
would include the cost of maintenance and overhauling of the generator, which will be borne by
PUS.
It may be assumed that HIN’s cost of capital is equal to the IRR offered by BAL.
Required:
Evaluate which of the above proposals should be accepted by HIN. (Ignore taxation) (12 marks)
Q.4 The management of JAP Recreation Club is evaluating the option to launch a restaurant that
would serve complete meal to its members. Presently, it has a snack bar shop which sells snacks
and drinks only.
A management consultant firm was hired at a fee of Rs. 85,000 to prepare the feasibility of the
project. JAP’s Accountant has extracted the following information from the consultant’s report:
(i) The restaurant will be launched on the first day of the next year.
(ii) The club membership has been increasing at the rate of 5% per annum. As a result of this
facility, it is expected that the rate would increase to 10% per annum.
(iii) The cost of equipment for the restaurant is estimated at Rs. 7,000,000. It would have a
residual value of Rs. 510,000 at the end of its estimated useful life of four years.
(iv) It is estimated that during the first year, an average of 100 customers would visit the
restaurant, per day. The number would increase in line with the increase in membership. The
average revenue from each customer is estimated at Rs. 400 whereas variable costs per
customer would be Rs. 260.
(v) Four employees would be appointed in the first year at an average salary of Rs. 200,000 per
annum. A fifth employee would be hired from the third year.
(vi) The annual fixed overheads for the current year are estimated at Rs. 4.8 million. 15% of the
fixed overheads are allocated to the snack bar. As a result of the establishment of the
restaurant the annual expenditure would increase as follows:
Rupees
Electricity and gas 340,000
Advertising 170,000
Repair and maintenance 85,000
After the establishment of restaurant, 20% of the overheads would be allocated to the
restaurant whereas allocation to snack bar would reduce to 10%.
(vii) The snack bar is presently serving an average of 250 customers per day and the number is
increasing in proportion to the number of members. If the restaurant is launched, the number
of customers would reduce by 40% in the first year but would continue to increase in
subsequent years in line with the member base. The average contribution margin from snack
bar is Rs. 50 per customer.
(viii) The tax rate applicable to the company is 35% and it is required to pay advance tax in four
equal quarterly instalments. JAP can claim tax depreciation at 25% under the reducing
balance method. Any taxable losses arising from this investment can be set off against profits
of other business activities.
(ix) JAP’s post tax cost of capital is 17% per annum before adjustment for inflation. The rate of
inflation is 10%.
Required:
Advise whether JAP should invest in the project. Assume that each year has 360 days. (16 marks)

Q.5 ARA Venture Capital Limited specialises in acquiring loss making companies and converting them
into profitable entities with the objective of disposing them subsequently.
Presently, ARA is planning to acquire 60% shareholdings in PUN Electric Supply Company. Its
Financial Analyst has obtained the following information about PUN’s operations:
(i) During the year ended December 31, 2010, total electricity demand and supply was Mwh 2.0
million, whereas the cumulative generation capacity of all the existing plants was Mwh 2.1
million. The demand for electricity is expected to grow at the rate of 5% per annum.
(ii) Cost of power generation per Kwh is Rs. 7 which is expected to increase by 8% per annum.
(iii) PUN’s line losses for the year were 30%.
(iv) The Power Tariff Regulatory Authority has allowed PUN to determine the tariff so as to sell
electricity at a margin of 10% above the average cost of generation. PUN is allowed to
include line losses of up to 20% in the cost of generation. The price per unit is determined by
the following formula:
(Total Cost + 10%) ÷ {Number of units produced × (1 – Permissible line losses %)}
where, one unit = 1 Kwh and 1 Mwh = 1,000 Kwh
(v) Revenue collection ratio for the year 2010 was 90% of the aggregate billing.
(vi) Other expenses, excluding depreciation and financial charges for 2010 amounted to Rs. 300
million and are expected to increase by 8% per annum.
(vii) Depreciation is charged on straight line method over the useful life of 20 years. Depreciation
for the year 2010 amounted to Rs. 75 million.
(viii) PUN has running finance facilities of Rs. 3,000 million from various banks at an average
mark-up of 13% per annum. The facilities utilized as of December 31, 2010 amounted to Rs.
2,785 million.
(ix) In order to meet the future requirements of electricity, PUN’s management has already
started work on a new generation plant that will be commissioned into operation by the end
of 2012 and will increase the present capacity by 15%. Total cost of the new project will be
Rs. 1,500 million and PUN had issued TFCs on January 1, 2011 at 14% per annum, to
finance the project.
(x) The issued share capital of PUN as at December 31, 2010 consisted of 500 million shares of
Rs. 10 each.
ARA intends to invest in PUN’s infrastructure facilities to reduce line losses. It also plans to
broaden the Recovery Department with the objective of improving the recovery ratio. The
projected figures for the next five years are as follows:
Year ending December 31 2011 2012 2013 2014 2015

Capital expenditures (Rs. in million) 500 600 500 - -
Additional staff cost in recovery
department (Rs. in million) 15 17 18 20 22
Line losses 28% 25% 22% 20% 18%
Recovery ratios 92% 94% 96% 97% 97%
The planned capital expenditures would be incurred at the end of the year. ARA would provide a
loan to PUN to finance the capital expenditures. The loan will be disbursed as required and carry a
mark up of 10% per annum. It would be repayable on December 31, 2015.
In addition, ARA would provide guarantees to different banks to secure additional running finance
facilities for PUN amounting to Rs. 8,000 million, at a mark up of 13% per annum.
ARA requires an IRR of 20% from its investment and expects to exit from this venture by selling its
shareholdings at the P/E multiple of 16.
Required:
Determine the purchase consideration that ARA should be willing to pay for the acquisition of 60%
shares in PUN. (Ignore taxation) (25 marks)

Q.6 URD Pakistan Limited, a listed company, is presently considering to acquire 100% shareholdings
of CHI Limited, an unlisted company, which is engaged in the same business.
The following information has been extracted from the latest audited financial statements of the
two companies:
URD CHI
----------Rs. in million----------
Non-current liabilities – Term Finance Certificates 1,500 -
Share capital (Rs. 10 each) 400 200
Retained earnings 100 100
Net profit after tax 300 250
Tax rate applicable to both the companies is 35%.
The directors of URD believe that a cash offer for the shares of CHI would have the best chance of
success. They are considering various options to finance this acquisition. The initial negotiations
suggest that interest rate on debt financing would depend upon the debt equity ratio of the
company as shown below:
Debt equity ratio (up to) 40:60 50:50 60:40 70:30

Interest rate 16% 17% 18% 20%
The shares of URD are currently traded at Rs. 52.50. According to the prevailing practice in the
market, price earning ratios of unlisted companies are 10% less than those of listed companies.
Required:
Write a report to the Board of Directors, on behalf of Mr. Shah Rukh, the Chief Financial Officer
of the company, discussing the following:
(a) Which of the following financing option should the company adopt?
(i) The acquisition of CHI Limited is entirely financed by debt.
(ii) The acquisition is financed by issue of debt and equity in the ratio of 60:40. The equity
is to be generated by the issue of right shares at Rs. 45 per share.
(b) What other matters should be considered and what impact these may have on the decision
arrived in (a) above? (17 marks)
(THE END)


Final Examinations – Winter 2010 December 8, 2010
Module F 100 marks - 3 hours
Q.1 (a) Briefly discuss the possible synergistic effects which are the primary motivation for most
mergers and takeovers. (05 marks)
(b) The board of directors of Platinum Limited (PL), a leading manufacturer of electrical goods, is
considering to takeover Diamond Limited (DL), a competitor of an important product line, by
offering seven ordinary shares for every six ordinary shares of DL.
The summarized statement of financial position and summarized income statement of the two
companies for the latest financial year are given below:
PL DL
Rupees in million
Total assets 4,535 959
Shareholders equity
Ordinary shares (Rs. 10 each) 900 192
Reserves 1,089 121
1,989 313
Total liabilities 2,546 646
Total equity and liabilities 4,535 959
Summarized Income Statement
PL DL
Rupees in million
Turnover 3,638 901
Profit before tax 312 86
Tax 81 28
Profit after tax 231 58
The current price earnings ratios of PL and DL are 15 and 19 respectively.
In case of successful bidding, the directors envisage that:

after tax savings in administrative costs would be Rs. 24 million per annum.
the price earnings ratio of the merged company would be 18.
the dividend payout ratio of PL would not be affected.
Required:
(i) Total value of the proposed bid based on PL’s current share price.
(ii) Expected earnings per share and share price of PL following the successful acquisition of
DL.
(iii) The board of directors is also considering the alternative to offer three zero coupon
debentures (redeemable in 8 years at Rs. 100) for every 2 DL shares. PL can currently
issue new 8 year loan at an interest rate of 11% per annum. Discuss whether this proposal
is likely to be viewed favourably by DL’s shareholders. (15 marks)

Q.2 Silver Limited (SL) is a large manufacturing concern in Malaysia. It deals in four major product
lines. As the financial controller of the company, you are faced with the following situations:
(I) SL has made arrangements to export leather shoes to a major customer in USA. It has been
agreed that one consignment would be shipped in each quarter and payment thereof would be
made at the end of the quarter. SL’s sole supplier of leather is in Pakistan and it has also agreed
to supply on 3 months credit. The estimated sales and purchases for the first two quarters of
2011 are as follows:
Purchases from
Sales to US Customer
Pakistani Supplier
First quarter ending March 31, 2011 USD 1,020,000 USD 775,000
Second quarter ending June 30, 2011 USD 1,224,000 USD 1,347,000
The management is considering to hedge the foreign currency transactions. In this regard SL’s
bank has provided the following information:
USD 1
Exchange Rates
Buy Sell
Spot rate MYR 3.030 MYR 3.110
3 months forward rates premium MYR 0.071 MYR 0.073
6 months forward rates premium MYR 0.160 MYR 0.164
Interest Rates Lending Borrowing

MYR 6.6% p.a. 7.9% p.a.
USD 5.8% p.a. 7.2% p.a.
(II) SL has sold one of its product lines for MYR 15 million. The proceeds are expected to be
received at the end of February, 2011. SL plans to use these funds in September, 2011 for one
of its major expansion project. Consequently, the management wants to invest this amount in a
fixed deposit account for a period of six months at 6% per annum.
The management is considering to hedge the interest rate risk by using interest rate futures. The
current price of March six months’ futures is 95.50 whereas the standard contract size is MYR
3 million.
Required:
(a) Determine which of the following options would be more beneficial to the company:
(i) Hedging through forward cover
(ii) Hedging through money market
(b) Determine how beneficial would it be for SL to use interest rate futures to hedge the interest
rate risk if at the end of February, 2011 interest rates:
(i) fall by 0.75% and future price moves by 1%; or
(ii) rise by 1% and future price moves by 1%. (20 marks)
Ignore transaction costs.
Q.3 Iron Limited (IL) is considering four projects for investing the excess liquidity available with the
company. Each project will last for three years. The details are as follows:
Projects
A B C D
Net annual cash flows (Rs. in millions) 85 87 90 95
Expected return 16% 14% 17% 15%
Standard deviation of returns 20% 18% 27% 30%
Estimated correlation of returns with market returns 0.82 0.85 0.91 0.78
The current market returns are 14% with a standard deviation of 16%. Risk free rate of return is
10%.

Required:
(a) Evaluate which of the above projects may be selected for investment by Iron Limited. Rank the
selected projects in order of preference.
(b) Determine the overall systematic risk that would be associated with the above investments if IL
decides to invest in all the projects selected in (a) above. (13 marks)
Q.4 Gold Limited (GL) manufactures textile machinery. The management has explored opportunities in
various South Asian countries and is optimistic that there is considerable demand for GL’s
machines in the region. However, exports from Pakistan are not financially viable on account of
higher input costs. Therefore, GL intends to establish a subsidiary either in Bangladesh or in Sri
Lanka. Based on initial studies, the management projections, at current prices, are as follows:
Alternative 1: Subsidiary in Bangladesh (SIB)

(i) SIB would require immediate outlay of BDT 110 million for the construction of a new
factory, i.e. BDT 80 million for acquisition of land and BDT 30 million as advance payment
for construction of factory. Balance payment of BDT 75 million would be made in year 1.
(ii) The installation and commissioning of plant and machinery would be completed in year 1 at
a cost of BDT 115 million.
(iii) The estimated working capital requirement in year 1 and year 2 is BDT 20 million and BDT
110 million respectively.
(iv) Production and sales in year 2 are estimated at 3,000 units and in years 3-5 at 4,000 units per
annum. The average price in year 2 is estimated at BDT 300,000 per unit.
(v) Total variable costs in year 2 are expected to be BDT 165,000 per unit.
(vi) Fixed overhead costs excluding depreciation, in year 2 are estimated at BDT 350 million.
(vii) Allowable tax depreciation on all fixed assets except land is 20% per annum on a reducing
balance method.
(viii) Applicable tax rate on SIB is 35%.
Alternative 2: Subsidiary in Sri Lanka (SISL)

(i) The investment would involve the purchase of an existing factory via a takeover bid. The
estimated cost of acquisition is LKR 90 million.
(ii) Additional investment of LKR 18 million in new plant and machinery and LKR 36 million in
working capital would be required immediately after the acquisition.
(iii) Pre-tax net cash flows (including tax savings from depreciation) are estimated at LKR 27
million in year 1 and LKR 35 million in year 2.
(iv) Applicable tax rate on SISL is 25%.
All the above projections are based on current prices and are expected to increase annually at the
current rate of inflation. Inflation rates for each of the next five years in Pakistan, Bangladesh and
Sri Lanka are expected to be 12%, 10% and 8% respectively.
The after-tax realizable value of the investment at the prices prevailing in year 5, is estimated at
BDT 145 million and LKR 115 million in case of Bangladesh and Sri Lanka respectively.
Current exchange rates are as follows:
BDT /PKR Rs. 0.83 – Rs. 0.85
LKR/PKR Rs. 1.31 – Rs. 1.34
GL’s cost of equity is 18%. It would finance the investment by borrowing at 12% per annum in
Pakistan after which its debt equity ratio would be approximately 30:70.
The tax rate applicable to GL in Pakistan is 30%. Pakistan has double taxation treaty agreements
with both the countries.
Required:
Evaluate which of the two subsidiaries (if any) should be established by GL. (Assume that tax in all
countries is payable in the same year and that all cash flows arise at the end of the year) (24 marks)

Q.5 The management of Copper Industries Limited (CIL) intends to raise financing for the company’s
expansion project but is concerned about the impact of proposed additional financing on the
company’s existing capital structure and values.
The management is aware that there is an inverse relationship between interest cover and cost of
long term debt and the following relationship exist between interest cover and cost of debt:
Interest cover (times) >8 6 to 8 4 to 6 2 to 4

Cost of long term debt 8% 9% 11% 13%
The management has found that the following two debt equity ratios are usually prevalent in the
industry and are also acceptable to the company’s banker.
(i) 70% equity, 30% debt by market values
(ii) 50% equity, 50% debt by market values
The latest audited financial statements depict the following position:
Rs. in million
Net profit before tax 272
Depreciation 50
Interest @ 9% 55
Capital expenditure 150
Market value of existing equity and debt is Rs. 825 million and Rs. 550 million respectively. CIL’s
equity beta is 1.25 and its debt beta may be assumed to be zero. The risk-free rate of return and
market return are 7% and 15% respectively. Applicable tax rate is 35%.
Assume that:
CIL’s cash flow growth rate would remain constant and would not be affected by any change in capital
structure.
Market value of the company at the existing weighted average cost of capital, after the proposed
expansion, would remain the same.
Required:
(a) Calculate the following under the current as well as each of the above debt equity ratios being
considered by the company:
(i) Weighted average cost of capital
(ii) Value of the company
(b) Compare the three options and give recommendations in respect thereof to the company.
(23 marks)
(THE END)

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
Final Examinations Summer 2010
June 9, 2010
BUSINESS FINANCE DECISIONS (MARKS 100)

(3 hours)
Q.1 YB Pakistan Limited is engaged in the manufacture of pharmaceutical products. On April 1,

2010 the Board of Directors approved a plan which envisages an investment of Rs. 300
million on account of capital expenditures over the next five years. Following information
has been extracted from the management accounts of the company which have been
prepared in respect of the year ended March 31, 2010:
Rs. in millions
Sales revenue 190.00
Cost of goods sold 110.00
Operating expense 30.00
Interest expense 15.00
Property plant and equipment 100.80
Shareholders’ equity 135.00
(i) Annual outlay of investment in next five years is estimated to be 13%, 16%, 22%,
22% and 27% respectively of the total amount.
(ii) The company expects that the operating profit (excluding depreciation) generated by
the existing assets will grow at the rate of 12% per annum. In addition, the new
investments would yield pre-tax cash flows of 15% per annum.
(iii) The company follows a policy of maintaining a debt equity ratio of 40:60.
(iv) Interest rates on existing and future long term debts are expected to be the same and
are not expected to change during the next five years. The current debt is repayable at
the end of five years. All future debts would be repayable on or after six years.
(v) The company has a short term financing facility of Rs. 50 million. The outstanding
balance as of March 31, 2010 was Rs. 20 million. Assume that interest @ 16% is
payable at the end of each year on the closing balances.
(vi) The company invests its surplus funds into highly secured investments which yield
8% per annum.
(vii) The additional working capital requirements are estimated at 10% of additional capital
expenditures.
(viii) Accounting depreciation is calculated at the rate of 15% of written down value. It is
equal to tax depreciation and therefore is allowable for tax purposes. The current
corporate tax rate is 40%. To promote corporate business, the Government has
announced an annual reduction of 2% in tax rate till it is reduced to 34%.
(ix) The company follows the residual dividend policy for payment of dividends.
You may assume that all cash flows are incurred at year end.
Required:
(a) Calculate the expected dividend for the next five years in accordance with the existing
payout policy of the company.
(b) Ascertain whether the company would be able to pay off its existing loan at the expiry
of five years. (22)

(2)
Q.2 MK Limited is presently considering a proposal to acquire 100 % shareholdings of ZA

Limited which is engaged in the same business. The financial data extracted from the latest
audited financial statements and other records of the two companies is presented below:
MK ZA
-----Rs. in million-----
Sales revenue 12,000 8,460
Operating expense excluding depreciation (7,695) (4,905)
Depreciation (1,305) (990)
Profit before interest and tax 3,000 2,565
Interest (644) (1,494)
Profit after interest 2,356 1,071
Taxation (35%) (825) (375)
Profit after taxation 1,531 696
Dividend payout 50% 55%

Capital expenditure during the year (Rs. in million) 700 650
Debt ratio 40% 55%
Market rate of interest on debentures 6.5% 7.5%
Number of shares issued (in million) 100 90
Market price of share (Rs.) 20 12
Equity beta 1.1 1.3
The following further information is available:

(i) Both the companies follow the policy of maintaining stable dividend payouts and debt
ratios.
(ii) Annual growth in sales, operating expenses, depreciation and capital expenditures are
estimated as under:
Year 1 – 2 Year 3 onward

MK 4.0% 5.0%
ZA 5.5% 5.0%
(iii) Accounting depreciation is the same as tax depreciation.

(iv) The prevailing risk-free rate of return is 8% whereas the market return is 13%.
The key aspects of the feasibility study carried out by MK are as follows:
MK would issue 7 shares in exchange for 9 shares of ZA.
A rationalization of administrative and operational functions after takeover would
reduce operating expenses including depreciation, from 75% to 70% of total sales.
The annual growth in sales, operating costs, depreciation and capital expenditures in
the merged company would be as follows:
Year 1 – 2 5.0%
Year 3 onward 5.5%
Required:
(a) Based on an analysis of Free Cash Flows, calculate the value of MK Limited, ZA
Limited and the company which would be formed after the merger.
(b) Estimate the synergy effect which is expected to accrue to MK Limited on account of
acquisition of ZA Limited. (25)
Q.3 (a) Briefly explain the Adjusted Present Value (APV) method and identify its advantages
over the Weighted Average Cost of Capital method. (04)

(3)
(b) NS Technologies Limited is in the business of developing financial software. The

directors of the company believe that the scope of future growth in the software sector is
limited and are considering to diversify into other activities. An option available with
the company is to sign an eight year distribution contract with a leading manufacturer of
telecommunication equipments.
Some of the important information related to the above proposal is as follows:
(i) Total investment is estimated at Rs. 600 million. It includes developing the
necessary infrastructure, purchase of equipment and working capital
requirements.
(ii) The investment is expected to generate pre-tax net cash flows of Rs. 180 million
per year.
(iii) Presently NS is paying interest @ 9% on its long term debt.
(iv) NS maintains a debt equity ratio of 55:45 whereas its equity beta is 0.9.
(v) Average debt ratio, overall beta and debt beta of telecommunication equipment
distribution segment is 40%, 1.5 and 1.3 respectively.
(vi) The market rate of return is 14% whereas yield on one year treasury bills is 6%.
(vii) Costs associated with the issuance of debt and equity instruments are estimated
at 1% and 3% respectively.
(viii) Tax rate applicable to the company is 35%. Tax is paid in the same year as the
income to which it relates.
(ix) In case the contract is not renewed upon expiry, after tax cash flows of Rs. 90
million would be generated from disposal of allied resources.
Required:
Evaluate the above proposal using the APV method. (12)
Q.4 DS Leasing Company Limited has been approached by BP Industries Limited, with a
request to arrange a 4-year lease contract in respect of a state of the art machine. The cost of
machine is Rs. 20 million and the expected useful life is 4 years. The residual value at the
end of lease term is estimated at 10% of cost.
DS would finance the purchase of machine by borrowing at 16% per annum. The interest
would be payable annually and the principal amount would have to be repaid in four equal
annual installments commencing from the end of first year.
DS provides free-of-cost maintenance services for all its leased assets. These services are
provided by the company’s Maintenance Department whose costs are mostly fixed. If BP
acquires this service from any other vendor, it would have to pay an annual fee of 3% of the
cost of machine. Insurance cost will be borne by BP and is estimated at 4% of the cost of
machine.
The tax rate applicable to both companies is 35% and the tax is payable in the next year.
Allowable initial and normal deprecation on the machine is 25% and 10% respectively. The
weighted average cost of capital of DS and BP are 18% and 20% respectively.
Both companies follow the same financial year. It may be assumed that the purchase would
be finalized on the last day of the financial year.
Required:
(a) Calculate the annual rental (payable in advance) which DS should charge in order to
break even on the lease contract. (08)
(b) Assume that BP has the following two options for financing the cost of machine:
(i) DS has offered to lease the machine at an annual rental of Rs. 7 million, payable
in advance.
(ii) EFT Bank has offered to finance the machine at 18% per annum. The loan
including interest would be repayable in 4 equal annual installments to be paid at
the end of each year. Insurance costs would be borne by BP.
Determine which course of action BP should follow. (12)
(4)
Q.5 The Directors of PSD Engineering Limited, a listed company, are planning to raise Rs. 100
million for a new project. They are considering two possible options of fund raising. The
first is to make a two-for-five right issue of ordinary shares priced at Rs. 12.50 per share.
The second option is to issue 9% Term Finance Certificates (TFCs) at par, redeemable in
2020.
The following information has been extracted from the financial statements of PSD for the
year ended March 31, 2010:
Rs. in million
Issued ordinary shares Rs. 10 each 200
590
10% TFCs at par, repayable in 2012 350
940
The shares of the company are currently traded at Rs. 16 per share. The profit before interest
and taxation of PSD for the year ended March 31, 2010 is Rs. 95 million.
It is expected that the right issue will not affect PSD’s current price earnings ratio. However,
the issue of TFCs would result in fall in price earnings ratio by 30%.
Required:
(a) Make appropriate calculations in each of the following independent situations:
(i) Assuming a right issue of shares is made, calculate:
the theoretical ex-rights price of an ordinary share.
the value of the right. (03)
(ii) Assuming the market is strong form efficient and it is expected that new project
would generate positive net present value of Rs. 96 million. Calculate the
theoretical ex-right price in this case. (02)
(iii) Assuming that the new project would increase the company’s profit before
interest and tax for the next year by 10%. Calculate the price of an ordinary share
in one year’s time under each of the two financing options. (09)
(b) Briefly discuss why issue of term finance certificates is expected to result in fall in
price earnings ratio. (03)
(THE END)

Final Examinations Winter 2009
December 9, 2009

(3 hours)
Q.1 Attock Index Tracker Fund (AITF) is an open-end mutual fund and was incorporated in
2004. However, since inception, its performance has remained unimpressive and it has
generally been outperformed by KSE-100 index.
You have recently joined AITF as its Fund Manager and have been asked by the
management to review the current composition of the portfolio. Details relating to the shares
currently held in the portfolio are as follows:
Price
Market Dividend
No of forecast
Name of price per Standard per share
shares Covariance after one
company share deviation next year
year
Rupees in 000 Rupees Rupees
A 25 150 0.150 0.024 27 2.00
B 15 230 0.240 0.039 17 1.00
C 46 190 0.160 0.044 52 2.50
D 106 50 0.320 0.033 111 4.00
E 75 100 0.190 0.018 85 2.00
F 114 120 0.220 0.041 125 3.00
G 239 60 0.190 0.032 220 5.50
H 156 80 0.210 0.040 168 3.00
I 145 35 0.180 0.034 170 2.50
J 67 45 0.220 0.033 75 1.00
(i) The average market return of the KSE-100 Index companies is 12% and the standard
deviation is 18%.
(ii) The risk free rate of return is 8%.
(iii) The correlation between the market value of securities held by AITF and KSE-100
Index is 0.737.
(iv) The average return on AITF’s shares is 11% with standard deviation of 22%.
Required:
(a) Compute the AITF's systematic risk and assess the extent to which AITF has matched
the performance of KSE-100 Index.
(b) Determine whether AITF achieves the return according to its risk profile.
(c) Identify those shares in AITF’s portfolio which are expected to underperform and
should be removed.
(d) Compute the revised beta of AITF i.e. after excluding the underperforming shares.
Assume that cash generated from disposal of underperforming shares will be used to
buy the remaining shares in proportion to their current holdings. (20)

(2)
Q.2 Kohat Limited (KL) is considering to set-up a plant for the production of a single product
IGM3. The initial capital investment required to set up the plant is Rs. 15 billion. The
expected life of the plant is only 5 years with a residual value of 20% of the initial capital
investment. The plant will have an annual production capacity of 1.0 million tons.
A local group has offered to purchase all the production for Rs. 8,000 per ton in year 1 and
thereafter at a price to be increased 5% annually. Other relevant information is as under:
(i) In year 1, operating costs (other than wages and depreciation) per annum would be Rs.
2,000 per ton. They are expected to increase in line with Producer Price Index (PPI).
Annual wages would be Rs. 1.0 billion and are linked to Consumer Price Index (CPI).
(ii) KL’s cost of capital for this project, in real terms is 6%. General inflation rate is 11%.
(iii) The tax rate applicable to the company is 30% and the tax is payable in the same year.
The company can claim normal tax depreciation at 20% per annum under the reducing
balance method.
Price indices of the last six years are given below:
Year 2003 2004 2005 2006 2007 2008

PPI 107 119 130 142 160 175
CPI 112 125 139 155 173 195
The costs linked to the above indices are expected to grow at their historic compound
annual growth rate.
Required:
Advise whether KL should invest in the project. (14)
Q.3 Tarbella Enterprises (Pvt) Limited (TEPL) is the manufacturer and supplier of chemical X.
Due to an internal conflict, the directors of TEPL have offered to sell the company to
Chakwal Limited (CL) which is one of its largest customers.
CL has hired you to determine the value at which it would be feasible for it to acquire
TEPL. The relevant information is as follows:
(i) CL would consider TEPL as a separate cash generating unit and it will have a useful
life of five years. The normal capacity of TEPL’s plant is 22,000 tons.
(ii) During the year ended June 30, 2009, CL consumed 15,000 tons of chemical X.
(iii) Summary of TEPL’s profit and loss account for the year ended June 30, 2009 is as
follows:
Rs. in million
Sales (20,000 tons) 240
Variable costs (80)
Fixed costs (50)
Operating profit 110
(iv) CL’s planning department has provided the following projections related to the next
five years:
CL’s demand for chemical X would increase by 5% each year.
The annual increase in the price of chemical X would be 10%.
The variable costs per ton of production of chemical X would increase by 12%
per annum.
Fixed costs would increase by 8% each year.
(v) CL intends to use the entire production of chemical X for its internal use only.
(vi) CL maintains a debt equity ratio of 50:50. Its cost of debt and cost of equity is 14%
and 20% respectively. Tax rate applicable to both the companies is 30%.
Required:
Compute the maximum price which CL may offer for the acquisition of TEPL. (13)

(3)
Q.4 The directors of Bannu Holdings Limited (BHL) have decided to sell off its wholly owned
subsidiary, Ziarat Engineering Limited (ZEL). Following information has been extracted
from the last audited financial statements of ZEL:
Rs. in million
Sales 2,958
Less: Cost of sales 1,928
Gross Profit 1,030
Allocated expenditures of BHL (255)
Operating expenses (388)
Other income 216
Financial charges (119)
Tax @ 30% (145)
Net profit 339
A team of executives and employees, lead by the CEO of ZEL is also interested in the
acquisition of the subsidiary. They plan to form a new company, Sibbi Engineering
(Private) Limited (SEL), which will acquire all the assets of ZEL. After intense negotiations
the directors of BHL have finally agreed to sell ZEL to the employees, under the following
terms and conditions:
(i) The value of ZEL will be Rs. 2,100 million.
(ii) BHL would pay off all the existing debts of ZEL.
(iii) BHL would acquire 10% shareholding in SEL.
The employees would invest Rs. 270 million in SEL in the form of equity. In order to
arrange the balance amount, they intend to accept any one of the following offers:
I A commercial bank has offered a loan on the following terms:
(i) Loan will carry markup @ KIBOR + 3% and would be payable annually. KIBOR
is currently at 8%.
(ii) The tenure of the loan would be 5 years and it would be repayable at maturity.
(iii) SEL will have to comply with the following debt equity ratio:
Year 1 2 3 4-5
Debt equity ratio 75% 70% 60% 50%
In case of failure to comply with the above condition, the bank would reserve the
right to demand repayment of the entire amount within a period of 30 days.
II An investment bank is willing to provide a convertible loan to SEL. The loan carries
interest at the rate of 10% per annum. The principal is repayable in four equal annual
installments commencing from the end of year 2. The investment bank will have the
option to convert the balance amount of loan into shares of SEL at Rs. 25 each and the
conversion option will be exercisable at the commencement of year 4 or year 5. SEL
would not be allowed to issue any dividend during the tenure of the loan.
SEL’s revenues/expenses are expected to grow in the following manner:
(i) Gross profit would increase at the rate of 3% per annum.
(ii) Operating expenses would increase by Rs. 100 million in year 1 and thereafter @3%
per annum.
(iii) 75% of the profit earned by SEL would be available in the form of cash, for
repayment of debt. In the case of option 1, SEL plans to invest it in various schemes,
till the loan becomes payable and consequently, the other income is expected to grow
@ 10% per annum.
Required:
(a) Analyse the two financing options to evaluate whether SEL would be in a position to
comply with the terms of the respective loans.
(b) Which offer should SEL accept and why? (24)

(4)
Q.5 Sajawal Sugar Mills Limited (SSML), a medium sized listed company, is planning to
expand its production capacity. The management has estimated that the expansion would
require an outlay of Rs. 300 million.
Following figures have been extracted from SSML’s financial statements for the year ended
June 30, 2009.
Statement of Financial Position
Rs. in million
Paid up capital (Rs. 10 each) 400
Non-current liabilities 600
1,250
Fixed assets 1,100

Current assets 150
1,250
Statement of Comprehensive Income
Rs. in million
Net profit after tax 125
EPS 3.13
To finance the expansion, SSML is considering a right issue. However, the management of
SSML wants to maintain its existing debt equity ratio, return on total assets ratio and
dividend payout percentage. Moreover, they wish to keep the ex-right price to be the same
as current market price.
SSML follows a policy of retaining 30% of its profits. The current market price of its shares
is Rs. 20 whereas its share price beta is 1.23. Presently, market return is 16% whereas yield
on one year treasury bills is 12%. Market is assumed to be strong form efficient.
Required:
Under the circumstances referred to in the above situation, what should be:
(a) The right ratio
(b) The right offer price
(c) Theoretical ex-right price
(d) Value of each right (17)
Q.6 Qalat Industries Limited (QIL) is a medium sized company which carries out extensive
trading (imports as well as exports) with various German companies. The management of
QIL is concerned about the recent fluctuations in the exchange rate parity between Pak
Rupee (Rs.) and Euro (€) and is considering to hedge the following transactions which it
expects to undertake, on December 15, 2009:
Due date of
Nature of transaction Amount
payment / receipt
(i) Import of IT equipment € 223,500 Jun. 15, 2010
(ii) Export of sports goods € 98,500 Mar.15, 2010
(iii) Export of medical instruments € 77,000 Jun. 15, 2010
(iv) Import of machinery Rs. 22,500,000 Mar.15, 2010

(5)

(i) According to QIL’s bank the following exchange rates are expected to prevail on
December 15, 2009:
€1
Buy Sell
Spot Rs. 124.22 Rs. 124.52
3 months forward Rs. 123.62 Rs. 123.96
6 months forward Rs. 123.21 Rs. 123.54
(ii) Interest rate on borrowing and lending in respective currencies are as follows:
Rs. €
3-months / 6 months borrowing 11% 5%
3-months / 6 months lending 6.5% 3%
Required:
(a) Calculate the net rupee receipts/payments that QIL should expect from the above
transactions under each of the following alternatives:
(i) Hedging through forward cover
(ii) Hedging through money market
(b) Determine which would be the better alternative for QIL.

(Ignore transaction costs) (12)
(THE END)

June 3, 2009

(3 hours)
Q.1 ABC Limited is engaged in manufacture and sale of spare parts of heavy vehicles.
Presently, the company is planning to raise Rs. 2,000 million to replace its existing
production machines with the latest machines. All machines will be imported from UK.
The company is considering the following two options to raise the finance:
(I) The company can issue Term Finance Certificates (TFCs) in the local market for a
period of three years at a rate of 6-months KIBOR plus 1.5%. Interest and principal
repayment will be made in six semi-annual installments. The company will be
required to pay 0.25% commitment fee at the time of raising the TFCs.
(II) UK Ex-Im bank has offered to provide the required amount for a period of three
years at a rate of 6-months LIBOR + 2.5%. Principal and interest will be payable in
six semi-annual installments.
It is anticipated that interest rates will vary in line with inflation forecasts in each country.
The forecasted interest rates expected at the beginning of half year for the next three years
are as follows:
6-months KIBOR 6 months LIBOR

July 2009 13.00% 5.00%
January 2010 12.50% 5.25%
July 2010 12.00% 5.50%
January 2011 11.50% 5.75%
July 2011 11.00% 6.00%
January 2012 10.50% 6.25%
July 2012 10.00% 6.50%
It is expected that the exchange rate on July 01, 2009 would be £1 = Rs. 105. The
company’s cost of capital is 13%.
Required:
Which of the two options would you recommend to the management? Show all relevant
calculations. (20)
Q.2 UVW Rental Services, a partnership concern, is in the business of providing power back-
up solutions to its corporate clients. At present, it is the policy of the company to replace
the old power generators with the new ones after every three years.
During a recent management meeting, the operation manager informed that a 350KVA
generator has reached its replacement period. He suggested that since the replacement cost
of this generator has significantly increased due to depreciation of rupee, the company
should not dispose of the generator at the end of its replacement period and rather get it
overhauled and continue.

(2)
Following information relating to the generator is available:

(i) Written Estimated
Current Replacement
Cost Down Cost of
Disposal Value Cost
Value Overhauling
--------------------------------Amount in Rupees-------------------------------------
3,900,000 1,750,000 2,200,000 945,000 5,250,000
(ii) It is expected that after overhauling:

the generator can be used for another two years. However, running cost of
overhauled generator would be Rs. 440 per hour which is 10% higher in
comparison with the running cost of the new generator.
the overhauled generator would be sold after two years at a value of 15% of
current replacement cost while the new generator is expected to fetch 25% of
current replacement value, after three years.
(iii) The company rents out the generator at Rs. 2,000 per hour and such generators are
hired for approximately 2,500 hours per annum, irrespective of their age.
(iv) The company’s cost of capital is 17% per annum before adjustment for inflation.
The rate of inflation is 8%.
(v) The company receives all payments after deduction of tax at the rate of 6% which is
considered full and final settlement of it’s tax liability.
Required:
(a) Advise whether the management should replace the generator or overhaul and
continue to use the existing one.
(b) Calculate the % change in estimated cost of overhauling at which the management
would be indifferent between the two options. (17)
Q.3 DEF Securities Limited (DEF) is a medium size investment company. During the month of
February 2009, the Research Department of DEF forecasted an increase in oil prices by
June 2009 which would have a positive impact on the share prices of oil marketing
companies and negative impact on the share prices of power generation companies. Based
on this research, the company entered into the following transactions on April 1, 2009:
(I) Purchased a three month American call option of 100,000 shares of Silver
Petroleum Limited (SPL), an oil marketing company, at Rs. 3 per share. The
exercise price is Rs. 155 per share.
(II) Purchased a three month European put option of 5,000,000 shares of Diamond
Electric Supply Corporation Limited (DESC), a power generation company, at
Re. 0.50 per share. The exercise price is Rs. 3.50 per share.
However, when the price of oil actually increased on May 21, 2009, DESC revised its
power tariff upward while due to tough competition SPL’s margins are expected to
decline. As a result, the company feels that it is now advisable to reconsider the situation.
While evaluating various options, the management has gathered the following information:
(i) As of June 1, 2009, the ready market price per share and one month future price per
share were as follows:
Ready market prices 1-month future prices

SPL Rs. 170 per share Rs. 173 per share
DESC Rs. 4.25 per share Rs. 4.35 per share
(ii) DEF can obtain finances at the rate of KIBOR plus 2%. Presently, the rate of
KIBOR is 12.5%.
(iii) Transaction costs are immaterial.
Required:
Based on the available information, recommend the best strategy to the management. (12)

(3)
Q.4 MNO Chemicals Limited is a fertilizer company. The company is planning to diversify
into the food business and has identified two companies, PQ (Pvt.) Limited and RS
Limited (a listed company), as potential target for acquisition. MNO Chemicals Limited
intends to buy one of these companies in a share exchange arrangement.
Extracts from the latest financial statements of the three companies are given below:
STATEMENT OF FINANCIAL POSITION
MNO PQ (Pvt.) RS
Chemicals Limited Limited
---------Rupees in millions-----------
Share capital (Rs 10 each) 1,500 800 1,200
Retained earnings 700 300 350
TFCs 1,000 400 500
Current liabilities 300 100 200

3,500 1,600 2,250
Non-current assets 3,000 1,400 1,800

Investment held for trading - - 300
Current assets 500 200 150
3,500 1,600 2,250
STATEMENT OF COMPREHENSIVE INCOME
MNO PQ (Pvt.) RS
Chemicals Limited Limited
---------Rupees in millions-----------
Sales 2,500.00 800.00 1,200.00
Operating profit before interest,
depreciation and income tax 1,250.00 400.00 540.00
Interest (100.00) (48.00) (55.00)
Depreciation (450.00) (180.00) (270.00)
Other income 200.00 20.00 45.00
Net profit before tax 900.00 192.00 260.00
Tax @ 35% (315.00) (67.20) (91.00)
Net profit 585.00 124.80 169.00
Dividend payout (50%:70%:50%) 292.50 87.36 84.50
Additional information:
(i) All companies maintain a stable dividend payout policy.
(ii) It is estimated that earnings of PQ and RS will grow by 4% and 5% respectively.
(iii) The risk free rate of return is 8% per annum and the market return is 13% per
annum. The market applies a premium of 300 basis point on the required returns of
unlisted companies.
(iv) RS Limited’s equity beta is estimated to be 1.20.
(v) Synergies in administrative functions arising from merger would increase after tax
profits by 5% in the case of PQ and 6% in the case of RS.
Required:
Which of the two companies should be acquired by MNO Chemicals Limited? Show
necessary computations to support your answer. (21)

(4)
Q.5 GHI Limited is an all equity financed company with a cost of capital of 14%. For last
several years, the company has been distributing 70% of its profits to the ordinary
shareholders and is expected to continue to do as in future. The company plans to enter
into a new line of business. Taking it as an opportunity to reduce the cost of capital, it is
considering to issue debt to finance the expansion. The Corporate Consultant of GHI has
provided the following industry data relating to different levels of leverage:
Debt/Assets 0% 10% 40% 50%

Cost of Debt - 8% 10% 12%
Equity Beta 1.20 1.30 1.50 1.70

(i) The estimated value of assets after the investment in new line of business would be
Rs. 250 million.
(ii) The forecasted revenue for the next year is Rs. 200 million.
(iii) Fixed costs for the next year are estimated at Rs. 40 million whereas variable costs
will be 60% of the revenue.
(iv) The par value of GHI’s ordinary share is Rs. 10.
(v) The tax rate applicable to the company is 35%.
The rate of return on 1-year Treasury Bills is 6% and the market return is 10%.
Required:
Advise the optimal capital structure which GHI Limited should formulate. Show all
relevant workings. (15)
Q.6 JKL Phone Limited is a cellular service provider. The Marketing Director has recently
proposed a marketing strategy which envisages the introduction of a new package for pre-
paid customers, to gain market share. He has carried out a market research and suggests
that the call rates forming part of the proposed package should either be Re. 0.75 or
Re. 1.00 or Rs. 1.25 per minute.
Based on market research, sales demand at different levels of economic growth is
estimated as follows:
Call Rates
Probability Rs. 0.75 Re. 1 Rs. 1.25
----- Subscribers in million -----
Recession 0.30 0.70 0.50 0.30
Moderate 0.50 0.80 0.60 0.40
Boom 0.20 0.90 0.80 0.60
He foresees that the average airtime usage per subscriber would be 1800 minutes or 1600
minutes with a probability of 40% and 60% respectively. In order to cater to the increased
subscriber base, the company would need to commission new cell sites, details of which
are as follows:
No. of subscribers Cost of new sites
(in million) (Rs. in million)
Up to 0.5 million 180.00
Between 0.5 – 0.8 million 300.00
Between 0.8 – 1.0 million 540.00
It is assumed that the present customers of the company would continue to use the existing
packages.
Required:
Evaluate the proposal submitted by the Marketing Director and advise the most suitable
call rates. (15)
(THE END)

December 3, 2008

(3 hours)
Q.1 Shoaib Investment Company Limited is a listed company having a share capital of
Rs. 1,000 million consisting of 100 million shares of Rs. 10 each. It’s net equity at book
value, as of March 31, 2008 was Rs. 2,000 million. The company maintains a debt equity
ratio of 70:30 based on market value. Long term debt constitutes 90% of total liabilities of
the company. It is the policy of the company to invest 60% of its total assets in listed
securities. The correlation between the market value of these listed securities held by the
company and KSE-100 Index is 1.1. On March 31, 2008, the company’s shares were
traded at price to book value ratio (P/B ratio) of 1.4.
During the quarter April 1, 2008 to June 30, 2008, KSE-100 Index fell by 20%. This fall
in Index also affected the market price of the company’s shares and as of June 30, 2008,
they were being traded at P/B ratio of 0.9. There was no significant change in the amount
of liabilities and other assets of the company, during the quarter.
Required:
(a) Compute the amount of fresh equity required to be injected as of June 30, 2008 in
order to maintain the debt equity ratio.
(b) The company has been approached by Mr. Alam, a large investor, who has offered
to provide the required capital as computed in (a) above at a discount of 10% of
market value. Compute the % holding of Mr. Alam in the company, if his proposal
is accepted. (13)
Q.2 Waseem Limited is engaged in manufacture and sale of consumer products. It’s
management is in the process of developing the sales plan for the next year. The Sales
Director is of the view that the main hurdle in increasing the sales is the availability of
finance.
The summarized Balance Sheet as of November 30, 2008 is shown below:
Rs. in million
ASSETS
Fixed assets 950
Current assets 730
1,680
LIABILITIES AND EQUITIES
Ordinary share capital 250
700
Long term debts 465
1,680

(2)
Following additional information is available:

(i) It has been established from the company’s past record that any increase in sales
require an investment of 140% of the additional sales amount, in inventories and
accounts receivable. Further, the accounts payable of the company also increase by
25% of the additional sales amount.
(ii) The current sales of the company is Rs. 1,100 million while the net profit after tax is
10% of sales.
(iii) It is the policy of the company to distribute 20% of its profit after tax among the
shareholders of the company.
Required:
Assuming that you are the Chief Financial Officer of the company, advise the
management on the following:
(a) How much additional finance would be required to achieve 20% increase in sales in
the next year?
(b) What would be the maximum growth in sales that the company can achieve if:
external finances are not available?
the additional financing is limited to an amount which will maintain the existing
debt equity ratio? (14)
Q.3 Imran Limited wants to borrow Rs. 70 million for two years with interest payable at six
monthly intervals. Due to recent hike in inflation, the company expects that the rate of
interest is likely to rise over the next 2 years. The company can borrow this amount from
a local bank at a floating rate of KIBOR plus 2% but wants to explore the use of swap to
protect it from any interest rate increase, during the next two years.
Another bank has offered the company that it will be willing to receive a fixed rate of
11% in exchange for payments of six month KIBOR.
Required:
(a) Calculate the six monthly interest payments if the swap arrangement is in place.
(b) Calculate the net amount receivable/payable by each party to the swap at the end of
the first 6 months if:
KIBOR is 13.5%.
KIBOR is 9%. (10)
Q.4 Hafeez Ltd is planning to bid for a contract to supply a machine under an operating lease
arrangement, for 5 years. The terms of proposed contract include a special arrangement
whereby the supplier / lessor will have to operate and maintain the machine, during the
term of lease. Hafeez Ltd is required to quote a consolidated annual fee consisting of
lease rentals and operating changes which shall be payable in arrears. The following
relevant information is available:
(i) The cost of machine is Rs. 50 million and the expected useful life is 10 years. The
residual value at the end of five years is estimated to be 25% of the cost of
machine.
(ii) Operating cost for the first year is estimated at Rs. 6 million and is expected to
increase at the rate of 10% per annum.
(iii) The tax rate applicable to the company is 35% and the tax is payable in the same
year. The company can claim initial and normal depreciation at 25% and 10%
respectively under the reducing balance method.
(iv) The weighted average cost of capital of the company is 14%.
Required:
(a) Calculate the annual consolidated fee to be quoted for the contract if the company’s
target is to achieve a Pre-tax Net Present Value of 15% of total capital outlay.
(b) Using the fee quoted above, calculate the project’s internal rate of return (IRR) to
the nearest percent. (18)

(3)
Q.5 Zaheer Ltd is a manufacturer of auto parts and is currently operating at below capacity
due to slump in the demand for automobiles. The company has received a proposal from a
truck assembler for supply of 40,000 gear boxes per annum for five years at Rs. 1,900 per
gear box .
The cost of each gear box is as follows:
Rupees
Material costs 800
Labour costs 500
Variable production overheads 150
Variable selling overheads 200
Fixed overheads (allocated) 150
1,800
Company has already incurred a cost of Rs. 5 million on the preparation of technical
feasibility. The additional cost for setting up the facility for this order would be Rs. 20
million.
The company maintains a debt equity ratio of 60:40. Cost of debt and cost of equity of the
company is 16% and 19% respectively. The rate of tax applicable to the company is 30%.
Required:
(a) Evaluate whether the proposal is financially feasible for the company. Assume that
revenue and cost of gear box will remain the same during the next five years.
(b) Carry out a sensitivity analysis to determine which of the following variables is most
sensitive to the feasibility of the order:
Material costs
Labour costs
Additional cost of setup (20)
Q.6 Javed Limited is a listed company and is engaged in the business of manufacture and
export of garments. 100% of the company’s revenue comes from exports which are
taxable @ 1% under final tax regime.
An extract of the company’s latest balance sheet as on June 30, 2008 is as follows:
Rs. in million
Ordinary Share capital (Rs. 10 each) 100
Capital Reserves 40
Retained Earnings 85
225
Term Finance Certificates (Rs. 100 each) 150
375
Term Finance Certificates (TFCs) are due to be redeemed at par on June 30, 2010. TFCs
carry floating mark up i.e. 6 months KIBOR plus 2% which is payable at half yearly
intervals. Currently, TFCs with similar credit rating are available at six months KIBOR
plus 1%.
During the year ending June 30, 2009, the company expects to post a net profit of Rs. 15
million. Cost of equity of a similar ungeared company is 19%. The shares of other
companies in this sector are being traded at P/E ratio of 8. On June 30, 2008 the six
monthly KIBOR was 14%.
Required:
Compute the Weighted Average Cost of Capital of the company as at July 1, 2008. (13)

(4)
Q.7 Mushtaq Limited is considering two possible investment projects. Both the projects have
a life of one year only. The returns from new projects are uncertain and depend upon the
growth rate of the economy. Estimated returns at different levels of economic growth are
shown below:
Economic Probability Returns (%)

Growth of
Project 1 Project 2 Market
(Annual Avg.) Occurrence
1% 0.25 20 22 30
3% 0.50 30 28 25
5% 0.25 40 40 40
Risk free rate of return is 10%.

Required:
Evaluate the above projects using the Capital Assets Pricing Model. (12)
(THE END)

June 4, 2008

(3 hours)
Q.1 Mr. Faraz, a large investor, wants to invest Rs. 100 million in the stock market by
developing a portfolio consisting of those shares which have a track record of good
performance.
He contacted a Stock Analyst to identify such stocks. After a detailed study, the Stock
Analyst recommended investments in shares of five different companies. Based on his
recommendation, Mr. Faraz invested the amount on January 1, 2008. The relevant details
are as follows:
Price per
Share on Expected Covariance
Investment Jan 1, 2008 Dividend Standard with
Company (Rs.) (Rs.) Yield Deviation KSE 100
A 15,000,000 60 3.50% 24% 2.10%
B 18,000,000 245 3.00% 22% 3.00%
C 22,000,000 225 2.50% 18% 2.60%
D 25,000,000 130 8.00% 15% 1.90%
E 20,000,000 210 5.00% 20% 2.80%
The stock analyst also informed him that the standard deviation and market return of the
KSE-100 Index is 15% and 20% respectively. The risk free rate of return is 8%.
Required:
(a) Assuming that Mr. Faraz estimates his cost of equity by using the Capital Asset
Pricing Model, compute the required rate of return on each security.
(b) As at December 31, 2008, compute the following:
Estimated value of portfolio.
Portfolio beta.
Estimated total return on portfolio. (18)
Q.2 The Share Capital and Term Finance Certificates (TFCs) of Faiz Limited (FL) are listed
on the Karachi Stock Exchange. An extract from the company’s latest balance sheet as
on December 31, 2007 is as follows:
Rs. in million
Ordinary share capital of Rs. 10 each 400
Revenue reserves 350
Other reserves 150
900
6% TFCs of Rs. 100 each 595
Short term loan – At KIBOR + 3% 80
Total debt and equity 1,575

(2)
6 years TFCs were issued on January 1, 2007. The coupon rate is 6% payable annually
and the expected IRR is 10%. These TFCs were issued to fund a medium term project.
The prevailing commercial rate for similar risk bonds is KIBOR plus 2%. The
accounting policy of the company states that TFCs and other Held to Maturity Liabilities
are carried at the amortized cost.
KIBOR is currently 9% which can be considered as risk free. FL has an equity beta value
of 1.6 with market equity premium of 6.25%. The rate of income tax is 35%.
The dividend paid in the year 2007 was 12.5% and current year’s dividend will be paid
shortly. The dividend is expected to grow at a constant rate of 10%.
Required:
Compute the following as on December 31, 2007:
(a) Market price of Faiz Limited’s Equity Shares and TFCs; and
(b) Weighted Average Cost of Capital. (12)
Q.3 Jalib Limited (JL) is planning to invest in a project which would require an initial
investment of Rs. 399 million. The project would have a positive net present value of
Rs. 60 million if funded only from equity. There are no internal funds available for this
investment and the company wants to finance the project through debt. However, JL’s
existing TFCs contain a covenant that at any point in time, the debt to equity ratio in
terms of Market Values should not exceed 1:1.
Currently, the market values of JL’s equity (40 million shares are outstanding) and debt
are Rs. 672 million and Rs. 599 million respectively. Markets can be assumed to be
strong form efficient.
Required:
(a) Using Modigliani & Miller theory relating to capital structure, calculate the
minimum amount of equity that the company will have to issue to comply with the
TFCs’ covenant.
(b) Advise the Board of Directors as regards the following:
the right share ratio and the price at which right shares may be issued to raise
the amount of equity as determined in (a) above, without affecting the market
price of shares.
What would be the impact on the market price of the company’s shares if the
required amount of equity is arranged by issue of shares at Rs. 14 per share? (15)
(Round off all the amounts to nearest millions and price computations to two decimal places)
Q.4 Mohani Limited (ML) has decided to acquire an additional machine to augment its
production. The cost of the machine is Rs. 3,200,000 and the expected useful life of the
machine is 5 years. The salvage value at the end of its useful life is estimated at
Rs. 400,000.
To finance the cost of machine, the company is considering the following options:
(A) Enter into a leasing arrangement on the following terms:
Lease term 5 years

Security deposits 10% of the cost of machine
Insurance costs payable by lessor
Installment Rs. 860,000 payable annually at the beginning
of the year.
Purchase Bargain Option At the end of lease term against security deposit.
(B) Obtain a 5 year bank loan at an interest of 11% per annum. The loan including
interest would be repayable in 5 equal annual installments to be paid at the end of
each year.

(3)
The company plans to depreciate the machine using straight-line method. The insurance
premium is Rs. 96,000 per annum. The corporate tax rate is 35%. For the purpose of
taxation, allowable initial and normal depreciation is 50% and 10% respectively under
the reducing balance method. The weighted average cost of capital is 14%.
Required:
Which of the two methods would you recommend to the management? Show all relevant
calculations. (18)
Q.5 Hali Ltd. (HL) is listed on the stock exchange of Country X and has its operations in
Country X and Country Y. The functional currency of both the countries is Rupee (Rs.).
In the latest balance sheet of the company, net assets were represented by the following:
Rupees in million
Ordinary share capital of Rs. 10 each 50
220
10% Debentures 30
10% Long term loans 40
290
The current market price of ordinary shares and debentures are Rs. 90 per share and
Rs. 130 per certificate respectively. In view of various legal and taxation issues, HL is
considering a demerger scheme whereby two different companies, HX and HY will be
formed. Each company would handle the operations of the respective country.
Mr. Bader, a director of HL, has proposed the following demerger scheme:
(i) The existing equity would be split equally between HX and HY. New ordinary
shares would be issued to replace the existing shares.
(ii) The debentures which are redeemable at par value of Rs. 100 in 2012, would be
transferred to HX as these were issued in Country X.
(iii) The long term loan was obtained in Country Y and will be taken over by HY.
Demerger would require a one time cost of Rs. 17 million in year one, which would be
split between the two companies equally. The finance director has submitted the
following projections in respect of the demerged companies:
HX HY
Year 1 Year 2 Year 3 Year 1 Year 2 Year 3
-------------------Rupees in million -------------------
Profit before tax and depreciation 39 42 44 26 34 36
Depreciation 12 11 13 9 10 11
The projections for year 3 are expected to continue till perpetuity.
Accounting depreciation is equivalent to tax depreciation and therefore it is allowable for

tax purposes. HX and HY will be subject to corporate tax at the rate of 30% and 25%
respectively. Over the next few years, the rate of inflation in Country X and Country Y is
expected to be 5% and 7% respectively.
Required:
Assuming your name is XYZ and HL’s weighted average cost of capital is 18%, prepare
a brief report for the Board of Directors discussing:
(a) the feasibility of the demerger scheme for the equity shareholders of Hali Limited,
based on discounted cash flow technique. Your answer should be supported by all
necessary workings.
(b) the additional information and analysis which could assist the Board of Directors in
the process of decision making. (20)

(4)
Q.6 Momin Industries Limited (MIL) is engaged in the business of export of superior quality
basmati rice to USA and EU countries. On May 15, 2008, MIL negotiated an order from
TLI Inc. (TLI), a USA based company, for the supply of 10,000 tons of rice at the rate of
US$ 2,000 per ton. Immediately after acceptance of the order by MIL, the Government
imposed a ban on the export of rice. In view of the long standing relationship, MIL has
offered to supply rice through Thailand which has been accepted by TLI. After due
consultation with the Thai Company, MIL and TLI agreed to the following terms and
conditions on May 31, 2008:
The quantity and price per ton will remain unchanged.
First consignment of 4,000 tons will be shipped in the last week of June 2008 and
the balance will be shipped during the last week of July 2008.
Shipment will be made directly to TLI.
TLI will make payment to MIL after one month of shipment.
It was agreed with the Thai Company that MIL shall make the payment on shipment, at
the rate of Thai Bhat 50,000 per ton.
MIL has a policy to hedge all foreign currency transactions in excess of Rs. 25 million
by obtaining forward cover. MIL’s bank has arranged the forward cover and advised the
following exchange rates on May 31, 2008:
Thai Bhat US $
Buy Sell Buy Sell
Spot Rs. 2.33 Rs. 2.36 Rs. 65.12 Rs. 65.24
The bank charges a commission of 0.01% on each transaction.

Required:
Calculate the profit or loss on the above transaction under each of the following options:
(a) the shipments are made according to the agreed schedule;
(b) on July 31, 2008, the parties agree to delay the second shipment for a period of two
months. The rates expected to prevail on July 31, 2008 are as follows:
Thai Bhat US$

Spot – July 31, 2008 Rs. 2.29 Rs. 2.32 Rs. 65.61 Rs. 65.73
(c) the second shipment is cancelled on July 31, 2008. The exchange rates are expected
to be the same as in (b) above. (17)
(THE END)

December 05, 2007

(3 hours)
Q.1 Your company is planning to acquire the entire shareholding of Hamid Limited, an
unlisted company. It has been suggested by on of the director to value the company
using fresh cash flow analysis. Following are the extracts from the latest financial
statements of Hamid Limited:
Profit and loss account for the year ended November 30, 2007
2007
Rs. in million
Sales revenue 74,000
Cost of sales – excluding depreciation (44,400)
Depreciation (4,440)
Gross profits 25,160
Administrative costs – excluding depreciation (7,881)
Depreciation (925)
Amortization (370)
Interest (1,480)
Profit after interest 14,504
Taxation (5,076)
Profit after tax 9,428
Extracts from Balance Sheet
2007 2006
Rs. in million Rs. in million
Receivables 1,700 2,030
Inventory 2,250 2,075
Other current assets 2,600 2,840
Current liabilities 1,800 2,120
Property, Plant & Equipment 14,000 12,500

Share Capital of Rs. 10 each 1,000 1,000
Bu considering the high growth of the company, it has been estimated that:
(i) Sales growth will be about 20% per annum for the next two years.
(ii) Cost of sales, excluding depreciation, will grown by 18% per annum.
(iii) Administrative costs excluding depreciation are expected to grow at the rate of
inflation i.e. 8% annually.
(iv) Amortization represents an annual fixed charge @10% of the cost of an intangible
asset acquired 2 years ago.
(v) Capital expenditures and working capital investments are expected to follow the
same pattern as that of sale. Depreciation however, will grow by 25% per annum.

(2)
(vi) After two years, the free cash flows are expected to grow by only 5% per annum in
perpetuity.
(vii) It is estimated that Hamid Limited’s cost of equity is 17.15% and weighted average
cost of capital is 15%.
(viii) The current coupon rate on the only debt of the company i.e. TFCs which are
maturing in 8 years, is 11.84%. The market value of the debt is 118.35%.
Required:
Using the above estimates, work out the value of each ordinary share and total value of
Hamid Limited. Assume that there will be no change in the debt equity ratio and tax rate
in near future. (15)
Q.2 Zahid Limited is engaged in trading and manufacturing of electronic toys. In order to
reduce the present net costs of financing the receivables and payables, the company is
planning to introduce the following changes in its collection and payment policies:
− Offer 1% discount to its customers which is expected to shorten the average credit
period by 30 days. Presently, the company sells 60% of its sales at 45-days credit.
− Avail the trade discount offered by the vendors of the company. Presently, the
company buys finished goods on terms of 2/60, net 90 and raw materials on terms of
1/40, net 75 but the discount is not availed.
Presently, the company’s working capital consists of the following:
Rupees in ‘000’
Raw materials 5,000
Finished goods – Own manufactured 12,000
Finished goods – Purchased 14,000
Debtors 30,000
Cash balances 1,000
Trade creditors (41,700)
The purchased finished goods inventory is maintained at an average level of 60 days’

stock. At the end of the current year, the inventory of such stock is 25% higher as
compared to the last year. Raw Material Turnover is approximately 24 times in a year.
The company finances its working capital through a running finance facility obtained
from a local bank at 13% per annum.
Required:
Evaluate each of the above policies and give your recommendations. Support your
answer with necessary workings. Assume a 360 day year. (12)
Q.3 Sajid Ltd has contacted a Hong Kong company (the supplier) for purchase of its annual
requirement of 100,000 liters of chemical “X”. The supplier has offered the following
terms:
(i) The price per litre shall be HK$76.

(ii) Delivery shall be made thirty days after the placement of order.
(iii) Payment shall be made two months after the date of delivery.
(iv) The minimum value of the order shall be HK$3,800,000.
(v) If the company places an order exceeding HK$ 7,000,000, 3% bulk purchase
discount shall be available.

(3)
The company estimated the following spot rates:
After three months 7.35/HK$

After six months 7.50/HK$
After nine months 7.70/HK$
Hong Kong $ is not directly quoted against Pak Rupees. Following forward rates are
quoted in the market:
3 months forward rate PKR/US$ 61.10 – 61.15

3 months forward rate HK$/US$ 8.37 – 8.40
The company’s cost of fund is 12% and its production is scheduled evenly throughout the
year.
Required:
Analyse the following four options available with the company:
(i) Avail bulk discount with forward cover.
(ii) Avail bulk discount without forward cover.
(iii) Do not avail bulk discount and obtain forward cover.
(iv) Do not avail bulk discount not obtain forward cover. (20)
Q.4 Wajid Limited has acquired 10,000 convertible bonds of Abid Telecom Limited which is
due for redemption after six years at the rate of Rs. 160 per bond. Interest is paid
annually and the coupon interest rate is 11%. The required rate of return of Wajid
Limited is 12% per annum.
The conversion option can be exercised at the end of third year at the rate of 5 ordinary
shares per bond. Thereafter, this option will lapse. Following information has been
obtained from the website of Karachi Stock Exchange:
Face Market
Value Value
Bond Rs. 100 Rs. 127
Share Rs. 10 Rs. 25
Annual interest on the bonds has just been paid by the company. The dividend paid this
year by the company was 18%. Capital gain is exempt from tax and the rate of income
tax is 35%.
Required:
(a) Compute the minimum growth rate in the market price of the ordinary shares of
Abid Telecom Limited at which you would advise Wajid Limited to hold the bonds
and exercise the conversion options.
(b) What would be the best investment decision among the following options:
- hold the bonds until redemption.
- convert the bonds into shares if the growth rate worked out in part (a) is certain.
- sell the bonds now.
Support your decision with appropriate reasons. (15)

(4)
Q.5 Khalid Limited produces three products viz. Aay, Cee and Dee to a very limited number
of customers. All the production of Cee is sold at Rs. 2,150 per unit. Presently, the plant
which produces Dee is working at full capacity and there is a high demand for Dee in the
market. The company has allocated separate spaces in the factory building for the
production of each product.
The annual production and gross profit, for each of the next five years, has been
estimated as under:
Aay Cee Dee

Rupees in thousand
Sales 191,800 5,805 60,000
COST OF SALES
Raw material 85,400 2,560 23,460
Labour 32,140 1,470 6,540
Factory overhead
Depreciation – Building (allocated) 1,000 50 500
Depreciation – Plant (directly identified) 9,000 200 8,500
Depreciation – Others (directly identified) 840 24 750
Plant maintenance contract 600 225 600
Industrial waste management cost 2,700 50 1,200
Power 12,000 500 4,000
Others
Variable 8,000 435 4,200
Fixed (directly attributable) 5,000 217 2,300
Fixed (Allocated) 1,600 81 732
Cost of sales 158,280 5,812 52,782
Gross Profit 33,520 (7) 7,218
Wahid Limited, a trust worthy customer, has requested the company to let out the space
available for product Cee for one ear. He has proposed as follows:
- Wahid Limited will pay an agreed monthly rental which is to be determined by
mutual consent. The space will be used to store newly imported machines worth
Rs. 130,000 thousand.
- Wahid Limited can supply the annual requirement of Cee for the next five years at
the rate of Rs. 2,100 per unit.
- Khalid Limited will be responsible to insure the machines.
Khlaid Limited is evaluating the offer and have worked out the following information:
(i) The existing plant and assets relating to Cee can be sold for Rs. 800 thousand. Gain
on sale of machinery will be Rs. 50 thousand.
(ii) The cost of insuring the machines would be Rs. 650 thousand.
(iii) The space can also be used to produce Dee which will increase the production of
Dee by 4%. However, it will require the following additional expenditures:
Rupees in thousand
Cost of machines 3,500
Maintenance cost 12
Waste management cost 48
Power 160
Other costs 260
The machines will be depreciated in five years and will have a residual value of
Rs. 700 thousand at the end of the fourth year.
(iv) The life of all existing plants and assets is five years with no residual value.

(5)
(v) The company uses discounted cash flow method to evaluate such offers. The
discounting rate used by the company is 12%. The rate of income tax is 35%.
Required:
Calculate the minimum rent which may be acceptable to Khlaid Limited under each of
the following options:
(a) Renting the premises for one year and thereafter continuing the production of Cee.
(b) Renting the premises for one year and thereafter start producing Dee. (23)
Q.6 Majid Limited having a share capital of 50 million shares of Rs. 10 each, is the
distribution agent of many local and international products.
After tax profits and dividend for the last four years are shown below:
2004 2005 2006 2007

----------Rupees in thousands----------
After tax profits 31,860 33,825 35,901 38,434
Dividend 27,000 29,160 31,493 34,012
The current cum dividend market price is Rs. 14.50. The risk fee rate is 8% and the
market return is 15%. The company’s overall beta, debt beta, and equity beta are 0.75,
0.20 and 0.80 respectively.
The company has recently invested Rs. 100,000 thousand to improve the warehousing
structure and supply chain management. As a result, the directors expect the post tax
profits ad dividend to increase by 20% for two years and then to revert to the company’s
existing growth rates.
The company estimates its cost of equity by using the Capital Assets Pricing Model.
Required:
(a) Estimate the value of the company’s shares using the dividend growth model, under
each of the following assumptions:
- the market is semi-strong form efficient.
- The market is strong form efficient.
(b) Would you advise the investors to buy the shares at the current price? (15)
(THE END)

June 6, 2007

(3 hours)
Q.1 Your company has identified a number of profitable projects for investment, having good
Internal Rate of Return projections. However, due to shortage of available funds, the
company cannot invest in all the projects.
You have been assigned to determine the best strategy for capital rationing. Following
information is available about the projects:
A B C D E
Investment needed today (Rs in million) 10.5 6.4 9.7 12.2 13.1
Projected annual cash inflows (Rs in million) 3.5 1.7 2.9 3.0 6.9
Cash inflows start from the end of the year 1 2 2 3 4
Life of the project (years) 6 10 9 12 10
Appropriate discount rate for relevant risk levels 10% 13% 8% 12% 11%
Total funds available with the company for investment are Rs 43 million. All projects are
mutually exclusive except for D and E which are mutually dependent. Assume that all
the projects are non-divisible.
Required:
Determine the most beneficial investment mix. (12)
Q.2 You are head of Finance Department of Fantastic Limited. Mr. Young has recently
joined your company as Assistant Manager. He is familiar with stock market and deals
on his personal account.
He submitted some suggestions to the board of directors for investment in stock market.
One such suggestion was about arbitrage opportunity in shares of Fast Limited as
detailed below:
Rupees
Spot price 181.00
Future price (two months from now) 187.00
Transaction cost (Spot) 0.20
Transaction cost (Future) 0.15
The Directors, being attracted with such effortless profit, asked you to analyze this
opportunity. You have extracted the following further information:
- Shares of Fast Limited had been performing quite well and gained around Rs 95
during the last three months.
- 10% margin is payable on the future transaction which is adjustable at the time
of final settlement.
- Future is marked to market on monthly basis i.e. the difference between the
transaction price and the quoted price at the end of the month is recovered / paid
as the case may be.
- Company’s incremental rate of borrowing is 14% per annum.

(2)
Required:
(a) Compute net gain on suggested arbitrage transaction. (04)
(b) At what price of share in future market quoted at the end of the first month, the
company may incur loss? (06)
Q.3 During the board meeting of Venus Industries Limited, one of the directors had stressed
the need to review the company’s dividend policy. According to him, the decision
regarding dividend payment should be based on ‘Tax Preference Theory’, which
suggests that investors prefer the return in the form which is more beneficial from tax
point of view.
Historically, the company has been paying a dividend of Rs 15 every year. Tax rate
applicable on dividends is 10% whereas capital gains are exempt from tax. The
transaction costs associated with sales/purchase of shares are estimated at 0.5% of the
value involved.
Currently company’s shares are being traded at Rs 150 (Ex-dividend). Based on

company’s earning potential, the share price is expected to increase by 15% by the end of
the year.
Required:
Estimate the impact on the price of the company’s share if the directors decide to
disclose that they do not intend to distribute dividend in the forthcoming year to allow
the shareholders to avail the benefit of tax exemption on capital gains. Assume that the
market is semi-strong form efficient. (09)
Q.4 Speedo Motors Limited has been in the business of Auto Assembling for over 10 years
The economic environment has induced the company to think about other projects also.
The data relating to the company’s performance is as follows:
Return on equity 17%

Dividend yield 11%
Standard deviation of returns 32%
The company is considering the following two projects:
(i) Establishing an auto parts factory; or

(ii) Entering into artificial leather manufacturing industry.
The expected returns etc. from these projects are as follows:
Auto Parts Artificial Leather

Average return 19% 13%
Standard deviation of returns 43% 27%
Co-relation of returns with existing operations 0.92 0.23
Market returns are 12% with a standard deviation of 20%. It is expected that after any
such investment is made, the new investment will constitute about 30% of the new
market value of the company.
Required:
Due to shortage of funds, the company can opt for only one of the above projects.
Evaluate the two options and advise. Combine standard deviation can be calculated by
using the following formula:
(σ 1W1 ) 2 + (σ 2W2 ) 2 + (2 × Correlation × σ 1W1 × σ 2W2 ) (15)

(3)
Q.5 Zuhair Limited is considering introducing a new product. Market research was carried
out by the company to determine the sales potential of the product, which costed
Rs 175,000. Research suggested that the demand will last for 4 years and the company
will be able to manufacture and sell 100,000 units each year. The initial price shall be Rs
110 per kg and will increase at a constant rate of 10% per annum. Production batch size
shall continue to be of 12,500 units.
Labour related information is as follows.
Rate Man Hours Learning Surplus Labour

Rs per hour per batch Curve Hours Available
Skilled Labour 100 6,250 NIL 20,000 hours available
in Year-1 and Year-2.
Unskilled Labour 40 5,000 90% NIL
The learning curve is expected to continue till the 8th batch. Based on the above, it has
been determined that 3,121 unskilled labour hours shall be required to produce the 8th
batch in the first year.
Labour charges are expected to increase by 5% per annum.
Three types of raw material will be required to manufacture this product. The relevant
information is as under:
Purchase Current Resale

Available in Requirement
Material price Price Price
stock (kgs.) per unit
Rs / kg Rs / kg Rs / kg
A 100,000 1.0 kg 10 8 6
B 20,000 0.5 kg 12 17 15
C 150,000 2.0 kg 18 20 16
Prices of raw material are expected to remain constant through out the period. Material A
is in regular use of the company. Material B would be sold if not used. Material C was
purchased few years back and is considered obsolete.
The production will be carried out on two machines RR and YY. RR was purchased two
years ago at a cost of Rs 900,000. It is working below capacity and can easily be used for
producing the required quantity of the new product. Machine YY is available in the
market at a cost of Rs. 750,000. Resale values of machines RR and YY after the end of
the project life are estimated at Rs 90,000 and Rs 75,000 respectively. The company has
a policy to depreciate the assets on straight line basis over the useful life of the machines.
Zuhair Limited cost of capital is 20% per annum. All the payments and receipts are
expected to arise on the last day of the year except where otherwise stated.
Required:
Determine whether Zuhair Limited should introduce the new product. Ignore taxation. (17)
Q.6 Matured Limited, a manufacturer of tomato ketchup, is in the process of expanding its
existing manufacturing facility in view of a surge in demand in the market. The cost of
the new facility is estimated at Rs 174 million, to be financed by equity and bank
borrowings in equal proportion. The borrowing is available at a fixed mark-up of 10% or
at KIBOR + 2.0%.

(4)
Another company Goldenage Limited, engaged in garment manufacturing, has been

awarded a three years contract for factory uniforms, by a large group of industries. This
order requires expansion in facilities, the cost of which is estimated at Rs 250 million.
70% of the cost is to be financed through equity and 30% through debt. Negotiations
finalized with the bank indicate a fixed mark-up of 12.5% or KIBOR + 4.25%.
Required:
(a) Advise each company whether they should opt for a fixed or a floating mark-up
rate. Support your opinion with reasons. (03)
(b) An investment bank has offered an interest swap arrangement to the two
companies. Should the companies accept its offer? (06)
(c) Assuming that both companies agree on a swapping arrangement on loans
amounting to Rs 75.0 million each and the actual KIBOR for the year is 9.0%,
compute the amount that will be paid by one company to the other. (Assume that
profit on swap arrangement is to be shared equally). (06)
Q.7 The directors of Infinity Limited are interested in evaluating the impact of variation in
capital structure on the company’s value and cost of capital. As a first step, they wish to
investigate the effect if the capital structure was 80% equity and 20% debt.
They have estimated that the following relationship exist between interest cover, credit
rating and cost of debt:
Interest Cover Credit Rating Required return on debt

Greater than 8.0 A 8%
4.0 to 8.0 B 9%
Less than 4.0 C 11%
Following is an extract from profit and loss account of the company for the year ended
December 31, 2006.
Rs in million
Net operating income before depreciation 210
Depreciation for the year 40
Interest on long term debt @ 11% 55
Capital spending in each year would almost be equal to the depreciation charged during
that year. Growth rate of operating cash flows after capital spending may be assumed to
be constant and unaffected by any change in capital structure.
Market value of equity and debt is Rs 795 million and Rs 500 million respectively.
Company’s equity beta is 1.4. The debt beta may be assumed to be zero. The risk free
rate is 5.5% and the market return is 14%.
Tax rate applicable on company’s income is 35%.
Required:
(a) Compute the following:
(i) Existing Weighted Average Cost of Capital;
(ii) Weighted Average Cost of Capital at the revised debt equity ratio using an
approximate ‘required return on debt’ (For this calculation assume that the
market value of the company after restructuring will remain the same).
(iii) Growth percentage of operating cash flows after capital spending; and
(iv) Revised market value of equity and debt.
(b) Calculate the rate of return on debt on the basis of revised market value. (22)
(THE END)

December 6, 2006

Module F (3 hours)
Q.1 Following data has been extracted from the published financial statements of
Progressive Limited.
2004 2005 2006

-----Rupees in thousand-----
Cash Flows from Operating Activities
Net profit 8,640 10,400 13,080
Depreciation 14,400 19,800 24,000
Interest expense 4,000 5,200 5,200
Provision for taxation 2,160 2,600 3,270
Changes in working capital
Trade debtors (500) (2,000) (1,500)
Trade creditors 200 900 400
Short term investments (1,000) (6,000) (1,000)
Interest paid (4,000) (5,200) (5,200)

Taxes paid (2,160) (2,600) (3,270)
21,740 23,100 34,980
Cash Flows from Investing Activities

Additions to factory building and plants - (45,000) (35,000)
Acquisition of land (26,000) (5,000) -
(26,000) 50,000) (35,000)
Cash Flows from Financing Activities

Quoted Debt issued at Par value - 15,000 -
Issuance of shares of Rs. 10 at par value - 15,000 -
- 30,000 -
Net Cash Flows during the year (4,260) 3,100 (20)
Cash at the beginning of the year 4,800 540 3,640
Cash at the end of the year 540 3,640 3,620
(i) Further information is given below:
Market price of shares at the beginning of

the year (Rs.) 14.4 14.4 17
Monthly sales (Rs. in '000') 3,750 5,000 6,000
Debt at the beginning (Rs. in '000') 50,000
Number of shares outstanding
at the beginning (in million) 5.0

(2)
(ii) The following information relates to the period 2003 to 2006:
Market form Semi-strong

Risk free rate of return 5%
Market rate 12%
Comparable security beta 2.0
Comparable Debt/Equity ratio 60:40
Market price of quoted debt (Par value Rs.1,000) 1280
Land was purchased in view of medium term speculative gain available in real
estate market.
(iii) Market price of the company's share at the end of the year 2006 was Rs. 19.20 per
share.
Progressive Limited, formed in 1996, has been managed by an employed management

consisting of highly qualified executives. The board of directors allows them
maximum free hand to operate the business. The management has always been keen in
expansion and highlights the growth in revenues as a proof of its success.
The relatively high level of liquidity is justified by the management as cover for
monthly expenditure and to avail the benefits of any investment opportunity that needs
an immediate decision.
Recently, directors are receiving severe criticism from the shareholders on company's
profit retention policy. Mr. Q, one of the directors, is a friend of yours. He shared the
above information with you and requested you to give your advice.
Required:
Prepare a brief note containing the following:
(a) Computation of 'Free cash flows' of the company along with other inflows. (07)
(b) Brief comments on application of the funds generated from the free cash flows
and other inflows. (07)
(c) Review of retention policy from the shareholders' perspective, for each year
separately. (09)
Q.2 Management of Accurate Limited is interested in evaluating the expected effect of a

recently announced tax rate reduction by the government on its share price and the cost
of capital. The announced tax cut has reduced the tax from 35% to 30%.
Accurate’s current capital structure is as follows:

Rupees
in million
Issued, subscribed and paid up share capital – Par value Rs 10 600
Share premium account 480
Other revenue reserves 620
Shareholders’ equity 1,700
10% irredeemable debentures – Par value Rs. 100 500
2,200
The company’s shares are currently trading at Rs 32 per share ex-dividend, and
debentures at Rs 125 per debenture.
Prior to tax change, the value of company’s equity beta was 1.2. The market return is
13% p.a. The tax cut is expected to increase the net present value of company’s
operating cash flows by Rs 150 million.

(3)
Required:
(a) Estimate the company’s current cost of capital (05)
(b) Using Modigliani & Miller’s theory of capital structure, estimate the following
after the change in tax rate:
(i) the expected share price (04)

(ii) the company’s expected cost of capital (07)
(c) Explain why a 5% fall in tax rate could not materially affect company’s cost of
capital? (04)
Q.3 You are the management accountant of a company that is in the process of evaluating a
new investment opportunity. Traditionally, the company has been using the Net
Present Value method for such evaluation, using its cost of capital of 10% as the
discount rate.
You have recently studied the concept of Residual Income and are keen to apply the
methodology at this new project. Following is the data you have collected about this
project:
(i) Sales in the first operating years are expected to be Rs 1 million. The sale in
nominal terms is expected to increase by 20% p.a. that includes price increase
of 2% per annum.
(ii) Raw material cost in first year of the operation is expected to be 30% of sales
revenue. The raw material price is subject to an annual increase of 5%.
(iii) The production will require specialized labour. In first operating year, labour
cost is estimated to be 25% of sales revenue. An annual increment rate of 10%
has been agreed with the labour union.
(iv) All other production costs (predominantly fixed) will be Rs 100,000 in today’s
terms. Any increase in price of such expenses is expected to be matched with
efficiency.
(v) Project life is spanned over five operating years.
(vi) Funding requirement will be Rs 1 million upfront to start the project. The
funding source is not expected to alter the company’s required rate of return.
The company plans to redeem the combined equity raised for this specific project
along with the cost thereon in five equal installments
Required:
Using annuity depreciation as appropriate, compute the residual income expected from
the project, in respect of each of the five years. (09)
Q.4 Fresh Limited is a manufacturer of four products A, B, C and D. While planning for
the coming year, the management is concerned about declining trend in the sales of A
and expected increase of variable cost of B. However, they are confident about the
continuity of the sale of B, C and D.
Data pertaining to last year is as under:
A B C D
Sales (thousands of units) 12,000 6,000 1,800 2,000
Fixed cost (Rs. per unit) 25 20 5 14
Variable cost (Rs. per unit) 32 20 4.50 13
Selling price (Rs. per unit) 75 60 15 25

(4)
Current year’s budget forecast is as under:
Sales (thousands of units) 11,400 7,000 2,000 2,000
Variable cost of item B is estimated as Rs. 21 per unit.
Discontinuance of production of D is also under consideration at least till next year

when the management will be in a position to increase its price.
Required:
The management has made the budget with reasonable care. Given the circumstances
the real challenge for the management would be to at least maintain the last year’s
profitability. Determine which of the following variable is most sensitive when viewed
in relation to the objective of maintaining the level of profitability.
- Volume of product A
- Price of product A
- Variable cost of product B (14)
Q.5 A company is analysing its short term investment strategy so as to select the
appropriate risk level in relation to investments for the coming year. Return for the
coming year is a function of the level of risk taken by the company in investment
strategy and the performance of market in the year ahead.
For decision making purposes, the level of risk that can be taken has been classified in
discrete categories representing High, Medium or Low level of risk. Similarly the
market performance has also been divided into similar performance achievements i.e.
High, Medium and Low levels of performance.
A schedule has been prepared showing the expected absolute returns in each of the
possible scenarios as follows:
Market
Return on: Rs.
Performance
High risk investment High 1,500,000
Medium 900,000
Low 300,000
Medium risk investment High 875,000
Medium 1,250,000
Low 500,000
Low risk investment High 500,000
Medium 750,000
Low 850,000
The probability profile for the market performance in the year ahead has been
estimated as High – 30%, Medium – 40% and Low – 30%.
The company is considering services of a market analyst who can provide information
about the performance of market on timely basis enabling the company to switch
quickly, from one investment to the other.
Required:
(a) Advise the company as to what level of risk it should be willing to take for its
investments in the coming year without hiring the services of analyst, to
maximize expected value? (08)

(5)
(b) Assuming that the information generated by the analyst will be perfect, what is
the maximum amount that the company may pay for such services? (04)
Q.6 Prudent Limited imports two major chemicals from USA, which are sold to a limited
number of buyers. Company negotiates the price of the product with the buyers at the
start of every half year.
Historically, US $ is getting stronger against Pak Re. that exposes the company to
exchange rate risk. For many years the company has been hedging all of its forex
transactions by way of forward booking.
You have recently joined the company as finance director and have been assigned to
prepare financial plan for the coming half year starting from January 01, 2007. While
reviewing forex hedging policy, you noticed that other avenues like futures and options
have never been evaluated by the management.
Following information is available with you:

- Company plans its imports on half yearly basis.
- The buyers have indicated their requirements at 6,000 kgs. for the coming year.
- The chemical is currently available at US $ 106/kg.
- Supply to buyers is almost evenly divided into months.
- Economic Order Quantity for the chemical is 500kgs.
- Import bills are paid one month after the date of order.
- Rates of interest on Rupee account and on US $ account are 10% and 5% per
annum respectively.
Assumptions to be made:
Following options will be available for sale with brokers on January 01, 2007.
Strike price Option cost Rs. / $

Rs. Jan Feb Mar April May June
Call Option 60.65 0.40 0.60 0.92 1.18 1.38 1.50
Put Option 60.65 0.35 0.51 0.85 1.05 1.29 1.35
Market quotes of futures on January 01, 2007 will be as under:
Maturing on:
January 31, 07 60.45/$ - 60.65/$
February 28, 07 61.27/$ - 61.50/$
March 31, 07 61.55/$ - 61.75/$
Required:
(a) Suggest your preferred hedging choice with justification. (04)

(b) To evaluate your suggestion given in (a) above, the board has requested you to
prepare a comparison of hedging effect in money term through forward, options
and futures assuming that following spot rates will be quoted in the market.
January 01, 07 60.10/$ - 60.50/$

January 31, 07 60.50/$ - 60.75/$
February 28, 07 60.05/$ - 60.20/$
March 31, 07 60.75/$ - 60.90/$ (18)
(THE END)

June 07, 2006

(3 hours)
Q.1 NiceOne Traders are a large multinational trading company with operations spread
in various cities around the world. The Finance Director of the company wants to
implement a hedging policy within the company that would prescribe use of foreign
currency futures as a hedge instrument. In order to test this policy, the Finance
Director has instructed his Chicago Office to hedge the following foreign currency
transactions carried out on April 16, 200X:
Export €697,500 Receivable on May 19, 200X
Import £790,800 Payable on July 31, 200X
After the year end on 30 September 200X, the finance director wants to evaluate the
impact of the decision.
Spot rates on the relevant dates were as under:

As on April 16 $1.3924/€ - $1.3927/€ $1.9271/£ - $1.9275/£
As on May 19 $1.3891/€ - $1.3895/€ -
As on July 31 - $1.9335/£ - $1.9339/£
Futures’ rates on the relevant dates were as under:
Maturing
Rates on April 16 Rates on May 19 Rates on July 31
on
Euro Futures Jun. 30 $1.3875/€ - $1.3880/€ $1.3846/€ - $1.3848/€ -
Sep. 30 $1.3887/€ - $1.3890/€ $1.3857/€ - $1.3860/€ -
Sterling Futures Jun. 30 $1.9327/£- $1.9331/£ - -
Sep. 30 $1.9352/£ - $1.9355/£ - $1.9411/£ - $1.9416/£
Market lot in future market for each currency is 100,000.
Required:
(a) Compute the gain / loss on above transactions:
(i) if these were carried out without hedging. (03)
(ii) after hedging. (09)
(b) Compute the effective foreign exchange rate applicable to the hedged
transaction. (03)
Q.2 BestOne Limited is exploring the opportunities to expand. One opportunity being
considered is that of buying a recently built manufacturing plant which has not yet
started operations. The cost and NPV of the project is estimated as Rs. 20 million
and Rs. 1.4 million respectively.
Rs. 8 million has been arranged in the form of debt financing at KIBOR + 4%. The
premium on this loan is considered to be in line with the market estimation of
BestOne’s risk profile. Bank will charge an arrangement fee of 2.5% for this loan.

(2)
Shares are to be issued for the remaining amount at par value of Rs 10. The issue
cost is estimated to be 7% of the amount issued.
Market is semi-strong form efficient and the directors only disclose information
about debt and equity amounts to be raised (not issue costs) and NPV of the project.
Current market price is Rs. 12.5 per share and the numbers of shares outstanding are
3.5 million.
Required:
Compute the theoretical post issuance market price of each share of BestOne
Limited. (09)
Q.3 Following information has been extracted by you regarding some companies listed
on the Karachi Stock Exchange:
Expected Equity Present Market Covariance

Company Standard deviation of
Returns Price with market
Name ‘return % on equity’
(Rs. / share) (Rs. / share) return%
A Limited 3.25 18.00 6.3 32
B Limited 18.60 212.00 4.8 19
C Limited 0.80 4.50 4.7 24
D Limited 4.15 20.00 6.9 43
Market return has been estimated to be on average around 14.5% per annum
(adjusted for the dividend exclusion thereof) with a variance of 25%, whereas the
risk free rate is around 6% per annum.
Required:
(a) Estimate and interpret the ‘Alpha Values’ for each of the given companies. (06)
(b) How will the analysis carried out in (a) above help you in deciding about
investing in the stock market? (07)
Q.4 GoodOne Limited, a manufacturer of cement blocks, has had a consistent profit
stream for many years. Accordingly, controlling and minority equity holders both
prefer stable and high dividend payout policy that ranges between 90-95% of the
earning.
The construction industry is showing an upward trend currently and demand of

construction material is expected to increase consistently in next 3-5 years period.
In line with the industry trend, the company is considering to acquire manufacturing
facilities to produce ceramic tiles and other similar items as part of its medium term
expansion strategy.
Investment opportunity presently available to the company are as under:
Project Expected upfront investment IRR of the project taking into account after
coded as for the project Rs. ‘000’ tax cash-flows for the life of the project
P 10,000 12.0%
Q 12,000 11.5%
R 12,200 11.0%
S 12,500 10.5%
T 10,500 10.0%

(3)
GoodOne has an existing and target debt to equity ratio of 0.75 to 1. Debt is
available at 8% per annum (after tax). The cost of its equity at the targeted gearing
level is 12.5% per annum, funded either from retained earnings or equity issue.
This year GoodOne has after tax earning of Rs. 25 million wherefrom the dividend
will be paid. Prior years’ balance of retained earning is Rs. 8.5 million.
Required:
You, being the CFO of the company, have been asked by the Board of Directors to
prepare a memorandum suggesting the amount that can be declared as dividend for
the current year keeping in view the opportunity of growth in the industry. (12)
Q.5 PoliteOne Limited, presently engaged in manufacturing of fancy tents, is

considering investing in a manufacturing facility for long life tents to be used as
shelter for victims of natural disasters all over the world. The project will change the
company’s balance sheet footing significantly. Other relevant details of the project
are as under:
(i) Total investment is expected to be Rs. 35 million.

(ii) Directors have decided to meet funding requirements through a debt of Rs.15
million and remainder by a fresh equity issue.
(iii) Debt is available at a subsidized rate of 12% per annum for this particular
project.
(iv) Operations will start from year one. Project’s life is expected to be infinite.
(v) Corporate tax is chargeable at the rate of 30%.
(vi) Debt equity ratio of the industry is around 35:65 with 15% cost of debt before
tax adjustment and 18% cost of equity. Company’s existing WACC is 21%.
(vii) The new project is expected to give revenue of Rs. 17.5 million in Year- 1
with a growth of 50% per annum till Year - 3. Revenue is expected to
stabilize at Rs. 60 million from Year – 4.
(viii) Margin in the industry is around 35%. Fixed costs of the company are Rs. 1.5
million per annum for the first year rising by 5% annually and stabilizing
from year-4.
(ix) It is assumed that costs are paid at the end of year. Revenue collection follows
a pattern of 15% in the year earned and remaining in the next year.
(x) Life of assets is taken as 4 years for tax purposes.
Required:
Should the company invest in this project? Support your answer with relevant
workings. (18)
Q.6 SimpleOne Limited is a manufacturer of bottles for industrial users. The company is
using a two-year old label printing machine having a book value of Rs. 450,000 and
remaining useful life of 5 years. The machine has no significant market value due to
some in-house alterations made to make it compatible with the company’s main
plant. Presently, it can be sold for Rs. 35,000 only.
Company’s production manager suggested that existing machine may be replaced

with a new state-of-the-art printing machine which is fully compatible with the
company’s existing plant.
The cost of new machine is Rs. 950,000 and has an expected useful life of 5 years
with a salvage value of Rs. 200,000.

(4)
The replacement will save fixed costs (excluding depreciation) amounting to

Rs. 35,000 per annum and consumables of Rs.12 per carton of bottles produced.
With the installation of new machine annual sales/production is expected to be 3,150
cartons, 5% more than the sale/production that can be achieved with the old
machine. Existing margin on each carton is Rs. 938.
One of the company’s directors, Mr. CareFull, is your friend and has requested you
to jot down some meaningful points for discussion during the forthcoming meeting
called for making a final decision on the proposal.
Required:
Prepare a brief for Mr. CareFull:
(i) Containing your recommendation based on the available information, and
(ii) Identify any information which may affect your recommendation in (i) above.
Support your answer with relevant workings. (14)
Q.7 SuperOne Limited follows an ‘acquisition’ model for expansion, that is, it acquires
existing businesses for expansion.
SuperOne is negotiating with the management of a targeted company, WeakOne

Limited. Following is some relevant information:
(i) Summarized balance sheet of the acquiree is as under:
Net Asset Rs. in million

Fixed assets 10.00
Other non-current assets 11.70
Current assets 25.00
Non-current liabilities (11.25)
Current liabilities (16.00)
Total 19.45
Represented by
Paid up capital (2.5 million shares) 25.00
Accumulated loss (5.55)
Total 19.45
(ii) Fixed assets include properties with a carrying value of Rs. 1.7 million and a
market value of Rs. 3.2 million.
(iii) Restructuring cost amounting to Rs. Rs. 2.2 million would be incurred which
would result in annual cost savings of Rs. 1.2 million.
(iv) Transaction cost to be borne by SuperOne is estimated at Rs. 1.5 million.
(v) WeakOne’s assessed tax losses are Rs. 6.0 million in aggregate, which will
be adjustable in three subsequent years equally against the project of the
acquirer.
(vi) Tax rate applicable on SuperOne is 30%.
(vii) The consideration for transaction has been agreed to be settled through the
issuance of marketable debt instruments having a face value of Rs. 5,000
carrying 16% return payable annually.

(5)
FB.COM/GCAOFFICIAL
(viii) Above instrument will be redeemed at the end of the third year.
(ix) Yield on debt instruments of a similar nature in the market is 12.5% per
annum and no significant variation is expected during the next three years.
(x) While deciding the swap ratio all the benefits of merger including expected
restructuring benefits will be shared by both companies equally.
(xi) Weighted average cost of capital of the merged company is 17.5%.
Required:
Advise SuperOne about the total number of debt instruments to be issued to the
shareholders of WeakOne Limited, and the value of goodwill to be incorporated in
its balance sheet. (14)
Q. 8 CreativeOne Limited has to settle a liability of Rs. 388.50 million payable at the end
of third year. It bought Rs. 300 million of 9 percent 3-year non-callable government
treasury bonds for the purpose. Return was payable annually and company was
expecting that it will always have the opportunity to reinvest the inflows at 9
percent. On the same assumption company was confident to settle the liability in full
at the end of third year without injecting further funds. However, at the end of first
half of first year the interest rate declined to 8.5% and further decline is also
possible.
The company’s CFO, in order to redress the situation, suggests:
(i) Floating of zero coupon bonds (discounted bonds) to general public backed by
cash inflows of above stated investment, and
(ii) Investment for a period of two and a half years in Government’s zero coupon
bonds presently offering 8.00% per annum yield.
Individual investors are expected to invest in such risk free issue of the company if
following rates are offered:
06 months 6.00%
12 months 6.25%
18 months 6.50%
24 months 6.75%
30 months 7.00%
36 months 7.25%
Issue cost is estimated as 1% of the face value.
Required:
You are required to compute the following (for simplicity you may take fractional
face values of bonds, if necessary):
(a) Face value, maturity period and sale price (based on semi-annual compounding)
of bonds to be issued to the public by CreativeOne Limited. (02)
(b) Future value of zero coupon bonds purchased by CreativeOne Limited against
the liability of Rs. 388.50 million. (03)
(THE END)

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Final Examinations

Business Finance Decisions

SUMMARIZED INCOME STATEMENT

SUMMARIZED BALANCE SHEET

Summarised cash flow projection for the next year is as follows:

VTL is considering to acquire BTL. It is estimated that after this acquisition:

Taha Popatia +923453086312

Taha Popatia +923453086312

Business Finance Decisions

Year 2016 2017 2018 2019 2020

Year 2016 2017 2018 2019 2020

At the end of year 1 2 3 4 5

Following information is also available:

The quoted exchange rates and interest rates are as follows:

He is presently considering investing a further amount of Rs. 20 million in equity market.

Ravi Limited (RL)

Jhelum Limited (JL)

The tax rate applicable to the company is 30%.

The effect of amortization of premium on TFC’s may be ignored in the computation of

The following information in relation to assembling of Ferris is available:

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Taha Popatia +923453086312

Business Finance Decisions

The existing portfolio of provident fund is summarized below:

(i) Investment in listed securities:

(iii) Money market securities:

Summarised Income Statement

Operating profit 884 836 754

Summarised Statement of Financial Position

Taha Popatia +923453086312

Conservative Proposed working capital strategy

Egyptian Pound (EGP) USD

The bank charges a commission of 0.01% on the transactions.

Taha Popatia +923453086312

Egyptian Pound (EGP) USD

Taha Popatia +923453086312

Business Finance Decisions

Year 2016 2017 2018 2019 2020

Year 2016 2017 2018 2019 2020

At the end of year 1 2 3 4 5

Following information is also available:

The quoted exchange rates and interest rates are as follows:

He is presently considering investing a further amount of Rs. 20 million in equity market.

Ravi Limited (RL)

Jhelum Limited (JL)

The tax rate applicable to the company is 30%.

The effect of amortization of premium on TFC’s may be ignored in the computation of

The following information in relation to assembling of Ferris is available:

Taha Popatia +923453086312

Taha Popatia +923453086312

Business Finance Decisions

----------------- Projects -----------------

Other relevant information is as follows:

The following information is also available:

The following information is also available:

Number of Installment due

It may be assumed that today is 1 January 2015.

Summarized statements of financial position

Share capital (Rs. 10 each) 1,500 200

Following additional information is also available: