FINANCIAL MANAGEMENT

Time allowed- 3:30 hours

[N.B. - The figures in the margin indicate full marks. Questions must be answered in English. Examiner will take account of the
quality of language and of the manner in which the answers are presented. Different parts, if any, of the same question
must be answered in one place in order of sequence.]
Marks
1. a) Karnofuli Ltd., a market leader in the cement industry and a listed Company, has been approached
to supply cement for the construction of a mega project. The contract will last for 5 years. The
following data was collected from Karnofuli Ltd.'s most recently published financial statements.
BDT ‘000
Equity Shares (10,000,000 shares) 350,000
14% Preference shares 250,000
12% (Bonds Irredeemable) 200,000
Total 800,000

Estimated investment for financing this project will cost BDT 100 million. 12% Irredeemable
bonds issued at the current market rate would be used to raise the entire amount. Preference share
and bond prices will not change.
The market risk premium for the cement sector is 2.5%, the bond rate for the Bangladesh
government for same tenure (5 years) is 8%, and Karnofuli Ltd. has a beta of 1.2. The current
market price for Irredeemable Bonds of BDT 1,000 nominal value is BDT 920.
The dividend payment policy of Karnofuli Ltd. is to pay a constant dividend, and this policy will
not change in the near future. The most recent dividend was BDT 5 per share. Karnofuli Ltd. pays
tax at 25% rate.
During the last board meeting, Chairman of the Board said that we should reform our Company’s
capital through share buy-back as gearing level is too low and cost of equity is higher than cost of debt.
Requirements:
i) Determine the cost of equity, current share price and current market capitalization of Karnofuli Ltd. 6
ii) Calculate the Weighted Average Cost of Capital (WACC) of Karnofuli Ltd. both before and
after undertaking of this project. 6
iii) State the circumstances when a company may opt for “share buy-back”. 2
iv) Recommend whether the “share buy-back” is a good choice for Karnofuli Limited. Justify
stating the factors that need to be considered for buying back the shares. 6
b) Clear Glass Company sells glass containers. It reported total sales of Tk. 1,580,000, with 60% of
the sales on credit. It takes 60 days to collect accounts receivable. The selling price is Taka 20 per
container while the variable cost is Taka 15 per container. The board is currently investigating a
change in the collection of accounts receivable that is expected to result in a 20% increase in credit
sales and a 10% increase in the average collection period. Bad debts will also increase, from 2%
to 4% of sales. The firm’s opportunity cost on its investment in accounts receivable is 12%. (Note:
Use a 365-day year.
Requirements:
i) Calculate bad debts in Taka for the current and proposed plans. 3
ii) Calculate the incremental bad debts to Clear Glass Company. 1
iii) Would you recommend the proposed plan? Why? 3
c) Modigliani and Miller (MM) on the one hand and Gordon and Lintner (GL) on the other have
expressed strong views regarding the effect of dividend policy on a firm’s cost of capital and value.
Requirements:
i) In essence, what are the MM and GL views regarding the effect of dividend policy on the cost
of capital and stock prices? 2
ii) How does the tax preference theory differ from the views of MM and GL? 2
Page 1 of 3
 iii) How could MM use the information content, or signaling, hypothesis to counter their
opponents’ arguments? If you were debating MM, how would you counter them? 2
iv) How could MM use the clientele effect concept to counter their opponents’ arguments? If you
were debating MM, how would you counter them? 2

2. a) Padma Limited imports raw materials from USA and Europe. In order to hedge for next 6 months,
it enters into 2 option contracts with New Bank Limited.
The details of the option contracts are as follows:
Details Transaction Strike Price/ Spot Rate on Option
Amount Exchange Rate Maturity Date premium
OPTION Bought call option to US$ 75m BDT 107/ USD BDT 105/ USD 3.00%
A buy USD against BDT
OPTION Bought call option to EUR 65m BDT 110/ EUR BDT 112/ EUR 3.5%
B buy Euro against BDT
Requirements:
i) Advice Padma Limited on whether to exercise Option A or Option B on the basis of its
profit/loss. 10
ii) Calculate overall gain/ loss of the hedge. 2

b) Bangla Metal Ltd. got a large contract with a European Company. The Company will pay in Euro
and there will be a credit period of 3 months. Being an accountant, you are worried about this
payment. You are not worried about credit risk rather than for foreign exchange risk due to volatile
nature of Euro and BDT which may cause a loss of substantial amount.
Requirement:
Write a report to CEO describing the points to consider in relation to foreign exchange risk and
available solutions to manage such risks. Your report should cover highlighting the nature (but not
the amount) of cost associated with each of following options:
i) Do nothing and accept the risk 3
ii) Using a forward exchange contract 4
iii) Carrying out a market hedge 4
iv) Buying a currency option 4

1. 3. Purnima RMG group has decided to expand through vertical integration and is considering to invest in
following mutually exclusive textiles:
Liza Textile Shormi Textile
BDT ‘000 BDT ‘000
Annual cash inflows 13,000 32,000
Cost of Machine 33,000 75,000
Scrap value of Machine 1,250 1,750
Expected life of the Project 6 6

Purnima depreciates property using the straight-line approach and its cost of capital is 9% per annum.
Requirements:
2. Calculate followings and advise the Company which projects should be taken based on these
calculations:
a) Each project's accounting rate of return. 4
b) Each project's Net Present Value (NPV). 4
c) Each project’s internal rate of return (IRR). 4
d) Each project’s payback period. 2

Page 2 of 3
4. Sky Air Ltd. is a new airlines maintenance company. A Turkish airline asked the company to take on
a maintenance contract for four years. Sky Air would receive an expected revenue of BDT 55 million
per year from the contract, based on foreign exchange rate between Taka and Turkish Lira. Sky Air
has conducted an in-depth feasibility study for the project at a cost of BDT 1 million. This suggests
that the effective solution would be to construct brand-new maintenance facilities on property that the
corporation already owns but does not actively use.
The new facilities will require a capital investment of BDT 115 million payable in advance. Except for a
BDT 12 m on the sale of the old maintenance facility at the end of the year, there would be no pre-tax
cash flows or efficiency savings in the year after the initial BDT 115m payment while the facility is being
built. Regarding BDT 12 million receipt in Year 1, no tax depreciation considerations are to be made.
In order to maintain Sky Air’s present level of maintenance activities, the new facilities would
thereafter deliver efficiency benefits that would save BDT 2.5 million annually. Additional revenue
will be generated from this new facility which will be BDT 2.7 million in the first year of operations
and increase by BDT 1.5 million annually over the next three of the predicted four-year operating life
of the new facility.
The maintenance facility is expected to be sold for BDT 12 m at the completion of Year 4 of its
operations, with the proceeds being received instantly. The directors plan to charge existing head office
overhead expenditures of BDT 6 million per year along with annual incremental costs during the
facility's operational period of 50% of sales revenue (contract from Turkey plus additional revenue
from the facility.
Company’s cost of capital is 8%. On the first BDT 115 million investment in the factory, 25% tax
depreciation allowances on a reducing basis are accessible immediately. Assume there are enough
profits available elsewhere in the business to utilize all tax benefits at once and in full.
Corporate tax rate is 25% and assumed to be the same during the whole project time. It is presumed
that all tax payments were made at the end of the relevant tax year. The project is estimated to have a
negligible working capital impact.
Requirements:
a) Calculate net present value of the proposed investment and decide whether it should be taken or not. 10
b) What additional factors to be considered before taking final decision on the proposed investment? 2

5. Sunmoon Ltd. is an unlevered firm with expected annual earnings before taxes of Tk. 21 million in
perpetuity. The current required return on the firm’s equity is 16%, and the firm distributes all of its
earnings as dividends at the end of each year. The company has 1.3 million ordinary shares outstanding
and is subject to a corporate tax rate of 35%. The firm is planning a recapitalization under which it will
issue Tk. 30 million of perpetual 9% debt and use the proceeds to buy back shares.
Requirements:
a) Calculate the value of the company before the recapitalization plan is announced. What is the value
of equity before the announcement? What is the value of equity after announcement? What is the
price per share? 4
b) Use the Adjusted Present Value (APV) method to calculate the company value after the
recapitalization plan is announced. What is the value of equity after the announcement? What is
the price per share? 4
c) How many shares will be repurchased? What is the value of equity after the repurchase has been
completed? What is the price per share? 4

---The End---

Page 3 of 3