ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

CHAPTER - 1 FOREX

Question 59
M/s Omega Electronics Ltd. exports air conditioners to Germany by importing all the components
from Singapore. The company is exporting 2,400 units at a price of Euro 500per unit. The cost
of imported components is S$ 800 per unit. The fixed cost and other variables cost per unit are
₹ 1,000 and ₹ 1,500 respectively. The cash flows in Foreign currencies are due in six months. The
current exchange rates are as follows:

₹/Euro 51.50/55
₹/S$ 27.20/25

After six months the exchange rates turn out as follows:

₹/Euro 52.00/05
₹/S$ 27.70/75
A. You are required to calculate loss/gain due to transaction exposure.
B. Based on the following additional information calculate the loss/gain due to transaction
and operating exposure if the contracted price of air conditioners is ₹ 25,000 :
(i) the current exchange rate changes to
₹/Euro 51.75/80
₹/S$ 27.10/15

(ii) Price elasticity of demand is estimated to be 1.5

(iii) Payments and receipts are to be settled at the end of six months.
Solution
(i) Profit at current exchange rates
2400 [€ 500 × ₹ 51.50 – (S$ 800 × ₹ 27.25 + ₹ 1,000 + ₹ 1,500)]
2400 [₹ 25,750 - ₹ 24,300] = ₹ 34,80,000

Profit after change in exchange rates

2400[€500× ₹ 52 – (S$ 800 × ₹ 27.75 + ₹ 1000 + ₹ 1500)]
2400[₹ 26,000 - ₹ 24,700] = ₹ 31,20,000

LOSS DUE TO TRANSACTION EXPOSURE

₹ 34,80,000 – ₹ 31,20,000 = ₹ 3,60,000

(ii) Profit based on new exchange rates

2400[₹ 25,000 - (800 × ₹ 27.15 + ₹ 1,000 + ₹ 1,500)]
2400[₹ 25,000 - ₹ 24,220] = ₹ 18,72,000

Profit after change in exchange rates at the end of six months

2400 [₹ 25,000 - (800 × ₹ 27.75 + ₹ 1,000 + ₹ 1,500)]
2400 [₹. 25,000 - ₹ 24,700] = ₹ 7,20,000

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Decline in profit due to transaction exposure

₹ 18,72,000 - ₹ 7,20,000 = ₹ 11,52,000
Current Price of each unit in € = = € 485.44
Price after change in exchange rate = = € 483.09
Change in price due to exchange rate = € 485.44 - € 483.09 = € 2.35 or (-) 0.48%
Price elasticity of demand = 1.5
Increase in demand due to fall in price = 0.48 x 1.5 = 0.72 %
Size of increased order = 2400 x 1.0072 = 2417 units
Profit = 2417 [₹ 25,000 – (800 x 27.75 + ₹ 1000 + ₹ 1500)]
= 2417 [₹ 25,000 - ₹ 24,700] = ₹ 7,25,100

Therefore, decrease in profit due to operating expenses

₹ 18,72,000 - ₹ 7,25,100 = ₹ 11,46,900

Alternatively, if it is assumed that Fixed Cost shall not be changed with change in units
then answer will be as follows:
Fixed Cost = 2400[₹ 1000] = ₹ 24,00,000
Profit = 2417 [ ₹ 25,000 – (800 × ₹ 27.75 + ₹ 1,500)] – ₹ 24,00,000
= 2417 ( ₹ 1,300) – ₹ 24,00,000 = ₹ 7,42,100
Therefore, decrease in profit due to operating exposure = ₹ 18,72,000 – ₹ 7,42,100
= ₹ 11,29,900

Question 60
Following are the details of cash inflows and outflows in foreign currency denominations of
MNP Co. an Indian export firm, which have no foreign subsidiaries:
Currency Inflow Outflow Spot rate Forward rate
US $ 4,00,00,000 2,00,00,000 48.01 48.82
French Franc (FFr) 2,00,00,000 80,00,000 7.45 8.12
U.K. £ 3,00,00,000 2,00,00,000 75.57 75.98
Japanese Yen 1,50,00,000 2,50,00,000 3.20 2.40
(i) Determine the net exposure of each foreign currency in terms of Rupees.
(ii) Are any of the exposure positions offsetting to some extent?
Solution:
1. Net exposure of each foreign currency in Rupees
Inflow Outflow Net Inflow Spread Net Exposure
(Millions) (Millions) (Millions) (Millions)

US$ 40 20 20 0.81 16.20

FFr 20 8 12 0.67 8.04
UK£ 30 20 10 0.41 4.10
Japan Yen 15 25 -10 -0.80 8.00
2. In Japanese Yen, the net exposure is payable, and the forward rate is quoted at a discount,
effectively offsetting the position. Likewise, in the remaining currencies, the net exposures are

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in receivables, and the related currencies are at a premium, offsetting the positions in their
respective currencies.

Question 19 (MTP/RTP/PP)
PKR Ltd. has made purchases worth USD 8,00,000 on 1st May 2020 for which it has to make
a payment on 1st November 2020. The present exchange rate is INR/USD 75. The company
can purchase forward dollars at INR/USD 74. The company will have to make an upfront
premium @ 1 per cent of the forward amount purchased.

The company can hedge its position with the following expected rate of USD in foreign
exchange market on 1st May 2020:
PKR Ltd. has made purchases worth USD 8,00,000 on 1st May 2020 for which it has to make
a payment on 1st November 2020. The present exchange rate is INR/USD 75. The company
can purchase forward dollars at INR/USD 74. The company will have to make an upfront
premium @ 1 per cent of the forward amount purchased.

The company can hedge its position with the following expected rate of USD in foreign
exchange market on 1st May 2020:
Exchange Rate Probability
(i) INR/USD 77 0.15
(ii) INR/USD 71 0.25
(iii) INR/USD 79 0.20
(iv) INR/USD 74 0.40
You are required to advise the company for a suitable cover for risk assuming that the
cost of funds to PKR Ltd. is 10 per cent per annum.
Solution:
(i) If PKR Ltd. does not take forward cover (Unhedged Position):
Expected Rate = ₹ 77 × 0.15 + ₹ 71 × 0.25 + ₹ 79 × 0.20 + ₹ 74 × 0.40
= ₹ 11.55 + ₹17.75 + ₹ 15.80 + ₹ 29.60 = ₹ 74.70
Expected Amount Payable = USD 8,00,000 × ₹74.70 = ₹ 5,97,60,000

(ii) If the PKR Ltd. hedge its position in the forward market:
Particulars Amount (₹)
If company purchases US$ 8,00,000 forward premium is (800000 × 74 5,92,000
× 1%)
Interest on ₹5,92,000 for 6 months at 10% 29,600
Total hedging cost (a) 6,21,600
Amount to be paid for US$ 8,00,000 @ ₹74.00 (b) 5,92,00,000
Total Cost (a) + (b) 5,98,21,600

Advice: Since cash outflow is lesser in case of unhedged position company should opt for the
same.

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Question 20 (MTP/RTP/PP)
Export Ltd., an export oriented unit invoices in the currency of the importer. It iexpecting
a receipt of USD 2,40,000 on 1st August, 2022 for the goods exported on 1st May, 2022.
The following information is available as on 1st May, 2022:
Exchange Rates Currency Futures Contract Size
USD/INR USD/INR
Spot 0.0125 May 0.0126
1 Month Forward 0.0124 July 0.0125 ₹ 6,40,000/-
3 Months Forward 0.0123

Initial Margin Interest Rates in India

May ₹ 15,000 9%
August ₹ 26,000 8.5%
On 1st August, 2022 the spot rate USD/INR is 0.0126 and currency future rate is 0.0125.
Suggest a suitable approach to Export Ltd. that would be most advantageous out of the
following methods.
(i) Forward Contract
(ii) Currency Futures
(iii) No hedge
Assume that the variation in margin would be settled on the maturity of the futures contract.
Solution
Receipts using a forward contract
USD 2,40,000/0.0123 = ₹ 1,95,12,195
Receipts using currency futures
The number of contracts needed is (USD 2,40,000/0.0125)/6,40,000 = 30
Initial margin payable is 30 contracts x ₹ 26,000 = ₹ 7,80,000
On August 1, 2022 Close at 0.0125
Receipts = USD 2,40,000/0.0126 = ₹ 1,90,47,619
Less: Interest Cost – (7,80,000 x 0.085 x 3/12) = ₹ 16,575
Net Receipts ₹ 1,90,31,044

Question 22 (MTP/RTP/PP)
An import customer booked a forward contract with the bank on 10 thApril for USD 20,000
due on 10thJune at ₹ 49.4000. The bank covered its position in the market at ₹ 49.2800.

The exchange rate for dollar in the interbank market on 10thJune and 20thJune were:
10th June 20th June
Spot USD 1 = ₹ 48.8000/8200 48.6800/7200
Spot/ June 48.9200/9500 48.8000/8500
Spot/July 49.0500/0900 48.9300/9900
Spot/August 49.3000/3500 49.1800/2500
Spot/September 49.6000/6600 49.4800/5600

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Exchange margin is 0.10%

Interest on outlay of funds 12%

Calculate how the bank will react, if the customer requires on 20th June:
i) To cancel the contract.
a) Exchange difference,
b) Swap loss,
c) Interest on outlay of funds and
d) Cancellation charges
ii) To Execute the contract.
iii) To Extend the contract with due date to fall on 10th August.
Solution
i. Cancellation of Contract
a. Exchange Difference:
The forward sale contract shall be cancelled at Spot TT Purchase for $ prevailing on the
date of cancellation as follows:
$/ ₹ Market Buying Rate ₹ 48.6800
Less: Exchange Margin @ 0.10% ₹ 0.0487
₹ 48.6313
Rounded off to ₹ 48.6325

Exchange Difference Payable

Bank sells $ 20,000 @ ₹ 49.4000 ₹ 9,88,000
Bank buys $ 20,000 @ ₹ 48.6325 ₹ 9,72,650
Amount payable by customer ₹ 15,350

b. Swap Loss
On 10th June the bank does a swap sale of $ at market buying rate of ₹ 48.8000 and
forward purchase for June at market selling rate of ₹ 48.9500.
Bank buys at ₹ 48.9500
Bank sells at ₹ 48.8000
Amount payable by customer ₹ 0.1500
Swap Loss for $ 20,000 is = ₹ 3,000

c. Interest on Outlay of Funds

On 10th June, the bank receives delivery under cover contract at ₹ 49.2800 and sell
spot at 48.8000.
Bank buys at ₹ 49.2800
Bank sells at ₹ 48.8000
Amount payable by customer ₹ 0.4800
Outlay for $ 20,000 is ₹ 9,600
Interest on ₹ 9,600 @ 12% for 10 days ₹ 31.56 or ₹ 32.00

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d. Cancellation Charges
Particulars Amount (₹)
Exchange Difference 15,350
Swap Loss 3,000
Interest on Outlay of Funds 32.00
Cancellation Charges payable by Customer 18,382
Or
Particulars Amount (₹)
Exchange Difference 15,350
Swap Loss 3,000
Interest on Outlay of Funds 31.56
Cancellation Charges payable by Customer 18,381.56

ii. Execution of Contract

Cancellation charges of ₹ 18,382 or ₹ 18,381.56 as computed above will be recovered. The
contract will be executed at the spot TT selling rate calculated as follows:
Dollar/₹ interbank spot selling rate ₹ 48.7200
Add: exchange margin at 0.10% + 0.0487
₹ 48.7687

iii. Extension of Contract

Cancellation charges of ₹ 18,382 or ₹ 18,381.56 as computed above will be recovered.
The contract will be extended at the current rate.

Dollar/₹ market forward selling rate for August ₹ 49.2500

Add: Exchange margin at 0.10% + 0.0492
₹ 49.2992

The exchange rate applied for the extended contract is ₹ 49.3000 or ₹ 49.2992.

Question 24 (MTP/RTP/PP)
XYZ Ltd. has imported goods to the extent of US$ 8 Million. The payment terms are as under:
(a) 1% discount if full amount is paid immediately; or
(b) 60 days interest free credit. However, in case of a further delay up to 30 days, interest
at the rate of 8% p.a. will be charged for additional days after 60 days. M/s XYZ Ltd. has
₹ 25 Lakh available and for remaining it has an offer from bank for a loan up to 90 days
@ 9.0% p.a.
The quotes for foreign exchange are as follows:
Spot Rate INR/ US$ (buying) ₹ 66.98
60 days Forward Rate INR/ US$ (buying) ₹ 67.16
90 days Forward Rate INR/ US$ (buying) ₹ 68.03
Advise which one of the following options would be better for XYZ Ltd.

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(i) Pay immediately after utilizing cash available and for balance amount take 90 days
loan from bank.
(ii) Pay the supplier on 60th day and avail bank’s loan (after utilizing cash) for 30 days.
(iii) Avail supplier offer of 90 days credit and utilize cash available.
Further presume that the cash available with XYZ Ltd. will fetch a return of 4% p.a. in India
till it is utilized.
Assume year has 360 days. Ignore Taxation.
Compute your working upto four decimals and cash flows in Crore.
Solution:
To evaluate which option would be better we shall compute the outflow under each option as
follows:
(i) Pay Immediately availing discount
Particulars
Spot Rate ₹ 66.98
Amount required in US$ US$ 7.92 Million
₹
Amount required in ₹ ₹ 53.0482 Crore
Cash Available ₹ 0.2500 Crore
Loan required ₹ 52.7982 Crore
Interest for 90 days @ 9% ₹ 1.1880 Crore
Total Outflow ₹ 53.9862 Crore

(ii) Pay the supplier on 60th day and avail bank’s loan (after utilizing cash) for 30 days.
Particulars
Applicable Forward Rate ₹ 67.16
Amount required in [₹ 67.16 x US$ 8 Million] ₹ 53.7280 Crore
Loan required [₹ 53.7280 Crore – ₹ 0.25 Crore] ₹ 53.4780 Crore
Interest for 30 days @ 9% ₹ 0.4011 Crore
₹ 53.8791 Crore
Interest earned on Cash for 60 days @ 4% ₹ 0.0017 Crore
Total Outflow ₹ 53.8774 Crore

(iii) Avail supplier offer of 90 days credit and utilize cash available
Particulars
Amount Payable US$ 8 Million
Interest for 30 days @ 8% US$ 0.0533 Million
Amount required in ₹ US$ 8.0533 Million
Applicable Forward Rate ₹ 68.03
Amount required in ₹ [₹ 68.03 x US$ 8.0533 Million] ₹ 54.7866 Crore
Cash Available ₹ 0.2500 Crore
Interest earned on Cash for 90 days @ 4% ₹ 0.0025 Crore

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Total Outflow ₹ 54.5341 Crore

Decision: Cash outflow is least in case of Option (ii) same should be opted for.

CHAPTER – 2A DERIVATIVES ANALYSIS AND VALUATION

Question 36 (OB Q.NO 52)

ABC Ltd. is a pharmaceutical company possessing a patent of a drug called ‘Aidrex’, a medicine
for aids patient. Being an approach drug ABC Ltd. holds the right of production of drugs and its
marketing. The period of patent is 15 years after which any other pharmaceutical company
produce the drug with same formula. It is estimated that company shall require to incur $ 12.5
million for development and market of the drug. As per a survey conducted the expected
present value of cashflows from the sale of drug during the period of 15 years shall be $ 16.7
million. Cash flow from the previous similar type of drug have exhibited a variance of 26.8% of
the present value of cashflows. The current yield on Treasury Bonds of similar duration (15
years) is 7.8%.
Determine the value of the patent.
Given:
ln(1.336) =0.2897
e 1.0005 = 0.3677 and e -1.17 = 0.3104
Solution
The given solution is like valuation of stock option wherein delay in introduction of drug ‘Aidrex’
shall cause the loss of cashflow which is like payment of dividend.
To value the patent, we shall use Black Scholes Model for option pricing as follows:
Inputs
S (Spot Price) = The Present Value of Cashflows = $16.7 million
E (Exercise Price) = Cost of Development Formula = $ 12.5 million
2
σ (Variance of Cash flow) = 26.8% i.e. 0.268
R (Risk Free Rate of Return) = 7.8%
D (Expected cost of Delays) = = 0.0667 i.e. 6.67%
Value Call option
C = SN (d1 ) e-df - Ee-rtN(d2 )
σ
σ
σ

Accordingly,

D1
D1
D1
d2 = 1.2315 – 2.005
d2 = - 0.7735
N (d1) = 0.8910

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

N (d2) = 0.2196

Value of Patent
= 16.7 x e-0.0667x15 x 0.8910 – 12.5 x e-0.078x15 x 0.2196
= 16.7 x 0.3677 x 0.8910 – 12.5 x 0.3104 x 0.2196
= 5.471 – 0.852 = 4.619

Thus, the value of patents is $ 4.619 million

Question 37 (OB Q.NO 53)

IPL already in production of Fertilizer is considering a proposal of building a new plant to produce
pesticides. Suppose the PV of proposal is ₹ 100 crore without the abandonment option. However,
if market conditions for pesticide turns out to be favorable the PV of proposal shall increase by
30%. On the other hand, market conditions remain sluggish the PV of the proposal shall be
reduced by 40%. In case company is not interested in continuation of the project it can be
disposed of for Rs 80 crore.
If the risk-free rate of interest is 8% then what will be value of abandonment option.
Solution
Decision Tree showing pay off
Year 0 Year 1 Pay Off
130 0
100
60 80 – 60 = 20
First of all we shall calculate probability of high demand (P) using risk neutral method as follows:
8% = p x 30% + (1-p) x (-40%)
0.08 = 0.30 p - 0.40 + 0.40p
P=
The value of abandonment option will be as follows:
Expected Payoff at Year 1
= p x 0 + [(1-p) x 20]
= 0.686 x 0 + [0.314 x 20]
= 6.28 crore
Since expected pay off at year 1 is 6.28 crore. Present value of expected pay off will be:
=
This is the value of abandonment option (Put Option).

Question 38 (OB Q.NO 54)

Suppose MIS Ltd. is considering installation of solar electricity generating plant for light the
staff quarters. The plant shall cost ₹ 2.50 crore and shall lead to saving in electricity expenses
at the current tariff by ₹ 21 lakh per year forever.
However, with change in Government in state, the rate of electricity is subject to change.
Accordingly, the saving in electricity can be of ₹ 12 lakh or ₹ 35 lakh per year and forever.
Assuming WACC of MIS Ltd. is 10% and risk-free rate of rate of return is 8%.
Decide whether MIS Ltd. should accept the project or wait and see.

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Solution:
Here we shall evaluate NPV in two possible situations:
i. As on Today
At cost of Capital of 10%, the value of saving forever =
NPV = 2.1 crore - 2.5 crore = - 0.4 crore.
Since NPV is negative, it does not worth to accept the project.

ii. After one Year

After one year these are two possible situations, either rate of electricity decreases or
increase.
a) If price of electricity increases
At cost of Capital of 10%, the value of saving forever =
The position of the NPV will be as follows:
= 3.50 crore - 2.50 crore = 1 crore
And Rate of Return will be (3.5/2.5) - 1 = 0.40 is 40%

b) If the price of electricity decreases, then value of saving forever will be

At cost of Capital of 10%, the value of saving forever =
The position of the NPV will be as follows:
= 1.20 crore - 2.5 crore = - 1.3 crore
and Rate of Return will be (1.2/2.5) - 1 = -0.52 i.e. – 52.00%

Diagrammatically it can be shown below:

3.50 Crore
2.5 Crore
1.20 Crore

Let prob. of price increase be p. Then using Risk Neutral Method, the risk-free rate of
return will be equal to expected saving as follows:
p x 0.40 + (1-p) (-0.52) = 0.08
0.40p - 0.52 + 0.52p = 0.08
0.92p = 0.60
p = 0.652

Hence, expected pay off = 0.652 x 1 crore + 0.348 x (- 1.30 crore) = 19.96 lakh.
PV of Pay off after one year = 19.96 lakh/ 1.08 = 18.48 lakh or ₹ 19.96 lakh/ 1.10 = ₹
18.15 lakh.

Thus, it shall be advisable to wait and see as NPV may turn out to be positive after one
year.

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Question 18 (MTP/RTP/PP)
Mr. V is a commodity trader and specialized himself in trading of rice. He has 24,000 Kg. of rice.
The following details are available as on date:
Spot price ₹/Kg. 70
3 month's future is trading at ₹/Kg 68
Expected Lower price after 3 months ₹/Kg 64
Contract size
500 Kg./ contract

You are required to advise to Mr. V:

(i) How to mitigate the risk of fall in price.
(ii) How to use the futures market.
(iii) What will be the effective realized price for his sales if, after 3 months, spot price is
₹ 69/ Kg. and the 3 months future contract price is
a. ₹ 72/ Kg.
b. ₹ 67/Kg.
Solution:
(i) In order to hedge its position Mr. V (trader) should use Future Contracts.
Particulars
(a) Quantity of Rice to be hedged 24000 kg.
(b) Contract Size 500 kg
(c) No. of Contracts (a/b) 48
(d) Future Price ₹ 68/kg.
(e) Exposure in the future market (a x d) ₹16,32,000

(ii) Mr. V should short 48 Future contracts at the price ₹ 68/kg and cancel its position after 3
months by buying Future contract at prevailing Future price.
(iii) After 3 months, trader would cancel its position in the future by buying a future contract of
same quantity and will sell Rice in the spot market and position shall be as follows:
Particulars
(a) Price of Future Contract 72/kg. 67/kg.
(b) Amount bought 17,28,000 16,08,000
(c) Exposure 16,32,000 16,32,000
(d) Gain/(Loss) on future position (b – c) (96,000) 24,000
(e) Spot Price 69/kg 69/kg
(f) Amount realized by selling in the spot market 16,56,000 16,56,000
(g) Effective Selling Amount (f + d) ₹ 15,60,000 ₹ 16,80,000
(g) Effective Selling Price ₹ 65/kg. ₹ 70/kg.

Question 19 (MTP/RTP/PP)
Following is the information available pertaining to shares of Omni Ltd.:
Current Market Price (₹) ₹420.00
Strike Price(₹) ₹450.00

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Maximum Price (₹)expected in next 3 months’ time ₹525.00

Minimum Price(₹ ) expected in next 3 months’ time ₹378.00
Continuously Compounded Rate of Interest (p.a.) (%) 8.00%
ert 1.0202
From the above:
(i) Calculate the 3 months call option by using Binomial Method and Risk Neutral Method.
Are the calculated values under both the models are same?
(ii) State also clearly the basis of Valuation of options under these models.
Solution
1. Call Option value using Binomial Model
₹ 525(75)

420
₹ 378(0)

₹ ₹
∆= ₹
= 0.51
Initial Investment= 0.51 x 420 = 214.20
Value of Portfolio if Price goes down to ₹378
Value of holding 0.51 x ₹378 = 192.78
Accordingly Let ‘P’ be the option price, then
₹214.20 - P = ₹192.78/1.0202 = ₹188.96
P = ₹25.24

2. Value of Call Option using Risk Neutral Method Let ‘’P’ be the probability of Price increase,
then
p x 525 + (1 - p) x 378 = 420(1.0202)
147p = 50.48
p = 0.34
Probability of Price increase = 0.34
Probability of Price decrease= 0.66
=₹25.24

Yes, the value of option under both Models is same.

ii) Basis of valuation of options :

 Binomial model uses an approach called “ Risk less Hedge Approach” to find the price of the
option, by creating a portfolio which will have same value at expiration irrespective of any
price. Hedge means to create an equal and opposite position for protecting the value of
portfolio.
 In Risk Neutral Model, valuation of options is based on arbitrage and is therefore independent
of risk preferences; one should be able to value options assuming any set of risk preferences
and get the same answer.

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Question 22 (MTP/RTP/PP)
Hari is holding 100 equity shares of VCC Ltd. which is being quoted at ₹ 210 per share. He is
interested in hedging downside risk of his holding as he is going to sell them after 2 month. A 2-
month Call option is available at a premium of ₹ 6 per share and a 2- month put option is available
at a premium of ₹ 5 per share. The strike price in both cases is ₹ 220.You are required to:
i. Suggest the position Hari should take in the option market to hedge his holding in the VCC
Ltd.
ii. Calculate his final position after 2 months if after 2 months i.e. on the day of exercise the
actual market price of per share of VCC Ltd. happens to be ₹ 200, ₹210, ₹ 220, ₹ 230 and
₹ 240.
Solution
(i) Since Hari holds 100 equity shares, he should buy equal no. of Put option i.e. 100 put options in
the same stock to hedge his position.
Total Premium amount to be paid = 5 x 100 Put = ₹ 500

(ii) Net Position after 2-months

(₹)
Share price on exercise day 200 210 220 230 240
Option exercise Yes Yes No No No
Inflow (strike price) 220 220 Nil Nil Nil
Inflow (in open market) - - 220 230 240
Less outflow (premium) 5 5 5 5 5
Position (per share) 215 215 215 225 235
Total Position 21500 21500 21500 22500 23500
Thus, from above table it can be observed in any case the value of holding of Hari in VCC Ltd.
shall not go below ₹ 215 per share.

Question 24 (MTP/RTP/PP)
Shyam buys 10,000 shares of X Ltd., @ ₹ 25 per share and obtains a complete hedge of shorting
400 Nifty at ₹ 1,100 each. He closes out his position at the closing price of the next day when
the share of X Ltd., has fallen by 4% and Nifty Future has dropped by 2.5%.
What is the overall profit or loss from this set of transaction?
Solution
Cash Outlay
= 10000 x ₹ 25 – 400 x₹ 1,100
= ₹ 2,50,000 – ₹ 4,40,000 = - ₹ 1,90,000
Cash Inflow at Close Out
= 10000 x ₹25 x 0.96 - 400 x ₹ 1,100 x 0.975
= ₹ 2,40,000 – ₹ 4,29,000 = - ₹ 1,89,000
Gain/ Loss
= ₹ 1,90,000 – ₹ 1,89,000 = ₹ 1,000 (Gain)

PRACTICAL QUESTIONS 13 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Question 25 (MTP/RTP/PP)
The price of ACC stock on 31 December 2022 was ₹ 220 and the Futures price on the same
stock on the same date, i.e., 31 December 2022 for March 2023 was ₹ 222. Other features of
the Futures contract and related information are as follows:
Time to expiration - 3 months (0.25 year)
Borrowing rate - 15% p.a.
Annual Dividend on the stock - 25% payable before 31.03. 2023
Face Value of the Stock - ₹ 10
Advise the investor the course of action to be followed by him so as to earn Risk free income if
he can sell the stock short at spot price.
Solution
Based on the above information, the futures price for ACC stock on 31 December 2022 should be:
Spot price + Interest Portion – Dividend
= 220 + (220 x 0.15 x 0.25) – (0.25 x 10) = 225.75
Thus, as per the ‘cost of carry’ criteria, the Futures price is ₹ 225.75, which is more than the actual
price of ₹ 222 on 31 March 2023. This would give rise to earn riskless arbitrage opportunity of ₹
3.75 i.e. (225.75 - 222)

Advise to the Arbitrager.

1. Short sell one unit of stock at spot price for ₹ 220.
2. Deposit ₹ 220 at 15% p.a. for 3 months.
3. Buy a 3-month Futures contract for one unit of stock of ACC at ₹ 222.

After 3 months
1. Take money out of the Bank.
2. Take delivery by paying ₹ 222 and return the unit of stock to the party whom short sell was made
along.
3. Pay the Dividend amount to the buyer whom short sell was made.
Total Inflow = 220 + (220 x 0.15 x 0.25) = ₹ 228.25
Total Outflow = 222 + 2.50 = ₹ 224.50
Net Gain to the Arbitrager = Total Inflow – Total Outflow
= ₹ 228.25 - ₹ 224.50
= ₹ 3.75
Thus, the arbitrager earns ₹ 3.75 per share without involving any risk.

Question 26 (MTP/RTP/PP)
Mr. H is holding 100 equity shares of V Ltd. which is being quoted at ₹ 2,100 per share. He is
interested in hedging downside risk of his holding as he is going to sell them after 2 months. A
2-month Call option is available at a premium of ₹ 60 per share and a 2-month put option is
available at a premium of ₹ 50 per share. The strike price in both cases is ₹ 2,200. You are
required to:
i. Suggest the position Mr. H should take in the option market to hedge his holding in the V Ltd.
ii. Calculate his final position if after 2 months i.e., on the day of exercise the actual market
price of per share of V Ltd. happens to be ₹ 2000, ₹ 2100, ₹ 2200, ₹ 2300 and ₹ 2400.

PRACTICAL QUESTIONS 14 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Solution
(i) Since Mr. H holds 100 equity shares, he should buy equal no. of Put option i.e. 100 put
options in the same stock to hedge his position.
Total Premium amount to be paid = 50 x 100 Put = ₹ 5,000

(ii) Net Position after 2-months

( )
Share price on exercise day 2,000 2,100 2,200 2,300 2,400

Option exercise Yes Yes No No No

Inflow (strike price) 2,200 2,200 Nil Nil Nil
Inflow (in open market) - - 2,200 2,300 2,400
Less outflow (premium) 50 50 50 50 50
Position (per share) 2,150 2,150 2,150 2,250 2,350
Total Position 2,15,000 2,15,000 2,15,000 2,25,000 2,35,000

Thus, from above table it can be observed in any case the value of holding of Mr. H in V Ltd.
shall not go below ₹ 2,150 per share.

Question 28 (MTP/RTP/PP)
Following is the information available pertaining to shares of Omni Ltd.:
Current Market Price (₹) ₹ 420.00
Strike Price (₹) ₹ 450.00
Maximum Price (₹) expected in next 3 months’ time ₹ 525.00
Minimum Price (₹) expected in next 3 months’ time ₹ 378.00
Continuously Compounded Rate of Interest (p.a.) (%) 8.00%
ert 1.0202
From the above:
a) Calculate the 3 months call option by using Binomial Method and Risk Neutral Method.
Are the calculated values under both the models are same?
b) State also clearly the basis of Valuation of options under these models.
Solution
(i) (1) Call Option value using Binomial Model

525 (75)

420
378 (0)
∆= = 0.51
Initial Investment= 0.51 x 420 = 214.20
Value of Portfolio if Price goes down to 378
Value of holding 0.51 x 378 = 192.78

PRACTICAL QUESTIONS 15 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Accordingly Let ‘P’ be the option price, then

214.20 - P = 192.78/1.0202 = 188.96
P = 25.24

(2) Value of Call Option using Risk Neutral Method

Let ‘’P’ be the probability of Price increase, then
p x 525 + (1 - p) x 378 = 420(1.0202)
147p = 50.48
p = 0.34
Probability of Price increase = 0.34
Probability of Price decrease= 0.66
= 25.24
Yes, the value of option under both Models is same.

(ii) Basis of valuation of options :

 Binomial model uses an approach called “ Risk less Hedge Approach” to find the price of the
option, by creating a portfolio which will have same value at expiration irrespective of any
price. Hedge means to create an equal and opposite position for protecting the value of
portfolio.

 In Risk Neutral Model, valuation of options is based on arbitrage and is therefore

independent of risk preferences; one should be able to value options assuming any set of
risk preferences and get the same answer.

Question 30 (MTP/RTP/PP)
The market received some information about ABC Lad's tie up with a Multinational Company.
This has induced the market price to move up. If the information is false, the ABC Ltd.'s stock
price will probably fall dramatically. To protect from this, an investor has bought the call and
put options.
He purchased one 3 month's call with a striking price of ₹ 45 for ₹ 3 premium and paid ₹ 2 per
share premium for a 3 month's put with a striking price of ₹ 42. Assume 100 shares for call and
put option.

You are required:

(i) To determine the investor's position if the tie up offer bids the price of ABC Ltd.'s
stock up to ₹ 44 in 3 months.
(ii) To determine the investor's position of the tie up offer program fails and the price of
the stocks falls to ₹ 34 in 3 months.
(iii) To determine the investor's position if the tie up offer program is successful and the
price of the stocks rise up to ₹ 46 in 3 months.
Solution
Total premium paid on purchasing a call and put option
= (₹ 3 per share × 100) + (₹ 2 per share × 100).
= ₹ 300 + ₹ 200 = ₹ 500

PRACTICAL QUESTIONS 16 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(i) In this case, investor exercises neither the call option nor the put option as both will result in a
loss for him.
Ending value= - ₹ 500 + zero gain = - ₹ 500
i.e. Net loss = ₹ 500

(ii) Since the price of the stock is below the exercise price of the call, the call will not be
exercised. Only put is valuable and is exercised.
Total premium paid = ₹ 500
Ending value = – ₹ 500 + ₹ [(42 – 34) × 100] = – ₹ 500 + ₹ 800 = ₹ 300
i.e. Net gain = ₹ 300

(iii) In this situation, the put is worthless, since the price of the stock exceeds the put’s exercise
price. Only call option is valuable and is exercised.
Total premium paid = ₹ 500
Ending value = - 500 + [(46 – 45) × 100] = - 500 + 100 = - ₹ 400
i.e. Net Loss = ₹ 400

CHAPTER – 2B INTEREST RATE RISK MANAGEMENT

Question 3 (MTP/RTP/PP)
IF an Indian firm has its subsidiary in Singapore and SF a Singapore firm has its subsidiary in
India and face the following interest rates:
Company IF SF
INR Floating Rate BPLR + 0.5% BPLR + 1.5%
SGD (fixed rate) 3% 3.50%
SF wishes to borrow Rupee loan at a floating rate and IF wishes to borrow SGD at a fixed rate.
The amount of loan required by both the companies is same at the current exchange rate. A
Bank arranges a swap and requires 50 basis points as its commission, which is to be shared
equally. IF requires a minimum gain of 20 basis points and SF requires a minimum gain of 10
basis points for structuring the deal. The Bank is very keen to structure the deal, even if, it
has to forego a part of its commission.
You are required to find out:
(i) Whether there are any advantages available to IF and SF?
(ii) Whether a swap can be arranged which may be beneficial to both the firms?
(iii) What rate of interest will they end up paying? Show detailed working.
Solution
(i) Though firm IF has an advantage in both the markets but it has comparative more advantage
in the INR floating-rate market. Firm SF has a comparative advantage in the SGD fixed
interest rate market.

However, firm IF wants to borrow in the SGD fixed interest rate market and firm SF want to
borrow in the INR floating-rate market. This gives rise to the swap opportunity.

IF raises INR floating rate at BPLR + 0.50% and SF raises SGD at 3.50%

PRACTICAL QUESTIONS 17 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Total Potential Gain = (INR interest differential) - (SGD rate differential)

= (BPLR + 1.50% - BPLR - 0.50%) + (3% - 3.50%) = 0.50%
Less: Banker's commission (To be shared equally) = *0.20%
Net gain (To be shared as: 0.20% for IF and 0.10% for SF) = 0.30%

*Since, bank’s commission is 0.50% which constitutes the entire gain, and it is mentioned that
bank will forego a part of its commission to structure the deal. Thus, it will forego the
minimum gain required by IF and SF i.e. 0.20% and 0.10% respectively.

(ii) Yes, a beneficial swap can be arranged

(iii) Effective cost of borrowing = pays to lenders + pays to other party - receives from other
party + banker's commission
IF = BPLR + 0.50% + 2.70%** - (BPLR + 0.50%) + 0.10% = 2.80%
(** has been arrived as 3% - 0.20% - 0.10%)
SF = 3.50% + BPLR + 0.50% - 2.70% + 0.10% = BPLR + 1.40%

Question 5 (MTP/RTP/PP)
A textile manufacturer has taken floating interest rate loan of ₹ 40,00,000 on 1 st April, 2012.
The rate of interest at the inception of loan is 8.5% p.a. interest is to be paid every year on 31st
March, and the duration of loan is four years. In the month of October 2012, the Central bank
of the country releases following projections about the interest rates likely to prevail in future.
Dates Interest Rate
31st March, 2013 8.75%
31st March, 2014 10.00%
31st March, 2015 10.50%
31st March, 2016 7.75%.

(i) ADVISE how borrower can hedge the risk arising out of expected rise in the rate of
interest when he is interested in pegging his interest cost at 8.50% p.a. and if option on
Interest Rate is available at 0.75% p.a.

(ii) Assume that the premium negotiated by both the parties at the above-mentioned rate
which is to be paid on upfront basis and the actual rate of interest on the respective due
dates happens to be as follows:
Dates Interest Rate
31st March, 2013 10.20%
31st March, 2014 11.50%
31st March, 2015 9.25%
31st March, 2016 8.25%.

Evaluate how the settlement will be executed on the respective interest due dates.
Solution
i. As borrower does not want to pay more than 8.5% p.a., on this loan where the rate of interest

PRACTICAL QUESTIONS 18 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

is likely to rise beyond this, hence, he is advised to hedge the risk by entering into an
agreement to buy interest rate caps with the following parameters:
 National Principal: ₹ 40,00,000/-
 Strike rate: 8.5% p.a.
 Reference rate: the rate of interest applicable to this loan
 Calculation and settlement date: 31st March every year
 Duration of the caps: till 31st March 2016
 Premium for caps: negotiable between both the parties

To purchase the caps this borrower is required to pay the premium upfront at the time of
buying caps. The payment of such premium will entitle him with right to receive the
compensation from the seller of the caps as soon as the rate of interest on this loan rises above
8.5%. The compensation will be at the rate of the difference between the rate of none of the
cases the cost of this loan will rise above 8.5% calculated on ₹ 40,00,000/-. This implies that in
none of the cases the cost of this loan will rise above 8.5%. This hedging benefit is received at
the respective interest due dates at the cost of premium.

ii. To evaluate the position of the borrower on respective dates we shall compute the interest
cost as follows:
Dates Interest Exercise Compensation Net Cost
Rate (a) of Option (b) (a) – (b)

31st March, 2013 10.20% Yes 10.20% - 8.50% = 1.70% 8.50%

31st March, 2014 11.50% Yes 11.50% - 8.50% = 3.00% 8.50%
31st March, 2015 9.25% Yes 9.25% - 8.50% = 0.75% 8.50%
31st March, 2016 8.25% No Nil 8.25%

Thus, form above it can be evaluated that the by paying an upfront premium of ₹ 30,000 each
year the borrower can ensure that its interest rate cost does not exceed 8.50% p.a.

CHAPTER – 3 Currency Futures & Currency Options

Question 10 (MTP/RTP/PP)
A Japanese company imports hi-tech printer cartridges from US worth $1 million. The chief
financial officer of the company wishes to know the best strategy for protection against
uncertainty, for the payment that has to be made at the end of 3 months. Financial team of the
company has collected the following options for evaluation:

Table-1: Exchange rates quoted in FOREX Market:

¥/$ Quotations Bid Price Offer/Ask Price
Spot Rates 146.03 146.63
3M – Forward Rates 144.03 145.00
6M – Forward Rates 146.35 146.70
Table-2 : Options Market rates for European options with 3 months expiry :

PRACTICAL QUESTIONS 19 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Type of Option Strike Price (X) (¥/$) Premium (%) for Call & Put Options
Call & Put 145.20 1.6766% (Call) & 1.7414% (Put)
Call & Put 146.00 1.3505% (Call) & 2.1006% (Put)

The expected spot price at expiry is ¥/$ : 144.90/145.05

Suggest the best strategy for CFO of the Japanese Company to protect against
uncertainty, with respect to the following alternatives :
(i) Forward Hedge
(ii) Buy 3 months call, X = 145.20
(iii) Sell 3 months put, X = 145.20
(iv) Buy call & sell put both having X = 146.00
Solution
(i) Forward Hedge
Amount payable after 3 months $ 1000000
3 month applicable buying rate ¥ 145/$
Amt. payable in Yen ¥ 145 million

(ii) Buy 3 month call option X = ¥ 145.20

If expected spot price after 3 month is ¥ 145.05

Then company would not exercise its option. Accordingly the cost of import will be
Buying Yen in spot Market after 3 month ¥ 145.05 million
Add: Premium Paid ¥ 145.20 x 1.6766%x $ 1 million ¥ 2.43 million
¥ 147.48 million

(iii) Selling 3 month Put at X = ¥ 145.20

If expected spot price after 3 month ¥ 144.90 , then Put Option buyer will exercise
his /her option.

Accordingly the import Bill will be :

Buying Yen in under option after 3 month ¥ 145.20 million
Less: Premium Receipt ¥ 145.20 x 1.7414%x $ 1 million ¥ 2.53 million
¥ 142.67 million

(iv) Buying Call and selling Put at X = ¥ 146

Net Premium receipt
Premium paid on call option = ¥ 146.00 x 1.3505% ¥ 1.9717 million
Premium Receipt on Put option = ¥ 146.00 x 2.1006% ¥ 3.0669 million
¥ 1.0952 million

If expected spot Rate expiry happens to be ¥ 144.90/145.05, then call option will be
lapsed and Put option by buyer will be exercised. Accordingly, the import bill will be:

Buying US$ under Put Option ¥ 146.00 million

PRACTICAL QUESTIONS 20 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Less: Receipt of Net Premium ¥ 1.09520 million

¥ 144.905 million

Decision: Since expected outflow is least in case of selling Put option, the same
strategy is recommended.

CHAPTER – 4B Security valuation: BONDS

Question 22 (MTP/RTP/PP)
Mr. Amit is happy with the investment in a company as it is paying good dividend for the last
few years. Last year it paid a dividend of ₹ 2 per share. The share is currently trading at
₹ 150 per share. He is of view that if he applies dividend discount model, the share is
undervalued. As a financial expert examine his view that dividend discount model
represents the fair value.

You being an expert is required to evaluate the market value of the share of the company.

Profit after tax of the company ₹ 290 crores

Equity capital of company ₹ 1,300 crores
Par value of share ₹ 40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ₹ 47
Depreciation per share ₹ 39
Change in Working capital ₹ 3.45 per share
Note: Round off figures (e.g. EPS etc.) upto 2 decimal points.
Solution
₹
No. of Shares ₹
EPS
₹
EPS ₹

Calculation of value per share using Free Cash Flow to Equity as basis:
FCFE = Net income – [(1-b) (capex – dep) + (1-b) (ΔWC)]
FCFE = 8.92 – [(1-0.27) (47-39) + (1-0.27) (3.45)]
= 8.92 – [5.84 + 2.52] = ₹ 0.564
Cost of Equity (Ke)= Rf + ß (Rm – Rf)
= 8.7 + 0.1 (10.3 – 8.7) = 8.86%
₹

PRACTICAL QUESTIONS 21 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Calculation of value per share using dividend discount model:

₹
From the above we can see that value per share on the basis of dividend discount model is more
than the value per share on the basis of free cash flow to equity model.

In the dividend discount model, the analyst considers the stream of expected dividends to
value the company’s stock. It is assumed that the company follows a consistent dividend
payout ratio which can be less than the actual cash available with the firm.

A stock’s intrinsic value based on the dividend discount model may not represent the fair value
for the shareholders because dividends are distributed in the form of cash from profits.
In case the company is maintaining healthy cash in its balance sheet then it means that
dividend pay-out is low which could result in undervaluation of the stock.

In the case of free cash flow to equity model a stock is valued on the cash flow available
for distribution after all the reinvestment needs of capex and incremental working capital are
met. Thus, using the free cash flow to equity model provides a better measure for valuations in
comparison to the dividend discount model.

Thus, the view of Mr. Amit that dividend discount model represents the fair value is
incorrect. The share is not under-valued rather it is overvalued if we take “free cash flow
to equity model” into consideration.

Question 23 (MTP/RTP/PP)
High Growth Ltd. (HGL) was having an excellent growth over a number of years. The Board
of Directors is considering a proposal to reward its shareholders by buying back 20%
shares at a premium. The premium is to be paid by raising a loan from the Bank. The
interest on loan is to be serviced by internal accruals as supported by the financials of
HGL. The company has a market capitalization of ₹ 15,000 crore and the current Earnings
Per Share (EPS) is ₹ 600 with a Price Earnings Ratio (PER) of 25. The Board expects a post
buy back Market Price per Share (MPS) of ₹ 10,000. The PER, post buy back, will remain
the same. The loan can be availed at an interest rate of 16 % p.a.
Applicable corporate tax rate is 30%.

You are required to calculate:

(i) The interest amount which can be paid for availing the bank loan.
(ii) The loan amount to be raised.
(iii) Buy back premium per share.
Solution
The interest amount which can be paid for availing the bank loan
Current Market Price per Share = ₹ 600 × 25 = ₹ 15,000
No. of Shares before Buyback =
= == 1 crore

PRACTICAL QUESTIONS 22 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

No. of Shares proposed to Buyback = 20% of 1 crore = 20 lakh

Total No. of Share after Buyback = 1 crore – 20 lakh = 80 lakh
Post Buy back Market Price per Share = ₹ 10,000
PE Ratio = 25
Post Buyback EPS = = = ₹ 400
EAT before Buyback = ₹ 600 × 1 crore = ₹ 600 crore
EBT before Buyback = = ₹ 857.1429 crore
EAT after Buyback = ₹ 400.00 × 80 lakh = ₹ 320 crore
EBT after Buyback = = ₹ 457.1429 crore
Interest which can be paid for availing bank loan:
EBT before Buyback ₹ 857.1429 crore
(-) EBT after Buyback ₹ 457.1429 crore
₹ 400.0000 crore

Alternatively, it can also be computed as follows:

Pre Buy back Market Capitalization (A) ₹ 15000 crore
Pre Buy back EPS (B) ₹ 600
Pre Buy back PER (C) 25
Pre Buy back Market Price Per Share ( ₹ 600x 5) D = B X C ₹ 15000
Pre Buy back No. of Shares (A)/ (D) 1 Crore
Post Buy back EPS (A) ( ₹ 10000/ 25) ₹ 400
Post Buy back No. of shares (B) 80 Lakh
Post Buy back Earning (C) = (A) X (B) ₹ 320 crore
Pre Buy back Earning 1 Crore X ₹ 600 (D) ₹ 600 crore
Post Tax Earning available for interest payment (D) – (C) ₹ 280 Crore
Pre- Tax amount of Interest 280crore ₹ 400 Crore
1-0.30

(ii) Loan Amount raised = = ₹ 2500 crore

(iii) Buyback Premium per Share
Amount of Loan for Buyback of 20 % Shares = ₹ 2500 crore No.
of Shares Buyback = 20 Lakh
Buyback price per Share = ₹ 2500 Crore/ 20 Lakh = ₹ 12500
Market Price after Buyback = ₹ 10000
Buyback Premium Per Share = ₹ 12500 – ₹ 10000 = ₹ 2500
Alternatively, it can also be computed as follows:
Amount of Loan (A) ₹ 2500 crore
No. of Shares to be bought back (B) 20 Lakh
Price Per Share to be paid (C) = (A)/ (B) ₹ 12,500
Post Buy back Share Price (D) ₹ 10,000
Buy Back Premium per share (C) – (D) ₹ 2,500

PRACTICAL QUESTIONS 23 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Question 24 (MTP/RTP/PP)
An investor, in the beginning of 2022, has purchased substantial number of 8 year 7.50%, ₹ 1000
bond with 5% premium on maturity at a required Yield to Maturity (YTM) of 8.50 %. However,
due to the continuing war in Europe, the inflation is running very high in the economies of the
countries. The yield on the bonds is decreasing. The risk averse investor wants to protect
himself from further loss and decides to sell the bonds in 2023. He has got a proposal from
another investor who is willing to purchase these bonds by shelling out ₹ a maximum amount of
797.50 per bond.
Investor follows intrinsic value method for valuation of the Bonds.

You are required to determine

(i) The Market price, Duration and Volatility of the bond.
(ii) Will it be a right decision of the new investor if he is looking for Required Yield to
Maturity (YTM) as 12% p.a.?
Period 1 2 3 4 5 6 7
PVIF (8.50%,n) 0.9217 0.8495 0.7829 0.7216 0.6650 0.6129 0.5649
Solution
(i) (A) Market Price of Bond
= 1,000 X 7.50% X (PVIAF 8.50%,7) + 1,050 X (PVIF 8.5%,7)
= 75 X 5.1185 + 1050 X 0.5649
= 383.89 + 593.15 = ₹ 977.04

(B) Duration of Bond

Year Cash Flow P.V. @ 8.5% Proportion of Proportion of bond
bond value value x time
(years)
1 75 0.9217 69.128 0.071 0.071
2 75 0.8495 63.713 0.065 0.130
3 75 0.7829 58.718 0.060 0.180
4 75 0.7216 54.120 0.055 0.220
5 75 0.6650 49.875 0.051 0.255
6 75 0.6129 45.968 0.047 0.282
7 1125 0.5649 635.513 0.651 4.557
977.035 5.695
Duration of the Bond is 5.695 years.

Alternatively, it can also be calculated as follows:

Year (1) Cash Flow (2) PVF (3) PV (4) (1) (4)
1 75 0.9217 69.13 69.13
2 75 0.8495 63.71 127.42
3 75 0.7829 58.72 176.16
4 75 0.7216 54.12 216.48
5 75 0.6650 49.88 249.40
6 75 0.6129 45.97 275.82

PRACTICAL QUESTIONS 24 CA PRATIK JAGATI

 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

7 1125 0.5649 635.51 4448.57

977.04 5562.98

Duration of the Bond = = = 5.69 years

C) Volatility of Bond-
Volatility = Duration/(1+YTM)
= 5.695/ (1+0.085) = 5.249
Or = 5.69/ (1+0.085) = 5.24

(ii) PV of Bond @ 12% YTM

= ₹ 75 PVIAF (12%, 7) + ₹ 1050 X PVIF (12%, 7)
= ₹ 75 X 4.5637 + ₹ 1050 X 0.4523
= ₹ 342.28 + ₹ 474.92 = ₹ 817.20

Since, Intrinsic Value of Bond is ₹ 817.20 the decision of new investor is right at purchase
price of ₹ 797.50.

Alternatively, it can also be solved as follows:

Price Difference between Current Selling Price & Intrinsic Value ₹ 179.54
Increase in Yield justified 3.50%
Justified YTM (8.50% + 3.50%) 12%
Thus, the decision of investor is right

Question 25 (MTP/RTP/PP)
An investor has recently purchased substantial number of 7 year 6.75% ₹ 1,000 bond with 5%
premium payable on maturity at a required Yield to Maturity (YTM) of 9%. However, due to a
financial crunch he is looking to sell these bonds and has got a proposal from another investor,
who is willing to purchase these bonds by shelling out a maximum amount of 897 per bond.
Investors follow intrinsic value method for valuation of bonds.
(i) You are required to determine
(1) The Market Price, Duration and Volatility of the bond and
(2) Required YTM of the new investor
(ii) What is relationship bet on the price of the bond and YTM?
Period (t) 1 2 3 4 5 6 7
PVIF (9%, t) 0.917 0.842 0.772 0.708 0.650 0.596 0.547
Solution
(i) (A) Market price of Bond
= 1,000 6.75% (PVIAF 9%, 7) + 1,050 (PVIF 9%, 7)
= 67.50 5.032 + 1050 0.547
= 339.66 + 574.35 = ₹ 914.01

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(b) Duration of Bond

Year Cash flow P.V. @9% Proportion of Proportion of bond value x
bond value time (years)
1 67.50 0.917 61.898 0.0677 0.0677
2 67.50 0.842 56.835 0.0622 0.1244
3 67.50 0.772 52.110 0.0570 0.1710
4 67.50 0.708 47.790 0.0523 0.2092
5 67.50 0.650 43.875 0.0480 0.2400
6 67.50 0.596 40.230 0.0440 0.2640
7 1117.50 0.547 611.273 0.6688 4.6816
914.011 5.7579

Duration of the Bond is 5.758 years

Alternatively, as per Short Cut Method

D= -
Where YTM = Yield to Maturity
c = Coupon Rate
t = Years to Maturity
= 1.09 - 1.09 + 7(0.0675 - 0.09) = 5.72
0.09 0.0675[(1.09)7 - 1] + 0.09

(C) Volatility of Bond-

Volatility = Duration/(1+YTM) = 5.758/(1+0.09) = 5.28

(2) Required yield of new Investor

= 67.50 PVIAF (r, 7) + 1050 X PVIF (r, 7)
Now, let us discount the cash flow by 9%
PV@ 9% = 67.5 5.032 + 1050 0.547
= 339.66 + 574.35 = 914.01
NPV @ 9% = 914.01 - 897 =₹ 17.01
Since, NPV of bond is positive, We need to increase discount rate say 12%
= 67.50 PVIAF (12%,7) + 1050 X PVIF (12%,7)
= 67.5 [0.893 + 0.797 + 0.712 + 0.636 + 0.567 + 0.507 + 0.452] + 1050X 0.452
= 67.5 4.564 + 474.60
= 308.07 + 474.6 = 782.67
NPV @ 12% = 782.67 - 897 = - ₹ 114.33
Now we use interpolation formula
Ke = LR+ r
=9% + 3%
=9% + 3%
= 9% + 0.39% = 9.39%

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(ii) Relationship between the price of the bond & YTM is opposite or inverse

Question 26 (MTP/RTP/PP)
Following information is related to the Convertible Bond of A Ltd. which is currently priced
at ₹ 1060 per Bond:
1) Conversion Parity Price - ₹ 53
2) Conversion Premium – 10.41667%
3) Percentage of Downside Risk with respect to Straight Value of Bond – 12.766%
Calculate:
(i) No. of shares on Conversion.
(ii) Current Market Price Per Share of A Ltd.
(iii) Straight Value of Bond
Solution:
(i) The No. of share on Conversion shall be computed as follows:
Conversion Parity Price =
₹ 53 =
Accordingly, No. of shares on Conversion = 20
(ii) To determine current Market Price Per Share of A Ltd. we shall use Conversion Premium as
follows:
Conversion Premium =
0.1041667 =
Conversion Value of Bond = ₹ 960
Since the No. of share on Conversion = 20
The current market price of share of A Ltd. shall be = ₹ 960/ 20 = ₹ 48 per share

(iii) To determine the Straight Value of Bond we shall use Percentage of Downside Risk as
follows:
–
Percentage of Downside Risk =
0.12766 =
Straight Value of Bond = ₹ 940 per Bond

Question 28 (MTP/RTP/PP)
Mr. X wants to invest ₹ 1,00,000 in the 7 years 8% bonds in the market (Face Value ₹ 100)
which were issued 2 years ago.
(i) You are requested to advise him what is the maximum price for bonds to be paid in the
following scenarios:
(1) If Mr. X is expecting minimum 9% return on the bonds
(2) If Mr. X is expecting minimum 7% return on the bonds
(3) If the present rate of similar bonds issued is 8.25%
(4) If the present rate of similar bonds issued is 7.75%
(ii) If the bonds are available at par and 1% is the transaction cost, what is the effective
yield?

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(iii) Find the number of days required to breakeven transaction cost if the bonds are
available at par and 2% is the transaction cost.
Solution
a. The maximum price to be paid for Bond
1. To have a return of 9% return on Bond.
=₹ 100 × = ₹88.89

Alternative Answer
= + + + +
= ₹ 7.34 + ₹ 6.73 + ₹ 6.18 + ₹ 5.67 + ₹70.19 = ₹ 96.11

2. To have a return of 7% return on Bond.

= ₹100 × = ₹114.29

Alternative Answer
= + + + +
= ₹ 7.48 + ₹ 6.99 + ₹ 6.53 + ₹ 6.10 + ₹ 77.00 = ₹ 104.10
3. If present rate of similar bond issued is 8.25%
= + + + +
= ₹ 7.39 + ₹ 6.83 + ₹ 6.31 + ₹ 5.83 + ₹ 72.66 = ₹ 99.02

Alternative Answer
= ₹100 × = ₹96.97

4. If present rate of similar bond issued is 7.75%

= + + + +
= ₹ 7.42 + ₹ 6.89 + ₹ 6.39 + ₹ 5.94 + ₹ 74.36
= ₹ 101.00

Alternative Answer
= ₹100 × = ₹103.23

b. Effective yield if transaction cost is 1% = × 100 = 7.92

c. No. of Days required for break even

= = = 90 days

Alternatively, if 365 days used in Calculation then answer will be as follows:

= = = 91.24 days say 91 days

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

CHAPTER-5 Business Valuation

Question 14
Using the chop – shop approach (or Break – up value approach), assign a value for Cranberry Ltd.
whose stock is currently trading at a total market price of € 4 million. For Cranberry Ltd, the
accounting data set forth three business segments: consumer wholesale, retail and general
centers. Data for the firm’s three segments are as follows:

Business Segment Segment Sales Segment Assets Segment Operating

Income
Wholesale € 225,000 € 600,000 € 75,000
Retail € 720,000 € 500,000 € 150,000
General € 2,500,000 € 4,000,000 € 700,000

Industry data for “pure-play” firms have been compiled and are summarized as follows:
Business Segment Capitalization / Sales Capitalization / Capitalization / Operating
Assets Income
Wholesale 0.85 0.7 9
Retail 1.2 0.7 8
General 0.8 0.7 4
Solution
Business Segment Capital - to - Sales Segment Sales Theoretical Values
Wholesale 0.85 € 225000 € 191250
Retail 1.2 € 720000 € 864000
General 0.8 € 2500000 € 2000000
Total value € 3055250

Business Segment Capital – to – Assets Segment Assets Theoretical Values

Wholesale 0.7 € 600000 € 420000
Retail 0.7 € 500000 € 350000
General 0.7 € 4000000 € 2800000
Total value € 3570000

Business Segment Capital – to – Operating Income Theoretical Values

Operating Income
Wholesale 9 € 75000 € 675000
Retail 8 € 150000 € 1200000
General 4 € 700000 € 2800000
Total value € 4675000

Average theoretical value =

Average theoretical value of Cranberry Ltd. = € 3766750

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Question 3 (MTP/RTP/PP)
Herbal Box is a small but profitable producer of beauty cosmetics using the plant, Aloe Vera.
Though it is not a high-tech business, yet Herbal’s earnings have averaged around ₹ 18.50
lakhs after tax, mainly on the strength of its patented beauty cream to remove the pimples.

The patent has nine years to run, and Herbal Box has been offered ₹ 50 lakhs for the
patent rights. Herbal’s assets include ₹ 50 lakhs of property, plant, and equipment, and ₹ 25
lakhs of working capital. However, the patent is not shown on the books of Herbal Box.
Assuming Herbal’s cost of capital being 14 percent, calculate its Economic Value Added
(EVA).
Solution:
EVA = Income Earned — (Cost of Capital x Total Investment)
Total Investments
Amount (¢ in Lakhs)
Working Capital 25.00
Property, Plant & Equipments 50.00
Patent Rights 50.00
Total 125.00
EVA = Profit Earned — WACC x Invested Capital
= ₹ 18.5 Lakhs — 14% x ₹ 125 Lakhs
= ₹ 1.00 Lakhs

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

CHAPTER-6 Mergers, Acquisitions and Corporate Restructuring

Question16 (MTP/RTP/PP)
Following is the Balance Sheet of M/s. PK Ltd. as on 31-03-2015:
Particulars ₹ in Lacs
I. Equity & Liabilities
Shareholders’ Fund
Equity Share Capital (₹ 10 each) 900.00
10% Preference Share Capital (₹ 100 each) 300.00
Reserves & Surplus (500.00)
Non-Current Liabilities
Term Loan 400.00
Current Liabilities
Trade Payables 400.00
Total (I) 1500.00
II. Assets
Non-Current Assets 1000.00
Current Assets :
Inventory 300.00
Trade Receivables 100.00
Cash & Bank Balance 100.00
Total (II) 1500.00
M/s PK Ltd. did not perform well and has suffered sizeable losses during the last few years.
However, it is now felt that the company can be nursed back to health by proper financial
restructuring and consequently the following scheme of reconstruction have been designed :

(i) Equity shares are to be reduced to ₹ 2 per share fully paid.

(ii) Preference shares are to be reduced by ₹ 50 per share and rate of dividend on
Preference shares is also reduced by 2%.
(iii) Trade Payables have agreed to forego 40% of their existing claims and for the balance
50% they have agreed to convert their claims into equity shares of ₹ 2 each, fully paid.
(iv) In order to make payment for Term Loan, the company issues 200 Lacs equity shares of
₹ 2 each at par. Entire sum is required to be paid on application.
(v) Non-Current Assets is to be revalued at ₹ 500 Lacs.
You are required:
(1) To show the impact of financial restructuring.
(2) To prepare Balance Sheet assuming the scheme of restructuring is implemented.
Solution:
(1) Impact of Financial Restructuring
Particulars in Lac
Benefits to PK Ltd.
1. Reduction in Equity Share capital (90×8) 720
2. Reduction in Preference Share Capital (3×50) 150

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

3. Waiver of Trade payables (400 @ 40%) 160

(A) Total (1+2+3) 1030
Amount of ₹ 1030 Lacs utilised to write off losses & overvalued assets
1. Losses 500
2. Over valued Non Current Assets (1000-500) 500
(B) Total (1+2) 1000
Amount unutilized transfer to Capital Reserve (A-B) 30

(2) Balance Sheet of PK Ltd. as on 31.03.2015 (after reconstruction)

Particulars ₹ in Lac
I. EQUITY & LIABILITIES
Shareholder’s Fund
Equity Share Capital (₹ 2 each) 700.00
8% Preference Share Capital (₹ 50 each) 150.00
Reserves & Surplus (Capital Reserve) 30.00
Current Liabilities
Trade Payable 120.00
Total (I) 1000.00
II. ASSETS
Non-Current Asset 500.00
Current Assets
Inventory 300.00
Trade Receivables 100.00
Cash & Bank balance 100.00
Total (II) 1000.00

Calculation of Equity Share Capital

1. Equity share capital after reconstruction 180.00
2. Issued in Cash (200×2) 400.00
3. Issued to Trade payables [50% of (60% of ₹ 400 Lacs)] 120.00
Total (1+2+3) 700.00

Question17 (MTP/RTP/PP)
Big Ltd. (BL), a listed company, is enjoying a price earnings ratio (PER) of 15 on an Earnings Per
Share (EPS) of ₹5. The Total number of outstanding shares are 2,00,000.
BL is proposing to acquire Small Pvt. Ltd. (SPL) an unlisted company by issuing shares in the
ratio 4:5 i.e. for 5 shares of SPL 4 shares of BL will be issued. The outstanding shares of SPL
are 50,000. SPL will be listed before the actual merger to discover its value. The EPS of the
merged entity will be 5.5.
No other information is available for SPL.
You are required to calculate:
(i) Pre-merger EPS of SPL.

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(ii) Expected Market Price per Share of SPL at the time of listing, if it expects a PER of 10
and,
(iii) Number of shares of BL to be issued to SPL if pre-merger EPS of BL is to be maintained
Solution:
(i) Pre Merger EPS
No. of shares to be issued by BL to SPL (50,000 x 4/5) 40,000
Existing number of shares of BL 2,00,000
Total no. of shares Post Merger 2,40,000
EPS (Post Merger) ₹ 5.50
Post-Merger (Total Earning) ₹ 13,20,000
Less: Pre-Merger Earning of BL (2,00,000 x 5) ₹ 10,00,000
Pre-Merger Earning of SPL ₹ 3,20,000
Number of shares of SPL (Existing) 50,000
EPS (₹ 3,20,000/50,000) ₹ 6.40

(ii) Expected Market Price of SPL share at the day of listing

EPS x PE Ratio (6.40 x 10) = ₹ 64.00

(iii) Number of shares to be issued to SPL to maintain Pre-Merger EPS

5.00 = 13,20,000/(2,00,000+X)
10,00,000 + 5X = 13,20,000
X = 64,000

Thus, 64,000 shares to be issued by BL to SPL to maintain pre-merger EPS.

Alternatively, it can also be computed as follows:
Swap Ratio if EPS before merger is maintained by BL
Then, Swap Ratio =6.4 / 5 = 1.28
Number of shares of BL is to be issued to SPL is 50000 shares x 1.28 = 64000 shares

Question 18 (MTP/RTP/PP)
The following information is provided relating to the acquiring Company R Ltd. And the target
Company K Ltd.:
Particulars R Ltd. K Ltd.
Promoter Holding 50% 60%
Share Capital (₹ in lakh) 100 50
Free Reserves & Surplus (₹ in lakh) 400 250
Paid up value per share (₹) 100 10
Free Float Market Capitalization (₹ in lakh) 200 64
P/E Ratio (times) 20 8

For deciding the swap ratio, weights are assigned to different parameters by the Board of
Directors of both the companies as follows:

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Book value 20%

EPS 60%
Market Price 20%

You are required to calculate:

(i) Swap ratio based on above weights.
(ii) Book Value per share, EPS and expected market price of R Ltd. after acquisition of K Ltd.
(Assuming PE multiple of K Ltd. remains unchanged and all assets and liabilities of K Ltd. are
taken over at book value)
(iii) Revised promoter's holding (%) in R Ltd. after acquisition.
(iv) Post-acquisition Free Float Market Capitalization.
Solution:
(i) Swap Ratio
R Ltd. K Ltd.
Share Capital 100 Lakh 50 Lakh
Free Reserves 400 Lakh 250 Lakh
Total 500 Lakh 300 Lakh
No. of Shares 1 Lakh 5 Lakh
Book Value per share ₹ 500 ₹ 60
Promoter’s holding 50% 60%
Non promoter’s holding 50% 40%
Free Float Market Cap. i.e. 200 Lakh 64 Lakh
relating to Public’s holding
Hence Total market Cap. 400 Lakh 160 Lakh
No. of Shares 1 Lakh 5 Lakh
Market Price ₹ 400 ₹ 32
P/E Ratio 20 8
EPS 20 4
Profits (₹ 1 lakh X 20) ₹ 20 lakh -
(₹ 4 lakh X 5) - ₹ 20 lakh
Calculation of Swap Ratio
Book Value 1 : 0.12 i.e. 0.12 x 20% 0.024
EPS 1 : 0.2 0.20 x 60% 0.120
Market Price 1 : 0.08 0.08 x 20% 0.016
Total 0.160
Swap ratio is for every one share of K Ltd., to issue 0.16 shares of R Ltd. Hence, total no. of
shares to be issued.
5 Lakh x 0.16 = 0.80 lakh shares

(ii) Book Value, EPS & Market Price

Total No of Shares 1 Lakh + 0.80 Lakh = 1.80 Lakh
Total Capital ₹ 100 Lakh + ₹ 80 Lakh = ₹ 180 Lakh

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Reserves ₹ 400 Lakh + ₹ 220 Lakh = ₹ 620 Lakh

₹ ₹
Book Value = ₹ 444.44 per share
EPS = = ₹ 22.22
Expected Market Price EPS (₹ 22.22) x P/E Ratio (8) = ₹ 177.76

(iii) Revised Promoter’s holding

Promoter’s Revised R Ltd. 50% i.e. 0.50 Lakh
Holding K Ltd. 60% i.e. 0.48 Lakh
Total 0.98 Lakh
Promoter’s % = 0.98/1.80 x 100 = 54.44%

(iv) Post Acquisition Free Float Market Capitalization

Free Float Market Capitalization = (1.80 Lakh – 0.98 Lakh) x ₹ 177.76 = ₹ 145.76 Lakh

Question19 (MTP/RTP/PP)
The following information of AB Ltd., is available below:
Market Value per share - ₹20 per share
Equity Share Capital - 12,00,000 shares @ the face value of ₹10 per share.
The company is planning to issue Rights Shares to the existing shareholders and raise
₹60,00,000 to finance a new project.
You are required:
(i) To calculate the ex-right price of shares and the value of right, if
(a) The company offers one right share for every three shares held.
(b) The company offers two right shares for every five shares held.
(ii) To show the effect of the rights issue on the wealth of a Shareholder X, who has 1,500
shares, when the company offers one right share for every three shares held,
assuming :
(a) He subscribes to the Rights issue
(b) He ignores the Rights issue
Solution:
(i) Ex-right price of share and the value of right
(a) Number of shares to be issued : 4,00,000
Subscription price ₹ 60,00,000 / 4,00,000 = ₹ 15
₹ ₹
Ex-Right Price = = ₹ 18.75
Value of a Right = ₹ 18.75 – ₹ 15 = ₹ 3.75
₹
Value of a Right Per Share Basis = = ₹ 1.25
(b) Number of shares to be issued : 4,80,000
Subscription price ₹ 60,00,000 / 4,80,000 = ₹ 12.50
₹ ₹
Ex-Right Price = = ₹ 17.86
Value of a Right = ₹ 17.86 – ₹ 12.50 = ₹ 5.36
₹ ₹
Value of a Right Per Share Basis = = ₹ 2.14 or
= ₹ 1.07

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(ii) (a) Shareholder’s wealth that is holding 1500 shares when firm offers one share for three
shares held and subscribes the offer.
Value of Shares after right issue (2000 X ₹ 18.75) ₹ 37,500
Less: Amount paid to acquire right shares (500 X ₹15) ₹ 7,500
₹ 30,000
Wealth before Right Issue = 1500 x 20 = ₹ 30,000
Thus, there is no change in the wealth

(b) Shareholder’s wealth that is holding 1500 shares when firm offers one share for three
shares held and does not subscribe the offer.
Value of Shares after right issue (1500 X ₹ 18.75) ₹ 28,125
Thus, if shareholder does not subscribe right offer there will be loss of wealth of ₹
1,875.

CHAPTER-7 Portfolio Management

Question 11(MTP/RTP/PP)
The expected returns and Beta of three stocks are given below
Stock A B C
Expected Return (%) 20 13 17
Beta Factor 1.9 0.8 1.4
If the risk-free rate is 9% and the expected rate of return on the market portfolio is
14%, examine which of the above stocks are over, under or correctly valued in the
market? What shall be the strategy?
Solution
Required Rate of Return is given by
Rj = Rf + (Rm-Rf)
For Stock A, Rj = 9% + 1.9 (14% - 9%) = 18.50%
Stock B, Rj = 9% + 0.8 (14% - 9%) = 13.00%
Stock C, Rj = 9% + 1.4 (14% - 9%) = 16.00%

Required Return % Expected Return % Valuation Decision

18.50% 20.00% Under Valued Buy
13.00% 13.00% Correctly Valued Hold
16.00% 17.00% Under Valued Buy

Question 12(MTP/RTP/PP)
Your client is holding the following securities:

Particulars of Cost Dividends/ Market price at the end Beta

Securities Interest of holding period

Equity Shares:

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

G Ltd. 20,000 1,450 19,600 0.6

S Ltd. 30,000 1,000 30,400 0.8
B Ltd. 28,000 1,400 32,000 0.6
GOI Bonds 72,000 5,060 71,980 0.01
Evaluate:
(i) Risk free rate of return.
(ii) Expected rate of return of each security (except GOI Bond), using the Capital Asset
Pricing Model (CAPM).
Note: (1) Use weighted average Beta in calculations.
(2) Round off calculations upto 3 decimal points.
Solution
Particulars of Securities Cost Market Price Capital gain Dividend/ Interest
G Ltd. 20,000 19,600 -400 1,450
S Ltd. 30,000 30,400 400 1,000
B Ltd. 28,000 32,000 4,000 1,400
GOI Bonds 72,000 71,980 -20 5,060
Total 1,50,000 1,53,980 3,980 8,910
(i) Risk free return [Return on Govt. Security (GOI Bond)]
–
= 7%
(ii) Weighted Average of Beta
0.6 x 19,600/1,53,980 + 0.8 x 30,400/1,53,980 + 0.60 x 32,000/1,53,980 + 0.01 x
71,980/1,53,980
= 0.076 + 0.158 + 0.125 + 0.005 = 0.364

Average Return on Portfolio

(8,910 + 3,980) / 1,50,000 x 100% = 8.593%

Market Return
8.593% = 7% + (Rm – 7%) x 0.364
Rm = 11.376%
Expected Rate of Return for each security is
Rate of Return = Rf + β (Rm – Rf)
G Ltd. = 7.000% + 0.6 (11.376% – 7.000%) = 9.626%
S Ltd. = 7.000% + 0.8 (11.376% – 7.000%) = 10.501%
B Ltd. = 7.000% + 0.6 (11.376% – 7.000%) = 9.626%

Question 13(MTP/RTP/PP)
Expected returns on two stocks against BSE SENSEX returns are given in the following
table under two scenarios-bullish and bearish:
Market return Scenario -1: Bullish Case Scenario -2:Bearish Case
BSE Sensex 25% -5%
Stock R 32% -4%
Stock Z 18% -3%

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

You are required to calculate:

(i) The Betas of two stocks R and Z.
(ii) Expected return on each stock, if the likelihood of market achieving Scenario-1 is thrice
the likelihood of the market achieving Scenario-2.
(iii) The Security Market Line (SML), if the risk free rate is 8% and likelihood of the market
return achieving the bullish base returns of 25% is thrice that of achieving -5% returns.
(iv) The Alphas of the two stocks based on Sharpe Index Model.
Solution
(i) The Betas of two stocks:
Stock R - (32% + 4%)/(25% + 5%) = 1.2
Stock Z - (18% + 3%)/(25% + 5%) = 0.70
Alternatively, it can also be solved by using the Characteristic Line Relationship as follows:
Rs = α + βRm
Where
α = Alpha
β = Beta
Rm= Market Return

For Stock R
32% = α + β(25%)
- 4% = α + β(-5%)
36% = β(30%)
β = 1.2

For Stock Z
18% = α + β(25%)
-3% = α + β(-5%)
21% = β(30%)
β = 0.70

Alternatively, Beta can also be calculated as follows:

Basic Calculation for stock R

(RR) RR RR - RR (RR - (Rm) RM Rm – RM (Rm – RM )2 (RR - RR )

RR )2
(Rm – RM )
32% 14% 18% 324 25% 10% 15% 225 270
-4% 14% -18% 324 -5% 10% -15% 225 270
Total 648 450 540

Basic Calculation for stock Z

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(RZ) RZ RZ - RZ (RZ - RZ (Rm) RM Rm – RM (Rm – RM (RZ - RZ )

)2 )2
(Rm – RM )
18% 7.5% 10.5% 110.25 25% 10% 15% 225 157.50
-3% 7.5% -10.5% 110.25 -5% 10% -15% 225 157.50
Total 220.50 450 315

Co- Variance (R, M) = 540/2 = 270

Co- Variance (Z, M) = 315/2 = 157.50
(σ M)2 = 450/2 = 225
Beta of stocks R & Z
Beta (R) = = 270/225 = 1.2
Beta (Z) = = 157.5/225 = 0.7
(ii) Expected returns of the two stocks:
Stock R - 0.75 x 32% - 0.25 x 4% = 23%
Stock Z - 0.75 x 18% - 0.25 x 3% = 12.75%

(iii) Expected return of market portfolio = 0.75 x 25% + 0.25% x (-5%) = 17.50%
Market risk prem. = 17.50% - 8.00% = 9.5%
SML is, required return = 8.00% + βi 9.5%

(iv) Alpha for two stocks

Required Return for Stock R
E (R) = αR + βRM
Accordingly
23% = αR + 1.20 x 17.50%
αR = 2%
Required Return for Stock Z
E (Z) = αZ + βRM
Accordingly
12.75% = αZ + 0.70 x 17.50%
αZ = 0.5%

Question 15 ((MTP/RTP/PP)
Mr. A owns a portfolio with the following characteristics:
Security X Security Y Risk Free security
Beta 1.60 1.80 0
Expected Return 15% 16% 7%
i. If Mr. A has ₹ 2,00,000 to invest and sells short ₹ 1,00,000 of security B and purchases
₹ 3,00,000 of security A what is the sensitivity of Mr. A’s portfolio ?
ii. If Mr. A borrows ₹ 2,00,000 at the risk free rate and invests the amount he borrows

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

along with the original amount of ₹ 2,00,000 in security X and Y in the same
proportion as described in part . what is sensitivity of the portfolio?
iii. What is the expected market risk premium?
Solution
i. Mr. A’s position in the two securities are +3 in security X and -1 in security Y. Hence the
portfolio beta shall be calculated as follows:
Sensitivity = 1.60 x300000/200000 - 1.80 x100000/200000 = 1.50 times

ii. Mr. A’s current position: -

Security X ₹ 6,00,000 / ₹ 2,00,000 = 3
Security Y -₹ 2,00,000 / ₹ 2,00,000 = -1
Risk Free Asset -₹ 2,00,000 / ₹ 2,00,000 = -1 Sensitivity = 3 x
1.60 + (-1 x 1.80) + (-1 x 0) times

iii. Expected Return = Risk Free Rate of Return + Risk Premium Let X be the market risk
premium,
Accordingly,
Using Security X’s Return
Total Return = 15% = 7% + 1.6X
Risk Premium (X) = 8% / 1.6 = 5%

Alternatively using Security Y’s Return

Total Return = 16% = 7% + 1.8X
Risk Premium (X) = 9% / 1.8 =5%

Question 17(MTP/RTP/PP)
Ramesh has identified stocks of two companies A and B having good investment potential:
Following data is available for these stocks:
Year A (Market Price per Share in ₹) B (Market Price per Share in ₹)
2013 19.60 8.70
2014 18.75 12.80
2015 33.42 16.20
2016 42.64 18.25
2017 43.25 15.60
2018 44.60 13.25
2019 34.75 18.60
You are required to calculate:
(i) The Risk and Return by investing in Stock A and B
(ii) The Risk and Return by investing in a portfolio of these Stocks if he invests in Stock
A and B in proportion of 6 : 4.
(iii) The better opportunity for investment
Solution:

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

A B
Year Market Return Return Squared Market Return Return Squared (Return - A ) x
Price Per (%) - Price Per (%) - (Return - B )
Share in Share in
₹ ₹
2013 19.60 8.70
2014 18.75 -4.34 -18.33 335.98 12.80 47.13 30.94 957.2836 -567.1302
89
2015 33.42 78.24 64.25 4128.06 16.20 26.56 10.37 107.5369 666.2725
25
2016 42.64 27.59 13.60 184.96 18.25 12.65 -3.54 12.5316 -48.1440
00
2017 43.25 1.43 -12.56 157.75 15.60 -14.52 -30.71 943.1041 385.7176
36
2018 44.60 3.12 -10.87 118.156 13.25 -15.06 -31.25 976.5625 339.6875
9
2019 34.75 -22.09 -36.08 1301.76 18.60 40.38 24.19 585.1561 -872.7752
64
83.95 6226.68 97.14 3582.1748 -96.3718
83
13.99 Variance Mean ( 16.19 Varianc 597.0291 Cov. = -16.0620
Mean ( ) 1037.7814 ) e
(i) Return A = 13.99% and Risk (SD) = √1037.7814= 32.2146 and Return B = 16.19% and Risk (SD)
= √597.0291= 24.4342
(ii) Return of Portfolio = 0.60 x 13.99% + 0.40 x 16.19% = 14.87%
Risk (Standard Deviation) of Portfolio = [0.602 x 1037.7814 + 0.402 x 597.0291 + 2 x 0.60 x
0.40 x (-16.0620)
= [373.6013 + 95.5247- 7.7098]½ = 21.4806
(iii) On the basis of Return ‘B’ is preferable and on the basis of Risk ‘Portfolio Investment’ is
preferable over the individual stocks.

Question 18(MTP/RTP/PP)
Mr. Potential has made investments in two mutual funds. The following information is
available:
Mutual Fund Smart Growth
Jensen Alpha 1.10% 1.50%
Treynor's Ratio 0.0714 0.0775
Actual Return 8.50% 9.10%
Risk Premium 4%
You are required to calculate:
(i) Beta (β) for both the funds
(ii) Risk free Rate
(iii) Security Market Line

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Solution:
Smart Growth
Jensen Alpha 0.011 0.015
Treynor’s Ratio 41
0.0714 0.0775
Actual Return 0.085 0.091
Risk Premium 0.04 0.04
Jensen Alpha = Actual Return - E(r)
Treynor’s Ratio = β
E(r) = Actual Return – Jensen Alpha

For Smart:
0.04βS = 0.074 – Rf (1)
0.0714βS =0.085 – Rf. (2)
On solving (1) and (2), we get βS = 0.35 and Rf = 0.06

For Growth:
0.04βG = 0.076 – Rf (3)
0.0775βG = 0.091 – Rf (4)
On solving (3) and (4), we get βG = 0.40 and Rf = 0.06
(i) Beta of Smart Mutual Fund is 0.35 and Growth Mutual Fund is 0.40.
(ii) Risk free Rate = 6%
(iii) Security Market Line for Smart = 0.06 + 0.04β
Security Market Line for Growth = 0.06 + 0.04β

Alternative Solution:
In case students have assumed Risk Premium as Equity Risk Premium of respective securities.
Working Notes:
(i) Smart
Jensen Alpha = 0.011
Actual Return = 0.085
Thus, expected return (as per CAPM) = 0.074
Accordingly, Risk Free Rate of Return:
0.074 = Rf + 0.04
Rf = 0.034
Treynor’s Ratio = 0.0714
0.0714 = β
βS = 0.714
Market Risk Premium = = 0.056

(ii) Growth
Jensen Alpha = 0.015
Actual Return = 0.091
Thus, expected return (as per CAPM) = 0.076

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Accordingly, Risk Free Rate of Return:

0.076 = Rf + 0.04
Rf = 0.036
Treynor’s Ratio = 0.0775 42
0.0775 = β
βG = 0.710
Market Risk Premium = = 0.056
Security Market Line for Smart = 0.034 + 0.056βS
Security Market Line for Growth = 0.036 + 0.056βG

Question 19(MTP/RTP/PP)
An Investor is proposing to invest ₹10,000/- in two Portfolios A and B in the ratio of 3 : 2.
The Portfolios have three securities each with following weights :
Wx Wy Wz
Portfolio A 0.30 0.25 0.45
Portfolio B 0.20 0.45 0.35
You are required to
(i) Calculate the weight of each stock.
(ii) Calculate the amount allocated to Y and Z if half of the funds are allocated to security X.

Note: In question paper in sub part (ii) Y and Z mistakenly got typed as B and C.
Solution:
(i) Investment committed to each security would be:
X Y Z Total
( ) ( ) ( ) ( )
Portfolio A 1,800 1,500 2,700 6,000
Portfolio B 800 1,800 1,400 4,000
Combined Portfolio 2,600 3,300 4,100 10,000
Stock weights 0.26 0.33 0.41
Alternatively, it can also be computed as follows:
Weight of Security X = 0.30 x 3/5 + 0.20 x 2/5 = 0.26
Weight of Security Y = 0.25 x 3/5 + 0.45 x 2/5 = 0.33
Weight of Security Z = 0.45 x 3/5 + 0.35 x 2/5 = 0.41

(ii) The equation of critical line takes the following form:

WY = a + bWX
Substituting the values of WX & WY from portfolio A and B in above equation, we get
0.25 = a + 0.30b, and
0.45 = a + 0.20b
Solving above equation we obtain the slope and intercept, a = 0.85 and b= -2 and thus, the
critical line is
WY = 0.85 – 2WX

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If half of the funds is invested in security X then,

WY = 0.85 – 1.00 = - 0.15
Since WX + WY + WZ = 1
WZ = 1 - 0.50 + 0.15 = 0.65 43
Allocation of funds to Security Y = - 0.15 x 10,000 = - ₹ 1,500 and
Security Z = 0.65 x 10,000 = ₹ 6,500
Alternatively, it can also be solved as follows:
Amount to be allocated to Y & Z if half of the funds are allocated to X.
The balance fund of ₹ 5,000 shall be allocated in the ratio of 33:41.
Allocation of funds to - Security Y = 5,000 x 33/74 = ₹ 2,230
Security Z = 5,000 x 41/74 = ₹ 2,770

Question20 (MTP/RTP/PP)
An investor has categorized all the available stock in the market into the following types and
the estimated weights of the categories of stocks in the market index are given below.
Further, the sensitivity of returns of these categories of stocks to two factors Inflation and
Stock market are also given below:
Category Weight in Factor 1 (Inflation) Factor 2 (Stock Market)
Market Beta 1 Expected Actual Beta 2 Expected Actual Value
Index Value in % Value in % Value in % in %

Small Cap 20% 1.20 6.70 6.70 0.80 10.00 10.50

Medium Cap 30% 1.75 4.50 6.00 0.90 7.00 8.00
Large Cap 15% 1.30 6.75 8.00 1.165 9.00 10.00
Flexi Cap 35% 1.70 7.00 6.50 0.85 8.85 9.75
Risk Free Rate of Interest is 7.50%.
Round off to 2 decimal.
You are required to calculate:
(i) Expected return on the market index for both the factors.
(ii) Expected return on the market index under Arbitrage Pricing Theory (Existing Scenario).
(iii) Expected return on the market index under Arbitrage Pricing Theory if the
composition of the Portfolio is changed to 25% equally in all four categories.
(iv) Which alternative (Existing or Changed) will be more profitable?
Solution:
(i) Expected Return on Market Index for Both factors
Factor 1
= 0.20 x 6.70% + 0.30 x 4.50% + 0.15 x 6.75% + 0.35 x 7.00%
= 1.34% + 1.35% + 1.01% + 2.45% = 6.15%
Factor 2
= 0.20 x 10% + 0.30 x 7% + 0.15 x 9% + 0.35 x 8.85%
= 2% + 2.10% + 1.35% + 3.10%
= 8.55%

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(ii) Calculation of expected Return on the Market index under Arbitrage Pricing Theory
(Existing Scenario):
Factor 1 (Inflation)
Category Beta Actual Expected Difference Beta x Diff.
value
44
value
(a) (b) (%) (c) (%) (b) - (c) = (d) (%) (e)
Small Cap 1.20 6.70 6.70 0.00 0.00
Medium Cap 1.75 6.00 4.50 1.50 2.63
Large Cap 1.30 8.00 6.75 1.25 1.63
Flexi cap 1.70 6.50 7.00 (0.50) (0.85)

Factor 2 (Stock Market)

Category Beta Actual Expected Difference Beta x Total
value value Diff.
(f) (g) (%) (h) (%) (g) – (h) = (i) (j) (e) + (j) = (k)
(%)
Small Cap 0.80 10.50 10.00 0.50 0.40 0.40
Medium Cap 0.90 8.00 7.00 1.00 0.90 3.53
Large Cap 1.165 10.00 9.00 1.00 1.17 2.80
Flexi cap 0.85 9.75 8.85 0.90 0.77 (0.08)

Category Weight in market Total Beta x Expected Return (2 x 1 =

index (1) Diff (2) 3)
Small Cap 20% 0.40 0.08
Medium Cap 30% 3.53 1.06
Large Cap 15% 2.80 0.42
Flexi cap 35% (0.08) (0.03)
Total 1.53
Add: Risk Free Rate of Interest 7.50
Expected Return (%) 9.03

(iii) Expected Return on the Market Index under Arbitrage Pricing Theory under changed scenario
Category Weight in market Total Beta x Diff Expected Return (2
index (1) (2) x 1 = 3)
Small Cap 25% 0.40 0.10
Medium Cap 25% 3.53 0.88
Large Cap 25% 2.80 0.70
Flexi cap 25% (0.08) (0.02)
Total 1.66
Add: Risk Free Rate of Interest 7.50
Expected Return (%) 9.16

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(iv) As per the above calculation, the investors by investing 25% equally in all four categories, is
profitable compared to the existing composition. As the proposed composition gives rate of
45
return of 9.16% per annuam when compared to the existing return of the present portfolio
which is 9.03%.

Question 22(MTP/RTP/PP)
M/s. Siri Ltd. Has a surplus amount of ₹ 3 crores to invest and has shortlisted the following
equity shares:
Company Beta
S Ltd. 1.6
K Ltd. 1
P Ltd. -0.3
D Ltd. 2
C Ltd. 0.6
Required:
(i) If M/s. Siri Ltd. invests an equal amount in all securities, what is the beta of the portfolio?
(ii) If M/s. Siri Ltd. invests 15% of its investment in S Ltd., 15% in P Ltd., 10% in C Ltd. and
the balance in equal amount in the other two securities, what is the beta of the portfolio?
(iii) If the expected return of market portfolio is 12% at a beta factor of 1.0, what will be
the portfolios expected return in both the situations given above?
(iv) If the Company changes its policy to invest in any 3 securities with a minimum of 20% in
each of these 3 securities to diversify risk, you are requested to advi se the company to have
a right mix of securities to maximize the return in the following two scenarios and also
calculate the expected return:
(1) Bull Phase: Expected Market returns 10%
(2) Bear Phase: Expected Market returns — 5%
Solution:
(i) Beta of the Portfolio
Investment Beta (β) Investment Weighted
( Lakhs) Investment
S Ltd. 1.6 60 96
K Ltd. 1.0 60 60
P Ltd. -0.3 60 -18
D Ltd. 2.0 60 120
C Ltd. 0.6 60 36
300 294

= = 0.98
Alternatively, it can also be computed as follows:
1.6 × + 1.0 × + (-0.30) × + 2 × + 0.6 × = 0.98
(ii) With varied percentages of investments portfolio beta is calculated as

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46
 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

follows:
Investment Beta (β) Investment ( Lakhs) Weighted Investment
S Ltd. 1.6 45 72
K Ltd. 1.0 90 90
P Ltd. -0.3 45 -13.50
D Ltd. 2.0 90 180
C Ltd. 0.6 30 18
300 346.50

Beta = = 1.155
(iii) Expected return of the portfolio with pattern of investment as in case (i) = 12% × 0.98 i.e.
11.76%
Expected Return with pattern of investment as in case (ii) = 12% × 1.155 i.e., 13.86%.
(iv) (1) Securities to be selected during Bull Phase Expected Market returns 10%
As it is bull Market Higher Beta stocks should be selected.
Shares % to be Beta (β) Investment Weighted
invested Investment
S Ltd. 20 1.6 60,00,000 96,00,000
K Ltd. 20 1 60,00,000 60,00,000
P Ltd. 0 -0.3 - -
D Ltd. 60 2 1,80,00,000 3,60,00,000
C Ltd. 0 0.6 - -
100 3,00,00,000 5,16,00,000

Portfolio or Weighted Beta (β) (5,16,00,000/ 3,00,00,000) 1.72

Portfolio Beta (β) 1.72
Market Return 10%
Expected Return 17.20%

(2) Securities to be selected During Bear Phase Expected Market returns – 5%

As it is bear market Lower Beta stocks should be selected
Shares % to be invested Beta (β) Investment Weighted Investment

S Ltd. 0 1.6 - -
K Ltd. 20 1 60,00,000 60,00,000
P Ltd. 60 -0.3 1,80,00,000 -54,00,000
D Ltd. 0 2 - -
C Ltd. 20 0.6 60,00,000 36,00,000
100 3,00,00,000 42,00,000

Portfolio or Weighted Beta (β) (42,00,000/ 3,00,00,000) 0.14

Portfolio Beta (β) 0.14

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Market Return -5%

Expected Return -0.70%

Question 23(MTP/RTP/PP) 47
Following is the information related to return on shares of three different companies :
Years A Ltd. B Ltd. C Ltd.
2018 2% 3% 5%
2019 6% 8% 7%
2020 13% 14% 15%
2021 7% 9% 11%
Required:
(i) Construct maximum number of portfolio and its return, if each portfolio consists of any two
Company's shares in proportion of 65% and 35% and suggest which portfolio
provides highest return.
(ii) Calculate portfolio return and beta (β), if Mr. X invests ₹ 65,000 in A Ltd. having beta (β) of
0.45; ₹20,000 in B Ltd. having beta (β) of 1.15 and ₹ 15,000 in C Ltd. having beta (β) of 1.8.
Solution:
Calculation of Average Return
Year A Ltd. B Ltd. C Ltd.
2018 2% 3% 5%
2019 6% 8% 7%
2020 13% 14% 15%
2021 7% 9% 11%
Sum 28% 34% 38%
Average 7% 8.50% 9.50%

(i) (1) Combination 1 - 65% in A Ltd. & 35% B Ltd.

Return = 7% × 0.65 + 8.50% × 0.35 = 4.55% + 2.975% = 7.525% or 7.53%
(2) Combination 2 – 65% in B Ltd. & 35% in C Ltd.
Return = 8.50% × 0.65 + 9.50% × 0.35 = 5.525% + 3.325% = 8.85%
(3) Combination 3 – 65% in C Ltd. & 35% in A Ltd.
Return = 0.65 × 9.50% + 0.35 × 7.00% = 6.175% + 2.45% = 8.625% or 8.63%
(4) Combination 4 – 65% in A Ltd. & 35% in C Ltd.
Return = 0.65 × 7% + 0.35 × 9.50% = 4.55% + 3.325% = 7.875% or 7.88%
(5) Combination 5 – 35% in A Ltd. & 65% in B Ltd.
Return = 0.35 × 7% + 0.65 × 8.50% = 2.45% + 5.525% = 7.975% or 7.98%
(6) Combination 6 – 35% in B Ltd. & 65% in C Ltd.
Return = 0.35 × 8.50% + 0.65 × 9.50% = 2.975% + 6.175% = 9.15%
Since maximum return is under Combination - 6 i.e. 65% investment in C Ltd. and 35% in B
Ltd. hence it should be opted for.
(ii) Calculation of Return and Beta of Portfolio
Return of Portfolio = 7% × + 8.50% × + 9.50% × = 7.675%

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Beta of Portfolio = 0.45 × + 1.15 × + 1.80 × = 0.7925 or 0.79

CHAPTER-8 Mutual Fund

48
Question 7(MTP/RTP/PP)
A mutual fund company introduces two schemes i.e. Dividend plan (Plan-D) and Bonus plan (Plan-
B). The face value of the unit is ₹ 10. On 1-4-2018 Mr. K invested ₹ 2,00,000 each in Plan-D and
Plan-B when the NAV was ₹ 38.20 and ₹ 35.60 respectively. Both the plans matured on 31-3-
2023.
Particulars of dividend and bonus declared over the period are as follows:
Date Dividend % Bonus Ratio Net Asset Value ( )
Plan D Plan B
30-09-2018 10 --- 39.10 35.60
30-06-2019 --- 1:5 41.15 36.25
31-03-2020 15 --- 44.20 33.10
15-09-2021 13 --- 45.05 37.25
30-10-2021 --- 1:8 42.70 38.30
27-03-2022 16 --- 44.80 39.10
11-04-2022 --- 1:10 40.25 38.90
31-03-2023 --- --- 40.40 39.70
Evaluate the Effective Yield Per Annum in respect of the above two plans.
Note:
1. Use following PV Factors:
PVIF (2%,5) = 0.9057, PVIF (4%,5) = 0.8219, PVIF (8%,5) = 0.6806, PVIF (13%,5)
= 0.5428
2. Round off calculations upto 2 decimal points.
Solution
Plan – D
Unit acquired = = 5235.60
Date Units held Dividend Re- investment New Total Units
Rate Units

% Amount
01.04.2018 5235.60
30.09.2018 5235.60 10 5235.60 39.10 133.90 5369.50
31.03.2020 5369.50 15 8054.25 44.20 182.22 5551.72
15.09.2021 5551.72 13 7217.24 45.05 160.20 5711.92
27.03.2022 5711.92 16 9139.07 44.80 204.00 5915.92
31.03.2023 Maturity Value (₹ 40.40 X 5915.92) ₹ 2,39,003.17

Less: Cost of Acquisition ₹ 2,00,000.00

Total Gain ₹ 39,003.17

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

₹
Effective Yield = x x 100 = 3.90%
₹
Now more accurate effective yield can be computed by using the IRR method as follows:
NPV at 4% = - ₹ 2,00,000 + ₹ 1,96,436.71 = - ₹ 3,563.29
49
NPV at 2% = - ₹ 2,00,000 + ₹ 2,16,465.17 = ₹ 16,465.17
IRR= LR + = (HR-LR) = 2 % + (4% − 2%) = 3.64 %
—

Plan – B
Date Particulars Calculation Working No. of Units NAV ( )

01.04.2018 Investment ₹ 2,00,000/35.60 = 5617.98 35.60

30.06.2019 Bonus 5617.98/5 = 1123.60 36.25
6741.58
30.10.2021 " 6741.58/8 = 842.70 38.30
7584.28
11.04.2022 " 7584.28/10 = 758.43 38.90
8342.71
31.03.2023 Maturity Value 8342.71 x ₹ 39.70 = 3,31,205.59
Less: Investment 2,00,000.00
Gain 1,31,205.59

Approximate Effective Yield = x x 100 = 13.12%

Now more accurate effective yield can be computed by using the IRR method as follows:
NPV at 13% = - ₹ 2,00,000 + ₹ 1,79,778.39 = - ₹ 20,221.61
NPV at 8% = - ₹ 2,00,000 + ₹ 2,25,418.52 = ₹ 25,418.52
IRR = LR + (HR-LR) = 8 % +

Question8 (MTP/RTP/PP)
M/S. Promising, an AMC, on 01.04.2018 has floated two schemes viz. Dividend Reinvestment
Plan and Bonus Plan. Mr. X, an investor has invested in both the schemes. Mr. X, while
submitting the tax papers, returned a capital loss on both the plans. Tax officials, suspicious on
the claim of Mr. X, decided to launch an investigation and were able to collect the following
details (except the issue price):
Date Dividend Bonus Ratio Nav ( )
Dividend Bonus Plan
Reinvestment Plan
01.04.2018 ? ?
31.12.2019 1:5 58 70
31.03.2020 12 60 72
31.03.2021 10 68 75
31.03.2022 15 75 66
31.12.2022* 1:3 70 60

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

31.03.2023 80 71

* In question paper this row got typed before the row of values of 31.03.2022.
50
Additional details Dividend Reinvestment Plan Bonus Plan
Investment(₹) ₹ 10,80,000 ₹ 10,00,000
Average Profit(₹) ₹ 1,21,824
Average Yield (%) 8.40%
Assume face value of unit as₹ 10.
You are required to assist the tax officials to calculate the issue price of both the schemes
as on 01.04.2018
Solution
(i) Dividend Plan
(a) Average Annual gain over a period of 5 Years ₹ 1,21,824
(b) Total gain over a period of 5 years (a*5) ₹ 6,09,120
(c) Initial Investment ₹ 10,80,000
(d) Total value of investment (b + c) ₹ 16,89,120
(e) NAV as on 31.3.2023 ₹ 80
(f) Number of units at the end of the period as on 31.03.2022 (d/e) 21114
1 2 3 4= (2*3) 5 6= [1/(4 + 7
5)]*4
Period Units Rate Unit Dividend NAV New Units* Balance Units
held value Pre Dividend
31.03.2022 21114 0.15 10 1.50 75 414 20700
31.03.2021 20700 0.10 10 1.00 68 300 20400
31.03.2020 20400 0.12 10 1.20 60 400 20000
Issue Price as on 01.04.2018
Investment 1080000/ Units purchased 20000 (c/i) = ₹ 54
* Let the units issued be X
X = (Closing Units/NAV + Dividend) x Dividend

Alternatively, it can also be computed as follows:

(i) Dividend Plan
Average Profit = ₹ 121,824
Total Gain = ₹ 121,824 x 5 = ₹ 6,09,120
Cost of Acquisition = ₹ 10,80,000
Maturity Value = ₹ 16,89,120 (₹ 6,09,120 + ₹ 10,80,000)
On 31.03.23 since the NAV of the Fund is ₹ 80 the units redeemed are:
= 2114
Let X be the NAV on 01.04.18.
Thus, units acquired on 01.04.18 =

Units added on 31.03.2020 = =

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Units added on 31.03.2021 = =

Units added on 31.03.2022= =
Thus, total units can be shown as follows:
= 21114 51
X= 54
Thus, the issue Price of units under Dividend Plan shall be ₹ 54

(ii) Bonus Plan

(a) Average Yield 0.084
(b) Investment ₹ 10,00,000
(c) Gain over a period of 5 years (a*b*5) ₹ 4,20,000
(d) Market Value as on 31.03.2023 (b + c) ₹ 14,20,000
(e) NAV as on 31.03.2023 71
(f) Total units as on 31.03.2023 (d/e) 20000
(g) No of units as on 31.03.2022 Pre bonus = 20000*3/ (3 + 1) 15000
(h) No of units as on 31.12.2019 Pre bonus = 15000*5/ (5 + 1) 12500
(i) Issue Price as on 01.04.2019
Investment ₹ 10,00,000/ Units purchased 12500 (b/h) ₹ 80
Alternatively, it can also be computed as follows:
Units on 01.04.2018 X
Units after bonus on 31.12.2019 (1:5) 1.20X
Units after bonus on 31.12.2022 (1:3) 1.60X
Average yield 0.084
Investment ₹ 10,00,000
Gain for 5 years (10,00,000 x 0.084 x 5) ₹ 4,20,000
Total Value (₹ 10,00,000 + ₹ 4,20,000) ₹ 14,20,000
Where, 1.6X x ₹ 71 = ₹ 14,20,000

Therefore, X = 12,500 units

Issue Price on 01.04.2018 = ₹ 10,00,000 / 12,500 units = ₹ 80
Alternatively, it can also be computed as follows:
Average Yield = 8.40%
Investment = ₹ 10,00,000
Gain over a period of 5 years = ₹ 10,00,000*0.084*5 = ₹ 4,20,000
Thus, Maturity Value on 31.03.23 shall be ₹ 14,20,000

No. of units = = 20,000

Now let B be the NAV on 01.04.18 then
Units acquired on 01.04.18 =
₹
Units added on 31.12.19=
Units added on 31.12.21=

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Thus, total units can be shown as follows:

=20000
B = ₹ 80
Thus, the issue Price of units under Bonus Plan shall be ₹ 80.
52
Question 9 (MTP/RTP/PP)
Mr. K has invested in three Mutual fund schemes as per details below:
Scheme A Scheme B Scheme C
Date of Investment 01-12-2018 01-01-2019 01-03-2019
Amount of Investment ₹ 5,00,000 ₹ 10,00,000 ₹ 5,00,000
Net Asset Value at entry date ₹ 10.50 ₹ 10.00 ₹ 10.00
Dividend received up
to 31-03-2019 ₹ 9,500 ₹ 15,000 ₹ 5,000
NAV as at 31-3-2019 ₹ 10.40 ₹ 10.10 ₹ 9.80

You are required to calculate the effective yield on per annum basis in respect of each of
the three schemes to Mr. K upto 31-03-2019, taking the year consisting of 365 days.
Provide a brief comment on the course of action he should take for future period.
(Calculation should be upto three decimal places)
Solution:
(i) Calculation of effective yield on per annum basis in respect of three mutual fund schemes to
Mr. K up to 31-03-2019:
Particulars Scheme A Scheme B Scheme C
(a) Investments ₹ 5,00,000 ₹ 10,00,000 ₹ 5,00,000
(b) Opening NAV ₹ 10.50 ₹ 10.00 ₹ 10.00
(c) No. of units(a/b) 47,619.048 1,00,000 50,000
(d) Unit NAV on 31-3-2019 ₹ 10.40 ₹ 10.10 ₹ 9.80
(e) Total NAV on 31-3-2019 (c x d) ₹ 4,95,238.099 ₹ 10,10,000 ₹ 4,90,000
(f) Increase/ Decrease of NAV(e - a) (₹ 4,761.901) ₹ 10,000 (₹ 10,000)
(g) Divdend Received ₹ 9,500 ₹ 15,000 ₹ 5,000
(h) Total yield (f+ g) ₹ 4,738.099 ₹ 25,000 (₹ 5,000)
(i) Number of Days 121 90 31
j) Effective yield p.a. (h/a x 365/i x 100) 2.859% 10.139% (-) 11.774%
Comments: Since the Effective Yield in Scheme C is negative and that of Scheme A is much
lower than Scheme B, it is advised that Mr. K should redeem the investments in Scheme A and
Scheme C and the proceeds should be invested in Scheme B in the next period.

Question 12(MTP/RTP/PP)
Mr. Potential has made investments in two mutual funds. The following information is available:
Mutual Fund Smart Growth
Jensen Alpha 1.10% 1.50%

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Treynor's Ratio 0.0714 0.0775

Actual Return 8.50% 9.10%
Risk Premium 4%
You are required to calculate: 53
i. Beta (β) for both the funds
ii. Risk free Rate
iii. Security Market Line
Solution
Mutual Fund Smart Growth
Jensen Alpha 0.011 0.015
Treynor’s Ratio 0.0714 0.0775
Actual Return 0.085 0.091
Risk Premium 0.04 0.04
Jensen Alpha = Actual Return - E(r)
Treynor’s Ratio =
E(r) = Actual Return – Jensen Alpha
For Smart:
0.04βS = 0.074 – Rf (1)
0.0714βS = 0.085 – Rf (2)
On solving (1) and (2), we get βS = 0.35 and Rf = 0.06
For Growth:
0.04βG = 0.076 – Rf (3)
0.0775βG = 0.091 – Rf (4)
On solving (3) and (4), we get βG = 0.40 and Rf = 0.06
i. Beta of Smart Mutual Fund is 0.35 and Growth Mutual Fund is 0.40.
ii. Risk free Rate = 6%
iii. Security Market Line for Smart = 0.06 + 0.04β
Security Market Line for Growth = 0.06 + 0.04β
Alternative Solution: In case students have assumed Risk Premium as Equity Risk Premium of
respective securities.

Working Notes:
i. Smart
Jensen Alpha = 0.011
Actual Return = 0.085
Thus, expected return (as per CAPM) 0.074
Accordingly, Risk Free Rate of Return:
0.074 = Rf + 0.04
Rf = 0.034
Treynor’s Ratio = 0.0714
0.0714 = β
βS = 0.714

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Market Risk Premium = 0.056

ii. Growth
Jensen Alpha = 0.015
Actual Return = 0.091
Thus, expected return (as per CAPM) = 0.076
54
Accordingly, Risk Free Rate of Return:
0.076 = Rf + 0.04
Rf = 0.036
Treynor’s Ratio = 0.0775
0.0775 = β
βG = 0.710
Market Risk Premium =
Security Market Line for Smart = 0.034 + 0.056βS
Security Market Line for Growth = 0.036 + 0.056βG

Question 13(MTP/RTP/PP)
Mr. S has invested in 3 different Mutual Fund Schemes. The following are the details of the
same:
Particulars Scheme A Scheme B Scheme C
Date of Investment 01-06-2022 01-07-2022 01-08-2022
Net Asset Value at Entry Date ₹ 11.00 ₹ 10.50 ₹ 12.00
Dividend received upto 31-03-23 (₹) 12,500.00 17,000.00 4,000.00
Unit NAV at 31-03-23 (₹) 11.25 11.48 10.80
Increase / (Decrease) in NAV (₹) 22,727.27 93,333.33 (50,000.00)
Effective Rate of Yield per annum 4.2296% 14.6978% (-) 13.8190%
Ignore Entry/Exit load expenditure.
Assume 365 days in a year. Round off the investment to nearest ₹ 100.
You are required to calculate:
i. The amount of investments made initially by Mr. S in these schemes.
ii. Number of units invested in the three schemes by Mr. S.
Advise also whether he can continue to hold this investment or can he redeem now.
Solution
i. Calculation of amount of investment made initially by Mr. S:
Particulars Scheme A Scheme B Scheme C
(a) Period of Investment 304 days 274 days 243 days
(b) Effective Yield p.a. 4.2296% 14.6978% (-) 13.8190%
(c) Effective Yield for holding 3.5227% 11.0334% (-) 9.2000%
period
(d) Dividend Received ₹ 12,500 ₹ 17,000 ₹ 4000
(e) Increase / Decrease of NAV ₹ 22,727.27 ₹ 93,333.33 (₹ 50,000)
(f) Total Yield (d + e) ₹ 35,227.27 ₹ 1,10,333.33 (₹ 46,000)

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(g) Initial Investment (f/c) ₹ 10,00,000 ₹ 10,00,000 ₹ 5,00,000

(h) NAV on date of Investment ₹ 11.00 ₹ 10.50 ₹ 12.00
ii. Units invested in three schemes by Mr. S
Particulars Scheme A Scheme B Scheme C
Initial Investment
55
₹ 10,00,000 ₹ 10,00,000 ₹ 5,00,000
NAV on date of Investment ₹ 11.00 ₹ 10.50 ₹ 12.00
Units of Investment 90,909.09 95,238.10 41,666.67
Or 90,909 95,238 41,667
Advise: He should continue to investment in Scheme B and get redeemed both schemes A and C
and invest their proceeds in Scheme B.

Question 14(MTP/RTP/PP)
Mr. Kar has invested in three mutual fund schemes as per details below:
MFX MFY MFZ
Amount of investment (₹) 5,50,000 4,20,000 1,00,000
Dividend received up to 31.03.2023 (₹) 10,000 6,000 Nil
NAV as on 31.03.2023 (₹) 11.50 11.00 9.50
Effective yield p.a. as on 31.03.2023 19.345% 22.59% -36.50%
Holding period 120 days 100 days 50 days
You are required to calculate Net Asset Value (NAV) at the time of purchase assuming 365 days
in a year.
Solution
MFX MFY MFZ

a. Amt. of Investment 550,000 420,000 1,00,000

b. Effective Yield p.a. 19.345% 22.59% -36.50%
c. Period of Holding 120 Days 100 Days 50 days
d. Return for Holding Period 34,980 25,993.97 - 5000
e. Dividend Received 10,000 6,000 -
f. Total Gain in NAV(D - E) 24,980 19993.97 -5,000
g. Total NAV at End of Holding Period (A + F) 5,74,980 4,39,993.97 95,000
h. NAV (p.u.) as on 31.3.23 11.50 11.00 9.50
i. No. of Units (G/H) 49,998.26 39,999.45 10,000
j. NAV (p.u.) at the time of Purchase (A/I) 11.00 10.50 10.00

Alternative Solution
MFX
= ×120
Or - 550000 + 10000 = 0.0636 × 550000
Or = 574980

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

Or × = = 11.00
MFY

= ×100
Or – 420000 + 6000 = 0.062 × 420000
Or = 440040
56
Or γ = = 10.50

MFZ
–
= × 50
Or – 100000 = - 0.05 × 100000
Or = 95000
Or Z = = 10.00

Question 15(MTP/RTP/PP)
Mr. A, has invested in the Growrich Mutual Fund's Scheme. The details of the Mutual Fund
Scheme are given below:
Asset Value at the beginning of the month ₹ 78.50
Annualized Return 16%
Distribution made in the nature of Income and Capital Gain (per unit ₹ 0.40 & ₹ 0.30
respectively)
You are required to:
(i) Calculate the month end Net Asset Value of the Growrich Mutual Fund Scheme (Round
off to 2 decimals)
(ii) Comment briefly on the Month end NAV.
Solution
(i) Calculation of NAV at the end of month:
Given Annual Return = 16%
Hence Monthly Return = 1.33% (r)
r=
0.0133 =
1.04405 = NAVt - ₹ 77.80
NAVt = ₹ 78.84
(ii) COMMENT- Closing NAV is increased by ₹ 0.34 i.e. (₹ 78.84 – ₹ 78.50).
So, there is slight change in NAV.

Question 16(RTP/RTP/PP)
The following particulars relating to S Fund Schemes:
Particulars Value in Crores
1. Investment in Shares (at cost)
a. Pharmaceuticals companies 158

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

b. Construction Industries 62
c. Service Sector Companies 112
d. IT Companies 68
e. Real Estate Companies 57 20
2. Investment in Bonds (Fixed Income)
a. Listed Bonds (8000, 14% Bonds of ₹ 15,000 each) 24
b. Unlisted Bonds 14
3. No. of Units outstanding (crores) 8.4
4. Expenses Payable 7
5. Cash and Cash equivalents 3
6. Market expectations on listed bonds 8.842%
The fund has incurred the following expenses:
Consultancy and Management fees ₹ 520 Lakhs
Office Expenses ₹ 180 Lakhs
Advertisement Expenses ₹ 48 Lakhs

Particulars relating to each sector are as follows:

Sector Index on Purchase date Index on Valuation date
Pharmaceutical companies 300 500
Construction Industries 275 490
Service Sector Companies 285 500
IT Companies 270 515
Real Estate Companies 265 440
Required:
(i) Calculate the Net Asset Value of the fund
(ii) Calculate the Net Asset Value per unit
(iii) Determine the Net return (Annualized), if the period of consideration is 4 years, and the
fund has distributed ₹ 2 per unit per year as cash dividend during the same period.
Note: Calculate figure in ₹ Crore upto 3 decimal points.
Solution:
(i) Calculation of NAV of the Fund
(in Crore)
1. Value of Shares
a. Pharmaceutical Companies 158 263.333

b. Construction Companies 62 110.473

c. Service Sector Companies 112 196.491

d. IT Companies 68 129.704
e. Real Estate Companies 20 33.208
2. Investment in Bonds
a. Listed Bonds 24 38.00

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

b. Unlisted Bonds 14.000

3. Cash and Cash Equivalents 3.00
788.209
Less: Expense Payable 58 7.000
NAV of the Fund 781.209

(ii) NAV of the Fund per Unit

NAV of the Fund ₹ 781.209 crore
Number of Units 8.40 crore
NAV Per Unit (₹ 781.209 crore/ 8.40 crore) ₹ 93.00

(iii) Net Return

Initial Cost Per Unit
Investment in Shares ₹ 420 crore

Bonds ₹ 38 crore ₹ 458 crore

Number of Units 8.40 crore
Cost Per Unit ₹ 54.52
Return
Capital Gain (₹ 93.00 – ₹ 54.52) ₹ 38.48
Dividend ₹ 4x 2 ₹ 8.00
₹ 46.48
Annualised Return 21.31%

Question 18 (MTP/RTP/PP)
Following is the information related to three mutual funds:
Year MF-A MF-B MF-C
2020 10% 5% 14%
2021 8% 10% 10%
2022 12% 8% 18%
Correlation between market and mutual fund:
MF-A MF-B MF-C
Correlation with market 0.45 0.25 0.65
Variance of the market is 9% and rate of return of government bond is 7%.
You are required to Rank the Mutual fund using Sharpe’s ratio and Treynor’s ratio.
Solution
i. Calculation of Standard Deviation of Funds
Year MF-A Dev. Dev.2 MFB Dev. Dev.2 MF-C Dev. Dev.2
(%) (%) (%)
2020 10 - - 5 -2.67 7.13 14 - -
2021 8 -2 4 10 2.33 5.43 10 -4 16
2022 12 2 4 8 0.33 0.11 18 4 16

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30 8 23 12.67 42 32
Avg. Var. Avg. Var. Avg. Var.
= 30/3 = 8/3 = 23/3 12.67/3 = 42/3 32/3 =
= 10 = 2.67 = 7.67 59 = 4.22 = 14 10.67
σA = σB = 2.05 σC = 3.27
1.63

ii. Calculation of Beta of MFs

r σM σi Var. of Market βi
MF-A 0.45 3 1.63 9 0.244
MF-B 0.25 3 2.05 9 0.171
MF-C 0.65 3 3.27 9 0.709

Reward to Variability (Sharpe Ratio)

Mutual Fund Rp Rf Rp – Rf σp Reward to Ranking
Variability
MF-A 10.00 7.00 3.00 1.63 1.84 2
MF-B 7.67 7.00 0.67 2.05 0.33 3
MF-C 14.00 7.00 7.00 3.27 2.14 1

Reward to Volatility (Treynor Ratio)

Mutual Fund Rp Rf Rp – Rf βp Reward to Ranking
Volatility
MF-A 10.00 7.00 3.00 0.244 12.30 1
MF-B 7.67 7.00 0.67 0.171 3.92 3
MF-C 14.00 7.00 7.00 0.709 9.87 2

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

CHAPTER-9 International Financial Management

Question11 (RTP/MTP/PP) 60
DK Ltd. is considering an investment proposal in Sri Lanka involving an initial investment of
LKR 25 billion. The current spot exchange rate is INR/LKR 0.370. The risk free rate in India
is 6% and the same in Sri Lanka is 5.02%.

The project will generate a cash flow of LKR 5 billion in the first year. The cash flow will
increase by LKR 1 billion each year for the next 4 years. The project will wind up on
completion of 5 years with no salvage value. The required rate of return for the project is 8%
(i) You are required to find out the investment worth of the project by using
(1) Home Currency Approach
(2) Foreign Currency Approach
(ii) Compare the outcome under both the approaches.
Given:
PVIF (8%, t) 0.92593 0.85734 0.79383 0.73503 0.68058
PVIF (7%, t) 0.93457 0.87344 0.81630 0.76290 0.71299

Note: Excepts rates show all calculations in Billion upto four decimal points.
Solution
Working Notes:
Calculation of Forward Exchange Rates
End of Year /LKR
1 0.37 x 0.373

2 0.373 x 0.376
3 0.376 x 0.379
4 0.379 x 0.382

5 0.382 x 0.385

1. Home Currency Approach

Year Cash Flow ₹/ LKR Cash flow PVF @ 8% PV
Billion LKR Billion ₹ Billion

1 5 0.373 1.865 0.92593 1.7269

2 6 0.376 2.256 0.85734 1.9342
3 7 0.379 2.653 0.79383 2.1060
4 8 0.382 3.056 0.73503 2.2463
5 9 0.385 3.465 0.68058 2.3582

10.3716

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Less: Investment 25 0.37 9.2500

NPV 1.1216

2. Foreign Currency Approach

61
(1 + 0.06) (1+ Risk Premium) = 1.08
1 + Risk Premium = 1.08/1.06 = 1.01887
Therefore, Risk adjusted LKR Rate = 1.01887 × 1.0502 – 1 = 0.07 i.e. 7%
Calculation of NPV
Year Cash Flow (Billion LKR) PVF @ 7% PV (Billion LKR)
1 5 0.93457 4.6729
2 6 0.87344 5.2406
3 7 0.81630 5.7141
4 8 0.76290 6.1032
5 9 0.71299 6.4169
28.1477
Less: Investment 25.0000
NPV 3.1477
Thus, Rupee NPV of the Project = ₹0.37 × 3.1477= ₹ 1.1646 billion
Decision: NPV is positive in the approach so, project will worth investment.

Question12 (MTP/RTP/PP)
Mr. Vishwas, a friend of Mr. Pramod who is one of the Directors of Ashirwad Limited, is a
citizen of Mauritius. His immediate family members including his parents, born in India are
residing in India. He has many friends in different parts of India, due to which he happens to
visit India on frequent basis. He along with Mr. Pramod evince interest in setting up
business in India and formally incorporate a company to commence their operations. Accordingly,
a company is called “Aerious Private Ltd.” got incorporated in Mumbai.
To start with he received a business proposal from one of his friends Nimish a consultant. It is
estimated that in equivalent terms the business shall require an initial investment of MUR 100
Million and thereafter MUR 2 Million each year will be needed as working capital fund.

He wished to evaluate whether the business proposal is viable or not. The information
related to exchange rate and inflation rate is as follows:
Spot Rate for 1 Mauritian Dollar (MUR) = 1.88 Indian Rupee (INR) The inflation in India is 6%
and in Mauritius is 5%.

It is expected that this inflation rate will remain unchanged for the next 4 years.
INR 8 Crore out of initial investment shall be required for setting up a plant. The useful life
of the plant is 4 years. At the end of 4th year estimated salvage value of this plant shall
be INR 80 lakhs. Depreciation of the plant shall be charged on the basis of straight-line
method.

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40 % of the investment shall be through debt funds from Mauritius at the cost of 10%
(post tax) while remaining funds shall be arranged by him and his friends. They expect a
rate of return of 12% on their funds.

62
Expected revenues & costs (excluding depreciation) in real term are as under:
Year 1 2 3 4
Revenues (₹ Crore) 6.00 7.00 8.00 8.00
Costs (₹ Crore) 3.00 4.00 4.00 4.00

Assume that applicable tax rate in India is 30%. Since there is Double tax avoidance agreement
between India and Mauritius, the company is not required to pay tax in Mauritius if tax has
been paid in India.

The applicable inflation rates for revenues & costs are as follows:
Year Revenues Costs
1 10% 12%
2 9% 10%
3 8% 9%
4 7% 8%

He wants an expert opinion for the same investment proposal.

Demonstrate whether investment in this project is viable option or not.
Note: 1. Round off calculations upto 4 decimal points.
2. Show INR calculations in Crore and MUR calculations in Million.
Solution
To evaluate whether investment in same project is a viable option or not, we shall compute the NPV
of the project.
Working Note:
(1) Expected Exchange Rates
End of Year INR INR/MUR
1 INR 1.88 1.8979

2 INR 1.8979 1.9160

3 INR 1.9160 1.9342

4 INR 1.9342 1.9526

(2) Initial Investment = MUR 100 Million x INR 1.88 = INR 18.80 crore
Working Capital (Year 1) = MUR 2 Million x 1.8979 = INR 0.3796 crore
Working Capital (Year 2) = MUR 2 Million x 1.9160 = INR 0.3832 crore
Working Capital (Year 3) = MUR 2 Million x 1.9342 = INR 0.3868 crore
Working Capital (Year 4) = MUR 2 Million x 1.9526 = INR 0.3905 crore

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 ADVANCED FINANCIAL MANAGEMENT – ADDITIONAL QUESTIONS FOR 3rd EDITION

(3) WACC = 40% x 10% + 60% x 12% = 11.20%

(4) Inflation adjusted Revenue
Year Revenue ( ) Revenue (Inflation Adjusted) ( )
1 6.00 crore 63
6.00 crore x 1.10 = 6.60 crore
2 7.00 crore 7.00 crore x 1.10 x 1.09 = 8.393 crore
3 8.00 crore 8.00 crore x 1.10 x 1.09 x 1.08 = 10.3594 crore
4 8.00 crore 8.0 crore x 1.10 x 1.09 x 1.08 x 1.07 = 11.0845 crore
(5) Inflation adjusted Cost
Year Cost ( ) Cost (Inflation Adjusted) ( )
1 3.00 crore 3.00 crore x 1.12 = 3.3600 crore
2 4.00 crore 4.00 crore x 1.12 x 1.10 = 4.9280 crore
3 4.00 crore 4.00 crore x 1.12 x 1.10 x 1.09 = 5.3715 crore
4 4.00 crore 4.0 crore x 1.12 x 1.10 x 1.09 x 1.08 = 5.8012 crore

(6) Annual cash flows (₹ Crore)

Year 1 2 3 4
Revenue 6.600 8.393 10.3594 11.0845
Less: Cost 3.360 4.928 5.3715 5.8012
Less: Depreciation 1.800 1.800 1.800 1.800
Profit before Tax (PBT) 1.440 1.665 3.1879 3.4833
Tax @ 30% 0.432 0.4995 0.9564 1.0450
Profit after Tax 1.008 1.1655 2.2315 2.4383
Add: Depreciation 1.800 1.800 1.800 1.800
Cash Flows 2.808 2.9655 4.0315 4.2383

NPV of the Project

Year 0 1 2 3 4
Initial Investment (₹ Crore) (18.80)
Working Capital (₹ Crore) - (0.3796) (0.3832) (0.3868) (0.3905)
Scrap Value (₹ Crore) 0.8000
W.C Recovered (₹ Crore) 1.5401
Annual Cash flows 2.8080 2.9655 4.0315 4.2383
Net Cash Flow (18.80) 2.4284 2.5823 3.6447 6.1879
Exchange Rate 1.88 1.8979 1.9160 1.9342 1.9526
Cash Flows (in Million MUR) (100) 12.7952 13.4776 18.8434 31.6906
[email protected]% 1 0.8993 0.8087 0.7273 0.6540
Present value (in Million MUR) (100) 11.5067 10.8993 13.7048 20.7257

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Net Present Value = - MUR 43.1635 Million

Advise: Since NPV of the project is negative the proposal is not a viable option for
investment.
64
Question13 (MTP/RTP/PP)
XY Ltd., is interested in expanding its operation and planning to install a unit at US. For the
proposed project, it requires a fund of $ 15 million (net of issue expenses/floatation cost). The
estimated floatation cost is 3%. To finance the project it proposes to issue GDRs.
You as a financial consultant is required to compute the number of GDRs, to be issued and cost
of the GDR with the help of following additional information.
(i) Expected market price of share at the time of issue of GDR is ₹350 (Face Value ₹100).
(ii) 3 shares shall underly each GDR and shall be priced at 6% discount to market price.
(iii) Expected Exchange Rate ₹84/$.
(iv) Dividend expected to be paid is 10% with growth rate of 8%.
Solution:
Net Issue Size = $15 million
Gross Issue = = $ 15.464 million
Issue Price per GDR in ₹ (350 x 3 x 94%) ₹ 987
Issue Price per GDR in $ (₹ 987/ ₹ 84) $ 11.75
Dividend Per GDR (D1) (₹ 10 x 3) ₹ 30
Net Proceeds Per GDR (₹ 987 x 0.97) ₹ 957.39
(i) Number of GDR to be issued = 1.316085 million
(ii) Cost of GDR to XY Ltd. Ke = + 0.08 =11.13%

CHAPTER-12 Risk Management

Question 11(MTP/RTP/PP)
On Tuesday morning (before opening of the capital market) an investor, while going through his
bank statement, has observed that an amount of ₹ 7 lakhs is lying in his bank account. This
amount is available for use from Tuesday till Friday. The Bank requires a minimum balance of ₹
1000 all the time. The investor desires to make a maximum possible investment where Value at
Risk (VaR) should not exceed the balance lying in his bank account. The standard deviation of
market price of the security is 1.5 per cent per day. The required confidence level is 99 per
cent.
Given
Standard Normal Probabilities
z 0.00 .01 .02 .03 0.04 .05 .06 .07 .08 .09
2.2 .9861 .9864 .9868 .9871 .9875 .9878 .9881 .9884 .9887 .9890
2.3 .9893 .9896 .9998 .9901 .9904 .9906 .9909 .9911 .9913 .9916
2.4 .9918 .9920 .9922 .9923 .9925 .9929 .9931 .9932 .9934 .9936
You are required to determine the maximum possible investment.
Solution

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Particulars Amount ( )

Amount available in bank account 7,00,000

Minimum balance to be kept 65
Available amount which can be used for potential investment for 4 days
1,000
6,99,000
Maximum Loss for 4 days at 99% level 6,99,000
Maximum Loss for 1 day at 99 % level = Maximum Loss for 4 days /√No. of 3,49,500
days = 699000 / √4
Z Score at 99% Level 2.33
Volatility in terms of Rupees (Maximum Loss / Z Score at 99% level) 1,50,000
= 349500 / 2.33
Maximum Possible Investment (Volatility in Rupees/Std Deviation) 1,00,00,000
= 150000 /.015

Question 12 (MTP/RTP/PP)
ABC Ltd. is considering a project X, which is normally distributed and has mean return of Rs. 2
crore with Standard Deviation of Rs. 1.60 crore.
In case ABC Ltd. loses on any project more than Rs. 1.00 crore there will be financial difficulties.
Determine the probability the company will be in financial difficulty.

Given: Standard Normal Distribution Table (Z-Score) providing area between Mean and Z score
Z Score Area
1.85 0.4678
1.86 0.4686
1.87 0.4693
1.88 0.4699
1.89 0.4706
Solution
For calculating probability of financial difficulty, we shall calculate the area under Normal Curve
corresponding to the Z Score obtained from the following equation (how many SD is away from
Mean Value of financial difficulty):

= -1.875 say 1.875

Corresponding area from Z Score Table by using interpolation shall be found as follows:

Z Score Area under Normal Curve

1.87 0.4693
1.88 0.4699
0.01 0.0006

The corresponding value of 0.005 Z score =

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Thus the Value of 1.875 shall be = 0.4693 + 0.0003 = 0.4696

Thus the probability the company shall be in financial difficulty is 46.96%.

Question 13 (MTP/RTP/PP) 66
Following is the information about Mr. J's portfolio:
Investment in shares of ABC Ltd. ₹ 200 lakh
Investment in shares of XYZ Ltd. ₹ 200 lakh
Daily standard deviation of both shares 1%
Co-efficient of correlation between both shares 0.3
Required:
Determine the 10 days 99% Value at Risk (VAR) for Mr. J's portfolio.
Given: The Z score from the Normal Table at 99% confidence level is 2.33. (Show your
calculations up to four decimal points).
Solution
Volatility (standard deviation) of the daily change in the investment in each share in terms of
rupees-
1% of ₹ 200 lakh = ₹ 2 lakh
The variance of the portfolio’s daily change –
V = 22 + 22 + 2 x 0.3 x 2 x 2 = 10.4 lakh
Standard Deviation of the portfolio’s daily change = = ₹ 3.2249 lakhs
The standard deviation of the 10-day change
= = ₹ 10.1981 lakhs

Therefore, the 10 – days 99% VAR = 2.33 × ₹ 10.1981 lakhs = ₹ 23.7616 lakhs

Question 14 (MTP/RTP/PP)
Mr. Bull is a rational risk taker. He takes his position in a single stock for 4 days in a week. He
does not take a position on Friday to avoid weekend effect and takes position only for four days
in a week i.e. Monday to Thursday. He transfers the amount on Monday morning and withdraws
the balance on Friday morning. He desires to make a maximum investment where Value At Risk
(VAR) should not exceed the balance lying in his bank account. The position by his manager, as
per standing instructions, is taken on the free balance lying in the bank account in the morning
on each Monday. On Monday morning (before opening of the capital market) he has transferred
an amount ₹ of 11 Crore to his bank account. A fixed deposit also matured on this Monday. The
maturity amount of₹ 63,42,560 was also credited to his account by the bank in the morning of
the Monday. However, Mr. Bull received the intimation of the same in the evening. The ₹ bank
needs a minimum balance of 1,000 all the time. The value of Z score, at the required confidence
level of 99 percent is 2.33.

The other information with respect to stocks X and Y, which are under consideration for this
week, is as under:
X Y
Return Probability Return Probability
6 0.10 4 0.10

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7 0.25 6 0.20
8 0.30 8 0.40
9 0.25 10 0.20
10 0.10 67 12 0.10

You are required to recommend a single stock, where maximum investment can be made
Solution
Working Notes:
(1) Security X
Return (1) Prob.(2) (1)x(2) Dev Dev.2 Dev.2x Prob
6 0.10 0.60 -2 4 0.40
7 0.25 1.75 1 1 0.25
8 0.30 2.40 0 0 0
9 0.25 2.25 1 1 0.25
10 0.10 1.00 2 4 0.40
8.00 1.30
Expected Return (Rx) = 8.00%
Variance ) = 1.30
Standard Deviation ( ) = = 1.14

(2) Security Y
Return(1) Prob. (2) (1) x (2) Dev. Dev.2 Dev.2 x Prob
6 0.20 1.20 -2 4 0.80
8 0.40 3.20 0 0 0
10 0.20 2.00 2 4 0.80
12 0.10 1.20 4 16 1.60
8.00 4.80
Expected Return (RY) = 8.00%
Variance ( = 4.80
Standard Deviation = = 2.19

No.of X Y
Days
Amount Transferred ₹ 110000000 ₹ 110000000
Maturity Proceeds of Fixed Deposit ₹ 6342560 ₹ 6342560
Amount available in bank account ₹ 116342560 ₹ 116342560
Minimum balance to be kept ₹ 1000 ₹ 1000
Available amount which can be used ₹ 116341560 ₹ 116341560
for potential investment for 4 days
Maximum loss for 4 days at 99% level 4 ₹ 116341560 ₹ 116341560
Maximum loss for 1 day at 99% level
= Maximum loss for 4 days
1 ₹ 58170780 ₹ 58170780

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= 116341560/
Z Score at 99% level 2.33 2.33
Volatility in terms of ₹ (Maximum ₹ 24966000 ₹ 24966000
Loss/Z Score at 99% Level)
Standard Deviation 0.0114 0.0219
Maximum Investment (Volatility in ₹ 2190000000 ₹1140000000
terms of ₹ / SD)

Recommendation: Position should be taken in X.

CHAPTER-13 Security Analysis

Question13 (MTP/RTP/PP)
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200X
were as follows:
Days Date Day Sensex
1 6 THU 14522
2 7 FRI 14925
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 15222
6 11 TUE 16000
7 12 WED 16400
8 13 THU 17000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 18000

Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 31 days
simple moving average of Sensex can be assumed as 15,000. The value of exponent for 31 days
EMA is 0.062.
Give detailed analysis on the basis of your calculations
Solution
1 2 3 4 5
Date Sensex EMA for 1-2 3×0.062 EMA 2 + 4
Previous day
6 14522 15000 (478) (29.636) 14970.364
7 14925 14970.364 (45.364) (2.812) 14967.55
10 15222 14967.55 254.45 15.776 14983.32
11 16000 14983.32 1016.68 63.034 15046.354
12 16400 15046.354 1353.646 83.926 15130.28

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13 17000 15130.28 1869.72 115.922 15246.202

17 18000 15246.202 2753.798 170.735 15416.937

Conclusion – The market is bullish. The market is likely to remain bullish for short term to medium
term if other factors remain the same. On the basis of this indicator (EMA) the investors /
brokers can take long position.

Question 14 (MTP/RTP/PP)
The closing value of Sensex for the month of October, 2007 is given below:
Date Closing Sensex Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260

With the help of above data evaluates the weak form of efficient market hypothesis
byapplying the run test at 5% and 10% level of significance.

Following value can be used :

Value of t at 5% is 2.101 at 18 degrees of freedom
Value of t at 10% is 1.734 at 18 degrees of freedom
Solution
Date Closing Sensex Sign of Price Charge
1.10.07 2800
3.10.07 2780 -
4.10.07 2795 +

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5.10.07 2830 +
8.10.07 2760 -
9.10.07 2790 +
10.10.07 2880 +
11.10.07 2960 +
12.10.07 2990 +
15.10.07 3200 +
16.10.07 3300 +
17.10.07 3450 +
19.10.07 3360 -
22.10.07 3290 -
23.10.07 3360 +
24.10.07 3340 -
25.10.07 3290 -
29.10.07 3240 -
30.10.07 3140 -
31.10.07 3260 +

Total of sign of price changes (r) = 8

No of Positive changes = n1 = 11
No. of Negative changes = n2 = 8

µ=

= = 2.06

Since too few runs in the case would indicate that the movement of prices is not random. We
employ a two- tailed test the randomness of prices.
Test at 5% level of significance at 18 degrees of freedom using t- table

The lower limit = 10.26 – 2.101 x 2.06 = 5.932

Upper limit = 10.26 + 2.101 x 2.06 = 14.588

At 10% level of significance at 18 degrees of freedom

Lower limit = 10.26 – 1.734 × 2.06 = 6.688
Upper limit = 10.26 + 1.734 × 2.06 = 13.832

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As seen r lies between these limits. Hence, the market exhibits weak form of efficiency.
*For a sample of size n, the t distribution will have n-1 degrees of freedom.

Question 15 (MTP/RTP/PP)
Mr. X is of the opinion that market has recently shown the Weak Form of Market Efficiency.
In order to test the validity of his impression he has collected the following data relating to
the movement of the SENSEX for the last 20 days.
Days Open High Low Close
1 33470.94 33513.79 33438.03 33453.99
2 33453.64 33478.11 33427.82 33434.83
3 33414.06 33440.29 33397.65 33431.93
4 33434.94 33446.18 33377.78 33383.41
5 33372.92 33380.27 33352.12 33370.93
6 33375.85 33389.49 33331.42 33340.75
7 33340.89 33340.89 33310.95 33330.98
8 33326.84 33340.91 33306.17 33335.08
9 33307.16 33328.22 33296.43 33301.97
10 33298.64 33318.60 33254.28 33259.03
11 33260.04 33228.85 33241.66 33251.53
12 33255.92 33289.46 33249.46 33285.89
13 33288.86 33535.67 33255.98 33329.28
14 33335.00 33346.21 33276.72 33284.17
15 33293.83 33310.86 33278.54 33298.78
16 33300.02 33337.79 33300.02 33325.38
17 33323.36 33356.34 33322.44 33329.95
18 33322.81 33345.98 33317.44 33319.67
19 33317.51 33321.18 33294.19 33302.32
20 33290.86 33324.96 33279.62 33319.61

You are required:

To test the Weak Form of Market Efficiency using Auto-Correlation test, taking time lag of
10 days.
Solution
Period 1 Closing Prices Change Period 2 Closing Prices Change
1 33453.99 11 33251.53
2 33434.83 -19.16 12 33285.89 34.36
3 33431.93 - 2.90 13 33329.28 43.39
4 33383.41 - 48.52 14 33284.17 - 45.11
5 33370.93 - 12.48 15 33298.78 14.61
6 33340.75 - 30.18 16 33325.38 26.6
7 33330.98 -9.77 17 33329.95 4.57
8 33335.08 4.1 18 33319.67 -10.28

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9 33301.97 - 33.11 19 33302.32 -17.35

10 33259.03 - 42.94 20 33319.61 17.29

X Y X2 Y2 XY
-19.16 34.36 367.11 1180.61 -658.34
-2.90 43.39 8.41 1882.69 -125.83
-48.52 -45.11 2354.19 2034.91 2188.74
-12.48 14.61 155.75 213.45 -182.33
-30.18 26.6 910.83 707.56 -802.79
-9.77 4.57 95.45 20.88 -44.65
4.1 -10.28 16.81 105.68 -42.15
-33.11 -17.35 1096.27 301.02 574.46
-42.94 17.29 1843.84 298.94 -742.43
2
∑X = -194.96 ∑Y = 68.08 ∑X = 6848.66 ∑Y2 = 6745.74 ∑XY = 164.68

= - 21.66 = 7.56

b= = 0.624
– = 21.08

r2 = 0.164
r = 0.405
There is moderate degree of correlation between the returns of two periods hence it can be
concluded that the market does not show the weak form of efficiency.

Question 16 (MTP/RTP/PP)
Closing Values of NIFTY Index from 3rd to 12th day of the month of January 2022 were as
follows:
Days Date Closing Values of NIFTY Index
1 03/01/2022 17626
2 04/01/2022 17805
3 05/01/2022 17925
4 06/01/2022 17746
5 07/01/2022 17813
6 10/01/2022 18003
7 11/01/2022 18056
8 12/01/2022 18212
The simple moving average of NIFTY Index for the month of December 2021 was 17174.
You are required to calculate
(i) The value of exponent for 15 days EMA.
(ii) The exponential moving average (EMA) of NIFTY during the above period. (Calculations
to be done up to 2 decimals only)

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(iii) Analyse the buy & sell signal on the basis of your calculations
Solution
(i) Value of Exponent for 15 Days EMA
= = 1.25

(ii) EMAt = a X Pt + (1 - a) (EMA (t - 1)) Where, a = exponent, Pt = Price of today

Date Sensex EMA for 1-2 3 × 0.125 EMA 2 + 4
Previous day
(EMA (t – 1))
1 2 3 4 5
03/01/2022 17626 17174 452 56.50 17230.50
04/01/2022 17805 17230.50 574.50 71.81 17302.31
05/01/2022 17925 17302.31 622.69 77.84 17380.15
06/01/2022 17746 17380.15 365.85 45.73 17425.88
07/01/2022 17813 17425.88 387.12 48.39 17474.27
10/01/2022 18003 17474.27 528.73 66.09 17540.36
11/01/2022 18056 17540.36 515.64 64.45 17604.82
12/01/2022 18212 17604.82 607.18 75.90 17680.71

(iii) A buy (bullish) signal is generated when actual price line (NIFTY in the give case) rises
through the moving average, while a sell a (bearish) signal is generated when actual NIFTY
level declines through the moving averages. In the case under consideration the price line of
NIFTY never breaches the 15 -day EMA line. In-fact it is hovering around the 15-day EMA
line only.

CHAPTER-14 Financial Policy and Corporate Strategy

Question 12(MTP/RTP/PP)
Excellent Ltd., reported a profit of ₹ 154 lakhs after 30% tax for the financial year 2019-
20. An analysis of the accounts revealed that there is an extraordinary loss of ₹ 20 lakhs
and the income included extraordinary items of ₹ 16 lakhs. The existing operations,
except for the extraordinary items, are expected to continue in the future. In addition, the
results of the launch of a new product are expected to be as follows:
in lakhs
Sales 140
Material costs 40
Labour costs 24
Fixed costs 20
You are required to:
(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Excellent Ltd.'s share capital being
comprised of 2,00,000 at 13% preference shares of ₹ 100 each and 100,00,000 equity
shares of ₹ 10 each and the P/E ratio being 12 times. (Ignoring Corporate Dividend Tax).

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Solution:
(i) Computation of Business Value
( Lakhs)
Profit before tax 220

Less: Extraordinary income (16)

Add: Extraordinary losses 20
Profit from new product (₹ Lakhs) 224

Sales 140
Less: Material costs 40
Labour costs 24
Fixed costs 20 (84) 56
280.00
Less: Taxes @30% 84.00
Future Maintainable Profit after taxes 196.00
Relevant Capitalisation Factor 0.14
Value of Business (₹ 196/0.14) 1400

(ii) Determination of Market Price of Equity Share

Future maintainable profits (After Tax) ₹ 1,96,00,000
Less: Preference share dividends 2,00,000 shares of ₹ 100 @ 13% ₹ 26,00,000
Earnings available for Equity Shareholders ₹ 1,70,00,000
No. of Equity Shares 1,00,00,000
Earning per share = = ₹ 1.70

PE ratio 12
Market price per share ₹ 20.40

Question15 (MTP/RTP/PP)
Sun Ltd. recently made a profit of ₹ 200 crore and paid out ₹ 80 crore (slightly higher than
the average paid in the industry to which it pertains). The average PE ratio of this industry is
9. The estimated beta of Sun Ltd. is 1.2. As per Balance Sheet of Sun Ltd., the shareholder’s
fund is ₹ 450 crore and number of shares is 10 crore. In case the company is liquidated,
building would fetch ₹ 200 crore more than book value and stock would realize ₹ 50 crore less.
The other data for the industry is as follows:
Projected Dividend Growth 4%
Risk Free Rate of Return 6%
Market Rate of Return 11%
Calculate the valuation of Sun Ltd. using
(a) P/E Ratio

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(b) Dividend Growth Model

(c) Book Value
(d) Net Realizable Value
Solution:
(a) ₹ 200 crore x 9 = ₹ 1800 crore
(b) Ke = 6% + 1.2 (11% - 6%) = 12%
= = ₹ 1040 crore
(c) ₹ 450 crore
(d) ₹ 450 crore + ₹ 200 crore – ₹ 50 crore = ₹ 600 crore

Question 20 (MTP/RTP/PP)
M/s. Raghu Ltd. is interested in expanding its operation and planning to install manufacturing
plant at US. It requires 8.82 million USD (net of issue expenses/ floatation cost) to fund the
proposed project. GDRs are proposed to be issued to finance this project. The estimated
floatation cost of GDRs is 2%.

Additional information:
(1) Expected market price of share at the time of issue of GDR is ₹ 360 (Face Value ₹ 100)
(2) Each GDR will represent two underlying Shares.
(3) The issue shall be priced at 10% discount to the market price.
(4) Expected exchange rate is INR/USD 72.
(5) Dividend is expected to be paid at the rate of 20% with growth rate of 12%.
Required:
(i) CALCULATE the number of GDRs to be issued.
(ii) ADVISE company for making GDR issue if the company receives an offer from a US Bank
willing to provide an equivalent loan with an interest rate of 12%?
Solution:
Working Notes:
Net Issue Size = $ 8.82 million
Gross Issue = = $9.00 million
Issue Price per GDR in ₹ (360 x 2 x 90%) ₹ 648
Issue Price per GDR in $ (₹ 648/ ₹ 72) $ 9.00
Dividend Per GDR (D1) = ₹ 20 x 2 = ₹ 40
Net Proceeds Per GDR = ₹ 648 x 0.98 = ₹ 635.04
(i) Number of GDR to be issued
= 1.00 million
(ii) To advise the company about the cheapest option first we shall compute the Cost of GDR as
follows:
Ke = + 0.12 = 18.30%
If the company receives an offer from US Bank willing to provide an equivalent amount of loan
with interest rate of 12%, it should accept the offer because there will be net saving of
6.30%.

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Question 21(MTP/RTP/PP)
MNO Ltd., a company based in India, manufactures very high quality modern furniture and
sells them to a small number of retail outlets in India and Nepal. It is facing tough
competition. Recent studies on marketability of product have clearly indicated that the
customers are now more interested in variety and choice rather than exclusivity and
exceptional quality. Since the cost of quality wood in India is very high, the company is
reviewing the proposal for import of wood in bulk from Nepalese supplier.

The estimate of net India (₹) and Nepalese Currency (NC) cash flow in nominal terms for this
proposal is shown below:
Net cash flow (in Millions)
Years NC India ( )
0 -38 0
1 1.8 1.9
2 3.2 3.5
3 4.1 4.4
4 5.4 5.8
5 6.5 6.9
The following information is relevant :
i. MNO Ltd. evaluates all investment by using a discount rate of 11% p.a. All Nepalese
customers are invoiced in NC. NC cash flows are converted to Indian ₹ at the forward
rate and discounted at the Indian rate.
ii. Inflation rate in Nepal and India are expected to be 11% and 10% p.a. respectively.
iii. The current exchange rate is ₹ 1 = NC 1.65
You are required to calculate Net Present value of the proposal.
Solution
Working Notes:
i. Computation of Forward Rates
End of year NC NC/
1 NC 1.65 ×[ ] 1.665
2 NC 1.665 ×[ ] 1.680
3 NC 1.680 ×[ ] 1.695
4 NC 1.695 ×[ ] 1.710
5 NC 1.710 ×[ ] 1.726

ii. NC Cash Flows converted in Indian Rupees

Year NC Conversion Rate (Million)
(Million)
0 -38.00 1.650 -23.03
1 1.80 1.665 1.081
2 3.20 1.680 1.905

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3 4.10 1.695 2.419

4 5.40 1.710 3.158
5 6.50 1.726 3.766
iii. Net Present Value
Year Cash Flow in Cash Flow in Total Cash PVF @ 11% PV
India Nepal Flow
0 --- -23.030 -23.030 1.000 -23.030
1 1.900 1.081 2.981 0.901 2.686
2 3.500 1.905 5.405 0.812 4.389
3 4.400 2.419 6.819 0.731 4.985
4 5.800 3.158 8.958 0.659 5.903
5 6.900 3.766 10.666 0.593 6.325
1.258

Question22 (MTP/RTP/PP)
i. What is sustainable growth rate?
ii. What makes an Organization Sustainable?
iii. Mr. X has submitted the following data:
Particulars (₹) in Lakhs
Total Assets 250
Total Liabilities 220
Net Income 12
Dividend Paid 4.5
Sales 100

Mr. X wants to know to what extent sales can be increased without going for additional
borrowings by using Sustainable Growth Rate (SGR) concept?
Solution
i. The sustainable growth rate is a measure of how much a firm can grow without borrowing more
money. After the firm has passed this rate, it must borrow funds from another source to
facilitate growth.
ii. In order to be sustainable, an organisation must:
 have a clear strategic direction;
 be able to scan its environment or context to identify opportunities for its work;
 be able to attract, manage and retain competent staff;
 have an adequate administrative and financial infrastructure;
 be able to demonstrate its effectiveness and impact in order to leverage further
resources; and
 get community support for, and involvement in its work.

SI. No Particulars Amount in Lakhs

1 Total Assets 250.00

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2 Total Liabilities 220.00

3 Net Income 12.00
4 Dividend Paid 4.50
5 Sales 100.00
6 Equity (a) – (b) 30.00
7 Return on Equity (ROE) (c) /(f) 40.00%
8 Dividend pay-out Ratio (d) /(c) 37.50%
9 SGR [g x (1-h)] 25.00%*
10 Additional Sales can be achieved without 25.00
further borrowings (e) × (i)
11 Maximum sales can be achieved without 125.00
further borrowings (e) + (j)

* Alternatively, it can also be computed as follows:

SGR = = 33.33% and then Additional Sales shall be ₹ 33.33 Lakhs and Maximum Sales
can be achieved without further borrowings shall be ₹ 133.33 Lakhs

CHAPTER-15 Advanced Capital Budgeting Decisions

Question 1 (MTP/RTP/PP)
R Ltd. is considering a project with the following Cash flows:
in
Years Cost of Plant Recurring Cost Savings
0 20,000
1 8,000 24,000
2 10,000 28,000
The cost of capital is 9%.
Evaluate the sensitivity of the project in respect of all factors except time such that:
i. NPV become zero and
ii. adversely varying factors value by 10%.

The P.V. factor at 9% are as under:

Year Factor
0 1
1 0.917
2 0.842
Note: Round off calculation upto 2 decimal points.
Solution
Working Note :
Year 1 Running Cost ₹ 8,000 x 0.917 = (₹ 7,336)
Savings ₹ 24,000 x 0.917 = ₹ 22,008
Year 2 Running Cost ₹ 10,000 x 0.842 = (₹ 8,420)

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Savings ₹ 28,000 x 0.842 = ₹ 23,576

₹ 29,828
Year 0 Less: P.V. of Cash ₹ 20,000 x 1 ₹ 20,000
Outflow
NPV 9,828
i. Sensitivity Analysis (by making NPV Zero)
(1) Increase of Plant Value by ₹ 9,828
x 100 = 49.14%

(2) Increase of Running Cost by ₹ 9,828

= x 100= 62.38 %

(3) Fall in Saving by ₹ 9,828

= x 100= 21.56%%

Hence, savings factor is the most sensitive to affect the acceptability of the project
as in comparison of other two factors a slight % change in this fact shall more affect
the NPV than others.
ii. Sensitivity Analysis if there is a variation of 10% in the factors.
a. If the initial project cost is varied adversely by say 10%.
NPV (Revised) (₹ 9,828 – ₹ 2,000) = ₹ 7,828
Change in NPV= = 20.35%

b. If Annual Running Cost is varied by say 10%.

NPV (Revised) (₹ 9828 – ₹ 800 X 0.917 – ₹ 1000 X 0.842)
= ₹ 9,828 – ₹ 733.60 – ₹ 842 = ₹ 8,252.40
Change in NPV = = 16.03 %

c. If Saving is varied by say 10%.

NPV (Revised) (₹ 9,828 – ₹ 2400 X 0.917 – ₹ 2800 X 0.842)
= ₹ 9,828 – ₹ 2,200.80 – ₹ 2,357.60 = ₹ 5,269.60
Change in NPV = x 100% = 46.38%

Hence, savings factor is the most sensitive to affect the acceptability of the project.

Question 2 (MTP/RTP/PP)
VK Ltd. is an Indian company which is planning to set up a manufacturing plant through its
subsidiary in the small country Farland, (where hitherto it was exporting) in view of growing
demand for its product and competition from other MNCs. The currency of Farland is the
Farroh (Fr.).

An initial investment of Fr. 80 million in plant and machinery would be required. In addition to
that the initial investment in working capital of Fr. 6 million would be also required which shall

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be financed through a loan from a local bank of Farland, at interest rate of 10% p.a. The
working capital shall also be subject to inflation. At the end of 5 years, the subsidiary would
be taken over by the Govt. of Farland for a price of Fr. 2 million. The part of the proceeds
would be used to pay off the bank loan.

It is expected that subsidiary shall produce Net Cash Flows from Operations of Fr. 30 million
per year at current price level over the five-year period, before allowing for Farland inflation
of 8% per year. Depreciation on Plant and Machinery shall be charged at 20% per year on
straight line basis. As a result of setting up the subsidiary, VK Ltd. expects to lose after-tax
export income from Farland of INR 8,00,000 per year in current price terms, before allowing
for India inflation of 3%. Profits in Farland are taxed at a rate of 20% after allowing
deduction for interest and depreciation. All after-tax cash profits are remitted to the India
at the end of each year. Indian tax @ 30% is charged on profit earned, but due to tax treaty
between Farland and the India the tax paid in Farland is allowed to be set off against any
India Tax liability. Taxation is paid in the year in which the liability arises. VK Ltd. requires
foreign investments to be discounted at 12%. The current exchange rate is Fr.2.5/INR and
the Farroh is expected to depreciate against INR by 5% per year.
Advise should VK Ltd. undertake the investment in Farland or not.
Note:- 1. Present Figures in thousands multiple.
2. Round off all calculations.
3. PVF @12%
Year 1 2 3 4 5
PVF 0.893 0.797 0.712 0.636 0.567
Solution:
Working Notes:
1. Calculation of the project cash flows for VK Ltd.’s subsidiary in Farland
Fr.’000
Year 0 1 2 3 4 5
Cash flows from operations 32400 34992 37791 40815 44080
Depreciation 16000 16000 16000 16000 16000
Interest 600 600 600 600 600
Profit before Tax 15800 18392 21191 24215 27480
Farland Tax 3160 3678 4238 4843 5496
Profit after Tax 12640 14714 16953 19372 21984
Add back Depreciation 16000 16000 16000 16000 16000
Initial Investment -80000 28640 30714 32953 35372 37984

Working Capital -6000 --- --- --- --- ---

Change in W.C. -480 -518 -560 -605 -653
Loan Capital -6000
Sale of Subsidiary --- --- --- --- --- 2000
-80000 28160 30196 32393 34767 33331

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2. Expected Exchange Rates

Year Rate
0 2.50
1 2.50 x 1.05 = 2.63
2 2.50 x (1.05)2 = 2.76
3 2.50 x (1.05)3 = 2.89
4 2.50 x (1.05)4 = 3.04
5 2.50 x (1.05)5 = 3.19

3. Calculation of Tax paid in India

Year 1 2 3 4 5
PBT (Fr) 15800 18392 21191 24215 27480
Tax @ 10% 1580 1839 2119 2422 2748
Exchange rate 2.63 2.76 2.89 3.04 3.19
Tax in India (INR ‘000) 601 666 733 797 861
Calculation Net Present Value (NPV) for VK Ltd.’s subsidiary at parent company level
Year 0 1 2 3 4 5
Project Cash Flows (Fr. '000) -80000 28160 30196 32393 34767 33331
Exchange Rate (Fr./INR) 2.50 2.63 2.76 2.89 3.04 3.19
Cash Invested from India (INR '000) -32000 -- -- -- -- --
Cash Received in India (INR '000) -- 10707 10941 11209 11437 10449
Tax in India (INR '000) 601 666 733 797 861
-32000 10106 10275 10476 10640 9588
Lost export after tax (INR '000) 824 849 874 900 927
Parent Cash Flow -32000 9282 9426 9602 9740 8661
PVF 1 0.893 0.797 0.712 0.636 0.567
-32000 8289 7513 6837 6195 4911
NPV 1745
Decision: Since NPV of the project is positive it should be accepted.

Question 3 (MTP/RTP/PP)
The ABC Startup has the following expected profits under different scenarios along
respective probabilities:
Year Best Case Base Case Worst Case
Revenue Expenses Revenue Expenses Revenue Expenses
1 ₹ 100,00,000 ₹ 80,00,000 ₹ 100,00,000 ₹ 90,00,000 ₹ 100,00,000 ₹ 95,00,000
2 ₹ 120,00,000 ₹ 92,40,000 ₹ 110,00,000 ₹ 95,70,000 ₹ 102,00,000 ₹ 98,94,000
3 ₹ 144,00,000 ₹ 108,00,000 ₹ 121,00,000 ₹ 102,85,000 ₹ 104,04,000 ₹ 101,95,920
Probability 30% 60% 10%
You are required to suggest the value of ABC Startup using First Chicago Method

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assuming that:
(i) Applicable discounting rate is 20%.
(ii) Startup is located in Tax-free Zone.
(iii) The multiple for Terminal is 10.
(iv) No depreciable assets are held by the ABC Startup.
Note: 1. Present Value Factor (PVF)
Year 1 2 3
PVF@20% 0.8333 0.6944 0.5787
2. Round off the calculation to whole numbers.
Solution:
Valuation of Startup under different scenarios:
(i) Best Case Scenario
Year 1 Year 2 Year 3
Revenue ₹ 100,00,000 ₹ 120,00,000 ₹ 144,00,000
Expenses ₹ 80,00,000 ₹ 92,40,000 ₹ 108,00,000
Cash Flow/ Earnings ₹ 20,00,000 ₹ 27,60,000 ₹ 36,00,000
Terminal Value ₹ 3,60,00,000
PVF @ 20% 0.8333 0.6944 0.5787 0.5787
PV ₹ 16,66,600 ₹ 19,16,544 ₹ 20,83,320 ₹ 2,08,33,200
Value of Startup
₹ 2,64,99,664

(ii) Base Case Scenario

Year 1 Year 2 Year 3
Revenue ₹ 100,00,000 ₹ 110,00,000 ₹ 121,00,000
Expenses ₹ 90,00,000 ₹ 95,70,000 ₹ 102,85,000

Cash Flow/ Earnings ₹ 10,00,000 ₹ 14,30,000 ₹ 18,15,000

Terminal Value ₹ 181,50,000
PVF @ 20% 0.8333 0.6944 0.5787 0.5787
PV ₹ 8,33,300 ₹ 9,92,992 ₹ 10,50,341 ₹ 105,03,405
Value of Startup ₹ 133,80,038

(iii) Worst Case Scenario

Year 1 Year 2 Year 3
Revenue ₹ 100,00,000 ₹ 102,00,000 ₹ 104,04,000
Expenses ₹ 95,00,000 ₹ 98,94,000 ₹ 101,95,920
Cash Flow/ Earnings ₹ 5,00,000 ₹ 3,06,000 ₹ 2,08,080
Terminal Value ₹ 20,80,800
PVF @ 20% 0.8333 0.6944 0.5787 0.5787

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PV ₹ 4,16,650 ₹ 2,12,486 ₹ 1,20,416 ₹ 12,04,159

Value of Startup ₹ 19,53,711

Value of ABC Startup as per First Chicago Method

= 0.30 x ₹ 2,64,99,664 + 0.60 x ₹ 133,80,038 + 0.10 x ₹ 19,53,711
= ₹ 79,49,899 + ₹ 80,28,023 + ₹ 1,95,371
= ₹ 1,61,73,293

Question 4 (MTP/RTP/PP)
JB Consultancy Group has determined relative utilities of cash flows of two forthcoming
projects of its client company as follows
Cash Flow in ₹ -150000 -100000 -40000 150000 100000 50000 10000
Utilities -100 -60 -3 40 30 20 10

The distribution of cash flows of project X and Project Y are as follows

Project X
Cash Flow (₹) -150000 - 100000 150000 100000 50000
Probability 0.10 0.20 0.40 0.20 0.10

Project Y
Cash Flow (₹) - 100000 -40000 150000 50000 100000
Probability 0.10 0.15 0.40 0.25 0.10
Which project should be selected and why?
Solution:
Evaluation of project utilizes of Project X and Project Y
Cash flow (in ₹) Project X
Probability Utility Utility value
-1,50,000 0.10 -100 -10
-1,00,000 0.20 -60 -12
1,50,000 0.40 40 16
1,00,000 0.20 30 6
50,000 0.10 20 2
2
Cash flow (in ₹) Project Y
Probability Utility Utility value
-1,00,000 0.10 -60 -6
-40,000 0.15 -3 -0.45
1,50,000 0.40 40 16
50,000 0.25 20 5
1,00,000 0.10 30 13
17.55
Project Y should be selected as its expected utility is more.

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