Chapter 1

No problems, only review questions

Chapter 2
PROBLEMS

1.

Determine the future values utilizing a time preference rate of 9 per cent: (i) The future value of Rs 15,000 invested now for a period of four years. (ii) The future value at the end of five years of an investment of Rs 6,000 now and of an investment of Rs 6,000 one year from now. (iii) The future value at the end of eight years of an annual deposit of Rs 18,000 each year. (iv) The future value at the end of eight years of annual deposit of Rs 18,000 at the beginning of each year. (v) The future values at the end of eight years of a deposit of Rs 18,000 at the end of the first four years and withdrawal of Rs 12,000 per year at the end of year five through seven. 2. Compute the present value of each of the following cash flows using a discount rate of 13 per cent: (i) Rs 2,000 cash outflow immediately. (ii) Rs 6,000 cash inflow one year from now. (iii) Rs 6,000 cash inflow two years from now. (iv) Rs 4,000 cash outflow three years from now. (v) Rs 7,000 cash inflow three years from now. (vi) Rs 3,000 cash inflow four years from now. (vii) Rs 4,000 cash inflow at the end of each of the next five years. (viii) Rs 4,000 cash inflow at the beginning of each of the next five years. 3. Determine the present value of the cash inflows of Rs 3,000 at the end of each year for next 4 years and Rs 7,000 and Rs 1,000 respectively at the end of years 5 and 6. The appropriate discount rate is 14 per cent. 4. Assume an annual rate of interest of 15 per cent. The sum of Rs 100 received immediately is equivalent to what quantity received in ten equal annual payments, the first payment to be received one year from now. What could be the annual amount if the first payment were received immediately? 5. Assume a rate of interest of 10 per cent. We have a debt to pay and are given a choice of paying Rs 1,000 now or some amount X five years from now. What is the maximum amount that X can be for us to be willing to defer payment for five years? 6. We can make an immediate payment now of Rs 13,000 or pay equal amount of A for the next 5 years, first payment being payable after 1 year. (a) With a time value of money of 12 per cent, what is the maximum value of A that we would be willing to accept? (b) What maximum value of A we would be willing to accept if the payments are made in the beginning of the year? 7. Assume that you are given a choice between incurring an immediate outlay of Rs 10,000 and having to pay Rs 2,310 a year for 5 years (first payment due one year from now); the discount rate is 11 per cent. What would be your choice? Will your answer change if Rs 2,310 is paid in the beginning of each year for 5 years? 8. Compute the present value for a bond that promises to pay interest of Rs 150 a year for thirty years and Rs 1,000 at maturity. This first interest payment is paid one year from now. Use a rate of discount of 8 per cent. 9. Exactly twenty years from now Mr Ahmed will start receiving a pension of Rs 10,000 a year. The payment will continue for twenty years. How much is pension worth now, assuming money is worth 15 per cent per year? 10. Using an interest rate of 10 per cent, determine the present value of the following cash flow series:
End of period 0 16 (each period) 7 8 912 (each period) Cash-flow (Rs) 10,000 + 2,000 1,500 + 1,600 + 2,500

11. Find the rate of return in the following cases: (i) You deposit Rs 100 and would receive Rs 114 after one year. (ii) You borrow Rs 100 and promise to pay Rs 112 after one year. (iii) You borrow Rs 1,000 and promise to pay Rs 3,395 at the end of 10 years. (iv) You borrow Rs 10,000 and promise to pay Rs 2,571 each year for 5 years.

12. A bank has offered a deposit scheme, which will triple your money in 9 years; that is, if you deposit Rs 100 today, you can receive Rs 300 at the end of 9 years. What rate of return would you earn from the scheme? 13. You have Rs 6,000 to invest. How much would it take you to double your money if the interest rate is ( a) 6%, (b) 10%, (c) 20%, and (d) 30%? Assume annual compounding. Would your answer change if compounding is done half-yearly? Show computations. 14. You had annual earnings of Rs 45,000 in 19X1. By 19X8, your annual earnings have grown to Rs 67,550. What has been the compound annual rate of growth in your earnings? 15. You are planning to buy a 200 square meters of land for Rs 40,000. You will be required to pay twenty equal annual instalments of Rs 8,213. What compound rate of interest will you be paying? 16. Jai Chand is planning for his retirement. He is 45 years old today, and would like to have Rs 3,00,000 when he attains the age of 60. He intends to deposit a constant amount of money at 12 per cent at each year in the public provident fund in the State Bank of India to achieve his objective. How much money should Jai Chand invest at the end of each year for the next 15 years to obtain Rs 3,00,000 at the end of that period? 17. (a) At age 20, how much should one invest at the end of each year in order to have Rs 10 lakh at age 50, assuming 10 per cent annual growth rate? (b) At age 20, how much lump sum should one invest now in order to have 10 lakh at the age of 50, assuming 10 per cent annual growth rate? 18. Your grandfather is 75 years old. He has total savings of Rs 80,000. He expects that he will live for another 10 years, and will like to spend his savings by then. He places his savings into a bank account earning 10 per cent annually. He will draw equal amount each year the first withdrawal occurring one year from nowin such a way that his account balance becomes zero at the end of 10 years. How much will be his annual withdrawal? 19. You buy a house for Rs 5 lakh and immediately make cash payment of Rs 1 lakh. You finance the balance amount at 12 per cent for 20 years with equal annual instalments. How much are the annual instalments? How much of the each payment goes towards reducing the principal? 20. You plan to buy a flat for Rs 200,000 by making Rs 40,000 down payment. A house financing company offers you a 12-year mortgage requiring end-of-year payments of Rs 28,593. The company also wants you to pay Rs 5,000 as the loan-processing fee, which they will deduct from the amount of loan given to you. What is the rate of interest on loan? 21. An investment promises to pay Rs 2,000 at the end of each year for the next 3 years and Rs 1,000 at the end of each year for years 4 through 7. ( a) What maximum amount will you pay for such investment if your required rate is 13 per cent? (b) If the payments are received at the beginning of each year, what maximum amount will you pay for investment? 22. Mr Sundaram is planning to retire this year. His company can pay him a lump sum retirement payment of Rs 2,00,000 or Rs 25,000 lifetime annuitywhichever he chooses. Mr Sundaram is in good health and estimates to live for at least 20 more years. If his interest rate is 12 per cent, which alternative should he choose? 23. Which alternative would you choose: (a) an annuity of Rs 5,000 at the end of each year for 30 years; ( b) an annuity of Rs 6,600 at the end of each year for 20 years; ( c) Rs 50,000, in cash right now? In each case, the time value of money is 10 per cent. 24. Ms. Punam is interested in a fixed annual income. She is offered three possible annuities. If she could earn 8 per cent on her money elsewhere, which of the following alternatives, if any, would she choose? Why? ( i) Pay Rs 80,000 now in order to receive Rs 14,000 at the end of each year for the next 10 years. (ii) Pay Rs 1,50,000 now in order to receive Rs 14,000 at the end of each year for the next 20 years. ( iii) Pay Rs 1,20,000 now in order to receive Rs 14,000 at the end of each year for the next 15 years. 25. You have come across the following investment opportunity: Rs 2,000 at the end of each year for the first 5 years plus Rs 3,000 at the end of each year from years 6 through 9 plus Rs 5,000 at the end of each year from years 10 through 15. (a ) How much will you be willing to pay for this investment if your required rate of return is 14 per cent? (b) What will be your answer if payments are received at the beginning of each year? 26. You have borrowed a car loan of Rs 50,000 from your employer. The loan requires 10 per cent interest and five equal end-of-year payments. Prepare a loan amortisation schedule. 27. If the nominal rate of interest is 12 per cent per annum, calculate the effective rate of interest when a sum is compounded (a) annually, (b) semi-annually, (c) quarterly, and (d) monthly. 28. What amount would an investor be willing to pay for Rs 1,000, ten-year debenture that pays Rs 75 interest halfyearly and is sold to yield 18 per cent? 29. The Madura Bank pays 12 per cent interest and compounds interest quarterly. If one puts Rs 1,000 initially into a savings account, how much will it have grown in 7 years?

30. An already issued government bond pays Rs 50 interest half-yearly. The bond matures in 7 years. Its face value is Rs 1,000. A newly issued bond, which pays 12 per cent annually, can also be bought. How much would you like to pay for the old bond? How much would you pay for the bond if it is redeemed at a premium of 10 per cent? 31. If you deposit Rs 10,000 in an account paying 8 per cent interest per year compounded quarterly and you withdraw Rs 100 per month, (a) How long will the money last? (b) How much money will you receive? 32. XY Company is thinking of creating a sinking fund to retire its Rs 800,000 preference share capital that matures on 31 December 19X8. The company plans to put a fixed amount into the fund at the end of each year for eight years. The first payment will be made on 31 December 19X1, and the last on 31 December 19X8. The company expects that the fund will earn 12 per cent a year. What annual contribution must be made to accumulate to Rs 8,00,000 as of 31 December 19X8? What would be your answer if the annual contribution is made in the beginning of the year, the first payment being made on 31 December 19X0? 33. In January 19X1, X Ltd issued Rs 10 crore of five-year bonds to be matured on 1 January 19X6. The interest was payable semi-annually on January 1 and July 1; the interest rate was 14 per cent per annum. Assume that on 1 January 19X2, new four-year bond of equivalent risk could be purchased at face value with an interest rate of 12 per cent and that you had purchased a Rs 1,000 X Ltd bond when the bonds were originally issued. What would be its market value on January 1, 19X2? 34. You want to buy a 285-litre refrigerator of Rs 10,000 on an instalment basis. A distributor of various makes of refrigerators is prepared to do so. He states that the payments will be made in four years, interest rate being 13%. The annual payments would be as follows:
Rs Principal Four years of interest at 13%, i.e., Rs 10,000 0.13 4 5,200 15,200 Annual payments, Rs 15,200/4 3,800 10,000

What rate of return the distributor is earning? 35. You have approached a loan and chit fund company for an eight-year loan of Rs 10,000; payments to the company to be made at the end of year. The loan officer informs you that the current rate of interest on the loan is 12% and that the annual payment will be Rs 2,013. Show that this annual cash flow provides a rate of return of 12% on the banks investment of Rs 1 0,000. Is 12% the true interest rate to you? In other words, if you pay interest of 12% on your outstanding balance each year, will the remainder of the Rs 2,013 payments be just sufficient to repay the loan? 36. If a person deposits Rs 1,000 on an account that pays him 10 per cent for the first five years and 13 per cent for the following eight years, what is the annual compound rate of interest for the 13-year period?

Chapter 3
PROBLEMS

1. Suppose you buy a one-year government bond that has a maturity value of Rs 1,000. The market interest rate is 8 per cent. (a) How much will you pay for the bond? ( b) If you purchased the bond for Rs 904.98, what interest rate will be you earn on your investment? 2. The Brightways Company has a perpetual bond that pay Rs 140 interest annually. The current yield on\ this type of bond is 13 per cent. (a) At what price will it sell? (b) If the required yield rises to 15 per cent, what will be the new price? 3. The Nutmate Limited has a ten-year debenture that pays Rs 140 annual interest. Rs 1,000 will be paid on maturity. What will be the value of the debenture if the required rate of interest is ( a) 12 per cent, (b) 14 per cent and (c) 16 per cent? 4. What will be the yield of a 16 per cent perpetual bond with Rs 1,000 par value, when the current price is ( a) Rs 800, (b) Rs 1,300 or (c) Rs 1,000? 5. You are considering bonds of two companies. Taxcos bond pays interest at 12 per cent and Maxcos at 6 per cent per year. Both have face value of Rs 1,000 and maturity of three years. ( a) What will be the values of bonds if the market interest rate is 9 per cent? ( b) What will be the values of the bonds if the market interest rate increases to 12 per cent? (c) Which bond declines more in the value when the interest rate rises? What is the

reason? (d) If the interest rate falls to 6 per cent, what are the values of bonds? ( e) If the maturity of two bonds is 8 years (rather than 3 years), what will be the values of two bonds if the market interest rate is ( a) 9 per cent, (b) 6 per cent and (c) 12 per cent? 6. Three bonds have face value of Rs 1,000, coupon rate of 12 per cent and maturity of 5 years. One pays interest annually, one pays interest half-yearly, and one pays interest quarterly. Calculate the prices of bonds if the required rate of return is (a) 10 per cent, (b) 12 per cent and (c) 16 per cent. 7. On 31 March 2003, Hind Tobacco Company issued Rs 1,000 face value bonds due 31 March 2013. The company will not pay any interest on the bond until 31 March 2008. The half-yearly interest is payable from 31 December 2008; the annual rate of interest will be 12 per cent. The bonds will be redeemed at 5 per cent premium on maturity. What is the value of the bond if the required rate of return is 14 per cent? 8. Determine the market values of the following bonds, which pay interest semi-annually:
Bond A B C D Interest Rate Required Rate Maturity Period (Years) 16% 14% 12% 12% 15% 13% 8% 8% 25 15 20 10

9. 10.

11.

12.

13.

14.

15. 16.

17.

If the par values of bonds are Rs 100 and if they are currently selling for Rs 95, Rs 100, Rs 110 and Rs 115, respectively, determine the effective annual yields of the bonds? Also calculate the semi-annual yields? A 20-year 10% Rs 1,000 bond that pays interest half-yearly is redeemable (callable) in twelve years at a buyback (call) price of Rs 1,150. The bonds current yield to maturity is 9.50% annually. You are required to determine (i) the yield to call, (ii) the yield to call if the buy-back price is only Rs 1,100, and (iii) the yield to call if instead of twelve years the bond can be called in eight years, buy-back price being Rs 1,150. A fertilizer company holds 15-year 15% bond of ICICI Bank Ltd. The interest is payable quarterly. The current market price of the bond is Rs 875. The company is going through a bad patch and has accumulated a substantial amount of losses. It is negotiating with the bank the restructuring of debt. Recently the interest rates have fallen and there is a possibility that the bank will agree for reducing the interest rate to 12 per cent. It is expected that the company will be able service debt t the reduce interest rates. Calculate stated and the expected yields to maturity? You are thinking of buying BISCOs a preference share Rs 100 par value that will pay a dividend of 12 per cent perpetually. (a) What price should you pay for the preference share if you are expecting a return of 10 per cent? (b) Suppose that BISCO can buy back the share at a price of Rs 110 in seven years. What maximum price should you pay for the preference share? The share of Premier Limited will pay a dividend of Rs 3 per share after a year. It is currently selling at Rs 50, and it is estimated that after a year the price will be Rs 53. What is the present value of the share if the required rate of return is 10 percent? Should the share be bought? Also calculate the return on share if it is bought, and sold after a year. An investor is looking for a four-year investment. The share of Skylark Company is selling for Rs 75. They have plans to pay a dividend of Rs 7.50 per share each at the end of first and second years and Rs 9 and Rs 15 respectively at the end of third and fourth years. If the investors capitalisation rate is 12 percent and the shares price at the end of fourth year is Rs 70, what is the value of the share? Would it be a desirable investment? A companys share is currently selling at Rs 60. The company in the past paid a constant dividend of Rs 1.50 per share, but it is now expected to grow at 10 per cent compound rate over a very long period. Should the share be purchased if required rate of return is 12 per cent? The earnings of a company have been growing at 15 per cent over the past several years and are expected to increase at this rate for the next seven years and thereafter, at 9 per cent in perpetuity. It is currently earning Rs 4 per share and paying Rs 2 per share as dividend. What shall be the present value of the share with a discount rate of 12 per cent for the first seven years and 10 per cent thereafter? A company retains 60 per cent of its earnings, which are currently Rs 5 per share. Its investment opportunities promise a return of 15 per cent. What price should be paid for the share if the required rate of return is 13 per cent? What is the value of growth opportunities? What is the expected rate of return from the share if its current market price is Rs 60?

18. The total assets of Rs 80,000 of a company are financed by equity funds only. The internal rate of return on assets is 10 per cent. The company has a policy of retaining 70 per cent of its profits. The capitalisation rate is 12 per cent. The company has 10,000 shares outstanding. Calculate the present value per share. 19. A prospective investor is evaluating the share of Ashoka Automobiles Company. He is considering three scenarios. Under first scenario the company will maintain to pay its current dividend per share without any increase or decrease. Another possibility is that the dividend will grow at an annual (compound) rate of 6 per cent in perpetuity. Yet another scenario is that the dividend will grow at a high rate of 12 per cent per year for the first three years; a medium rate of 7 per cent for the next three years and thereafter, at a constant rate of 4 per cent perpetually. The last years dividend per share is Rs 3 and the current market price of the share is Rs 80. If the investors required rate of return is 10 per cent, calculate the value of the share under each of the assumptions. Should the share be purchased? 20. Vikas Engineering Ltd has current dividend per share of Rs 5, which has been growing at an annual rate of 5 per cent. The company is expecting significant technical improvement and cost reduction in its operations, which would increase growth rate to 10 per cent. Vikas capitalisation rate is 15 per cent. You are required to calculate (a) the value of the share assuming the current growth rate; and ( b) the value of the share if the company achieves technical improvement and cost reduction. Does the price calculated in ( b) make a logical sense? Why? 21. Consider the following data of four auto (two / three-wheelers) companies.
Companies 1. Bajaj 2. Hero Honda 3. Kinetic 4. Maharashtra Scooters EPS (Rs) 11.9 10.2 12.0 20.1 DIV (%) 50 22 25 25 Share Price (Rs) 275.00 135.00 177.50 205.00

The face value of each companys share is Rs 10. Explain the relative performance of the four companies. 22. The dividend per share of Skyjet Company has grown from Rs 3.5 to Rs 10.5 over past 10 years. The share is currently selling for Rs 75. Calculate Skyjets capitalisation rate. 23. Rama Tours and Travels Limited has current earnings per share of Rs 8.60, which has been growing at 12 per cent. The growth rate is expected to continue in future. Rama has a policy of paying 40 per cent of its earnings as dividend. If its capitalisation rate is 18 per cent, what is the value of the share? Also calculate value of growth opportunities. 24. A company has the following capital in its balance sheet: (a) 12-year 12% secured debentures of Rs 1,000 each; principal amount Rs 50 crore (10 million = crore); the required rate of return (on debentures of similar risk) 10 per cent; (b) 10-year 14% unsecured debentures of Rs 1,000 each; principal amount Rs 30 crore; interest payable half-yearly; the required rate of return 12 per cent; ( c) preference share of Rs 100 each; preference dividend rate 15%; principal amount Rs 100 crore; required rate of return 13.5 per cent; and ( d) ordinary share capital of Rs 200 crore at Rs 100 each share; expected dividend next year, Rs 12; perpetual dividend growth rate 8 per cent; the required rate of return 15 per cent. Calculate the market values of all securities. 25. Satya Systems Company has made net profit of Rs 50 crore. It has announced to distribute 60 per cent of net profit as dividend to shareholders. It has 2 crore ordinary shares outstanding. The companys share is currently selling at Rs 240. In the past, it had earned return on equity of 25 per cent and expects to main this profitability in the future as well. What is the required rate of return on Satyas share? 26. A company has net earnings of Rs 25 million (1 crore = 10 million). Its paid-up share capital is Rs 200 million and the par value of share is Rs 10. If the company makes no new investments, its earnings are expected to grow at 2 per cent per year indefinitely. It does have an investment opportunity of investing Rs 10 million that would generate annual net earnings of Rs 2 million (1 million = 10 lakh) for next 15 years. The companys opportunity cost of capital is 10 per cent. You are required: ( a) to find the share value if the company does not make the investment; (b) to calculate the proposed investme nts NPV; and (c) to determine the share value if the investment is undertaken? 27. Gujarat Bijali Ltd has earnings of Rs 80 crore and it has 5 crore shares outstanding. It has a project that will produce net earnings of Rs 20 crore after one year. Thereafter, earnings are expected to grow at 8 per cent per annum indefinitely. The companys required rate of return is 12.5 per cent. Find the P/E ratio.

28. Symphony Limited is an all-equity financed company. It has 10 million shares outstanding, and is expected to earn net cash profits of Rs 80 million. Shareholders of the company have an opportunity cost of capital of 20 per cent. (a) Determine the company share price if it retained 40 per cent of profits and invested these funds to earn 20 per cent return. Will the share price be different if the firm retained 60 per cent profits to earn 20 per cent? (b) What will be the share price if investments made by the company earn 24 per cent and it retains 40 per cent of profits? Will share price change if retention is 60 per cent? 29. Sonata Company has no investment opportunities. It expects to earn cash earnings per share of Rs 10 perpetually and distribute entire earnings as dividends to shareholders.( a) What is the value of the share if shareholders opportunity cost of capital is 15 per cent? (b) Suppose the company discovers an opportunity to expand its existing business. It estimates that it will need to invest 50 per cent of its earnings annually for ten years to produce 18 per cent return. Management does not foresee any growth after this ten-year period. What will be Sonatas share price if shareholders opportunity cost of capital is 15 per cent?