Suggested Answers: May 2005

Final Course : Group 1

PAPER 2 : MAAGEME! ACC"#!$G A% F$AC$A& AA&'S$S
Question No. 1 is compulsory. Answer any four questions from the rest. Figures in the
margin indicate marks allotted to each questions.
Working notes should form part of the answer.
(uestion 1
ABC Ltd. is considering a proposal to acquire a machine costing s. 1!1"!""" paya#le
s. 1"!""" down and #alance paya#le in 1" annual equal instalments at the end of each year
inclusi$e of interest chargea#le at 1%&. Another option #efore it is to acquire the asset on a
lease rental of s. 1%!""" per annum paya#le at the end of each year for 1" years. 'he
following information is also a$aila#le.
(i) 'erminal *crap $alue of s. +"!""" is reali,a#le! if the asset is purchased.
(ii) 'he company pro$ides 1"& depreciation on straight line method on the original cost.
(iii) -ncome ta. rate is %"&.
/ou are required to compute the analyse cash flows and to ad$ise as to which option is
#etter. (+" marks)
Answer
"ption $ : !o )uy t*e asset:
In this option the firm has to pay Rs. 10,000 down and the balance Rs. 1,00,000 together
with interest @ 15% is payable in 10 annual equal instalments. he instalment amount may
be calculated by di!iding Rs. 1,00,000 by the "#$% for 10 years at 15% i.e.
$nnual repayment & Rs. 1,00,000'5.01(( & Rs. 1),)*5
he cash flows of the borrowing and purchase option may be computed as follows+
/ear -nstalment -nterest epayment Balance
s. s. s. s.
1 1),)*5 15,000 ,,)*5 )5,0-5
* 1),)*5 1,,*.1 5,.., (),,11
/ 1),)*5 1/,,1* .,51/ (*,()(
, 1),)*5 1*,,/5 -,,)0 -5,,0(
5 1),)*5 11,/11 (,.1, ..,-),
. 1),)*5 10,01) ),)0. 5.,(((
- 1),)*5 (,5// 11,/)* ,5,,).
( 1),)*5 .,(*, 1/,101 /*,/)5
FINAL EXAMINATION : MAY, 2005
) 1),)*5 ,,(5) 15,0.. 1-,/*)
10 1),)*5 *,5).0 1-,/*)
+ 1ifference between the outstanding balance and the last instalment 2i.e. Rs. 1),)*5 3
Rs. 1-,/*) & Rs. *,5).4
/ear -nstalmen
t
-nterest 0epreciation 'a. *hield
%"& (+ 1 2)
Net CF
(134)
56F 56
(1) (+) (2) (4) (%) (7) (8)
s. s. s. s. s. s.
0 10,000 1.000 10,000
1 1),)*5 15,000 11,000 1/,000 .,)*5 .(-0 .,0*5
* 1),)*5 1,,*.1 11,000 1*,./1 -,*), .-5. 5,51,
/ 1),)*5 1/,,1* 11,000 1*,*0. -,-1) ..5( 5,0-)
, 1),)*5 1*,,/5 11,000 11,-1( (,*0- .5-* ,,.),
5 1),)*5 11,/11 11,000 11,15. (,-.) .,)- ,,/5(
. 1),)*5 10,01) 11,000 10,510 ),,15 .,/* ,,0.-
- 1),)*5 (,5// 11,000 ),-.- 10,15( ./-. /,(1)
( 1),)*5 .,(*, 11,000 (,)1* 11,01/ ./*- /,.01
) 1),)*5 ,,(5) 11,000 -,)/0 11,))5 .*(, /,,0-
10 1),)*5 *,5). 11,000 .,-)( 1/,1*- .*,- /,*,*
"resent !alue of total outflows 5/,(0.
10 5al!age !alue 2after ta64 10,000 .*,- 7*,,-0
8et present !alue of outflows 51,//.
It may be noted that 2i4 depreciation of Rs. 11,000 has been pro!ided for all the 10 years.
his is 10% of the original cost of Rs. 1,10,000. 2ii4 he asset is fully depreciated during its life
of 10 years, therefore, the boo9 !alue at the end of 10th year would be :ero. $s the asset is
ha!ing a sal!age !alue of Rs. *0,000, this would be capital gain and presuming it to be ta6able
at the normal rate of 50%, the net cash inflow on account of sal!age !alue would be Rs.
10,000 only. his is further discounted to find out the present !alue of this inflow.
"ption $$ E,aluation o- &ease "ption:
In case the asset is acquired on lease, there is a lease rent of Rs. 15,000 payable at the
end of ne6t 10 years. his lease rental is ta6 deductible, therefore, the net cash outflow would
be only Rs. -,500 2after ta64. he "#$% for 10 years @ 15% is 5.01((. 5o, the present !alue
of annuity of Rs. -,500 is
24
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
"resent !alue of annuity of outflow & Rs. -,500 5.01(( & Rs. /-,.,1.
Ad,i.e:
If the firm opts to buy the asset, the present !alue of outflow comes to Rs. 51,//.; and in
case of lease option, the present !alue of outflows comes to Rs. /-,.,1. <ence, the firm
should opt for the lease option. In this way, the firm will be able to reduce its costs by Rs.
1/,.)5 i.e. Rs. 51,//. 3 Rs. /-,.,1. his may also be referred to as 8et =enefit of >easing.
8ote+ 5tudents may also discount cash flows under both alternati!es at after ta6 cost i.e. 15%
21 3 054 & -.5%. 1iscounting will not ha!e any impact on this decision since any discount
factor will lead to p! of lease to be less than that of p! of debt4.
(uestion 2
(a) 9/: Ltd. is considering merger with ABC Ltd. 9/: Ltd.;s shares are currently traded at
s. +%. it has +!""!""" shares outstanding and its earning after ta.es (<A') amount to
s. 4!""!""". ABC Ltd. has 1!""!""" shares outstanding= its current market price is s.
1+.%" and its <A' is s. 1!""!""". 'he merger will #e effected #y means of a stock
swap (e.change). ABC Ltd. has agreed to a plan under which 9/: Ltd. will offer the
current market $alue of ABC Ltd.;s shares.
(i) >hat is the pre3merger earnings per share (<5*) and 5?< ratios of #oth the
companies@
(ii) -f ABC Ltd.;s 5?< ratio is A! what is its current market price@ >hat is the e.change
ratio@ >hat will 9/: Ltd.;s post merger <5* #e@
(iii) >hat must the e.change ratio #e for 9/: Ltd.;s pre3merger and post3merger <5*
to #e the same@
(#) A Company pays a di$idend of s. +."" per share with a growth rate of 8&. 'he risk
free rate is B& and the market rate of return is 12&. 'he Company has a #eta factor of
1.%". Cowe$er! due to a decision of the Finance Danager! #eta is likely to increase to
1.8%. Find out the present as well as the likely $alue of the share after the decision.
2c) B- sold a B1 day '3#ill of face $alue of s. 1"" at an yield of 7&. >hat was the issue
price@
(d) <.plain the term EFffer for *aleG. (A 1 7 1 + 1 4 H +"
marks)
Answer
/a0 Merger and EPS
Company 9/: ABC
s. s.
25
FINAL EXAMINATION : MAY, 2005
?ar9et price of equity shares *5.00 1*.50
8o. of equity shares outstanding *,00,000 1,00,000
@arning after ta6 ,,00,000 1,00,000
2i4
@"5 & Rs.
shares *,00,000
,,00,000
,
shares 1,00,000
1,00,000 Rs.
&
*.00 1.00
"'@ ratio & Rs. *5'*, 1*.50'1 1*.5 1*.5
2ii4 2a4 If $=A >td. "'@ ratio is (, its current mar9et price will be Rs. ( only 2( 14.
2b4 hen the e6change ratio will be ('*5 i.e. /*'100. %or e!ery 100 shares of
$=A, /* shares of BCD will be issued 21,00,000 /*4'100 & /*,000
shares of BCD will be issued to all the shareholders of $=A >td.
2c4 "ost merger @"5 of BCD >td. & otal earning'otal shares &
5,00,000'*,/*,000 equity shares & Rs. *.1..
2iii4 otal earnings Rs. 5,00,000'@"5 Rs. * & *,50,000 equity shares i.e. 50,000
shares of BCD will ha!e to be issued to the shareholders of $=A i.e. one share
of BCD will be issued for e!ery two shares held by $=A shareholders.
hen preEmerger and postEmerger @"5 of BCD will be same as follows+
"reEmerger @"5 of BCD Rs. *.00
"ostEmerger @"5 of BCD Rs. 5,00,000'*,50,000 equity shares
& Rs. *.00
/)0 In order to find out the !alue of a share with constant growth model, the !alue of Fe
should be ascertained with the help of GA$"?H model as follows+
Fe & Rf 7 2Fm 3 Rf4
Ihere,
Fe & Aost of equity
Rf & Ris9 free rate of return
& "ortfolio =eta i.e. mar9et sensiti!ity inde6
Fm & @6pected return on mar9et portfolio
=y substituting the figures, we get
Fe & 0.0) 7 1.5 20.1/ 3 0.0)4
& 0.15 or 15%
and the !alue of the share as per constant growth model is
26
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
g4 E 29
1
"
e
1
0
=
Ihere,
"0 & "rice of a share
11 & 1i!idend at the end of the year 1
Fe & Aost of equity
J & growth
g4 E 29
*.00
"
e
0
=
0.0- E 0.15
*.00
"
0
=
& Rs. *5.0
<owe!er, if the decision of finance manager is implemented, the beta 2 4 factor is li9ely
to increase to 1.-5 therefore, Fe would be
Fe & Rf 7 2Fm 3 Rf4
& 0.0) 7 1.-5 20.1/ 3 0.0)4
& 0.1. or 1.%
he !alue of share is
g4 E 29
1
"
e
1
0
=
0.0- E 0.1.
*.00
"
0
=
& Rs. **.**
/.0 >et the issue price be B
=y the terms of the issue of the Ebills.
100
)1
/.5

6
6 E 100
% . =
( ) 6 E 100
/.,500
6 )1 .
% . =

=
& 0.01,). 6 & 100 3 6
)(.5/ Rs.
1.01,).
100
6 = =
27
FINAL EXAMINATION : MAY, 2005
/d0 Kffer for sale is also 9nown as bought out deal 2=K14. It is a new method of offering
equity shares, debentures etc., to the public. In this method, instead of dealing directly
with the public, a company offers the shares'debentures through a sponsor. he sponsor
may be a commercial ban9, merchant ban9er, an institution or an indi!idual. It is a type
of wholesale of equities by a company. $ company allots shares to a sponsor at an
agreed price between the company and sponsor. he sponsor then passes the
consideration money to the company and in turn gets the shares duly transferred to him.
$fter a specified period as agreed between the company and sponsor, the shares are
issued to the public by the sponsor with a premium. $fter the public offering, the sponsor
gets the shares listed in one or more stoc9 e6changes. he holding cost of such shares
by the sponsor may be reimbursed by the company or the sponsor may get the profit by
issue of shares to the public at premium.
hus, it enables the company to raise the funds easily and immediately. $s per 5@=I
guidelines, no listed company can go for =K1. $ pri!ately held company or an unlisted
company can only go for =K1. $ small or medium si:e company which needs money
urgently chooses to =K1. It is a low cost method of raising funds. he cost of public
issue is around (% in India. =ut this method lac9s transparency. here will be scope for
misuse also. =esides this, it is e6pensi!e li9e the public issue method. Kne of the most
serious short coming of this method is that the securities are sold to the in!esting public
usually at a premium. he margin thus between the amount recei!ed by the company
and the price paid by the public does not become additional funds of the company, but it
is poc9eted by the issuing houses or the e6isting shareholders.
(uestion 1
(a) A firm has proIected the following cash flows from a proIect under e$aluationJ
/ear s. lakhs
" (8")
1 2"
+ 4"
2 2"
'he a#o$e cash flows ha$e #een made at e.pected prices after recogni,ing inflation.
'he firm;s cost of capital is 1"&. 'he e.pected annual rate of inflation is %&.
*how how the $ia#ility of the proIect is to #e e$aluated.
(#) >rite a note a#out the functions of merchant #ankers.
(c) 'he following figures are collected from the annual report of 9/: Ltd.J
s.
Net 5rofit 2" lakhs
28
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
Futstanding 1+& preference shares 1"" lakhs
No. of equity shares 2 lakhs
eturn on -n$estment +"&
>hat should #e the appro.imate di$idend pay3out ratio so as to keep the share price at
s. 4+ #y using >alter model@ (A 1 7 1 7 H +"
marks)
Answer
/a0 It is stated that the cash flows ha!e been adLusted for inflation; hence they are MnominalN.
he cost of capital or discount rate is MrealN. In order to be compatible, the cash flows
should be con!erted into Mreal flowN. his is done as below+
/ea
r
Nominal
cash flows
AdIusted
-nflationK
factor
eal cash
flows
56F L 1"& 56 of cash
flows
0 2-04 2-04 1.000 2-04
1 /0 0.)5* *(.5. 0.)0) *5.).
* ,0 0.)0- /..*( 0.(*. *).)-
/ /0 0.(., *5.)* 0.-51 1).,-
otal -5.,0
LessJ Aash out flow -0.00
8"# 274 5.,0

0 1'1.05; 1'21.054
*
; 1'21.054
/
;
with positi!e 8"#, the proLect is financially !iable.
$lternati!ely, instead of con!erting cash flows into real terms, the discount rate can be
con!erted into nominal rate. Result will be the same.
$n alternati!e solution is presented herewith
Alternati,e solution:
/ear Nominal cash flows 56F L 1"& adIusted #y the
inflation factor i.e. %&K
56 of cash flows
0 2-04 1.000 2-04
1 /0 0.(.. *5.)(
* ,0 0.-,) *).).
/ /0 0..,) 1).,-
29
FINAL EXAMINATION : MAY, 2005
Aash inflow -5.,1
>ess+ Aash out flow -0.00
8et present !alue 5.,1
0 0..,)
1.15-.
0.-51
0.-,),
1.10*5
0.(*.
0.(..,
05 . 1
)0) . 0
= = =
with positi!e 8"#, the proLect is financially !iable.
/)0 Fun.tions o- Mer.*ant 2an3ers:
he basic function of merchant ban9er or in!estment ban9er is mar9eting of corporate
and other securities. In the process, he performs a number of ser!ices concerning
!arious aspects of mar9eting, !i:., origination, underwriting, and distribution, of
securities. 1uring the regime of erstwhile Aontroller of Aapital Issues in India, when new
issues were priced at a significant discount to their mar9et prices, the merchant ban9erHs
Lob was limited to ensuring press co!erage and dispatching subscription forms to e!ery
corner of the country. 8ow, merchant ban9ers are designing inno!ati!e instruments and
perform a number of other ser!ices both for the issuing companies as well as the
in!estors. he acti!ities or ser!ices performed by merchant ban9ers, in India, today
include+
1. "roLect promotion ser!ices.
*. "roLect finance.
/. ?anagement and mar9eting of new issues.
,. Onderwriting of new issues.
5. 5yndication of credit.
.. >easing ser!ices.
-. Aorporate ad!isory ser!ices.
(. "ro!iding !enture capital.
). Kperating mutual funds and off shore funds.
10. In!estment management or portfolio management ser!ices.
11. =ought out deals.
1*. "ro!iding assistance for technical and financial collaborations and Loint !entures.
1/. ?anagement of and dealing in commercial paper.
1,. In!estment ser!ices for nonEresident Indians.
/.0 s. in lakhs
30
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
8et "rofit /0
LessJ "reference di!idend 1*
@arning for equity shareholders 1(
herefore earning per share 1('/ & Rs. ..00
Aost of capital i.e. 29e4
2$ssumed4 1.%
>et, the di!idend pay out ratio be B and so the share price will be+
e
e
e
F
F
14 E r2@

F
1
" + =
<ere 1 & .6; @ & Rs. .; r & 0.*0 and Fe & 0.1. and " & Rs. ,*
0.1. 0.1.
.64 E 2. 0.*

0.1.
.6
,* Rs. <ence

+ =
or Rs. ,* & /-.50B 7 ,..(-5 21 364
& )./-56 & ,.(-5
6 & 0.5*
5o, the required di!idend payout ratio will be & 5*%
(uestion 4
2a) Fn Manuary +A! +""% an importer customer requested a #ank to remit *ingapore 0ollar
(*N0) +%!""!""" under an irre$oca#le LC. Cowe$er! due to #ank strikes! the #ank could
effect the remittance only on Fe#ruary 4! +""%. 'he inter#ank market rates were as
followsJ
Manuary! +A Fe#ruary 4
Bom#ay O*P1 H s. 4%.A%?4%.B" 4%.B1?4%.B8
London 5ound 1 H O*P 1.8A4"?1.8A%" 1.887%?1.888%
5ound 1 H *N0 2.1%8%?2.1%B" 2.12A"?2.12B"
'he #ank wishes to retain an e.change margin of ".1+%&. Cow much does the
customer stand to gain or lose due to the delay@
(Calculate rate in multiples of ."""1)
(#) am #uys 1"!""" shares of 9 Ltd. at s. ++ and o#tains a complete hedge of shorting
4"" Nifties at s. 1!1"" each. Ce closes out his position at the closing price of the ne.t
day at which point the share of 9 Ltd. has dropped +& and the nifty future has dropped
1.%&. >hat is the o$erall profit?loss of this set of transaction@
3
FINAL EXAMINATION : MAY, 2005
(c) >rite a #rief note a#out regulation of NBFCs in -ndia. (A 1 4 1 A H +"
marks)
Answer
/a0 Kn Panuary *(, *005 the importer customer requested to remit 5J1 *5 la9hs.
o consider sell rate for the ban9+
O5 Q & Rs. ,5.)0
"ound 1 & O5Q 1.-(50
"ound 1 & 5J1 /.15-5
herefore, 5J1 1 &
/.15-5 5J1
1.-(50 0 ,5.)0 Rs.
5J1 1 & Rs. *5.),(*
$dd+ @6change margin 20.1*5%4 Rs. 0.0/*,
Rs. *5.)(0.
Kn %ebruary ,, *005 the rates are
O5 Q & Rs. ,5.)-
"ound 1 & O5Q 1.---5
"ound 1 & 5J1 /.1/(0
herefore, 5J1 1 &
/.1/(0 5J1
1.---5 0 ,5.)- Rs.
5J1 1 & Rs. *..0/),
AddJ @6change margin 20.1*5%4 Rs. 0.0/*5
Rs. *..0-1)
<ence, loss to the importer
& 5J1 *5,00,000 2Rs.*..0-1) 3 Rs.*5.)(0.4
& Rs. *,*(,*50

/)0 5articulars ate Amount (s.) Amount (s.)
10,000 shares 3 =uy Rs. ** *,*0,000 *% ,,,00 >oss
,00 8ifties 3 short Rs. 1,100 ,,,0,000 1.5% .,.00 Jain
*,*00 8et gain
32
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
/.0 /a0 2i4 Meaning o- 2FC5s: $n 8=%A is a company or an institution basically
engaged in acceptance of deposits under different schemes and to in!est
these monies in any manner. 8=%A may be registered as a Aompany under
Aompanies $ct, 1)5., or may be other form of organi:ation. he Reser!e =an9
of India $ct defines an 8=%A as 214 a financial institution which is a company.
2ii4 a nonEban9ing institution which is a company ha!ing its principal business
the recei!ing of deposits under any scheme or lending in any manner 2iii4 such
other nonEban9ing institution as the R=I may specify with the appro!al of
Aentral Jo!ernment. 8onEban9ing financial companies, normally, pro!ides
supplementary finance to the corporate sector. %or the purpose of growing
economy the role of 8=%AHs is important. he finance and related ser!ices is
the maLor acti!ity of 8=%AHs.
2ii4 =y implication any nonEban9ing financial institution engaged in deposits and
lending acti!ities is called 8=%A. Kn the basis of types of acti!ities, 8=%As
may be consisting of
2i4 >oan Aompanies
2ii4 In!estment companies.
2iii4 <ire purchase finance companies.
2i!4 @quipment leasing companies.
2!4 ?utual benefit finance companies.
2!i4 <ousing finance companies.
2!ii4 ?iscellaneous finance companies.
2!iii4 Kther and residuary finance companies
2i64 Ahit fund companies
he R=I regulates the acti!ities of 8=%As through the following sets of
directions+
2i4 8=%A acceptance of public deposits 2Reser!e =an9 of India4 directions,
1))(.
2ii4 8=%A prudential norms 2Reser!e =an9 of India4 directions, 1))(.
2iii4 8=%A $uditors Report 2Reser!e =an9 of India4 directions, 1))(.
2i!4 8=%A 2Reser!e =an9 of India4 directions, 1)(-.
2!4 ?iscellaneous 8onE=an9ing Aompanies 2Reser!e =an9 of India4
directions, 1)--.
he R=I has amended the 8=%AsH regulations from time to time so that 8=%As
grow on sound and healthy lines and to protect the interest of 8=%A
depositors.
2iii4 Regulation of 8=%As 3 R=I $ct
33
FINAL EXAMINATION : MAY, 2005
he R=I $ct regulates different types of 8=%As under the pro!isions of
Ahapter III 3 = R Ahapter A.
5ilent features of Ahapter III 3 =
he two compulsory prerequisites as per Ahapter III = are
2a4 he 8=%A should obtain a certificate of registration.
2b4 It must ha!e 8K% 28et Kperating %unds4 of Rs. *00 lacs.
hese two requirements are cumulati!e.
Aomputation of 8K% 28et Kperating %unds4 will be as follows
8K% is defined in the 5ection ,5, IE$ of the $ct. he basis of computation is
the latest =alance 5heet of the Aompany. %ollowing items are considered for
8K%.
1. "aid up equity capital and free reser!es.
*. $ccumulated losses, deferred re!enues e6penditure and intangible
assets.
/. In!estment in shares of subsidiaries, companies in the same group and
other 8=%As.
,. =oo9 !alue of 1ebentures, bonds made in subsidiaries or companies in
the same group.
5. 1eposit with subsidiaries and companies in the same group.
he calculation of 8K% is
B & 1 7 *
C & / 7 , 7 5.
If 10% of C e6ceeds the B then e6cess to be find out.
he 8K% of the 8=%A will be B the e6cess amount.
"rocedure for obtaining registration.
$pplication must be in the form prescribed by R=I and should be submitted to
the Regional Kffice of the R=I.
"rocessing of application by R=I.
R=I ensures capacity of the 8=%A to meet the creditors claim in full, general
character of the management and the capital structure. he acti!ity of 8=%A
shall not be preLudicial to the operation and consolidation of the financial
sector and also shall not be preLudicial to the public interest.
Aancellation of registration.
Registration can be cancelled under section ,,I$ 2.4 wherein certain
conditions are prescribed under the section such as
34
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
8onEcompliance of directions issued by the R=I.
%ails to maintain accounts in accordance with any law or order issued by
R=I.
%ailed to submit or offer for inspection its boo9s of accounts or other
rele!ant documents when demanded by R=I.
%ailed to comply with any conditions specified by R=I while granting
certificate of registration.
"rocedure for cancellation of registration
8=%A should be gi!en a reasonable opportunity of being heard. 8=%A must
generally be gi!en an opportunity by R=I for ta9ing necessary steps to comply
with the conditions, e6cept in cases where R=I is of the opinion that the delay
in canceling the certificate of registration shall be preLudicial to public interest
or to the interest of the depositors of the 8=%A.
$ppellate Remedy
he 8=%A can prefer and appeal to Aentral Jo!ernment within /0 days from
the date on which the cancellation order was communicated to it. If no appeal
has been prescribed then the decision of R=I shall be final.
(uestion 5
(a) 5roIect 9 and 5roIect / are under the e$aluation of 9/ Co. 'he estimated cash flows
and their pro#a#ilities are as #elowJ
5roIect 9 J -n$estment (year ") s. 8" lakhs
5ro#a#ility weights ".2" ".4" ".2"
/ears s. lakhs s. lakhs s. lakhs
1 2" %" 7%
+ 2" 4" %%
2 2" 4" 4%
5roIect / J -n$estment (year ") s. A" lakhs.
5ro#a#ility weighted Annual cash flows through life
s. Lakhs
".+" 4"
".%" 4%
".2" %"
(a) >hich proIect is #etter #ased on N56! criterion with a discount rate of 1"&@
35
FINAL EXAMINATION : MAY, 2005
(#) Compute the standard de$iation of the present $alue distri#ution and analyse the
inherent risk of the proIects.
2#) A share of 'ension3free <conomy Ltd. is currently quoted at! a price earning ratio of 8.%
times. 'he retained earning per share #eing 28.%& is s. 2 per share. ComputeJ
(1) 'he company;s cost of equity! if in$estors e.pect annual growth rate of 1+&.
(+) -f anticipated growth rate is 12& p.a.! calculate the indicated market price! with
same cost of capital.
(2) -f the company;s cost of capital is 1A& and anticipated growth rate is 1%& p.a.!
calculate the market price per share! assuming other conditions remain the same.
(1+ 1 A H +" marks)
Answer
/a0 Cal.ulation o- P6 7y Co8:
5roIect 9 Cash flow 56F 56
/ear
1 2/0 0./4 7 250 0.,4 7 2.5 0./4 ,(.5 0.)0) ,,.0)
* 2/0 0./4 7 2,0 0.,4 7 255 0./4 ,1.5 0.(*. /,.*(
/ 2/0 0./4 7 2,0 0.,4 7 2,5 0./4 /(.5 0.-51 *(.)1
10-.*(
8"#+ 210-.*( 3 -0.004 & 274 /-.*(
"roLect C
1E/ 2,0 0.*4 7 2,5 0.54 7 250 0./4 ,5.5 *.,(. 11/.11
8"# 211/.11 3 (0.004 274 //.11
/)0 Aalculation of 5tandard de!iation
"roLect B
Cear
1
( ) ( ) ( ) ,(.5 E .5 ,(.5 E 50 ,(.5 E 2/0
* * *
+ +
*,.(/
*
( ) ( ) ( )
* * *
,1.5 E 55 ,1.5 E ,0 ,1.5 E 2/0 + +
1-.(0
/
( ) ( ) ( ) /(.5 E ,5 /(.5 E ,0 /(.5 E 2/0
* * *
+ +
10.(1
"roLect C
( ) ( ) ( )
* * *
,5.5 E 50 ,5.5 E ,5 ,5.5 E ,0 + +
-.1*
$s per <illierHs model
36
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
( ) r 1

*
n
0
*
*
+ =

=

<ence
"roLect B
Cear ( ) r 1
*
+
*

0 1.00 ,,)00 ,,)00

1 0.(/ .1- 51*
* 0..) /1- *1)
/ 0.5. 11- ..
5,.)-
5tandard de!iation & -5.,( .)- , 5 =
"roLect C
/ear
0 1.00 .,,00 .,,00
1 0.(/ 51 ,*
* 0..) 51 /5
/ 0.5. 51 *)
.,50.
5tandard de!iation & (0... 50. , . =
AnalysisJ
"roLect B is recommended because of higher 8"# and lower standard de!iation
2ris9 of !ariability4
/)0 18 Cal.ulation o- .ost o- .apital
Retained earnings /-.5% Rs. / per share
1i!idend0 .*.5% Rs. 5 per share
@"5 100.0% Rs. ( per share
"'@ ratio -.5 times
?ar9et price is Rs. -.5 ( & Rs. .0 per share
Aost of equity capital & 21i!idend'price 1004 7 growth %
& 25'.0 1004 7 1*% & *0.//%.
0

= 5 Rs. .*.5
/-.5
/ Rs.
28 ?ar9et price & 1i!idend'2cost of equity capital % growth rate %4 & 5'2*0.//%
1/%4 & 5'-.//% & Rs. .(.*1 per share.
37
FINAL EXAMINATION : MAY, 2005
18 ?ar9et price & 1i!idend'2cost of equity capital % growth rate %4 & 5'21(% 15%4
& 5'/% & Rs. 1..... per share.
(uestion 9
(a) 'he following information is pro$ided relating to the acquiring company <fficient Ltd. and
the target Company Cealthy Ltd.
<fficient Ltd. Cealthy Ltd.
No. of shares (F.6. s. 1" each) 1"."" lakhs 8.% lakhs
Darket capitali,ation %""."" lakhs 8%"."" lakhs
5?< ratio (times) 1"."" %.""
eser$es and *urplus 2""."" lakhs 17%."" lakhs
5romoter;s Colding (No. of shares) 4.8% lakhs %."" lakhs
Board of 0irectors of #oth the Companies ha$e decided to gi$e a fair deal to the
shareholders and accordingly for swap ratio the weights are decided as 4"&! +%& and
2%& respecti$ely for <arning! Book 6alue and Darket 5rice of share of each companyJ
(i) Calculate the swap ratio and also calculate 5romoter;s holding & after acquisition.
(ii) >hat is the <5* of <fficient Ltd. after acquisition of Cealthy Ltd.@
(iii) >hat is the e.pected market price per share and market capitali,ation of <fficient
Ltd. after acquisition! assuming 5?< ratio of Firm <fficient Ltd. remains unchanged.
(i$) Calculate free float market capitali,ation of the merged firm.
(#) (i) >ho can #e appointed as Asset Danagement Company (ADC)@
(ii) >rite the conditions to #e fulfilled #y an ADC.
(iii) >hat are the o#ligations of ADC@
(c) >rite short notes on the followingJ
1. 0e#t *ecuritisation.
+. *tock Lending *cheme Q its meaning! ad$antages and risk in$ol$ed.
(1+ 1 4 1 4 H +" marks)
Answer
/a0 Swap Ratio E--i.ient &td8 :ealt*y &td8
?ar9et capitalisation 500 la9hs -50 la9hs
8o. of shares 10 la9hs -.5 la9hs
?ar9et "rice per share Rs. 50 Rs. 100
"'@ ratio 10 5
@"5 Rs. 5 Rs. *0
38
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
"rofit Rs. 50 la9h Rs. 150 la9h
5hare capital Rs. 100 la9h Rs. -5 la9h
Reser!es and surplus Rs. /00 la9h Rs. 1.5 la9h
otal Rs. ,00 la9h Rs. *,0 la9h
=oo9 #alue per share Rs. ,0 Rs. /*
2i4 Cal.ulation o- Swap Ratio
@"5 1 + , i.e. ,.0 ,0% 1..
=oo9 !alue 1 + 0.( i.e. 0.( *5% 0.*
?ar9et price 1 + * i.e. *.0 /5% 0.-
otal *.5
5wap ratio is for e!ery one share of <ealthy >td., to issue *.5 shares of @fficient
>td. <ence, total no. of shares to be issued -.5 la9h *.5 & 1(.-5 la9h shares
"romoterHs holding & ,.-5 la9h shares 7 25 *.5 & 1*.5 la9h shares4 & 1-.*5 la9h
i.e. "romoterHs holding % is 21-.*5 la9h'*(.-5 la9h4 100 & .0%.
Aalculation of @"5, ?ar9et price, ?ar9et capitali:ation and free float mar9et
capitalisation
2ii4 otal 8o. of shares 10 la9h 7 1(.-5 la9h & *(.-5 la9h
otal capital 100 la9h 7 1(-.5 la9h & Rs. *(-.5 la9h
@"5
*(.-5
*00

la9h *(.-5
la9h 150 la9h 50

shares of 8o.
profit otal
=
+
=
& Rs. ..)5.
2iii4 @6pected mar9et price @"5 ..)5. "'@ 10 & Rs. .).5.
?ar9et capitali:ation & Rs. .).5. per share *(.-5 la9h shares
& Rs. 1,))).(5 la9h
2i!4 %ree float of mar9et capitali:ation & Rs. .).5. per share 2*(.-5 la9h ,0%4
& Rs. -)).), la9h
/)0 2i4 Asset Manage;ent Co;pany /AMC0: $ company formed and registered under
Aompanies $ct 1)5. and which has obtained the appro!al of 5@=I to function as an
asset management company may be appointed by the sponsorer of the mutual fund
as $?A.
2ii4 he following conditions should be fulfilled by an $?A
39
FINAL EXAMINATION : MAY, 2005
214 $ny director of the asset management company shall not hold the place of a
director in another asset management company unless such person is
independent director referred to in clause 2d4 of subEregulation 214 of regulation
*1 of the Regulations and the appro!al of the =oard of asset management
company of which such person is a director, has been obtained.
2*4 he asset management company shall forthwith inform 5@=I of any material
change in the information or particulars pre!iously furnished which ha!e a
bearing on the appro!al granted by 5@=I.
2a4 8o appointment of a director of an asset management company shall be
made without the prior appro!al of the trustees.
2b4 he asset management company underta9es to comply with 5@=I 2?utual
%unds4 Regulations, 1))..
2c4 8o change in controlling interest of the asset management company shall
be made unless prior appro!al of the trustees and 5@=I is obtained.
2i4 a written communication about the proposed change is sent to each
unit holder and an ad!ertisement is gi!en in one @nglish 1aily
newspaper ha!ing nation wide circulation and in a newspaper
published in the language of the region where the head office of the
mutual fund is situated.
2ii4 he unit holders are gi!en an option to e6it at the pre!ailing 8et
$sset #alue without any e6it load.
2iii4 he asset management company shall furnish such information and
documents to the trustees as and when required by the trustees.
2iii4 Kbligations of the $?A+
214 he $?A shall manage the affairs of the mutual funds and operate the
schemes of such fund.
2*4 he $?A shall ta9e all reasonable steps and e6ercise due diligence to ensure
that the in!estment of the mutual funds pertaining to any scheme is not
contrary to the pro!isions of 5@=I Regulations and the trust deed of the mutual
fund.
/.0 /10 %e)t Se.uritisation:
1ebt securitisation is a method of recycling of funds. It is especially beneficial to
financial intermediaries to support the lending !olumes. $ssets generating steady
cash flows are pac9aged together and against this assets pool mar9et securities
can be issued. he process can be classified in the following three functions.
1. 'he origination function+ $ borrower see9s a loan from finance company, ban9
or housing company. Kn the basis of credit worthiness repayment schedule is
structured o!er the life of the loan.
40
PAPER 2 : MANAGEMENT ACCOUNTING AND FINANCIAL ANALYSIS
*. 'he pooling function+ 5imilar loans or recei!ables are clubbed together to
create an underlying pool of assets. his pool is transferred in fa!our of a 5"#
25pecial "urpose #ehicle4, which acts as a trustee for the in!estor. Knce, the
assets are transferred they are held in the organi:ers portfolios.
/. 'he securitisation function+ It is the 5"#Hs Lob to structure and issue the
securities on the basis of asset pool. he securities carry coupon and an
e6pected maturity, which can be asset based or mortgage based. hese are
generally sold to in!estors through merchant ban9ers. he in!estors
interested in this type of securities are generally institutional in!estors li9e
mutual fund, insurance companies etc. he originator usually 9eeps the
spread.
Jenerally, the process of securitisation is without recourse i.e. the in!estor bears
the credit ris9 of default and the issuer is under an obligation to pay to in!estors
only if the cash flows are recei!ed by issuer from the collateral.
/20 Sto.3 &ending S.*e;e:
5toc9 lending means transfer of security. he legal title is temporarily transferred
from a lender to a borrower. he lender retains all the benefits of ownership, e6cept
!oting power'rights. he borrower is entitled to utili:e the securities as required but
is liable to the lender for all benefits such as di!idends, rights etc. he basic
purpose of stoc9 borrower is to co!er the short sales i.e. selling the shares without
possessing them. 5@=I has introduced scheme for securities lending and borrowing
in 1))-.
Ad,antages:
214 >enders to get return 2as lending charges4 from it, instead of 9eeping it idle.
2*4 =orrower uses it to a!oid settlement failure and loss due to auction.
2/4 %rom the !iewEpoint of mar9et this facilitates timely settlement, increase in
settlement, reduce mar9et !olatility and impro!es liquidity.
2,4 his prohibits fictitious bull run.
he borrower has to deposit the collateral securities, which could be cash, ban9
guarantees, go!ernment securities or certificates of deposits or other securities,
with the appro!ed intermediary. In case, the borrower fails to return the securities,
he will be declared a defaulter and the appro!ed intermediary will liquidate the
collateral deposited with it.
In the e!ent of default, the appro!ed intermediary is liable for ma9ing good the loss
caused to the lender.
he borrower cannot discharge his liabilities of returning the equi!alent securities
through payment in cash or 9ind.
8ational 5ecurities Alearing Aorporation >td. 285AA>4, 5toc9 <olding Aorporation
of India 25<AI>4, 1eutsche =an9, Reliance Aapital etc. are the registered and
4
FINAL EXAMINATION : MAY, 2005
appro!ed intermediaries for the purpose of stoc9 lending scheme. 85AA> proposes
to offer a number of schemes, including the $utomated >ending and =orrowing
?echanism 2$>=?4, automatic borrowing for settlement failures and case by case
borrowing.
42