FINANCIAL MANAGEMENT-I

Term End Examinations

Time: 3 Hours.
Marks: 100
Instructions:
1)
Answer all the questions
2)
Furnish your answer in the space provided below the question
3)
No additional anwer Booklets will be given
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01.

The following are the historic returns for RIL and Market Index:
Year
1
2
3
4
5
6

RIL (%)
24
12
-16
13
21
6

Market Index (%)

12
-8
17
11
6
-9

Based on this information, compute the following:

a) The standard deviation of the company and the index.
b) Covariance between RIL and Market Index
c) The correlation coefficient between RIL and the Market index.
d) The beta of RIL.
( Marks:4+2+2+2=10)

Solution:
YEAR

RIL

MI

DEVRIL

DEVMI

SQRDEVRIL

SQRDEVMI

COVRILMI

24

12

14

7.17

196

51.36

100.33

12

12.83

164.69

25.67

16

17

26

12.17

676

13

11

6.17

38.03

18.50

21

11

1.17

121

1.36

12.83

13.83

16

191.36

55.33

SUM

60

29

1022

594.83

155

MEAN
RET.

10

4.83

0 SUM/5

204.4

118.97

31

STDEV

14.30

BETA=

148.03 316.33

10.91

0.26 CORRR

0.1988

02.

Energy Ltd. issues a bond for 20 years having face value of Rs.1000 and carrying a coupon interest
rate of 10%. Calculate the following and explain the inferences you draw from each such
calculations
a) Current Yield if the bond is purchased for Rs 1100 by an investor and for Rs 900 by another
investor in the market?
b) Yield to Maturity if the bond is purchased for Rs 1100 by an investor and for Rs 900 by
another investor in the market, when the left over period for maturity is
a. 15 years,
b. 5 years?
c) Value of the bond,
a. WhenYTM is 11% and the period left over for maturity is 15 years?
b. WhenYTM is 11% and the period left over for maturity is 5 years?
c. When YTM is 9% and the period left over for maturity is 15 years
d. When YTM is 9% and the period left over for maturity is 5 years?
(Marks: 3 +7 +5 =15)
ANSWERS
a) Current Yield : 9.09% and 11.11%
b) YTM
a. For 15 years : 8.80% and 11.34%
b. For 5 years : 7.54% and 12.76%
c) Bond Value
a. 928.10
b. 962.6
c. 1081.1
d. 1039

03(A) Mr.Subuddhi wishes to save money to provide for his retirement. One year from now, he will begin
depositing some fixed amount each year for the next 30 years into a retirement savings account.
Starting from 31st year end onwards, he would like to withdraw Rs. 1, 00,000 annually, from such
account. After the 25th widrawal, the balance in the retirement savings account would be zero.
Assume that the account earns 12% annually over both the periods that he is depositing money and
the period he makes withdrawals. In order for Mr. Subuddhi to have sufficient funds in his account to
fund his retirement, how much should he deposit annually in the initial 30 years? (Round the amount
to the nearest Rupee)? (Marks: 3 +3 = 6)

Answer:
The amount in the account at the end of 30 years =
Present value of Rs 1 00 000 for 25 years @12% =Rs. 7 84 313
The Annual installments in the initial 30 years =
Future value of Annuity for 30 years @ 12% Interest = Rs. 3,249

03(B) Chiranjeevi is now 60 years old and has just been sold an insurance policy with Rs1000000
protection on his life. The cost is Rs 17000 per year. If he lives up to the age 100, the insurance
company will pay him Rs 2000000. What portion of the annual cost can be called an investment and
what portion of the cost is for purchase of protection? Assume the following:
a) Chiranjeevi lives up to the age 100 years,
b) Payments are made at the end of the year
c) Minimum acceptable rate of return is 10%.
(Marks: 4)
Answer:
Find out how much you would have to invest to save 2000000 in 40 years at 10% interest.
Annuity =Rs. 4519.
Actual amount paid = Rs 17000
Hence amount paid per annum for insurance = Rs 17000 Rs 4519 = Rs12481

04.

A Manufacturing machine A costs Rs. 75,000 and provides net cash flow of Rs. 20,000 per year
for six years. Another substitute machine B would cost Rs. 50,000 and generates net cash flow of
Rs. 14,000 per year for six years. If the required rate of return is 11%, which of these two machines
is to be preferred for purchase?
Substantiate your answer applying the following techniques of capital budgeting
a) Net Present Value,
b) Internal Rate of Return
( Marks : 4 + 6= 10 )

Answers: Machine A should be preferred because of High NPV and Low IRR
Machine NPV IRR
Discounted payback Period
A
9611 15.34%
5 years and 1.2 months
B
9228 17.20%
4 years and 9.5 months
Discount
Rate
year
Machine A
Machine B

11%
0
75000
50000

1
20000
14000

2
3
4
20000 20000 20000
14000 14000 14000

5
20000
14000

6 NPV IRR
20000 9611 15.34%
14000 9228 17.20%
Discounted
Payback Period
Years months

Machine A
PV of
Cash Flow
Cumulative
Cash Flow
Machine B
PV of
Cash Flow
Cumulative
Cash Flow

20000

20000 20000 20000

20000

20000

40000 60000 80000 100000 120000

14000

14000 14000 14000

28000 42000 56000

14000

70000

Yr and
Months

5 -15.000

5 yr -15
months

4 yr -5.1
months

14000

84000

-5.143

05.

The Happy Sing Co. Ltd has 1,500 bonds with a face value of Rs 1 000 each carrying a coupon rate
of 11% P.A. They are selling at present for Rs.1, 060 each and are due to mature in 10 years. The
company also has 5,000 shares of 12% irredeemable preferred stock issued at Rs.50 is trading now at
Rs.32 each. The common stock is priced at Rs.26 a share and there are 36,000 shares outstanding.
The tax rate is 30%. The latest DPS of the company. was Rs. 5. The company is expected to grow at
3% forever.
Calculate the weighted average cost of capital using the market value weights.
SOLUTION:
Finding weights using market value
Debt
= Rs. 1060 X 1500 = 15,90,000
Preferred stock
= Rs. 32 X 5000 = 1,60,000
Common stock
= Rs. 26 X 36000= 9,36,000
Total
26,86,000
Weights:
Debt
Preferred stock
Common stock

= 15,90,000 / 26,86,000 = .5920 (59.20%)

= 1,60,000/26,86,000 = .0596 (5.96%)
= 9,36,000/26,86,000 = .3485 (34.85%)

Cost of capital per component:

Kd =

= 10.01%

Alt: (when discount and premium is not adjusted for tax we can use the following formula)
.

Kd =
Kp =
Ke =

= 6.89%

= 18.75 %
g

0.03 = 22.81%

WACC = .5920(10.01) (1 - .30) + .0596 (18.75) + .3485(22.81) = 13.21% (for method 1)

WACC = .5920(6.89) + .0596 (18.75) + .3485(22.81) = 12.97% (for method 2)

06.

Estimates for five stocks are as follows:

Stock
Current price Expected price
A
25
26
B
40
42
C
33
37
D
64
66
E
50
53

Expected Dividend Beta

1.00
0.70
0.50
1.00
1.00
1.15
1.10
1.40
-0.30

Risk free rate is 5% and rate of return on benchmark market index is 9%.
Using the data in the table:
a) Draw Security market line (SML) and position the stocks relative to it.
b) Compute the excess return (alpha) for stocks.
c) Determine whether the stocks are properly valued, under valued or over valued if SML is
used for strategic investment decisions. ( Marks: 10)

Solution:
STOCK
A
B
C
D
E
RFR

STOCKS
A
B
C
D
E

CP
25
40
33
64
50
0.05

ESTIMATED
RET=
((EPCP)+ED)/CP
0.0800
0.0625
0.1515
0.0484
0.0600

EP
26
42
37
66
53
RM

ED
1
0.5
1
1.1
0.09

REQ RET=
RFR+BETA(RMRF)
0.0780
0.090
0.096
0.106
0.038

EST-REQ
0.00200
-0.02750
0.055515
-0.05756
0.02200

BETA
0.7
1
1.15
1.4
-0.3
RM-RF=.04

EVALUATION
PV
OV
UV
OV
UV

POSITION
RELATIVE
TO SML
ON SML
UNDERSML
ABOVESML
UNDERSML
ABOVESML

07(A) Explain the distingusing features of Forward contracts and Futures in a trabular manner.(Marks: 6)
Answer:
FUTURES CONTRACTS
FORWARD CONTRACTS
1. These are traded in organized
location known as exchange.
2. The terms of the contract are highly
standardized.
3. Contracts are cleared by a separate
clearing house.
4. Clearing house guarantees the
performance of the contract.

It is an over-the-counter product.

5. Traders have to deposit initial

margin irrespective of their trading
position.
6. Traders have to pay daily settlement
margin depending on the movement
in the price of the underlying stock.
7. Futures contracts can be easily
closed.
8. Futures markets are monitored and
regulated by special agencies.
9. Marking to market is done at the
end of every trading day.

No compulsion to make such deposits.

Terms are structured to suit both the

contracting parties.
No such facility exists.
No organization guarantees the performance
of the counterparty. Depends on the worth of
the counterparty.

No such provisions are in vogue.

Quite difficult to do so.

Regulation is not as tight as in futures
markets.
No such adjustments are carried out.

07. (B) Distinguish between Money and capital markets (Marks: 4)

Answer:
MONEY MARKETS
The money market deals in the lending and
borrowing of short-term finance (i.e., for one
year or less),
The main instruments of the money market are
call money, collateral loans (repos/reverse
repos), bills of exchange, commercial paper,
certificate of deposits, T-bills and GOI bonds.
The money market meets the short-term credit
needs of business for providing working
capital to the companies or to meet short term
obligations of banks/Governments.

08.

CAPITAL MARKETS
The capital market deals in the lending and
borrowing of long-term finance (i.e., for more
than one year).
The main instruments used in the capital
market are stocks, shares, debentures, bonds,
securities of the government.
The capital market, caters the long-term credit
needs of the companies and provides fixed
capital to buy land, machinery, etc. or to meet
long-term requirements of banks/FIs or
Governments.

Supersonics Ltd paid a dividend of Rs. 8 per share during the latest year end, which is expected to
remain constant for the next three years. Fourth year onwards, the dividends will grow at the rate of
17% each year for four years, there after at 12% for next four years after which they will grow at a
constant growth rate of 5% each year forever. Find out the present value of the stock, if the required
rate of return on equity is 18%.
( Marks: 10)
Solution:
Year

0
1
2
3
4
5
6
7
8
D0 D1
D2 D3 D4
D5
D6
D7
D8
Dividends 8
8
8
8
9.36 10.95 12.81 14.99 16.79
TV
PV
6.78 5.75 4.87 4.83 4.79 4.75 4.71 4.47
Value
83.86

09

9
D9
18.80

10
D10
21.06

11
D11
23.59

4.24

4.02

3.82

12
D12
24.77
190.52
30.85

Pinnacle Ltd. an automobile company - is considering introduction of new model with an estimated
life of 5 years. The following are the other details:
The outlay on the project is Rs 150 crores with a salvage value of Rs. 20 crore. The project requires
an additional investment in NWC of Rs 40 crores. At the end of the project, working capital will be
fully recovered at par. The capital is depreciated following WDV method at the rate of 25 percent per
year. The project will result in additional sales of Rs 200 crore per year with an additional cost (other
than depreciation & taxes) of Rs 80 crore per year. However this new bike would take away the sales
of an existing model to the tune of Rs. 30 crores per year due to brand switching. The company is in
the 35 percent tax bracket and its cost of capital is 15% PA.
Advise the company on the viability of the project after considering cash flows and Net present
Value.
(Marks: 15)

SOLUTION:

IntialOutlay

FixedAssets

IncreaseinNWC

NetInitialCashOutlay(1+2)

OperatingCashFlows
Revenues
Costs(otherthan
depreciationand

110.00
interest)(80+30)
BookValueoftheMachine
150.00 112.50
Depreciation@25%WDV

37.50
PBIT

52.50
Tax@35%

18.38
PBIT(1t)

34.13
ChangeinNWC

0.00
NetOperatingCashFlow
[PBIT(1t)+DepNWC](9+6

71.63
10)

TerminalCashFlows

Saleoffixedassets

TaxonCapitalGain

Recoveryofnetworking

capital
NetTerminalCashFlow(11

12+13)

NCF(I+II+III)
71.63
190.00

PVofNCF
62.28
190.00

4
5
6
7
8
9
10
II

11
12
13
III

IV

0
1

150.00
40.00

190.00

200.00

200.00

200.00

200.00

200.00

110.00

110.00

110.00

110.00

84.38
28.13
61.88
21.66
40.22
0.00

63.28
21.09
68.91
24.12
44.79
0.00

47.46
15.82
74.18
25.96
48.22
0.00

35.60
11.87
78.13
27.35
50.79
0.00

68.34

65.88

64.04

62.65

Marks

2
3

20.00
5.46

40.00

65.46

68.34

65.88

64.04

128.11

51.68

43.32

36.61

63.69

NPV

67.59
Total

2
15