Pile cp6

6
Security Analysis
Question 1
Why should the duration of a coupon carrying bond always be less than the time to its maturity?
(3 Marks) (June 2009) (S)
Answer
Duration is nothing but the average time taken by an investor to collect his/her investment. If an investor
receives a part of his/her investment over the time on specific intervals before maturity, the investment will
offer him the duration which would be lesser than the maturity of the instrument. Higher the coupon rate,
lesser would be the duration.
Question 2
Mention the various techniques used in economic analysis.
(4 Marks) (May 2011)
Answer
Some of the techniques used for economic analysis are:
(a)
Anticipatory Surveys: They help investors to form an opinion about the future state of the
economy. It incorporates expert opinion on construction activities, expenditure on plant and
machinery, levels of inventory all having a definite bearing on economic activities. Also future
spending habits of consumers are taken into account.
(b)
Barometer/Indicator Approach: Various indicators are used to find out how the economy shall
perform in the future. The indicators have been classified as under:
(1)
Leading Indicators: They lead the economic activity in terms of their outcome. They relate to
the time series data of the variables that reach high/low points in advance of economic
activity.
(2)
Roughly Coincidental Indicators: They reach their peaks and troughs at approximately the
same in the economy.
(3)
Lagging Indicators: They are time series data of variables that lag behind in their
consequences vis-a- vis the economy. They reach their turning points after the economy
has reached its own already.
All these approaches suggest direction of change in the aggregate economic activity but
nothing about its magnitude.
The Institute of Chartered Accountants of India
Security Analysis
(c)
6.2
Economic Model Building Approach: In this approach, a precise and clear relationship between
dependent and independent variables is determined. GNP model building or sectoral analysis is
used in practice through the use of national accounting framework.
Question 3
Write short notes on Zero coupon bonds.
Answer
As name indicates these bonds do not pay interest during the life of the bonds. Instead, zero coupon
bonds are issued at discounted price to their face value, which is the amount a bond will be worth when
it matures or comes due. When a zero coupon bond matures, the investor will receive one lump sum
(face value) equal to the initial investment plus interest that has been accrued on the investment made.
The maturity dates on zero coupon bonds are usually long term. These maturity dates allow an investor
for a long range planning. Zero coupon bonds issued by banks, government and private sector
companies. However, bonds issued by corporate sector carry a potentially higher degree of risk,
depending on the financial strength of the issuer and longer maturity period, but they also provide an
opportunity to achieve a higher return.
Question 4
Explain briefly the capital Asset pricing model used in the context of valuation of securities.
(6 Marks) (November 2009)(M)
Answer
CAPM- Portfolio theories have undergone major changes over the years. The current standard in
valuation theory is found in the CAPM. It is an economic noted that describes how securities are priced
in the market. Its major merit lies in recognizing the difference or distinction between risk of holding a
single asset and holding a portfolio.
The CAPM formula:

E (Rp) = Rf + p [ E(Rm) Rf ]
Where:
E (Rp)
= Expected return of portfolio
Rf
= Risk free rate of Return
= Port folio Beta
E(Rm)
= Expected return on Market portfolio
The CAPM formula is based on certain assumptions regarding rationality and homogeneity of investors
etc. and is subjected to criticism on this score.
Strategic Financial Management
6.3
Question 5
ABC Limiteds shares are currently selling at ` 13 per share. There are 10,00,000 shares outstanding.
The firm is planning to raise ` 20 lakhs to Finance a new project.
Required:
What are the ex-right price of shares and the value of a right, if
(i)
The firm offers one right share for every two shares held.
(ii)
The firm offers one right share for every four shares held.
(iii)
How does the shareholders wealth change from (i) to (ii)? How does right issue increases
shareholders wealth?
(6 Marks) (November 2004)
Answer
(i)
Number of shares to be issued : 5,00,000

Subscription price ` 20,00,000 / 5,00,000 = ` 4
(ii)
Ex-right Pr ice
` 1,30,00,000 ` 20,00,000
` 10
15,00,000
Value of right
` 10 - ` 4
3
2
Subscription price ` 20,00,000 / 2,50,000 = ` 8
Ex-right Pr ice
` 1,30,00,000 ` 20,00,000
` 12
12,50,000
Value of right
` 12 ` 8
` 1.
4
(iii) Calculation of effect of right issue on wealth of Shareholders wealth who is holding, say 100
shares.
(a)
When firm offers one share for two shares held.

Value of Shares after right issue (150 X ` 10)
` 1,500
Less: Amount paid to acquire right shares (50X`4)
` 200
`1,300
(b)
When firm offers one share for every four shares held.
Value of Shares after right issue (125 X ` 12)
` 1,500
Less: Amount paid to acquire right shares (25X`8)
` 200
`1,300
Security Analysis
(c)
Wealth of Shareholders before Right Issue
6.4
`1,300
Thus, there will be no change in the wealth of shareholders from (i) and (ii).
Question 6
The share of Galaxy Ltd. of a face ` 10 is being quoted at ` 24. The company has a plan to make a
right issue of one equity share for every four shares currently held at a premium of 40% per share.
You are required to:
(i)
Determine the minimum price that can be expected of share after the issue.
(ii)
Calculate the theoretical value of the rights alone.
(iii)
Show the effect of the right issue on the wealth of a shareholder who has 1500 shares, if
(a) he sells the entire rights, and

(b) he ignores the rights.
(8 Marks)(November 2010) (M)
Answer
(i)
Expected minimum price

P=
M x N Sr
Nr
Where P= Theoretical Post right price per share

M = Market price of share
24x4 14x1
Nr
N = No. of existing shares

S = Subscription price
96 14
= ` 22
5
(ii)
r = No. of rights
Post right price Subscription price

` 22 - ` 14 = ` 8
or (M-P) x N
(`24 - ` 22) x 4 = ` 8
(iii) (a)
Value of 1500 shares before right issue

1500 x ` 24 = `36,000
After Rights issue
1500 x ` 22 = `33,000
Add Sale proceeds of right
375 x `8
= ` 3,000
`36,000
Net effect on wealth is Nil.
(b) Value of 1500 Shares
6.5
Before rights
`36,000
After rights
`33,000
Loss to Shareholder
`(3000)
Question 7
On the basis of the following information:
Current dividend (Do)

Discount rate (k)
Growth rate (g)
=
=
=
`2.50
10.5%
2%
(i)
Calculate the present value of stock of ABC Ltd.
(ii)
Is its stock overvalued if stock price is ` 35, ROE = 9% and EPS = `2.25? Show detailed
calculation.
(6 marks) (November 2007)
Answer
(i)
Present Value of the stock of ABC Ltd. Is:Vo
(ii)
2.50(1.02)
= `30/-.
0.105 0.02
Pay out ratio of ABC Ltd.

=
2 .5
= 1.111
2.25
Hence, Retention ratio = 1 -1.111

= -0.111
Or -11.1%
Sustainable growth ratio is = -0.111 0.09
= -0.00999
= -0.999%
Using the constant growth model, the value is
=
2.475
` 2.50(0.99)
=
= ` 21.52
0.105 ( 0.00999) 0.11499
This value is less than the stock price of `30/- as calculated above or ` 35, as given in the
question, which indicates that stock of ABC Ltd. is Overvalued.
Alternative answer (ii)
Security Analysis
(MV) of Stock in `
6.6
D (1 g)
D1
0
k e g (k e g)
2.5 1.02
= 30
= 0.105 0.02
(BV) =
Again
So,
` 2.25
` 25
0.09
(MV ) k r g
where symbols denote their usual notations.
(BV ) k e g
0.09 0.02 (MV )

0.07 (MV )
or ,
0.105 0.02 25
0.085 25
(MV )
Based on
` 0.07
25 ` 20.59
0.085
( MV )
ratio and based on perpetual growth model the price of the share should be
( BV )
`20.59 and `30 respectively which are lower than the present (MV) of `35.
The stock is therefore, Overvalued.
Question 8
A company has a book value per share of ` 137.80. Its return on equity is 15% and follows a policy of
retaining 60 percent of its annual earnings. If the opportunity cost of capital is 18 percent, what is the
price of its share?[adopt the perpetual growth model to arrive at your solution].
(5 marks) (November 2011)
Answer
The company earnings and dividend per share after a year are expected to be:
EPS = ` 137.80 0.15 = ` 20.67
Dividend = 0.40 20.67 = ` 8.27
The growth in dividend would be:
g = 0.6 0.15 = 0.09
Dividend
Perpetual growth model Formula : P0 =
Ke - g
P0 =
8.27
0.18 - 0.09
6.7
P0 = ` 91.89
Question 9
MNP Ltd. has declared and paid annual dividend of ` 4 per share. It is expected to grow @ 20% for the
next two years and 10% thereafter. The required rate of return of equity investors is 15%. Compute the
current price at which equity shares should sell.
Note: Present Value Interest Factor (PVIF) @ 15%:
For year 1 = 0.8696;
For year 2 = 0.7561
Answer
D0 = ` 4
D1 = ` 4 (1.20) = ` 4.80
D2 = ` 4 (1.20)2 = ` 5.76
D3 = ` 4 (1.20)2 (1.10) = ` 6.336
D1
D2
TV
P=
(1 k e ) (1 k )2 (1 k )2
e
e
TV =
D3
ke - g
4.80
P=
6.336
=
= 126.72
0.15 - 0.10
5.76
(1+ 0.15) (1+ 0.15)2
126.72
(1+ 0.15)
= 4.80 x 0.8696 + 5.76 x 0.7561 + 126.72 x 0.7561 = 104.34

Question 10
X Limited, just declared a dividend of ` 14.00 per share. Mr. B is planning to purchase the share of X
Limited, anticipating increase in growth rate from 8% to 9%, which will continue for three years. He
also expects the market price of this share to be ` 360.00 after three years.
You are required to determine:
(i)
the maximum amount Mr. B should pay for shares, if he requires a rate of return of 13% per
annum.
(ii)
the maximum price Mr. B will be willing to pay for share, if he is of the opinion that the 9%
growth can be maintained indefinitely and require 13% rate of return per annum.
(iii)
the price of share at the end of three years, if 9% growth rate is achieved and assuming other
Security Analysis
6.8
conditions remaining same as in (ii) above.

Calculate rupee amount up to two decimal points.
Year-2
Year-1
FVIF @ 9%
1.090
1.188
1.295
FVIF @ 13%
1.130
1.277
1.443
PVIF @ 13%
0.885
0.783
0.693
Year-3
(4+2+4 Marks) (May 2013)

Answer
(i)
Expected dividend for next 3 years.

Year 1 (D1) ` 14.00 (1.09) = ` 15.26
Year 2 (D2) ` 14.00 (1.09)2 = ` 16.63
Year 3 (D3) ` 14.00 (1.09)3 = ` 18.13
Required rate of return = 13% (Ke)
Market price of share after 3 years = (P3) = ` 360
The present value of share
P0 =
D3
P3
D1
D2
2
3
1 ke 1 ke 1 ke 1 ke 3
P0 =
15.26
16.63
18.13
360
2
3
1 0.13 1 0.13 1 0.13 1 0.133
P0 = 15.26(0.885) + 16.63(0.783)+18.13(0.693)+360(0.693)
P0 = 13.50 + 13.02 + 12.56 + 249.48
P0 = ` 288.56
(ii)
If growth rate 9% is achieved for indefinite period, then maximum price of share should Mr. A
willing be to pay is
P0 =
D1
` 15.26
` 15.26
=
=
= ` 381.50
ke g 0.13-0.09 0.04
(iii) Assuming that conditions mentioned above remain same, the price expected after 3 years will
be:
P3 =
D4
D 3 (1.09)
18.13 1.09 19.76
=
=
=
= ` 494
k e g 0.13 0.09
0.04
0.04
6.9
Question 11
Capital structure of Sun Ltd., as at 31.3.2003 was as under:
(` in lakhs)
80
40
64
32
Equity share capital

8% Preference share capital
12% Debentures
Reserves
Sun Ltd., earns a profit of ` 32 lakhs annually on an average before deduction of income-tax, which
works out to 35%, and interest on debentures.
Normal return on equity shares of companies similarly placed is 9.6% provided:
(a)
Profit after tax covers fixed interest and fixed dividends at least 3 times.
(b)
Capital gearing ratio is 0.75.
(c)
Yield on share is calculated at 50% of profits distributed and at 5% on undistributed profits.
Sun Ltd., has been regularly paying equity dividend of 8%.

Compute the value per equity share of the company.
Answer
(a)
Calculation of Profit after tax (PAT)
`
Profit before interest and tax (PBIT)
Less: Debenture interest (` 64,00,000 12/100)
Profit before tax (PBT)
Less: Tax @ 35%
Profit after tax (PAT)
Less: Preference Dividend
(` 40,00,000 8/100)
Equity Dividend (` 80,00,000 8/100)
Retained earnings (Undistributed profit)
32,00,000
7,68,000
24,32,000
8,51,200
15,80,800
3,20,000
6,40,000
Calculation of Interest and Fixed Dividend Coverage
PAT Debenture interest

Debenture interest Preference dividend
15,80,800 7,68,000
7,68,000 3,20,000
23,48,800
= 2.16 times
10,88,000
(b) Calculation of Capital Gearing Ratio
9,60,000
6,20,800
Security Analysis
Capital Gearing Ratio =
6.10
Fixed interest bearing funds

Equity shareholders' funds
Preference Share Capital Debentures 40,00,000 64,00,000 1,04,00,000

=
=
= 0.93
1,12,00,000
Equity Share Capital Reserves
80,00,000 32,00,000
(c) Calculation of Yield on Equity Shares:

Yield on equity shares is calculated at 50% of profits distributed and 5% on undistributed profits:
(` )
50% on distributed profits (` 6,40,000 50/100)
3,20,000
5% on undistributed profits (` 6,20,800 5/100)
31,040
Yield on equity shares

Yield on equity shares %
3,51,040
=
Yield on shares
100
Equity share capital
3,51,040
100 = 4.39% or, 4.388%.
80,00,000
Calculation of Expected Yield on Equity shares

Note: There is a scope for assumptions regarding the rates (in terms of percentage for every one time
of difference between Sun Ltd. and Industry Average) of risk premium involved with respect to Interest
and Fixed Dividend Coverage and Capital Gearing Ratio. The below solution has been worked out by
assuming the risk premium as:
(i)
1% for every one time of difference for Interest and Fixed Dividend Coverage.
(ii)
2% for every one time of difference for Capital Gearing Ratio.
(a) Interest and fixed dividend coverage of Sun Ltd. is 2.16 times but the industry
average is 3 times. Therefore, risk premium is added to Sun Ltd. Shares @ 1%
for every 1 time of difference.
Risk Premium = 3.00 2.16 (1%) = 0.84 (1%) = 0.84%
(b) Capital Gearing ratio of Sun Ltd. is 0.93 but the industry average is 0.75 times.
Therefore, risk premium is added to Sun Ltd. shares @ 2% for every 1 time of
difference.
Risk Premium
= (0.75 0.93) (2%)
= 0.18 (2%) = 0.36%

(%)
Normal return expected
9.60
6.11
Add: Risk premium for low interest and fixed dividend coverage
0.84
Add: Risk premium for high interest gearing ratio
0.36
10.80
Value of Equity Share
4.39
Actual yield
Paid-up value of share =
100 = ` 40.65
10.80
Expected yield
=
Question 12
Given the following information:
` 5.00
Current Dividend
Discount Rate
Growth rate
10%
2%
(i)
Calculate the present value of the stock.
(ii)
Is the stock over valued if the price is ` 40, ROE = 8% and EPS = ` 3.00. Show your calculations
under the PE Multiple approach and Earnings Growth model.
Answer
(i)
Present Value of the stock:-
5.00(1.02)
= `63.75/-.
0.10 0.02
Vo =
(ii)
Pay out ratio

=
5.00
= 1.667
3.00
Hence, Retention ratio = 1 1.667

= -0.667
Or
-66.67%
Sustainable growth ratio is = -0.667 0.08

= -0.0534
= -5.34%
Using the constant growth model, the value is
Security Analysis
6.12
4.733
` 5.00(0.9466)
=
= `30.85
0.10 ( 0.0534) 0.1534
This value is less than the stock price of `30.85/- as calculated above or `40, as given in the question,
which indicates that stock of ABC Ltd. is Overvalued.
Question 13
ABC Ltd. has been maintaining a growth rate of 10 percent in dividends. The company has paid
dividend @ ` 3 per share. The rate of return on market portfolio is 12 percent and the risk free rate of
return in the market has been observed as 8 percent. The Beta co-efficient of companys share is 1.5.
You are required to calculate the expected rate of return on companys shares as per CAPM model and
equilibrium price per share by dividend growth model.
(6 Marks) (November 2008) (M)
Answer
CAPM formula for calculation of Expected Rate of Return is :
ER
= Rf + (Rm Rf)
= 8 + 1.5 (12 8)
= 8 + 1.5 (4)
=8+6
=14% or 0.14
Applying Dividend Growth Model for the calculation of per share equilibrium price:
ER
0.14=
D1
+g
P0
3 (1.10)
+ 0.10
P0
0.14 0.10 =
3.30
P0
0.04 P0
= 3.30
P0
3.30
= ` 82.50
0.04
Per share equilibrium price will be ` 82.50.
6.13
Question 14
A Company pays a dividend of ` 2.00 per share with a growth rate of 7%. The risk free rate is 9% and
the market rate of return is 13%. The Company has a beta factor of 1.50. However, due to a decision of
the Finance Manager, beta is likely to increase to 1.75. Find out the present as well as the likely value
of the share after the decision.
Answer
In order to find out the value of a share with constant growth model, the value of Ke should be ascertained
with the help of CAPM model as follows:
Ke = Rf + (Km Rf)
Where,
Ke = Cost of equity
Rf = Risk free rate of return
= Portfolio Beta i.e. market sensitivity index
Km = Expected return on market portfolio
By substituting the figures, we get
Ke = 0.09 + 1.5 (0.13 0.09) = 0.15 or 15%
and the value of the share as per constant growth model is
P0
D1
(k e - g)
Where,
P0 = Price of a share
D1 = Dividend at the end of the year 1
Ke = Cost of equity
G = growth
P0 =
2.00
(k e - g)
P0 =
2.00
= ` 25.00
0.15 - 0.07
However, if the decision of finance manager is implemented, the beta () factor is likely to increase to 1.75
therefore, Ke would be
Ke = Rf + (Km Rf)
Security Analysis
6.14
= 0.09 + 1.75 (0.13 0.09) = 0.16 or 16%

The value of share is
D1
(k e - g)
2.00
= ` 22.22
P0 =
0.16 - 0.07
P0
Question 15
Calculate the value of share from the following information:
Profit of the company

Equity capital of company
Par value of share
Debt ratio of company
Long run growth rate of the company
Beta 0.1; risk free interest rate
Market returns
Capital expenditure per share
Depreciation per share
Change in Working capital
` 290 crores
` 1,300 crores
` 40 each
27
8%
8.7%
10.3%
` 47
` 39
` 3.45 per share
Answer
No. of Shares =
` 1,300 crores
= 32.5 Crores
` 40
EPS =
PAT
No.of shares
EPS =
` 290 crores
= ` 8.923
32.5 crores
FCFE = Net income [(1-b) (capex dep) + (1-b) ( WC )]

FCFE = 8.923 [(1-0.27) (47-39) + (1-0.27) (3.45)]
= 8.923 [5.84 + 2.5185] = 0.5645
Cost of Equity = Rf + (Rm Rf)
= 8.7 + 0.1 (10.3 8.7) = 8.86%
6.15
Po =
FCFE(1 g) 0.5645(1.08) 0.60966
=
= ` 70.89
0.0886 .08 0.0086
Ke g
Question 16
XYZ company has current earnings of ` 3 per share with 5,00,000 shares outstanding. The company
plans to issue 40,000, 7% convertible preference shares of ` 50 each at par. The preference shares
are convertible into 2 shares for each preference shares held. The equity share has a current market
price of ` 21 per share.
(i)
What is preference shares conversion value?
(ii)
What is conversion premium?
(iii)
Assuming that total earnings remain the same, calculate the effect of the issue on the basic
earning per share (a) before conversion (b) after conversion.
(iv) If profits after tax increases by ` 1 million what will be the basic EPS (a) before conversion and
(b) on a fully diluted basis?
(8 Marks) (November 2009)(S)
Answer
(i)
Conversion value of preference share

Conversion Ratio x Market Price
2 ` 21 = ` 42
(ii)
Conversion Premium
(` 50/ ` 42) 1 = 19.05%
(iii) Effect of the issue on basic EPS
BEFORE CONVERSION
Total (after tax) earnings 3 ` 5,00,000
15,00,000
Dividend on Preference shares
1,40,000
13,60,000
Earnings available to equity holders

No. of shares
EPS
ON DILUTED BASIS
Earnings
No of shares ( 5,00,000 + 80,000)
EPS
5,00,000
2.72
15,00,000
5,80,000
2.59
Security Analysis
6.16
(iv) EPS with increase in Profit
`
Earnings
25,00,000
Dividend on Pref. shares

Earning for equity shareholders
1,40,000
23,60,000
No. of equity shares
5,00,000
4.72
EPS
On DILUTED BASIS
Earnings
25,00,000
No. of shares
5,80,000
EPS
4.31
Question 17
Shares of Voyage Ltd. are being quoted at a price-earning ratio of 8 times. The company retains 45%
of its earnings which are ` 5 per share.
You are required to compute
(1)
The cost of equity to the company if the market expects a growth rate of 15% p.a.
(2)
If the anticipated growth rate is 16% per annum, calculate the indicative market price with the
same cost of capital.
(3)
If the company's cost of capital is 20% p.a. & the anticipated growth rate is 19% p.a., calculate
the market price per share.
(3+3+2 Marks) (May 2011)
Answer
(1)
Cost of Capital
Retained earnings (45%)
Dividend (55%)
` 5 per share
` 6.11 per share
EPS (100%)
` 11.11 per share
P/E Ratio
8 times
Market price
` 11.11
8 = ` 88.88
Cost of equity capital
` 6.11
Div
100 + Growth % =
100 +15% = 21.87%
` 88.88
Pr ice
(2)
Market Price
Dividend
Cost of Capital(%) - Growth Rate(%)
6.17
(3)
Market Price
` 6.11
= ` 104.08 per share
(21.87 - 16)%
` 6.11
(20 - 19)%
Alternative Solution
As in the question the sentence The company retains 45% of its earnings which are ` 5 per share
amenable to two interpretations i.e. one is ` 5 as retained earnings (45%) and another is ` 5 is EPS (100%).
Alternative solution is as follows:
(1)
Cost of capital
EPS (100%)
` 5 per share
Retained earnings (45%)
` 2.25 per share
Dividend (55%)
` 2.75 per share
P/E Ratio
8 times
Market Price
`5
8 = ` 40
Cost of equity capital
` 2.75
Div
100 + Growth % =
100 +15% = 21.87%
` 40.00
Pr ice
(2)
Market Price
Dividend
` 2.75
=
Cost of Capital(%) - Growth Rate(%) (21.87 - 16)%
= ` 46.85 per share

(3)
Market Price
` 2.75
(20 - 19)%
Question 18
A share of Tension-free Economy Ltd. is currently quoted at, a price earnings ratio of 7.5 times. The
retained earnings per share being 37.5% is ` 3 per share.
Compute:
(1)
The companys cost of equity, if investors expect annual growth rate of 12%*.
(2)
If anticipated growth rate is 13% p.a., calculate the indicated market price, with same cost of
capital.
(3)
If the companys cost of capital is 18% and anticipated growth rate is 15% p.a., calculate the
market price per share, assuming other conditions remain the same.
(8 Marks) (May 2005), (8 Marks) (November 2013)
Security Analysis
6.18
* In November 2013 Examination the phrase if investors expect annual growth rate of 12% got printed
as if investors expected rate of return is 12%
Answer
1.
Calculation of cost of capital
Retained earnings
37.5%
` 3 per share
Dividend*
62.5%
` 5 per share
EPS
100.0%
` 8 per share
P/E ratio
7.5 times
Market price is ` 7.5 8 = ` 60 per share

Cost of equity capital = (Dividend/price 100) + growth %
= (5/60 100) + 12% = 20.33%.
`3
62.5 ` 5
*
37
.
5
2.
Market price = Dividend/(cost of equity capital % growth rate %) = 5/(20.33% 13%) = 5/7.33%
= ` 68.21 per share.
3.
Market price = Dividend/(cost of equity capital % growth rate %) = 5/(18% 15%) = 5/3% = `
166.66 per share.
Question 19
Following Financial data are available for PQR Ltd. for the year 2008:
8% debentures
10% bonds (2007)
Equity shares (` 10 each)
Reserves and Surplus
Total Assets
Assets Turnovers ratio
Effective interest rate
Effective tax rate
Operating margin
Dividend payout ratio
Current market Price of Share
Required rate of return of investors
(` in lakh)
125
50
100
300
600
1.1
8%
40%
10%
16.67%
`14
15%
6.19

(i)
Draw income statement for the year
(ii)
Calculate its sustainable growth rate
(iii)
Calculate the fair price of the Company's share using dividend discount model, and
(iv) What is your opinion on investment in the company's share at current price?
(6 Marks) (November 2009) (S)
Answer
Workings:
Asset turnover ratio
= 1.1
Total Assets
= ` 600
Turnover ` 600 lakhs 11 = ` 660 lakhs

Effective iinterest rate
Interest
8%
Libilities
Liabilities
= ` 125 lakhs + 50 lakhs = 175 lakh
Interest
= ` 175 lakhs 0.08 = ` 14 lakh
Operating Margin
= 10%
Hence operating cost
= (1 - 0.10) ` 660 lakhs = ` 594 lakh
Dividend Payout
= 16.67%
Tax rate
= 40%
(i)
Income statement
Sale
Operating Exp
EBIT
Interest
EBT
Tax @ 40%
EAT
Dividend @ 16.67%
Retained Earnings
(` Lakhs)
660
594
66
14
52
20.80
31.20
5.20
26.00
Security Analysis
(ii)
6.20
SGR = G = ROE (1-b)

ROE =
PAT
and NW ` 100 lakh ` 300 lakh 400 lakh
NW
ROE =
` 31.2 lakhs
100 = 7.8%
` 400 lakhs
SGR = 0.078(1 - 0.1667) = 6.5%

(iii) Calculation of fair price of share using dividend discount model
Po =
Do (1 g)
ke g
Dividends =
` 5.2 lakhs
= ` 0.52
` 10 lakhs
Growth Rate = 6.5%

Hence Po =
` 0.521 0.065 ` 0.5538

=
= ` 6.51
0.15-0.065
0.085
(iv) Since the current market price of share is ` 14, the share is overvalued. Hence the investor
should not invest in the company.
Question 20
Following Financial Data for Platinum Ltd. are available:
For the year 2011:

Equity Shares (` 10 each)
8% Debentures
10% Bonds
Reserve and Surplus
Total Assets
Assets Turnover Ratio
Effective Tax Rate
Operating Margin
Required rate of return of investors
Dividend payout ratio
Current market price of shares
(i)
Draw income statement for the year
(ii)
Calculate the sustainable growth rate
(` In lakhs)
100
125
50
200
500
1.1
30%
10%
15%
20%
`13
6.21
(iii)
Compute the fair price of the company's share using dividend discount model, and
(iv) Draw your opinion on investment in the company's share at current price.
(8 Marks)(November 2012)
Answer
Workings:
Asset turnover ratio
= 1.1
Total Assets
= `500 lakhs
Turnover ` 500 lakhs 1.1 = `550 lakhs

Interest
= `125 lakhs0.08 + `50 lakhs0.10 = `15 lakh
Operating Margin
= 10%
Hence operating cost
= (1 - 0.10) `550 lakhs = `495 lakh
Dividend Payout
= 20%
Tax rate
= 30%
(i)
Income statement
Sale
Operating Exp
EBIT
Interest
EBT
Tax @ 30%
EAT
Dividend @ 20%
Retained Earnings
(ii) SGR = G = ROE (1-b)

ROE =
PAT
NW
and NW = `100 lakhs + `200 lakhs = `300 lakhs
` 28 lakhs
100 = 9.33%
` 300 lakhs
SGR = 0.0933(1 - 0.20) = 7.47%
(iii) Calculation of fair price of share using dividend discount model
D (1 g)
Po = 0
ke g
ROE =
(` Lakhs)
550.00
495.00
55.00
15.00
40.00
12.00
28.00
5.60
22.40
Security Analysis
Dividends =
6.22
` 5.6 lallakhs lakhs

= `0.56
10 lakhslakhs
Growth Rate = 7.47%

Hence Po =
` 0.56 1 0.0747
0.15 - 0.0747
` 0.6018
= `7.99 say `8.00
0.0753
(iv) Since the current market price of share is `13.00, the share is overvalued. Hence the investor
should not invest in the company.
Question 21
M/s X Ltd. has paid a dividend of ` 2.5 per share on a face value of ` 10 in the financial year ending on
31st March, 2009. The details are as follows:
Current market price of share
` 60
Growth rate of earnings and dividends
10%
Beta of share
0.75
Average market return
15%
Risk free rate of return
9%
Calculate the intrinsic value of the share.
Answer
Intrinsic Value P0=
D1
kg
Using CAPM
k = Rf + (Rm-Rf)
Rf = Risk Free Rate
= Beta of Security
Rm = Market Return
= 9% + 0.75 (15% - 9%) = 13.5%
P=
2.5 1.1
2.75
= ` 78.57
0.135 - 0.10 0.035
Question 22
Mr. A is thinking of buying shares at ` 500 each having face value of ` 100. He is expecting a bonus at
the ratio of 1:5 during the fourth year. Annual expected dividend is 20% and the same rate is expected
to be maintained on the expanded capital base. He intends to sell the shares at the end of seventh year
6.23
at an expected price of ` 900 each. Incidental expenses for purchase and sale of shares are estimated
to be 5% of the market price. He expects a minimum return of 12% per annum.
Should Mr. A buy the share? If so, what maximum price should he pay for each share? Assume no tax
on dividend income and capital gain.
(4 Marks) (May 2010)(M)
Answer
P.V. of dividend stream and sales proceeds
Year
1
2
3
4
5
6
7
7
Divd. /Sale
` 20/` 20/` 20/` 24/` 24/
` 24/
` 24/
` 1026/- (` 900 x 1.2 x 0.95)
PVF (12%)
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.452
Less : - Cost of Share (` 500 x 1.05)

Net gain
PV (`)
17.86
15.94
14.24
15.26
13.61
12.17
10.85
463.75
` 563.68
` 525.00
` 38.68
Since Mr. A is gaining ` 38.68 per share, he should buy the share.
Maximum price Mr. A should be ready to pay is ` 563.68 which will include incidental expenses. So the
maximum price should be ` 563.68 x 100/105 = ` 536.84
Question 23
A convertible bond with a face value of ` 1,000 is issued at ` 1,350 with a coupon rate of 10.5%. The
conversion rate is 14 shares per bond. The current market price of bond and share is ` 1,475 and ` 80
respectively. What is the premium over conversion value?
Answer
Conversion rate is 14 shares per bond. Market price of share ` 80
Conversion Value 14 x ` 80 = ` 1120
Market price of bond = ` 1475
Premium over Conversion Value (` 1475- ` 1120) =
355
x 100 = 31.7%
1120
Security Analysis
6.24
Question 24
Saranam Ltd. has issued convertible debentures with coupon rate 12%. Each debenture has an option
to convert to 20 equity shares at any time until the date of maturity. Debentures will be redeemed at `
100 on maturity of 5 years. An investor generally requires a rate of return of 8% p.a. on a 5-year
security. As an investor when will you exercise conversion for given market prices of the equity share of
(i) ` 4, (ii) ` 5 and (iii) ` 6.
Cumulative PV factor for 8% for 5 years
3.993
PV factor for 8% for year 5
0.681
Answer
If Debentures are not converted its value is as under: -
PVF @ 8 %
3.993
0.681
Interest - ` 12 for 5 years

Redemption - ` 100 in 5th year
`
47.916
68.100
116.016
Value of equity shares:-
Market Price
`4
`5
`6
No.
20
20
20
Total
` 80
` 100
` 120
Hence, unless the market price is ` 6 conversion should not be exercised.

Question 25
The data given below relates to a convertible bond:
Face value
Coupon rate
No. of shares per bond
Market price of share
Straight value of bond
Market price of convertible bond
` 250
12%
20
` 12
` 235
` 265
Calculate:
(i) Stock value of bond.
(ii)
The percentage of downside risk.
(iii)
The conversion premium
(iv) The conversion parity price of the stock.
6.25
Answer
(i)
Stock value or conversion value of bond

12 20 = ` 240
(ii)
Percentage of the downside risk
` 265 - ` 235
= 0.1277 or 12.77%
` 235
This ratio gives the percentage price decline experienced by the bond if the stock becomes
worthless.
(iii) Conversion Premium
` 265 - ` 240
Market Pr ice Conversion Value
100 = 10.42%
100 =
Conversion Value
` 240
(iv) Conversion Parity Price
Bond Pr ice
` 265
=
` 13.25
20
No. of Shares on Conversion
This indicates that if the price of shares rises to ` 13.25 from ` 12 the investor will neither gain nor lose
on buying the bond and exercising it. Observe that ` 1.25 (` 13.25 ` 12.00) is 10.42% of ` 12, the
Conversion Premium.
Question 26
GHI Ltd., AAA rated company has issued, fully convertible bonds on the following terms, a year ago:
Face value of bond
` 1000
Coupon (interest rate)
8.5%
Time to Maturity (remaining)
3 years
Interest Payment
Annual, at the end of year
Principal Repayment
At the end of bond maturity
Conversion ratio (Number of shares per bond)
25
Current market price per share
` 45
Market price of convertible bond
` 1175
AAA rated company can issue plain vanilla bonds without conversion option at an interest rate of 9.5%.
Required: Calculate as of today:
(i)
Straight Value of bond.
Security Analysis
(ii)
Conversion Value of the bond.
(iii)
Conversion Premium.
6.26
(iv) Percentage of downside risk.

(v)
Conversion Parity Price.
t
PVIF0.095, t
0.9132
0.8340
0.7617
(4 +1+1+1++1= 8 Marks) (May 2014)
Answer
(i)
Straight Value of Bond

= ` 85 x 0.9132 + ` 85 x 0.8340 + ` 1085 x 0.7617 = ` 974.96
(ii)
Conversion Value
= Conversion Ration x Market Price of Equity Share
= ` 45 x 25 = ` 1,125
(iii) Conversion Premium

Conversion Premium = Market Conversion Price - Market Price of Equity Share
=
` 1,175
- ` 45 = ` 2
25
(iv) Percentage of Downside Risk
` 1,175 ` 974.96
=
(v)
` 974.96
100 = 20.52%
Conversion Parity Price
Bond Price
=
No. of Share on Conversion
` 1,175
= ` 47
25
Question 27
Pineapple Ltd has issued fully convertible 12 percent debentures of ` 5,000 face value, convertible into
10 equity shares. The current market price of the debentures is ` 5,400. The present market price of
equity shares is ` 430.
Calculate:
(i)
the conversion percentage premium, and
(ii)
the conversion value
(3+3 Marks) (November 2011)
6.27
Answer
(i)
As per the conversion terms 1 Debenture = 10 equity share and since face value of one
debenture is ` 5000 the value of equity share becomes ` 500 (5000/10).
The conversion terms can also be expressed as: 1 Debenture of ` 500 = 1 equity share.
The cost of buying ` 500 debenture (one equity share) is:
R` 500
5400
` 540
5000
Market Price of share is ` 430. Hence conversion premium in percentage is:
540 - 430
100 = 25.58%
430
(ii)
The conversion value can be calculated as follows:

Conversion value
= Conversion ratio X Market Price of Equity Shares

= 10 ` 430 = ` 4300
Question 28
Rahul Ltd. has surplus cash of ` 100 lakhs and wants to distribute 27% of it to the shareholders. The
company decides to buy back shares. The Finance Manager of the company estimates that its share
price after re-purchase is likely to be 10% above the buyback price-if the buyback route is taken. The
number of shares outstanding at present is 10 lakhs and the current EPS is ` 3.
(i)
The price at which the shares can be re-purchased, if the market capitalization of the company
should be ` 210 lakhs after buyback,
(ii)
The number of shares that can be re-purchased, and
(iii)
The impact of share re-purchase on the EPS, assuming that net income is the same.
Answer
(i)
Let P be the buyback price decided by Rahul Ltd.

Market Capitalisation after Buyback
1.1P (Original Shares Shares Bought Back)
= 1.1P 10 lakhs -
27% of 100 lakhs
= 11 lakhs P 27 lakhs 1.1 = 11 lakhs P 29.7 lakhs

Again, 11 lakhs P 29.7 lakhs
Security Analysis
6.28
or 11 lakhs P = 210 lakhs + 29.7 lakhs

or P =
(ii)
239.7
= ` 21.79 per share
11
Number of Shares to be Bought Back :-
` 27 lakhs
= 1.24 lakhs (Approx.) or 123910 share
` 21.79
(iii) New Equity Shares :10 lakhs 1.24 lakhs = 8.76 lakhs or 1000000 123910 = 876090 shares
EPS =
3 10 lakhs
= ` 3.43
8.76 lakhs
Thus, EPS of Rahul Ltd., increases to ` 3.43.

Question 29
With the help of the following information of Jatayu Limited compute the Economic Value Added:
Capital Structure
Cost of equity
Financial Leverage
Income Tax Rate
Equity capital ` 160 Lakhs

Reserves and Surplus ` 140 lakhs
10% Debentures ` 400 lakhs
14%
1.5 times
30%
Answer
Financial Leverage = PBIT/PBT
1.5 = PBIT / (PBIT Interest)
1.5 = PBIT / (PBIT 40)
1.5 (PBIT 40) = PBIT
1.5 PBIT 60 = PBIT
1.5 PBIT PBIT = 60
0.5 PBIT = 60
or PBIT
60
= `120 lakhs
0.5
NOPAT = PBIT Tax = `120 lakhs (1 0.30) = `84 lakhs.

Weighted Average Cost of Capital (WACC)
6.29
= 14% (300 / 700) + (1 0.30) (10%) (400 / 700) = 10%

EVA = NOPAT (WACC Total Capital)
EVA = `84 lakhs 0.10 ` 700 lakhs
EVA = ` 14 lakhs
Question 30
Calculate economic value added (EVA) with the help of the following information of Hypothetical
Limited:
Financial leverage
Capital structure
1.4 times
Equity Capital ` 170 lakhs
Reserves and surplus ` 130 lakhs

10% Debentures ` 400 lakhs
Cost of Equity
Income Tax Rate
17.5%
30%.
(6 Marks)(November 2004)
Answer
Financial Leverage = PBIT/PBT
1.4 = PBIT / (PBIT Interest)
1.4 = PBIT / (PBIT 40)
1.4 (PBIT 40) = PBIT
1.4 PBIT 56 = PBIT
1.4 PBIT PBIT = 56
0.4 PBIT = 56
or PBIT
56
` 140 lakhs
0.4
NOPAT = PBIT Tax = ` 140 lakhs (1 0.30) = ` 98 lakhs.

Weighted average cost of capital (WACC) = 17.5% (300 / 700)+ (1 0.30) (10%)
(400 / 700)
= 11.5%
EVA = NOPAT (WACC Total Capital)
= ` 98 lakhs 0.115 ` 700 lakhs
= ` 17.5 lakhs
Security Analysis
6.30
Question 31
Tender Ltd has earned a net profit of ` 15 lacs after tax at 30%. Interest cost charged by financial
institutions was ` 10 lacs. The invested capital is ` 95 lacs of which 55% is debt. The company
maintains a weighted average cost of capital of 13%. Required,
(a)
Compute the operating income.
(b)
Compute the Economic Value Added (EVA).
(c)
Tender Ltd. has 6 lac equity shares outstanding. How much dividend can the company pay before
the value of the entity starts declining?
Answer
Taxable Income
Operating Income
EVA
EVA Dividend
` 15 lac/(1-0.30)
` 21.43 lacs
Taxable Income + Interest
` 21,42,857 + ` 10,00,000
` 31,42,857
EBIT (1-Tax Rate) WACC x Invested Capital
` 31,42,857(1 0.30) 13% x ` 95,00,000
` 22,00,000 ` 12,35,000 = ` 9,65,000
` 9,65,000
= ` 1.6083
` 6,00,000
or ` 21,42,857
or
` 31.43 lacs
Question 32
The following information is given for 3 companies that are identical except for their capital structure:
Total invested capital

Debt/assets ratio
Shares outstanding
Pre tax cost of debt
Cost of equity
Operating Income (EBIT)
Net Income
Orange
1,00,000
0.8
6,100
16%
26%
25,000
8,970
The tax rate is uniform 35% in all cases.

(i)
Compute the Weighted average cost of capital for each company.
(ii)
Compute the Economic Valued Added (EVA) for each company.
Grape
1,00,000
0.5
8,300
13%
22%
25,000
12,350
Apple
1,00,000
0.2
10,000
15%
20%
25,000
14,950
6.31
(iii)
Based on the EVA, which company would be considered for best investment? Give reasons.
(iv) If the industry PE ratio is 11x, estimate the price for the share of each company.
(v)
Calculate the estimated market capitalisation for each of the Companies.

(12 Marks) (May 2010) (S)
Answer
(i)
Working for calculation of WACC
Orange
Grape
Apple
Total debt
80,000
50,000
20,000
Post tax Cost of debt
10.4%
8.45%
9.75%
Equity Fund
20,000
50,000
80,000
WACC
Orange:
(10.4 x 0.8) + (26 x 0.2)
13.52%
Grape:
(8.45 x 0.5) + (22 x 0.5)
15.225%
Apple:
(9.75 x 0.2) + (20 x 0.8)
17.95%
(ii)
WACC
EVA [EBIT (1-T)-(WACC x Invested Capital)]
Orange
13.52
2,730
Grape
15.225
1,025
Apple
17.95
-1,700
(iii) Orange would be considered as the best investment since the EVA of the company is highest and
its weighted average cost of capital is the lowest
(iv) Estimated Price of each company shares
EBIT (`)
Interest (`)
Taxable Income (`)
Tax 35% (`)
Net Income (`)
Shares
EPS (`)
Stock Price (EPS x PE Ratio) (`)
Orange
25,000
12,800
12,200
4,270
7,930
6,100
1.3
14.30
Grape
25,000
6,500
18,500
6,475
12,025
8,300
1.448795
15.94
Apple
25,000
3,000
22,000
7,700
14,300
10,000
1.43
15.73
Since the three entities have different capital structures they would be exposed to different
degrees of financial risk. The PE ratio should therefore be adjusted for the risk factor.
Security Analysis
(v)
6.32
Market Capitalisation
Estimated Stock Price (`)
14.30
15.94
15.73
No. of shares
6,100
8,300
10,000
87,230
1,32,302
1,57,300
Estimated Market Cap (`)

Question 33
Delta
Ltd.s
current
financial
years
income
statement
reports
its
net
income
as
` 15,00,000. Deltas marginal tax rate is 40% and its interest expense for the year was
` 15,00,000. The company has ` 1,00,00,000 of invested capital, of which 60% is debt. In addition,
Delta Ltd. tries to maintain a Weighted Average Cost of Capital (WACC) of 12.6%.
(i)
Compute the operating income or EBIT earned by Delta Ltd. in the current year.
(ii)
What is Delta Ltd.s Economic Value Added (EVA) for the current year?
(iii)
Delta Ltd. has 2,50,000 equity shares outstanding. According to the EVA you computed in (ii),
how much can Delta pay in dividend per share before the value of the company would start to
decrease? If Delta does not pay any dividends, what would you expect to happen to the value of
the company?
Answer
(i)
Taxable income = Net Income /(1 0.40)

or, Taxable income = ` 15,00,000/(1 0.40) = ` 25,00,000
Again, taxable income = EBIT Interest
or, EBIT
= Taxable Income + Interest

= ` 25,00,000 + ` 15,00,000 = ` 40,00,000
(ii)
EVA = EBIT (1 T) (WACC Invested capital)

= ` 40,00,000 (1 0.40) (0.126 ` 1,00,00,000)
= ` 24,00,000 ` 12,60,000 = ` 11,40,000
(iii) EVA Dividend = ` 11,40,000/2,50,000 = ` 4.56

If Delta Ltd. does not pay a dividend, we would expect the value of the firm to increase because it will
achieve higher growth, hence a higher level of EBIT. If EBIT is higher, then all else equal, the value of
the firm will increase.
Question 34
RST Ltd.s current financial year's income statement reported its net income as ` 25,00,000. The
applicable corporate income tax rate is 30%.
Following is the capital structure of RST Ltd. at the end of current financial year:
6.33
`
Debt (Coupon rate = 11%)
Equity (Share Capital + Reserves & Surplus)
Invested Capital
40 lakhs
125 lakhs
165 lakhs
Following data is given to estimate cost of equity capital:
`
Beta of RST Ltd.
Risk free rate i.e. current yield on Govt. bonds
Average market risk premium (i.e. Excess of return on market portfolio over
risk-free rate)
1.36
8.5%
9%
Required:
(i)
Estimate Weighted Average Cost of Capital (WACC) of RST Ltd.; and
(ii)
Estimate Economic Value Added (EVA) of RST Ltd.
(4 + 4 = 8 Marks) (May 2014)
Answer
Cost of Equity as per CAPM
ke = Rf + x Market Risk Premium
= 8.5% + 1.36 x 9%
= 8.5% + 12.24% = 20.74%
kd = 11%(1 0.30) = 7.70%
Cost of Debt
WACC
(ko) = ke x
E
D
+ kd x
E +D
E +D
= 20.74 x
125
40
+ 7.70 x
165
165
= 15.71 + 1.87 = 17.58%

Taxable Income
= ` 25,00,000/(1 - 0.30)
= ` 35,71,429 or ` 35.71 lakhs
Operating Income
= Taxable Income + Interest

= ` 35,71,429 + ` 4,40,000
= ` 40,11,429
EVA
or
` 40.11 lacs
= EBIT (1-Tax Rate) WACC x Invested Capital

= ` 40,11,429 (1 0.30) 17.58% x ` 1,65,00,000
= ` 28,08,000 ` 29,00,700 = - ` 92,700
Security Analysis
6.34
Question 35
Abhishek Ltd. has a surplus cash of ` 90 lakhs and wants to distribute 30% of it to the shareholders.
The Company decides to buyback shares. The Finance Manager of the Company estimates that its
share price after re-purchase is likely to be 10% above the buyback price; if the buyback route is taken.
The number of shares outstanding at present is 10 lakhs and the current EPS is ` 3.
(a)
The price at which the shares can be repurchased, if the market capitalization of the company
should be ` 200 lakhs after buyback.
(b)
The number of shares that can be re-purchased.
(c)
The impact of share re-purchase on the EPS, assuming the net income is same.
Answer
(a)
Let P be the buyback price decided by Abhishek Ltd.

Market Capitalisation After Buyback:
1.1 P (Original Shares Shares Bought back)
= 1.1P (10 Lakhs
30% of 90 lakhs
= 11 Lakhs x P 27 lakhs x 1.1= 11 lakhs x P 29.7 lakhs

Market capitalization rate after buyback is 200 lakhs.
Thus, we have:
11 Lakhs x P 29.7 lakhs = `200 lakhs
or 11P = 200 + 29.7
or P =
(b)
Number of shares to be bought back:
(c)
229.7
` 20.88
11
27 Lakhs
1.29 lakhs (Approxima tely)
20.88
New Equity Shares

= (10 1.29) lakhs
EPS =
8.71 lakhs
3 10 lakhs 30 L
Rs. 3.44
8.71lakhs 8.71L
Thus EPS of Abhishek Ltd., increases to `3.44
6.35
Question 36
If the market price of the bond is ` 95; years to maturity = 6 yrs: coupon rate = 13% p.a (paid annually)
and issue price is ` 100. What is the yield to maturity?
Answer
C+
YTM =
(F - P)
n
F +P
2
13
C= Coupon Rate; F= Face Value (Issue Price) ; P= Market Price of Bond
100 - 95
6
100 95
2
YTM
= 0.1418 or 14.18%
Question 37
An investors is considering the purchase of the following Bond:
` 100
Face value
Coupon rate
Maturity
11%
3 years
(i)
If he wants a yield of 13% what is the maximum price he should be ready to pay for?
(ii)
If the Bond is selling for ` 97.60, what would be his yield?

Answer
(i)
Calculation of Maximum price

Bo
= ` 11 PVIFA (13%,3) + ` 100 PVIF (13%,3)

= ` 11 2.361 + ` 100 0.693 = ` 25.97 + ` 69.30 = ` 95.27
(ii)
Calculation of yield
At 12% the value
= ` 11 PVIFA (12%,3) + 100 PVIF (12%,3)

= ` 112.402 + ` 1000.712 = ` 26.42 + ` 71.20 = ` 97.62
It the bond is selling at ` 97.60 which is more than the fair value, the YTM of the bond would be
less than 13%. This value is almost equal to the amount price of ` 97.60. Therefore, the YTM of
the bond would be 12%.
Security Analysis
6.36
Question 38
Calculate Market Price of:
(i)
10% Government of India security currently quoted at ` 110, but interest rate is expected to go up
by 1%.
(ii)
A bond with 7.5% coupon interest, Face Value ` 10,000 & term to maturity of 2 years, presently
yielding 6% . Interest payable half yearly.
Answer
(i)
Current yield = (Coupon Interest / Market Price) X 100

(10/110) X 100 = 9.09%
If current yield go up by 1% i.e. 10.09 the market price would be
10.09 = 10 / Market Price X 100
Market Price = ` 99.11
(ii)
Market Price of Bond = P.V. of Interest + P.V. of Principal

= ` 1,394 + ` 8,885 = ` 10,279
Question 39
Find the current market price of a bond having face value ` 1,00,000 redeemable after 6 year maturity
with YTM at 16% payable annually and duration 4.3202 years. Given 1.166 = 2.4364.
Answer
The formula for the duration of a coupon bond is as follows:
=
1+ YTM (1+ YTM) + t ( c - YTM)

YTM
c ( 1+ YTM)t -1 + YTM
Where YTM = Yield to Maturity

c= Coupon Rate
t= Years to Maturity
Accordingly, since YTM =0.16 and t= 6
4.3202 =
1.16 1.16 + 6(c 0.16)

0.16 c ( 1.16)6 -1 + 0.16
4.3202= 7.25 -
1.16 + ( 6c - 0.96)
1.4364c + 0.16
1.16 6c 0.96
2.9298
1.4364 c 0.16
6.37
0.2 + 6c = 4.20836472 c + 0.468768

1.79163528c = 0.268768
C = 0.150012674
c = 0.15
Where c = Coupon rate

Therefore, current price = `(1,00,000/- x 0.15 x 3.685 + 1,00,000/- x 0.410) = `96,275/-.
Question 40
There is a 9% 5-year bond issue in the market. The issue price is ` 90 and the redemption price ` 105.
For an investor with marginal income tax rate of 30% and capital gains tax rate of 10% (assuming no
indexation), what is the post-tax yield to maturity?
Answer
Calculation of yield to Maturity (YTM)
YTM
Coupon Pr o-rated discount

( Re demption price Purchase Pr ice)/ 2
After tax coupon = 9 (1 .30) = 6.3%

After tax redemption price = 105 (15 .10) or ` 103.5
After tax capital gain = 103.50 90 = ` 13.50
YTM
6.3 13.5/ 5
9.00
or
9.30%
(103.5 90)/ 2
96.75
Question 41
MP Ltd. issued a new series of bonds on January 1, 2000. The bonds were sold at par (` 1,000), having
a coupon rate 10% p.a. and mature on 31st December, 2015. Coupon payments are made semiannually
on June 30th and December 31st each year. Assume that you purchased an outstanding MP Ltd. bond
on 1st March, 2008 when the going interest rate was 12%.
Required:
(i)
What was the YTM of MP Ltd. bonds as on January 1, 2010?
(ii)
What amount you should pay to complete the transaction? Of that amount how much should be
accrued interest and how much would represent bonds basic value.
Answer
(i)
Since the bonds were sold at par, the original YTM was 10%.
YTM =
Interest ` 100
10%
Pr incipal ` 1,000
Security Analysis
(ii)
Price of the bond as on 1st March, 2008
= `50
6.38
9.712 + ` 1,000 0.417
= ` 485.60 + ` 417
= `902.60
Total value of the bond on the next
= `902.60 + `50 interest date = `952.60
Value of bond at purchase date
= `952.60
1
(1+ 0.6)1/ 3
= `952.60 `0.980764 (by using excel)

= `934.28
The amount to be paid to complete the transaction is `934.28. Out of this amount `49.04 represent
accrued interest and `885.24 represent the bond basic value.
Question 42
ABC Ltd. issued 9%, 5 year bonds of ` 1,000/- each having a maturity of 3 years. The present rate of
interest is 12% for one year tenure. It is expected that Forward rate of interest for one year tenure is
going to fall by 75 basis points and further by 50 basis points for every next year in further for the same
tenure. This bond has a beta value of 1.02 and is more popular in the market due to less credit risk.
Calculate
(i)
Intrinsic value of bond
(ii)
Expected price of bond in the market
Answer
(i)
Intrinsic value of Bond = PV of Interest + PV of Maturity Value of Bond
Forward rate of interests

1st Year 12%
2nd Year 11.25%
3rd Year 10.75%
PV of interest =
` 90
(1 0.12)
` 90
(1 0.12)(1 0.1125)
` 90
(1 0.12)(1 0.1125)(1 0.1075)
= ` 217.81
PV of Maturity Value of Bond =
`1000
= ` 724.67
(1+ 0.12)(1+ 0.1125)(1+ 0.1075)
Intrinsic value of Bond = ` 217.81 + ` 724.67 = ` 942.48

(ii)
Expected Price = Intrinsic Value x Beta Value

= ` 948.48 x 1.02 = ` 961.33
6.39
Question 43
The following is the Yield structure of AAA rated debenture:
Period
Yield (%)
3 months
8.5%
6 months
9.25
1 year
10.50
2 years
11.25
3 years and above
12.00
(i)
Based on the expectation theory calculate the implicit one-year forward rates in year 2 and year
3.
(ii)
If the interest rate increases by 50 basis points, what will be the percentage change in the price of
the bond having a maturity of 5 years? Assume that the bond is fairly priced at the moment at `
1,000.
Answer
(i)
Implicit rates for year 2 and year 3

For year 2
f2 =
For year 3
(1 r2 ) 2
1
1 r1
(1.1125)2
(1.1050)
- 1 = 12%
(1+ r )3
3
f3 =
-1
(1+ r ) (1+ f )
1
2
(1.12)3
(1.1050) (1.12)
-1=
1.404928
1.2376
- 1 = 13.52%
(ii) If fairly priced at ` 1000 and rate of interest increases to 12.5% the percentage charge
will be as follows:
Price
1000(1.12)5 1762.34168
=
=
1.8020
(1.125)5
= 977.99 or ` 987
Security Analysis
% charge =
1000 - 978
1000
100 =
22
1000
6.40
100
= 2.2%
Question 44
Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for valuing
bonds:
Credit Rating
Discount Rate
AAA
364 day T bill rate + 3% spread
AA
AAA + 2% spread
AAA + 3% spread
He is considering to invest in AA rated, ` 1,000 face value bond currently selling at `1,025.86. The
bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The
next interest payment is due one year from today and the bond is redeemable at par. (Assume the 364
day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invest in the bond?
Also calculate the current yield and the Yield to Maturity (YTM) of the bond.
(5 Marks) (November 2008)(M), (8 Marks) (November 2011)
Answer
The appropriate discount rate for valuing the bond for Mr. Z is:
R = 9% + 3% + 2% = 14%
Time
1
2
3
4
5
CF
150
150
150
150
1150
PVIF 14% PV (CF)

0.877
0.769
0.675
0.592
0.519
PV (CF) i.e. P0 =
PV (CF)
131.55
115.35
101.25
88.80
596.85
1033.80
Since, the current market value is less than the intrinsic value; Mr. Z should buy the bond. Current yield =
Annual Interest / Price = 150 / 1025.86 = 14.62%
The YTM of the bond is calculated as follows:
@15%
P = 150 PVIFA 15%, 4 + 1150 PVIF 15%, 5
= 150 2.855 + 1150 0.497 = 428.25 + 571.55 = 999.80
6.41
@14%
As found in sub part (a) P0 = 1033.80

By interpolation we get,
= 14% +
7.94
7.94
(15% - 14%) = 14% +
%
7.94 - ( -26.06)
34
YTM = 14.23%
Question 45
M/s Agfa Industries is planning to issue a debenture series on the following terms:
Face value
` 100
Term of maturity
10 years
Yearly coupon rate

Years
14
9%
58
10%
9 10
14%
The current market rate on similar debentures is 15 per cent per annum. The Company proposes to
price the issue in such a manner that it can yield 16 per cent compounded rate of return to the
investors. The Company also proposes to redeem the debentures at 5 per cent premium on maturity.
Determine the issue price of the debentures.
Answer
The issue price of the debentures will be the sum of present value of interest payments during 10 years of its
maturity and present value of redemption value of debenture.
Years
1
2
3
4
5
6
7
8
9
10
Cash out flow ( ` )

9
9
9
9
10
10
10
10
14
14 + 105 = 119
Thus the debentures should be priced at ` 71.327
PVIF @ 16%
.862
.743
.641
.552
.476
.410
.354
.305
.263
.227
PV
7.758
6.687
5.769
4.968
4.76
4.10
3.54
3.05
3.682
3.178 + 23.835
71.327
Security Analysis
6.42
Question 46
ABC Ltd. has ` 300 million, 12 per cent bonds outstanding with six years remaining to maturity. Since
interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a ` 300 million issue
of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bond will be ` 6 million
and the call premium is 4 per cent. ` 9 million being the unamortized portion of issue cost of old bonds
can be written off no sooner the old bonds are called off. Marginal tax rate of ABC Ltd. is 30 per cent.
You are required to analyse the bond refunding decision.
Answer
1.
Calculation of initial outlay:-
` (million)
a.
Face value
Add:-Call premium
b.
12
Cost of calling old bonds
312
Gross proceed of new issue
300
Less: Issue costs

Net proceeds of new issue
c.
300
6
294
Tax savings on call premium

and unamortized cost 0.30 (12 + 9)
6.3
Initial outlay = ` 312 million ` 294 million ` 6.3 million = ` 11.7 million
2.
Calculation of net present value of refunding the bond:Saving in annual interest expenses
` (million)
[300 x (0.12 0.10)]
6.00
Less:- Tax saving on interest and amortization

0.30 x [6 + (9-6)/6]
1.95
Annual net cash saving
4.05
PVIFA (7%, 6 years)
4.766
Present value of net annual cash saving
` 19.30 million
Less:- Initial outlay
` 11.70 million
Net present value of refunding the bond
` 7.60 million
Decision: The bonds should be refunded
6.43
Question 47
M/s. Earth Limited has 11% bond worth of ` 2 crores outstanding with 10 years remaining to maturity.
The company is contemplating the issue of a ` 2 crores 10 year bond carring the coupon rate of 9%
and use the proceeds to liquidate the old bonds.
The unamortized portion of issue cost on the old bonds is ` 3 lakhs which can be written off no sooner
the old bonds are called. The company is paying 30% tax and it's after tax cost of debt is 7%. Should
Earth Limited liquidate the old bonds?
You may assume that the issue cost of the new bonds will be ` 2.5 lakhs and the call premium is 5%.
Answer
1.
` (lakhs)
Calculation of initial outlay:-
a.
Face value
200.00
Add:-Call premium
b.
10.00
Cost of calling old bonds
210.00
Gross proceed of new issue
200.00
Less: Issue costs
2.50
Net proceeds of new issue

c.
Tax savings on call premium

and unamortized cost 0.30 (10 + 3)
197.50
` 3.90 lakhs
Initial outlay = ` 210 lakhs ` 197.50 lakhs ` 3.90 lakhs = ` 8.60 lakhs
2.
Calculation of net present value of refunding the bond:Saving in annual interest expenses
` (lakhs)
[` 200 x (0.11 0.09)]
4.000
Less:-Tax saving on interest and amortization 0.30 x [4+(3-2.5)/10]
1.215
Annual net cash saving
2.785
PVIFA (7%, 10 years)
7.024
Present value of net annual cash saving
` 19.56 lakhs
Less:- Initial outlay
Net present value of refunding the bond
` 10.96 lakhs
Decision: The bonds should be refunded
8.60 lakhs
Security Analysis
6.44
Question 48
M/s Transindia Ltd. is contemplating calling ` 3 crores of 30 years, ` 1,000 bond issued 5 years ago
with a coupon interest rate of 14 per cent. The bonds have a call price of ` 1,140 and had initially
collected proceeds of ` 2.91 crores due to a discount of ` 30 per bond. The initial floating cost was `
3,60,000. The Company intends to sell ` 3 crores of 12 per cent coupon rate, 25 years bonds to raise
funds for retiring the old bonds. It proposes to sell the new bonds at their par value of ` 1,000. The
estimated floatation cost is ` 4,00,000. The company is paying 40% tax and its after cost of debt is 8
per cent. As the new bonds must first be sold and their proceeds, then used to retire old bonds, the
company expects a two months period of overlapping interest during which interest must be paid on
both the old and new bonds. What is the feasibility of refunding bonds? (10 Marks) (November 2005)
Answer
NPV for bond refunding
`
PV of annual cash flow savings (W.N. 2)
(3,49,600 PVIFA 8%,25) i.e. 10.675
Less: Initial investment (W.N. 1)
NPV
37,31,980
29,20,000
8,11,980
Recommendation: Refunding of bonds is recommended as NPV is positive.

Working Notes:
(1)
Initial investment:
(a)
Call premium
Before tax (1,140 1,000) 30,000

Less tax @ 40%
After tax cost of call prem.
(b)
Floatation cost
(c)
Overlapping interest
Before tax (.14 2/12 3 crores)

Less tax @ 40%
(d)
25,20,000
4,00,000
7,00,000
2,80,000
4,20,000
Tax saving on unamortised discount on

old bond 25/30 9,00,000 .4
(e)
42,00,000
16,80,000
(3,00,000)
Tax savings from unamortised floatation
Cost of old bond 25/30 3,60,000 .4
(1,20,000)
29,20,000
6.45
(2)
Annual cash flow savings:

(a)
Old bond
Interest cost (.14 3 crores)

Less tax @ 40%
(ii) Tax savings from amortisation of discount
9,00,000/30 .4
savings
from
amortisation
(iii) Tax
floatation cost 3,60,000/30 .4
Annual after cost payment of Debt (A)
42,00,000
16,80,000
(i)
(b)
25,20,000
(12,000)
of
(4,800)
25,03,200
New bond
Interest cost before tax (.12 3 crores)

Less tax @ 40%
After tax interest
(ii) Tax savings from amortisation of floatation cost
(.4 4,00,000/25)
Annual after tax payment
(i)
36,00,000
14,40,000
21,60,000
(6,400)
21,53,600
3,49,600
Question 49
The following data are available for a bond
Face value
Coupon Rate
Years to Maturity
Redemption value
Yield to maturity
` 1,000
16%
6
` 1,000
17%
What is the current market price, duration and volatility of this bond? Calculate the expected market
price, if increase in required yield is by 75 basis points.
Answer
1.
Calculation of Market price:
Discount or premium
Coupon int erest
Years left
YTM
Face Value Market value
2
Discount or premium YTM is more than coupon rate, market price is less than Face Value i.e. at
discount.
Security Analysis
6.46
Let x be the market price
(1,000 - x)
160
x = ` 960.26
0.17
1,000 x
2
Alternatively, the candidate may attempt by
160 (PVIAF 17%,6) + 1,000 (PVIF 17%,6)
= 160 (3.589) + 1,000 (0.390) = 574.24 + 390 = 964.24
2.
Duration
Year
Cash flow
1
2
3
4
5
6
160
160
160
160
160
1160
P.V. @ 17%
.855
.731
.624
.534
.456
.390
136.80
116.96
99.84
85.44
72.96
452.40
964.40
Proportion of
bond value
0.142
0.121
0.103
0.089
0.076
0.469
1.000
Proportion of bond
value x time (years)
0.142
0.246
0.309
0.356
0.380
2.814
4.247
Duration of the Bond is 4.247 years

3.
Volatility
Volatility of the bonds =

4.
Duration 4.247
=
= 3.63
(1 + yields) 1.17
The expected market price if increase in required yield is by 75 basis points.

= ` 960.26 .75 (3.63/100) = ` 26.142
Hence expected market price is ` 960.26 ` 26.142 = ` 934.118
Hence, the market price will decrease
This portion can also be alternatively done as follows
= ` 964.40 .75 (3.63/100) = ` 26.26
then the market price will be
= ` 964.40 26.26 = ` 938.14
Question 50
XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2007. These
debentures have a face value of ` 100 and is currently traded in the market at a price of ` 90.
6.47
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31.
Interest payments for the first 3 years will be paid in advance through post-dated cheques while for the
last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par on
December 31, 2011 at the end of 5 years.
Required :
(i)
Estimate the current yield and the YTM of the bond.
(ii)
Calculate the duration of the NCD.
(iii)
Assuming that intermediate coupon payments are, not available for reinvestment calculate the
realised yield on the NCD.
Answer
(i)
Current yield =
` 14
= 0.1555 or 15.55%
` 90
YTM can be determined from the following equation

7 PVIFA (YTM, 10) + 100 PVIF (YTM, 10) = 90
Let us discount the cash flows using two discount rates 15% and 18% as follows:
Year
0
1
2
3
4
5
6
7
8
9
10
Cash Flows
-90
7
7
7
7
7
7
7
7
7
107
PVF@7.5%
1
0.930
0.865
0.805
0.749
0.697
0.648
0.603
0.561
0.522
0.485
Now we use interpolation formula

7.5% +
6.57
1.5%
6.57 ( 2.90)
7.5% +
6.57
1.5 =8.54%
9.47
PVF@ 9%
1
0.917
0.842
0.772
0.708
0.650
0.596
0.547
0.502
0.460
0.422
PV@7.5%
-90
6.51
6.06
5.64
5.24
4.88
4.54
4.22
3.93
3.65
51.90
6.57
PV@9%
-90
6.42
5.89
5.40
4.96
4.55
4.17
3.83
3.51
3.22
45.15
-2.90
Security Analysis
(ii)
6.48
The duration can be calculated as follows:
6 Months
Time
1
2
3
4
5
6
7
8
9
10
Duration =
Cash
Flow
7
7
7
7
7
7
7
7
7
107
PVF@
8.54%
0.921
0.849
0.782
0.721
0.664
0.612
0.563
0.519
0.478
0.441
PV
Time x pv
6.45
5.94
5.48
5.05
4.65
4.28
3.94
3.63
3.35
47.19
89.96
6.45
11.88
16.44
20.20
23.25
25.68
27.58
29.04
30.15
471.90
662.57
662.57
= 7.362 time (6 months) i.e. 3.68 years
90
(iii) Realized Yield:
7 10 100
90
(1 R)10
(1 + R) 10 =
170
90
1/10
170
R=
90
1 = 0.0.65665 is 6.5665% for 6 months
i.e 13.133% p.a.

Question 51
(a)
Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both the
bonds have a face value of ` 1,000 and coupon rate of 8% (with annual interest payments) and
both are selling at par. Assume that the yields of both the bonds fall to 6%, whether the price of
bond will increase or decrease? What percentage of this increase/decrease comes from a change
in the present value of bonds principal amount and what percentage of this increase/decrease
comes from a change in the present value of bonds interest payments?
(b)
Consider a bond selling at its par value of ` 1,000, with 6 years to maturity and a 7% coupon rate
(with annual interest payment), what is bonds duration?
6.49
(c)
If the YTM of the bond in (b) above increases to 10%, how it affects the bonds duration? And
why?
(8+6+3 Marks) (June 2009)(S)
Answer
(a)
If the yield of the bond falls the price will always increase. This can be shown by following
calculation.
IF YIELD FALLS TO 6%
Price of 5yr. bond
` 80 (PVIFA 6%, 5yrs.)
+ ` 1000 (PVIF 6%, 5yrs.)
` 80 (4.212)+ ` 1000 (0.747)

` 336.96 + ` 747.00 = ` 1,083.96
Increase in 5 years bond price = ` 83.96
Current price of 20 year bond
` 80 (PVIFA 6%, 20) + ` 1,000 (PVIF 6%, 20)
` 80 (11.47) + ` 1,000 (0.312)
` 917.60 + ` 312.00 = ` 1229.60
So increase in bond price is ` 229.60
PRICE INCREASE DUE TO CHANGE IN PV OF PRINCIPAL
5 yrs. Bond
` 1,000 (PVIF 6%, 5) ` 1,000 (PVIF 8%, 5)
` 1,000 (0.747) ` 1,000 (0.681)
` 747.00 ` 681.00 = ` 66.00
& change in price due to change in PV of Principal
(` 66/ ` 83.96) x 100 = 78.6%
20 yrs. Bond
` 1,000 (PVIF 6%, 20) ` 1,000 (PVIF 8%, 20)
` 1,000 (0.312) ` 1,000 (0.214)
` 312.00 ` 214.00 = ` 98.00
& change in price due to change in PV of Principal
(` 98/ ` 229.60) x 100 = 42.68%
Security Analysis
6.50
PRICE CHANGE DUE TO CHANGE IN PV OF INTEREST

5 yrs. Bond
` 80 (PVIFA 6%, 5) ` 80 (PVIFA 8%, 5)
` 80 (4.212) ` 80 (3.993)
` 336.96 ` 319.44 = ` 17.52
% change in price
` 17.52
x 100 = 20.86%
` 83.96
20 yrs. Bond
` 80 (PVIFA 6%, 20) ` 80 (PVIFA 8%,20)
` 80 (11.47) ` 80 (9.82)
` 917.60 ` 785.60 = ` 132
& change in price =
` 132
x 100 = 57.49%
` 229.60
(b) Duration in the average time taken to recollect back the investment
Years
(A)
1
2
3
4
5
6
Coupon Redemption
Payments
(`)
(`)
70
70
70
70
70
70
1000
Total
(`)
(B)
70
70
70
70
70
1070
PVIF @ 7%
(`)
(C)
0.935
0.873
0.816
0.763
0.713
0.666
ABC
Duration =
ABC
Purchase Price
` 5097.94
= 5.098 years
` 1000
(c)
If YTM goes up to 10% , current price of the bond will decrease to

` 70 x PVIFA (10%,6) + ` 1000 PVIF (10%,6)
` 304.85 + ` 564.00 = ` 868.85
(A )x(B)x
(C)
(`)
65.45
122.22
171.36
213.64
249.55
4,275.72
5,097.94
6.51
Year
(A)
1
2
3
4
5
6
Inflow (`)
(B)
70
70
70
70
70
1070
PVIF @ 10%
(C)
0.909
0.826
0.751
0.683
0.621
0.564
ABC
(A )x(B)x (C)
(`)
63.63
115.64
157.71
191.24
217.35
3,620.88
4,366.45
New Duration ` 4,366.45/ ` 868.85 = 5.025 years

The duration of bond decreases, reason being the receipt of slightly higher portion of ones
investment on the same intervals.
Question 52
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200X were as
follows:
Days
1
2
3
4
5
6
7
8
9
10
11
12
Date
6
7
8
9
10
11
12
13
14
15
16
17
Day
THU
FRI
SAT
SUN
MON
TUE
WED
THU
FRI
SAT
SUN
MON
Sensex
14522
14925
No Trading
No Trading
15222
16000
16400
17000
No Trading
No Trading
No Trading
18000
Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days simple
moving average of Sensex can be assumed as 15,000. The value of exponent for 30 days EMA is
0.062.
Give detailed analysis on the basis of your calculations.
Security Analysis
6.52
Answer
Date
6
7
10
11
12
13
17
1
Sensex
14522
14925
15222
16000
16400
17000
18000
2
EMA for
Previous
day
15000
14970.364
14967.55
14983.32
15046.354
15130.28
15246.202
1-2
30.062
5
EMA
2+4
(478)
(45.364)
254.45
1016.68
1353.646
1869.72
2753.798
(29.636)
(2.812)
15.776
63.034
83.926
115.922
170.735
14970.364
14967.55
14983.32
15046.354
15130.28
15246.202
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 53
The closing value of Sensex for the month of October, 2007 is given below:
Date Closing
1.10.07
3.10.07
4.10.07
5.10.07
8.10.07
9.10.07
10.10.07
11.10.07
12.10.07
15.10.07
16.10.07
17.10.07
19.10.07
22.10.07
23.10.07
24.10.07
25.10.07
29.10.07
Sensex Value
2800
2780
2795
2830
2760
2790
2880
2960
2990
3200
3300
3450
3360
3290
3360
3340
3290
3240
6.53
30.10.07
31.10.07
3140
3260
You are required to test the weak form of efficient market hypothesis by applying 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
Value of t at 5% is 2.086 at 20 degrees of freedom.
Value of t at 10% is 1.725 at 20 degrees of freedom.
Answer
Date
1.10.07
3.10.07
4.10.07
5.10.07
8.10.07
9.10.07
10.10.07
11.10.07
12.10.07
15.10.07
16.10.07
17.10.07
19.10.07
22.10.07
23.10.07
24.10.07
25.10.07
29.10.07
30.10.07
31.10.07
Closing Sensex
2800
2780
2795
2830
2760
2790
2880
2960
2990
3200
3300
3450
3360
3290
3360
3340
3290
3240
3140
3260
Total of sign of price changes (r) = 8

No of Positive changes = n1 = 11
No. of Negative changes = n2 = 8
Sign of Price Charge

+
+
+
+
+
+
+
+
+
+
+
Security Analysis
r=
2 11 8
1 = 176/19 + 1 = 10.26
11 8
2n1n2 (2n1n2 n1 n2 )
(n1 n2 )2 (n1 n2 1)
(2 11 8) (2 11 8 11 8)
=
(11 8)2 (11 8 1)
2n1n2
1
n1 n2
6.54
176 157
=
(19)2 (18)
4.252 = 2.06
Since too few runs in the case would indicate that the movement of prices is not random. We employ a twotailed test the randomness of prices.
Test at 5% level of significance at 18 degrees of freedom using t- table
The lower limit
= t =10.26 2.101 2.06 = 5.932

r
Upper limit
= +t
=10.26 + 2.101 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
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 54
Tiger Ltd. is presently working with an Earning Before Interest and Taxes (EBIT) of ` 90 lakhs. Its
present borrowings are as follows:
` In lakhs
12% term loan
Working capital borrowings:
From Bank at 15%
Public Deposit at 11 %
300
200
100
6.55
The sales of the company are growing and to support this, the company proposes to obtain additional
borrowing of ` 100 lakhs expected to cost 16%.The increase in EBIT is expected to be 15%.
Calculate the change in interest coverage ratio after the additional borrowing is effected and comment
on the arrangement made.
(6 Marks) (June 2009, Adapted),
Answer
Calculation of Present Interest Coverage Ratio
Present EBIT = ` 90 lakhs
Interest charges (Present)

Term loan @ 12%
Bank Borrowings @ 15%
Public Deposit @ 11%
Present Interest Coverage Ratio =
`lakhs
36.00
30.00
11.00
77.00
EBIT
` 90 lakhs
1.169
=
Interest Ch arg es ` 77 lakhs
Calculation of Revised Interest Coverage Ratio

Revised EBIT (115% of ` 90
lakhs)
`103.50 lakhs
Proposed interest charges

Existing charges
` 77.00 lakhs
Add: Additional charges (16% of additional Borrowings i.e. `100 lakhs)
` 16.00 lakhs
Total
` 93.00 lakhs
Revised Interest Coverage Ratio =
` 103.50 lakhs
1.113
` 93.00 lakhs
Analysis: With the proposed increase in the sales the burden of interest on additional borrowings of
`100 lakhs will adversely affect the interest coverage ratio which has been reduced. (i.e. from 1.169 to
1.113).
Question 55
Trupti Co. Ltd. promoted by a Multinational group INTERNATIONAL INC is listed on stock exchange
holding 84% i.e. 63 lakhs shares.
Profit after Tax is ` 4.80 crores.
Free Float Market Capitalisation is ` 19.20 crores.
Security Analysis
6.56
As per the SEBI guidelines promoters have to restrict their holding to 75% to avoid delisting from the
stock exchange. Board of Directors has decided not to delist the share but to comply with the SEBI
guidelines by issuing Bonus shares to minority shareholders while maintaining the same P/E ratio.
Calculate
(i)
P/E Ratio
(ii)
Bonus Ratio
(iii)
Market price of share before and after the issue of bonus shares
(iv) Free Float Market capitalization of the company after the bonus shares.
Answer
1.
P/E Ratio:
% of holding
84%
16%
100%
Promoters Holding
Minority Holding
Total Shares
Free Float Market Capitalization
Hence Market price
`19.20 crores
12.00 lacs
EPS (PAT/No. of Shares)
= ` 19.20 crores
= `160 per share
(` 4.80 crores /75 lac) = ` 6.40 per share
P/E Ratio (` 160/ ` 6.40)

2.
No. of Shares
63 Lacs
12 Lacs
75 Lacs
= 25
No. of Bonus Shares to be issued:
Promoters holding 84%,
= 63 lacs shares
Shares remains the same, but holding % to be taken as 75%

Hence Total shares
63 lacs
75%
Shares of Minority
= 84 lacs
= 84 lacs 63 lacs = 21 lacs
Bonus 9 lacs for 12 lacs i.e. 3 bonus for 4 held

3.
Market price before & after Bonus:
Before Bonus
After Bonus
= `160 per share
6.57
` 4.80 crores
New EPS
New Market Price
4.
84 lacs
(25 x ` 5.71)
= ` 5.71
= ` 142.75
Free Float Capitalization is
` 142.75 x 21 lacs
= ` 29.9775 crores
Question 56
A Company passes through three stages: growth, transition and maturity stage. The growth stage is
expected to last for 2 years, while the transition stage lasts for 3 years. During the transition stage the
growth rate of dividends changes from 18% to 9%. What would be the rate of dividend at the end of the
first year of the transition stage?
(5 Marks) (November 2010) (M)
Answer
1/ 3
18
= 18% -
= 18% - 0.79% = 17.21%

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6

(4 Marks) (May 2011)

The Institute of Chartered Accountants of India

(4 Marks) (May 2012)

The CAPM formula:

= Expected return of portfolio

= Risk free rate of Return

= Port folio Beta

= Expected return on Market portfolio

The Institute of Chartered Accountants of India

Strategic Financial Management

Number of shares to be issued : 5,00,000

Subscription price ` 20,00,000 / 2,50,000 = ` 8

When firm offers one share for two shares held.

Less: Amount paid to acquire right shares (50X`4)

Less: Amount paid to acquire right shares (25X`8)

The Institute of Chartered Accountants of India

Wealth of Shareholders before Right Issue

Calculate the theoretical value of the rights alone.

(a) he sells the entire rights, and

(8 Marks)(November 2010) (M)

Expected minimum price

Where P= Theoretical Post right price per share

N = No. of existing shares

Post right price Subscription price

Value of 1500 shares before right issue

Add Sale proceeds of right

Net effect on wealth is Nil.

(b) Value of 1500 Shares

The Institute of Chartered Accountants of India

Strategic Financial Management

Current dividend (Do)

Calculate the present value of stock of ABC Ltd.

Present Value of the stock of ABC Ltd. Is:Vo

Pay out ratio of ABC Ltd.

Hence, Retention ratio = 1 -1.111

Alternative answer (ii)

The Institute of Chartered Accountants of India

0.09 0.02 (MV )

The Institute of Chartered Accountants of India

Strategic Financial Management

(5 Marks) (May 2014)

(1+ 0.15) (1+ 0.15)2

= 4.80 x 0.8696 + 5.76 x 0.7561 + 126.72 x 0.7561 = 104.34

The Institute of Chartered Accountants of India

conditions remaining same as in (ii) above.

(4+2+4 Marks) (May 2013)

Expected dividend for next 3 years.

The Institute of Chartered Accountants of India

Strategic Financial Management

Equity share capital

Capital gearing ratio is 0.75.

Yield on share is calculated at 50% of profits distributed and at 5% on undistributed profits.

Sun Ltd., has been regularly paying equity dividend of 8%.

(12 Marks) (November 2003)

Calculation of Profit after tax (PAT)

Calculation of Interest and Fixed Dividend Coverage

PAT Debenture interest

(b) Calculation of Capital Gearing Ratio

The Institute of Chartered Accountants of India

Capital Gearing Ratio =

Fixed interest bearing funds

Preference Share Capital Debentures 40,00,000 64,00,000 1,04,00,000