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Pinnacle Academy
June 2015 Revision Tests
201-202, Florence Classic, Besides Unnati Vidhyalay,
10, Ashapuri Society, Jain Derasar Rd., Akota, Vadodara-20. ph: 98258 561 55
Strategic Financial Management
Revision Test
Conducted on 23rd June 2015
[Solution is at the end with marking for self-assessment]
Time Allowed-1.5 hours
Q1
Maximum Marks- 80
Amazon Ltd. wishes to take over Nile Ltd. Following details are available:
% Shareholding of Promoters
Share Capital
Free Reserves
Paid up value per share
Free Float Market Capitalization
PE Ratio (times)
Amazon Ltd.
Nile Ltd.
50%
Rs.200 lakhs
Rs.900 lakhs
Rs.100
Rs.500 lakhs
10
60%
Rs.100 lakhs
Rs.600 lakhs
Rs.10
Rs.156 lakhs
4
For swap ratio, 25 % weight is assigned to BVPS, 50 % to EPS and 25 % to MPS.
Determine:
(i)
Swap ratio
(ii)
EPS and MPS of Amazon Ltd. after merger assuming PE ratio of Amazon
Ltd. prevails even after merger
(iii)
Post merger free float market capitalization
(12 Marks)
Q2
A Ltd. has 1,00,000 shares and B Ltd. has 50,000 shares. Current MPS of A Ltd. is
Rs.100. A Ltd. wishes to take over B Ltd. for which it has two offers, which are:
(i) Buy B Ltd. in cash by paying 25 % premium over its current MPS of Rs.40.
(ii) Issue shares at swap ratio of 0.25
It is expected that the post merger MPS for each of the offer shall be:
Only cash offer: Rs.150; Only stock offer: Rs.120
You are required to determine the NPV of each offer for A Ltd.
(8 Marks)
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Q3
An analyst intends to value an IT company in terms of the future cash generating
capacity. He has projected following after-tax cash flows:
(millions of rupees)
Year
EBITDA
Depreciation
Interest
1
266
66
17.1
2
75
15
17.1
3
105
15
17.1
4
151
11
17.1
5
210
10
17.1
It is further estimated that beyond the 5th year, cash flows will perpetuate at a
constant growth rate of 7% p.a. mainly on account of inflation. The perpetual cash
flow is estimated to be Rs.968 million at the end of 5th year. Tax rate is 50%.
(a)
What is the value of the company based on expected future cash flows? You
may assume cost of capital to be 20% and CFAT of each year to be FCF.
(b)
The company has outstanding 5 % debt of Rs.342 million and cash / bank
balance of Rs.256 million. Calculate value of one equity share, if number of
equity shares is 15.15 million.
(c)
The company has received takeover bid of Rs.190 per share. Is it a good offer?
(6 + 3 + 1 = 10 Marks)
Q4
(a)
As an investment manager you are given the following information:
Investment in
Equity shares
of---A. Cement Ltd.
Steel Ltd.
Liquor Ltd.
B. Government of
India Bonds
Initial Price
(Rs.)
25
35
45
1,000
Dividends
(Rs.)
Market Price
at the end of
Year (Rs.)
Beta
risk
factor
2
2
2
50
60
135
0.80
0.70
0.50
140
1,005
0.99
Risk free return may be taken at 14%. You are required to calculate:
(i) Expected rate of returns of portfolio in each using Capital Asset Pricing Model
(ii) Average return of portfolio
(6 Marks)
(b)
An investor is seeking the price to pay for a security, whose standard deviation is 3
%. The correlation coefficient for the security with the market is 0.8 and the market
standard deviation is 2.2 %. The return from government securities is 5.2 % and
from the market portfolio is 9.8 %. What is the required rate of return on which the
price of the security shall be based?
(6 Marks)
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(c)
The current risk free rate is 10% and the expected return on the market portfolio is
15%. The expected returns for four scrips are listed together with their expected
betas.
Scrip
Infosys
Bank of Baroda
Reliance Industries
TCS
Expected
Return (%)
17
14.5
15.5
18
Expected
beta
1.3
0.8
1.1
1.7
i.
Given the above, which of these shares should the fund manager buy and why?
ii.
If the risk free rate were to rise to 12% and the expected return on the market
portfolio rose to 16.5%, other factors remaining the same, would the fund manager’s
decision change?
(6 Marks)
Q5
(a)
Shares of D Ltd. are currently selling at Rs.500 per share. A 3-month call option and
put option are available at a strike price of Rs.520 at a premium of Rs.5 and Rs.3 per
share respectively. The expected market price of the share at the end of the option
period is predicted to be Rs.540 by one stock-analyst, while another stock-analyst
predicts the same to be Rs.510.
Determine net pay off of the investor at the two probable spot prices for –
(i) Long Call
(ii) Long Put
(iii) Long Straddle
Which strategy do you suggest?
(8 Marks)
(b)
A Brazilian exporter has sold coffee for $1,000,000 and will receive payment in 6
months. The current spot rate of the dollar is R$2.43. The 6-month forward rate is
R$2.49. The Brazilian interest rate is 10.6 % p.a. and the US interest rate is 6% p.a.
Currency put option is available for 6 months at strike price of R$2.5 at premium of
R$0.0352. Currency call option is available for 6 months at strike price of R$2.5 at
premium of R$0.0350. Ignore time value of options premium. Analyse forward
market hedge, money market hedge and currency options as method of hedging.
Recommend best hedging method.
(12 Marks)
Q6
Beta Ltd. is planning to import a multi-purpose machine from Japan at a cost of
Rs.7,200 lakhs yen. The company can avail loans at 15% interest p.a. with quarterly
rests with which it can import the machine. However there is an offer from Tokyo
branch of an India based bank extending credit of 180 days at 2% p.a. against
opening of an irrevocable letter of credit. Other Information:
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Present exchange rate
180 days’ forward rate
Rs.100 = 360 yen.
Rs.100 = 365 yen.
Commission charges for letter of credit at 2% per 12 months.
Advice whether the offer from the foreign branch should be accepted?
(12 Marks)
Solution prepared by
CA. Ashish Lalaji
Be free to send your suggestions / comments to
CA. Ashish Lalaji at 9825856155 /
ashishlalaji@rediffmail.com
4
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Solution of
SFM Revision Test
Conducted on 23rd June 2015
Q1
(i) Calculation of Pre-merger BVPS:
(a) Share Capital
(b) Free Reserves
(c) Equity Funds
(d) No. of equity shares
(e) BVPS (c / d)
Amazon Ltd. Nile Ltd.
200
100
900
600
1,100
700
2
10
550
70
Share exchange ratio based on BVPS = 70 / 550 = 0.1273
(2 Marks)
Calculation of Pre-merger EPS:
Amazon Ltd. Nile Ltd.
(a) Free Float Market Capitalisation
500
156
(b) Non Promoter Holding
50%
40%
(c) Total Market Capitalisation (a / b)
1,000
390
(d) No. of equity shares
2
10
(e) MPS (c / d)
500
39
(f) PE Ratio
10
4
(g) EPS (e / f)
50
9.75
Share exchange ratio based on EPS = 9.75 / 50 = 0.195
(3 Marks)
Share exchange ratio based on MPS = 39 / 500 = 0.078
(1 Mark)
Agreed Swap Ratio = 0.1273 (.25) + 0.195 (.50) + 0.078 (.25) = 0.1488
(1 Mark)
(ii)
New shares issued = 10 X .1488 = 1.488 lakhs
Post Merger Shares = 2 + 1.488 = 3.488 lakhs
Post Merger EPS = (2 X 50) + (10 X 9.75) / 3.488 = Rs.56.62
Post Merger MPS = 56.62 X 10 = Rs.566.20
(2 Marks)
(iii)
New shares issued to promoters of Nile = (10 X 60%) X .1488 = 0.8928 lakhs
Total shares owned by promoters = (2 X 50%) + .8928 = 1.8928 lakhs
% of promoters holding post merger = 1.8928 / 3.488 i.e. 54.27 %
Public holding = 45.73 %
Free Float Capitalisation = 3.488 X 45.73% X 566.2 = Rs.903.12 lakhs
(3 Marks)
Solution prepared by
CA. Ashish Lalaji
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Q2
Determination of Pre-Merger Market Value of Firm:
A
B
(a) No. of shares
1,00,000
50,000
(b) Pre-Merger MPS
100
40
(c) Pre-merger Market Value [a X b] 1,00,00,000 20,00,000
(2 Marks)
Determination of Net Present Value [NPV]:
(i) Only Cash Offer:
Market Value of Combined Entity = 1,00,000 shares X Rs.150 = Rs.1,50,00,000
Synergy = 1,50,00,000 – 1,00,00,000 - 20,00,000 = Rs.30,00,000
Cost of Merger = [50,000 shares X Rs.50*] – 20,00,000 = Rs.5,00,000
* Rs.40 + 25% Premium
NPV of merger = 30,00,000 – 5,00,000 = Rs.25,00,000
(3 Marks)
(ii) Only Stock Offer:
New shares issued = 50,000 X .25 = 12,500 shares
Market Value of Combined Entity = 1,12,500 shares X Rs.120 = Rs.1,35,00,000
Synergy = 1,35,00,000 – 1,00,00,000 - 20,00,000 = Rs.15,00,000
Cost of merger = [12,500 / 1,12,500 {1,35,00,000}] – 20,00,000
= (Rs.5,00,000)
NPV of merger = 15,00,000 – (-5,00,000) = Rs.20,00,000
(3 Marks)
Q3
(a)
Determination of Value of Firm as per FCFF Approach:
(millions of rupees)
Year EBITDA Depreciation PBT
1
2
3
4
5
266
75
105
151
210
66
15
15
11
10
5 Continuing Value
200
60
90
140
200
Taxes PAT
@ 50%
100
30
45
70
100
CFAT /
PVF
FCFF (20%)
100
30
45
70
100
166
45
60
81
110
PV
.833
.694
.579
.482
.402
138.28
31.23
34.74
39.04
44.22
287.51
7,967.38
.402 3,202.89
Value of Firm (as a whole) 3,490.40
(5 Marks)
th
th
Continuing Value at end of 5 year = FCFF (at end of 6 year) / ko – g
= 968 (1.07) / 20 % - 7% = Rs.7,967.38 million
(1 Mark)
Solution prepared by
CA. Ashish Lalaji
Be free to send your suggestions / comments to
CA. Ashish Lalaji at 9825856155 /
ashishlalaji@rediffmail.com
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(b)
Computation of value per share:
Particulars
Amount
(Rs. in millions)
3,490.40
256.00
3,746.40
342.00
3,404.40
15.15
224.71
Value of Firm (as a whole)
Add: Cash and Bank
Less: Outstanding Debt
Value of Firm (for equity shareholders)
No. of equity shares
Value per share
(3 Marks)
Solution prepared by
(c)
CA. Ashish Lalaji
True worth of the share of company is Rs.224.71. Takeover bid of Rs.190 per share
is lower than the real value of the share. It is not a good offer.
(1 Mark)
Q4
(a)
There is absence of information related to market return. It is assumed that the
securities given in the question are the only securities trading in the market. On the
basis of this assumption, market return is determined as under:
Investment
Cement Ltd.
Steel Ltd.
Liquor Ltd.
GOI Bonds
Closing
MPS
50
60
135
1,005
Purchase
Price
25
35
45
1,000
1,105
Capital
Appreciation
25
25
90
5
Dividend /
Interest
2
2
2
140
Total
Return
27
27
92
145
291
Market return (km) = 291 / 1,105 = 26.33 %
(3 Marks)
Determination of Required Return as per CAPM:
As per CAPM –
E(r) = Rf + β (km – Rf)
E(r) = 14 + β (26.33 – 14)
E(r) = 14 + 12.33β
Cement:
Steel:
Liquor:
GOI Bond:
14 + 12.33 (0.80)
14 + 12.33 (0.70)
14 + 12.33 (0.50)
14 + 12.33 (0.99)
= 23.86 %
= 22.63 %
= 20.17 %
= 26.21 %
(2 Marks)
Average return = 23.86 + 22.63 + 20.17 + 26.21 / 4 = 23.22 %
(1 Mark)
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(b)
Determination of Beta:
Beta = 0.8 (3) / 2.2 = 1.09
(3 Marks)
Determination of Required Return as per CAPM:
As per CAPM –
E(r) = Rf + β (km – Rf)
E(r) = 5.2 + 1.09 (9.8 – 5.2) = 10.21 %
(3 Marks)
(c)
(i) Analysis of shares to be purchased / sold:
Scrip
Actual Return as per CAPM
Return
Infosys
BOB
Reliance
TCS
17 %
14.5%
15.5%
18%
10 + 1.3 (5) = 16.5%
10 + 0.8 (5) = 14.0%
10 + 1.1 (5) = 15.5%
10 + 1.7 (5) = 18.5%
Nature
of scrip
Investment
Decision
Under-priced
Under-priced
Correctly priced
Over-priced
BUY
BUY
HOLD
SELL
(3 Marks)
Solution prepared by
CA. Ashish Lalaji
(ii) Analysis of shares to be purchased / sold:
Scrip
Actual
Return
Return as per CAPM
Nature
of scrip
Investment
Decision
Infosys
BOB
Reliance
TCS
17 %
14.5%
15.5%
18%
12 + 1.3 (4.5) = 17.85%
12 + 0.8 (4.5) = 15.60%
12 + 1.1 (4.5) = 16.95%
12 + 1.7 (4.5) = 19.65%
Over-priced
Over-priced
Over-priced
Over-priced
SELL
SELL
SELL
SELL
(3 Marks)
Q5
(a)
(i) Statement showing net payoff for Long Call:
Spot Price
Strike Price
Gross Pay off
Premium paid
Net Pay off
540 510
520 520
20
0
5
5
15 (5)
(2 Marks)
(ii) Statement showing net payoff for Long Put:
Spot Price
Strike Price
Gross Pay off
Premium paid
Net Pay off
540 510
520 520
0
10
3
3
(3)
7
(2 Marks)
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(iii) Statement showing net payoff for Long Straddle:
Spot Price
Strike Price
Call
Put
Gross Pay off
Call
Put
Premium paid
Net Pay off
540 510
520 520
520 520
20
0
20
8
12
0
10
10
8
2
(3 Marks)
Conclusion: Investor is better-off with the Straddle Position.
(1 Mark)
(b)
Analysis of Forward Contract:
Enter into forward contract to sell $ 10 lakhs at 6-months forward rate of
R$2.49 / $
Amount received after 6 months = 10 X 2.49 = R$ 24.9 lakhs
(2 Marks)
•
•
•
Analysis of Money Market Hedge:
As on today:
Borrow $ 9.709 lakhs [10 / [ 1 + .06X 6 / 12]] at 6 % p.a. for 6 months in US
At current spot rate, R$-equivalent of $ 9.709 lakhs is R$ 23.593 lakhs [9.709
X 2.43]
Invest R$ 23.593 in Brazil at 10.6 % p.a. for 6 months
(2 Marks)
•
•
After 6 months:
The US client shall make the payment. Use the money received to repay the
US borrowing
Investment in Brazil shall mature. Amount received after 6 months is –
23.593 + [23.593 X 10.6 % X 6 / 12] i.e. R$ 24.843 lakhs
(2 Marks)
Analysis of Currency Options:
The Brazilian exporter needs to sell $ 10 lakhs received after 6 months and
hence shall prefer currency put option.
Options premium = 10 X 0.0352 = R$ 0.352 lakhs
(1 Mark)
Net pay off is determined as under:
Spot rate after 6 months (assumed same as forward rate)
Strike price for long put
Gross pay off p.u. of deal size
X Deal size (in lakhs)
Total gross payoff (in lakhs)
Premium paid (in lakhs)
Net pay off (in lakhs) (Cash outflow)
2.49
2.50
0.01
10
0.1
0.352
0.252
(3 Marks)
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Currency options shall simply result into settlement on net basis. Actual sale
of currency shall take place in cash market. $ 10 lakhs shall be sold at
R$2.49 / $ to receive R$ 24.9 lakhs.
Amount received after 6 months = 24.9 lakhs – 0.252 = R$ 24.648 lakhs
(2 Marks)
Conclusion: The firm is better off by selecting forward market hedge in view
of highest cash inflow after 6 months.
Q6
Following direct quotes are obtained:
Spot rate: 1 ¥ = Re.0.2778
180 days forward rate: 1 ¥ = Re.0.2740
(1 Mark)
Analysis of Loan Option:
Amount
(Rs. in lakhs)
Cost of Machine [¥ 7,200 X 0.2778]
Add: Interest @ 15% for –
• 1st quarter [2,000 X 15% X 3/12]
• 2nd quarter [2,075 X 15% X 3/12]
∑ PVCO
2,000
75.00
77.81
2,152.81
(4 Marks)
Analysis of Letter of Credit Option:
Amount
(Rs. in lakhs)
Commission for LC [2,000 X 2% X 180 / 360]
Add: Opportunity cost @ 15% for –
• 1st quarter [20 X 15% X 3/12]
• 2nd quarter [20.75 X 15% X 3/12]
Cost of machine after 180 days
[¥ 7,200 X 0.2740]
Interest cost of Letter of Credit
[1,972.80 X 2% X 180 / 360]
∑ PVCO
20.00
0.75
0.78
1,972.80
19.73
2,014.06
(6 Marks)
Conclusion: The offer of the foreign branch of opening letter of credit should
be accepted in view of lower ∑ PVCO.
(1 Mark)
Solution prepared by
CA. Ashish Lalaji
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