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Pinnacle Academy
Mock Tests for
November 2015 C A Final Examination
201-202, Florence Classic, Besides Unnati Vidhyalay,
10, Ashapuri Society, Jain Derasar Rd., Akota, Vadodara-20. ph: 98258 561 55
Strategic Financial Management Mock Test 1
Conducted on 31st August 2015
[Solution is at the end with marking for self-assessment]
Time Allowed-2 hours
Maximum Marks- 60
Q 1 is compulsory.
Answer any 2 from the remaining.
Q1
(a)
Zaz plc. a UK company is in the process of negotiating an order amounting to Є2.8
million with a large German retailer on 6 months credit. If successful, this will be the
first time that Zaz shall export goods to highly competitive German market. Zaz is
considering following 3 alternatives for managing the transaction risk before the
order is finalized:
i.
Mr. Peter, marketing head, has suggested that in order to remove transaction risk
completely, Zaz should invoice German firm in Sterling using the current spot rate.
ii.
Mr. Wilson, CEO, is doubtful about Mr. Peter’s proposal and suggested an
alternative of invoicing the German firm in Є and using forward exchange contract to
hedge the transaction risk.
iii.
Ms. Karen, CFO is agreed with the proposal of Mr. Wilson to invoice the German firm
in Є, but she is of the opinion that Zaz should use 6-months futures contracts (do not
over-hedge) to hedge transaction risk.
Following data is available:
Spot rate
6 months swap points
6 months futures contract currently trading at
6 months futures contract size
Spot rate and 6 months futures rate
Є 1.1960 – Є 1.1970 / £
60 / 55
Є 1.1943 / £
£ 62,500
Є 1.1873 / £
You are required to calculate sterling receipts (rounded off up to 4 digits after
decimal point) in millions for Zaz plc under each of the above three proposals and
suggest the most appropriate proposal.
(12 Marks)
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(b)
Following information is for M Ltd.:
Earnings of the company
Dividend Payout ratio
No. of shares outstanding
Rate of return on investment
Capitalisation rate
Rs.10,00,000
60 %
2,00,000
15 %
12 %
Determine:
(i)
(ii)
Value per share as per Walter’s model
Maximum and Limiting value per share as per Walter’s model
(8 Marks)
Q2
(a)
The following historical data is available:
Annual Returns (%)
Zeta Ltd.
Market
-2
-1
12
15
10
13
8
10
17
21
5
9
20
24
The risk free return is 7%. Based on this information, calculate the following:
(i) Beta coefficient of Zeta Ltd.
(ii) Alpha of Zeta Ltd. as per Market Model
(iii) Alpha of Zeta Ltd. as per CAPM
(iv) Equation of CML of Zeta Ltd.
(v) Is the security efficiently priced?
(8 Marks)
(b)
An investor is planning to make investment in bonds of one of the two companies X
Ltd. and Y Ltd. Details of these bonds areCompany Face Value Coupon Rate Maturity Period
X Ltd.
Rs.10,000
6%
5 years
Y Ltd.
Rs.10,000
4%
5 years
Current market price of bond of X Ltd. is Rs.10,796.80. Both the bonds have same
yield. Investor considers duration of bonds as the basis of decision making. What
bond should be preferred by the investor?
(8 Marks)
(c)
XY Ltd. is able to issue commercial paper of Rs.90,00,000 every 3 months at a rate
of 9.5% p.a. on face value. The cost of placement of commercial paper is Rs.4,500
per issue.
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XY Ltd. is required to maintain line of credit of Rs.4,50,000 in bank balance. The
applicable income tax rate for XY Ltd. is 30%. Maturity of commercial paper is 3
months.
What is the post tax cost of funds to XY Ltd. for commercial paper issue?
Base your cost of funds on net cash received.
(4 Marks)
Q3
(a)
Mr. X owns a portfolio with the following characteristics:
Factor 1 Sensitivity
Factor 2 Sensitivity
Expected Return
Security A Security B Risk Free Security
0.8
1.5
0
0.6
1.2
0
15%
20%
10%
It is assumed that security returns are generated by a two factor model.
i.
If Mr. X has Rs.1,00,000 to invest and short sells Rs.50,000 of security B and
purchases Rs.1,50,000 of security A, what is the sensitivity of Mr. X’s
portfolio to the two factors?
ii.
If Mr. X borrows Rs.1,00,000 at risk free rate and invests the amount he
borrows along with the original amount of Rs.1,00,000 in security A and B in
the same proportion as described in part (i), what is the sensitivity of the
portfolio to the two factors?
iii.
What is the expected risk premium of factor 2?
(10 Marks)
(b)
A mutual fund made an issue of 10,00,000 units of Rs.10 each on January 01, 2014.
No entry load was charged. It made the following investments on that date:
50,000 equity shares of Rs.100 each @ Rs.160
7 % Government Securities
9 % Debentures (Unlisted)
10 % Debentures (Listed)
Amount
(Rs.)
80,00,000
8,00,000
5,00,000
5,00,000
98,00,000
During the year, dividends of Rs.12,00,000 were received on equity shares. Interest
on all types of debt securities was received as and when due. At the end of the year
equity shares and 10% debentures are quoted at 175% and 90% respectively of
their par values. Other investments are at par. Operating expensed paid during the
year amounted to Rs.4,00,000 out of Rs.4,89,400. No portion of investments were
sold during the year. Dividend equivalent to 60% of realised earnings was paid on
31st December 2014. Determine return for an investor who has purchased 1,000
units of the mutual fund as on 1st January 2014 if units are held as on 31st December
2014. Investor has selected Dividend Option.
(10 Marks)
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Q4
(a)
When should one exit from investment in mutual funds?
(5 Marks)
(b)
IT Solutions Pvt. Ltd. is a closely held company. It is planning to go for public issue
and hence wants to value its shares. Following estimates are made by the company:
Year
1
2
3
4
Sales
1,00,000 1,15,000 1,32,250 1,32,250
EBIT
16,000
18,400
21,160
21,160
Less: Cash Tax Payments
4,800
5,520
6,348
6,348
Operating Profits after taxes
11,200
12,880
14,812
14,812
Less: Capital Expenditure
1,695
1,950
2,242
--Additional Working
Capital
2,348
2,700
3,105
--Free Cash Flow
7,157
8,230
9,465
--Required:
(i) Value of the company if WACC is 12%
(ii) Market Value Added (MVA) if invested capital in year 0 is Rs.31,304.12
(iii) Value per share if the company has debt of Rs.4,000 and 2,000 shares.
(5 Marks)
(c)
What are the assumptions of CAPM?
(d)
Following inter-bank quotes prevail:
(5 Marks)
Mumbai:
Spot Rate
3 months forward
USD / INR
60.45 / 75
40 / 60
Frankfurt:
Spot Rate
3 months forward
USD / EUR
0.8630 / 35
60 / 40
Required (round off to two decimals):
(i)
You want to buy EUR spot. What shall be the applicable spot EUR /
INR rate?
(ii)
An exporter wants to enter into 3 months forward contract. What shall
be the applicable EUR / INR rate?
(5 Marks)
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Solution of
SFM Mock Test 1
Conducted on 31st August 2015
Q1
(a)
Exchange rates are tabulated as under:
1 Є per £ (Indirect quote for UK Firm)
Spot
Swap Points
6 months forward rate
1.1960
.0060
1.1900
1.1970
.0055
1.1915
1 £ per Є (Direct quote for UK Firm)
Spot
6 months forward rate
Bid Rate
0.8354
0.8393
Offer Rate
0.8361
0.8403
(i) Value of deal in euros is 2.8 million. One needs to find that amount in pounds,
which if sold right now shall result into receipt of EUR 2.8 million. If pound is sold
then bank shall buy at bid rate. Hence. GBP receipt shall be –
2.8 X .8354 i.e. £ 2.3391 million
2.8 X .8354 i.e. £ 2.3391 million
(4 Marks)
(ii) 6 months forward exchange contract should be acquired to sell EUR. Such
contract is available at EUR 0.8393 per GBP. Hence, GBP receipt shall be –
2.8 X .8393 i.e. £ 2.3500 million
(2 Marks)
(iii) 6 months futures rate as direct quote is: EUR 0.8373 per GBP
Standard size of 1 contract in EUR = 62,500 / 0.8373 i.e. EUR 74,645
No. of contracts required = 2.8 / 0.074645 = 37.51 i.e. 37 contracts as over-hedging
is to be avoided.
Gain / Loss for futures is determined as under –
Spot rate after 6 months
Contracted futures rate for selling
Loss per unit
X Contract size (74,645 X 37) (in millions)
Total Loss (GBP in millions)
0.8422
0.8373
0.0049
2.7619
0.0135
Actual sale of EUR 2.8 million shall be done in the spot market after 6 months. Thus,
GBP receipt is –
2.8 X .8422 i.e. 2.3582 – Loss on futures 0.0135 i.e. £ 2.3447 million
(6 Marks)
Recommendation:
Forward Contract in view of highest GBP receipts after 6 months.
Solution prepared by
CA. Ashish Lalaji
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(b)
(i)
Value per share = 3 + 15 / 12 (5 – 3) / 12% = Rs.45.83
(2 Marks)
(ii)
For the given firm Ra > Rc i.e. it is a growth firm. Optimal D / P ratio for a growth firm
is 0%. Hence, maximum value per share shall be at 0 % D / P ratio and limiting
(minimum) value per share shall be at 100 % D / P ratio.
(2 Marks)
Maximum Value per share = 0 + 15 / 12 (5 – 0) / 12% = Rs.52.08
(2 Marks)
Limiting Value per share = 5 + 15 / 12 (5 – 5) / 12% = Rs.41.67
(2 Marks)
Q2
(a)
The question demands ex post beta and alpha. Ex post refers to beta and alpha
based on historical data.
rs
rs
rm
rm
(rs – rs)
(rm – rm)
(rs – rs)2
(rm – rm)2
(rs – rs) (rm – rm)
-2
12
10
8
17
5
20
10
10
10
10
10
10
10
-1
15
13
10
21
9
24
13
13
13
13
13
13
13
-12
2
0
-2
7
-5
10
-14
2
0
-3
8
-4
11
144
4
0
4
49
25
100
326
196
4
0
9
64
16
121
410
168
4
0
6
56
20
110
364
σs = under root of 326 / 7 = 6.83% ;
σm = under root of 410 / 7 = 7.65%;
Cov(s,m) = 364 / 7 = 52
(i) β = Cov(s,m) = 52 / 58.5225 = 0.89
σm2
(ii) E(r) = α + β.km. Hence, 10% = α + 0.89(13). Thus, α = -1.57%.
(iii) α = E(r) – E(r) as per CAPM = 10 – [7 + 0.89 (13 – 7)] = 10 – 12.34 = - 2.34%
(iv) Equation of CML = -1.57% + 13β
(v) Actual return expected (10%) is lower than Expected Return as per CAPM (12.34%).
Hence, the security is not efficiently priced. In fact, it is over-priced.
(2 marks for statistical calculations; 6 marks for portfolio analysis)
(b)
For determining duration, cash flows from bond should be discounted at existing
yield. However, yield is not available. It is determined as under –
YTM = 600 + (10,000 – 10,796.8) / 5 / [1/2 (10,000 + 10,796.8) = 4.24%
(2 Marks)
Solution prepared by
CA. Ashish Lalaji
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Determination of Duration:
Year
1
2
3
4
5
PVF
(4.24%)
.959
.920
.883
.847
.813
Duration =
Bond X
Bond Y
Cash
Inflow
PV
Year X
PV
Cash
Inflow
PV
Year X
PV
600
600
600
600
10,600
575.4
552.0
529.8
508.2
8,617.8
10,783.2
575.4
1,104.0
1,589.4
2,032.8
43,089.0
48,390.6
400
400
400
400
10,400
383.6
368.0
353.2
338.8
8,455.2
9,898.8
383.6
736.0
1,059.6
1,355.2
42,276.0
45,810.4
48,390.6
------------- = 4.49 years
10,783.2
45,810.4
------------ = 4.63 years
9,898.8
(5 Marks)
Recommendation:
Bond X in view of lower duration.
(1 Mark)
(c)
Determination of Net Cash Provided by Commercial Paper Issue:
Particulars
Amount
(Rs.)
Face Value
Less: To be maintained in bank
Less: Issue Expenses:
Interest (90,00,000 X 9.5% X 3/12)
Placement expenses
Amount
(Rs.)
90,00,000
4,50,000
85,50,000
2,18,250
2,13,750
4,500
83,31,750
(2 Marks)
2,18,750 (1 – 0.3) 12
Cost of Commercial Paper (post tax) = -------------------------- X --- X 100 = 7.35%
83,31,750
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(2 Marks)
Q3
(a)
(i)
Composition of Portfolio:
Security Amount Invested Weight
A
1,50,000
1.5
B
(50,000)
- .5
1,00,000
1.0
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Sensitivity of Portfolio to Factor 1:
Sensitivity = 0.8 (1.5) + 1.5 (-.5) = 0.45
Sensitivity of Portfolio to Factor 2:
Sensitivity = 0.6 (1.5) + 1.2 (-.5) = 0.30
(3 Marks)
(ii)
Composition of Portfolio:
Security
Amount Invested Weight
Borrowed Funds
(1,00,000)
-1
A
3,00,000*
3
B
(1,00,000)*
-1
1,00,000
1.0
* Original Rs.1,00,000 + Borrowed Rs.1,00,000 i.e. Rs.2,00,000 in ratio of 1.5 : - .5
Sensitivity of Portfolio to Factor 1:
Sensitivity = 0.8 (3) + 1.5 (-1) + 0** (-1) = 0.90
Sensitivity of Portfolio to Factor 2:
Sensitivity = 0.6 (3) + 1.2 (-1) + 0** (-1) = 0.60
** Risk factor for borrowed funds is zero as it is risk free
(3 Marks)
(iii)
As per APM –
E(r) = Rf + Summation of Factor Sensitivity X Risk Premium (RP)
For Security A:
10 + 0.8RP1 + 0.6RP2 = 15
i.e. 0.8RP1 + 0.6RP2 = 5 … … … … (1)
For Security B:
10 + 1.5RP1 + 1.2RP2 = 20
i.e. 1.5RP1 + 1.2RP2 = 10 … … … … (2)
Multiplying equation (1) by “2” and solving –
1.6RP1 + 1.2RP2 = 10
1.5RP1 + 1.2RP2 = 10
------------------------------0.1RP1 = 0
RP1 = 0
Substituting RP1 = 0 in equation (1) –
RP2 = 5 / 0.6 = 8.33%
(4 Marks)
Solution prepared by
CA. Ashish Lalaji
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(b)
Determination of Cash and Bank Balance on 31.12.14:
Cash received from 10,00,000 units issued @ Rs.10
Investments Purchased on 01.01.14
Dividend Received
Interest Received:
7 % Government Securities (8,00,000 X 7%)
9 % Debentures (5,00,000 X 9%)
10 % Debentures (5,00,000 X 10%)
Operating Expenses paid in cash
Dividend Paid (13,51,000 X 60%)
Realised Earnings:
Dividend Received
Interest Received
1,00,00,000
(98,00,000)
12,00,000
56,000
45,000
50,000
1,51,000
(4,00,000)
(8,10,600)
12,00,000
1,51,000
13,51,000
Cash and Bank Balance on 31.12.14
3,40,400
(4 Marks)
Determination of NAV on 31.12.14:
Cash and Bank Balance on 31.12.14
Value of Investments
Equity Shares (50,000 X 175)
7 % Government Securities (at par)
9 % Debentures (Unlisted) (at cost)
10 % Debentures (Listed) (5,00,000 X 90%)
Outstanding Management Expenses
(a) Total Net Assets
(b) Total number of units outstanding
(c) NAV per unit
3,40,400
1,05,00,000
87,50,000
8,00,000
5,00,000
4,50,000
(89,400)
1,07,51,000
10,00,000
10.751
(4 Marks)
Determination of Return to Investor:
Purchase cost of units = 1,000 X 10 = Rs.10,000
Dividend p.u. declared by Mutual Fund = 8,10,600 / 10,00,000 = 0.8106
Dividend received by investor = 0.8106 X 1,000 = Rs.810.6
Value of units at year end = 1,000 X 10.751 = Rs.10,751
[10,751 – 10,000] + 810.6
Return from fund = ------------------------------------- X 100 = 15.616 %
10,000
(2 Marks)
Q4
(a)
i.
ii.
iii.
iv.
v.
Mutual fund is consistently underperforming the broad based index
Mutual fund consistently underperforms its peer group
Mutual fund changes its objectives which is not in tune with objectives of the
investor
There is change in objective of investment of investor and objectives of mutual
fund is not in tune with it
Fund manager of the mutual fund is changed and the image, expertise and
reputation of the new entrant is not known
(5 Marks)
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(b)
(i)
Valuation of IT Solutions Pvt. Ltd. as per FCFF Approach:
Year
1
2
3
3
FCFF
7,157
8,230
9,465
PVF (12%)
0.893
0.797
0.712
PV
6,391.20
6,559.31
6,739.08
19,689.59
1,23,433.33*
0.712
87,884.53
Value of Firm (as a whole) 1,07,574.12
* Continuing Value = 14,812 / 12 % - 0% = Rs.1,23,433.33
(2½
Marks)
(ii)
MVA = Company Value – Invested Capital = 1,07,574.12 – 31,304.12 = Rs.76,270
(iii)
Value per share = 1,07,574.12 – 4,000 / 2,000 = Rs.51.79
(1½
Marks)
(1 Mark)
(c)
Assumptions of CAPM:
i.
Investors are risk averse although at times risk seeking behaviour is adopted for
gains.
ii.
Investors are rational i.e. they will select that security which gives maximum return
for a given level of risk, or that security which has minimum risk for a given level of
return
iii.
Unsystematic risk is eliminated with the help of efficient diversification.
iv.
Capital markets are efficient
v.
Securities can be exchanged without payment of brokerage, commissions or taxes
or any other transaction costs
(5 Marks)
(d)
Tabulation of Exchange Rates:
Mumbai
Frankfurt
Bid Rate Offer Rate Bid Rate Offer Rate
Spot Rate
60.45
60.75
0.8630
0.8635
3 months forward rate
60.85
61.35
0.8570
0.8595
(1 Mark)
(i)
Buy USD in Mumbai, which the dealer shall sell at spot offer rate of Rs.60.75 / $.
Sell USD in Frankfurt, which the dealer shall buy at spot bid rate of € 0.8630 / $.
Rate to buy EUR Spot (Spot Offer Rate) = 60.75 / 0.8630 i.e. 1 € = Rs.70.39
(2 Marks)
Solution prepared by
CA. Ashish Lalaji
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(ii)
An exporter shall receive EUR, which is to be sold.
Using EUR received, buy USD in Frankfurt, which the dealer shall sell at forward
offer rate of € 0.8595 / $.
Sell USD in Mumbai, which the dealer shall buy at forward bid rate of Rs.60.85 / $.
Rate to sell € 3-m fwd (Fwd bid rate) = 60.85 / 0.8595 i.e. 1 € = Rs.70.80
(2 Marks)
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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