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Pinnacle Academy
Mock Test Series for
May 2016 C A Final Examination
2nd Floor Florence Classic, 10, Ashapuri Society,
Besides Unnati Vidhyalay, Opp. VUDA Flats, Jain Derasar Rd., Akota, Vadodara-20
Time Allowed-2 hours
SFM Mock Test 1
Maximum Marks- 60
27th February 2016
Q 1 is compulsory.
Answer any 2 from the remaining.
Q1
(a)
(b)
Unicorn Ltd. wishes to lease-out an asset costing Rs.15,00,000. The useful life of the
asset is 4 years and the asset shall be leased for its entire useful life. Unicorn can
charge depreciation at 25% and the salvage value at the end of useful life of 4 years
shall be equal to the written down value of the asset at the end of 4th year. Assume
there are large number of assets in the block of 25%. Unicorn pays taxes at 30%
and its cost of capital is 12%. A prospective client wishes to take the asset owned by
Unicorn on lease rent of Rs.5,00,000 payable at the end of each year. Should
Unicorn accept this offer? Analyze the sensitivity of residual value to lease
arrangement being economical.
(8 Marks)
Armada Leasing Company is considering a proposal to lease out a school bus. The
bus can be purchased for Rs.5,00,000 and in turn be leased out at Rs.1,25,000 per
year for 8 years with payments occurring at the end of each year:
(i) Estimate the internal rate of return for the company. Ignore tax.
(ii) What should be the yearly lease payment charged by the company in order to earn
20 per cent annual compounded rate of return before expenses and taxes?
(iii) Calculate the annual lease rent to be charged so as to amount to 20 per cent after
tax annual compound rate of return assuming tax rate to be 40%, straight-line
depreciation, annual expenses of Rs.50,000 and resale value of Rs.1,00,000 after
the term.
(8 Marks)
(Assessed answer papers shall be returned on 12th March 2016)
[Question paper and solution shall be hosted on:
www.ashishlalaji.net]
Best of Luck!
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(c)
Suppose you contemplate to buy a call option with strike price of Rs.42/$ as you
expect the following spot rates with their probabilities:
Rs./$
Probability
40.00
0.15
41.50
0.25
43.00
0.30
44.50
0.20
46.00
0.10
What should be the option premium to enable you to break-even?
(4 Marks)
Q2
(a)
i.
ii.
A Ltd. has currently 10 lakh shares outstanding. It has surplus cash of Rs.315 lakhs
of which it wants to distribute 50% to its shareholders. The company has decided to
buy back its own shares using the surplus cash at a buy back price of Rs.105. This
buy back price is 5% higher than theoretical buy back price. The current EPS of the
company is Rs.12 per share. After the buy back the PE multiple shall rise to 8.5
times. You are required to determine:
Pre-buyback MPS, Market Capitalisation and PE Multiple
Post-buyback MPS, Market Capitalisation and EPS
(8 Marks)
(b)
Smart Ltd. wants to acquire Dull Ltd. The balance sheet of Dull Ltd. as on 31st March
2007 is as follows:
Liabilities
Amount
Equity Share Capital (Rs.10)
6,00,000
Retained Earnings
2,00,000
12 % Debentures
2,00,000
Creditors and other liabilities
3,20,000
Total 13,20,000
Assets
Amount
Cash
20,000
Debtors
30,000
Inventories
1,70,000
Plant and Equipment 11,00,000
Total 13,20,000
Shareholders of Dull Ltd. shall get 1 share in Smart Ltd. for every 2 shares. External
Liabilities are expected to settle at Rs.3,00,000. Shares of Smart Ltd. shall be issued
at its current market price of Rs.15 per share. Debenture holders will get 13 %
convertible debentures of Smart Ltd. for the same amount. Debtors and inventories
are expected to realize Rs.1,80,000.
Smart Ltd. has decided to operate the business of Dull Ltd. as a separate division.
The division is likely to give cash flows after tax of Rs.3,00,000 each year for 6
years. Smart Ltd. has planned to demerge this division at the end of 6th year and
hive it off for Rs.1,00,000.
Cost of capital of Dull Ltd. is 12 % and for Smart Ltd. is 14 %.
Is the merger of Dull Ltd. financially sound decision for Smart Ltd.?
(8 Marks)
(c)
i.
ii.
Distinguish between (any one):
Futures and Options
Leasing and Hire Purchase
(4 Marks)
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Q3
Sparkle Company, a Surat based diamond company, has exported on 1st
September 2007, polished diamonds worth SAR 40 million to a business man based
in Saudi Arabia. The business man has made immediate payment of 25% of the
deal and shall pay balance after 3 months. He has made spot payment and shall
make future payment in Saudi Rials (SAR).
The spot rates are as under:
1 $ = Rs.40.91 / 95 and 1 $ = SAR 3.76 / 78
The Swap points are as under:
3-month:
$ and INR: 105 / 108 $ and SAR:
4/8
The Saudi business man has alternatively proposed to pay $ 8 million after 3
months.
Sparkle Company wishes to hedge only for 75 % of its exposure. Accordingly, the
finance manager has suggested following alternatives:
I.
Receive payment in SAR after 3 months and get it converted into INR at 3-months
forward contract cross rate between SAR and INR.
II.
Accept offer of receiving payment in USD and adopt money market strategy.
Relevant interest rates are: US:
Deposit 3% Borrowing: 5%
India: Deposit 8% Borrowing: 12%
III.
Accept offer of receiving payment in USD and enter into currency futures contract.
The contract size is $ 2 million and futures price is Rs.41.90/$.
After 3 months, actual spot rates turn out as under:
1 $ = Rs.41.81 / 85 and 1 $ = SAR 3.78 / 85
Approximate exchange rates and receipt calculations till 2 decimal points.
Calculate for each alternative described above, the total amount received in INR
after 3 months (including amount received on date of export).
(20 Marks)
Q4
Following is the balance sheet of Yuga Ltd. as on 31st March 2007:
Liabilities
Amount
(Rs.)
Share Capital- Equity
Shares of Rs. 10 each
Reserves
4,00,000
Creditors
60,000
40,000
5,00,000
Assets
Plant
Machinery
Stock
Debtors
Bank
Preliminary Expenses
Amount
(Rs.)
30,000
1,50,000
40,000
2,10,000
60,000
10,000
5,00,000
The management of the company wishes to put its company for sale and hence
wishes to gauge its value. It provides following additional information:
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Profit expectations: Profit before tax for last three years are:
2004-05: 7,000 2005-06: 12,000 2006-07: 20,000
Profit of 2005-06 is after providing for abnormal loss of Rs.3,000. The company has
obtained an advantageous contract. The advantage is valued at Rs.25,000 increase
in profit. Future expected tax rate is 30 %.
Goodwill Valuation: Peers in the industry earn 6 % on closing capital employed.
Company shall value its goodwill at three years purchase of super profits. Ignore
depreciation on change in value of fixed assets. Weights should not be applied for
projecting future profit.
Dividend Profile: Yuga Ltd. is a regular dividend paying company. It has paid
dividend at 14 % (against industry average of 11%) and is expected to continue the
same in future (in case business is not sold).
Industry PE multiple: The PE multiple of peers is on an average 15 times. Discount
of 15% is considered adequate.
Current Valuations: Current value of Plant is Rs.50,000, Machinery is Rs.1,40,000
and Stock is Rs.58,000.
Future Cash Flows: Cash flow after tax for the coming year is estimated at
Rs.10,000, which shall thereafter increase at 12 % p.a. for next 4 years and at the
end of which shall grow perpetually at a stable growth rate of 7% p.a. Every
incremental rupee is expected to come at incremental cash outflow of Re.0.35. The
relevant cost of capital for the firm is 9%.
You are required to value the company as per following methods:
(i) Discounted Cash Flow Technique
(ii) Asset Backing Method
(iii) Dividend Yield Method
(iv) Earnings Yield Method
(v) PE Multiple Valuation Method
(20 Marks)
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Solution of
SFM Mock Test 1
27th February 2016
Q1
(a)
(i)
Analysis of Leasing Alternative from the view-point of lessor:
Year
1
2
3
4
4
Lease
Depreciation
Receipts
5,00,000
5,00,000
5,00,000
5,00,000
Salvage
3,75,000
2,81,250
2,10,938
1,58,203
EBT
1,25,000
2,18,750
2,89,062
3,41,797
Taxes
@ 30%
Net
Cash
Inflows
37,500 4,62,500
65,625 4,34,375
86,719 4,13,281
1,02,539 3,97,461
4,74,609
Less:
PVF
(12%)
PV
0.893
4,13,013
0.797
3,46,197
0.712
2,94,256
0.636
2,52,785
0.636
3,01,851
Σ PVCI 16,08,102
Σ PVCO 15,00,000
NPV 1,08,102
In view of positive NPV Unicorn Ltd. should lease out its asset.
(6 Marks)
(ii)
The lessor shall reject the leasing decision if the NPV is zero or less. If the PV of
salvage value reduces by Rs.1,08,102 from its existing level of Rs.3,01,851 i.e. by
35.81%, the leasing proposal shall become uneconomical.
(b)
(i) Calculation of Pre-Tax Internal Rate of Return (IRR):
(2 Marks)
Year
1–8
Cash Inflow PVF (10%)
1,25,000
PV (10%)
5.335
6,66,875
Less: Σ PVCO 5,00,000
NPV (10%)
1,66,875
PVF (20%)
PV (20%)
3.837
4,79,625
Less: Σ PVCO 5,00,000
NPV (20%)
(20,375)
1,66,875
Pre-Tax IRR = 10% + ---------------------------- X 10 = 18.91%
1,66,875 – (-20,375)
(3 Marks)
(ii) Calculation of Lease Rent to give Pre-tax and Pre-expense return of 20%:
Cost of asset to be recovered
5,00,000
Lease Rent = ------------------------------------------ = --------------- = Rs.1,30,310
PVF (20%, 8yrs.)
3.837
(1 Mark)
Solution prepared by
CA. Ashish Lalaji
5
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(iii)
Calculation of Lease Rent to give Post-tax and Post-expense return of 20%:
Let the lease rent to be charged be Rs. X.
Year
1–8
Cash Inflow Taxes @ 40% CFAT
X
0.4X
0.6X
PVF (20%)
3.837
PV (20%)
2.302X
*Total expenses p.a.: Depreciation: 50,000 + Expenses: 50,000 i.e. Rs.1,00,000
*Tax shield on total expenses p.a.: 1,00,000 X 40% i.e. Rs.40,000
*PV of tax shield on total expenses: 40,000 X 3.837 i.e. Rs.1,53,480
*PV of cash outflow on account of expenses: 50,000 X 3.837 i.e. Rs.1,91,850
*PV of salvage value at end of 8th year: 1,00,000 X 0.233 i.e. Rs.23,300
Thus, total cash inflows due to leasing = 2.302X + 1,53,480 + 23,300 – 1,91,850 i.e.
2.302X – 15,070.
Now, lease rent should be so charged that the cost of the asset is recovered----i.e. 2.302X – 15,070 = 5,00,000 i.e. X = Rs.2,23,749.
(4 Marks)
(c)
Assuming call option is American Styled:
Let the premium to be charged be Rs. x.
Spot Price
Exercise Price
Gross Pay-off
Premium paid
Net Pay-off
40
42
--x
-x
41.5
42
--x
-x
43
42
1
x
1-x
44.5 46
42
42
2.5
4
x
x
2.5-x 4-x
Based on the probabilities given, the expected net pay-off shall be-x (0.15) + -x (0.25) + (1 – x) (0.3) + (2.5 – x) (0.2) + (4 – x) (0.1)
i.e. –0.15X – 0.25X + 0.3 – 0.3X + 0.5 – 0.2X + 0.4 – 0.X
i.e. 1.2 – X
Now, to break even, net pay off has to be “0” i.e. 1.2 – X = 0 i.e. X = Rs.1.20. Thus,
the maximum premium acceptable is Rs.1.20.
Assuming call option is European Styled:
Let the premium to be charged be Rs. x.
Expected spot rate = 40 (0.15) + 41.5 (0.25) + 43(0.30) + 44.5 (0.20) + 46 (0.10) =
Rs.42.775.
Net pay-off shall be: 42.775 – 42 – x i.e. 0.775 – x.
Now, to break even, net pay off has to be “0” i.e. 0.775 – x = 0 i.e. X = Re.0.775.
(4 Marks for any one approach)
Solution prepared by
CA. Ashish Lalaji
6
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Q2
(a)
(i)
Actual buy back price = 1.05 (Theoretical Buy Back Price)
i.e. Theoretical buy back price = 105 / 1.05 = Rs.100
Now, cash to be distributed to buy back shares = 315 X 50% i.e. Rs.157.5 lakhs.
Thus, no. of shares repurchased = 157.5 / 105 = 1.5 lakh shares.
Now, Theoretical buy back price = MN / N – n
i.e. 100 = M(10) / 10 – 1.5
i.e. M = Rs.85.
Thus, pre-buy-back MPS is Rs.85
Pre-buy back Market Capitalisation = 85 X 10 lakh shares = Rs.850 lakhs
Pre-buy back PE multiple = 85 / 12 = 7.08 times
(5 Marks)
(ii)
Post-buy back EPS = 12 X 10 / 8.5 lakh shares = Rs.14.12
Post-buy back MPS = 14.12 X PE ratio 8.5 = Rs.120.02
Post-buy back Market Capitalisation = 120.02 X 8.5 lakh shares = Rs.1,020 lakhs
(3 Marks)
(b)
Calculation of Cost of Merger:
Issue of equity shares
(60,000 X ½ X Rs.15)
Issue of 13 % Convertible Debentures
Settlement of External Liabilities
Amount (Rs.)
4,50,000
Less:
Debtors and inventory
Cash balance
2,00,000
3,00,000
9,50,000
1,80,000
20,000
7,50,000
(4 Marks)
Calculation of Benefits of Merger:
Year
Cash
PVF
PV
Inflow (14%)
1 – 6 3,00,000 3.889 11,66,700
6
1,00,000 0.456
45,600
12,12,300
(4 Marks)
Conclusion:
As benefits of merger are higher than its cost, merger is financially viable.
(c)
(i)
Distinction between Options and Futures:
 Futures are agreements/contracts to buy or sell specified quantity of the underlying
assets at a price agreed upon by the buyer and seller, on or before a specified time.
In other words, both the buyer as well as the seller is obligated to buy/sell the
underlying asset. In case of options, the buyer of the option has only a right to
buy/sell the underlying asset and not the obligation. Such obligation is on part of
seller of the option only.
Solution prepared by
CA. Ashish Lalaji
7
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 Futures contracts have a symmetric risk profile for both buyers as well as sellers;
whereas options have asymmetric risk profile. In case of options, for the option
holder (i.e. buyer), upside potential is unlimited, while losses are limited to the
premium paid by him to the option writer, while for the option writer (i.e. seller),
upside potential is limited to the premium received from the buyer, while losses are
unlimited.
 Futures contracts prices are affected mainly by the prices of the underlying asset.
Prices of options are affected not only by the prices of the underlying asset, but also
the time remaining for expiry of the contract, the volatility of the underlying asset and
various other quantifiable and non-quantifiable factors.
 It costs nothing to enter into a futures contract, whereas there is a cost of entering
into an options contract, termed as premium.
(ii)
Leasing vis-à-vis Hire Purchase:
Basis
Ownership
Hire Purchase
Lease Financing
It passes to the hirer on The lessor is the owner of the asset
payment of last instalment leased and the ownership of the
asset never passes to the lessee.
However, at the termination of the
lease agreement the lessee may
have the option to purchase the
assets leased to him
Down
payment
20%-25% of the cost of the No down payment is to be paid.
asset has to be paid as
down payment
Depreciation
Depreciation is charged in Depreciation is charged by the
the books of hirer
lessor in case of operating lease,
while the same is charged by the
lessee in case of financial lease (as
per AS-19).
Maintenance
Maintenance cost is borne Maintenance cost is borne by the
by the hirer
lessor in case of operating lease,
while the same is borne by the
lessee in case of financial lease
Tax benefits
Hirer has two tax benefits, Entire lease rental paid by the
namely, depreciation and lessee is tax deductible.
claim of finance charge
involved in the hiring
charge payable by him.
Risk of
The risk of obsolescence is The risk of obsolescence is borne
obsolescence borne by the hirer
by the lessor in case of operating
lease, while the same is borne by
the lessee in case of financial lease.
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Q3
The given exchange rates are tabulated as under:
Bid Price Offer Price
$ and INR:
Spot
3-month fwd
Actual spot
40.91
41.96
41.81
40.95
42.03
41.85
$ and SAR:
Spot
3-month fwd
Actual spot
3.76
3.80
3.78
3.78
3.86
3.85
(2 Marks)
Spot payment of SAR 10 million is received, which shall be converted to INR as
under:
• Buy $ at spot offer rate of SAR 3.78 / $
• Sell $ at spot bid rate of Rs.40.91 / $
Thus, effective cross rate is: 40.91 / 3.78 i.e. 1 SAR = Rs.10.82
i.e. payment received is – 10 X 10.82 i.e. Rs.108.2 million
(4 Marks)
(I) Analysis of Forward Market Hedge:
3-month forward rate for selling SAR is: 41.96 / 3.86 i.e. 1 SAR = Rs.10.87
Question requires only 75% of exposure to be hedged i.e. 30 X 75% i.e. SAR
22.5 million. Thus, receipts of SAR 22.5 million (30 X 75% as firm shall hedge only
for 75% of the exposure) is converted to INR at forward rate to receive – 22.5 X
10.87 i.e. Rs.244.58 million.
Remaining, non-hedged receipts of SAR 7.5 million shall be converted to INR at
actual spot rate after 3 months, which is 1 SAR = Rs.10.86 [41.81 / 3.85]. Thus,
balance receipts are: 7.5 X 10.86 i.e. Rs.81.45 million.
Thus, total receipts = 108.2 + 244.58 + 81.45 = Rs.434.23 million.
(3 Marks)
(II) Analysis of Money Market Hedge:
Counter offer is to pay $8 million instead of SAR 30 million. Hence, again 75% of
exposure shall be hedged i.e. 75% of $8 million i.e. $6 million.
• Borrow in US $[6 / 1 + (0.05 X 3/12)] i.e. $ 5.93 million at 5 % p.a. for 3 months
• Convert $ 5.93 million to INR at spot bid rate of Rs.40.91/$ to receive Rs.242.60
million
• Invest Rs.242.60 million in India at 8% p.a. for 3 months to receive after 3
months – Rs.247.45 million.
Remaining, non-hedged receipts of $2 million shall be converted to INR at actual
spot bid rate after 3 months of Rs.41.81 to receive Rs.83.62 million.
Thus, total receipts = 108.2 + 247.45 + 83.62 = Rs.439.27 million.
(5 Marks)
Solution prepared by
CA. Ashish Lalaji
9
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(III) Analysis of Currency Futures:
No. of contracts required = Amount hedged / Contract size = (8 X 75%) / 2 = 3
contracts. Thus, firm shall sell 3 contracts at Rs.41.90. Thus, after 3 months the firm
has a right to sell $6 million at contracted futures price of Rs.41.90 / $ i.e. amount
received = 6 X 41.9 = Rs.251.4 million.
Remaining, non-hedged receipts of $2 million shall be converted to INR at actual
spot bid rate after 3 months of Rs.41.81 to receive Rs.83.62 million.
Thus, total receipts = 108.2 + 251.4 + 83.62 = Rs.443.22 million.
(6 Marks)
Conclusion: Firm should adopt currency futures as the hedging strategy in view of
highest eventual receipts. In other words, even the offer of the Saudi business man
of making payment in dollars should also be accepted.
Q6
Valuation of Yuga Ltd. as per –
(i) Discounted Cash Flow Technique:
Year Gross
Incre.
CFAT Invesmt
1 10,000
2 11,200
420
3 12,544
470
4 14,049
527
5 15,735
590
5
Net
CFAT
10,000
10,780
12,074
13,522
15,145
PVF
[9%]
0.917
0.842
0.772
0.708
0.650
822550*
0.650
PV
9170
9077
9321
9574
9844
46986
534658
581644
* 15,735 + 7% = 16,836 – [(16,836 – 15,735) X 0.35] = 16,451 / 0.02
(3 Marks)
(ii) Asset Backing Method:
Determining Average Future Maintainable Profits (FMP):
2004-05
2005-06
7,000
Add: Abnormal loss
12,000
3,000
Add: Increase in closing stock
20,000
18,000
2006-07
Divided by: no. of years
Average PBT
Add: Advantageous contract
Average adjusted PBT
Less: Tax at 30%
Average FMP:
15,000
38,000
60,000
3
20,000
25,000
45,000
13,500
31,500
(4 Marks)
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Determining Closing Capital Employed:
Plant
50,000
Machinery
1,40,000
Stock
58,000
Debtors
2,10,000
Bank
60,000
5,18,000
Less: Creditors
40,000
4,78,000
(3 Marks)
Valuation of Goodwill:
Average FMP
Less: Normal Profits
Super Normal Profits
X No. of years of purchase
Goodwill:
31,500
28,680 (4,78,000 X 6%)
2,820
3
8,460
(1 Mark)
Value of Firm:
Value of net assets (calculated above)
Add: Value of Goodwill
4,78,000
8,460
4,86,460
(3 Marks)
(iii) Dividend Yield Method:
Value per share = [14 / 11] X 10 = Rs.12.73
Value of firm = 12.73 X 40,000 shares = Rs.5,09,200
(2 Marks)
(iv) Earnings Yield Method:
Company’s ROE = 31,500 / 4,00,000 = 7.875 %
Value per share = [7.875 / 6] X 10 = Rs.13.125
Value of firm = 13.125 X 40,000 shares = Rs.5,25,000
(2 Marks)
(v) PE Multiple Valuation Method:
Value of firm = 31,500 X 12.75* = Rs.4,01,625
* 15 X 85%
(2 Marks)
Solution prepared by
CA. Ashish Lalaji
11
Dear Student,
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This time the assessment has been done by those who actually evaluate
CA Examination answer sheets. Your marks are thus that much close to
what it would have been in the Final Examination. Hope you reap the
benefits of one more student friendly step taken by Pinnacle Academy.
Sharing with you the observations of the evaluator.
Yours lovingly
CA. Ashish Lalaji
Observations on evaluation of Answer Books for FMQuestion Paper Dated; 27-Feb-16
1(a)
-
Majority of the students correctly calculated Depreciation, Net cash inflows & PV.
Mistakes observed in some cases were (1) missing out to consider Salvage value, (2) Incorrect
PV factor
1(b)
-
Part (i) & (ii) of the question is satisfactorily answered in most of the cases
In Part (iii), majority students faced difficulty in analysing correct PV of post-tax cash flows.
1 (c)
-
Satisfactorily answered in most of the cases under either of the approach selected.
2 (a)
-
In part (i) Theoretical buy back price Rs 100 is commonly mistaken as Pre-buy back MPS in many
cases, resulting in incorrect calculation of Market Capitalisation & PE as well.
Those who could correctly answer part (i) are generally right with part (ii)
2 (b)
-
Benefits of Merger is rightly answered by most of all cases except some students who wrongly
considered PV factor for 12% instead of 14%
Cost of Merger is generally calculated rightly except some students who calculated Value of Net
Assets transferred instead of Cost of Merger
2 (c)
-
Students are conceptually clear about distinctions as asked in the question. Some students who
have discussed only few points of distinction should try to cover more points of distinction.
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3
-
This optional question was most opted by majority students
Many students missed to consider 75% exposure as hedged and 25% as non-hedged and to
calculate the receipts for both these portions at separate applicable rates.
In some cases, bid & offer rates were misinterpreted resulting in incorrect calculation of
receipts.
Students who were careful in above two points, were successful in answering satisfactorily.
4
-
This optional question was least opted, and not fully answered correctly by those who opted
Closing capital employed was satisfactorily calculated by majority students who opted.
Increase in closing stock Rs 20000 was most commonly missed out element in calculation of
Future Maintainable Profits, this also resulted in incorrect goodwill.
General Observation:
Certain students attempted excess questions.
Please note that as per current practice of evaluation if student has attempted excess
question then last attempted optional question will be considered as Excess and no
evaluation should be done for said question.
For instance if you answer Q7 and score 16 but Q7 is an excess question & answered last
and you have also attempted Q6 before Q7 and scored 6 marks in it. Marks of Q 7 shall not
be considered as you attempted that last. So your final total of marks shall be less by 10
marks.
Suggestion for the student would be to attempt question first in which they are sure and
confident.
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