FM_Solution •
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Q4) Company Alfa and Beta have issued bonds with following
details. Answer the questions that follow.
Company Alfa and Company Beta
Par value 1000 and 100
Coupon rate 8% &amp; 11%
Term in years 10 &amp; 7 (both bonds are redeemable at par on
maturity)
(a) If the required rate of return is 9% what will be the market price
of the bonds issued by Beta. 
(b) Which bond is more volatile with respect to the change in
required rate of interest and why? 
(c) Suppose if the bonds were issued for perpetuity and an investor
is ready to pay Rs 768 for Bond of Alpha company,
what price would he be ready to pay for Bond of Beta (risk and
other factors are same)? 
(d) Calculate the YTM for bond of Alpha (yield to Maturity) if it is
Available for Rs.900. 
a) Price = PVIFA (9%,7yrs) x 11 + PVIF(9%,7yrs) x 100
=5.033 x 11 + 0.547 x 100 = 110.63
b) Bond A is more volatile as bonds with low coupon
rate and higher maturity period are more volatile
c) 80/768 = 11/Price
=&gt;
Price = 105.60
d) Interpolation using 9%
PVIFA(9%,10yrs) x 80 + PVIF(9%,10yrs) x 1000
= 935.44
Interpolation using 10%
PVIFA(10%,10yrs) x 80 + PVIF(9%,10yrs) x 1000
= 877.60
(contd….)
9% + (10% - 9%) x 935.44 – 900
= 9.61%
935.44 – 877.60
• Or using direct formula
• YTM = 80 + (1000 – 900)/10
0.4 x (1000) + 0.6 x 900
9.57%
• Q5)
a) A person requires Rs.20,000 at the beginning of each year from 2025 to
2029. How much should he deposit at the end of each year from 2015 to
2020, if the interest rate is 12%.
The discounted value of Rs.20,000 receivable at the beginning of each year
from 2025 to 2029, evaluated as at the beginning of 2024 (or end of 2023)
is:
Rs.20,000 x PVIFA (12%, 5 years)
=
Rs.20,000 x 3.605 = Rs.72,100.
The discounted value of Rs.72,100 evaluated at the end of 2020 is
Rs.72,100 x PVIF (12%, 3 years)
=
Rs.72,100 x 0.712 = Rs.51,335
If A is the amount deposited at the end of each year from 2015 to 2020
then
A x FVIFA (12%, 6 years) = Rs.51,335
A x 8.115 = Rs.51,335
A = Rs.51,335 / 8.115 =
Rs.6326
(b) ABCD Corporation has provided the following
information. Compute the Upper control limit
(UCL) and return point (RP) using Miller and
Orr Model. Take 1 year = 365 days

• Std deviation of company’s daily cash flow’s
Rs.1,00,000.
• Annual Yield on Marketable securities is 12%.
• It maintains a minimum cash balance of
3,00,000.
• Cost of buying or selling marketable security is
Rs.1500 per transaction.
•
• RP =
•
3 3 x 1500 x (100000)2 + 3,00,000
4 x (0.12 &divide; 365)
= 3,24,660
• UCL = 3 x 3,24,660 – 2 x 3,00,000
•
= 3,73,980
Q6) Attempt both the questions that follow
a) KC corporation requires certain raw material for the
factory. The probability distribution of the daily usage rate
and the lead time for procurement are given below.
(These distributions are independent).
Daily usage rate in
Tonnes
Probability
Days
Probability
2
0.2
25
0.2
3
0.6
35
0.5
4
0.2
45
0.3
The stockout cost is estimated at Rs 8,000 per tonne and
the carrying cost is Rs. 2000 per tonne per year.
• Calculate (a) the optimal level of safety stock.

•
(b)Probability of stock out

• Normal Usage = 2(0.2) x 25(0.2) = 50 (0.04)
•
2(0.2) x 35(0.5) = 70 (0.10)
•
2(0.2) x 45(0.3) = 90 (0.06)
•
3(0.6) x 25(0.2) = 75 (0.12)
•
3(0.6) x 35(0.5) = 105 (0.30)
•
3(0.6) x 45(0.3) = 135 (0.18)
•
4(0.2) x 25(0.2) = 100 (0.04)
•
4(0.2) x 35(0.5) = 140 (0.10)
•
4(0.2) x 45(0.3) = 180 (0.06)
• Weighted = 2 + 7 + 5.4 + 9 + 31.5 + 24.3 + 4 + 14 + 10.8
•
= 108
Safety
Stock
Stock
outs
Stockout cost
Probablity
Expected
Stockout cost
Carrying
cost
Total cost
72
0
0
0
0
144,000
144,000
32
40
320,000
0.06
19,200
64,000
83,200
27
45
5
360,000
40,000
0.06
0.10
21,600
4,000
25,600
54,000
79,600
0
72
32
27
576,000
256,000
216,000
0.06
0.10
0.18
34,560
25,600
38,800
98,960
0
98,960
The optimum level of Safety Stock = 27
The probability of stockout when the safety stock is
27 tons is 6% + 10% = 16%
(b) Price of a company’s share is Rs.80, and the
value of growth opportunities is Rs.20, what is
the E/P ratio and how much is the earnings
per share if market capitalization rate (r) is
15%?

EPS/Price = K(1 – PVGO/Price)
=&gt; EPS/Price = 0.15(1 – 20/80)
=&gt; E/P = 11.25%
E/P = 11.25% and P = 80
EPS = 11.25% x 80 = 9
• Q7) Attempt both the question that follow [3+3]
a) ABC Company is considering relaxing its
collection effort. Its sales are Rs.40 million and
average collection period is 20 days, its variable
costs to sales ratio, V, is 0.80 and cost of capital
is 12%, and its bad debt ratio is 5%. The
relaxation will push up sales by 5 million and
increase average collection period to 40 days
and raise the bad debt ratio to 6%. Tax rate is
40%. What will be the effect on residual income
if this change is implemented?
•
RI = [5,000,000 (0.2) – 700,000](0.6) –
0.12[40,000,000(40-20) + 5,000,000 x 40 x 0.80]
360
360
= - 140,000
Particuars
Jan
Feb
March
Receipts
Opening cash balance
Cash Sales
Collection during the 1st month (50% of credit sales)
Collection during 2nd month (50% of credit sales)
2.00
0.40
2.70
2.25
3.55
0.50
1.80
2.70
3.55
0.60
2.25
1.80
Total Receipts
7.35
8.55
8.20
Payments
Payment to Creditors (10% cash)
Payment at the end of credit period
Wages (50% last month + 50% current month)
Expenses
Plant (25% of the cost plus installation charge)
First Installment
Total Payment
0.30
0.90
2.10
0.50
3.80
0.20
1.80
2.20
0.50
0.30
5.00
0.10
2.70
2.30
0.50
0.25
5.85
Closing Balance (Receipts – Payments)
3.55
3.55
2.35