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IMT 59 Financial Management M2

PART – A

Q1. Contrast the objective of maximizing earnings with that of maximizing wealth.

Q2. An investor is holding IDBI deep discount bonds purchased for Rs 12750/- to be redeemed after 30 years at a face value of Rs 5,00,000. What is the interest rate implicit in the bond? What is the current value of bond if the current market yield is 9%?

Q3. a) The risk free return is 8% and the expected return on market portfolio is 12%. If the required return on a stock is 15%, what is its beta?

b )An investor is 50 years of age today. He will retire at the age of 60. In order to receive Rs 2,00,000 annually for 10 years after retirement, how much amount should he have at the time of retirement.

Assume the required rate of return is 10%.

Q4. Write short notes on :

a. Leverage ratios

b. Earning per share

Q5. The required rate of return of investors is 15%. ABC Ltd. Declared & paid annual dividend of Rs4/- per share. It is expected to grow at the rate of 20% for the next 2 years and at the rate of 10% thereafter.

Compute the price at which he should sell it?

PART – B

Q1. Discuss the important functions performed by financial markets.

Q2. Important ratios of the firm for the year 2011 are given below:

Stock Velocity

4

Debt collection period

2 months

Creditors payment period

73 days

Gross Profit

Rs 2,00,000

Gross Profit margin

20%

Cash & Bank balance

5% of sales

Credit purchases

25%

The firm expects an increase of 50% in sales in the ensuing year. Estimate the working capital

requirement of the firm for the ensuing year.

Q3. “ Despite its weakness the pay back period method is popular in practice”. What are the reasons for its popularity?

Q4. Describe the traditional view on the optimum capital structure. Compare & contrast this view with the net operating income approach

Q5. Define cost of capital? Explain its significance in financial decision making.

PART – C

Q1. Write short notes on:

a. Bonus shares

b. Share split

Q2. How would you determine the optimum level of current assets? Illustrate your answer

Q3. Band Box is considering the purchase of a new wash & dry equipment in order to expand its operations. Two types of options are available; A low speed system (LSS) with a Rs. 20000 initial cost and a high speed system (HSS) with an initial cost of Rs. 30000. Each system has a 15 year life and no salvage value. The net cash flows after taxes (CFAT) associated with each investment proposal are ;

Low Speed System

(LSS)

High Speed System

(HSS)

CFAT for Years 1

through 15

Rs. 4000

Rs. 6000

Which Speed System should be chosen by BandBox, assuming 14% cost of capital?

Q4. A company is considering raising Rs 100 lakh by one of the two alternative methods, viz 14% institutional term loan and 13% non convertible debentures. The term loan option would attract no major incidental cost. The debentures would have to be issued at a discount of 2.5% and would involve Rs 1 lakh as cost of issue. Advice the company as to the better option based on effective cost of capital in each case . Assume a tax rate of 35%

Q5. Differentiate between:

a. Conservative approach & Aggressive approach of financing the working capital

b. Net Income approach and net operating income approach of capital structure theories

CASE STUDY – 1

Aries Ltd. wishes to raise additional finance of Rs 10 lakh for meeting its investment plans. It has Rs 2,10,000 in the form of retained earnings available for investment purposes. The following are the further details:

1.Debt- equity mix 30:70

2 Cost of debt: Upto Rs 1,80,000, 10%(before tax);beyond 1,80,000 12% (before tax)

3 Earning per share, Rs 4

4 Dividend payout, 50% of earnings

5 Expected growth rate in dividend 10%

6 Current market price per share, Rs 44

7 Tax rate 35%

You are required:

a) To determine the pattern for raising additional finance, assuming the firm intends to maintain the existing debt / equity mix.

b) To determine the post tax average cost of additional debt

c) To determine the cost of retained earnings and cost of equity

d) Compute the overall weighted average after tax cost of additional finance.

CASE STUDY – II

Seshasayee Industries Ltd. is considering replacing a hand operated weaving machine with a new fully automated machine .Given the following information ,advise the management whether the machine should be replaced or not. Assume the company has only this machine in 25% block of assets and the block of assets and the block will cease to exist after the useful life of the automated machine.

EXISTING SITUATION

PROPOSED SITUATION

One full time operator’s salary Rs 36000

Fully automated operation ,no operator needed

Variable Overtime Rs 3000

Cost of machine Rs 180000

Fringe Benefits Rs 3000

Transportation Charges Rs 3000

Cost of defects Rs 3000

Installation Cost Rs 15000

Original price of hand operated machine

Rs 60000

Expected life 5 years

Expected life 10 years

Depreciation method WDV

Age 5 Years

Annual maintenance Rs 3000

Depreciation method WDV

Cost of defects Rs 3000

Current salvage value of old machine

Rs 36000

Salvage after 5 years Rs 20000

Tax rate 35%

Required rate of return 15%

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