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Fiancial, Treasury and Forex MgtRevisionary Test Paper (December 2014)

Important Note: All those questions marked in class are also to be revised.(Theory + Practical)

Working Capital Management :-

Q.1 A company has prepared its annual budget, relevant details of which are produced below:(i) Sales Rs.46.80 lakh (25% cash sales

And balance on credit) : 78,000 units(ii) Raw material cost : 60% of sales value(iii) Labour cost : Rs. 6 per unit(iv) Variable overheads : Rs. 1 per unit(v) Fixed overheads : Rs. 5,00,000 (including Rs. 1,10,000

as depreciation(vi) Budgeted stock levels:

Raw materials : 3 weeksWork-in-progress : 1 week(material 100%; labour and

overheads 50%)Finished goods : 2 weeks

(vii) Debtors are allowed audit : 4 weeks(viii) Creditors allow : 4 weeks credit(ix) Lag in payment of overheads : 2 weeks(x) Cash in hand required

(a) for 1st and 2nd week : in the 3rd week(b) for 3rd and 4th week : in the next week.

Prepare working capital budget (requirement) for a year for the company. Assume one year = 52 weeks.Answer:Unit Selling Price and Cost

Selling Price Rs. 60Raw Materials 36 (60% of Rs. 60)Labour 6

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God help those who help themselves.Variable overheadsFixed Overheads (3,90,000/78,000) 5 (Excluding depreciation)Total 48

Statement of Working Capital RequirementA. Current Assets

Raw Materials (3 x 1500 x 36) 1,62,000Raw-in-Progress (1 x 1500 x 42) 63,000Finished Goods (2 x 15000 x 48) 1,44,000Debtors (4500 x 48) 2,16,000Cash-in-hand 50,000Total Current Assets 6,35,000

B. Current LiabilitiesCreditors (4 x 1500 x 36) 2,16,000Lag in Wages (2 x 1500 x Rs6) 18,000Lag in Payment of overheads [2 x 1500 x Rs 6) 18,000Total Current Liabilities 2,52,000Net Working Capital required (CA-CL) 3,83,000

Notes:(1) Total sales for 4 weeks are 6,000 units. Excluding 25% cash sales, credit sales

amounts to 4500 units.(2) One year is assumed to be 52 weeks and weekly sale is 78,000 / 52 = 1500 units(3) Work-in-process is valued at Rs. 42 (i.e 369 +3 +3)(4) Total overheads per unit is Rs.(1+5). As no fund is required for depreciation, this has

been deducted from total fixed cost.(5) Some candidate may calculate the debtors at selling price and in that case, the debtors

would be Rs. 2,70,000 and working capital amount would be Rs.4,37000.

Q.2 Ashoka Ltd. A newly formed company, has applied to the commercial bank for the first time for financing its working capital requirements. The following information is available about the projections for the current year:

Estimated level of activity : 1,04,000 completed units of production plus 4,000 units of work-in-progress. Based on the above activity, estimated cost per units is:

(Rs. Per unit)

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Prepare time table and follow the same.Raw material 80Direct wages 30Overheads (exclusive of depreciation) 60Total cost 170Selling price 200

- Raw material in stock : Average 4 weeks consumption- Work-in-progress : 50% completion stage in respect of

Conversion cost while materials issued at start of the processing

- Finished goods in stock : 8,000 units- Credit allowed by suppliers : Average 4 weeks- Credit allowed to debtors/receivables: : Average 8 weeks- Lag in payment of wages : Average 1.5 weeks- Cash at banks is expected to be : Rs.25,000

Assume that production is carried on evenly throughout the year (52 year) and wages and overheads accrue similarly. All sales are on credit basis only.Find out-(i) The net working capital required on total value method; and(ii) The maximum permissible bank finance under second method of financing as per

Tandon Committee Norms.A(i):Working Notes

Amount in Rs.Cost of Production (for 1,04,000 units) 83,20,000Raw Material @ Rs. 80 31,20,000Direct wages @ Rs. 30 62,40,000Overhead (exclusive of depreciation) 1,76,80,000Total Cost of Production for 1,04,000 units Rs. 170Cost per unit (Rs.1,76,80,000/1,04,000)Work in ProgressRaw Materials (4000 units @ Rs 80) 3,20,000Direct wages (4000 units @ Rs 30 x 50/100) 60,000Overhead (4000 units @ Rs 60 x 50/100) 1,20,000Total 5,00,000Raw Material StockRaw material stock i.e Average 4 weeks consumption

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Dream is what does not allow you to sleep.(2000x4x80) 6,40,000Stock Finished Goods8,000 units @ Rs 170 unit 13,60,000Debtors 8 weeksSince Ashoka Limited is a newly formed company so there will be opening stock. Expected total sales in the yeari.e (1,04,000-8,000) 96,000 unitsDebtors (Assumed at cost of production) i.e. 96,000*8/52*170 25,10,769Debtors (Assumed at Sales Value) i.e. Rs. 96,000*8/52*200 29,53,846Creditors for Raw MaterialTotal Purchased during the year i.e(Rs. 83,20,000 + Rs. 3,20,000 + 64,000) 92,80,000Total creditor at the end of year i.e. 92,80,000*4/52 7,13,846Creditors for wagesDirect wages paid during the year i.e (Rs.31,20,000 + Rs. 60,000)Creditors for wages i.e (Rs. 31,20,000 + Rs. 60,000) 31,80,000Creditors for wages i.e (Rs. 31,80,000*1.5/52) 91,731Computation of Net Working CapitalCurrent AssetsRaw Material 6,40,000Work in progress 5,00,000Finished Goods 13,60,000Debtors (at cost of production) 25,10,769Debtors (at sales value) 29,53,846Cash at bank 25,000Total Current assets (if debtors taken at sales value) 54,78,846Total Current assets (if debtors valued at cost of production) 50,35,769Current LiabilitiesCreditors for Raw Material 7,13,846Creditors for wages 91,731Total 8,05,577Net working capital (if debtors taken at sales value) 46,73,269Net working capital (if debtors taken at cost of production) 42,30,192

Ans (ii): Maximum Permissible Bank Finance as per Tandon Committee

Method 275% of Current Assets – Current LiabilitiesIf debtors taken at sales value (75% of Rs.54,78,846 – Rs8,05,577) Rs 33,03,558If debtors taken at cost of production

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(75% of Rs 50,60,384 – Rs 8,07,,471) Rs 29,71,250 पापा कहते है बड़ा नाम करेगा, बेटा हमारा ऐसा काम करेगा,

Financial Decisions

Q.3 The capital structure of the Progressive Corporation consists of ordinary share capital of Rs. 10, 00,000 (shares of Rs 100 each) and Rs. 10,00,000 of 10% debentures. The selling price is Rs. 10 per unit; variable costs amount to Rs 6 per unit and fixed expenses amount to Rs. 2, 00,000 . The income tax rate is assumed to be 50%. The sales level is expected to increase from 1,00,000 units to 1,20,000 units.

(a) You are required to calculate:(i) The percentage increase in earnings per share.(ii) The degree of operating leverage at 1,00,000 units and 1,20,000 units(iii) The degree of operating leverage at 1,00,000 units and 1,20,000 units

(b) Comment on the behavior of operating and financial leverages in relation to increase in production from 1, 00,000 units to 1, 20,000 units.

Q.4 Three companies X Ltd. Y Ltd. are in the same type business and hence having similar operating risks. However, the capital structure of each of them is different as follows:

X Ltd. Y Ltd. Z Ltd. (Rs.) (Rs.) (Rs.)

Equity share capital (face value Rs 10 per share) 4,00,000 2,50,000 5,00,000Market value per share 15 20 12Dividend per share 2.70 4.00 2.88Debentures (face value Rs 100 per debenture) Nil 1, 00,000 2,50,000Market value per debenture - 125 80Interest rate on debenture - 10% 8%Assume that the current level of dividend is expected to continue indefinitely and the income tax rate is 30%.You are required to compute the weighted average cost of capital (at market value) of each company.

Ans:________________________________________________________________________X Limited Y Limited Z Limited

Cost of EquityMarket Value per share (Rs) 15 20 12

Dividend per Share (Rs) 2.70 4.00 2.88Cost of Equity in % 2.70 x 100 4.00 x 100 2.88 x 100

15 20 12

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Formula :Dividend per share x 100Market Value per share =18 =20 =24 Cost of Debt in %Market Value per Debenture (Rs) - 125 80Interest Rate on Debenture (%) - 10 8

Cost of Debt in % (Pretax) 10 x 100 8 x 100 125 80

Formula:Interest per debenture x 100Market value per debenture - 8 10 Cost of Debt after Tax (%) - 8(1-0.30) 10(1-0.3)Formula:Pre tax cost of Debt (1-Tax rate) =8(0.70) =10(0.70) =5.6 =7

Calculation of Market Value of Shares and Debentures

Company No. of Market Total No of Market Total Total Shares Value Market Debenture Value per Market Market

per value of Debenture value of Value Share Share Deben- of Sha- (Rs) (Rs) tures(Rs) res and

Deben- Tures(Rs)

______________________________________________________________________________X 4,00,000/10 - - - =40,000 15 6,00,000 - - - 6,00,000 Y 2,50,000/10 1,00,000/100 =25,000 20 5,00,000 =1000 125 1,25,000 6,25,000 Z 5,00,000/10 2,50,000/100 =50,000 12 6,00,000 =2,500 80 2,00,000 8,00,000

Calculation of Weighted Average Cost of Capital at market value of Each CompanyFormula for calculation of weighted cost of capital Cost of Equity x M.V. Equity Shares + Cost of Debt x M.V. of Debentures

Total of M.V. of shares & Debentures Total of M.V. Shares & Debentures

X Limited = 18%

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Y Limited – 20 x 5,00,000 + 5.6 x 1,25,000 6,25,000 6,25,000

Respect your parents= 17.12%

Z Limited -24 x 6,00,000 + 7 x 2,00,000 8,00,000 8,00,000= 19.75%

*MV stands for Market Value

Q.5 The capital structure of Supreme Ltd. is as under: Rs.

2,000, 6% Debentures of Rs 100 each (I issue) 2,00,0001,000, 7% Debentures of Rs 100 each (II issue) 1,00,0002,000, 8% Cumulative preference shares of Rs 100 each 2,00,0004,000, Equity shares of Rs 100 each 4,00,000Retained earnings 1,00,000Earnings per share of the company in the past many years has been Rs 15. Shares of the company are sold in the market at book value. The company’s tax rate is 30% and shareholders personal tax liability is 10%.Find out weighted average cost of capital of the company.

Ans:(a) Cost of Debentures (I issue) : (I/NP) x 100(1-t)

= (Rs 6/100) x 100(1-0.3)= 4.2 %

(Where I is the interest rate, NP is Net Proceed and t is tax rate)(b) Cost of Debentures (II issue) : (I/NP) x 100(1-t)

= (Rs 7/100)x100 (1-0.3)= 4.9%

(Where is the Interest rate, NP is Net Proceed and t is tax rate)(c) Cost of Preference Share Capital : (DPS/NP)x100

= (Rs 8/100) x 100= 8%

(Where DPS is the Dividend per Shares, NP is Net Proceed)(d) Cost of equity share capital : (EPS/MPS) x 100

= Rs 15/125 x 100= 12%

(Where EPS is the Earning per Share, MPS is Market Price per Share)Market Price per share = Equity Share Capital + Retained Earnings

Total number of Equity Shares= Rs. 4,00,000 + Rs. 1,00,000

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4000 equity shares(e) Cost of Retained Earnings : E(1-tp)/MP X 100

= Rs 15(1-0.10) / Rs 125 x 100= 10.8%

__________________________________________________________________________Sources Amount (Rs) Weights Cost of Capital Weighted

AverageCost

Debenture(I issue) 2,00,000 0.2 0.042 0.0084Debentures (II issue) 1,00,000 0.1 0.049 0.0049Preference ShareCapital 2,00,000 0.2 0.08 0.0160Equity Share Capital 4,00,000 0.4 0.12 0.0480Retained Earnings 1,00,000 0.1 0.108 0.0108 0.0881 Weighted Average Cost of Capital = 0.0881 or 8.81%

Q. 6 The following information is related to Sunrise Ltd :Sales 4,00,000Less : Variable expenses 35% 1,40,000Contribution 2,60,000Less : Fixed expenses 1,80,000EBIT 80,000Less: Interest Taxable income 10,000

70,000You are required to submit the following to management of the company:(i) What percentage will taxable income increase, if the sales increase by 6% ? Use

combined leverage.(ii) What percentage will EBIT increase, if there is a 10% increase in sales? Use

operating leverage.(iii) What percentage will taxable income increase, if EBIT increase by 6% Use

financial leverage.Ans:The combined leverage on sales of Rs 4,00,000 of Sunrise Ltd.

Contribution = 2,60,000 =3.714Taxable income 70,000If sales increased by 6 per cent the taxable income will increase by

3.714x0.06 = .22284 = 22.28% (ii) The degree of operating leverage at sales level of Rs 4,00,000

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Contribution = 2,60,000 =3.714Taxable Income 70,000

Think PositiveIf sales increase by 10 percent the EBIT will increase by 3.25 x 0.10 =0.325 = 32.5%

(iv) Degree of financial leverage EBIT = 80,000 = 1.143Taxable Income 70,000If EBIT, increase by 6 percent taxable income will increase by 1.143 x 0.06 = 0.686 = 6.86%.

Q.7 Ruta Max Ltd. and Buta Max Ltd. operate in the same risk class and are identical in all respect except that Ruta Max Ltd. uses debt financing white Buta Max Ltd. does not opt for debt financing.Ruta Max Ltd. has Rs.25,00,000 debentures carrying coupon rate of 10%. Both the companies earn 20% profit before interest and taxes on their total assets of Rs 50 lakh. Assume perfect capital markets and rational investors and so on. The capitalization rate for an all equity company is 15%. The corporate tax rate is 30%.You are required to compute the value of both companies according to bet income (NI) and net operating income (NOI) approach.

Ans(i) Value of firm under Net Income ApproachRuta Max Ltd. (Rs) Buta Max Ltd. (Rs.)(Leverage Firm) (Unlevered Firm)

EBIT (20% OF 50 Lakh) 10,00,000 10,00,000Less: Interest 2,50,000 -

7,50,000 10,00,000Less: Taxes 30% 2,25,000 3,00,000EAT or Profit available for Shareholders 5,25,000 7,00,000Equity Capitalization Rate .15 .15Market Value of Equity EAT/Ke 35,00,000 46,66,666Market Value of Debt(Kd) 25,00,000 -

Total Value of Firm 60,00,000 46,66,666

(iii) Value of firm under Net Operating Income Approach.Value of Buta Max Ltd. (Unlevered Firm)

= EBIT (1-t) = 10,00,000(1-.30) = Rs. 46,00,000 Ke 0.15

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Value of Ruta Max Ltd. (Levered firm)= Value of Unlevered firm + D(t)

मन के हारे हार है ,मन के जीते जीत = 46,66,666 + 25,00,000 (.3)= 46,66,666 + 7,50,000 = Rs 54,16,666

Portfolio Mgt

Q.8 During a 5 year period, the relevant results for the aggregate market are that the risk - free rate (rf) is 8 % and the return on market (rm) is 14%.For that period, the results of five portfolio managers are as follows :

Portfolio Actual Average Beta ()Manager Return (%) A 13 0.80 B 14 1.05 C 17 1.25 D 13 0.90 E 15 0.95

Using CAPM model, your are required to –(i) Calculate the expected rate of return for each portfolio manager and compare the

actual returns with the expected return: and(ii) Based upon your calculations, select the portfolio manager with the best

performance.Ans: CAPM equation

Ri = Rf + β(Rm - Rf)Where Ri = Expected rate of return

Rf = Risk free rateRm = Return on marketβ = Beta

The expected rates of return are as follows:

Portfolio Expected Return Actual DifferenceManager (%) Average between

Return Actual & Exp-(%) cted Returns(%)

________________________________________________________________________A rA = 8% +0.80 (14% - 8%) = 12.8 13 + 0.25B rB = 8% + 1.05 (14% - 8%) = 14.3 14 - 0.3C rC = 8% + 1.25 (14% - 8%) = 15.5 17 + 1.5

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D rC = 8% + 0.90 (14% - 8%) = 13.4 13 + 0.4I can and I will

E rE = 8% + 0.95 (14% - 8%) = 13.7 15 + 1.3

(ii) Portfolio managers A,C and E did better than expected. A exceeded the expected return by 1.56 per cent (0.2% ÷ 12.8%), C exceeded the expected return by 9.68 per cent 1.5% ÷ 15.5%) and E bettered the expected return by 9.49 percent (1.3% ÷ 1.37%). Therefore, portfolio manager C showed the best performance.

Q.9 Vivek is holding 1,000 shares of Right Choice Ltd. the current rate of dividend paid by the company is Rs 5 per share and the share is being sold at Rs 50 per share in the market. However, several factors are likely to change during the course of the year as indicated below:

Existing RevisedRisk free rate 14% 12%Market risk premium 8% 6%Beta (β) value 1.42 1.27Expected growth rate 6% 10%

In view of above factors, whether Vivek should buy, or hold or sell the shares and why?

Ans: The expected rate of return can be calculated by applying the CAPM as follows:Ke = Rf + β (Rm – Rf)Existing Rate of Return = 14% + 1.42 (8%) = 14% + 11.36% = 25.36%Revised Rate of Return = 12% + 1.27 (6%) = 12% + 7.62% = 19.62%Original Share Price P0 = D(1 + g) = 5 ( 1 + 6%)

Ke – g .2536-0.06Or 5 (1.06) = 5.30 =Rs 27.38

.2536-0.06 .1936Revised Share price Po = D ( 1+ g) = 5 (1+10%)

Ke – g .1962 -.10Or 5(1.10) = 5.5 = Rs 57.17

.1962-.10 .0962Comment:

(i) Under the growth rate of 6% the share price is expected to be Rs 27.38 but the existing share price is Rs 50 which is overpriced. If the growth rate remains same at 6% under equilibrium process it is expected that share price will fall from Rs 50 to Rs 27.38. So sell the stock.

(ii) Under the revised growth rate of 10% the expected share price is Rs 57.17. The current market price is Rs 50. So Mr. Vivek can hold the share for further price rise.

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Success come to those who will and dare.Forex

Q.10 Give the following information:Exchange rate - Canadian dollar 0.665 per DM (spot)

Canadian dollar 0.670 per DM( 3 months)Interest rates - DM 7% p.a.

Canadian dollar 9% 9.a.What operations would be carried out to take the possible arbitrage gains

Q.11 Following are the spot exchange rates quoted at three different forex markets:USD/INR 48.30 in MumbaiGBP/INR 77.52 in LondonGBP/USD 1.6231 in New York

The arbitrage has USD 1, 00,00,000. Assuming that there are no transaction costs, explain whether there is any arbitrage gain possible from the quoted spot exchange rates.

Ans: The arbitrage gain/loss be assessed by the under given processStep 1 - Money realized from conversion of 1,00,000

USD in Indian Rupees at spot rate of Rs 48.30Step 2 - Money realized from conversion of 48,30,00,000

INR in GBP at spot rate of 77.52 in Londoni.e. 48,30,00,000/77.52

Step 3 - Money realized from conversion of 62,30,650.155GBP in USD at spot rate of 1.6231 in New York

i.e. 62,30,650.155 x 1.6231 USD 101,12,968.27Arbitrage Gain i.e. USD (101,12,968.27-1,00,00,000)

Derivatives

Q.12 Identify the profit or loss (ignoring dealing cost and interest) in each of the following cases :

(i) A put option with exercise price of Rs 250 is bought for a premium of Rs 42. The price of underlying share is Rs 189 at the expiry date.

(ii) A put option with an exercise price of Rs 300 is written for a premium of Rs 57. The price of the underlying share is Rs 314 at the expiry date.

Ans: (i) Exercise price of Put Option

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Less :Price of the Underlying Shares at the expiry date Rs 189Premium Paid Rs 42 Rs 231

Profit Rs 19i.e. a profit of Rs 19 per contract purchased.

(ii) Exercise Price = Rs 300, put option is written on exercise price for a premium of Rs 57.On the expiry date, the put option will not be exercised against the investor. Profit position would be equal to the amount of premium received i.e Rs 57.

Q.13 Internet Services Ltd. is a listed company and the share price have been volatile. An investor expects that the share price may fall from the present level of Rs 1,900 and wants to make profit by a suitable option strategy. He is short of share at a price of Rs 1,900 and wants to protect himself against and loss. The following option rate are available:

Strike Price Call Option Put Option(Rs.) (Rs.) (Rs)1,700 325 651,800 200 801,900 85 1202,000 70 2002,100 65 280

The investor decides to buy a call at a strike price of Rs. 1,800 and to write a put at a strike price of 2,000. Find out the profit or loss profile of the investor if the share price on

the expiration date is Rs 1,600, Rs 1,700, Rs 1,800, Rs 1,900, Rs 2,000 or Rs 2,100 respectively.

Ans: (Amount in Rs)Strike Price Premium

Long Call Option 1800 200Shot Put Option 2000 200

Net Premium --(Amount in Rs)

Price on Expiry Payoff on Call Payoff on Put Net Premium Net Payoff

1600 - -400 - -4001700 - -300 - -300

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Actions speak louder than words1800 - -200 - -2001900 100 -100 - Nil2000 200 - - 2002100 300 - - 300

Q.14 Zenith company has a beta of 0.5 with Nifty. Each Nifty contract is equal to 100 units. Zenith company now quotes at Rs 250 and the Nifty future is 4,000 index points. X is long on 1,200 shares of Zenith company in the spot market.(i) How many futures contracts will X have to take?(ii) If the price in spot market drops by 10%, how is X protected?

Ans: (i) Since X is long on the shares of Zenith Company in the Rs 1,50,000Spot market, he will have to go short in the futures market.He will have to sell Nifty. Market value of holding to beHedged = 1200 x Rs 250 x 0.5No of Future contracts to be sold i.e. Rs 1,50,000/Rs 4,00,000 0.375

(i) If the price in spot market is down by 10%, then NiftyWould go down by 10%/0.5 = 20%Loss on shares i.e. 1200 x Rs 250 x10/100 Rs. 30,000Gain on Nifty i.e. 4,000 x 100 x 0.375 x 20/100 Rs. 30,000Difference NilSo, Mr X is fully protected

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