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Question Paper
Strategic Financial Management:
Theory and Practice (MB3H2F) : January 2009
Section A : Basic Concepts (30 Marks)
• This
section consists of questions with serial number 1 - 30.
• Answer
all questions.
• Each
question carries one mark.
• Maximum
time for answering Section A is 30 Minutes.
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1. Which
of the following is not a
fundamental part of a firm’s financial structure? |
<Answer |
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(a) |
Ownership
structure |
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(b) |
Financial planning |
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(c) |
Financial leverage |
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(d) |
Executive compensation |
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(e) |
Managerial
hierarchy. |
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2. Feasibility study takes into consideration
I.
Frequency of the decision.
II.
Suitability of the area in which decision is
required.
III.
Comparison of costs and benefits.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (I) and (II) above
(e)
All (I), (II) and (III) above.
<Answer
>
3. Which of the following statements is false with respect to quality costing?
(a)
Quality of design refers to
variation in products that have the same functional use
(b)
Total Quality Control is often
associated with Just-In-Time manufacturing
(c)
Appraisal costs are the costs
incurred to ensure that materials, products, and services meet quality
standards
(d)
A Quality-Costing system monitors
and accumulates the costs incurred by a firm in maintaining or improving
product quality
(e)
Quality of conformance refers to
the degree with which the final product fails to meet its specifications.
<Answer
>
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4. Which of the following is/are
external factor(s) that lead to the bankruptcy of a firm? |
<Answer |
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> |
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I.
Shortage in supply of raw materials.
II. Fraudulent
practices by management.
III. Labour unrest.
IV. Technological obsolescence.
V.
Disputes among promoters.
(a)
Only (I) above
(b)
Only (II) above
(c)
Both (I) and (II) above
(d)
Both (III) and (IV) above
(e)
Both (IV) and (V) above.
5. The failure of executive compensation plan is usually because of
I.
Correlation between the size of the company and its
payment structure.
II.
Emphasis on short term
performance of the company.
III. More focus on the accounting
measures while designing the compensation contracts.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (II) and (III) above
(e)
All (I), (II) and (III) above.
Page 1 of 18
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<Answer
>
(a)
1
(b)
2
(c)
3
(d)
4
(e)
5.
7. Which of the following statements is/are false regarding Ratio Comparison Approach?
I.
It provides a popular way of valuing firms,
projects or assets.
II.
This method is never used in real
asset valuation.
III. This approach uses ratio of price
to earnings for valuation.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (I) and (II) above
(e)
Both (II) and (III) above.
<Answer
>
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8. The real option valuation
approach of valuing a project shows that the value of revolving uncertainty
depends |
<Answer |
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> |
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on |
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I.
Future decision involving exploration.
II. Current
value of oil prices.
III. Uncertainty type.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
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9. As per Modigliani and Miller
hypothesis value of levered firm is equal to value of unlevered firm. This |
<Answer |
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implies |
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I.
The cost of equity increases.
II. Stock
holder’s risk exposure increases.
III.
The weighted average cost of
capital changes with leverage.
IV. Leverage does not increase/decrease risk.
(a)
Only (I) above
(b)
Only (II) above
(c)
Both (I) and (II) above
(d)
Both (I) and (IV) above
(e)
Both (II) and (III) above.
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10 |
Which
of the following statements is/are false
regarding dividend decisions? |
<Answer |
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(a) |
Liquidity
does not affect dividend decisions |
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(b) |
Firms resort to high payout if the profitable
investments are lacking |
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(c) |
The cost of external financing influences
dividend decisions |
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(d) |
Firms tend to have a high pay-out ratio if the
shareholders have a strong preference towards current |
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dividends |
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(e) |
Restrictive
covenants limit the flexibility of the company in determining its dividend
policy. |
<Answer |
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11. All of the following models
are used for predicting sickness of a firm except |
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(a) |
Beaver
Model |
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(b) |
BCG Matrix |
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(c) |
Altman’s Z Score Model |
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(d) |
Argenti Score Board |
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(e) |
Wilcox
Model. |
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Page 2 of 18
12
The institutionalization of
knowledge created during the process of developing and installing a model
. known as
(a)
Validation
(b)
Implementation
(c)
Construction
(d)
Documentation
(e)
Revision.
I. Losing of professional analysts.
II. Delisting of stocks.
III. Decrease in normal bid ask
spread.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (I) and (II) above
(e)
Both (II) and (III) above.
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14 Which of the following
statements is/are true with respect to Activity Based Costing (ABC)? |
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ABC is
based on historical costs. |
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I. |
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II. |
ABC does not highlight the causes of costs. |
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III. |
ABC
divides cost into fixed and variable costs. |
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (I) and (II) above
(e)
Both (II) and (III) above.
15. As per
Marshall and Bansal asset-liability management is an effort to manage/minimize
exposure to
I.
Price risk.
II.
Interest rate risk.
III. Exchange risk.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (II) and (III) above
(e)
All (I), (II) and (III) above.
<Answer is
>
<Answer
>
<Answer
>
<Answer
>
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16 Electric Circuits Ltd. is an
Indian firm, it imports electric parts from Japan. If the Yen is
strengthening, Indian |
<Answer |
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> |
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firm is
exposed to |
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(a)
Translation risk
(b)
Transaction risk
(c)
Economic risk
(d)
Interest rate risk
(e)
Political risk.
17. Anti
trust laws aim to
I.
Protect economic freedom and
opportunity.
II.
Provide a better deal to customers by promoting
competition in market place.
III. Create a level playing field and
encouraging new entrants into the industry.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (II) and (III) above
(e)
All (I), (II) and (III) above.
<Answer
>
Page 3 of 18
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(a) |
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Rs.3.22 lakh |
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(b) |
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Rs.2.11 lakh |
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(c) |
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Rs.1.22 lakh |
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(d) |
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Rs.1.12 lakh |
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(e) |
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Rs.1.05 lakh. |
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22 According to Du-Pont equation for Return On
Equity (ROE), other things remaining constant, which of the <Answer |
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> |
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.
following statements is/are false? |
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(a) |
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An increase in the net profit margin
will increase the ROE |
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(b) |
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A decrease in debt to assets ratio
will increase the ROE |
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(c) |
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A decrease in return on assets will
decrease the ROE |
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(d) |
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An increase in the average asset
turnover will increase the ROE |
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(e) |
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An increase in equity multiplier
increases the ROE. |
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Page 4 of 18 |
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Annual interest rate on marketable
securities |
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=
9% |
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Fixed conversion costs |
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= Rs.2,000 |
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Estimated cash requirement over 6
months planning period |
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= Rs.5,00,000 |
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21. The following data
is available for Infodata Ltd.: |
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<Answer |
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> |
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Debt-service coverage ratio of the
company is |
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(a) |
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1.59 |
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(b) |
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1.76 |
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(c) |
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1.84 |
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(d) |
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2.24 |
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(e) |
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2.70. |
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19 |
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<Answer There are two firms, Akash Ltd. and
Prakash Ltd. They are similar in all respects except that Akash Ltd. is > |
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. unlevered, while Prakash Ltd. has
Rs.5 crore of 11% debentures outstanding. Both companies have a net operating income of Rs.1 crore each.
The tax rate applicable to both the companies is 35%. The discount rate for
both the companies is 10% p.a. The value of Prakash Ltd., considering
Modigliani-Miller position on leverage holds good is |
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(a) |
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Rs.1.00 crore |
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(b) |
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Rs.3.50 crore |
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(c) |
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Rs.6.50 crore |
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(d) |
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Rs.8.25 crore |
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(e) |
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Rs.9.30 crore. |
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20 |
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<Answer The current ratio and quick ratio of
Kendra Industries Ltd., are 1.2 and 0.8 respectively. The net working > |
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.
capital of the firm
is Rs.6,00,000 with an inventory of |
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(a) |
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Rs. 7.50 lakh |
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(b) |
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Rs. 9.00 lakh |
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(c) |
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Rs.11.25 lakh |
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(d) |
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Rs.12.00 lakh |
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(e) |
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Rs.14.00 lakh. |
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<Answer |
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> |
18. Consider
the following data of M/s. Super Colors Ltd. for the year 2008 – 09:
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Profit
after tax |
Rs.14.98
lakhs |
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Interest
expenses |
Rs..9.2
lakhs |
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Non
cash charges |
Rs.6.5
lakhs |
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Repayment
of term loan |
Rs.7.5
lakhs |
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Effective
tax rate |
26% |
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(a) |
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Both (I) and (II) above |
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(b) |
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Both (II) and (IV) above |
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(c) |
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(I), (II) and (IV) above |
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(d) |
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(II), (III) and (IV) above |
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(e) |
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All (I), (II), (III), and (IV)
above. |
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I. |
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II. |
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III. |
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IV. |
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Minimize the probability of occurrence of an
adverse event such as an accident. Cut the cost when an accident occurs. |
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Shift responsibility to other parties to the
extent possible, when the event occurs. Obtain more information to make risk
assessment methodology as robust as possible. |
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27. While managing environmental risks, risk
managers perform which of the following tasks? |
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(a) |
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Only (I) above |
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(b) |
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Only (II) above |
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(c) |
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Only (III) above |
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(d) |
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Only (IV) above |
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(e) |
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All (I), (II), (III) and (IV)
above. |
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26 According
to which of the following models firm’s |
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. symptoms based on numerical assessment of the
firm? |
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(a) |
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Beaver Model |
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(b) |
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The Wilcox Model |
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(c) |
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Blum Marc’s Failing Company
Model |
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(d) |
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Altman’s Z score Model |
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(e) |
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Argenti Score Board. |
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23 Metalic Steel earns 10% on the
equity and the growth rate of dividends and earnings is 5%. The book value |
<Answer |
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> |
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. per share is Rs.80. If the market price of
the shares of Metalic Steel is Rs.70, according to the Marakon |
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Model,
the cost of equity is approximately |
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(a)
9.67%
(b)
10.71%
(c)
12.45%
(d)
13.78%
(e)
14.67%.
24 Infrastructure Ltd., is
considering following five projects:
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. |
Project |
Initial investment (Rs.) |
NPV
(Rs.) |
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1 |
1000 |
210 |
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2 |
6000 |
1560 |
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3 |
5000 |
850 |
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4 |
2500 |
500 |
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5 |
500 |
95 |
The
project that will be ranked first as per Profitability Index method is
(a)
Project 1
(b)
Project 2
(c)
Project 3
(d)
Project 4
(e)
Project 5.
25 Which of the following factors
is/are not considered by Alcar
Model?
. I. Operating
profit margin.
II. Incremental
investment in working capital.
III. Income tax rate.
IV. Dividend growth rate.
<Answer
>
<Answer
>
|
weakness
are classified as defects, mistakes and |
<Answer |
||
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> |
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<Answer
>
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|
Which
of the following statements is/are false
with respect to Bankruptcy Models? |
<Answer |
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> |
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. |
I. |
According
to Wilcox Model, the net liquidation value of the firm is the best indicator
of the financial |
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health of the firm. |
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II. |
Blum
Marc’s Model is based on liquidity ratios only. |
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III. According to the Beaver Model, the ratio of cash flow to total
debt is the single best predictor of corporate failure.
(a)
Only (I) above
(b)
Only (II) above
(c)
Only (III) above
(d)
Both (I) and (III) above
(e)
All (I), (II) and (III) above.
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29 An
organization can achieve goal congruence by |
<Answer |
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> |
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Paying
bonuses to managers. |
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I. |
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II.
Rewarding managers with shares.
III. Monitoring managerial behavior.
(a)
Only (I) above
(b)
Only (II) above
(c)
Both (I) and (II) above
(d)
Both (II) and (III) above
(e)
All (I), (II) and (III) above.
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30 Best Ltd. has net profit
margin 8%, the assets to equity ratio 3 and total asset turnover 1.5, the
return on |
<Answer |
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> |
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. |
equity
is |
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(a) |
12% |
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(b) |
24% |
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(c) |
36% |
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(d) |
48% |
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(e) |
60%. |
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END OF SECTION A
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Strategic Financial Management: Theory and Practice (MB3H2F) : January
2009
Section B : Problems/Caselet (50 Marks)
• This
section consists of questions with serial number 1 – 5.
• Answer
all questions.
• Marks are
indicated against each question.
• Detailed
workings/explanations should form part of your answer.
• Do not
spend more than 110 - 120 minutes on Section B.
1 Prakash Pvt. Ltd. manufactures
toys for kids. The company intends to maintain the cash balance of
. Rs.5,000. The following additional information is available on the
balances of various current assets and liabilities of the company.
|
Particulars |
Opening
balances |
Closing
balances |
|
|
(Rs.) |
(Rs.) |
||
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Raw
material |
3,450.00 |
4,100.00 |
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Work-in-progress |
55.00 |
72.50 |
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Finished
goods |
638.00 |
1,100.00 |
|
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Account
receivables |
756.00 |
1,165.00 |
|
|
Accounts
payables |
2,500.00 |
7,500.00 |
<Answer
>
Purchases basically consist of procuring raw
materials for manufacturing of toys, and are generally bought on credit basis.
The company incurs manufacturing expenses of Rs.1,140 in the process of
manufacturing the toys. The depreciation expenses of the company amount to
Rs.245. The company is also paying Rs.4,550 towards selling and distribution
expenses and pays customs and excise duty of Rs.35,000. During the year, the
company pays Rs.1,000 to creditors and receives
Page 6 of 18
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Rs.53,801 from its debtors. Number of units produced is equal to the
number of units sold. Market price of each toy is Rs.10. (Assume 360 days in a
year).
You are required to:
a.
Calculate the weighted operating cycle of the
company.
1
marks
( 0 )
b.
Determine the working capital
requirement of the company based on the weighted operating cycle.
2 The
following details at the end of the last one year of operations are available
with regard to . Xenon Industries
Ltd.:
|
|
EBIT |
Rs.150
lakh |
|
|
Total
debt |
Rs.800
lakh |
|
|
Paid up
equity share capital |
Rs.250
lakh |
|
|
Reserves
and surplus |
Rs.150
lakh |
|
|
Effective
interest rate |
10% |
|
|
Effective
tax rate |
36% |
|
You are
required to answer the following
questions: |
|
|
a.
What was the return on equity of the company in the
last year?
b.
The company’s business is
expected to grow in the current year and it plans to finance the increase in
its business entirely by additional debt. It is assumed that the borrowing will
be done at the beginning of the current year and the net worth will remain at
the existing level throughout the current year, and the interest rate on the
additional debt will be same as the present effective interest rate. The
company is planning to increase the return on equity by 4.8 percentage points
in the current year. If other factors remain constant then what should be the
level of debt in the current financial year?
|
3 Duracell Ltd. is manufacturing
a special type of |
cable
used by electricity undertaking. The |
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. company has furnished the
following information pertaining to its capital structure: |
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Particulars |
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Rs. in
lakh |
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|
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Equity
shares of Rs.100 each |
|
20 |
|
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Retained
earnings |
|
10 |
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9%
Preference shares |
|
12 |
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7%
Debentures |
|
8 |
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Total |
|
50 |
|
The company earns a return of 12% on capital employed. Owing to the
increasing demand of the product in the market, the company has made an
expansion programme. The company requires a sum of Rs.25 lakh to finance its
expansion programme for which the following plans are available:
marks ( 2
)
<Answer
>
marks ( 4
)
marks ( 6
)
<Answer
>
|
Plans |
Particulars |
1
Issue of 20,000 equity shares at a premium of Rs.25
per share entirely.
2
Issue of equity shares at a
premium of Rs.25 per share and 8% debentures in the ratio of 2:3 respectively.
3
Issue of 8% debentures entirely.
It is estimated that the P/E ratios of the aforementioned three
alternative financing plans would be 21.4, 17.0 and 15.7 respectively. The
income-tax rate of the company is 33%.
You are required to:
a.
Recommend which of the three financing plans
company should implement and why?
b.
Compute the indifference level of EBIT between plan
(1) and plan (3) above.
marks
( 8 ) marks
( 2 )
Caselet
Read the caselet carefully and answer the following
questions:
Page 7 of 18
4 What are the essential features which encompasses Enterprise-Wide Risk
Management, that are set . discerned
in practice?
5 What is Enterprise Risk Management? Under Enterprise Risk Management
discuss the various . objectives and
approaches of managing environmental issues.
Today
financial services companies operate in increasingly complex, competitive and
global
markets.
The ability to manage risks across geographies, products, asset classes,
customer
segments and functional departments is of paramount importance. The inability
to manage these
risks can cause
irreparable damage. Convergence,
consolidation, globalization and
shifting
regulations have posed innumerable and hitherto unprecedented challenges
for the financial
services
industry. The objective is to give an overview of risk management in the
financial services
industry.
This defines the major risks from the perspective of financial services
industry, which
covers the components of Enterprise wide risk management and the role of
technology in risk
management.
In general corporate government policies serve numerous objectives like
reduction of
cost,
motivation of employees, minimization of the possibilities of accidents etc.
An
Enterprise-Wide Risk Management which is discerned in practice has various principal
and
attributes
that encompasses several features. The risk management framework in the
enterprise
attempts risk awareness. The temptation to ignore risk that cannot be
quantified is avoided. Thus
the risk culture incorporates the value which desires the factors for
minimizing risks. The ubiquity
of risk
management necessitates other features such as internal audit procedures and
management
control
systems and looking forward to desired freedom that gained enough paramount
irrespective
of the
entrepreneurial or conservative culture of the firm.
The last
twenty years have been marked by substantial financial deregulation.
Accompanying this
deregulation has
been a plethora
of methodologies and
technologies for managing
the
risks/rewards created by this deregulation. Companies have also been
captured by environmental
risk.
Many companies equate environmental risk management with regulatory compliance.
In
actual practice, there is much more control and discretion when it comes
to environment related
expenditures, than commonly assumed. The effective approaches to manage
the regulations are
self-regulation
and govt. regulation. An important Theory is Valdez Theory, which had to be
accepted by public companies before the group, allowed its funds to be
invested in the companies
share. The Valdez Theory includes protection of the Biosphere, Reduction
and disposal of waste,
Damage
compensation, Disclosure, etc. Environmental management which is performed with
a
principle of rational responsibility, a principle of exploitation, aims
to create environmentally
sustained
environment. Thus the principle involves all the necessary criteria required to
protect the
environment.
The
Enterprise Risk Management has various components, which covers Corporate Governance,
Line
Management, Risk Transfer, Data and Technology resources and Risk Analytics.
Risk
management
is a continuously evolving mix of science and art. Losses are inevitable, but
one must
keep
learning from the past. Risk itself is not bad, but risk that is misplaced,
mismanaged,
misunderstood, or unintended is bad. Each institution needs to assess
which method best suits its
objectives, its business, its view of the world or its pockets. A clear
distinction should be made
between risk management and risk taking. Risk management oversees and
ensures the integrity of
the process with which risks are taken. To maintain the objectivity,
risk management cannot be a
part of
the risk taking process. Individuals who manage risk need to be completely independent
from
individuals who are responsible for taking risk.
<Answer
marks
> ( 9 )
<Answer
marks
> ( 9 )
END OF CASELET
END OF SECTION B
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Section C : Applied Theory (20 Marks)
•
This section consists of questions with serial
number 6 – 7.
• Answer
all questions.
• Marks are
indicated against each question.
• Do not
spend more than 25 -30 minutes on Section C.
Page 8 of 18
Strategic Financial Management:
Theory and Practice (MB3H2F) : January 2009
Section A : Basic Concepts
|
|
Answer |
Reason |
|
|
1. |
E |
Managerial
hierarchy is not a fundamental part of a firm’s financial structure. |
<TOP> |
|
2. |
E |
Feasibility Study |
<TOP> |
The foremost step in developing a model is to
ascertain the feasibility of a model assisting the decision making process. The
various points that are required to be considered are
Whether the decision under consideration is a
one-time process, or is required to be taken as a routine measure
The suitability of the area in which the decision
is required to be made, to be supported by a model
The possibility of all the relevant variables being
unambiguously identified The possibility of all the variables being built-in
into a single model
The
expected effectiveness of the model
The acceptability of a model replacing human
judgment to the management The possibility of obtaining the required data on an
ongoing basis
The possibility of integrating the model with the
normal decision-making process
The costs involved with setting up and running the
model, and its comparison with the expected benefits.
If it is feasible to construct an efficient and
effective model for the decision process under consideration, and if the model
can be easily integrated with the process, the ,firm can proceed to the next
step of constructing the model,
3.
E Quality of design refers to
variations in products that have the same functional use; and
Total
quality control often associated with just-in-time manufacturing.
Appraisal costs are the costs incurred to ensure that materials,
products, and services meet quality standards.
A quality-costing system monitors and accumulates the costs incurred by
a firm in maintaining or improving product quality;
Quality of conformance refers to the degree with which the the final
product meets (not fail to meet) its specifications.
4. A Shortage
in supply of raw materials is an external factor, others are internal factors.
<TOP>
<TOP>
Page 9 of 18
5. E The
basic reasons for the failure of executive compensation plan are: < TOP >
•
Correlation between the size of
the company and its payment structure. Because of the existence of the strong
correlation between the size of the company based on its asset value and sales
and payment structure, companies sometimes tend to strive for bigger size
irrespective of the fact that it adds to the value of the concern
•
Emphasis on the short-term
performance of the company. It has been frequently observed that the short-term
performance indicators such as sales and growth in the earnings provide a
greater weightage in incentive compensation that is paid to the executive.
•
More focus on accounting measures
is given while designing the compensation contracts. Some of the measures are
earnings and the return on investments.
6. B P = m(d + e/3) < TOP >
⇒ 56 = m(18
+ 30/3)
⇒ m = 2
7.
B A popular way of valuing firms,
projects or assets is to compare them with other < TOP > traded firms, projects or assets. The ratio comparison approach
provides a way by which such valuations can be accomplished. This is generally
predominant in cases of
real asset valuations. The ratio comparison approach uses ratio of price
to earnings for valuation.
|
8. |
E |
The
real option valuation approach of valuing a project shows that the |
value
of < TOP > |
|
|
|
|
revolving
uncertainty depends on the following factors: |
|
|
|
|
|
• Future decision involving exploration. |
|
|
|
|
|
Current
value of oil prices. |
|
|
|
|
|
Uncertainty
type. |
|
|
|
9. |
C |
VL = VU implies
that an increase in the leverage has following effects: |
|
<TOP> |
|
|
|
|||
|
|
|
• The cost of equity increases. |
|
|
Stock
holder’s risk exposure increases.
The
weighted average cost of capital remains unchanged.
M & M do not ignore risk. On contrary, they
recognize that leverage increases the stockholder’s risk and that of equity
must increase to compensate for that additional risk.
10.
A Traditional theories have
postulated that a dividend decision is solely a function of the
< TOP > earnings of the firm. While
earnings are an important determinant for the dividend decision, the role of
liquidity cannot be ignored. Dividend pay-out entails cash out
flow for the firm. Hence the quantum of dividends
proposed to be distributed depends critically on liquidity position of the
firm. Normally firms tend to have low pay-out if the profitable investment
opportunities exist and conversely tend to resort high pay-outs if the
profitable investment opportunities are lacking. The cost of external financing
has an influence on dividend policy. Firms tend to have a high pay-out ratio if
the shareholders have a strong preference towards current dividends.
Restrictive covenants limit the flexibility of the company in determining its
dividend policy.
11.
B BCG matrix classifies the products
into four broad categories. All others are the < TOP > models for predicting
sickness
of a firm.
12.
D The institutionalization of
knowledge created during the process of developing and
< TOP > installing a model is known as
documentation
Page 10 of 18
13.
D The substantial loss in the
market value of firm’s equity can result in several liquidity
< TOP > effects. They are summarized as
:
• The may go on losing out its professional analysts who play a vital role
in supporting the flow of information about a stock.
This may result in normal trading activities of the stock and increase
the normal bid ask spread.
The
exchange may also delist its stocks based on its listing requirements.
14.
A One of the weakness of ABC is
that it is based on historical cost. ABC highlights
< TOP > cause of costs. ABC does not
partition between fixed and variable costs.
15.
E According to Marshall and
Bansal asset-liability management is an effort to < TOP > manage/minimize exposure to
I. Price risk.
II. Interest
rate risk
III. Exchange risk.
16.
B Electric Circuits Ltd. is an
Indian firm; it imports electric parts from Japan. If the Yen
< TOP > is strengthening, Indian firm is
exposed to Transaction risk.
17.
E Anti-trust laws aim to protect
economic freedom and opportunity and provide a better
< TOP > deal to the customers by
promoting competition in the market place. The basic premise of anti-trust laws
is that increased completion leads to lower prices, better quality and more
choice for customers. Anti-trust laws also aim at creating a level playing
field and encouraging new entrants into industry.
|
18. |
C Debt service coverage ratio |
|
|
<TOP> |
|||||||
|
|
|
|
PAT + Non-cash charges + Interest |
|
|||||||
|
|
= |
|
I + Re payment of TL |
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14.98 + 6.5 + 9.2 |
= |
30.68 |
=1.84 |
|
|
|||
|
|
= |
9.2 + 7.5 |
16.7 |
|
|
||||||
|
|
|
|
|
|
|
||||||
|
19. |
D |
|
|
|
|
|
O(1 − t) |
|
|
<TOP> |
|
|
|
|
|
|
|
|
|
|
||||
|
|
Value
of Prakash Ltd.= |
|
k |
+ B × t |
|||||||
|
|
|
1 × 0.65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
= |
|
0.10 + 0.35 × 5 |
|
|
|
|
||||
|
|
= |
6.50 +
1.75 |
|
|
|
|
|
|
|
||
|
|
= |
Rs.8.25
crores |
|
|
|
|
|
|
|||
20. D Given
CA/CL = 1.2 and (CA – Inventory)/CL = 0.8 < TOP > Net working capital = CA – CL = Rs.6,00,000
1.2 CL –
CL = 6,00,000
CL =
Rs.30,00,000
CA = 1.2
x 30,00,000 = Rs.36,00,000
Now,
(36,00,000 – Inventory)/30,00,000 = 0.8
36,00,000
– Inventory = 0.8 x 30,00,000 = 24,00,000
Inventory
= Rs.12,00,000.
|
21. |
B |
2bT |
|
2× 500000 × 2000 |
|
<TOP> |
|
|
C = |
= |
= 210818.5107 Rs.2.11Lakh |
|||
|
|
|
|
||||
I
0.045
Page 11 of 18
22. B According
to Du-Pont equation: < TOP >
Return On Equity (ROE) = Net Profit Margin x
Average Asset Turnover x Equity Multiplier
1
Where,
Equity Multiplier = 1 − Debt to
assets ratio .
Hence ROE will increase when the equity multiplier
increases or in other words when the debt to assets ratio increases. Hence,
option (b) is incorrect and option (e) is correct.
When net profit margin and /or average asset turnover
ratio increases ROE will increase. Hence, options (a) and (d) are correct.
ROE can also be written as Return On Equity (ROE)=
Return on assets x Equity Multiplier.
Hence, Decrease in Return On Assets decreases the
ROE. So option (c) is also correct.
23. B B(r − g) < TOP >
K − g
|
|
80(0.1− 0.05) |
|
|
|
|
70 = |
( 0.01x − 0.05) |
|
|
= 0.7 x – 3.5 = 4
x
= 10.71%.
|
24. |
B |
|
|
|
|
|
|
|
|
|
|
Cash inflows |
|
|
||
|
|
|
|
Initial investment |
NPV |
(PV) |
|
|
|
|
|
Project |
(Rs.) |
(Rs.) |
(Rs.) |
PI |
Rank |
|
|
|
(1) |
(2) |
(3) |
(4) = (2)+(3) |
(5) =
(4)/(2) |
|
|
|
|
1 |
1000 |
210 |
1210 |
1.21 |
II |
|
|
|
2 |
6000 |
1560 |
7560 |
1.26 |
I |
|
|
|
3 |
5000 |
850 |
5850 |
1.17 |
V |
|
|
|
4 |
2500 |
500 |
3000 |
1.20 |
III |
|
|
|
5 |
500 |
95 |
595 |
1.19 |
IV |
25.
D According to the Alcar model,
there are seven value drivers that affect a firm’s value. These are:
<TOP>
<TOP>
• The rate of growth of sales. Operating profit margin. Income tax rate.
Incremental investment in working capital. Incremental investment in
fixed assets. Value growth duration.
Cost of
capital
26.
E Argenti Score Card is
classified in three weakness namely defects, mistakes and
< TOP > symptoms.
27.
E All the four tasks have to be
performed by the risk managers while managing < TOP > environmental risks.
Page 12 of 18
28.
B The Wilcox model considers the
net liquidation value of the firm as the best indicator
< TOP > of a firm’s financial health.
Blum Marc’s failing company model is based on a set of
12 ratios divided into liquidity, profitability and
variability ratios. The Beaver model identifies the cash flow to total debt as
the single best indicator of a firm’s financial health.
29.
E Goal congruence can be achieved
by paying bonuses, incentives, rewarding managers < TOP > with shares etc. as these measures may motivate the managers to take
the decisions which are consistent with the objectives of shareholders.
Alternative measures like the management audit to monitor the behavior of the
mangers can also help in establishment of goal congruence.
|
30. |
C |
|
|
Net profit |
× |
Sales |
× |
Total assets |
|
<TOP> |
|
|
|
|
|
|||||||
|
|
ROE |
= |
|
Sales |
Total assets |
Equity |
|
|
||
|
|
|
|
|
|
|
|
|
|
||
|
|
|
= |
0.08 × 1.5 × 3 |
|
|
|
|
|||
|
|
|
= |
0.36
i.e. 36%. |
|
|
|
|
|||
Strategic Financial Management:
Theory and Practice (MB3H2F) : January 2009
Section B : Problems
|
1. a. Raw material purchased = Closing balance of accounts |
payable
+ Payments made to < TOP |
|||
|
creditors – Opening balance of accounts payable |
|
> |
|
|
|
|
|
|
|
|
= 7,500 + 1,000 – 2,500 = Rs.6,000
Consumption of raw material = Opening balance of raw material +
purchases of raw material – Closing balance of Raw material
= 3,450 + 6,000 – 4,100 = Rs.5,350. Consumption of raw material per day =
5,350 / 360 = Rs.14.86
3, 450 + 4,100
|
Average
raw material inventory = |
2 |
= Rs.3,775 |
Raw
material storage period = 3,775 / 14.86 = 254.04 days.
55 + 72.50
|
Average
W-I-P inventory = |
2 |
= Rs.63.75 |
Cost of process = Opening WIP + Raw material consumed + Manufacturing
expenses + Depreciation – Closing WIP
=
55 + 5,350 + 1,140 + 245 – 72.50
=
Rs.6,717.50
|
|
|
6,
717.50 |
|
|
|
|
||
|
|
|
|
|
|
|
|
|
|
|
Cost of
process per day = |
360 |
|
=
Rs.18.66 |
|
||||
|
63.75 |
|
|
|
|
|
|||
|
|
|
|
|
|
||||
|
WIP
inventory period = 18.66 = 3.42 days |
|
|||||||
|
|
|
|
|
|
|
638 + 1,100 |
|
|
|
|
|
|
|
|||||
|
Average Finished goods inventory = |
2 |
=
Rs.869 |
||||||
|
Cost of
goods sold = |
Opening
FG inventory + Cost of process + Excise duty + Selling |
|||||||
|
|
|
and
administration expenses – Closing FG inventory |
||||||
=
638 + 6,717.50 + 35,000 + 4,550 – 1,100 =
Rs.45,805.50
Cost of
goods sold per day = 45,805.50 / 360 = Rs.127.24
869
Finished
Goods storage period = 127.24 = 6.83 days
Page 13 of 18
960.5
Average
collection period = 150.58 = 6.38 days
Average
Accounts payable
=
Opening balance of acounts payables + Clo sin g balance of accounts
payables
2
|
|
2,500 + 7,500 |
|
|
|
|
|
|
|
|
|
|
= |
2 |
|
=
Rs.5,000 |
|
|
|
|
6,000 |
|
|
|
|
|
|
|
|
|
Average
purchases per day = |
|
360 = Rs.16.67 |
||
5,000
Average
payment period = 16.67 = 300 days
Calculations of weights:
Weight to raw material = Raw material consumed per day/ Sales per day =
Rs.14.86/150.58 = 0.099
Processing
cost excluding raw material = Rs.18.66 – Rs.14.86 = Rs.3.8
Weight to WIP = Raw material cos t consumed
perday + (0.50
× Pr occe sin g cos t per day)
Sales per
day
= (14.86 + 0.5 × 3.8 )/150.58 = 0.1113 Cost of
goods sold per day
|
Weight
to Finished Goods = |
|
Sales
per day |
|
|
|
||
|
|
|
|
|
|
|
|
|
|
Weight
to finished goods = Rs.127.24/ Rs.150.58 = 0.845 |
|||||||
|
|
|
Sales per day |
|
|
Rs.150.58 |
||
|
Weight to Accounts receivables = Sales per day = |
|
|
|
||||
|
|
Rs.150.58 = 1 |
||||||
|
|
Purchases per day |
|
|
|
|||
|
|
|
|
|
|
|||
|
Weight
to Accounts Payables = |
|
Sales per day |
= Rs.14.86/Rs.150.58 = 0.099 |
||||
Duration of weighted operating cycle = (Dr x Wr)
+ (Dw x Ww) + (Df x Wf) + (Dd x Wd)
– (Dp x
Wp)
=
(254.04 x 0.099) + (3.42 x
0.1113) + (6.83 x 0.845) + (6.38 x 1) – (300 x 0.099) = 7.98 days
b.
Working capital requirements =
(Sales per Day x Weighted operating cycle) + Required Cash balance
Working
capital requirement = (150.58 x 7.98) + 5,000 = Rs.6,201.63
Page 14 of 18
|
2. |
|
|
|
|
D |
||
|
|
ROI + (ROI - Kd ) |
|
|
||||
|
|
|||||||
|
a. ROE = |
|
|
E ( 1– t) |
||||
|
|
|
EBIT |
|
|
150 |
|
|
|
ROI = Total assets1 |
= (800 + 250 + 150) = 0.125 i.e., 12.5% |
||||||
|
Kd |
= 10%
(given) |
|
|
|
|
|
|
|
t |
= 36%
(given) |
|
|
|
|
|
|
<
TOP
>
D
800
E = (250+150) = 2
∴ ROE = [
0.125 + (0.125 – 0.10) × 2]
(1–0.36) = 0.112 i.e., 11.2%
Total asset = Total
debt + Net worth
=
Total debt + (Paid up equity capital + Retained
earnings)
b.
Targeted ROE = 11.2 + 4.8 = 16%
Let the
required amount of additional debt be D :
∴ Total
debt = 800 + D
Equity = 250 + 150 = 400
|
|
|
|
|
|
|
(800 + D) |
|||
|
|
|
0.125 + (0.125 - 0.10) |
|
|
|
||||
|
|
|
400 |
|||||||
|
∴ 0.16 = |
|
|
|
(1 –
0.36) |
|||||
|
|
|
|
|
|
0.025 (800 + D) |
|
|||
|
or 0.25
= 0.125 + |
400 |
|
|
|
|||||
|
|
0.125 |
= |
|
800+D |
|
|
|
|
|
|
or 0.025 |
|
400 |
|
|
|
|
|
||
|
|
|
|
|
|
|
|
|||
or 5.00 × 400 = 800 + D
or D = (5.00 × 400) – 800 = 1,200
∴ Additional
debt to be taken in the current year = Rs.1,200 lakh
∴ Total
debt in the current year should be = 1,200 + 800 = Rs.2,000 lakh.
3.
a. An alternative
which would ensure
the highest market
price per share
should be < TOP
recommended. Estimated earnings per share (EPS) and market price per
share (MPS) under > the
various financing plans are as follows:
|
Particulars |
At |
Plan (1) |
|
|
Present |
|||
|
|
|
||
|
|
|
|
|
|
Earnings
before interest and tax |
|
|
|
|
(EBIT) |
6,00,000 |
9,00,000 |
|
|
at the rate of 12% on Rs.75 lakh |
|
|
|
|
(Rs.) |
|
|
|
|
Less: Interest – Old |
56,000 |
56,000 |
|
|
Interest-
New |
– |
– |
|
|
|
|
|
|
|
Profit
before tax (PBT) |
5,44,000 |
8,44,000 |
|
|
Less: Tax @ 33% |
1,79,520 |
2,78,520 |
|
|
|
|
|
|
|
Profit
after tax (PAT) |
3,64,480 |
5,65,480 |
|
|
Less:
Preference dividend – |
1,08,000 |
1,08,000 |
|
|
Old
(Rs.) |
|
|
|
|
|
|
|
|
|
Profit
for equity shares |
2,56,480 |
4,57,480 |
|
|
No. of
equity shares |
20,000 |
40,000 |
|
|
EPS |
12.82 |
11.44 |
|
|
P.E.
Ratio |
– |
21.4 |
|
|
Market
price per share (EPS × |
– |
244.82 |
|
|
|
|
|
Page 15 of 18
|
Plan
(2) |
Plan
(3) |
|
|
|
|
9,00,000 |
9,00,000 |
|
56,000 |
56,000 |
|
1,20,000 |
2,00,000 |
|
|
|
|
7,24,000 |
6,44,000 |
|
2,38,920 |
2,12,520 |
|
|
|
|
4,85,080 |
4,31,480 |
|
1,08,000 |
1,08,000 |
|
|
|
|
3,77,080 |
3,23,480 |
|
28,000 |
20,000 |
|
13.47 |
16.17 |
|
17.0 |
15.7 |
|
229.00 |
253.87 |
|
|
|
Recommendation: The objective of financial management is to maximize the wealth of the
owners, which in the context of companies means maximizing the market price of
the company’s equity shares. The above analysis shows that the market price per
share in debenture financing (plan 3) is Rs.253.87, which is maximum. EPS is
higher in the case of debenture financing without undue financial risk.
Therefore, debenture financing alternative is recommended.
b.
Indifference point on between alternative plans 1
and 3:
(EBIT – Rs.56,000)(1 – T) ÷ 40,000 = (EBIT – Rs.2,56,000)(1 – T) ÷
20,000 EBIT – Rs.56,000 = 2(EBIT – Rs.2,56,000)
EBIT =
Rs.5,12,000 – Rs.56,000 = Rs.4,56,000.
4.
An enterprise-wide risk management culture
encompasses several features, some of the principal < TOP
attributes of which, as discerned in practice, are
indicated here: >
• An awareness of risk pervades the enterprise. Performance measurement
and pricing are risk adjusted. The priorities of risk management are reflected
in the compensation schemes thereby encouraging risk-taking behavior that is
aligned with the capacity to bear risk. The analysts and the stakeholders
obtain a more complete understanding of the risks undertaken with the help of
risk-adjusted forecasts and returns.
Risks are identified, reported and quantified to the greatest possible
extent. This means setting up extensive historical risk and loss databases, and
identifying risks precisely. Some risks can be quantified while some risks
elude quantification. Nevertheless, both quantifiable and unquantifiable is
avoided. The risk charter of the United Bank of Switzerland typically lists
reputation protection or reputation risk, generally avoided in reporting, as
one of its five risk factors.
The risk culture is defined and enshrined within the organization. The
risk appetite of the enterprise is clearly understood in all its spheres. Risk
management is aligned with that culture to give managers and employees the
desired freedom for taking the right course of action irrespective of the
entrepreneurial or conservative culture of the film.
The firm does not venture into those products and/or businesses that are
not comprehended by the enterprise with regard to commercial feasibility. To
know enough so as to understand the adversities involved with reasonable levels
of estimation is proper risk management. A product/business that delivers
excellent profits, is nevertheless found by the management to have inherent
risks beyond the accepted level of complexity and is kept aside. Not to do what
is not understood is the general prescription.
5.
ERM is the discipline by which an organization in
any industry assesses, control, exploits, < TOP
finances and monitor risks from all sources for the purpose of
increasing the organization’s short > and long-term value to its shareholders.
The
corporate environmental policies serve the following objectives:
• Reduction of costs through measures such as recycling or energy
conservation. Improvement of the company’s reputation.
Motivation
of employees by providing a better environment.
Improvement of relationships with regulatory authorities in general and
the government in particular.
Minimizing
the possibility of accidents.
Conforming
to a code of ethics
The
following are the different approaches for managing environmental issues:
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• First approach is a strong commitment to environment friendly processes
or products through heavy investments.
Firm can influence environmental regulations invest in environment
protection and force other firms to make similar investments.
The firm may be able to invest in environmental performance improvement,
without any reduction in profits.
Combination of product differentiation, competition management and cost
saving to change the basis for competition and redefine the market so that both
the firm and the environment can benefit.
The last approach is on risk manage perspective, calling for a
systematic method to deal with risks such as accidents and activist attacks.
Section C: Applied Theory
6.
The Alcar model uses the
discounted cash flow analysis to identify value-adding strategies.
< TOP > According to this model, there
are seven ‘value drivers’ that affect a firm's value. These are
• The rate
of growth of sales
Operating
profit margin
Income
tax rate
Incremental
investment in working capital
Incremental
investment in fixed assets
Value
growth duration
Cost of
capital.
Value growth duration refers to the time period for
which a strategy is expected to result in a higher than normal growth rate for
the firm. The first six factors affect the value of the strategy for the firm
by determining the cash flows generated by a strategy. The last term, i.e. the
cost of capital affects the value of the strategy by determining the present
value of these cash flows. The following figure represents the Alcar approach.
According to the model, a strategy should be
implemented if it generates additional value for a firm. For ascertaining the
value generating capability of a strategy, the value of the firm's equity
without the strategy is compared to the value of the firm's equity if the
strategy is implemented. The strategy is implemented if the latter is higher
than the former. The following steps are undertaken for making the comparison.
Calculate the value of the firm's equity without
the strategy: The present value of the expected cash flows of the firm is
calculated using the cost of capital. The cash flows should take the firm's
normal growth rate and its effect on operating flows and additional investment in
fixed assets and working capital into consideration. The cost of capital would
be the weighted average cost of the various sources of finance, with their
market values as the weights. The value of the equity is arrived at by
deducting the market value of the firm's debt from this present value.
Calculate the value of the firm if the strategy is
implemented: The firm's cash flows are calculated over the value growth
duration, taking into consideration the growth rate generated by the strategy
and the required additional investments in fixed assets and current assets.
These cash flows are discounted using the post-strategy cost of capital. The
post-strategy cost of capital may be different from the pre-strategy cost of
capital due to the financing pattern of the additional funds requirement, or
due to a higher cost of raising finance. The PV of the residual value of the
strategy is added to the present value of these cash flows to arrive at the
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value of the firm. The residual
value is the value of the steady perpetual cash flows generated by the
strategy, as at the end of the value growth duration. The value of the
post-strategy market value of debt is then deducted from the value of the firm
to arrive at the post-strategy value of equity.
The value of the strategy is given by the
difference between the post-strategy value of the firm's equity and the
pre-strategy value of the firm's equity. A strategy should be accepted if it
generates a positive value.
7. A brief
description of some non-financial measures of performance is presented below. < TOP >
a.
Employee Productivity: This can
be measured by calculating output obtained per employee or sales affected per
employee or the value added per employee. In addition to the measurement of
employee productivity it is possible to measure the output per unit of the
inputs consumed i.e. a measure of overall productivity.
b.
Marketing Effectiveness: This
would measure the success of the marketing efforts put in by the divisions. For
this purpose, a report on market position must be obtained from the divisional
managers. The market position is represented by the percentage of sales to
total sales in the market and also by the ability of the division to meet the
outside competition successfully. An appraisal has to be made of each of the
major products handled by the division including an analysis of the product
market leadership, superior or inferior of features in the own product compared
with outsider's product.
c.
Employee Morale and Attitude: This is
a vital aspect of performance. The divisional managers sometimes ignore the
impact of their decisions on employees in an attempt to maximize production and
profitability. It is, therefore, necessary to evaluate whether during the last
one-year employee morale has decreased or increased. Absolute precision in
measurement of this element of performance is seldom possible and if attempted,
could be a time consuming process. Hence, a judgment made by a team of
executives after a thread-bare discussion may be sufficient for this purpose.
d.
Social Responsibility:
Contribution of social responsibility can also be considered as one of the
measures of performance. The managers can sometimes deliberately ignore this
aspect of performance in their bid to show a high amount of profit or return on
capital employed.
e.
Qualitative Aspects of Performance: The
qualitative aspects must also figure in the list of performance measures. These
include – the number of complaints received from customers, the errors and
frauds, timely submission of daily, weekly and monthly reports to higher
authorities, regularity of attendance in meetings, etc.
f.
Management practices: Adherence to better corporate
governance eg. Transparency in the operations, investment handling of
investors, client’s grievances dealing with creditors, debtors and development
of human resources etc. all reflect the type of management practices being
followed.
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