Financial Management (MB211) - July 2005

8/12/2019 Financial Management (MB211) - July 2005

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Financial Management (MB211): July 2005

Section A : Basic Concepts (30 Mars)

! "#is section consists o$ %uestions &it# serial num'er 1 30! Ans&er all %uestions

! *ac# %uestion carries one mar

! Ma+imum time $or ans&ering Section A is 30 Minutes1 ,#ic# o$ t#e $ollo&ing is true-

(a) *$$ecti.e rate o$ interest is al&ays lo&er t#an t#e nominal interest rate

(') "#e e$$ecti.e rate o$ interest increases &it# increase in t#e $re%uency o$compoun/ing

(c) "#e nominal interest rate increases &it# increase in t#e $re%uency o$ compoun/ing

(/) "#e e$$ecti.e an/ nominal interest rates are e%ual i$ t#e $re%uency o$ compoun/ing is

less t#an$our

(e) "#e $re%uency o$ compoun/ing /oes not a$$ect t#e e$$ecti.e an/ nominal interest

rates

Ans&er 2 ,#o among t#e $ollo&ing players in t#e international capital marets collect t#e rupee

/i.i/en/s on t#eun/erlying s#ares an/ repatriate t#e same to t#e /epository in S /ollars$oreign e%uity-

(a) 4ea/ Managers (') n/er&riters

(c) Custo/ians (/) Corporate 'orro&ers (e)4en/ers

Ans&er

3 ,#ic# o$ $ollo&ing statements are true regar/ing issuance o$ Commercial aper (C)-

6 "#ey normally #a.e a 'uy'ac $acility66 Corporate nee/ prior appro.al o$ 7B6 $or C issue

666 Cs are issue/ in multiples o$ 7s1 la#68 n/er&riting o$ a C issue is not man/atory(a) Bot# (6) an/ (66) a'o.e (') (6)9 (66) an/ (666) a'o.e

(c) Bot# (6) an/ (666) a'o.e (/) Bot# (6) an/ (68) a'o.e

(e) All (6)9 (66)9 (666) an/ (68) a'o.e Ans&er

6n a $ore+ maret i$ an in.estor &ants to #e/ge #is $ore+ payments an/ #a.e minimum

ris9 ic# o$ t#e

$ollo&ing s#oul/ t#e in.estor pre$er-(a) Sell t#e $ore+ $utures

(') *nter into a $or&ar/ contract to purc#ase t#e re%uire/ $ore+

(c) *nter into a call option to purc#ase t#e re%uire/ $ore+(/) Buy $ore+ $utures

(e) *nter into a put option to sell t#e re%uire/ $ore+

Ans&er 5 All ot#er t#ings 'eing t#e same9 ic# o$ t#e $ollo&ing &ill result in an increase in

stoc price-

6 "#e $irm;s 'eta /ecreases

66 "#e $i+e/ assets increase


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666 "#e retention ratio increases

68 7ecently t#e 7e'el Furniture Company #as 'een $acing pro'lems As a result9 its

$inancial situation #as

/eteriorate/ 7e'el approac#e/ t#e C#arminar Ban $or a loan9 'ut t#e loan o$$icerinsiste/ t#at t#e

current ratio (currently 0?) 'e impro.e/ to at least close to 10 'e$ore t#e 'an &oul/

e.en consi/er

maing t#e loan ,#ic# o$ t#e $ollo&ing actions &oul/ 'e t#e most appropriate toimpro.e t#e ratio in

t#e s#ort run an/ &oul/ liely 'e t#e least costly to 7e'el-

(a) sing some cas# to pay o$$ some longterm an/ s#ortterm lia'ilities

Ans&er (') urc#asing some a//itional ra& materials on cre/it t#ere'y creating an a//itional

accountspaya'le

(c) aying o$$ some notes paya'le &it# cas# to re/uce t#e $irm;s /e't

(/) Selling some $i+e/ assets $or cas#(e) Collect some current accounts recei.a'le

? "#e tra/ers in a $utures e+c#ange9 o ten/ to carry positions $or longer perio/ o$

time are no&n as

(a) osition tra/ers (') @ual tra/ers (c) Scalpers (/) e/gers (e) Floor 'roers Ans&er

o& can in.estors re/uce t#e .aria'ility o$ returns in t#eir in.estment port$olio-

6 By a//ing per$ectly correlate/ securities to t#eir port$olio66 By a//ing securities to t#eir port$olio t#at are not per$ectly correlate/

666 By a//ing some mutual $un/s to t#eir port$olio

(a) =nly (6) a'o.e (') =nly (66) a'o.e(c) =nly (666) a'o.e (/) Bot# (66) an/ (666) a'o.e

(e) All (6)9 (66) an/ (666) a'o.e

Ans&er

,#ic# o$ t#e $ollo&ing 'on/s &ill #a.e t#e greatest percentage increase in .alue i$ allinterest rates

/ecrease 'y 1 percent-

(a) 20year9 Dero coupon 'on/ (') 10year9 Dero coupon 'on/(c) 20year9 10 percent coupon 'on/ (/) 20year9 5 percent coupon 'on/

(e) 10year9 5 percent coupon 'on/

Ans&er 10 6$ t#e stoc;s current * ratio e+cee/s t#e e+pecte/ *9 t#en ic# o$ t#e $ollo&ing

statements isare

true-

6 Stoc is o.erprice/


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66 6t is time to 'uy t#e stoc

666 "#e stoc is correctly price/

(a) =nly (6) a'o.e (') =nly (66) a'o.e(c) =nly (666) a'o.e (/) Bot# (66) an/ (666) a'o.e

(e) Bot# (6) an/ (66) a'o.e

Ans&er 11 6$ t#e net present .alue (


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(e) "#e $irm s#oul/ maintain #uge cas# 'alance an/ #a.e an o.er/ra$t arrangement &it#

a 'an

1> ,#ic# o$ t#e $ollo&ing proHects &ill you select t#at &ill gi.e t#e ma+imuma/.antage to t#e $irm-

(a) roHect GA; ic# #as a positi.e internal rate o$ return

(') roHect GB; ic# #as a


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(') Category GA; items are t#ose ic# #a.e t#e #ig#est rupee in.estment

(c) Category GA; items are t#ose ic# #a.e t#e least count in terms o$ num'ers

(/) nit cost un/er category GA; item is .ery costly(e) nit cost un/er category GA; item is .ery c#eap

Ans&er

22 Consi/er t#e $ollo&ing=pening stoc o$ $inis#e/ goo/s 7s2929000

Closing stoc o$ $inis#e/ goo/s 7s29509000

Cost o$ pro/uction 7s591>900Selling a/ministration an/ $inancial e+pen/iture 7s 2950

Custom an/ e+cise /uty 7s 59000

Finis#e/ goo/s storage perio/ (in /ays) $or t#e company assuming 3>0 /ays in a year is

(a) 3 /ays (') 153 /ays (c) 1?2 /ays (/) 12 /ays (e)3>5 /ays

Ans&er

23 6$ t#e cumrig#t price per s#are is 7s9 t#e t#eoretical .alue o$ t#e rig#t is 7s2 an/

su'scription priceat ic# t#e rig#ts are issue/ is 7s2> per s#are9 t#e num'er o$ e+isting s#ares re%uire/

$or a rig#t s#areis

Ans&er

(a) 5 (') 10 (c) 15 (/) 20 (e)25

2 "#e operating e+posure

(a) 7epresents t#e e+posure t#at arises $rom t#e nee/ o$ a $irm to con.ert .alues o$

$oreign currency/enominate/ assets an/ lia'ilities into /omestic currency .alues

(') 7epresents t#e e+posure t#at arises $rom $oreign currency /enominate/ transactions

ic# a $irmis committe/ to complete

(c) 7epresents t#e e+posure o$ current pro$its o$ a $irm to t#e mo.ements in e+c#ange

rates(/) 7epresents a notional e+posure9 as t#ere is no real gain or loss arising out o$

e+c#ange rate

mo.ements

(e) Arises out o$ t#e economic conse%uences o$ e+c#ange rate mo.ement on t#e .alue o$a $irm

Ans&er

25 ,#ic# o$ t#e $ollo&ing is a part o$ t#e $inancing /ecision o$ a company-(a) rocuring ne& mac#ineries $or t#e 7 I @ acti.ities

(') Spen/ing #ea.ily $or t#e a/.ertisement o$ t#e pro/uct o$ t#e company

(c) A/opting stateo$t#eart tec#nology to re/uce t#e cost o$ pro/uction(/) urc#asing a ne& 'uil/ing at @el#i to open a regional o$$ice

(e) @esigning an optimal capital structure 'y using suita'le $inancial instruments

Ans&er

2> 6$ a security;s return is plotte/ a'o.e t#e security maret line9 t#en


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(a) "#e ris $ree rate is e%ual to t#e re%uire/ rate o$ return on t#e security

(') "#e security;s rate o$ return is more t#an t#e return on t#e maret port$olio

(c) "#e security;s 'eta is less t#an one an/ #ence it is a conser.ati.e security(/) "#e security is sai/ to 'e o.er.alue/

(e) "#e security is to 'e 'oug#t imme/iately

Ans&er 2? ,#ic# o$ t#e $ollo&ing are not a source o$ longterm $inance-

(a) *%uity s#ares (') @e'entures

(c) re$erence s#ares (/) Commercial papers(e) 7eser.es an/ surplus

Ans&er

2 ,#ic# o$ t#e $ollo&ing issues is consi/ere/ un/er tec#nical aspects o$ proHect

appraisal-(a) ast an/ present consumption tren/s

(') A.aila'ility o$ t#e re%uire/ %uality an/ %uantity o$ ra& materials an/ ot#er inputs

(c) 6mpact o$ t#e proHect on t#e /istri'ution o$ income in t#e society

(/) rice an/ crosselasticity o$ /eman/(e) ro/uction constraints

Ans&er 2 ,#ic# o$ t#e $ollo&ing &ill /ecrease &it# an increase in t#e interest rate-

(a) Future 8alue 6nterest Factor

(') Future 8alue 6nterest Factor $or Annuity(c) Capital 7eco.ery Factor

(/) resent 8alue 6nterest Factor $or a erpetual Annuity

(e) 6n.erse o$ resent 8alue 6nterest Factor $or Annuity

Ans&er 30 ,#ic# o$ t#e $ollo&ing is an assumption in t#e economic or/er %uantity mo/el-

(a) Carrying cost per unit increases as t#e num'er o$ units or/ere/ increases

(') @eli.ery o$ t#e material taes place &it#in a certain time as t#e or/er is place/(c) urc#ase price per unit o$ t#e ra& material increases as t#e num'er o$ units or/ere/

/ecreases

(/) =r/ering cost is constant(e) 6n.entory le.el /uring t#e year .aries as per t#e 'oom p#ase an/ recessionary p#ase

in 'usiness

Ans&er

*


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in$ormation $or t#e ne+t year:

Kou are re%uire/ to

a Fin/ out t#e e+pecte/ return an/ ris $or t#e e%uity s#ares o$ t#e company' Fin/ out t#e e+pecte/ return an/ ris $or t#e maret

(5 L mars) Ans&er

2 Sonal *nterprises 4t/ (S*4)9 a tra/ing concern9 #a/ t#e $ollo&ing receipts o$ an item9co/e/ "F059 o.er t#e last

%uarter:

"#e opening 'alance o$ t#e item in January &as 7s59000 an/ t#e closing 'alance o$ t#eitem in Marc# &as

7s09000 "#e purc#ase price o$ t#e item is 7s1 per unit an/ t#e carrying cost is 25

o$ t#e a.erage in.entory

.alue per annum "#e cost $or placing an or/er is $i+e/ an/ it is 7s00 per or/er "#epurc#ase price per unit o$ t#e

item #as not c#ange/ in t#e last %uarter an/ it is not e+pecte/ to c#ange in t#e ne+t si+

mont#s9 ic# is t#e

planning perio/ "#eir supplier9 7e//y 6n/ustries 4t/ (764)9 #as o$$ere/ a /iscount o$25 on or/er siDes o$ >9000

units an/ a'o.e 6t is assume/ t#at t#e /eman/ $or t#e item is e.enly /istri'ute/ o.er t#eentire year

Kou are re%uire/ to $in/ out t#e $ollo&ing:

a "#e economic or/er %uantity o$ t#e item' "#e optimal or/er siDe $or t#e item Clearly s#o& t#e rele.ant costs an/ 'ene$its

in.ol.e/ 6gnore ta+es

(5 L ? 12 mars) Ans&er

3 "#e e%uity capitaliDation rate o$ Ayus#i 6n/ustries 4t/ is 12 percent "#e company #as509000 s#ares outstan/ing

ic# #a.e a maret price o$ 7s200 eac# "#e company e+pects a net income o$

7s?9009000 at t#e en/ o$ one yearan/ plans to /eclare a /i.i/en/ o$ 7s> per s#are at t#at time "#e company also plans to

in.est 7s109009000 in a

proHect a$ter one year 6t is assume/ t#at t#e assumptions un/erlying t#e Mo/iglianiMiller mo/el on /i.i/en/

policy are applica'le

Kou are re%uire/ to s#o& t#at t#e Mo/iglianiMiller mo/el on /i.i/en/ policy #ol/s

goo/ irrespecti.e o$ et#er/i.i/en/s are pai/ or not

( mars) Ans&er

Mr ras#ant is planning to purc#ase a #ouse ic# costs 7s9009000 e #ascontacte/ t&o #ousing $inance

companies .iD9 Metro ousing Finance 4t/ (MF4) an/


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39000 ?29000 19000

Suggeste/ Ans&ersFinancial Management (MB211): July 2005

Section A : Basic Concepts

(11 mars) Ans&er

5 Central 6n/ustries 4t/ (C64) is consi/ering in.esting in a lat#e mac#ine "#ere aret#ree mac#ines o$$ere/ 'y

t#ree /i$$erent manu$acturers "#e price %uotations an/ operational costs $or t#e t#ree

mac#ines are gi.en 'elo&:"#e cost o$ capital $or t#e company is 15

Kou are re%uire/ to $in/ out t#e mac#ine t#at s#oul/ 'e selecte/ $or in.estment 'y C649

using a suita'le appraisalcriterion

( mars) Ans&er

*


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@iscuss t#e signi$icance o$ collection program in t#e management o$ recei.a'les

(? mars) Ans&er

*09000 19209000 19009000

se$ul li$e (years) 5 101 Ans&er : (')

7eason : "#e interest rate usually speci$ie/ on an annual 'asis in a loan agreement orsecurity is no&n as t#e nominal rate o$ interest 6$ compoun/ing is /one

more t#an once a year9 t#e actual rate o$ interest pai/ (or recei.e/) is calle/

"=

e$$ecti.e interest rate *$$ecti.e interest rate &oul/ 'e #ig#er t#an t#e nominal interest

rate

"#e e$$ecti.e rate o$ interest increases &it# increase in t#e $re%uency o$compoun/ing For e+ample9 t#e e$$ecti.e rate o$ interest un/er %uarterly

compoun/ing &ill 'e more t#an t#e e$$ecti.e rate o$ interest un/er semiannual

compoun/ing ence option (') is correct2 Ans&er : (c)

7eason : Custo/ians #ol/ t#e un/erlying s#ares an/ collect rupee /i.i/en/s on t#e

un/erlying s#ares an/ repatriate t#e same to t#e /epository in S/ollars$oreign e%uity

ence (c) is t#e ans&er

4ea/ managers un/ertae acti.ities lie preparation o$ o$$er circular9

mareting t#e issues etcn/er&riters o$ t#e issue 'ear interest rate or maret riss mo.ing against

t#e issuer 'e$ore t#ey #a.e place/ 'on/s or /epository receipts

"=

3 Ans&er : (/)

7eason : Cs are normally issue/ in multiples o$ 7s5 la#s ence9 666 is not true "#eissuance o$ Cs /oes not re%uire t#e appro.al o$ 7B6 ence9 66 is not true

n/er&riting o$ a C issue is not man/atory an/ t#e issuers generally #a.e a

'uy 'ac $acility ence9 6 an/ 68 are true an/ t#e ans&er is (/)

"=


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Ans&er : (c)

7eason : Call option is a contract t#at con$ers t#e rig#t9 'ut not an o'ligation to t#e#ol/er to 'uy an un/erlying asset at a price agree/ on a speci$ic /ate or 'y a

speci$ic e+piry /ate 6n t#e gi.en case9 t#e in.estor is intereste/ to #e/ge #is

$ore+ payments an/ #a.e a minimum ris position ence9 it is 'etter $or #imto enter into a call option to purc#ase t#e re%uire/ $ore+ at an agree/ price on

t#e e+pecte/ $uture /ate "#us i$ t#e e+c#ange rate 'e#a.es against t#e

e+pectation t#e in.estor s#all not e+ercise #is rig#t an/ t#e loss t#at &ill 'eincurre/ &ill 'e only t#e premium pai/ 'y #im to t#e &riter o$ t#e option

ence9 t#e ans&er is (c)

"#oug# payment can 'e #e/ge/ t#roug# purc#asing t#e $ore+ $utures or entering

into a $or&ar/ contract to purc#ase9 t#ere is no /o&nsi/e limit to t#e loss t#atcan 'e incurre/

"=

5 Ans&er : (a)7eason : 6ncrease in stoc price is /irectly relate/ to /i.i/en/s (or /ecrease in

retention ratio) an/ /ecrease in re%uire/ rate o$ return (or /ecrease in 'eta)ence9 6 &ill increase t#e stoc price ile 66 /oes not /etermine t#e stoc

price an/ 666 /ecreases t#e stoc price "#e correct ans&er is (a)

"=

> Ans&er : (')

7eason : "o impro.e t#e current ratio 7e'el Furniture Company is e.aluating t#e

$ollo&ing alternati.es:(i) sing some cas# to pay o$$ some long term an/ s#ort term lia'ilities

6t &ill $urt#er /eteriorate t#e current ratio as t#e amount o$ current assets

re/uce/ is more t#an t#e amount o$ current lia'ilities(ii) urc#asing some a//itional ra& materials on cre/it an/ t#ere'y creating

an a//itional accounts paya'le Current assets an/ current lia'ilities

increase 'y same amount an/ as t#e e+isting ratio is less t#an t#e one t#eincrease in t#e 'ot# t#e components &ill impro.e t#e current ratio

(iii) aying o$$ some notes paya'le &it# cas# Current assets an/ current

lia'ilities &ill /ecrease 'y t#e same amount an/ as t#e e+isting ratio is

less t#an one t#e /ecrease in 'ot# t#e components &ill $urt#er re/uce t#ecurrent ratio

(i.) Selling $i+e/ assets $or cas# "#is &ill /e$initely impro.e t#e current

ratio(.) Collect some accounts recei.a'le "#e components o$ t#e current assets

&ill c#ange 'ut t#is &ill not c#ange t#e current ratio

"=

ence9 o$ t#e $i.e alternati.es9 ii an/ i. &ill impro.e t#e current ratio 'ut ii is

least costly an/ t#e ans&er is (')

? Ans&er : (a)


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7eason : "#e tra/ers in a $utures e+c#ange9 o ten/ to carry positions $or longer

perio/s are no&n as Gposition tra/ers;

"=

Ans&er : (e)

7eason : 8aria'ility o$ returns o$ a port$olio is re/uce/ 'y a//ing securities to t#eport$olio "#e re/uction &oul/ 'e more i$ t#e securities #a.e negati.e

correlation ence9 all t#e t#ree statements are true an/ t#e ans&er is (e)

"=

Ans&er : (a)

7eason : 4onger t#e term to maturity9 #ig#er &ill 'e t#e price c#ange =$ t#e 20year

Dero coupon 'on/ an/ 10year Dero coupon 'on/9 price c#ange is #ig# in caseo$ 20 year 'on/ Smaller t#e coupon rates #ig#er are t#e price c#ange &it# a

c#ange in K"M ence9 o$ (a)9 (c) an/ (/)9 t#e c#ange in price is #ig#er in

case o$ (a)

"=

10 Ans&er : (a)7eason : 6$ t#e e+pecte/ * e+cee/s t#e current *9 t#e stoc is sai/ to 'e currently

o.erprice/ an/ it is time to sell t#e stoc ence9 only 6 is correct

"=

11 Ans&er : (/)

7eason : ,#en


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"=

1 Ans&er : (/)7eason : Agency cost are cost on account o$ restriction impose/ 'y cre/itors on t#e

$irm in t#e $orm o$ some protecti.e co.enants Commission paya'le 'y t#e

company to its purc#asing an/ selling agents9 t#e e+penses incurre/ in/istri'ution o$ t#e pro/ucts o$ t#e company9 or t#e /i.i/en/s pai/ 'y t#e

company /oes not come un/er t#e agency cost

"=

15 Ans&er : (')

7eason : 6n.esting all cas# in s#ares &oul/ 'e more risier ostpone o$ loan

repayment an/ maing less cas# sales is also /angerous "#e $irm s#oul/eit#er maintain a/e%uate cas# 'alance or #a.e an o.er/ra$t arrangement &it#

a 'an "#e $irm s#oul/ not eep #uge cas# 'alance as i/le

"=

1> Ans&er : (')

7eason : roHect B &ill gi.e t#e ma+imum a/.antages to t#e $irm ic# #as a


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proper initiati.e $or t#e sources o$ $inance as mentione/ in t#e ot#er options

to $inance its current assets

"=

20 Ans&er : (')

7eason : 6n aggressi.e approac# company generally su'Hecte/ to #ig#er /egree o$ rist#an t#e company $ollo&ing conser.ati.e approac# ence option (') is

correct "#e turno.er o$ current asset &ill 'e #ig# "#e current assets un/er

t#is approac# is generally not $inance/ 'y long term sources "#e in.estmentin current assets $or a gi.en le.el o$ sales $orecast is not #ig#

"=

21 Ans&er : (')7eason : Category GA; items are t#ose ic# #a.e t#e #ig#est rupee in.estment 6t

/oes not necessary t#at per unit cost un/er category GA; item s#oul/ 'e .ery

costly or .ery c#eap 6t is also not necessary t#at category GA; items s#oul/

least count in terms o$ num'ers ence option (') is t#e correct ans&er "=

22 Ans&er : (c)

7eason : A.erage stoc o$ $inis#e/ goo/s

7s29>>9000Cost o$ sales =pening stoc o$ $inis#e/ goo/s L Cost o$ pro/uction L

Selling a/ministration o$ $inancial e+pen/iture L Custom

an/ *+cise /uly Closing stoc o$ limite/ goo/s

2929000 L 591>00 L 2950 L 59000 29509000 7s595>9?50

@aily cost o$ sales 15>52

"#e $inis#e/ goo/s storage perio/

1?2 /ays

7s2929 000 29 509 0002

L

595>9?50

3>0A.erage stoc o$ $inis#e/ goo/s

@aily cos t o$ sales

29 >>9 00015>52

"=

23 Ans&er : (')

7eason : "#eoretical .alue o$ rig#t

=r 2

=r 2< L 2 22


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o S

< 1

OL

2>

< 1O

L

"=

=r 2< 20

< 10

2 Ans&er : (')7eason : =perating e+posure is a result o$ economic conse%uences rat#er t#an

accounting conse%uences o$ e+c#ange rate mo.ements on t#e .alue o$ a

$irm

"=

25 Ans&er : (e)7eason : An optimal capital structure can satis$y t#e return e+pectations o$ t#e

stae#ol/ers at a lo&er cost t#at &ill result in s#are price o$ t#e company to a

#ealt#ier one 6t is a $inancing /ecision ,#ile t#e cases mentione/ in t#eot#er alternati.es are t#e in.estment /ecisions as t#ese may 'ring return to t#e

company o.er a perio/ o$ time

"=

2> Ans&er : (e)

7eason : 6$ a security;s return plots a'o.e t#e security maret line (SM4) t#en t#e

return on t#e security is more t#an t#e re%uire/ rate o$ return on t#e securityaccor/ing to t#e SM4 A greater return means a lesser price o$ t#e security

t#an its intrinsic .alue t#at implies t#e security is un/er price/ an/ #ence t#at

s#oul/ 'e 'oug#t imme/iately to 'oo pro$it in $uture as its price increases "=

2? Ans&er : (/)

7eason : Commercial papers are issue/ $or a perio/ o$ 15 /ays to one year 'y t#erepute/ companies to $inance t#eir &oring capital re%uirements *%uity

capital an/ reser.es an/ surplus are perpetual capital &it# an in$inite maturity

perio/ ile pre$erence s#ares an/ /e'entures are generally issue/ $or a longterm ence9 (/) is t#e ans&er

"=

2 Ans&er : (')

7eason : ast an/ present consumption tren/s9 rice an/ crosselasticity o$ /eman/

an/ pro/uction constraints are t#e issues to 'e consi/ere/ maret aspects o$

proHect appraisal 6mpact o$ t#e proHect on t#e /istri'ution o$ income in t#e


15/26

society is issue to 'e consi/ere/ un/er economic aspects o$ proHect appraisal

A.aila'ility o$ t#e re%uire/ %uality an/ %uantity o$ ra& materials an/ ot#er

inputs is t#e issue relating tec#nical aspects o$ proHect appraisal encealternati.e (') is t#e ans&er

"=

2 Ans&er : (/)

7eason : resent .alue $actor $or a perpetual annuity

ence it /ecreases &it# an increase in t#e interest rate ence (/) is t#ecorrect option

Future 8alue 6nterest Factor

ence it increases &it# increase in t#e interest rate

Future 8alue 6nterest Factor For Annuity (F86FA) F86FAalso increases &it# increase in t#e interest rate

Capital 7eco.ery Factor 6t is t#e in.erse o$ 86FA9 ic#

/ecreases &it# increase in interest rate "#ere$ore9 Capital 7eco.ery Factor

increases &it# increase in t#e interest rate6n.erse o$ 86FA is capital reco.ery $actor9 ic# increases &it# increase in

t#e interest rateence9 options (a)9 (')9 (c) an/ (e) are incorrect

1

i(1L i)n

(1 i)n 1

i

L On

n

i(1 i)(1 i) 1

L

L O "=

30 Ans&er : (/)

7eason : "#e assumptions o$ t#e economic or/er %uantities are as $ollo&s: "=

! Constant or uni$orm /eman/ o$ t#e pro/uct t#roug#out t#e year! Constant unit price o$ t#e ra& material

! Constant carrying cost o$ t#e material

! Constant or/ering cost! 6nstantaneous /eli.ery o$ t#e materials

! ence9 t#e option (/) is t#e correct c#oice

Section B : ro'lems

1 a


16/26

*+pecte/ rate o$ return $rom t#e s#are Ppii

1?5 (030) L 125 (00) L >25 (030)

1257is $or t#e s#are

Q(1?5 1250)2 (030) L (1250 1250)2 (00) L (>25 1250)2 (030)R12

Q11?1 L 0 L 11?1R12

' *+pecte/ return $rom t#e maret Ppim

15 (030) L 12 (00) L (030) 11?0

7is $or t#e maret9 m QPpi (m )2R12

Q(15 11?0)2 (030) L (12 11?0)2 (00) L ( 11?0)2 (030)R12

Q32>? L 003> L 10?R12 (?1)12 2?2

"=

2 a *conomic or/er %uality (*=N)

sage () /uring t#e planning perio/:sage in t#e last %uarter =pening 'alance L "otal receipts closing 'alance

59000 L (>39000 L ?29000 L 19000) 09000 7s109000

sage in t#e last %uarter (in units) 109000 units

sage () in t#e planning perio/ o$ ne+t si+ mont#s 109000 T 2 209000 unitsFi+e/ cost per or/er9 F 7s00 (gi.en)

nit price 7s1 (gi.en)

Carrying cost $or t#e entire year 25

Carrying cost $or t#e planning perio/ o$ si+ mont#s9 C 125*conomic or/er %uantity (*=N)

9000 units

Scenario =ptimistic

110 L O

01251

>

105 3 L O

00>25


17/26

1

>

3 L Oie9 1?5 ie9 125 >25

ro'a'ility 030 00 030

Q 2 R1 2Ppi (i O )

m

C2F

1

109000

225

1 (0125)

2T00T 209000

' 4et t#e *=N 'e /enote/ as NU an/ let t#e minimum re%uire/ or/er siDe $or getting t#e/iscount 'e /enote/

000 units (gi.en)@iscount per unit9 @ rice per unit T ercentage o$ /iscount

7e 05

@iscount earne/ o.er t#e entire planning perio/ @ 209000 T 05 7s9000

Sa.ings in or/ering cost F 7s15006ncrease in carrying cost

7s201259000 units

"=

3 8alue o$ t#e $irm en /i.i/en/s are pai/:

4et :rice per s#are a$ter one year 1

rice per s#are no& 0

@i.i/en/ per s#are a$ter 1 year @10 ere G; is t#e e%uity capitaliDation rate

=r 200

=r 1 112 T 200 > 7s21Since /i.i/en/s &ill 'e pai/ t#e company &ill #a.e to issue ne& s#ares in or/er to raise

t#e amount o$ $un/s use/

in paying /i.i/en/s 4et n1 an/ 1 'e t#e num'ers o$ s#are to 'e issue/ a$ter one year

an/ 1 'e t#e price per s#are


18/26

a$ter 1 year respecti.ely

Amount to 'e raise/:

n11 6n.estment (*arnings @i.i/en/s pai/) 109009000 (?9009000 509000 T >) 7s>9009000

XO

N

NU

O

X O2

NUC

2N ( @)C

NX

100

1 (25)

X

ON

NU

00

>9000

2090009000

209000

O


19/26

O

X O

2

NUC2

N ( @)C

( )2

(9000) (1) (0125)

2

(>9000) (1 05) 0125 OO

1 1 @

1

LL

1 > 112

L


20/26


21/26

Amount o$ $inance $rom 09000

"#e present .alue o$ t#e annual cost o$ operation 7s 19>09000 T 86FA (159 5)

7s 19>09000 T 3352 7s 593>9320

ence t#e present .alue o$ costs 7s 9009000 L 593>9320 7s1393>9320

"#e annual capital c#arge &ill 'e 7s

001(101)

(101) O1(323 5)

(311 5)

(1 1?)1? T O

O

O

L


22/26

12 (1 r)2

509000

(1 r)09000

L

LL

> 12 2

>(1012)

50000

(1012)

00000012(1012)

(1012) 1 L L

O

> 12 2>

(1011)50000

(1011)

00000011(1011)

(1011) 1 L L

O

(? 300>2)(12 11)

O

O1393>9320

86FA(1595)

7s399>>3 (appro+)Supplier : ,estern *ngineering 4t/ (,*4)

Cost o$ t#e mac#ine 7s129009000

Annual cost o$ operation 7s 19209000

"#e present .alue o$ t#e annual cost o$ operation 7s 19209000 T 86FA (159 years) 7s19209000 T ? 7s59390

ence9 t#e present .alue o$ cost 7s 129009000 L 7s 59390 7s1?9390

"#e annual capital c#arge &ill 'e Supplier: Sout#ern 6n/ustries 4t/ (S64)

Cost o$ t#e mac#ine 7s 19009000

Annual cost o$ operation 7s19009000"#e present .alue o$ t#e annual cost o$ operations 19009000 T 86FA (15910)

19009000 T 501

7s 5901900

ence9 t#e present .alue o$ Costs 19009000 L 5901900


23/26

23901900

"#e annual capital c#arge

"#e annual capital c#arge is least $or t#e lat#e mac#ine manu$acture/ 'y ,*4 encelat#e mac#ine

manu$acture/ 'y ,*4 s#oul/ 'e selecte/

"= Section C: Applie/ "#eory

> "#e riss ic# arise out o$ /i$$erent sources an/ a$$ect in.estments in securities an/

port$olios are gi.en 'elo&:6nterest 7ate 7is

6nterest rate ris is t#e .aria'ility in a securityYs return resulting $rom c#anges in t#e le.el

o$ interest rates =t#er

t#ings 'eing e%ual9 security prices mo.e in.ersely to interest rates "#is ris a$$ects'on/#ol/ers more /irectly t#an

e%uity in.estors

Maret 7is

Maret ris re$ers to t#e .aria'ility o$ returns /ue to $luctuations in t#e securities maretAll securities are

e+pose/ to maret ris 'ut e%uity s#ares get t#e most a$$ecte/ "#is ris inclu/es a &i/erange o$ $actors

e+ogenous to securities t#emsel.es lie /epressions9 &ars9 politics9 etc

6n$lation 7is,it# rise in in$lation t#ere is re/uction o$ purc#asing po&er9 #ence t#is is also re$erre/ to

as purc#asing po&er ris

an/ a$$ects all securities "#is ris is also /irectly relate/ to interest rate ris9 as interest

rates go up &it# in$lationBusiness 7is

"#is re$ers to t#e ris o$ /oing 'usiness in a particular in/ustry or en.ironment an/ it

gets trans$erre/ to t#ein.estors o in.est in t#e 'usiness or company

Financial 7is

Financial ris arises en companies resort to $inancial le.erage or t#e use o$ /e't$inancing "#e more t#e

company resorts to /e't $inancing9 t#e greater is t#e $inancial ris

4i%ui/ity 7is

"#is ris is associate/ &it# t#e secon/ary maret ic# t#e particular security is tra/e/in A security ic# can

'e 'oug#t or sol/ %uicly &it#out signi$icant price concession is consi/ere/ li%ui/ "#e

greater t#e uncertaintya'out t#e time element an/ t#e price concession9 t#e greater t#e li%ui/ity ris Securities

ic# #a.e rea/y marets

lie treasury 'ills #a.e lesser li%ui/ity risc "=

? =.ertra/ing an/ n/ertra/ing

1393>9320

3352


24/26

1?939 0

86FA(159)

7s1?93907s39?9 3(appro+)

?

23901900

86FA(15910)

7s239019007s959>3?(appro+)

501

=.ertra/ing: =.ertra/ing is a situation ic# is t#e opposite o$ un/ertra/ing "#esymptoms o$ o.ertra/ing can

'e notice/ $rom t#e /isproportionately #ig# turno.er o$ assets compare/ to t#e .olume o$

sales 6n t#e conte+t o$

&oring capital o.ertra/ing can 'e notice/ $rom #ig# turno.er o$ current assetscompare/ to similar companies

,#ile increase in t#e turno.er o$ current assets is generally consi/ere/ to 'e a .irtue9/isproportionately #ig#

turno.er is in/icati.e o$ less amount o$ cas# in.este/ in current assets ic# can create

pro'lems o$ li%ui/ity at t#etime o$ maing payments $or current o'ligations "#e pro'lem o$ o.er tra/ing can 'e

restate/ as one o$

un/ercapitaliDation

recautionary measures $or o.ertra/ing can 'e taen 'y initially re/ucing t#e sales to ale.el commensurate &it#

t#e amount o$ assets an/ a $inal solution lies in increasing t#e asset 'ase t#roug#

a//itional $inances raise/ t#roug#t#e issuance o$ s#ares an/or o'taining loan $un/s

n/ertra/ing: A situation o$ un/ertra/ing arises in a company en t#e .olume o$

sales is muc# less t#an t#eamount o$ assets employe/ "#is 'ecomes apparent en t#e per$ormance o$ t#e

company is compare/ against

similar companies n/ertra/ing also in/icates t#at $un/s o$ t#e company are loce/ up

in current assets resultingin a lo&er turno.er o$ &oring capital Anot#er &ay o$ stating un/ertra/ing is t#at a

company is o.er capitalise/

compare/ to t#e .olume o$ sales As t#is &oul/ result in lo&er turno.er9 t#e company#as to tae precautionary

measures suc# as altering capital structure so t#at t#e /e'te%uity ratio comes /o&n9

#astening t#e collectionprocess9 re/ucing t#e le.els o$ in.entory to reasona'le le.els compare/ to t#e sales

$orecast an/ pro/uction plans

nless t#ese measures are taen9 t#e rate o$ return on e%uity is liely to come /o&n as a

result o$ ic# t#e maret


25/26

price o$ t#e company can 'e a/.ersely a$$ecte/

nless a company taes precautionary measures once it o'ser.es symptoms o$ o.er or

un/ertra/ing9 it may runinto serious &oring capital pro'lems as outline/ a'o.e

"=

Signi$icance o$ collection program in t#e management o$ recei.a'les"#e collection e$$ort o$ a company is /eci/e/ 'y t#e collection policy9 ic# is a part o$

t#e o.erall cre/it policy

o$ t#e company "#e o'Hecti.e o$ collection policy is to ac#ie.e timely collection o$recei.a'les9 t#ere'y releasing

$un/s loce/ up in recei.a'les $or a longer perio/ t#an t#ey s#oul/ #a.e 'een un/er t#e

cre/it terms an/ to

minimiDe 'a/ /e't losses"#e collection program consists o$ t#e $ollo&ing:

! Monitoring t#e state o$ recei.a'lesZ

! @espatc# o$ letters to customers ose /ue /ate is approac#ing

! "elegrap#ic an/ telep#onic a/.ice to customers aroun/ t#e /ue /ate! "#reat o$ legal action to o.er/ue accounts

! 4egal action against o.er/ue accounts,#ile $ormulating t#e collection policy a company s#oul/ recon &it# t#e $actor t#at a

.ery rigorous collection

policy may act as an irritant to customers9 t#ere'y Heopar/iDing t#e goo/ customerrelations 'uilt o.er t#e years

Furt#er9 t#e sales o$ t#e company may /ecline as customers &it# some o.er/ues may

$ear to place $urt#er or/ers

o&e.er9 t#e amount o$ recei.a'les an/ 'a/ /e't losses &ill re/uce to a certain e+tent ast#e company increases

t#e collection e+pense associate/ &it# collection programs

"#e general pattern o$ t#e relations#ip 'et&een collection e+penses incurre/ an/ 'a//e't losses &ill 'e suc# t#at

initial increase may not #a.e percepti'le impact ile su'se%uent amounts up to a

certain le.el &ill #a.e apronounce/ impact in re/ucing 'a/ /e't losses "#is is /epicte/ in t#e $orm o$ a grap#

'elo& "#e amount o$

e+penses incurre/ 'eyon/ t#e saturation point are liely to #a.e .ery little impact on 'a/

/e't lossesFigure 1 : Be#a.ior o$ 'a/ /e't lossescollection e+penses

Similarly9 /eli'erate la+ity on t#e part o$ t#e company in t#e rigor o$ collection e$$ort is

liely to increase sales9increase a.erage collection perio/9 increase 'a/ /e't losses an/ to some e+tent re/uce

collection e+penses

=nce again9 t#e incremental $inancial 'ene$its in t#e $orm o$ t#e cost o$ $un/s release/'y a re/uction in t#e le.el

o$ recei.a'les an/ t#e re/uction in 'a/ /e't losses #a.e to 'e compare/ &it# t#e

incremental costs associate/ &it#


26/26

a//itional collection e+penses an/ policy c#ange is &arrante/ only en t#e incremental

net 'ene$its are positi.e

Documents

Financial Management (MB211) - July 2005