PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT

Question No.1 is compulsory.

Candidates are also required to answer any five questions out of the remaining six questions.
Working notes should form part of the respective answer.
Question 1
(a) The Asset Management Company of the mutual fund (MF) has declared a dividend of
9.98% on the units under the dividend reinvestment plan for the year ended 31 st March,
2021. The investors are issued additional units for the dividend at the rate of closing Net
Asset Value (NAV) for the year as per the conditions of the scheme.
The closing NAV was ` 24.95 as on 31st March, 2021. An investor Mr. X who is having
20,800 units at the year-end has made an investment in the units before the declaration
of the dividend and at the rate of opening NAV plus an entry load of ` 0.04. The NAV has
appreciated by 25% during the year.
Assume the face value of the unit as ` 10.00.
You are required to calculate:
(i) Opening NAV,
(ii) Number of the units purchased,
(iii) Original amount of the investment. (5 Marks)
(b) The Bank BK enters into a Repo for 9 days with Bank NE in 6% Government bonds 2022
for an amount of ` 2 crore. The other relevant details are as follows:
First Leg Payment (Start Proceed) ` 2,00,06,750
Second Leg Payment (Repayment Proceed) ` 2,00,31,759
Initial Margin 1.25%
Days of accrued interest 240
Assume 360 days in a year.
You are required to calculate:
(i) Repo Rate
(ii) Dirty Price and
(iii) Clean Price (5 Marks)
(c) M/s. SKPD Ltd. employs certainty-equivalent approach in the evaluation of risky
investments. The finance department of the company has developed the following
information regarding a new project:

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 2 FINAL (OLD) EXAMINATION: JULY, 2021

Year Expected CFAT (` ) Certainty equivalent quotient

0 (Initial Outlays) 300,000 1.0
1 140,000 0.8
2 130,000 0.7
3 120,000 0.6
4 115,000 0.4
5 80,000 0.3
Following is the other information:
(i) The firm's cost of equity capital is 18%;
(ii) Cost of debt is 9%,
(iii) Present risk free rate of interest in the Market on the treasury bonds is 6%, which
will rise by 200 basis points from 4th year onwards.
Year (t) 1 2 3 4 5
PVIF (6%, t) 0.943 0.890 0.840 0.792 0.747
PVIF (8%, t) 0.926 0.857 0.794 0.735 0.681
You are required to :
(i) To find out the viability of the project; and
(ii) To advise on the popularity of this method. (5 Marks)
(d) NM Ltd. (NML) is aspiring to enter the capital market in a three years' time. The Board
wants to attain the target price of ` 70 for its shares at the end of three years. The
present value of its shares is ` 52.03. The dividend is expected to grow at a rate of 15%
for the next three years. NML uses dividend growth model for its projections.
The required rate of return is 15%.
You are required to calculate the amount of dividend to be declared by the board in the
base year so as to achieve the target price.
Period (t) 1 2 3
PVIF (15%, t) 0.8696 0.7561 0.6575
(5 Marks)
Answer
(a) (i) Let N be the opening NAV, then
N (1 + 0.25) = ` 24.95
N = ` 19.96
i.e., beginning NAV = ` 19.96

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 3

(ii) Let X be the number of units purchased

Then ending units = 20,800
Accordingly,
0.998X
20800 = X +
24.95
24.05X + 0.998X
20800 =
24.95
X = 20000
Thus, number of units to be purchased = 20,000
(iii) Original amount of investment
Initial NAV ` 19.96
Entry Load ` 0.04
` 20.00
Number of funds purchased 20,000
Amount of investment ` 4,00,000

 No. of days 
(b) (i) Second Leg = Start Proceed x  1+ Repo Rate  
 360 
 9 
` 2,00,31,759 = ` 2,00,06,750 x  1 + Repo Rate 
 360 
 9 
1.00125 =  1 + Repo Rate 
 360 
Repo Rate = 0.05 = 5%
Dirty Price 100 − Initial Margin
(ii) First Leg (Start Proceed) = Nominal Value x 
100 100
Dirty Price 100 − 1.25
` 2,00,06,750 = ` 2,00,00,000 x 
100 100
10003.375 = 98.75 x Dirty Price
Dirty Price = ` 101.30

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 4 FINAL (OLD) EXAMINATION: JULY, 2021

(iii) Dirty Price = Clean Price + Interest Accrued

240
101.30 = Clean Price + 100   6%
360
Clean Price = ` 97.30
(c) (i) Statement Showing the Net Present Value of Project
Year Cash Flow C.E. Adjusted Applicable PVIF Present
end (`) (b) Cash flow (`) Value (`)
(a) (c) = (a)  (b) (d) (e) = (c)  (d)
1 1,40,000 0.8 112,000 0.943 1,05,616
2 1,30,000 0.7 91,000 0.890 80,990
3 1,20,000 0.6 72,000 0.840 60,480
4 1,15,000 0.4 46,000 0.735 33,810
5 80,000 0.3 24,000 0.681 16,344
Total PV of Cash Flows 2,97,240
Less: Initial Investment 3,00,000
Net Present Value - 2,760
Decision: Since the net present value of the Project is negative, it should not be
accepted.
(ii) In Certainty Equivalent approach we incorporate risk to adjust the cash flows of a
proposal so as to reflect the risk element and also adjust future cash flows rather
than discount rates. But the procedure for reducing the forecasts of cash flows is
implicit and likely to be inconsistent from one investment to another. Therefore, it is
not popular.
(d) Present value of Share = PV of Stream of Dividend upto 3 years + PV of Target price of
share after 3 years
` 52.03 = PV of Stream of Dividend upto 3 years + 70.00 × 0.6575
PV of Stream of Dividend upto 3 years = ` 52.03 – ` 46.03 = ` 6
Let Base Dividend is D 0, then
` 6 = D0 (1+g) × PVIF (15%,1) + D0 (1+g)2PVIF(15%, 2) + D 0 (1+g)3 PVIF (15% , 3)
` 6 = D0 (1.15) × 0.8696 + D 0 (1.15)2 × 0.7561 + D0 (1.15)3 × 0.6575
` 6 = D0 +D0 +D0 = 3D0
D0 = ` 2
Thus, Company should declare a dividend of ` 2 in base year.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 5

Question 2
(a) XL Limited (XLL) is considering a proposal to expand its plant capacity and is seriously
considering equipment on lease for a period of three years. The CFO has advised that an
amount of ` 15,78,039 will be available during the next three years. This amount can be
utilized towards annual lease rent to be paid at the end of the each year. However, this
amount will be available in an increasing manner such that they are in the ratio of 1:2:3
over the next three years.
LF Limited (LFL), a leasing company, can provide the required equipment. Depreciation
is to be charged at Written Down Value (WDV) basis at the rate of 20%. Marginal
Income Tax Rate of LFL is 30%. The required rate of return is 12%.
Ignore salvage value.
You are required to calculate the cost of equipment (to be leased), which can be
supported by the cash flow of XLL.
Year (t) 1 2 3
PVIF (12%, t) 0.893 0.797 0.712

(8 Marks)
(b) An investor has recently purchased substantial number of 7 year 6.75% ` 1,000 bond
with 5% premium payable on maturity at a required Yield to Maturity (YTM) of 9%.
However, due to a financial crunch he is looking to sell these bonds and has got a
proposal from another investor, who is willing to purchase these bonds by shelling out a
maximum amount of ` 897 per bond. Investors follow intrinsic value method for valuation
of bonds.
(i) You are required to determine
(1) The Market Price, Duration and Volatility of the bond and
(2) Required YTM of the new investor
(ii) What is relationship between the price of the bond and YTM?
Period (t) 1 2 3 4 5 6 7
PVIF (9%, t) 0.917 0.842 0.772 0.708 0.650 0.596 0.547

(8 Marks)
Answer
(a) The amount to paid as lease rent for 3 years will be computed as follows:
Let R the rent of first year then

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 6 FINAL (OLD) EXAMINATION: JULY, 2021

1R + 2R + 3R = Rs 15,78,039
R = ` 2,63,006.50
Thus, yearly rent payment by XL Ltd. will be as follows
Year 1 ` 2,63,006.50
Year 2 ` 5,26,013.00
Year 3 ` 7,89,019.50
` 15,78,039.00
Let X be the Cost of equipment to be leased thus PV Cash inflows (Net of taxes) of LFL
Year Lease Dep. Lease after Tax Cash Flow
(a) (b) (c) (d) (e = c + d)
1 2,63,006.50 0.20X 1,84,104.55 – 0.14X 1,84,104.55 + 0.06X
2 5,26,013.00 0.16X 3,68,209.10 – 0.112X 3,68,209.10 + 0.048X
3 7,89,019.50 0.128X 5,52,313.65 – 0.896X 5,52,313.65 +
0.0384X
Now we shall equalize PV of cash flows to cost of machine as follows:
X = 0.893(1,84,104.55 + 0.06X) + 0.797(3,68,209.10 + 0.048X) + 0.712(5,52,313.65 +
0.0384X)
X = 1,64,405.36 + 0.05358X + 2,93,462.65 + 0.03826X + 3,93,247.32 + 0.02734X
X – 0.11918X = 8,51,115.33
X = 9,66,276.12
Thus, the Cost of equipment to be leased should be ` 9,66,276.12
(b) (i) (1) (A) Market Price of Bond
= 1,000 X 6.75% X (PVIAF 9%,7) + 1,050 X (PVIF 9%,7)
= 67.50 X 5.032 + 1050 X 0.547
= 339.66 + 574.35 = 914.01
(B) Duration of Bond
Year Cash P.V. @ 9% Proportion of Proportion of
flow bond value bond value x
time (years)
1 67.50 0.917 61.898 0.0677 0.0677

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 7

2 67.50 0.842 56.835 0.0622 0.1244

3 67.50 0.772 52.110 0.0570 0.1710
4 67.50 0.708 47.790 0.0523 0.2092
5 67.50 0.650 43.875 0.0480 0.2400
6 67.50 0.596 40.230 0.0440 0.2640
7 1117.50 0.547 611.273 0.6688 4.6816
914.011 5.7579

Duration of the Bond is 5.758 years

Alternatively, as per Short Cut Method
1+ YTM (1+ YTM) + t (c - YTM)
D= -
YTM [ ]
c ( 1+ YTM)t -1 + YTM
Where YTM = Yield to Maturity
c = Coupon Rate
t = Years to Maturity
= 1.09 _ 1.09 + 7(0.0675 – 0.09) = 5.72
0.09 0.0675 [(1.09) 7 – 1] + 0.09
(C) Volatility of Bond-
Volatility = Duration/(1+YTM) = 5.758/(1+0.09) = 5.28
(2) Required yield of new Investor
= 67.50 PVIAF (r, 7) + 1050 X PVIF (r, 7)
Now, Let us discount the cash flow by 9%
PV @ 9% = 67.50 X 5.032 + 1050 X 0.547
= 339.66 + 574.35 = 914.01
NPV @ 9% = 914.01 – 897 = `17.01
Since, NPV of bond is positive, We need to increase discount rate say 12%
= 67.50 PVIAF (12%,7) + 1050 X PVIF (12%,7)
= 67.50 X [0.893 + 0.797 + 0.712 + 0.636 + 0.567 + 0.507 + 0.452] + 1050 X
0.452
= 67.50 X 4.564 + 474.60
= 308.07 + 474.60= 782.67

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 8 FINAL (OLD) EXAMINATION: JULY, 2021

NPV @ 12% = 782.67 - 897= - `114.33

Now we use interpolation formula
NPV at LR
K e = LR + × Δr
NPV at LR - NPV at HR
17.01
= 9% + × 3%
17.01 - (- 114.33)
17.01
= 9% + × 3%
131.34
= 9% + 0.39% = 9.39%
(ii) Relationship between the price of the bond & YTM is opposite or inverse
Question 3
(a) SM Limited has a market capitalization of ` 3,000 crore and the current earnings per
share (EPS) is ` 200 with a price earnings ratio (PER) of 15. The Board of directors is
considering a proposal to buy back 20% of the shares at a premium which can be
supported by the financials of the company. The Boards expects post buy back market
price per share (MPS) of ` 3057. Post buy back PER will remain same. The company
proposes to fund the buy back by availing 8% bank loan since available resources are
committed for expansion plans.
Applicable income tax rate is 30%.
You are required to calculate :
(i) The interest amount which can be paid for availing the bank loan,
(ii) The loan amount to be raised and
(iii) The premium per share and percentage premium paid. over the current MPS.
(12 Marks)
(b) Aggressive Ltd., is proposing to fund its expansion plan of ` 12 crore by making a rights
issue. The current market price (CMP) is ` 40. The Board is willing to offer a discount of
20% on the CMP for the rights issue. The Board is also desirous that the fall in Ex-right
price of the shares be restricted to 10% of CMP.
You are required to calculate:
(i) The number of new equity shares to be offered for each rights held,
(ii) Theoretical value of right and
(iii) The total number of equity shares to be issued. (4 Marks)

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 9

Answer
(a) Current Market Price of Share = ` 200 × 15 = ` 3,000
Market capitalisation
No. of Shares =
Market price of share
` 3,000 crore
= = 1 crore
` 3,000
No. of Shares proposed to Buyback = 20% of 1 core = 20 Lakh
Post Buy back per share (`) = ` 3,057
PE Ratio = 15
3057
Post Buy back EPS = = ` 203.80
15
EAT = ` 203.80 × 80 Lakh = ` 16,304 Lakh
16,304
Pre Tax Earning after Buyback = = ` 23,291.429 Lakh
(1 − 0.30)
Earning Before Buyback = ` 200 × 100 = 20,000 Lakh
20,000
Pre Tax Earning before Buyback = = ` 28571.429 Lakh
(1 − 0.30)

Particulars
Pre Tax Earning before Buyback ` 28571.429 Lakhs
Pre Tax Earning after Buyback ` 23291.429 Lakhs
Interest which can be paid for availing bank loan ` 5,280.00 Lakhs
5280 lakh ` 66,000 Lakhs
Loan Amount raised =
0.08
Amount paid for Buy back of Share ` 66,000 Lakhs
No. of Shares Bought back 20 Lakhs
Share Buyback price per share = 66,000/20 Lakhs ` 3,300
Current Market Price per share (` 200 × 15) ` 3,000
Premium ` 300
300
% Premium over current market price = x 100 = 10%
3000

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 10 FINAL (OLD) EXAMINATION: JULY, 2021

(b) (i) Number of new equity shares to be offered for each rights head
Subscription Price = ` 40 × 0.80 = ` 32 per share
Ex Right Price to be restricted to = ` 40 × 0.90 = ` 36
Let R be the ratio in which right share to be issued then
` 40 + `32 × R
` 36 =
1+ R
36 + 36R = ` 40 + 32R
R=1
Thus, 1 equity share be offered for each share held.
(ii) Theoretical Value of right = ` 36 – ` 32 = ` 4
`12crore
(iii) No. of equity share to be issued = = 37,50,000 or 0.375 shares
` 32
Question 4
(a) M/s. Poor Ltd. (PL) has logged in a credit sales of ` 6 crore for the year ended 31 st
March, 2021. The receivables are 15% of credit sales. The average financing cost of
receivables is 5%. Administration cost and Bad debts, on an average, amount to 2% and
7% of the receivables respectively. PL, as per an internal assessment, expects that the
Bad debts may rise to 10% of the receivables in the coming year.
PL is actively looking for a factor who can undertake management of credit
administration on non-recourse basis. Factor, as per industry norms, will maintain a
receivable collection period of 30 days and keeps a reserve of 20% of the receivables.
The Factor charges an interest rate of 7% per annum on the advances.
You are required to advise
(i) The maximum amount which PL can offer as the commission to the Factor,
(ii) Whether a deal can be structured, if Factor requires a commission of 2.5% on the
credit sales,
(iii) Whether a deal is possible by negotiation wherein PL may offer extra commission
due to savings on account of probable increase in Bad debts and the Factor, who is
also eager to get business offers a 20% discount on its commission. (12 Marks)
(b) M/s. Strong an AMC has floated a dividend bonus plan on 1st April, 2016 at a certain net
asset value (NAV). The fund has a robust growth and has declared a bonus of 1:5
(1 bonus unit for 5 right units held) on 30 th September, 2017 and a second bonus of 1:4
(1 bonus unit for 4 right units held) on 30 th September 2019. The fund, as on 31st March
2021, has generated an average yield of 17.5%.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 11

Mr. Optimistic has made an investment of ` 16 lakhs in the plan before the declaration of
the first bonus and remain invested thereafter.
The following information is also available :
Date 01.04.2016 30.09.2017 30.09.2019 31.03.2021
NAV (`) ? 85 92 100
You are required to advise to Mr. Optimistic the opening NAV, which is required by him
to calculate the capital appreciation. (4 Marks)
Answer
(a) (i) Working Notes:
Particulars `
(a) Estimated Receivables (15% of ` 6,00,00,000) 90,00,000
 30 
(b) Estimated Receivables under Factor  6,00,00,000 ×  50,00,000
 360 
Reduction in Receivables (a – b) 40,00,000
Total Savings (A)
(a) Reduction in finance costs (5% of `40,00,000) ` 2,00,000
(b) Saving of Administration costs (2% of ` 90,00,000) ` 1,80,000
(c) Saving of Bad debts (7% of ` 90,00,000) ` 6,30,000
Total (a + b + c) ` 10,10,000
Total Cost of Factoring (B)
(a) Net Interest on advances by Factor
Interest (` 50,00,000 x 80% = ` 40,00,000 @ 7%) = ` 2,80,000
Less- Overdraft Interest rate
(` 50,00,000 x 80% = ` 40,00,000 @ 5%) = ` 2,00,000 ` 80,000
(b) Total Saving due to factoring ` 10,10,000
Maximum amount of Commission offered by PL (b – a) ` 9,30,000
(ii)
(a) Required commission by factor (2.5% of ` 6,00,00,000) ` 15,00,000
(b) Maximum commission offered by PL ` 9,30,000
Deficit in Commission (a – b) ` 5,70,000
So, Deal cannot be structured.

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 12 FINAL (OLD) EXAMINATION: JULY, 2021

(iii)
(a) Additional savings on account of probable loss in Bad Debts ` 2,70,000
(3% of ` 90,00,000)
(b) Maximum amount of commission offered by PL ` 9,30,000
Total amount offered ` 12,00,000
Commission after discount of 20% by factor (80% of ` 15,00,000) ` 12,00,000
Yes, Deal is possible
Alternative Solution based on 365 days in a year
(i) Working Notes:
Particulars `
(a) Estimated Receivables (15% of ` 6,00,00,000) 90,00,000
30
(b) Estimated Receivables under Factor 6,00,00,000 × 49,31,507
365
Reduction in Receivables (a – b) 40,68,493
Total Savings (A)
(a) Reduction in finance costs (5% of `40,68,493) ` 2,03,425
(b) Saving of Administration costs (2% of ` 90,00,000) ` 1,80,000
(c) Saving of Bad debts (7% of ` 90,00,000) ` 6,30,000
Total (a + b + c) ` 10,13,425
Total Cost of Factoring (B)
(a) Net Interest on advances by Factor
Interest (` 49,31,507 x 80% = ` 39,45,206 @ 7%) = ` 2,76,164
Less- Overdraft Interest rate
(` 49,31,507 x 80% = ` 39,45,206 @ 5%) = ` 1,97,260 ` 78,904
(b) Total Saving due to factoring ` 10,13,425
Maximum amount of Commission offered by PL (b – a) ` 9,34,521
(ii)
(a) Required commission by factor (2.5% of ` 6,00,00,000) ` 15,00,000
(b) Maximum commission offered by PL ` 9,34,521
Deficit in Commission (a – b) ` 5,65,479
So, Deal cannot be structured.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 13

(iii)
(a) Additional savings on account of probable loss in Bad Debts ` 2,70,000
(3% of 90,00,000)
(b) Maximum amount of commission offered by PL ` 9,34,521
Total amount offered ` 12,04,521
Commission after discount of 20% by factor (80% of 15,00,000) ` 12,00,000
Yes, Deal is possible
(b)
Particulars
(a) Amount invested by Mr. Optimistic as on 01/04/2016 ` 16,00,000
(b) Gain during 5 years (16,00,000 x 17.5% x 5 years) ` 14,00,000
(c) Value of investment as on 31/03/2021 (a + b) ` 30,00,000
(d) NAV as on 31/03/2021 ` 100 per Unit
(e) Total number of units as on 31/03/2021 (c / d) 30000 Units
Total units before second bonus = 30,000 x 4/5 24000 Units
Total units before first bonus = 24,000 x 5/6 20000 Units
NAV as on 01/04/2016 = 16,00,000/ 20000 ` 80 per Unit
Question 5
(a) Mr. X is having 1 lakh shares of M/s. Kannyaka Ltd. The beta of the company is 1.40.
Mr. Y a financial advisor has suggested having the following portfolio:
Security Beta % holding
S 1.20 10
K 0.75 10
P 0.40 30
D 1.40 50
100
Market Return is 12%
Risk free rate is 8%
You. are required to calculate the following for the present investment and suggested
portfolio:
(i) What is the expected return based on CAPM and also

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 14 FINAL (OLD) EXAMINATION: JULY, 2021

(1) If the market goes upby 2.5%.

(2) If the market goes down by 2.5%
(3) If the market gives Negative Returns of 2.5%
(ii) If the probability of market giving negative return is more, please advise Mr. X
whether to continue the holdings of M/s. Kannyaka Ltd. or to buy the portfolio as per
the suggestion of Mr. Y. If so why? (10 Marks)
(b) M/s. Raghu Ltd. is interested in expanding its operation and planning to install
manufacturing plant at US. It requires 8.82 million USD (net of issue expenses/ floatation
cost) to fund the proposed project. GDRs are proposed to be issued to finance this
project. The estimated floatation cost of GDRs is 2%.
Additional information:
(i) Expected market price of share at the time of issue of GDR is ` 360 (Face Value
` 100)
(ii) Each GDR will represent two underlying Shares.
(iii) The issue shall be priced at 10% discount to the market price.
(iv) Expected exchange rate is INR/USD 72.
(v) Dividend is expected to be paid at the rate of 20% with growth rate of 12%.
(1) You, as a financial consultant, are required to compute the number of GDRs to be
issued and cost of the GDR.
(2) What is your suggestion if the company receives an offer from a US Bank willing to
provide an equivalent loan with an interest rate of 12%?
(3) How much company can save by choosing the option as recommended by you?
(6 Marks)
Answer
(a) Working Notes -
Calculation of Portfolio Beta suggested by Mr. Y
Security Beta Wt. of Holding Beta x Wt. of Holding
S 1.20 0.1 0.120
K 0.75 0.1 0.075
P 0.40 0.3 0.120
D 1.40 0.5 0.700
Total 1.0 1.015

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 15

Portfolio Beta is 1.015

Calculation of Expected Return based on CAPM at present situation-
Particulars Risk Free Beta Market Risk Beta X Expected
Rate (Rf) Return Premium = Risk Return
Rm-Rf Premium
a b c d e=d-b f=cxe g=b+f
Kannyaka
Ltd. 8 1.400 12 4 5.600 13.60
Portfolio 8 1.015 12 4 4.060 12.06
(i) (1) Calculation of Expected Return based on CAPM if market goes up by 2.5% :
Particulars Risk Beta Market Risk Beta X Expected
Free Return Premium= Risk Return
Rate (Rf) Rm- Rf Premium

a b c d e=d-b f=cXe g=b+f

Kannyaka
Ltd. 8 1.400 14.5 6.5 9.100 17.10
Portfolio 8 1.015 14.5 6.5 6.598 14.60
(2) Calculation of Expected Return based on CAPM if market goes down by 2.5%:
Particulars Risk Beta Market Risk Beta X Expected
Free Return Premium= Risk Return
Rate(Rf) Rm - Rf Premium

a b c d e=d-b f=cXe g=b+f

Kannyaka
Ltd. 8 1.400 9.5 1.5 2.100 10.10
Portfolio 8 1.015 9.5 1.5 1.523 9.52
(3) Calculation of Expected Return based on CAPM if market gives negative
returns of 2.5%-
Particulars Risk Beta Market Risk Beta X Expected
Free Return Premium= Risk Return
Rate(Rf) Rm-Rf Premium
a b c d e=d-b f=cXe G=b+f
Kannyaka
Ltd. 8 1.400 -2.5 -10.5 -14.700 -6.70
Portfolio 8 1.015 -2.5 -10.5 -10.658 -2.66

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 16 FINAL (OLD) EXAMINATION: JULY, 2021

(ii) If the probability of market giving negative return is more, It is advisable to Mr. X to
buy the portfolio suggested by Mr. Y because Beta of the portfolio is less than of
Kannyaka Ltd.
(b) Net Issue Size = $ 8.82 million
8.82
Gross Issue = = $9.00 million
0.98
Issue Price per GDR in ` (360 x 2 x 90%) ` 648
Issue Price per GDR in $ (` 648/ ` 72) $ 9.00
Dividend Per GDR (D 1) = ` 20 x 2 = ` 40
Net Proceeds Per GDR = ` 648 x 0.98 = ` 635.04
(1) (a) Number of GDR to be issued
$ 9.00 million
= 1.00 million
$9
(b) Cost of GDR
40.00
ke = + 0.12 = 18.30%
635.04
(2) If the company receives an offer from US Bank willing to provide an equivalent
amount of loan with interest rate of 12%, it should accept the offer.
(3) If the offer is accepted there will be net saving of 6.30%.
Question 6
(a) On 1st October, 2020 Mr. Guru, an exporter, enters into a forward contract with the Bank
to sell USD 1,00,000 on 31 st December 2020 at INR/USD 75.40. However, at the request
of the importer, Mr. Guru received the amount on 30 th November, 2020. Mr. Guru
requested the bank take delivery of the remittance on 30th November, 2020 i.e. before
due date.
The inter-bank rate on 30 th November 2020 was as follows:
Spot INR/USD 75.22-75.27
One Month Premium 10/15
Assume 365 days in a year.
(i) If bank agrees to take early delivery then what will be net inflow to Mr. Guru
assuming that the prevailing prime lending rate is 18% per annum.
(ii) If Mr. Guru can deploy these funds in USD, he gets return at the rate of 3% per
annum. Which is better ? Why ?

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 17

(b) Mr. Mammen, an Indian investor invests in a listed bond in USA. If the price of the bond
at the beginning of the year is USD 100 and it is USD 103 at the end of the year. The
coupon rate is 3% payable annually.
Find the return on investment in terms of home country currency if :
(i) USD is Flat.
(ii) USD appreciates during the year by 3%.
(iii) USD depreciates during the year by 3%.
(iv) Indian Rupee appreciates during the year by 5%.
(v) Will your answer differs if Mr. Mammen invests in the bond just before the interest
payable.
Answer
(a) (i) If Bank agrees to take early delivery-
Working Notes-
(1) Swap Difference
(a) Bank Sells at Spot Rate on 30 thNovember 2020 ` 75.22
(b) Bank Buys at Forward Rate of 31 stDecember 2020 ` 75.42
(75.27 + 0.15)
Swap loss per US$ (a – b) – ` 0.20
Swap loss for US$ 1,00,000 (1,00,000 x -0.20) ` 20,000
(2) Interest on Outlay Funds
(a) On 30th November Bank sells at ` 75.22
(b) It buys from customer at ` 75.40
Outlay of Funds per US$ (b – a) ` 0.18
Interest on Outlay fund for US$ 1,00,000 for 31 days ` 275.18
(US$100000 x 00.18 x 31/365 x 18%)
(3) Charges for early delivery
Swap loss ` 20,000.00
Interest on Outlay fund for US$ 1,00,000 for 31 days ` 275.18
Total charges of early delivery ` 20,275.18

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 18 FINAL (OLD) EXAMINATION: JULY, 2021

Net Inflow to Mr. Guru

Amount received on sale (` 75.40 x 1,00,000) ` 75,40,000

Less: Charges for early delivery payable to bank ` 20,275.18
Net Inflow to Mr. Guru ` 75,19,724.82
(ii) If Mr. Guru deploys these funds in US$, then inflow will be -
Receipt of US$ on 30th November 2020 US$ 1,00,000
 31*  US$ 254.79
Add: Interest for 31 Days  1,00,000 ×3% × 
 365 
US$ available on 31st December 2020 for sale US$ 1,00,254.79

Sale of US$ 1,00,000 to bank as per agreed rate (` 75.40) ` 75,40,000.00

Sale of US$ 254.79 @ ` 75.32 i.e. Forward Rate ` 19,190.78
Amount of Inflows ` 75,59,190.78
Advice: Since Cash Inflow will be higher in deployment of funds option the same
should be chosen.
(b) (i) If USD is flat
(Price at end - Price at begining)+Interest
Return =
Price at begining
(103 - 100) + 3
=
100
3+3
= = 0.06 say 6%
100

(ii) If USD appreciates by 3%

(1+0.06)(1+0.03) -1 = 1.06 X1.03 - 1 = 0.0918 i.e. 9.18%
(iii) If USD depreciates by 3%
(1+0.06)(1-0.03) -1 = 1.06 X 0.97 - 1 = 0.0282 i.e. 2.82%
(iv) If Indian Rupee is appreciated by 5%
(1+0.06)(1-0.05) -1 = 1.06 X 0.95 - 1 = 0.007 i.e. 0.7%.
(v) No, our answer will not differ even if Mr. Mammen invests in bond just before the
interest is payable.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 19

Question 7
Attempt any four of the following :
(a) Unrelated companies come together to form an entity. What this relationship is called?
Discuss briefly the features of this entity.
(b) Investors are the lifeline of the capital markets. Who are the other participants giving
lifeline to capital markets ? Briefly discuss any one.
(c) "Liquidity is the effectiveness of working capital management, corporate policies for
stock and creditors, management and ability of the corporate to meet their commitment in
the short run." This is one of the ingredients in credit rating analysis. What a re the other
ingredients of the model ? Discuss briefly.
(d) There exists a vast difference between Project and Parent cash flow ?
What are these factors ? Briefly discuss.
(e) "Cross-Border M & A is a popular route for global growth and overseas expansio n." Do
you agree or disagree? Justify your stand. (4 x 4 = 16 Marks)
Answer
(a) Unrelated companies come together to form an entity. Such relationship is called
conglomerate merger.
Such mergers involve firms engaged in unrelated type of business operat ions. In other
words, the business activities of acquirer and the target are neither related to each other
horizontally (i.e., producing the same or competing products) nor vertically (having
relationship of buyer and supplier).
Features:
❖ In a pure conglomerate merger, there are no important common factors between the
companies in production, marketing, research and development and technology.
❖ There may however be some degree of overlapping in one or more of these common
factors. Such mergers are in fact, unification of different kinds of businesses under one
flagship company.
❖ The purpose of merger remains utilization of financial resources, enlarged debt capacity
and also synergy of managerial functions.
(b) Though investors are the lifeline of any capital markets. Since a vibrant capital market
the capital market should be capable enough to attract the savings of investors. Investors
belong to various categories such as Retail Investors, Institutional Investors like mutual
funds, insurance companies and Foreign Portfolio Investors.
However other important participants of capital markets are as follows:
❖ Stock Exchange: Stock Exchange is a place where securities issued by issuer
companies are listed and traded. The term is synonymously used for secondary market.

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 20 FINAL (OLD) EXAMINATION: JULY, 2021

❖ Depository: A depository is an organisation which holds securities (like shares,

debentures, bonds, government securities, mutual fund units etc.) of investors in
electronic form at the request of the investors through a registered Depository
Participant. It also provides services related to transactions in securities.In India there
are two depositories namely National Securities Depository Limited (NSDL) and Central
Depository Services (India) Limited (CDSL).
❖ Intermediaries: Intermediaries are those entities which offer various services in relation
to the capital markets. There are various categories of intermediaries such as stock
brokers, merchant bankers, underwriters etc.
(c) Although the ‘Liquidity’ is the effectiveness of working capital management, corporate
policies for stock and creditors, management and the ability of the corporate to meet their
commitment in the short run but other ingredient of CAMEL Model of Credit Rating are as
follows:
(i) Capital – Composition of Retained Earnings and External Funds raised; Fixed
dividend component for preference shares and fluctuating dividend component for
equity shares and adequacy of long-term funds adjusted to gearing levels; ability of
issuer to raise further borrowings.
(ii) Assets – Revenue generating capacity of existing / proposed assets, fair values,
technological / physical obsolescence, linkage of asset values to turnover,
consistency, appropriation of methods of depreciation and adequacy of charge to
revenues. Size, ageing and recoverability of monetary assets viz receivables and its
linkage with turnover.
(iii) Management – Extent of involvement of management personnel, team-work,
authority, timeliness, effectiveness and appropriateness of decision making along
with directing management to achieve corporate goals.
(iv) Earnings – Absolute levels, trends, stability, adaptability to cyclical fluctuations
ability of the entity to service existing and additional debts proposed.
(d) There exists a big difference between the project and parent cash flows due to tax rules,
exchange controls.
Management and royalty payments are returns to the parent firm. The basis on which a
project shall be evaluated depend on one’s own cash flows, cash flows accruing to the
parent firm or both.
Evaluation of a project on the basis of own cash flows entails that the project should
compete favourably with domestic firms and earn a return higher than the local
competitors. If not, the shareholders and management of the parent company shall invest
in the equity/government bonds of domestic firms. A comparison cannot be made since
foreign projects replace imports and are not competitors with existing local firms. Project
evaluation based on local cash flows avoid currency conversion and eliminates proble ms
associated with fluctuating exchange rate.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 21

For evaluation of foreign project from the parent firm’s angle, both operating and financial
cash flows actually remitted to it form the yardstick for the firm’s performance and the
basis for distribution of dividends to the shareholders and repayment of debt/interest to
lenders. An investment has to be evaluated on the basis of net after tax operating cash
flows generated by the project. As both types of cash flows (operating and financial) are
clubbed together, it is essential to see that financial cash flows are not mixed up with
operating cash flows.
(e) Yes, I agree with the statement that “Cross-border M&A is a popular route for global
growth and overseas expansion” since Cross-border M&A is also playing an important
role in global M&A especially true for developing countries such as India.
Major factors that motivate multinational companies to engage in cross -border M&A in
Asia include the following:
• Globalization of production and distribution of products and services.
• Integration of global economies.
• Expansion of trade and investment relationships on international level.
• Many countries are reforming their economic and legal systems and providing
generous investment and tax incentives to attract foreign investment.
• Privatization of state-owned enterprises and consolidation of the banking industry.

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