Final Mock Test

Financial Management
Sec: CAP II Dec 23 Date: Kartik 20, 2080
Full Marks: 100 Time: 3 hrs

Attempt all questions.

Working notes should form part of the answer. Make assumptions wherever necessary.

1. Nepal Pharmaceutical is considering two mutually exclusive projects out of which one it should undertake.
The Finance Director thinks that the project with the higher NPV should be chosen whereas the Managing
Director thinks the one with higher IRR should be undertaken especially as both projects have the same initial
outlay and length of life. The company anticipates a cost of capital of 10% and the net after tax cash flows of
the projects are as follows:
Year 0 1 2 3 4 5
(Cash flows figs. 000)
Project X (200) 35 80 90 75 20

Project Y (200) 218 10 10 4 3

Required: [8+3.5+3.5+5=20 marks]

a) Calculate the NPV and IRR of each project.
b) State with reasons which project you would recommend.
c) Explain the inconsistency in the ranking of the two projects.
d) Mention the assumptions of the Capital Assets Pricing Model (CAPM).
The discount factors are given as under:
Year 0 1 2 3 4 5
Discount Factors
(10%) 1 0.91 0.83 0.75 0.68 0.62
(20%) 1 0.83 0.69 0.58 0.48 0.41

2.
a) Peace Limited is thinking to change its credit policy which is expected to increase the average collection
period from one month to two months. The relaxation of credit terms is expected to produce an increase in sales
volume by 25%. Following are other relevant data:
Sales price per unit Rs. 10
Profit per unit Rs. 1.5
Current sales revenue per annum Rs. 2,400,000
Required rate of return on investment 20%
Assume that 25% increase in sales would result in additional stock of Rs. 100,000 and additional creditors of
Rs. 20,000.
Required: [5+5=10 marks]
Advise the company whether the credit terms should be revised in following circumstances:
i) If all the customers take longer terms of 2 months.
ii) If current customers do not opt for revised credit terms and only new customers opt the revised credit terms.
b) Prepare a Cash Budget for Shrawan to Poush from the following information. [5 marks]
The estimated sales and expenses are as follows:
Particulars Jestha Ashadh Shrawan Bhadra Ashwin Kartik Mangsir Poush
Sales 200,000 220,000 120,000 100,000 150,000 240,000 200,000 200,000
Salaries 30,000 30,000 24,000 24,000 24,000 30,000 27,000 27,000
Misc. 27,000 27,000 21,000 30,000 24,000 27,000 27,000 27,000
expenses

• Cash sales are 75% less than the credit sales

• The firm has gross margin of 25% on sales
• 50% of the credit sales are collected in the month following the sales, 60% of the remaining in the
second month and balance in third month.
• Material for the sale of each month is purchased one month advance on a credit for two months.
• The time lag in the payment of salaries is one third of month and miscellaneous expenses one month.
• 12% debentures Rs. 40,000 were issued on 1st January. (Half yearly interest due on end of Ashadh and
end of Poush.
• The firm maintains a minimum cash balance of Rs. 40,000. Funds can be borrowed @ 12%
p.a. in the multiple of Rs. 1,000. Interest is payable on monthly basis.
Cash balance at the end of Ashadh is Rs. 60,000.

3.
a) Shivam Ltd. listed on the Nepse has 100,000 shares in issue. The dividend just paid was Rs. 15 per share. In
the current investment level, dividends are expected at this level for the next 3 years, but will then demonstrate
perpetual growth of 10 % p. a. The company is currently all equity financed and the required rate of return of
the equity investors is estimated to be 18%.

The company has got an investment opportunity available which will involve a capital outlay in each of the next
2 years and which will produce benefits during the following 3 years. A summary of the financial implications
of this investment is given below:
Year 1 2 3 4 5
Cash Flow in Rs. ‘000 -1,000 -1,000 500 1,500 2,500

The company has a long established policy of not using any debt finance and because of the current depressed
state of the stock market, could not, in the near future, issue new equity. The only possible way of financing the
investment is, therefore, to reduce the dividend payments in the next 2 years. Cash received from the new
investment will all be distributed in the form of dividend. Growth in old dividends at the rate of 10% will also
be maintained because of other operations.
Required: [3+5=8 marks]
i) Calculate the current value of share of Shivam Ltd. at current investment level.
ii) Calculate the share value after the investment opportunity has been accepted using dividend valuation model,
assuming that the market knows of the dividend changes that will result from the investment.
b) Three companies A, B and C are in the same type of business and hence have similar operating risks.
However, the capital structure of each of them is different and the following are the details:

A B C
Equity Share Capital (Rs.) 400,000 250,000 500,000
[Face value Rs. 10 per share]
Debentures (Rs) - 100,000 250,000
[Face value per debenture Rs. 100]
Market value per share (Rs.) 15 20 12
Market value per debenture (Rs.) - 125 80
Dividend per share (Rs.) 2.70 4 2.88
Interest Rate - 10% 8%

Assume that the current levels of dividends are generally expected to continue indefinitely and the income-tax
rate at 50%.
Required:
Compute the weighted average cost of capital of each company. [7 marks]

4.
a) A company is planning to set up a new production facility which is estimated to cost Rs. 5 million and is
expected to produce EBIT of Rs. 0.5 million. The financing of investments required will be done via taking
bank loan and right issue of equity shares. The rate of interest expected on bank loan are as follows:
Investments Initial Price Cash Dividend Closing Price Beta
ABC shares 140 10 170 0.80
MNO shares 150 15 160 0.90
XYZ shares 200 20 250 1.10
IJK debentures 1,100 100 1,200 0.60

You are required to advise best financing alternative for shareholder’s wealth maximization and explain the
effect of leverage on the result based on RoCE. [8 Marks]

b) The valuation of a company has been done by an investment analyst. Based on an expected free cash flow of
Rs. 5.40 million for the following year and an expected growth rate of 9 percent, the analyst has estimated the
value of the company to be Rs. 180 million. However, he committed a mistake of using the book values of debt
and equity.
The book value weights employed by the analyst are not known, but you know that the company has a cost of
equity of 20 percent and post-tax cost of debt of 10 percent. The market value of equity is thrice its book value,
whereas the market value of its debt is nine-tenth of its book value.
Required: [7 Marks]
Calculate the correct value of the company.
5.
a) The following information is given regarding a portfolio:
Investments Initial Price Cash Dividend Closing Price Beta
ABC shares 140 10 170 0.80
MNO shares 150 15 160 0.90
XYZ shares 200 20 250 1.10
IJK debentures 1,100 100 1,200 0.60

Rate of interest on government bond is 6%.

Calculate expected rate of returns of investments by using CAPM. [5 marks]

b) Discuss about sensitivity analysis in capital budgeting. [5 marks]

c) Asia Bank offers a Fixed Deposit Scheme whereby Rs. 10,000 matures to Rs. 12,544 after 2 years on yearly
compounding basis. The bank is facing deposit crisis because for its growth. What will be the revised maturity
value if the bank wishes to amend the scheme by compounding interest on:
[5 marks]
i) Half yearly basis
ii) Quarterly Basis
iii)Monthly Basis

6. Write short note/ answer on: [4×2.5 =10 marks]

a) Debt securitization
b) Various kinds of float
c) Black-Scholes model
d) Private equity

7. Distinguish between: [4×2.5 =10 marks]

a) Capital market and money market
b) Discretionary Portfolio management services and Non-Discretionary Portfolio management services
c) Horizontal Analysis and Vertical Analysis
d) Permanent and Temporary Working Capital