Question Paper Financial Management – I (141) : January 2006
	· Answer all questions. · Marks are indicated against each question.

1.

Sustainable growth rate increases with a decrease in

(a) Payout ratio (b) Debt ratio (c) Profit margin ratio

(d) Sales-assets ratio (e) Retention ratio.

(1 mark)

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2.

The objective of financial management is to

(a) Maximize the revenues (b) Minimize the expenses

(c) Maximize the return on investment (d) Minimize the risk

(e) Maximize the wealth of the owners by increasing the value of the firm.

(1 mark)

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3.

Which of the following is true with respect to a public limited company?

(a) Minimum number of persons to form a Public Limited Company is five

(b) Disqualification of a Director under section 274 (1)(g) of the Companies Act, 1956 is not applicable

(c) Minimum number of directors is two

(d) Formation of Audit Committee is applicable to companies whose paid up capital is not less than Rs.5 Crores

(e) Quorum required for a general meeting is 2.

(1 mark)

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4.

Which of the following statements is/are true with respect to derivative instruments?

I. Option is a contract that confers the right, but not the obligation to the holder to buy (put option) or to sell (call option) an underlying asset at a price agreed on a specific date or by a specific expiry date.

II. The futures contracts are always traded on an organized exchange with standardized terms of contract.

III. The clearing house guarantees that all the traders in the futures market honor their obligations.

(a) Only (I) above (b) Only (III) above

(c) Both (I) and (III) above (d) Both (II) and (III) above

(e) All (I), (II), and (III) above.

(1 mark)

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5.

Which of the following is/are not true with reference to the different functions of Reserve Bank of India (RBI)?

I. The Cash Reserve Ratio is the cash that banks deposit with Reserve Bank as a proportion of their deposits.

II. The bank rate is the rate at which the RBI issues its 365 day T-Bills.

III. Statutory Liquidity Ratio is the part of the Cash Reserve Ratio where the banks are required to maintain specified reserves in the form of government securities, specified bonds and approved securities.

(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) Both (I) and (II) above

(e) Both (II) and (III) above.

(1 mark)

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6.

Which of the following is/are true regarding the relationship between the real and nominal rate of interest?

I. Expected nominal rate of interest will be less than the real rate of interest if the expected rate of inflation and risk premium are more than zero.

II. Expected nominal rate of interest and real rate of interest will be equal if expected rate of inflation and risk premium are zero.

III. If expected rate of inflation is equal to risk premium, then expected nominal rate of interest will exceed the real rate of interest by twice the risk premium.

(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) Both (II) and (III) above

(e) Both (I) and (II) above.

(1 mark)

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7.

Mr. Sharma wishes to purchase a 91 day T-bill of face value Rs.100, maturing after 60 days. If, on maturity, he wishes to earn a yield of 11.5%, the purchase price of T-bill for Mr. Sharma should be

(a) Rs.88.50 (b) Rs.92.21 (c) Rs.97.22

(d) Rs.98.14 (e) Rs.99.03.

(1 mark)

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8.

Which of the following statements is/are true with respect to foreign exchange market?

I. The day on which delivery of foreign currency takes place is known as Value Date.

II. Ready transaction is a transaction in which an agreement to buy and sell in the forex market, is agreed upon and executed on the same date.

III. If the delivery date of foreign currency is after ten days from the date of the agreement, it is referred to as Tom Market.

IV. If the delivery date of foreign currency takes place at a specified future date, it is referred to as forward transaction.

(a) (I), (II) and (III) above (b) (I), (II) and (IV) above

(c) (I), (III) and (IV) above (d) (II), (III) and (IV) above

(e) All (I), (II), (III) and (IV) above.

(1 mark)

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9.

Which of the following is not an advantage of rolling settlement system?

(a) It eliminates the need to synchronize the settlement dates across the exchanges

(b) It reduces settlement risk

(c) It reduces settlement period pressure as shares are delivered and cash is paid at the end of every week

(d) It narrows bid-ask spreads

(e) It reduces arbitrage and speculation in scrips.

(1 mark)

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10.

Which of the following statements is/are false regarding a rights offering?

I. The position of current shareholders is protected.

II. A rights offering provides the firm with a built-in securities market.

III. More interest may be generated in the market.

IV. The Rupee value of rights traded on exchanges is high.

(a) Only (I) above (b) Only (II) above

(c) Only (IV) above (d) (I),(II) and (III) above

(e) (I), (III) and (IV) above.

(1 mark)

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11.

An order has been limited at a fixed price of Rs.230 which includes a brokerage of Rs.10. What type of order is this?

(a) Limited discretionary order (b) Best rate order

(c) Immediate order (d) Limit order (e) Stop loss order.

(1 mark)

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12.

A government security in the form of stock certificate is

I. Transferable by endorsement.

II. Transferable on payment of stamp duty only.

III. Transferable by transfer deed only.

IV. Not transferable.

(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) Only (IV) above

(e) Both (II) and (III) above.

(1 mark)

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13.

A bond with a coupon rate of 6 month LIBOR + 0.5 is issued in the international capital market for a period of 6 years. This instrument can be categorized as

(a) Note issuance facility (b) Medium term notes

(c) American depository receipt (d) Straight debt bond

(e) Floating rate notes.

(1 mark)

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14.

Which of the following is/are the features of Eurobonds?

I. Taxes of any kind are withheld on interest payments.

II. They are in bearer form with interest coupon attached.

III. They are listed on one or more stock exchanges but issues are generally traded in the over-the-counter market.

(a) Only (I) above (b) Only (II) above (c) Only (III) above

(d) Both (I) and (II) above (e) Both (II) and (III) above.

(1 mark)

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15.

Joy Pharma Ltd. recently issued preference shares to redeem its outstanding debentures. The amount of preference dividend is same as the amount of interest on the debentures. How will the degree of financial leverage (DFL) of the firm be affected?

(a) It will increase

(b) It will decrease

(c) It will remain constant

(d) It will become zero

(e) The effect on DFL cannot be predicted.

(1 mark)

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16.

Suppose someone offered you the choice of two equally risky annuities, each paying Rs.10,000 per year for five years. One is an ordinary (or deferred) annuity; the other is an annuity due. Which of the following statement is true?

(a) The present value of the ordinary annuity must exceed the present value of the annuity due, but the future value of an ordinary annuity is less than the future value of the annuity due

(b) The present value of the annuity due exceeds the present value of the ordinary annuity, while the future value of the annuity due is less than the future value of the ordinary annuity

(c) The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity

(d) If interest rates increase, the difference between the present value of the ordinary annuity and the present value of the annuity due remains the same

(e) The present value of the annuity is less than the present value of annuity due while the future value of the annuity due is more than the future value of annuity.

(1 mark)

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17.

Mr. Prashant borrowed an amount of Rs. 7, 80,000 from M/s. Krishna Finance Ltd. As per the loan agreement, he has to repay Rs.3 lakhs at the end of 7^th year, Rs.4 lakhs at the end of 8^th year, Rs.2 lakhs at the end of 9^th year and Rs.1 lakh at the end of 10^th year from now. In order to meet these payments, he wants to deposit money in a bank scheme that offers an interest rate of 9% p.a. The approximate amount that Mr. Prashant should invest at the end of every year for a period of 6 years, so that he can repay the loan as per the agreement is

(a) Rs.1,02,090 (b) Rs.1,11,280 (c) Rs.1,21,293

(d) Rs.1,28,905 (e) Rs.1,89,389.

(2 marks)

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18.

Which of the following is/are true regarding the capital recovery factor?

I. It is the inverse of the PVIF factor.

II. It represents the amount that has to be invested at the end of every year for a period of ‘n’ years at the rate of interest ‘k’ in order to accumulate Re.1 at the end of the period.

III. It can be applied to find out the amount to be invested periodically to liquidate a loan over a specified period at a given rate of interest.

(a) Only (II) above (b) Only (III) above

(c) Both (II) and (III) above (d) Both (I) and (III) above

(e) All (I), (II) and (III) above.

(1 mark)

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19.

If the interest rate is 9% per annum, how much should you invest today in a bank scheme that would fetch you an annuity of Rs.2,000 for a period of 6 years commencing from the beginning of fourth year?

(a) Rs.6,352.18 (b) Rs.6,926.38 (c) Rs.7,554.42

(d) Rs.8,232.32 (e) Rs.10,655.50.

(1 mark)

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20.

The effective rate of interest under a particular scheme is 8.48%. If the frequency of compounding is three times in a year, the nominal rate of interest under the scheme is

(a) 6.78% (b) 7.35% (c) 8.25 % (d) 8.74% (e) 9.35%.

(1 mark)

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21.

Mr. Ajay Pathak borrowed Rs.1,00,000 from a bank to pay for a new air conditioning system. The loan is for a period of 5 years at an interest rate of 10% and requires 5 equal end-of-year payments that include both principal and interest on the outstanding balance. What will be the outstanding balance after the third payment?

(a) Rs. 15,245 (b) Rs. 20,865 (c) Rs. 45,788

(d) Rs. 50,866 (e) Rs. 60,000.

(1 mark)

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22.

Shruti, a government officer is trying to determine the cost of health care to college students, and their parents' ability to cover those costs. She assumes that the cost of one year of health care for a college student is Rs.1,000 today and it is expected to increase at the rate of 10% every year. The average student is 18 years old when he or she enters college. Parents can save Rs.100 per year at 6% for a period of 18 years since the birth of the child to help cover their children's health care costs. All payments occur at the end of the relevant period, and the Rs.100/year savings will stop the day the child enters college. Shruti wants a health care plan, which covers the fully inflated cost of health care for a student for 4 years, during Years 19 through 22 (with payments made at the end of years 19 through 22). How much would the government have to set aside now (when a child is born), to supplement the average parent's share of a child's college health care cost? (The lump sum the government sets aside will also be invested at 6 percent, annual compounding).

(a) Rs.1,082.76 (b) Rs.3,997.81 (c) Rs.5,674.23

(d) Rs.7,472.08 (e) Rs.8,554.84.

(2 marks)

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23.

In a forex market, if an investor wants to hedge his forex payments and have minimum risk, which of the following should the investor prefer?

(a) Sell the forex futures

(b) Enter into a forward contract to purchase the required forex

(c) Enter into a call option to purchase the required forex

(d) Buy forex futures

(e) Enter into a put option to sell the required forex.

(1 mark)

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24.

Which of the following is true, if beta of a stock is equal to one?

(a) The required rate of return on the stock is equal to the risk-free rate of return plus market return according to the CAPM approach

(b) According to the Single index model, the required rate of return on the stock will be more than the market return, if the alpha intercept of the Characteristic Regression Line is positive

(c) The stock is said to be correctly priced according to the CAPM approach

(d) If the market return varies by 10%, the return on stock varies by 1%

(e) The stock is said to be a defensive stock.

(1 mark)

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25.

If the return on a security lies below the security market line,

(a) The security is conservative security

(b) The security is aggressive security

(c) The risk free rate of return is more than the expected return from that security

(d) The security is over priced

(e) The security is under priced.

(1 mark)

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26.

What will happen to the Security Market Line, if inflation expectations increase and investors become more risk averse?

(a) Shift up and have a steeper slope (b) Shift down and have the same slope

(c) Shift down and have a steeper slope (d) Shift up but have less slope

(e) Shift up and have the same slope.

(1 mark)

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27.

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25 percent. The returns of the three stocks are independent of one another (i.e., the correlation coefficients are all equal to zero). Assume that there is an increase in the market risk premium, but that the risk-free rate remains unchanged. Which of the following statements is correct?

(a) The required return of all three stocks will increase by the amount of the increase in the market risk premium

(b) The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium

(c) The required return of all stocks will remain unchanged since there was no change in their betas

(d) The required return of the Stock B will remain unchanged, but the return on Stock C will decrease while the returns on Stock A will increase

(e) The required return of the average Stock B will remain unchanged, but the returns on Stock C will increase while the returns on Stock A will decrease.

(1 mark)

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28.

Assume that the rate of return on common stock of FTC Ltd. over the coming year is normally distributed with an expected value of 16% and a standard deviation of 20%. What is the probability of earning a negative rate of return?

(a) 3.59% (b) 10.56% (c) 16.49% (d) 21.19% (e) 40.13%.

(1 mark)

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29.

Consider the following information for three stocks, Stock A, Stock B, and Stock C. The returns on each of the three stocks are positively correlated, but they are not perfectly correlated.

Stock	Expected Return	Standard Deviation	Beta
Stock A	10%	20%	1.0
Stock B	10%	20%	1.0
Stock C	12%	20%	1.4

Portfolio P has half of its funds invested in Stock A and half invested in Stock B. Portfolio Q has invested its funds equally in each of the three stocks. The risk-free rate is 5 percent, and the market is in equilibrium. Which of the following statements is correct?

(a) Portfolio P has a standard deviation of 20 percent

(b) Portfolio P’s coefficient of variation is greater than 2.0

(c) Portfolio Q’s expected return is 10.67 percent

(d) Portfolio Q has a standard deviation of 20 percent

(e) Portfolio P’s required return is greater than the required return on Stock A.

(2 marks)

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30.

Which of the following assumptions is/are true while calculating the external funds requirement?

(a) Debt-Equity ratio will increase at a constant rate

(b) Net profit margin will increase at a constant rate

(c) Dividend payout ratio will remain constant

(d) Fixed assets will increase proportionately to sales while current assets remain constant

(e) The current liabilities will increase proportionately to sales.

(1 mark)

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31.

A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is 5 percent. What is the market risk premium?

(a) 1.30% (b) 6.30% (c) 6.50% (d) 7.25% (e) 15.00%.

(1 mark)

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32.

The current risk-free rate is 6 percent and the market risk premium is 5 percent. Harika is preparing to invest Rs.30,000 in the market and she wants her portfolio to have an expected return of 12.5 percent. Harika is concerned about bearing too much stand-alone risk; therefore, she will diversify her portfolio by investing in three different assets (two mutual funds and a risk-free security). The three assets she will be investing in are an aggressive growth mutual fund that has a beta of 1.6, an NSE 50 index fund with a beta of 1, and a risk-free security that has a beta of 0. She has already decided that she will invest 10 percent of her money in the risk-free asset. In order to achieve the desired expected return of 12.5 percent, what proportion of Harika’s portfolio must be invested in the NSE 50 index fund?

(a) 23.33% (b) 33.33% (c) 53.33% (d) 66.66% (e) 76.66%.

(2 marks)

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33.

A Ltd. and B Ltd. are two companies that manufacture computer hardware. The most recent dividend paid by these two companies is Rs.1.80 per share and the required rate of return for both the companies is 11%. The intrinsic value of the share of A Ltd. is Rs.34.12. The dividends of B Ltd. are expected to grow at a rate of 8% annually for 3 years, followed by “x%” annual growth rate from year 4 to infinity. The price of the security of A Ltd. is greater than the price of the share of company B by Rs.7.60. The value of “x” approximately is

(a) 1% (b) 2% (c) 3% (d) 4% (e) 5%.

(2 marks)

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34.

Which of the following is true regarding the earning power of two companies?

(a) Pre-tax earnings being same, higher the tax rate, lower the earning power

(b) Debt-equity ratio and pre-tax earnings being same, higher the interest rate, lower the earnings power

(c) Total assets being same, higher the debt-equity ratio, higher the earning power

(d) Pre-tax earnings being the same, greater the total assets, higher the earning power

(e) Sales and pre-tax earnings being the same, greater the total assets turnover ratio, higher the earnings power.

(1 mark)

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35.

Which of the following is not true with regard to valuation of bonds?

(a) An increase in the required rate of return, other things remaining the same, will decrease the bond value

(b) An increase in the number of years to maturity, other things remaining the same, will increase the present value of the face value of the bond payable at maturity

(c) An increase in the coupon rate, other things remaining the same, will increase the bond value

(d) An increase in the face value of the bond payable at maturity, other things remaining the same, will increase the bond value

(e) An increase in yield to maturity will occur, if the amount payable at maturity increases, other things remaining the same.

(1 mark)

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36.

Which of the following is/are true regarding price-earnings ratio (P/E)?

I. It reveals how earnings affect the market price of the firm’s stock.

II. It is the most popular financial ratio in the stock market for secondary market investors.

III. It is used to calculate the rate of return investors expect before they purchase the stock.

(a) Only (I) above (b) Both (I) and (II) above

(c) Both (I) and (III) above (d) Both (II) and (III) above

(e) All (I), (II) and (III) above.

(1 mark)

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37.

Which of the following is/are true with regard to the convertible debentures?

I. The conversion value is the minimum value of the convertible based on the current price of the issuer’s stock.

II. In case of optionally convertible debentures, on the exercise of the option of conversion the holder of the instrument has to pay the issuer the specified amount.

III. Conversion premium is the difference between the conversion price and the conversion value.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (II) above (d) Both (I) and (III) above

(e) Both (II) and (III) above.

(1 mark)

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38.

The current sales and net income of M/s. Excel Industries Ltd. is Rs.25 lakh and Rs.4 lakh respectively. It is expected to increase its sales by 30%. If the company maintains the present net profit margin ratio, pays out 30% as dividends and does not resort to external equity but maintains the debt-equity ratio of 1.75, the increase in borrowings will be

(a) Rs.2.10 lakh (b) Rs.3.64 lakh (c) Rs.5.20 lakh

(d) Rs.6.37 lakh (e) Rs.9.10 lakh.

(2 marks)

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39.

Rololar Industries Ltd. just paid a dividend of Rs.1.50, and projects supernormal growth rate of 12% for the next three years. After that growth is expected to slow down to a normal 4% and go on at that rate for the foreseeable future. Similar stocks are earning a return of 10%. How much would you pay for a share of Rololar Industries Ltd. today?

(a) Rs.26.00 (b) Rs.28.28 (c) Rs.32.08

(d) Rs.37.70 (e) Rs.45.25.

(2 marks)

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40.

Assume that you are considering the purchase of a Rs.1,000 par value bond that pays interest of Rs.70 semiannually and has 10 years to go before it matures. If you buy this bond, you expect to hold it for 5 years and then to sell it in the market. You (and other investors) currently require a nominal annual rate of 16 percent, but you expect the market to require a nominal rate of only 12 percent when you sell the bond due to a general decline in interest rates. How much should you be willing to pay for this bond?

(a) Rs.731.85 (b) Rs.842.00 (c) Rs.967.00

(d) Rs.1,115.81 (e) Rs.1,359.26.

(2 marks)

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41.

Which of the following are techniques of financial projection?

I. Proforma balance sheet.

II. Operating budget.

III. Projected income statement.

IV. Cash budget.

V. Projected statement of changes in financial position.

(a) Both (II) and (III) above (b) Both (I) and (IV) above

(c) (III), (IV) and (V) above (d) (II), (III) and (IV) above

(e) All (I), (II), (III), (IV) and (V) above.

(1 mark)

< Answer >

42.

Ms. Rajarsita Sur is interested to borrow some money from a private bank. She has the option to borrow using either a credit card that charges 1% per month or a loan from the bank with a 12 percent quoted nominal interest rate that is compounded quarterly. Which option should she choose?

(a) The Credit Card Loan with effective interest of 12% p.a

(b) The Credit Card Loan with effective interest of 12.4825% p.a

(c) The Bank Loan with effective interest of 12% p.a

(d) The Bank Loan with effective interest of 12.5509 %

(e) Without the information of the principal amount, it is not possible to comment.

(2 marks)

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43.

What is the current value of the common stock of Vizag Limited if you know the current dividend yield is 6.14%, the P/E is 16, and the annual dividend is Rs.1.35?

(a) Rs.8.29 (b) Rs.21.60 (c) Rs.21.99

(d) Rs.52.25 (e) Rs.98.24.

(1 mark)

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44.

Indiana’s stock is selling for Rs.70 today. Similar stocks are producing a return of 15%. You have estimated a capital gains yield of 10%. Calculate the next dividend expected on the stock.

(a) Rs.2.00 (b) Rs.2.50 (c) Rs.3.00 (d) Rs.3.50 (e) Rs.4.00.

(1 mark)

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45.

Bright Metals Ltd. issued fully convertible debentures with a face value of Rs.100 each. The coupon rate is 9 percent and the interest is payable half yearly over a period of three years. After three years, each bond will be converted into 10 equity shares of face value Rs.10 per share which is expected to fetch a dividend of Rs.1.00 per share every year. Presently, the yield on the risk-free securities is 5 percent per annum. The bondholders of the company need 3 percent more as the risk premium while the expected return to the equity shareholders will go up by an additional risk premium of 4 percent. The intrinsic value of these fully convertible debentures is: (Round off your answer to the nearest integer).

(a) Rs.83 (b) Rs.98 (c) Rs.118 (d) Rs.129 (e) Rs.136.

(2 marks)

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46.

According to Du-Pont equation for Return On Equity (ROE), other things remaining constant, which of the following statements is/are false?

I. An increase in the net profit margin will increase the ROE.

II. A decrease in debt to assets ratio will increase the ROE.

III. A decrease in return on assets will decrease the ROE.

IV. An increase in the average asset turnover will increase the ROE.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (II) above (d) Both (I) and (III) above

(e) (II), (III) and (IV) above.

(1 mark)

< Answer >

47.

Which of the following statements is/are false regarding coverage ratios?

I. Higher the debt service coverage ratio, lower the ability to meet the debt service obligations.

II. Interest coverage ratio measures debt servicing ability comprehensively because it considers all the interest, principal repayment obligations, lease payments and preference dividends.

III. Fixed charges coverage ratio considers the coverage of interest of pure debt only.

(a) Only (I) above (b) Only (II) above

(c) Both (I) and (III) above (d) Both (II) and (III) above

(e) All (I), (II) and (III) above.

(2 marks)

< Answer >

48.

Consider the following data about the companies M/S.X Ltd. and M/s.Y Ltd.

Particulars	X Ltd.(Rs.)	Y Ltd.(Rs.)
Sales	32,00,000	30,00,000
Net profit after tax	1,23,000	1,58,000
Equity capital (Rs.10 per share)	10,00,000	8,00,000
General reserves	2,32,000	6,42,000
Long-term debt	8,00,000	5,60,000
Creditors	3,82,000	5,49,000
Bank credit (short term)	60,000	2,00,000
Fixed assets	15,99,000	15,90,000
Inventories	3,31,000	8,09,000
Other current assets	5,44,000	4,52,000

Which of the following statements is/are false?

I. The quick ratio of company X exceeds company Y by 0.30.

II. The return on equity of company Y exceeds company X by 0.57%.

III. The earnings per share (EPS) of company Y exceeds company X by 0.745.

(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.

(2 marks)

< Answer >

49.

The net worth and total debt (carrying an average interest rate of 8 percent) of Subsonic Industries Ltd. amount to Rs.150 lakh and Rs.250 lakh respectively. The net profit of the company after deducting a marginal tax rate of 20 percent is Rs. 24 lakh. The return on investment of Subsonic Industries is

(a) 3.00 percent (b) 5.00 percent (c) 12.50 percent

(d) 20.00 percent (e) 33.33 percent.

(2 marks)

< Answer >

50.

If net profit margin is 12.50%, asset turnover ratio is 0.85 and return on net worth is 24%, the debt-asset ratio is

(a) 0.37 (b) 0.44 (c) 0.56 (d) 0.63 (e) 0.97.

(1 mark)

< Answer >

51.

Consider the following data of M/S PODDAR Ltd.

Gross profit (20 % of sales)	Rs.60,000
Share holder’s equity	Rs.50,000
Credit sales to total sales	80%
Total asset turnover ratio	3 times
Inventory turnover ratio (to cost of sales)	8 times
Average collection period (a 360 day year)	18 days
Current ratio	1.6
Long term debt to equity	40%

The creditors are

(a) Rs.30, 000 (b) Rs.20, 000 (c) Rs.60, 000 (d) Rs.55, 000 (e) Rs.50, 000.

(2 marks)

< Answer >

52.

Following figures are taken from the annual report of M/s. Laxmi Ltd. for the year ended 2004-05 :

12% Term Loan (principal to be repaid in 5 equal annual installments beginning from 2005-06)	Rs.10 lakh
14% Debentures (principal to be repaid in 6 equal annual installments beginning from 2005-06)	Rs.24 lakh
15% Perpetual Preference Shares	Rs.20 lakh
Net Worth	Rs.40 lakh
Applicable tax rate	40 %
Depreciation	Rs.5.44 lakh
Dividend per share	Rs.1.50
Number of outstanding shares	6,00,000
Dividend pay out ratio	100 %

Assuming that depreciation and dividend paid out remains the same, the fixed charges coverage ratio for the year 2005-06 for Laxmi Ltd. is

(a) 1.534 (b) 2.534 (c) 3.534 (d) 4.534 (e) 5.534.

(2 marks)

< Answer >

53.

The following information is related to Grand Hotels Ltd.:

Gross profit	Rs.45 lakh
Gross profit margin	20 percent
Total assets turnover ratio	3
Total debt to equity ratio	1.50
Current assets	Rs.35 lakh
Current ratio	2.50

What is outstanding amount of term loan in its balance sheet? (Assume term loan is the only interest bearing borrowings made by the company)

(a) Rs.22 lakh (b) Rs.25 lakh (c) Rs.28 lakh

(d) Rs.31 lakh (e) Rs.34 lakh.

(2 marks)

< Answer >

54.

Valence company’s stock and the market had the following returns during the last three years and the same trend is expected to continue in the future:

Year	1	2	3
Market (%)	16	8	0
Valence’s stock (%)	13	9	4

The gilt edged securities are trading at 6 percent. If equilibrium exists and the expected return on the market is 12 percent, what is the approximate expected return on Valence’s stock?

(a) –2.25% (b) 4.76% (c) 8.45% (d) 9.37% (e) 16.0%.

(2 marks)

< Answer >

55.

Following is the data of Tripti Manufacturing Company:

Particulars	(Rs.)
Provision for contingencies	60,000
Short term working capital investment	60,00,000
Short term loans and advances (given)	10,00,000
The following changes have occurred during the year:
Particulars	(Rs.)
Increase in provision for contingencies	10,000
Short term loans and advances (taken)	500,000
Decrease in short term working capital investment	30,00,000

After considering the above changes, the net working capital of the firm is

(a) Rs.70,000 (b) Rs.1,00,000 (c) Rs.9,30,000

(d) Rs.10,70,000. (e) Rs.34,30,000.

(2 marks)

< Answer >

56.

Current liabilities are Rs.20,000 and current assets are Rs.30,000. If debtors realized amount to Rs.6,000, raw materials purchased on credit amount to Rs.3,000 and Rs.6,000 worth of preference shares are converted into equity, the impact on the net working capital (NWC) would be

(a) Decrease of Rs.3,000 in NWC (b) Increase of Rs.3,000 in NWC

(c) No change in NWC (d) Increase of Rs.9,000 in NWC

(e) Decrease of Rs.9,000 in NWC.

(1 mark)

< Answer >

57.

Consider the following information of M/s. ABC Ltd:

Preference dividend	Rs.30,000
Corporate tax rate	40%
Interest	Rs.65,000
Fixed expenses	Rs.6,00,000
Selling price per unit	Rs.900
Variable cost per unit	Rs.400

The level of output at which Degree of Total Leverage (DTL) will be undefined is

(a) 1480 units (b) 1430 units (c) 1390 units (d) 1366 units (e) 1354 units.

(1 mark)

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58.

Consider the following information:

Expected return on market	15%
Required rate of return on stock X as per CAPM	13.2%
Beta of stock X	0.8
Expected rate of return on stock X	15%

Which of the following is/are true regarding stock X according to the Security Market Line (SML)?

I. It is correctly priced as its return is equal to the market return.

II. It is a stock of below average risk as its beta is less than 1.

III It is an over valued security as its expected rate of return is more than its required rate of return.

IV. It will lie below the SML as its beta is less than 1.

(a) Only (I) above (b) Only (II) above

(c) Both (II) and (IV) above (d) Both (II) and (III) above

(e) (II), (III) and (IV) above.

(1 mark)

< Answer >

59.

Which of the following statements is/are true with respect to funds flow statement?

(a) It shows the changes in the ownership patterns of the company

(b) It shows the sources and uses of funds at any particular date in a year

(c) It can be considered as a snapshot picture for the operations of the business

(d) It cannot be manipulated by means of window dressing

(e) It indicates how the business financed its fixed assets.

(1 mark)

< Answer >

60.

Which of the following is considered while preparing funds flow statement on working capital basis?

(a) Increase in pre-paid expenses (b) Payment of dividend

(c) Decrease in sundry creditors (d) Decrease in provision for tax

(e) Purchase of raw materials.

(1 mark)

< Answer >

61.

Which of the following is not shown by a funds flow statement on cash basis?

(a) The sources of cash (b) The uses of cash

(c) Decrease in cash (d) The net change in working capital

(e) Increase in cash.

(1 mark)

< Answer >

62.

The following details pertain to Sania Ltd:

Balance Sheet

Liabilities	1/4/2004 (Rs.)	31/3/2005 (Rs.)	Assets	1/4/2004 (Rs.)	31/3/2005 (Rs.)
Creditors	1,40,000	1,30,000	Cash in hand	50,000	70,000
Bills Payable	40,000	30,000	Cash at Bank	1,00,000	1,20,000
Bank overdraft	50,000	---	Debtors	1,65,000	1,00,000
Tax Provision	75,000	65,000	Prepaid Expenses	4,000	3,000
Reserves	80,000	80,000	Stock	1,50,000	1,00,000
P & L Account	84,000	28,000	Fixed Assets	5,00,000	4,80,000
Share Capital	5,00,000	6,00,000	Good will	---	60,000
	9,69,000	9,33,000		9,69,000	9,33,000

In 2004 – 2005 a dividend of Rs.84,000 was paid.

The assets of another corporation were purchased at Rs. 1,00,000 payable in 10,000 shares of Rs. 10/- each. The assets include – stock of Rs.10,000, fixed assets of Rs.30,000 and goodwill estimated at Rs. 60,000. Income tax paid in 2004-2005 was Rs.10,000.

The funds from operations are

(a) (Rs.56,000) (b) Rs.12,000 (c) Rs.38,000 (d) Rs.50,000 (e) Rs.88,000.

(2 marks)

< Answer >

63.

You are given the following comparative balance sheet of Durga. Ltd.

Particulars	2004 (Rs.)	2005 (Rs.)
Assets:
Cash	4,700	3,000
Debtors	11,500	12,000
Land	6,600	5,000
Stock	9,000	8,000
	31,800	28,000
Liabilities:
Accounts Payable	4,500	7,000
Capital	25,000	20,000
Retained Earnings	2,300	1,000
Total	31,800	28,000

The amount of net increase/decrease in working capital and funds generated/lost from the operations respectively are

(a) Rs.5,200 increase and Rs.1,000 generated

(b) Rs.5,200 decrease and Rs.1,000 lost

(c) Rs.4,700 increase and Rs.2,300 generated

(d) Rs.4,700 increase and Rs.2,300 lost

(e) Rs.4,700 increase and Rs.1,300 lost.

(2 marks)

< Answer >

64.

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years remaining to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required nominal rate on this debt has now risen to 16 percent. What is the current value of this bond (Face Value = Rs.1,000 per bond)?

(a) Rs.273 (b) Rs.345 (c) Rs.483 (d) Rs. 550 (e) Rs. 650.

(2 marks)

< Answer >

65.

The conservative firm will utilize

(a) A high degree of operating leverage (b) A low degree of operating leverage

(c) Higher fixed costs (d) A higher profit margin

(e) Lower fixed costs.

(1 mark)

< Answer >

66.

Which of the following is/are true regarding leverages?

I. When the firm is operating at a level greater than the operating breakeven point, DOL decreases as the level of quantity produced and sold increases.

II. As fixed cost increases, financial breakeven point decreases.

III. Increase in debt financing increases the fluctuations in the return on equity.

(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) Both (I) and (III) above

(e) Both (II) and (III) above.

(1 mark)

< Answer >

67.

Pacific Ltd. is a toy manufacturing company. The Degree of Operating Leverage and the Degree of Financial Leverage for the company are 1.1 and 1.5 respectively. The company has a debt of Rs.6 crore on which interest is paid at 10% p.a. It has a preference capital of Rs.4 crore on which preference dividend is payable at 10 % p.a. The variable cost to sales ratio is 40%. The tax rate applicable to the firm is 50%.

The sales revenue and the fixed costs of the firm are respectively:

(a) Rs. 7.7 crores and Rs. 40 lakhs (b) Rs. 7.0 crores and Rs. 42 lakhs

(c) Rs. 7.7 crores and Rs. 42 lakhs (d) Rs. 8.0 crores and Rs. 50 lakhs

(e) Rs. 9.6 crores and Rs. 40 lakhs.

(2 marks)

< Answer >

68.

The EBIT for a company at 6,000 level of production is Rs.7,50,000. At the financial break even point, the EBIT of the company is Rs.2,10,000. The Degree of Financial Leverage (DFL) for the company at 6000 level of production is

(a) 1.56 (b) 1.51 (c) 1.49 (d) 1.46 (e) 1.39.

(1 mark)

< Answer >

69.

Consider the following data regarding M/s. Delta Ltd:

Total assets	Rs.56 lakhs
Fixed operating costs	Rs.24 lakhs
Variable cost to sales ratio	0.6
Total asset turnover ratio	2
Interest coverage ratio	3.2

Which of the following statements is/are true?

(a) If the sales increase by 1%, EPS will increase by 3.12%

(b) If the sales decrease by 1%, EBIT will decrease by 2.15%

(c) If EBIT increases by 1%, EPS will increase by 3.12%

(d) If the sales increase by 1%, EBIT will increase by 1.56%

(e) Both (a) and (b) above.

(2 marks)

< Answer >

70.

What is the degree of operating leverage (DoL) for Telco Ltd. given the following information?

Quantity produced	10,000 units
Variable cost per unit	Rs.3,60,000
Selling price per unit	Rs.6,50,000
Fixed cost	Rs.6.00 crore

(a) 1.02 (b) 1.85 (c) 1.96 (d) 2.85 (e) 3.00.

(1 mark)

< Answer >

71

For the year 2005-06, Bagaria Industrial Corporation Ltd. targeted to increase its sales turnover to Rs.1560 lakh which is 30 percent more than the sales in the year 2004 – 05. The fixed assets as well as the spontaneous liabilities of the company are expected to increase proportionately with the increase in sales. The fixed assets are 66.67 percent of the total assets and 40 percent of the current assets are financed by spontaneous liabilities. The annual report for the year 2004-05 indicates that the company maintained a total assets turnover ratio of 1.6 and recorded a net profit margin of 8 percent and retained 40 percent of its total earnings. How much amount of external funds should be required by the company in order to achieve the targeted growth rate? (Round off your answer to the nearest integer.)

(a) Rs.145 lakh (b) Rs.165 lakh (c) Rs.180 lakh (d) Rs.200 lakh (e) Rs.225 lakh.

(2 marks)

< Answer >

72

If the degree of operating leverage is increased by 50% and the degree of financial leverage is decreased by 20%, then the degree of total leverage will

(a) Decrease by 20% (b) Remain unchanged (c) Increase by 20%

(d) Increase by 50% (e) Increase by 100%.

(1 mark)

< Answer >

73

Reshmi Beverages has the following historical balance sheet:

(Rs in lakhs)

Liabilities		Assets
Equity Capital	270	Net plant & equipment	420
Retained earnings	110	Accounts receivable	240
Long term bonds	260	Inventory	320
Accounts payable	200	Cash	20
Notes Payable	130
Accruals	30

Over the next year Reshmi’s current assets and accounts payable will grow in proportion to sales. Sales for the last year were Rs.800 lakhs and this year’s sales are expected to increase by 40 percent. The firm will retain Rs.58 lakhs in earnings to fund current asset growth, and the rest of the increase will be funded entirely with accounts payable. The net plant and equipment account will increase to Rs.500 lakhs and will be funded directly by a new equity issue. What will Reshmi's new current ratio be after the changes in the firm's financial picture are complete?

(a) 1.52 (b) 1.61 (c) 1.26 (d) 1.21 (e) 1.37.

(2 marks)

< Answer >

74

Prakash’s father, who is 60, plans to retire in 2 years, and live independently for 3 years after retirement. His father wants to have a real income of Rs.40,000 in today's rupees in each year after he retires. His retirement income will start the day he retires, 2 years from today, and he will receive a total of 3 retirement payments.

Inflation rate is expected to be constant at 5 percent. Prakash’s father has Rs.1,00,000 in savings on which he can earn 8% interest. How much should he save each year, starting today, to meet his retirement goals?

(a) Rs.1,863 (b) Rs.2,034 (c) Rs.2,716

(d) Rs.5,350 (e) Rs.6,102.

(2 marks)

< Answer >

Suggested Answers
Financial Management – I (141) : January 2006

1.

Answer : (a)

Reason : A decrease in the pay-out ratio increases the sustainable growth rate. Hence the answer is (a).

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2.

Answer : (e)

Reason : When the market value of the firm increases, the wealth of its owners increases. The ultimate objective of financial management is to maximize the wealth of the owners. All the other alternatives may not necessarily maximize the wealth of the owners.

Hence option (e) is the answer.

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3.

Answer : (d)

Reason : In a Public Limited Company :

Minimum number of persons to form a Public Limited Company is Seven.

Disqualification of a Director under section 274 (1)(g) of the Companies Act, 1956 is applicable.

Minimum number directors is Three.

Formation of Audit Committee is applicable to companies whose paid up capital is not less than Rs.5 Crores is a true statement.

Quorum required for a General Meeting is 5.

Hence option (d) is the answer.

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4.

Answer : (d)

Reason : Option is a contract that confers the right, but not the obligation to the holder to buy (call option) or to sell (put option) an underlying asset at a price agreed on a specific date or by a specific expiry date.

The futures contracts are always traded on an organized exchange with standardized terms of contract.

The clearing house gurantees that all the traders in the futures market honor their obligations .

Hence option (d) is the answer.

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5.

Answer : (e)

Reason : The Cash Reserve Ratio is the cash that banks deposit with reserve bank as a proportion of their deposits. It is a true statement.

The bank rate is the rate at which the RBI rediscounts the first class commercial bills of exchange and not at which the RBI issues its 365 days T-Bills. Statement (II) is not true.

Statutory Liquidity Ratio is the reserve in addition to the Cash Reserve Ratio where the banks are required to maintained specified reserves in the form of government securities, specified bonds and approved securities. Statement (III) is not true.

Hence option (e) is the answer.

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6.

Answer : (d)

Reason : Expected nominal rate of interest is equal to real rate of interest + expected rate of inflation + risk premium. If expected rate of inflation and risk premium are zero, expected nominal rate of interest is equal to real rate of interest. Hence, statement II is true. In the above equation if expected rate of interest is equal to risk premium, expected nominal rate of interest exceeds the real rate of interest by twice the risk premium. Hence, III is also true and the answer is (d).

If expected rate of inflation and risk premium are more than zero, expected nominal rate of interest will be more than the real rate of interest. Hence, I is incorrect. Hence option (d) is the answer.

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7.

Answer : (d)

Reason : Yield is calculated as

Where, F is face value

P is purchase price

d is the duration/maturity period

In the given case, yield =

If yield = 11.5%, P is calculated as,

= 0.115

=

= 0.0189

or, 1.0189 P = 100 Þ P = or, P = Rs.98.14. Hence option (d) is the answer.

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8.

Answer : (b)

Reason : The day on which delivery of foreign currency takes place is known as Value Date. It is a true statement.

Ready transaction is an agreement to buy and sell in the forex market which is agreed upon and executed on the same date. It is a true statement.

If the delivery date of foreign currency is the second working day of the day of the agreement, it is referred to as Spot Market and not Tom Market. Thus statement (III) is not true

If the delivery date of foreign currency takes place at a specified future date, it is referred to as forward transaction, whose duration varies from one month to three months. It is a true statement.

Hence option (b) is the answer.

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9.

Answer : (c)

Reason : Reduces settlement period pressure as shares are delivered and cash is paid everyday and not at the end of every week. The rolling settlement spreads the delivery and payment throughout the week.

Hence option (c) is the answer.

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10.

Answer : (c)

Reason : The subscription price for shares, under a rights offering, is usually somewhat lower than the current market share price. This and the short time before expiry of the right keep the value of the right to a minimum. Hence the statement the rupee value of rights traded on exchanges is high is false.

Hence option (c) is the answer.

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11.

Answer : (d)

Reason : Limit order is a type of order where it is limited by fixed price, which may include brokerage.

Hence option (d) is the answer.

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12.

Answer : (c)

Reason : A Government security in the form of stock certificate is transferable by transfer deed only.

Hence option (c) is the answer.

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13.

Answer : (e)

Reason : FRNs can be described as bonds issued with a maturity of 5-7 years having coupon rate pegged with another security /libor/ refixed at periodic intervals.

Hence option (e) is the answer.

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14.

Answer : (e)

Reason : All Eurobonds, through their features can appeal to any class of issuer or investor. The characteristics which make them unique and flexible are:

a. No withholding of taxes of any kind on interests payments.

b. They are in bearer form with interest coupon attached.

c. They are listed on one or more stock exchanges but issues are generally traded in the over-the-counter market.

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15.

Answer : (a)

Reason : Degree of Financial Leverage (DFL) =

Now, as the coupon rate of the debentures and preference shares is same, so I = D_p

But interests on debentures is a pre-tax expense while the dividend on preference share is a
post-tax expense.

As the tax rate T>O, the DFL of the company will increase as the negative part of the denominator increases.

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16.

Answer : (c)

Reason : By definition, an annuity due is received at the beginning of the year while an ordinary annuity is received at the end of the year. Because the payments are received earlier, both the present and future values of the annuity due are greater than those of the ordinary annuity.

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17.

Answer : (b)

Reason : At the end of 6 years, the future value of the amount that Prashant deposits each year for a period of 6 years, should be equal to the present value of the payments that he has to make under the loan agreement in the 7^th, 8^th, 9^th and 10^th years.

The discounted value of the payments to be made at the end of 7^th, 8^th, 9^th and 10^th years, as at the end of the 6^th year =

Future value of the deposits made at the end of every year, for a period of 6 years =

X. FVIFA_{(9%, 6 years)} ( where X is the amount to be invested at the end of every period till 6 years).

X. FVIFA_{(9%, 6 years)} = Rs. 8.3721 lakh

X = i.e. Rs. 1,11,280.

Hence, Prashant has to deposit Rs. 1,11,280 at the end of every period for 6 years so as to be able to make the payments under the loan agreement.

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18.

Answer : (b)

Reason : Capital recovery factor is the inverse of the PVIFA factor. It can be applied to find out the amount that can be withdrawn periodically for a certain length of time, if a given amount is invested today. Hence I is not true and III is true and the answer is (b). Hence option (b) is the answer.

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19.

Answer : (c)

Reason : Amount that you should invest = Rs 2,000 x PVIFA_{(9%,6 years)} x PVIF_{(9%,2 years)}

= 2,000 x 4.486 x 0.842 = Rs. 7,554.42

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20.

Answer : (c)

Reason : If ‘k’ is the nominal interest rate then the effective interest rate (say ‘r’) can be computed as:

r = (1+)^m – 1 where, m is the frequency of compounding per year.

Hence, 0.0848 = (. Hence, k = 8.25%.

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21.

Answer : (c)

Reason : A= Rs 100,000/3.791 = Rs.26,378.26

Balance = Rs 100,000 – Rs 16,378 – Rs 18,016 – Rs 19,818 = Rs 45,788

Year	Installment	Interest @10%	Principal	Outstanding Principal
1	Rs.26, 378.26	Rs.10,000.00	Rs.16, 378.26	Rs.83, 621.74
2	Rs.26, 378.26	Rs.8, 362.17	Rs.18, 016.09	Rs.65, 605.65
3	Rs.26, 378.26	Rs.6, 560.56	Rs.19, 817.70	Rs.45, 787.95

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22.

Answer : (d)

Reason : Parent's savings:

N = 18

I = 6 %

AMT = 100

FV = 0

PV = Rs1,082.76.

Health Care Costs, Years 19-22:

-Rs1,000(1.1)¹⁹ = -Rs6,115.91

-Rs1,000(1.1)²⁰ = -Rs6,727.50

-Rs1,000(1.1)²¹ = -Rs7,400.25

-Rs1,000(1.1)²² = -Rs8,140.27

PV of Health care costs =

-Rs.8,554.84 PV of Health care costs

Rs.1,082.76 PV of parents' savings

-Rs7,472.08 Lump sum government must set aside

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23.

Answer : (c)

Reason : Call option is a contract that confers the right, but not an obligation to the holder to buy an underlying asset at a price agreed on a specific date or by a specific expiry date. In the given case, the investor is interested to hedge his forex payments and have a minimum risk position. Hence, it is better for him to enter into a call option to purchase the required forex at an agreed price on the expected future date. Thus if the exchange rate behaves against the expectation the investor shall not exercise his right and the loss that will be incurred will be only the premium paid by him to the writer of the option. Hence, the answer is (c).

Though payment can be hedged through purchasing the forex futures or entering into a forward contract to purchase, there is no downside limit to the loss that can be incurred.

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24.

Answer : (b)

Reason : According to the single-index model, the required rate of return on stock is equal to alpha + beta (Market return). If beta is equal to one, required rate of return will be equal to alpha +market return and if the alpha intercept is more than one, then the required rate of return will be more than the market return. Hence (b) is true.

According to the CAPM approach, required rate of return is equal to risk free rate of return + beta(market return – risk free rate of return). If beta is equal to one, required rate of return will be equal to market return. Hence, (a) is not correct.

According to CAPM, a stock is said to be correctly priced if expected rate of return is equal to required rate of return. Hence, (c) is not correct.

Beta is equal to one implies that if market return increases by 10%, the return on the stock varies by 10%. Hence, (d) is also incorrect.

A defensive stock has a beta of less than one. Hence, (e) is also not correct.

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25.

Answer : (d)

Reason : As the return on a security lies below the security market line, the security is over priced as the expected return is less than the required return. The statements as stated in the options (a), (b) and (c) are not related to the security market line.

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26.

Answer : (a)

Reason : If inflation expectations increase, investors will demand more return and hence SML will move upwards and if investors become more risk averse so risk free rate will go down thus will increase the slope of the SML.

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27.

Answer : (b)

Reason : If there is an increase in the market risk premium, but the risk-free rate remains unchanged then the required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

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28.

Answer : (d)

Reason : _{P = 0.2119 or 21.19%}

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29.

Answer : (c)

Reason : Standard deviation of portfolio P will be less than 20% since the correlation coefficients are between 0 and 1.

Expected return from portfolio P = 0.5 x 10 + 0.5 x 10 = 10%

Portfolio P’s coefficient of variation will be less than 2.0 since S.D. is less than 20% and expected return is 10%.

Expected return from portfolio Q = 1/3(10 + 10 +12) = 10.67%

Standard deviation of portfolio Q will be less than 20% since the correlation coefficients are between 0 and 1.

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30.

Answer : (c)

Reason : External funds requirement is equal to

Where EFR = External financing requirement

A/S = Current assets and fixed assets as a proportion of sales

DS = Expected increase in sales

L/S = Spontaneous liabilities as a proportion of sales

m = net profit margin

S₁ = Projected sales for next year

d = Dividend pay-out ratio.

The above equation assumes that the dividend pay-out ratio remain constant. Hence, the answer is (c).

In the above equation the assets of the firm are assumed to increase proportionately to sales and not cost of goods sold. Hence, (a) is not true. Similarly, net profit margin is assumed to be constant. Hence, (b) is also not true. Fixed assets, current assets and spontaneous liabilities are assumed to increase proportionately to sales. Hence, (d) and (e) are also not true.

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31.

Answer : (b)

Reason : 12.25% = 5% + (RP_M)1.15

7.25% = (RP_M)1.15

RP_M = 6.30%.

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32.

Answer : (a)

Reason : The aggressive growth mutual fund has an expected return of:

k_AGMF = 6% + (5%)1.6 = 14%.

The NSE 50index fund has an expected return of:

k_SP500 = 6% + 1.0(5%) = 11%.

So, to get the return she desires, Harika must solve for X, the percentage of her portfolio invested in the NSE 50index fund:

12.5% = 0.10(6%) + (0.90 – X)(14%) + X(11%)

11.9% = 12.6% - 14%X + 11%X

-0.7% = -3%X

0.2333 = X.

So invest 23.33% in the NSE 50index fund, invest 66.67% in the aggressive growth fund, and invest 10.00% in the risk-free asset.

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33.

Answer : (c)

Reason : Intrinsic value (IV) of A Ltd. = Rs.34.12

\ IV of B Ltd. = 34.12 – 7.60

Price of B Ltd. = 34.12 – 7.60 = Rs.26.52

Price = PV of dividends

=

= 1.751 + 1.704 + 1.658 +

1.658 + 1.658x = 2.355 – 21.407x

23.065x = 0.6968

x = 0.03

Hence x = 3% and answer is (c).

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34.

Answer : (e)

Reason : Earnings power is not affected by tax and leverage. Hence, (a), (b) and (c) are not correct.

Greater the total assets, lower the earning power. Hence, (d) is also not correct. Sales and pre-tax earnings being the same, earning power would be higher if the total assets turnover ratio is higher. Hence, the answer is (e).

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35.

Answer : (b)

Reason : In the intrinsic value formula the face value of the bond is multiplied with the factor PVIF(r,n). The factor PVIF(r,n) decreases as the number of years to maturity increases, other things remaining the same. Hence, other things remaining the same, the present value of the face value of the bond decreases as the number of years to maturity increases. Therefore alternative (b) is not true. All other alternatives are true.

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36.

Answer : (e)

Reason : The price-earnings ratio (also P/E multiple) is calculated by taking the market price of the stock and dividing it by earnings per share.

The ratio gives the relationship between the market price of the stock and its earnings by revealing how earnings affect the market price of the firm’s stock. If a stock has a low P/E multiple, for example 3/1, it may be considered as an undervalued stock. If the ratio is 80/1, it may be viewed as overvalued. Hence, (I) is true. It is the most popular financial ratio in the stock market for secondary market investors. The P/E ratio method is useful as long as the firm is a viable business entity, and its real value is reflected in it’s profits. Hence (II) is true. It helps to determine the expected market value of a stock. Hence (III) is true. The P/E ratio also may be used to calculate the rate of return investors expect before they purchase a stock.

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37.

Answer : (d)

Reason : The conversion value represents the market value of the convertible if it were converted into stock. This is the minimum value of the convertible based on the current price of the issuer’s stock. Hence, I is true. Conversion premium is the difference between the conversion price and the conversion value. Hence, III is also true and the answer is (d).

Whether it is optionally convertible debenture or compulsorily convertible debenture, whether it is fully convertible or partially convertible debenture, on conversion cash is not involved. It is merely, the old security is traded and appropriate number of new securities is issued in turn. Hence, II is incorrect.

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38.

Answer : (d)

Reason : New sales = 25 (1.3) = Rs.32.5 lakhs

NPM = ,

New PAT = 32.5 x 0.16 = Rs.5.2 lakhs

Dividends = 30% of 5.2 = Rs.1.56 lakhs

Retained earnings = Rs.3.64 lakhs

Increase in borrowings = 3.64 x 1.75 = Rs.6.37 lakhs

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39.

Answer : (c)

Reason :

D₁ = 1.50(1.12) = 1.68 D₂ = 1.88 D₃ = 2.11 D₄ = 2.11(1.04) = 2.19

P₃ = 2.19/(.10 – .04) = 36.50

P₀ = 1.68(.9091) + 1.88(.8264) + 2.11(.7513) + 36.50(.7513) = Rs.32.08

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40.

Answer : (c)

Reason : The expected market price at the end of the 5^th year

= Rs.70(PVIFA_6%,10) + Rs.1,000(PVIF_6%,10)

= Rs.70(7.3601) + Rs.1,000(0.5584) = Rs.1,073.61.

Market Price of the Bond at Present value

= Rs.70(PVIFA_8%,10) + Rs.1,073.61(PVIF_8%,10)

= Rs.70(6.7101) + Rs.1,073.61(0.4632) = Rs.967.00.

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41.

Answer : (e)

Reason : All the given techniques are used to forecast financial statements. Hence, (e) is the answer.

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42.

Answer : (d)

Reason : Credit card loan : Effective Annual rate = (1 + 0.01)¹² – 1.0 = (1.01)¹² –1.0 = 1.126825 – 1.0

=0.126825 = 12.6825 %

Bank loan : Effective Annual rate = (1 + 0.03)⁴ – 1.0 = (1.03)⁴ –1.0 = 1.125509 – 1.0

=0.125509 = 12.5509 %

Hence, option (d) is the correct option.

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43.

Answer : (c)

Reason : Price = dividend/current yield = Rs.1.35/0.0614 = Rs.21.99

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44.

Answer : (d)

Reason : k = D₁/P₀ + (P₁ – P₀)/P₀

15% = Dividend Yield + 10%

Dividend Yield = 5% = D₁/P₀

5% = D₁/70

D₁ = Rs.3.50

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45.

Answer : (a)

Reason : Discount rate before conversion = 5 + 3 = 8 percent and the same after conversion will be = 8 + 4 = 12 percent.

The expected cash flows from that instrument will be as follows:

Year	1	2	3	4	5	6
Cash flows	9	9	9	10	10	10

Here, the cash flows for the first three years will occur half-yearly where each installment is of Rs.4.50 and it has been assumed that the holder of the instrument will hold all the shares and will get the dividends.

The intrinsic value of the debentures is = Present value of all the above cash flows

= Rs.4.50 × PVIFA (4%,6) +10 × {PVIF (12%,4) + PVIF (12%,5) + PVIF (12%,6) + ….}

= Rs.4.5 ´ 5.24 +

Hence, the required intrinsic value = Rs.82.90 = Rs.83 (approximately).

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46.

Answer : (b)

Reason : According to Du-Pont equation:

Return On Equity (ROE) = Net Profit Margin x Average Asset Turnover x Equity Multiplier

Where, Equity Multiplier = .

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.

When net profit margin and /or average asset turnover ratio increases ROE will increase. Hence, statements (I) and (IV) are correct.

ROE can also be written as Return On Equity (ROE)= Return on assets x Equity Multiplier.

Decrease in Return On Assets decreases the ROE. So statement (III) is also correct.

Hence, option (b) is correct answer.

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47.

Answer : (e)

Reason : Debt service coverage ratio=(PAT + Depreciation + Other non-cash charges + interest on term loan)/(Interest on term loan + Repayment of the term loan)

Higher the debt service coverage ratio, greater the ability to meet the total obligations. So statement (I) is incorrect.

Interest coverage ratio=EBIT/Interest expense

Interest coverage ratio considers the coverage of interest of pure debt only. So statement (II) is incorrect.

Fixed charges coverage ratio=(Earnings before depreciation, debt interest and lease payments and taxes)/(Debt interest + Lease rentals+(Loan repayment installment)/(1-tax rate)+Preference dividends/(1-tax rate))

Fixed charges coverage ratio measures debt servicing ability comprehensively because it considers all the interest, principal repayment obligations, lease payments and preference dividends. So statement (III) is incorrect.

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48.

Answer : (d)

Reason : Quick ratio=(current assets-inventory)/current liabilities

Quick ratio (company X) =Rs.5, 44, 000/Rs.4, 42, 000=1.23

Quick ratio (company Y)=Rs.4, 52, 000/Rs.7, 49, 000=0.60

So quick ratio of company X exceeds company Y by 0.63

So statement (I) is incorrect.

Return on equity funds=net profit/equity funds.

Return on equity funds (company X)=Rs.1, 23, 000/Rs.12, 32, 000=9.98%

Return on equity funds (company Y)=Rs.1, 58, 000/Rs.14, 42, 000=10.96%

So return on equity funds of company Y exceeds company X by 0.98%

So statement (II) is incorrect.

Earnings per share (EPS)=net profit/Number of shares.

Earnings per share (EPS)(company X)=Rs.1, 23, 000/1, 00, 000=1.23

Earnings per share (EPS)(company Y)=Rs.1, 58, 000/80, 000=1.97

So Earnings per share (EPS) of company Y exceeds company Y by 0.74

So statement (III) is correct.

Hence option (d) is the answer.

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49.

Answer : (c)

Reason : Total asset of a company is financed by equity capital and total debt.

So, the total asset of Subsonic Industries = Rs.150 lakh + Rs.250 lakh = Rs.400 lakh.

The return on investment (ROI) of a company is defined as:

ROI = = = 12.50 percent.

Here, post-tax income = Rs.24 lakh and so the pre-tax earnings = Rs.30 lakh as the tax rate = 20 percent. Interest expenses = Rs.250 lakh ´ 8 percent = Rs.20 lakh.

Hence, the amount of earnings before interest and taxes = Rs.30 lakh + Rs.20 lakh = Rs.50 lakh.

So, the return on investment for Subsonic Industries Ltd. = 12.50 percent.

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50.

Answer : (c)

Reason : Return on net worth = Net profit margin ´ Asset turnover ´

or, 0.24 = 0.125 ´ 0.85 ´

or, = = 2.26

\= 0.443

1 – = = = 1 – 0.443 = 0.557 » 0.56

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51.

Answer : (a)

Reason : Creditors=(total liabilities-equity-long-term debt)

Gross profit margin=gross profit/sales x 100

Sales=Rs.60, 000/20%=Rs.3, 00, 000

Total asset turnover ratio=sales/total assets=3.

=Rs.3, 00, 000/total assets=3.

So total assets=total liabilities=Rs.1, 00, 000

Debt-equity ratio =Long term debt/equity=0.40

=Long term debt=0.40x50, 000=20, 000

So creditors=Rs.1, 00, 000-Rs.50, 000-Rs.20, 000=Rs.30, 000

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52.

Answer : (a)

Reason : Fixed charges coverage ratio

=

Here interest on term loan and debentures = 10 ´ 12% + 24 x 14% = Rs.4.56 lakhs.

Loan repayment installments = = 2 + 4 = Rs.6 lakhs.

Preference dividends = 20 ´ 0.15 = Rs.3.00 lakhs.

The amount of dividend paid by the company = Rs.1.50 ´ 600,000 = Rs.9.00 lakh

and so the net profit of the company is = 9 + 3 = Rs.12 lakh.

So, profit before tax = 12/(1 - 0.4 ) = Rs.20 lakh

Hence, the profit before interest, depreciation and taxes was = 20 + 5.44 + 4.56 = Rs.30 lakh

So, the required fixed charges coverage ratio is

== = = 1.534

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53.

Answer : (d)

Reason : Gross profit = Rs.45 lakhs and gross profit margin = 0.2

So, the sales turnover = = Rs.225 lakhs

Total assets = = = Rs.75 lakhs.

But, total assets = Total liabilities = Total Debt + Total equity

and the total debt equity ratio = 1.50

So, total debt = 75 ´ = Rs.45 lakhs.

And total equity = 75 ´ = Rs.30 lakhs

Now, the amount of current liabilities

= = = Rs.14 lakhs

So, the amount of term loan in its balance sheet = 45 – 14 = Rs.31 lakhs.

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54.

Answer : (d)

Reason : Average return on market= 8%

Average return on valance stock =

=

Beta of the stock = 0.5625

Expected return = 0.06 + 0.5625(0.12 – 0.06) = 9.37%.

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55.

Answer : (e)

Reason : Provision for contingencies =60,000 + 10,000 = Rs. 70,000

Short term investment = 60,00,000 – 30,00,000 = Rs.30,00,000

Therefore Current assets = 30,00,000 +10,00,000 = Rs.40,00,000

Current liabilities = 70,000 + 500,000 = Rs. 570,000

Net working capital = 40,00,000 –570, 000 = Rs.34,30,000

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56.

Answer : (c)

Reason : Realization of debtors involves conversion of receivables to cash. To that extent the current assets remain constant. Raw materials purchased on credit causes an equal increase in current assets (inventory) and current liabilities (Sundry creditors). Conversion of preference shares in to equity involves the conversion of one form of long term finance to another form of long term finance. Considering the above we can say that there is no change in the NWC.

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57.

Answer : (b)

Reason : The point at which DTL is undefined is called the overall break-even point. At this point the quantity produced can be computed as:

Q = ,

Where, F is the fixed expenses

I is the interest expense

D_p is the preference dividend

T is the corporate tax rate

S is the selling price per unit and V is the variable cost per unit

Hence Q = = 1,430 units.

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58.

Answer : (b)

Reason : Beta is a measure of the non-diversifiable risk of an asset relative to that of the market portfolio. Beta of the market portfolio is 1 and the securities with beta of less than 1 are classified as securities with below average risk and beta of more than 1 as securities with above average risk. Hence, statement II is true.

According to SML, a security is said to be correctly priced, if its required rate of return according to SML is equal to its expected return. As the required rate of return is not equal to the expected return the stock cannot be said to be correctly priced. Hence, statement I is not true. If the expected rate of return is more than the required rate of return the stock is said to be undervalued and if the expected rate of return is less than the required rate of return it is said to be overvalued. In the given case, as the expected rate of return is more than the required rate of return, the stock is an undervalued security. Hence, statement III is not true. When security’s expected return and beta are plotted on a graph with reference to the SML of the security, the security will lie above the SML if it is undervalued and will lie below the SML if it is overvalued. In the given case, as the security is undervalued it will lie above the SML and the beta of the security is immaterial. Hence, statement IV is not true.

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59.

Answer : (e)

Reason : Except alternative (e), all are false with respect to funds flow statement.

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60.

Answer : (b)

Reason : All other alternatives will cause either an equal increase in current assets and current liabilities or an increase in one current asset and decrease in another current asset by the same amount or an equal decrease in current liabilities and current assets or a decrease in one current liability and increase in another current liability by the same amount. These will not cause any change in the working capital position. Hence, these are not considered while preparing funds flow statement on working capital basis.

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61.

Answer : (d)

Reason : A funds flow statement on cash basis does not show the net change in working capital.

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62.

Answer : (e)

Reason : Funds from operations (Rs.) :

Closing Balance of P & L A/c.	28,000
Less : Opening balance of P & L A/c	(84,000)
	(56,000)
Add : Dividends Paid	84,000
Add : Income Tax Paid	10,000
Add : Depreciation	50,000
	88,000
Calculation of Depreciation :
Opening Balance of Fixed Assets:	5,00,000
Add : Purchase	30,000
	5,30,000
(-) Closing Balance of Fixed assets	(4,80,000)
Depreciation	50,000

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63.

Answer : (e)

Reason :

Particulars	2004	2005	Increase	Decrease
	(Rs.)	(Rs.)	(Rs.)	(Rs.)
Current Assets:
Cash	4,700	3,000		1,700
Debtors	11,500	12,000	500
Stock	9,000	8,000		1,000
Current Liabilities:
Accounts Payable	4,500	7,000		2,500
Decrease in working Capital			4,700
			5,200	5,200

Funds lost from Operations: (Rs.)

Retained earnings 2005 1,000

Less earnings 2004 2,300

1,300

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64.

Answer : (d)

Reason :

Numerical solution:

V_B = Rs.40(PVIFA_8%,30) + Rs.1,000(PVIF_8%,30)

= Rs.40((1- 1/1.02³⁰)/0.02) + Rs.1,000(1/1.02³⁰)

= Rs.40(11.2578) + Rs.1,000(0.0994) = Rs.549.71 » Rs.550.

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65.

Answer : (b)

Reason : Not all firms would choose to operate at a high degree of operating leverage given the risks involved.

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66.

Answer : (d)

Reason : When the firm is operating at a level greater than the operating breakeven point, DOL decreases as the level of quantity produced and sold increases. Hence, I is true. Increase in debt financing, increases the interest payments and reduces the earnings left to the equity shareholders and thus increases the fluctuations in the return on equity. Hence, III is also true and the answer is (d)

Financial breakeven point is equal to interest + preference dividend adjusted for tax. Hence, fixed costs does not come into picture and II is incorrect.

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67.

Answer : (c)

Reason : Let S represent Sales, V represent variable costs and F represent fixed costs.

Degree of Operating Leverage = = 1.1

i.e. = 1.1

i.e. 0.6 S = 0.66S-1.1F i.e. 0.06 S-1.1F = 0. -------- (Equation 1)

Degree of Financial Leverage = = 1.5.

i.e. = 1.5 = 1.5

i.e. 0.6S-F = 0.9S – 1.5 F – 210,00,000 i.e. 0.3S-0.5F = 210,00,000. ------------(Equation 2)

Multiplying equation 1 by 0.3 and multiplying equation 2 by 0.06, and solving the resultant equations, we get

0.018 S – 0.33 F = 0

0.018 S – 0.03 F = 12,60,000.

0.30 F = –12,60,000

i.e. F = Rs. 42,00,000.

Putting the value of F in equation 1, we get S = = Rs. 770,00,000.

Hence the sales revenue for the firm is Rs.7,70,00,000 and the fixed costs are Rs.42,00,000.

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68.

Answer : (e)

Reason : At the financial break even point, EBIT = I +

i.e. I + = Rs 2,10,000.

DFL = = =

Hence, option (e) is the correct choice.

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69.

Answer : (e)

Reason : Change in EBIT with change in sales is reflected by DOL, change in EPS with change in EBIT is measured by DFL and change in EPS with change in sales is measured by DTL.
DOL =

Total assets turnover = i.e. 2 =

Hence, sales = Rs. 1,12,00,000.

(in Rs.)

Sales	1,12,00,000
Less: Variable costs (60% of sales)	67,20,000
Contribution	44,80,000
Less fixed costs	24,00,000
Earnings Before Interest and Taxes	20,80,000

Degree of Operating Leverage=

=

DOL=2.15 indicates that if the sales increase or decrease by 1%, then EBIT will increase or decrease by 2.15%.

Hence, (b) is correct and (d) is incorrect.

Where EBIT = 20,80,000

I = given by interest coverage ratio of 3.2 and P_d is nil

DFL of 1.45 indicates if EBIT increase/decrease by 1%, EPS will increase/decrease by 1.45% Hence, (c) is incorrect.

DTL = DOL x DFL = 2.15 x 1.45 = 3.12.

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70.

Answer : (a)

Reason : DOL = = = 1.02

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71.

Answer : (a)

Reason : The amount of sales in the year 2002-03 was lakh

Total assets in the last year was = lakh and

the amount of current assets = Rs.750 lakh ´ 33.33 percent = Rs.249.975 lakh Rs.250 lakh.

The amount of spontaneous liabilities = Rs.250 lakh * 40 percent = Rs.100.

The amount of external funds requirements (EFR) is given by:

EFR =

EFR=

Here, A/S = 1/1.6, L/S = 100/1200 DS = Rs.1560 lakh – Rs.1200 lakh = Rs.360 lakh, S₁ = Rs.1560 lakh, m = 8 percent and (1 – d) = 0.4

So, EFR = 225 – 30 – 49.92 = Rs.145.08 lakh = Rs.145 lakh (approximately)

Therefore, the required amount of external funds requirements = Rs.145 lakh.

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72.

Answer : (c)

Reason : Degree total leverage = Degree of operating leverage (DOL) ´ Degree of financial Leverage (DFL). In the given situation the degree of operating leverage after the increase becomes 1.5 DOL. The degree of financial leverage after the decrease becomes 0.80 DFL. Therefore, the degree of total leverage (DTL) after the changes becomes 1.5 DOL x 0.80 DFL

= 1.2 DOL x DFL = 1.2 DTL

Hence we can see that the degree of total leverage (DTL) increases by 20%.

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73.

Answer : (a)

Reason :

Assets	Rs. in Lakhs	Rs. in Lakhs	Liabilities	Rs. in Lakhs	Rs. in Lakhs
Cash	20	28	Acc pay	200	280
Accounts Receivable	240	336	Notes pay	130	212
Inventory	320	448	Accruals	30	42
Total Current Assets	580	812	Curr liab	360	534
Net Plant	420	500	LT bonds	260	260
			Equity	270	350
			RE	110	168
Total Assets	Rs.1,000	Rs.1,312	Total L&E	Rs1,000	Rs1,312

The old current ratio = 580/360 = 1.61

New current assets = Rs28 + Rs336 + Rs448 = Rs812.

New LT debt and equity = Rs260 + Rs350 + Rs168 = Rs778.

New current liabilities = New total assets - LT debt and equity

= Rs1,312 - Rs778 = Rs534.

The new current ratio = 812/534 = 1.52

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74.

Answer : (d)

Reason :

The retirement payments, which begin at t = 2, must be:

t = 2: 40,000(1.05)² = Rs. 44,100

t = 3: 44,100(1.05) = Rs. 46,305

t = 4: 46,305(1.05) = Rs. 48,620

Present Value of these payments at the end of year 2

= + + = Rs.1,28,659

Prakash’s father has Rs 1,00,000 in savings now.

The Rs.1,00,000 now on hand will compound at 8% for 2 years:

100,000(1.08) ² = Rs.1,16,640

The net funds needed is:

Need at t = 2 Rs. 128,659

Will have (1,16,640)

Net needed Rs. 12,019

Let amount needed now to accumulate Rs 12,019 at the end of two years @ 8% be ‘A’

A (1.08)² = 12019

A= Rs 5350.

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