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Question Paper

Financial Management-I (MB2E1): October 2008
• Answer all 72 questions. • Marks are indicated against each question. Total Marks : 100 1. Which of the following implies the significant advantage of a public limited company over a proprietorship firm? (a) (b) (c) (d) (e) 2. Limited liability Difficulty to transfer ownership interest Limited life Inability to mobilize large funds Fewer government regulations.
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(1 mark)
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Which of the following players cannot act as a borrower in the call money market? (a) (b) (c) (d) (e) Discount and Finance House of India SBI Mutual Fund State Bank of India Securities Trading Corporation of India Reserve Bank of India.

(1 mark)
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3.

Which of the following statements represents the financing decision of a company? (a) (b) (c) (d) (e) Procuring new machineries for the R & D activities Recruiting the new employees in order to increase the productivity of the company Adopting state of the art technology to reduce the cost of production Purchasing a new building to expand the business Designing an optimal capital structure by using suitable financial instruments.

(1 mark)
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4.

Which of the following is not a feature of certificate of deposit issued by a bank? (a) (b) (c) (d) (e) It is a document of title to a time deposit There is no lock-in period for transferring it to others It is not subject to the reserve requirement of the bank It is transferable by endorsement and delivery The maximum maturity period is one year.

(1 mark)
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5.

Which of the following is a sterling denominated foreign bond raised in the United Kingdom domestic securities market? (a) (b) (c) (d) (e) Samurai Bonds Yankee Bonds Bulldog Bonds Shibosai Bonds Matador Bonds.

(1 mark)
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6.

Which of the following instruments in the international capital market are fixed-interest securities having a maturity of over one year? (a) (b) (c) (d) (e) Commercial Papers Medium-Term Notes American Depository Receipts Treasury Bills Global Depository Receipts.

7.

If an amount of Rs.50 crores is borrowed in the call money market, then the interest rate is decided by

(1 mark) (1 mark) <Answer>

1

(a) (b) (c) (d) (e) 8.

The lender The borrower The Reserve Bank of India as the amount involved is huge Negotiation between lender and borrower Both lender and borrower but within the maximum limit prescribed by RBI.
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M/s. Pee & Cee Ltd., has received the third highest credit rating for its issue of commercial paper. If its fund based working capital limit is Rs.3 crores, and assuming other requirements are met then which of the following is true? (a) (b) (c) (d) (e) It can issue commercial paper within the maximum limit of Rs.3 crores It can issue commercial paper but the amount should not be less than Rs.5 lakhs It can issue commercial paper but the amount should be less than Rs.5 lakhs It can issue commercial paper to any amount It cannot issue commercial paper.

(1 mark)
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9.

In the foreign exchange market if an agreement on a transaction took place on July 1, 2008 and the value date is July 3, 2008, then the transaction is said to be a part of the (a) (b) (c) (d) (e) Spot market Tom market Cash market Ready market Forward market.

(1 mark)
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10. Which of the following situations leads to the increase in volatility in the call money market? (a) (b) (c) (d) (e) Reduction in cash reserve ratio Prepayment of term loans by a large number of borrowers Entry of the financial institutions (FIs) into the market Payment of large amount of advance taxes by the banks and FIs Decrease in the demand for loanable funds in the economy.

(1 mark)
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11. If the effective rate of interest is 10.25% per annum and the nominal rate of interest is compounded twice a year, then the nominal rate of interest per annum is (a) (b) (c) (d) (e) 9.00% 10.00% 10.50% 11.00% 12.00%.

(1 mark)
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12. Mr. Sameer is considering investing in the equity shares of Wilson Company. He gathers the following information on the equity shares of the company: Return on the stock when the market return is zero 4% Rate of return on the market 12% Beta of the shares 0.9 Expected Earnings per share next year Rs.3 Pay-out ratio 60% Current market price of the share Rs.40 Mr. Sameer expects the earnings of the company to grow at a constant rate and the pay-out ratio to remain constant. If the equity share is in market equilibrium, the expected price of the share at the end of five years will be (convert to the nearest integer) (a) (b) (c) (d) (e) Rs.72 Rs.65 Rs.58 Rs.45 Rs.35.

13. Vision Ltd., a Non-Banking Financial Company (NBFC) offers car loans with two different schemes. Scheme A offers 10% discount on down payment of cash. Scheme B asks for a down payment of Rs. 18,000 and a monthly payment of Rs. 4,100 for 5 years. If the cost of the car is Rs. 2.5 lakhs and the required rate of return is 9%, which of the following 2

(2 marks) (2 marks) <Answer>

2.500.000 and remainder in equal installments of Rs.000. (in %) (in %) 0. II.00. 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. The probability distribution of returns of stock of M/s. the risk premium for the stock of M/s.25. Rs. (1 mark) <Answer> 15.50. Which of the following statements is/are true with respect to portfolio risk? I.18.000.21.000 at the end of every year for a period of 8 years. III.182 Rs. (1 mark) <Answer> 17. Probability (P) (2 marks) <Answer> 16.000. The higher the degree of positive correlation between the stocks. (a) (b) (c) (d) (e) Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (I) and (III) above.2. Rs. the greater is the amount of risk reduction that is possible.20 16 14 The covariance of market returns 2 with return on the stock is 9.000 by making a down payment of Rs.35. III. Arrow Ltd. Which of the following is/are true regarding the capital recovery factor? I.2.45 (%) .17.72% 3.000 Rs.2. If a borrower promises to repay Rs.25.1 at the end of the period.77% 2.2. According to CAPM. the effective annual interest rate on this loan is (a) (b) (c) (d) (e) 8% 10% 12% 13% 14%. The portfolio risk will be minimum.15 14 10 0.582 Rs.43% 2. It is the inverse of the PVIF factor. The rate of interest to the firm is (a) (b) (c) (d) (e) 6% 8% 10% 11% 14%.1.35 8 5 0.39%.2. is (a) (b) (c) (d) (e) 1. Rs.2.8. (1 mark) (1 mark) <Answer> 3 .30 7 9 0. 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. II.000 Rs.1.25. <Answer> 14.2. Rs.2. Rs. and the returns on market are given below: Returns of stock of Market returns M/s.274 at the end of eight years from now in return for a loan of Rs.2.50. The risk free rate of return is 6%.17. Kiran Automobiles purchases a machinery for Rs. The diversifying effect of each additional stock increases with an increase in the number of stocks in the portfolio. Arrow Ltd.represents the present value of cash inflows of both the schemes? (a) (b) (c) (d) (e) Rs.56% 2.000 for six years. Arrow Ltd.50. 18.18.000.17. if the stocks are perfectly negatively correlated.000.2.

60 per share in the market and it is expected to pay a dividend of Rs. then what should be the increase/decrease in the price of the security such that it is at equilibrium? (a) (b) (c) (d) (e) Increase by Rs. The security can be purchased. III. Only (II) above Both (I) and (III) above Both (II) and (III) above (I). The investor is expecting this security to provide a return of 12%. If the expected risk free rate is 6% and expected return on the market index is 14%. II. The stock price expected one year hence has the following probability distribution: Probability Price (Rs. India Investment Fund holds the following portfolio: 4 (2 marks) (2 marks) <Answer> . An investor has purchased a security that has a beta of 0.15 Decrease by Rs. the one which has the highest mean value. (a) (b) (c) (d) (e) The security falls above the SML. the last dividend paid is Rs.(a) (b) (c) (d) (e) Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (I) and (III) above.21.50 80 0. 24. has the highest standard deviation.33 Decrease by Rs. higher the standard deviation. higher the standard deviation. (III) and (IV) above. (II) and (III) above. III. which of the following is/are true according to CAPM? I.20 90 The expected return from investing in the stock is (2 marks) <Answer> 22. II. Alpha intercept is positive. is currently quoting at Rs. (1 mark) <Answer> 20. (2 marks) <Answer> 23. Of the two probability series.2 per share in the current year.30 Security is already at equilibrium. Higher the range.) approximately (a) (b) (c) (d) (e) 15% 19% 23% 25% 35%. Which of the following is/are true regarding variability? I. The security is overvalued.2 and the growth rate is 7%. (a) (b) (c) (d) (e) Only (I) above Only (II) above Only (III) above Both (I) and (II) above All (I). 0.21. (III) and (IV) above (II). Which of the following relationships is represented by the characteristic regression line (CRL)? (a) (b) (c) (d) (e) The return on the portfolio and the variance of its returns The return on the portfolio and the return on the market index The return on the portfolio and its beta The return on the portfolio and the risk free rate of return The return on the portfolio and the market risk premium. Higher the variance.50.. If the required rate of return on security according to CAPM is 10%. (1 mark) <Answer> 21. The current purchase price of a security is Rs. IV.6. <Answer> 19.30 70 0.33 Increase by Rs. The stock of Golden Technologies Ltd.

Which of the following is a key determinant of operating leverage? (a) (b) (c) (d) (e) Sales variability Physical location of production facilities Cost of debt Capital structure Level of fixed costs.4%. crore) Beta A 200 0. (a) (b) (c) (d) (e) Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above All (I). (1 mark) 26. which of the following would occur? (a) (b) (c) (d) (e) The required return will decrease by the same amount for both Stock A and Stock B The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A The required return will increase for Stock A but will decrease for Stock B The required return will increase for Stock B but will decrease for Stock A The required return on Portfolio P will remain unchanged. he found that the ratio of the price of an equity share at the end of a 1-year period to its price at the beginning of the 1-year period is 5:4. <Answer> 25. which of the following statements is/are true according to CAPM? I. which of the following will increase the quantity produced at the operating break-even point? 5 (1 mark) (1 mark) <Answer> . Required rate of return of the given stock is equal to the risk free rate of return. Stock will lie on the SML. Other things remaining the same.8 and Stock B has a beta of 1. Mr. If the market risk premium were to increase but the risk-free rate remained constant. After a year.100 crores and use the proceeds to purchase stock D which has a beta of 3. (II) and (III) above. What is the capital gain yield from the equity share? (a) (b) (c) (d) (e) 20% 25% 60% 75% 80%. 50 percent of Portfolio P is invested in Stock A and 50 percent is invested in Stock B. The fund manager has proposed to sell C for Rs. 30.3%. Slope of SML is zero. (1 mark) <Answer> 29. If the beta of a stock is equal to zero.Stock Investment (Rs.8% 18. The required rate of return of the new portfolio according to CAPM is (a) (b) (c) (d) (e) 12. II. <Answer> (1 mark) <Answer> 27. (1 mark) <Answer> 28.8% 20.2.5 B 200 2 C 100 4 The required rate of return on the market is 14% and that of the above portfolio according to CAPM is 20. Which of the following statements is not true? (a) (b) (c) (d) (e) Each level of EBIT has a distinct DFL DFL is undefined at financial breakeven point DFL will be negative when the EBIT level goes below the financial breakeven point DFL will be positive for all values of EBIT that are above the financial breakeven point DTL above breakeven point increases as quantity produced keeps on increasing.2% 21. Stock A has a beta of 0.1% 18. III.Amit bought 100 equity shares of a company.

It is expected that there will be no change in its capital structure in the near future.100. Which of the following statements is/are true regarding 91-day T-bills? 6 (1 mark) (1 mark) <Answer> . then which of the following can be concluded? I.6..I.600 Interest 990 Taxes 1. which has a book value of Rs.593 crores Rs.4 crores on which interest is paid at 8% p. If EBIT has to increase by 5%. 35.a. <Answer> 31.16.50.a. Vipul Auto Ltd.. III. Further the company has employed preference share capital.38%.25%.170 crores Rs.550 crore. The company has a debt of Rs.4. (2 marks) <Answer> 33.5. The sales revenue is approximately (a) (b) (c) (d) (e) Rs. variable cost per unit is Rs.30 crore.820 crores Rs. III. (II) and (III) above. Decrease in the selling price per unit.2. There is considerable growth prospect in Vipul. in crore) Sales 22. Price of Vipul is lower.780 crores Rs.5% 6.. The investors of Vipul can expect higher capital gains yield than the dividend yield. (a) (b) (c) (d) (e) Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above.1. If the company plans to increase its EPS by 25%.500 Variable costs 11. DPS and required rate of return of both the companies are same. II. the percentage change in sales should be (a) (b) (c) (d) (e) 4% 5% 5. the percentage increase in sales will be (a) (b) (c) (d) (e) 15. is a pharmaceutical company whose degree of financial leverage is 1. Increase in the variable cost per unit.32% 5.36% 10. II. is given below: Particulars (Rs.02 crores. Pie Ltd. is showing a lower dividend yield and higher price-earning ratio than Vijay Auto Ltd.250 Net profit 3.4 crore on which preference dividend is payable at 9% p. and the dividend rate on the same is 20%.460 The paid up equity capital of the company consists of 3000 lakh equity shares of Rs.47% 8. The tax rate is 45%.000 units. If EPS..433 crores. selling price per unit is Rs. (3 marks) <Answer> 34.000.200 Fixed costs 5.000 and fixed cost is Rs.79% 12.0.40 each. The quantity produced by a firm is 10. Decrease in the fixed costs of the firm.04% 9. It has a preference capital of Rs.9. (a) (b) (c) (d) (e) Only (III) above Both (I) and (II) above Both (II) and (III) above Both (I) and (III) above All (I). The variable cost to sales ratio is 40% and fixed cost is Rs. The income statement of Indian Cement Company Ltd. (2 marks) <Answer> 32.

This year the firm had earnings per share of Rs. zero coupon bond 10-year.242 Rs. Increase in the cost of equity capital. Increase in the expected dividend payout ratio. The risk-free rate is 10 percent and the expected market return is 14. 685 Rs.2. (a) (b) (c) (d) (e) Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above Both (I) and (III) above. (3 marks) <Answer> 40. Three bonds A. Which of the following is/are not true regarding the dividend ratios? I. what is the current value of the issue? (a) (b) (c) (d) (e) Rs.5% per annum.2.11. (1 mark) <Answer> 39. 8%and 12% respectively.500 and yield to maturity of 11. (1 mark) <Answer> 37. par value and maturity have yields to maturity (YTMs) of 10%.14 A decrease of Rs.0. 10 percent coupon bond 20-year. It is desirable to invest in a company having a high dividend yield irrespective of its profitability and liquidity.I. They cannot be rediscounted with RBI.827 Rs.2. III.1.0. B and C? (a) (b) (c) (d) (e) A>B>C A>C>B B>A>C C>A>B C>B>A. all other factors remaining constant? (a) (b) (c) (d) (e) An increase of Rs. 7 (1 mark) (1 mark) <Answer> .0. (a) (b) (c) (d) (e) Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (I) and (III) above.1. Ajanta's stock is currently selling for Rs. Earnings are expected to grow 7% a year in the foreseeable future. 5 percent coupon bond.40 Remains same. II. Dividend yield is always expressed as a percentage of earnings of the company. Which of the following will lead to an increase in the expected Price-Earning ratio? I. (1 mark) <Answer> 38.1. 41.2 percent.451 Rs. II. zero coupon bond 20-year.99 An increase of Rs. 5 percent coupon bond 10-year. Which of the following bonds will have the greatest percentage increase in value if all interest rates decrease by 1 percent? (a) (b) (c) (d) (e) 20-year.40 A decrease of Rs. They are issued through auctions conducted by RBI. III.80 and the current dividend is Rs.44. Dividend yield is calculated as dividend pay-out ratio divided by the P/E ratio. <Answer> 36.500. What will be the effect on the price of Ajanta’s stock if systematic risk of the stock increases by 40 percent. They are also referred to as PSU bonds.68. II. Then which of the following expressions is/are true regarding the value of bonds A. A zero-coupon bond that matures 5 years from today has a par value of Rs. B and C with same coupon rate.1.2.

Which of the following is/are true with regard to the convertible debentures? I. IV. Both (I) and (II) above Both (I) and (IV) above Both (II) and (III) above (I). other things remaining the same. other things remaining the same. (1 mark) <Answer> 44. Conversion premium is the difference between the conversion price and the conversion value. (1 mark) <Answer> 45. Who among the following players in the international capital markets collect the rupee dividends on the underlying shares and repatriate the same to the depository in US dollars/foreign equity? (a) (b) (c) (d) (e) Lead Managers Underwriters Custodians Corporate borrowers Lenders. Which of the following statements is not true with regard to valuation of bonds? (a) (b) (c) (d) (e) An increase in the required rate of return. The conversion value is the minimum value of the convertible based on the current price of the issuer’s stock. Bought-out deal. Rights issue. (1 mark) <Answer> 43. other things remaining the same. Which of the following is not true with regard to the multi period valuation model of equity shares? (a) (b) (c) (d) (e) There is a pre-specified maturity period The value of an equity share is equal to the present value of the dividends over an infinite duration The model can be applied to the instances of constant dividends and constant growth in dividends The model can also be applied in case of variable growth in dividends The model can be applied to find out the fair value of the shares. 47. When the market is low. In case of optionally convertible debentures. <Answer> 42. III. II. other things remaining the same. Private placement. (1 mark) <Answer> 46. II. other things remaining the same. will increase the bond value An increase in the face value of the bond payable at maturity. (III) and (IV) above. which of the following methods of raising capital are preferred? I. (a) (b) (c) (d) (e) Initial public offer. (a) (b) (c) (d) (e) Only (I) above Only (II) above Both (I) and (II) above Both (I) and (III) above Both (II) and (III) above.III. on the exercise of the option of conversion the holder of the instrument has to pay the issuer the specified amount. Which of the following is a feature of secured premium notes (SPN)? 8 (1 mark) (1 mark) <Answer> . (II) and (IV) above All (I). will increase the bond value An increase in yield to maturity will occur if the amount payable at maturity increases. will decrease the bond value An increase in the number of years to maturity. Increase in the growth rate. will increase the present value of the face value of the bond payable at maturity An increase in the coupon rate. (a) (b) (c) (d) (e) Only (I) above Only (II) above Only (III) above Both (I) and (III) above Both (II) and (III) above. (II). III.

44 Rs.36 Rs.56 per share and the price after the rights issue was Rs.. Consider the following data for BTC Ltd. (1 mark) <Answer> 53. Martin & Company Ltd. The least expensive form of financing for the firm is (a) (b) (c) (d) (e) Existing common stock Preferred stock Debenture capital New common stock Retained earnings. company wants to expand its business.48.40 Rs. one of the implicit assumptions is that (a) (b) (c) (d) (e) Retained earnings have no cost The equity shareholders require a premium over the return required by bondholders The equity shareholders require a premium over the return required by preference shareholders The equity shareholders require a premium over the risk-free rate of return The equity shareholders will continue to expect the same returns from the share as in the past. When the realized yield approach is applied for finding out the cost of equity capital.: Earnings Per Share (EPS) Rs. For which they decided to raise the funds through equity. <Answer> 48. the market value of equity according to 9 (1 mark) (2 marks) <Answer> . Crystal Ltd. recently issued 1 right share for every 5 shares held. (1 mark) <Answer> 52. (2 marks) <Answer> 50. the cost of raising fresh equity (a) (b) (c) (d) (e) Is equal to the existing retained earnings Can be less or more than the existing cost of retained earnings depending on the market conditions Will be more than the existing cost of retained earnings on account of floatation costs Depends on the earnings per share of the company Is free of cost.(a) (b) (c) (d) (e) It is a kind of non-convertible debenture with an attached warrant It is convertible debenture with options The warrants attached to the SPN gives the holder the right to apply for one preference share It is partly convertible debenture with attached warrants It is an example of participating preference shares. So.46 Rs. the subscription price of each right share was (a) (b) (c) (d) (e) Rs.000. If the price of the stock at the time of the issue was Rs. (1 mark) <Answer> 51.00. 54. Which of the following is a feature of preference shares? (a) (b) (c) (d) (e) Preference-dividend is tax deductible Preference share holders shall invariably participate in the surplus Voting rights can be given to the preference shareholders in the case of cumulative preference shares Perpetual preference share capital will remain with the company forever Preference shares are always redeemable.54 per share. (1 mark) <Answer> 49..10 Dividend Payout Ratio 50% Equity Capitalization Rate 10% Rate of Return on Investments 12% If the number of shares outstanding for the firm is 2. The term agency costs in the context of capital structure means (a) (b) (c) (d) (e) The commission payable by a company to its purchasing agents The commission payable by a company to its selling agents The expenses incurred in distribution of the products of the company The cost on account of restrictive covenants imposed on a company by its lenders The dividends paid by a company to its shareholders.

50 18-40 8.900 = 30% Debenture is redeemable at a premium of 5% after 5 years.2.2 lakh.16.30.00 1 and above 12.00.8% 9. Alpha Ltd.95% 10.1.95% 11.4.30 crores .14.Rs.2% 6.00.50 crores for the same.00 Debt 0-18 7.60 lakh Market value of debt Rs. in crores) 0-9 15.2 lakh Rs.1.: Face Value Rate of interest Amount realized per debenture = Corporate tax rate = Rs. 30% 10% 60% Sources of Finance Equity The weighted marginal cost of capital of new financing in the range of Rs.2 lakh Rs.95% 9.Walter model is (a) (b) (c) (d) (e) Rs.20. The following information is given about the debentures issued by M/s.00 The company is considering to expand its operations and requires Rs. Consider the following data of KSN Ltd.2%.00 9-30 16.40.000 Rs.Magnet Enterprises: Range of new financing from the source Post tax Cost (%) (Rs..10. Rs.3.50 Preference 0-1 10.00.95%.000 = 8% p.15.. <Answer> 55.17. BNN Ltd. (2 marks) <Answer> 57. and GSN Ltd.000. (2 marks) (2 marks) <Answer> 10 . 58. the net operating income for the firm is (a) (b) (c) (d) (e) Rs. It is planning to raise funds from these sources in the following proportions: Equity Preference Debt (a) (b) (c) (d) (e) 8. has the following data: Market value of equity Rs.13.000 Rs.50.000 Rs.00.2 lakh Rs.000 Rs.a.00.50 crores is (3 marks) <Answer> 56.2% 7.5% 8. The following details are available regarding the long term sources of finance of M/s.2 lakh Rs.40 lakh Cost of equity 17% Cost of debt 15% Assuming that the firm is operating under the regime of no taxes.5. The cost of debenture capital is approximately (a) (b) (c) (d) (e) 5.95% 12.

.000 Rs. (1 mark) <Answer> 61.15.00 7 According to the traditional approach to the dividend policy. Mars Ltd.00.3. (Rs.51% 50. The face value of its shares is Rs.15 million this year.000.00. The cost of which of the following sources of finance can be found out by the bond yield plus risk premium approach? (a) (b) (c) (d) (e) Bonds Term loan Trade credit Preference capital Equity capital. 5 Rs.000 Rs.. If the firm follows a strict residual dividend policy.000. MSK Ltd. 59.40.00.6.24.8. Fast Foods posted a net income of Rs. 5.000 by way of equity dividends.20.000 Interest on debt @ 8% 2.01% 35.58.00. As per the MM Hypothesis.000 Rs.50 Rs.) GSN Ltd.00. Financial planners at Fast Foods anticipate to have a capital budget of approximately Rs. (Rs.20 and it had posted a profit after tax of Rs. (1 mark) <Answer> 62.25. 11 (2 marks) .00.000 and 15% preference share capital of Rs.15 Rs. what is their expected dividend payout ratio? (a) (b) (c) (d) (e) 28% 36% 50% 64% 72%. The firm also anticipates retaining its target capital structure of 60% equity and 40% debt.00.10 Rs.00. The following information regarding the equity shares of M/s. <Answer> (2 marks) <Answer> 60.18 million.61% 55.000 Rs.) Net operating income 5. Mars Ltd.9.61% 45.10 and market value is Rs. The company paid Rs.30.25. is (2 marks) <Answer> 63..000 5.KSN Ltd. the EPS for M/s.000 Corporate tax rate 50% 50% the value of levered firm exceeds the unlevered firm by (a) (b) (c) (d) (e) Rs. has an equity of Rs. If the dividends grow at 5% then the cost of equity according to earning price ratio approach is (a) (b) (c) (d) (e) 25.20 Rs. is given below: Market Price = Dividend per share = Multiplier = (a) (b) (c) (d) (e) Rs.00.40. Which of the following is not a merit of using book values as weights for calculating the weighted average cost of capital? (a) (b) (c) (d) (e) The book value weights are independent of the fluctuations of the market prices The calculation of weights is simple The book values of the different sources of finance are approximately related to their present economic values The book value weights are suitable for a firm whose securities are not traded regularly The book value weights are the most suitable for the unlisted firms.000 this year.36. Rs.01%.

In case of high investments the return on investment will not be constant. Floatation cost is associated with (a) (b) (c) (d) (e) Cost of existing preference capital Cost of term loan Cost of existing debenture capital Cost of external equity Cost of retained earnings.10 per share for the current year. The business risk of the firm has a direct impact on the value of the firm. (II). These costs represent certain restrictions on the firm in the form of some prospective covenants incorporated in the loan contract. 80 Rs. Rs. (III) and (IV) above All (I). (a) (b) (c) (d) (e) Only (I) above Only (III) above Both (I) and (III) above (II). (1 mark) <Answer> 66.00. The current market price of each share is Rs.28. 60 Rs. Expected cost of bankruptcy increases as debt-equity ratio decreases. <Answer> (1 mark) <Answer> 65.75.00. The company expects a net profit of Rs.000 shares outstanding. Which of the following statements is false regarding assumption made under the Modigliani and Miller approach for dividend policy of a firm? (a) (b) (c) (d) (e) Existence of perfect capital markets Non-existence of differential tax rates for the dividend income and capital gains Constant investment policy of the firm Existence of floatation and the transaction costs Non-influence of single investor on the share value. IV. (III) and (IV) above.100 Rs.00 crore 40 percent 60. 6.120. 69. Exclusive financing by retained earnings make the model suitable only for all equity firms. has 80.000 12 percent 16 percent What is market price per share (2 marks) <Answer> 68. (II) and (III) above. II.000 during the year and it belongs to a risk class for which the approximate capitalization rate has been estimated to be 20%. The company is considering dividend of Rs.. These costs represent a loss. Oswal Industries Ltd. According to the Modigliani and Miller model.00. 40 Rs. Which of the following statements is/are true with respect to bankruptcy costs? I.000 for an approved investment expenditure during the year? (1 mark) (3 marks) <Answer> 12 . The probability of bankruptcy increases at an increasing rate as the debt-equity ratio increases. The following information is collected from the annual report of Wilson Ltd. (1 mark) <Answer> 67.64. (a) (b) (c) (d) (e) Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above All (I).12. thus cost of equity capital cannot be constant.: Net profit Dividend pay out ratio Number of outstanding shares Equity capitalization rate Rate of return on investment according to Walter’s model on dividend policy? (a) (b) (c) (d) (e) Rs. how many new shares must the company issue if the dividend is paid and the company needs Rs. which can be easily diversified away. Which of the following is/are the limitation(s) of Walter’s model? I. III. III. II.

<Answer> 70. The firm follows traditional approach to dividend policy with a multiplier of 6. 94. these advantages 13 .5% 0.00 Rs. The relevant data regarding the company and the market are as under: Current market price of share Growth rate of earnings and dividends Beta of share Average market return Risk free rate The intrinsic value of the stock is (a) (b) (c) (d) (e) Rs. 60.1 9.000 shares 24. for a public limited company.75 7.(a) (b) (c) (d) (e) 12. Consider the following data regarding the bonds issued by Xeta Ltd. 2008. The dividend payout ratio of a firm is 40%. the members don’t have any further liability to bail out whereas in a proprietorship firm.95 The yield to maturity of the bond to a prospective investor is (a) (b) (c) (d) (e) 9. 89. If the company turned to an insolvent one.25.104. Current market price as on July 15. Biogenerics Ltd.. Moreover it has unlimited life.95 12. But for a proprietorship company.90% 12.00 Rs.000 shares 20. The P/E ratio of the firm is (a) (b) (c) (d) (e) 4.3.10. the ownership can be easily transferred and resources can be mobilized.7 8. Hence (a) is true. 80. has paid a dividend of Rs.000 shares 30. on July 15. 2008 Rs.50 per share on a face value of Rs. The governmental regulations for a public limited company are more than applicable to a partnership firm.00 in the financial year ended 31st March. END OF QUESTION PAPER (2 marks) Suggested Answers Financial Management-I (MB2E1): October 2008 ANSWER 1.4 5. the liability of the owner is unlimited.000 shares 18.27% 10.a.100 Issued at a discount of 10% Redeemable at a premium of 10% Interest payable semi-annually 8% p.5. 2006 to be redeemed on July 15.2 6. = = = = = Rs.. However. (1 mark) <Answer> 71.5% 6% (2 marks) <Answer> 72. A REASON A public limited company is said to be in a significant advantage owing to its limited liability. 2013: Face value of the bond Rs.000 shares.24% 12.48 Rs.55%.26 Rs.66% 13.

Medium-Term Notes (MTNs) are defined as sequentially issued fixed-interest securities which have a maturity of over one year. (a).are not available. (c). (b) and (c) are not correct. iv. any company wishing to raise money through CP has to fulfill the following requirements: i. It enables an issuer to issue Euronotes for different maturities. E 4. The call loans are of very short term in nature and any amount of money can be lent or borrowed at a convenient interest rate. Samurai bonds are bonds issued by non-Japanese borrowers in the domestic Japanese markets. the interest is decided by the lender and the borrower and RBI has no role in the interest determination. DFHI. in the given case. Of the above. options (a). 2. which are raised in the United Kingdom domestic securities market. Hence. Hence (e) is the answer. B All the participants in the call money market are split into two categories. Hence (b) is the correct choice. Board resolution authorizing the issue is required. CDs are transferable simply by endorsement and delivery by the holder without any restriction. Hence (c) is not a feature of CDs. Hence. An optimal capital structure can satisfy the return expectations of the stakeholders at a lower cost that will result in share price of the company to a healthier one. While the cases mentioned in the other alternatives are the investment decisions as these may bring return to the company over a period of time. which is acceptable to both the lender and the borrower and there is no maximum ceiling on the interest rate. In the call money market day-to-day surplus funds of banks are traded. unsecured promissory notes issued by well known companies that are financially strong and carry a high credit rating. Treasury Bills are short-term instruments issued by the government.4 crores. Certificate of deposit (CD) is a financial instrument where an investor has to invest a certain sum to get a fixed amount (principal and accrued interest) on maturity at the contracted rate. Hence option (c) is the correct choice. E . though the amount is huge. Bulldog bonds are sterling denominated foreign bonds. Commercial Papers are short-term. Hence. The tangible net worth of issuing company should not be less than Rs. Hence. (b) cannot borrow in the call money market. from one year up to the desired level of maturity. whereas its maturity period ranges from 15 days to one year.e. The fund based working capital limit should not be less than Rs. The company should obtain the second highest credit rating from one of the approved credit rating agencies. D 8. Matador bonds are foreign bonds issued in Spain. C 6. STCIL and commercial banks belong to the first category and all the financial institutions and mutual funds belong to the second. in the given case. the company has not met (ii) and (iii). B 7. Commercial papers are short-term.4 crores iii. It is a financing decision. unsecured promissory notes issued at a discount to face value by well-known companies that are financially strong and carry a high credit rating. (d) is also not correct because the condition (ii) will be met but the condition (iii) will not be met. Hence. Yankee bonds are US dollar denominated bonds issued by foreign borrowers in the US domestic markets. it cannot issue commercial paper of any amount. The correct answer is (d). ii. So it is similar to a time deposit. American Depository Receipts (ADRs) are dollar denominated negotiable certificates and they represent a non-US company’s publicly traded equity. Global depository receipts are negotiable instruments which represents publicly traded local currency equity share. 14 3. But as it is a liability to the issuing banks. The first comprises the entities who can borrow as well as lend in the market and the second comprises only lenders i. Shibosai Bonds are Yen denominated privately placed bonds issued in the Japanese Markets. RBI. As per the guidelines. C 5. the participants in the second category cannot borrow in the call money market. (d) and (e) are false. CDs are also subjected to the reserve requirements of the bank.

50.65. 0.Hence.30.000 + 48.581*4.000 out of total cost of Rs.6.5 lakh . B 0.000 + Rs.100 = 18.10 Hence.9 × 0.60) *4.000* PVIFA(r.72%) = 18.8% As the shares are said to be in equilibrium.50.000 immediately.000 + PVIFA(k. So the amount Rs. Rs.103)5 0.103 = Rs.50. The duration of the same varies Hence the answer is (a).1.00.17. 9.09)1/12 – 1 = 0. The firm pays Rs.000 = Rs. C D6 k− g = 3 × 0. 2.1025 or r = ( 1.. If the agreement to buy & sell is agreed upon and executed on same day it is called Ready market (transaction) or cash transaction.50.148 g = 0. 11.9182.1025 =  r 1+ 2 = 1. Hence. C .148 = 40 0.103 = 14. option (c) is the answer.6y) 15 14.5 lakh * 10%) = Rs.6 × (1. Ri = α + β R m ⇒ = 0.1025 = or ∴ 12. k = (1. If the delivery takes place at a specified future date it is referred as forward market.Rs.148 − 0.50. It generally comes down with the following reasons: • • • Increase in cash reserve ratio (CRR) Larger amount borrowed by several borrowers following an increase in demand for the loanable funds 10.000 remains outstanding which is paid by way of annuity of Rs. PV of cash inflows in case of scheme A = (Rs. MP at the end of 5 years = 13. According to the single-index model.0072 i.25 lakh PV of cash inflows in case of scheme B = 18.1. 10%. 2. 2.8.045 + g = 0. A If the delivery takes place on second business day after the agreement or transaction takes place it is called ‘spot market’.1.1025 – 1)2 = 0.04 + 0. If the delivery date is next working day it is called ‘TOM market’.182.e.000 for 6 years. option (d) is the answer. The volatility in the call money market increases with the reduction of the liquidity in the market.10 = Rs. D Withdrawal of funds by the banks and financial institutions suddenly to meet their respective corporate requirements Payment of a large amount of advance taxes by the banks and FIs will lead to the reduction in liquidity in the system thereby increases the volatility in the call money market. B r   1+  − 1 2  2 2 r   1+  2 1.e. the answer is (e). 2.6 + g = 0.12 D1 + g = Ri Po 3 × 0.6.10 i.100 (Where. 19.

Hence. = 10. option (b) is the correct choice. Range is referred as the difference between the highest and lowest values.15 0.333 for 6 years is found nearer at 10% column.333 PVIFA(10%.25 =8. ‘xi’ is the price expected and ‘pi’ is the probability Hence. irrespective of the range being the lowest or highest. E Expected price = Σ xipi Where. r = 8%. Hence. the standard deviation will also be higher. Lower the degree of positive correlation.25 5.637 Hence.6y) = 4.884 = 10. value of 4. expected price = 70 × 0. S. Hence. H.79 The expected one year return is calculated as (Expected Price at the end + Expected dividend) − Price at the beginning × 100 Price at the beginning 16 .45 17. Hence.75 k ∑ (km.6875 Hence.43%. greater is the amount of risk reduction that is possible. = 0.75 – 6) = 2.5125 10. the effective rate of interest is 10% approximately. B K j = α j + β jk m + e j The CRL is plotted by plotting Kj along the Y-axis and Km along X-axis. 50. So. C Capital recovery factor is the inverse of the PVIFA factor.2 = Rs. 000 PVIFA(r. A 19.p 0. statement III is correct. II is also not true. Highest mean does not mean that it should have highest standard deviation.6y) = 1.01875 4. B Risk premium = β(Rm – Rf) Probability 0.30 0.6y) = 4. It can be applied to find out the amount that can be withdrawn periodically for a certain length of time.5 + 90 × 0. C The amount of risk reduction depends on the degree of correlation between the stocks.m )2. 15. Standard deviation. Risk premium = 0. I is not true.884 (8.3 + 80 × 0. C 20.6.355 In PVIFA table. III is true and the answer is (c).23437 5.637 At r = 8%. (c) is the answer. Hence. Standard deviation may be the highest. 000 PVIFA(r.274 FVIFAr. Hence statement III is true and the answer is (c). If the variance is higher. 50.6875 k β A =. L. if a given amount is invested today. The equation for the Characteristic Regression Line (CRL) is given as: Cov(k A k m ) 9. a measure of dispersion around the expected (or average). statement II is incorrect. 21. The effective annual interest is the value of ‘r’ in the following: 2000 FVIFA (r.75 1. 18.92187 0. The portfolio risk will be minimum if the stocks are perfectly negatively correlated.8 = 10. Var(k m ) 16. Statement I is incorrect as the diversifying effect of each additional stock diminishes with increase in number of stocks.25 -3. Hence.m ) 0. is the square root of the variance of the rates of return.35 0.8) = 21.20 km = km 9 5 10 14 kmP (km.

In the SML equation.14 = = 71. B B Capital gain yield from an equity share = The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A. 26. Hence. B According to CAPM.8 Required rate of return according to CAPM = Rf + β (Rm – Rf) =Rf + 1. required rate of return = Rf + β (Rm – Rf) Where Rf is the risk-free rate of return.4 = 0. slope is measured by R m – Rf and the Beta of the stock is not relevant to find the slope of SML.Expected return = 22.6(14 – 6) = 10. If Beta is equal to zero.33.5 + 200 × 2 + 100 × 3)/500 = 1. 25.8% As the required return from the stock is lower than the actual return produced by the stock. D Ri = Rf+β (Rm-Rf) Ri.33 – 50 = Rs.6 New required rate of return = 6 + 1. E D The quantity produced at operating break-even point is computed as where F represents the fixed costs of the firm S represents the selling price per unit.5 + 200 × 2 + 100 × 4)/500 = 1. 23. then the DTL will be positive.07 0. option (b) is the correct answer. D 0 (1 + g) ke − g 2(1. V is the variable cost per unit. A P0 = P0 = (79 + 2) − 60 × 100 60 = 35%.2 – 1. P1 − P0 × 100 P0  P1  5  − 1 × 100 =  − 1 × 100 = 25%  P 4    = 0 . Weighted beta = (200 × 0. Hence. DTL decreases as Q increases and reaches a limit of 1. (III) is not true and the answer is (b).21.07) 2.8 Rf = 6% New weighted Beta = (200 × 0.8 Rf = 4. A stock whether it will lie below or above the SML depends on whether the stock’s required rate is more than or less than the expected rate of return. C ⇒ Rf + 25.33 0. Therefore. required rate of return is equal to risk-free rate of return. will fall above the SML and will have positive alpha. 30.6(14 – 6) = 18. (II) is true. (e) is not correct and the rest are correct.8%. Hence. E If the level of output is greater than the overall break-even point. = 6 + 0. β is the Beta of the stock and R m is the market return.03 Therefore the increase in the price of the security = 71.4 24. (I) is not true. increase in fixed costs will increase the quantity produced at operating break-even point. 27.8(14 – Rf) = 20. Hence. It is determined by the level of fixed costs. Other things remaining the same.8 Rf = 20. F (S − V) 29. 28. DOL determines the change in the EBIT with change in sales. It is immaterial whether the Beta is equal to zero or not. increase in the variable costs will decrease the 17 . Hence the stock can be purchased and the answer is (d). Other things remaining the same. the stock is undervalued.10 − 0.

600 Rs.655 0. 00. 00. Other things remaining the same.5.433 3.32 − 0.6S − 1. 00. Hence.500 – 11.460 + 1. 000) = Q(S − V) − F 10. 700 = = 1. 000. 00.197 crs (1 − t) 0. 460 Tax rate (t) = = 36. 300 5. 50.5. 000(2. Hence. percentage increase in sales should be = 1. 700 = 1. 250 3. 000 − 1. hence it will decrease the quantity produced at operating break-even point.9 = 1.982 x 1. Q(S − V) 10.142 Rs.54S = S = 32.6S − 1. 31. 000 − 1. 00.6S – 1. C EBIT = = S (P – V) – F 0.25 = 4%.433 0. A DOL = Dp (1 − t) 0.433 − 0.433 EBIT EBIT − I − Again DFL = 1.20 = Rs. 700 − 990 − 172. 000.575 = 0.489 18 .82 crores.172. 00. 600 EBIT EBIT − I − DFL = EBIT = = = = DP (1 − t) Interest Net profit + Taxes + Interest (or) Q (P – V) – F 3.) Preference dividend (Dp) = 550 × . increase in the selling price per unit will increase the denominator.12% (approx. 33.803 Degree of total leverage (DTL) = DOL x DFL = 1. 000(2. hence it will increase the quantity produced at operating break-even point.700 crores Rs.990 (given) crore Taxes Pr ofit before tax = 1.256 = 2. 537. 200 − 5.110 crs Dp 110 ∴ = = Rs. 500 − 11.6388 ∴ DFL = 5. 200 DOL= 22. I is correct and the answer is (d).25 12.197 4. II is correct and III is not correct. 700 5.250 + 990 or 22. 50. 000 = 1.denominator. 000 = The percentage increase in EBIT ∆ EBIT EBIT = ∆S DOL × S 5 Hence. 000) − 30.14S – 4.256 5.6S – 1.982 22. C Q(P − V) DOL = Q(P − V) − F = QP − QV QP − QV − F = 11. 500 − 11.200 –5. 000 15.

For zero-coupon bonds. B In the intrinsic value formula the face value of the bond is multiplied with the factor PVIF(r. Hence.042βj P = Rs.8(1. Therefore. Dividend yield is the dividend per share divided by market price per share. As growth prospects are higher the price of Vipul should be higher.451.n) decreases as the number of years to maturity increases.042βj . C According to the bond value theorems. II is correct. price change is higher in case of 20 year bond. the present value of the face value of the bond decreases as the number of years to maturity increases. Treasury bills are also referred to as gilt securities.10 + 0. C EPS. D Expected Price-earning ratio is computed as From the above equation. Hence.07) = Rs.1. Hence.10 + βj (0. III is also true and the answer is (d). It can also be calculated as dividend pay out ratio divided by P/E ratio.07) = Rs. A 37. option (d) is the answer.11.99 a share. II is true.147 .07)/(0. 40. 91 days Treasury bills are issued by auctions conducted by RBI. Hence. III is correct. (c) and (d).80 New ke = 0.1. the expected return depends more on the capital gains yield and less on the dividend yield.147 P =Rs. 19 . Hence.9. Hence. Hence.450.(11. 0.60 = Rs.10 + 0. other things remaining the same.0. Hence. 2.10) = 0.142-0.489 =10.142 .) 34.115 ) 5 = 35.1.68(1. Longer the term to maturity. All other alternatives are true. RBI neither rediscounts nor participates in auctions of these T-Bills. 500 ( 1. higher is the price change with a change in YTM.DTL = Percentage change in EPS Percentage change in sales revenue Percentage change in EPS DTL ∴ Percentage change in sales revenue = Give : Desired increase in EPS = 25% 25 ∴ Required increase in net sales = 2. Increase in the cost of capital will decrease the Expected Price-earning ratio. 42.0. (II) is incorrect. The factor PVIF(r. the change in price is higher in case of (a). Therefore alternative (b) is not true. the value of the bond decreases. 39. in the given question the value of bond B will be greater than the value of bond A which is greater than the value of bond C. Of the 20-year zero coupon bond and 10-year zero coupon bond.1) =0 .44 βj = 0. As YTM increases.45 A decrease of Rs. duration will be the maturity. As the growth rate increases. Hence.4)(0. Expected Dividend payout ratio Cost of capital − growth rate 41. price of the security and the yield to maturity are inversely related.68(1.45) = Rs. low dividend yield and high P/E ratio implies that there is considerable growth prospects in Vipul.07)/(0. B Value of zero coupon bond C ke = Re+ βj(Rm-Rf) = Rs. other things remaining constant. of (a). D 36. Hence statements I and III are correct.10 + 0.0.44-9. PSU bonds are the securities issued by the public sector entities. I is not true. DPS and required rate of return being the same.04% (approx.n). we can conclude that increase in the expected dividend payout ratio and increase in the growth rate will lead to increase in Expected Price-earning ratio. Hence. other things remaining the same. II is correct and I and III are not true. Smaller the coupon rates. Hence. I is not correct and the answer is (c).0. E 38. the answer is (c). Hence. Old ke = 0. A company must be liquid and profitable to pay consistent and adequate dividends. higher will be the price change.

the expenses incurred in distribution of the products of the company. In the realized yield approach one of the implicit assumptions is that the equity shareholders will continue to expect the same returns from the share as in the past. I is true. public issue and rights issue may not be successful. Conversion premium is the difference between the conversion price and the conversion value. 51. or the dividends paid by the company does not come under the agency cost. Preference shares (except participating preference shares) do not participate in the surplus. Underwriters of the issue bear interest rate or market risks moving against the issuer before they have placed bonds or depository receipts. When the market is low. Of the given methods of private placement and bought out deal should be preferred. Thus only option (d) is correct. Hence. III is also true and the answer is (d). 56 per share Ex-rights price = Rs. The debt capital is the cheapest source of financing but it should be used within reasonable limits. II is incorrect. 44. 44 per share. Rest are incorrect. 20 52. whether it is fully convertible or partially convertible debenture. Voting rights can not be given to the cumulative preference shares. Custodians hold the underlying shares and collect rupee dividends on the underlying shares and repatriate the same to the depository in US dollars/foreign equity. C Ex-rights value of share = Where N. A D There is no pre-specified maturity period in the multi-period valuation model of equity shares. 54 per share ∴ or or 50. Lead managers undertake activities like preparation of offer circular. bought out deal is the most preferred because the sponsor or the merchant banker who is involved in the deal takes up the issue with an intention of offloading to the public at a later stage when the market picks up. A 48. D 49. cash flows over an infinite duration are considered. It is merely. This is the minimum value of the convertible based on the current price of the issuer’s stock. marketing the issues etc. E . SPN is a kind of non-convertible debenture with an attached warrant.43. on conversion cash is not involved. C 47. Hence. It is neither a convertible or partly convertible debenture nor any option can be attached to it. the old security is exchanged for the appropriate number of new securities is issued in turn. Agency cost are cost on account of restriction imposed by creditors on the firm in the form of some protective covenants. C 46. The warrants attached to the SPN does not gives holders the right for the preference shares. Rest are incorrect. Preference shares can be redeemable or irredeemable. Hence. Po and S have their usual meanings Given: N = 5 Po = Rs. Commission payable by the company to its purchasing and selling agents. Preference dividends are not tax deductible. Preference shareholders have preference over equity shareholders on the post tax earnings of the firm. Of the two. Whether it is optionally convertible debenture or compulsorily convertible debenture. The conversion value represents the market value of the convertible if it were converted into stock. Hence option (e) is the correct answer. Hence (c) is the answer. Therefore only option (a) is correct. NP0 + S N+ 1 45. It is also not an example of participating preference shares. Perpetual preference share capital will remain with the company forever. C D 54 S S = = = 5 (56) + S 5+ 1 54 (6) – 56 (5) Rs.

1 =10 18/0.3 15.00 Debt 0.3 16.00 16.00 Preference 0. C Calculation of breaking point Source of finance Equity Preference Debt Cost % 15.50 30-66.95 + 1.5 4.50 8.67-100 Equity 0. C The cost of raising fresh equity involve the flotation cost which increases its cost more than the cost of retained earnings.1 12.50 10-30 Equity 0. B = = = ∴ Market value of equity 55.95 1.00.12(10 − 5) 5 + 0.8 = 10. D i(1 − t) + f−p n f+ p 2 Range of total new financing (Rs.6*8 = 4.00 Preference 0.1*12 + 0.2 4.15 (40/100) + 0.00.30) + = = 57. Hence (c) is the correct answer. In crores) 0-10 80(1 − 0.20.3*16.5 1 4.67 Equity 0.6 7.00 Debt 0.00 7.000 Breaking point (Rs.3 = 100 1/0.2. It is not free of cost.00 Debt 0.53. and it does not depends on the earning per share of the company.6 7. 9/0.8% 975 Overall capitalization rate = K0 = = Net operating income/market value of the firm kd (B/B+S) + Ke (S/B+S) 0. D 1050 − 900 5 1050 + 900 2 56 + 30 = 8.50 Preference 0.8 4.00 Range of new financing (Rs.95% 56.50 Preference 0.10) 2 50 + 60 110 110 × 2. In crores) 0-30 30-100 0-10 10 and above 0-30 30-66.000 Rs.95 1.00 weighted marginal cost of capital = 0.6 = 66.2 4.50 10.67 Proportion Cost % Equity 0.17(60/100) 21 .1 12.3 = 30 30/0.1 12.67 Weighted Cost % 4.3 16. According to Walter model = D r(E − D) / Ke + Ke Ke 54.1 10.2 Therefore.10 (0.5 1.00 12.5 4.2 + 4. In crores) Range of total new financing (Rs. So it is not equal to the existing cost of retained earnings.6 = 30 40/0. In crores) 0-9 9-30 0-1 1 and above 0-18 18-40 Source of finance = = 0.50 + 0.6 8.00 66.3 15.

40. A 0.000.08 = Rs. 63. E The bond yield plus risk premium approach is used to find out the cost of equity capital. 60.15.00.64(1+0. the value of levered firm exceeds the unlevered firm by the amount of tax shield.18 million 40:60 40 Capital budget Debt equity ratio Therefore debt 18 × 100 = Rs.05) = 10.40. B = = E = 8.162 × 100 16.2 million 22 .90.000 – Rs.000/100 = Rs.10.2 lakh As per the MM Hypothesis.102 0. 000 Amount of debt Tax shield = = = = 0.00.g. It is illogical to apply for finding out the cost of bonds because the basis of this approach is the yield or cost of the bond itself. The cost of preference capital is found out by discounting the preference dividends and redemption value.61%.122/20=0. D Number of equity shares of the company = Preference dividend paid = 15 × 6. C 62. etc.35 E = 10. the land price may appreciate.000/10 = 84.8. Rs.05 = Rs.9.50 or.90.00.64 Accord into earnings price ratio approach cost of equity = E1/P = E1 = Earnings per share for the next year P = Market price per the share = E1 = E(1+g) = 9.10 = = = Rs.8. 58.35 3 = 3. or.000 = Rs.000/ 84. the machine may become obsolete.000/ 84. According to the traditional approach P 58. or.7.162 k0 × market value of the firm 0.000 × 0. and the cost of term loan is found out by adjusting the nominal interest cost for tax.000 B(t) 30.00.9.50 Rs.5061=50.30.000 = Rs.06 + 0. The book values of the different sources of finances may not be related to their current economic values e. 2. The reasons stated in the other options are the advantages of using book values as the basis of the weights for the calculation of the cost of capital. Generally there are no explicit costs associated with trade credit and there is no logical connection between the cost of trade credit and bond yields.122 Cost of equity = 10.= = Net operating income = = = So option (d) is the answer. A 5+ E 3 E  m D +  3  E  7 5+  3  61. 59.00.000.000 Earnings per share = Net profit – Preference dividend/no of equity shares = Rs.

Rest capital budget = Rs.16 ( 10 − 4 ) / 0.12 = Rs. B = Rs.15 million Therefore residual dividend = Rs. D Miller and Modigliani Model: Assumptions: • The first assumption is the existence of a perfect market in which all investors are rational. Cost of external equity comes into picture.8 = Rs. D = Rs. Agency costs (not bankruptcy costs) represent certain restrictions on the firm in the form of some prospective covenants incorporated in the loan contract. This assumptions was however.10.12 4 + = 33. Secondly. Walter’s model on dividend capitalization states that: 65. as bankruptcy costs represent a loss. Hence (b) is the correct answer. r = 16 percent and Ke = 12 percent.10.10 × 40 percent = Rs. the required market value of the share as per Walter’s model will be = Rs. Therefore statement (III) is true. The securities are infinitely divisible and hence no single investors in large enough to influence the share value. So. (II) and (IV) are wrong.00 per share.4. it is assumed that there are no taxes. In perfect market condition there is easy access to information and the flotation and the transaction costs do not exist.4. • • The third assumption is a constant investment policy of the firm.8 million Net income = Rs. The probability of bankruptcy for a levered firm is higher than for an unlevered firm. P1 is 23 . P0 is P0 = 1 1 + ke ( D1 + P ) 1 Step 1:Since the firm pays a dividend of Rs. 67. the earnings per share for the company = Rs.000/60. the market price per share.000 = Rs.15million = 28%. This means that the expected cost of bankruptcy increases when the debt-equity ratio increases. we have.6. which is faced with the prospect of bankruptcy.100. according to Walter’s model is given as: 0.15 – 10. the probability of bankruptcy increases at an increasing rate as the debt-equity ratio increases. and statements (I). 69. dropped out of the model.2 million Dividend payout ratio 64. the price at the end of year 1.12 P = 0.4. 66.10. 68.2 million Rs.100 Hence. All the given statements are limitations of Walter’s model. Therefore. when there are certain floatation costs involved in the process of raising equity from the market. Investors expect a higher rate of return from a firm. Finally. E As per MM model. Statement (I) is wrong.4. implying that there is no differential tax rate for the dividend income and the capital gains.33 + 66. D E D P= D r ( E − D) / Ke + Ke Ke Here. the current market price of the share.00. E = Rs.18 million – Rs.7. which cannot be easily diversified away. which will not change the risk complexion nor the rate of return even in cases where the investments are funded by the retained earnings.10 and the amount of dividend paid per share = Rs.67 0. the dividend and the share value of the firm with certainty.2 million = Rs.00. it was also assumed that the investors are able to forecast the future earnings.00. Beyond a threshold level.

00. the answer is (b). we get E  P = 6  0.10 At i = 5%.82 i= = 5.48 The YTM is the value of ‘i’ in the following: 95 = 4PVIFAi. 000 The company has to issue 30. Po = Using CAPM K P 72.4 D1 k− g 6+ 0. 00.40 E +  = E ( 2. 5+ 98.10 + 110PVIFi.428 At i = 6%. 70.45 = 10.4 + 2 ) 3  ∴ P 71.95 (12.075 = Rs.9% (approximately) Hence.428 − 95 98.000 new shares. 000 − (12. 00.428 − 90. RHS = 98.000 -80.80. B Intrinsic Value. 000 / 80 = 30.12175 − 0.000x10) 80n 1 = 24.2) − 10 1 P = Rs.5 – 6) = 12. RHS = 90. A According to the Traditional approach P = m D+ E ( 3 ) where symbols are in their standard use Substituting the values.075 0.00.82 < TOP OF THE DOCUMENT > 24 .75 = 1 1 + 0. B = = E = 4. 000 n1 = 24.2 (10 + P ) 1 P = (75 x1.175% Rf + β(Rm – Rf) = 3.80 1 Step 2: Amount to be raised by the issue of new shares: n1 P = I − ( E − nD1 ) 1 n1 x80 = 28.5 × 1.