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N.L.

DALMIA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH


FULL TIME - SEMESTER III FINANCE STREAM
ADVANCED FINANCIAL MANAGEEMNT – PROF. P.L.ARYA

Duration :3 Hours Max. Marks


: 100

Notes : Attempt Total 6 questions.


For MMS students the weightage is 60 Marks and for PGDBM students the
weightage in 100 Marks.

Q.1.The income statement and Balance Sheets of Deepam Silks for year 1 and 2 are as
follows :-

Profit And Loss Account Year 1 Year 2


Net Sales 600 720
Gross Profit 450 500
Cost Of Goods Sold 150 220
Selling Expenses 50 60
General and Administration expenses 36 40
Depreciation 30 40
Operating profit 34 80
Non operation surplus/deficit 10 8
Profit before interest and tax 44 72
Interest 10 12
Profit before tax 34 60
Tax 14 26
Profit after tax 20 34
Dividends 12 15
Retained earnings 8 19

Balance Sheet Year 1 Year 2


Assets :
Fixed Assets (Net) 240 270
Investments 10 10
Current Assts, Loans and Advances :
- Cash and Bank 5 6
- Receivables 80 90
- Inventories 125 144
- Loans and advances 25 30
Miscellaneous expenditure and losses 15 10
Total 500 560

Balance Sheet Year 1 Year 2


Liabilities :
Share Capital
- Equity 100 100
- Preference 20 20
Reserve and Surplus 150 169
Secured Loans :
Bank Borrowing 60 80
Unsecured Loans:
Public deposits - 11
Current Liabilities and Borrowings :
-Trade Creditors 125 130
Provisions 45 50
500 560

Prepare the proforma income statement for year 3 and the proforma balance sheet as at
the end of year 3, based on the following assumptions :
a) The projected sales for year 3 are 850.
b) The forecast values for the following profit and loss account items may be
derived using the percent of sales method (for this purpose, assume that the average of
the percentages for years 1 and 2 is applicable).

- Cost of goods sold


- Selling expenses
- General and administration expenses
- Non-operating surplus/deficit
- Interest

c) The forecast values for the other items of the profit and loss account are as follows:
- Depreciation : 45
- Tax : 50 percent of earnings before tax
- Dividends : 21
d) The forecast values of various balance sheet items may be derived as follows :-
- Fixed Assets (net) : Budgeted at 300
- Investments : No change over year 2
- Current Assets : Percent of sales method where in the percentages are
based on the average for the previous tow years.
- Miscellaneous exp. : Expected to be reduced to 5 and losses
- Equity and pref. Capital : No change over year 2
-Reserves and Surplus : Proforma Profit and Loss Account
- Bank borrowings and current : Percent of sales method where in the percentage
Are liabilities and provisions based on the
Average for the previous two years.
- Public deposits : No change
- External fund required : Balancing item

Q.2. Divya Electronics was promoted about twenty years by Dipankar Mitra, who
continues to be the Executive Chairman of the firm. Initially, the firm employed a debt
equity ratio of 1.5 : 1 as the promoter had limited resources. While the firm had a few bad
patches, it had performed fairly well and has been reasonably profitable. Over time, the
proportion of debt in the capital structure diminished. The firm also issued bonus shares
on two occasions once before making its IPO eight years ago and once subsequently.
The financial statements of the firm for he just concluded financial year are given
below. The profit and Loss Account has been cast in the contribution format to facilitate
the calculation of leverages.

Balance Sheet Profit and Loss Account


Source of Funds : Rs.in Rs.in
Million Million
1) Shareholders funds: Revenues 8000
-Paid up equity capital (140 1400 Variable Costs 4800
Milliom shares of Rs.10 each)
- Reserves and Surplus 2600 Contribution Margin 3200
2) Loan Funds 2000 Fixed Operating costs 1800
6000 Profit Before interest and 1400
taxes
Application of Funds : Interest 200
1) Net Fixed Assets 4000 Profit Before Tax 1200
2) Net Current Assets 2000 Tax 360
6000 840

The Current market price per share is Rs. 115 giving a retrospective PE ration of 19.17
the highest in its history.

Dipankar Mitra and his family holds 45 million shares of Divya Electronics. The rest is
held more or less equally by institutional investors and retail investors.

The firm has an expansion project on hand that will require and outlay of Rs. 2000
milliom which will be supported by external financing. The expansion project is expected
to generate an annual revenue of Rs. 2400 million. Its variable costs will be 60 percent of
revenues and its fixed operating costd would be Rs.500 million. The expansion can be
completed quickly.

EMAN Consultants, the merchant bankers of Divya Elctronics. Believe that Divya
Electronics can make a public issue of equity shares at Rs.106. the issue expenses,
however, will be Rs. 6 per share. The other option is to privately palce debentures
carrying an interest rate of 8 percent.

The board of directors of Divya Electronics would be meeting shortly to decide on the
means of financing to be adopted for the proposed expansion plan.

You have been requested to present an analysis of the two options. In particular, you have
been asked to :
a) Computer the EPS-EBIT indifference point for the two financing options.
b) Calculate the EPS for the following year under the two financing options assuming
that the expansion project would be fully operational.
c) Show how the degree of total leverage will change under the two financing options.
d) Highlight any other issued that you believe are important for taking the decision.

Q.3. Ram Ltd. And Shyam Ltd. Belongs to the same risk class- these companies are
identical in all respects excepts that Ram Ltd. Has no debt in its capital structure, whereas
Shyam Ltd. Employs debt in its capital structure. The relevant financial particulars of the
two companies are given below :-
Ram Limited Shyam Limited
Net Operating Income Rs. 10,00,000 Rs. 10,00,000
Debt Interest Rs. 3,00,000
Equity earnings Rs.10,00,000 Rs. 7,00,000
Debt Capitalization rate - 10%
Equity capitalization rate 14% 18%
Market value of debt - Rs.30,00,000
Total market value of the firm Rs. 71,42.857 Rs.38,88,888
Total market value of the firm Rs. 71,42,857 Rs.68,88,888
Average cost of capital 14% 14.52%

Praveen owns Rs.1,00,000 worth of Ram Ltd. Equity.What arbitrage will he resort to?
Q.4. Magnavision Corporation is expected t grow at a higher rate of 4 years; thereafter
the growth rate will fall and stabilize at a lower level. The following information has been
assembled:

Base Year (Year 0 ) Information

Revenues Rs. 3000 Million


EBIT Rs. 500 Million
Capital expenditure Rs. 350 Million
Depreciation Rs. 250 Million
Working Capital as a percentage of revenues 25%
Corporate tax rate (for all time) 30%
Paid up equity capital (Rs. 10 par) Rs. 400 million
Market value of debt Rs. 1200 Million

Inputs for the High Growth Phase

Length of high growth phase 4 years


Growth rate in revenues, depreciation EBIT and Capital expenditure 20%
Working capital as a percentage of revenues 25%
Cost of Debt (pre-tax) 13%
Debt-equity ratio 1:1
Risk Free Rate 11%
Market risk Premium 7%
Equity beta 1.129
Inputs for the Stable Growth Phase
Expected growth rate in revenues and EBIT 10%
Capital expenditure are offset by depreciation
Working capital as a percentage of revenues 25%
Cost of Debt (pre-tax) 12.14%
Risk free rate 10%
Market risk premium 6%
Equity beta 1.0
Debt equity ratio 2:3

i) What is the WACC for the high growth phase and the stable growth phase?
ii) What is the value of the firm?

Q.5. The income statement for year 0 (the year which has just ended)and the balance
sheet at the end of the year 0 for Futura Ltd. Are as follows:

Income Statement Balance Sheet


-Sales 10,000 Equity 6000 Fixed Assets 4000
Gross Margin(20%) 2,000
Selling and general 1000 Current 2000
Administration (10%) Assets
- Profit before tax 1000
- Tax 300
-Profit After tax 700 6000 6000

Future Lts. Is debating whether it should maintain the status quo or adopt a new strategy.
If it maintains the status quo:
The sales will remain constant at 10,000.
The gross margin will remain at 20% and the selling, general and administrative
expenses will be 10% of sales.
Depreciation charges will be equal to new investments.
The asset turnover ratios will remain constant.
The discount rate will be 15 percent.
The income tax rate will be 30 percent.

If Futura Ltd. Adopts a new strategy. Its sales will grow at a rate of 20 percent per year
for three years. The margins, the turnover ratios, the capital structure, the income tax rate,
and the discount rate, however will remain unchanged. Depreciation charges will be
equal to 10 percent of the net fixed assets at the beginning of the year.

What value will the new strategy create?

Q.6. Write short notes on (ANY TWO)


a) Forward Contracts
b) Futures and Future Contracts
c) Currency Swaps
d) Options and Option Contracts

Q.7. What do you understand by investment Banking? Briefly describe important


guidelines of SEBI for initial public offering?

Q.8. Write short notes (ANT TWO) of the following


a) Financial Management of Sick units
b) Financial Management of PSU’s
c) Credit Rating Agencies and Process.

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