Seat No.: ________ Enrolment No.

___________

GUJARAT TECHNOLOGICAL UNIVERSITY

Subject Code: 2820003 Date: 07/NOV/2017

Q. No.1 From the four alternative answers given against each of the following cases, 6
indicate the correct answer:(just state A, B, C or D)

Q.1 (a) Sun Limited has an obligation to redeem 500 Mn bonds 6 years hence. How much
should the company deposit annually in a sinking fund account wherein it earns 14
percent to cumulate 500 Mn in 6 years time?
A. 58.575 B. 68.755
1.
C. 60.00 D. 62.575
100 par value bonds bearing a coupon rate of 12 percent will mature after 5 years.
What is the value of the bond, if the discount is 15 percent?
2. A. 92.56 B. 89.92
C. 100 D 79.53
The cost of equity capital is all of the following EXCEPT:
A. The minimum rate that a firm should earn B. A return on the equity-
on the equity-financed part of an financed portion of an
investment. investment that, at worst,
3. leaves the market
price of the stock
unchanged.
C. By far the most difficult component cost to D. Generally lower than the
estimate before-tax cost of debt.
All of the following influence capital budgeting cash flows EXCEPT:
A. Accelerated depreciation. B. Salvage value.
4.
C. Tax rate changes. D. Method of project financing
used.
Which of the following would be consistent with a more aggressive approach to
financing working capital?
A. Financing some long-term needs with B. Financing permanent
5. short-term funds. inventory buildup with
long-term debt.
C. Financing seasonal needs with short-term D. Financing short-term needs
funds with short-term funds.
Which of the following is an argument for the relevance of dividends?
A. Informational content. B. Reduction of uncertainty.
6.
C. Some investors' preference for current D. All of the above.
income.

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Q.1 (b) Answer in brief: 04
1 What is agency problem?
2 What is equity capitalization rate?
3 What is meant by right issue of shares?
4 Define an annuity due.
Q.1 (c) Briefly explain the three basic reasons why profit/EPS maximization fails to be 04
consistent with wealth maximization.

Q.2 (a) You want to borrow 1,080,000 to buy a flat. You approach a housing financing 07
company which charges 12.5 percent interest. You can pay 1,80,000 per year
toward loan amortization. What should be the maturity period of the loan?

(b) The bonds of Aries Ltd currently sell at 115.They have a 12 per cent coupon rate 07
of interest and 100 par value. The interest is paid annually and the bonds have 18
years to maturity. Compute the yield to maturity (YTM) of the bond. Compare the
computed YTM with the coupon interest rate. How do you explain the difference
between the current price and the par value of the bond?
OR
(b) “The recommendations of the committee to frame guidelines for follow-up of bank 07
credit ( Tandon Committee) are a revolutionary development”. Comment.

Q.3 (a) Three Financing plans are available to Anmol Products, which needs 10,00,000 07
for construction of a new plant. Anmol wants to maximize EPS. Currently the
equity share is selling for 30 per share. The EBIT resulting from the plant
operation is 1,50,000 per year. Anmol’s marginal tax rate is 50 %.Money can be
borrowed at the rate indicated:

Up to 1,00,000 at 10 %
Over 1,00,000 to 5,00,000 at 14 %
Over 5,00,000 at 18 %
The three financing plans are as follows:
Plan X: Use 1,00,000 debt; Expected EBIT = 2,50,000
Plan Y: Use 3,00,000 debt; Expected EBIT = 3,50,000
Plan Z: Use 6,00,000 debt; Expected EBIT = 5,00,000
Determine the EPS for these three plans and indicate the financing plan which will
result in the highest EPS.
(b) The present credit terms of MiniMax Company are 2/15, net 45.Its sales are 200 07
million, its average collection period, is 30 days, its variable costs to sales ratio is
0.80, and its cost of capital is 12 per cent. The proportion of sales on which
customers currently take discount is 0.50.MiniMax is considering relaxing its
discount terms to 3/15, net 45.Such a relaxation is expected to increase sales by
10 million, reduce the ACP to 27 days, and increase the proportion of discount
sales to 0.60.MiniMax’s tax rate is 40 per cent. What will be the effect of
liberalizing the cash discount on residual income?
OR
Q.3 (a) Global Electronics plans to use equity and debt in the following proportions: 07
Equity: 40 & Debt : 60
Bases on its discussions with its merchant bankers and lenders Global Electronics
estimates the cost of its sources of finance for various levels of usage as follows:

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 Source of Finance Range of New Financing Cost (%)
( in millions)
Equity 0-30 18
More than 30 20
Debt 0-50 10
More than 50 11
Determine Weighted Average Cost of Capital for various ranges of Total
Financing.

(b) Since the rights issue allows the ordinary shareholders to purchase the shares at a 07
price much lower than the current market price, why does shareholders’ wealth not
increase? Illustrate your answer?
Q.4 (a) A company belongs to a risk class for which the approximate capitalization rate is 07
10 per cent. It currently has outstanding 25,000 shares selling at 100 each. The
firm is contemplating the declaration of a dividend of 5 per share at the end of the
current financial year. It expects to have a net income of 2,50,000 and has a
proposal for making new investments of 5,00,000.Show that under the MM
assumptions, the payment of dividend does not affect the value of the firm?

(b) What are the possible disinvestments avenues available to venture capital firm in 07
India? Explain their merits and demerits.

OR
Q.4 (a) An all equity financed company has 10,00,000 ordinary shares of face value 10 07
in issue with a current share price of 25 ex-dividend. Annual earnings are 4.50
per share and in the absence of new investment will remain constant in perpetuity
all earning are distributed at present. A new investment is available which will
cost 35,00,000 in 1 year’s time and will produce annual cash inflow thereafter of
7,00,000.Analyse the effect of the new project on dividend payment and the
share price.

(b) The primary purpose for which a firm exists is the payment of dividend. Therefore, 07
irrespective of the firm’s needs and the desires of shareholders, a firm should
follow a policy of very high dividend payout. Do you agree? Why or Why not?

Q.5 JSP Pvt. Ltd is considering a capital project. The investment outlay on the project 14
will be 100 million. This consists of 80 million on plant and machinery and
20 million on net working capital. The entire outlay will be incurred at the
beginning of the project. The life of the project is expected to be 5 years. At the
end of 5 years, fixed assets will fetch a net salvage value of 30 million, whereas
net working capital will be liquidated at its book value. The project will be
financed with 45 million of equity capital, 5 million of preference capita, and
50 million of debt capital. Preference capital will carry a dividend rate of 15
percent; debt capital will carry an interest rate of 15 percent. The project is
expected to increase the revenues of the firm by 120 million per year. The
increase in costs on account of the project is expected to be 80 million per year
(This includes all items of costs other than depreciation, interest, and tax). The
effective tax rate will be 30 percent.
 Plant and machinery will be depreciated at the rate of 25 percent per year as per
the written down value method. From the given case: calculate (a) Operating
Cash flow & Terminal cash flow.

OR
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 Finance manager of Dhan Rice Mill Ltd have been considering the proposal to 14
Q.5 replace the existing coal-fired furnace in the paddy boiling section by a new
furnace is cyclone type husk-fired furnace. The capital cost of the new furnace is
expected to be 1 lakh.It will have useful life of 10 years at the end of which
period its residual value will be negligible. The present furnace has a book value of
15,000 and can be used for another 10 years with only minor repairs. If scrapped
now, it can fetch 10,000 but it cannot fetch any amount if scrapped after ten more
years of use.
The basic advantage of the new furnace is that it does not depend on the coal
whose supplies are becoming increasingly erratic in recent years. On a
conservative estimate, the new furnace will result in a saving of 25,000 per
annum on account of elimination coal cost. However, the cost of electricity and
other operating expenses are likely to go up by 8,000 and 4,000 per annum
respectively.
The hunk which results as a by-product during the normal milling operations at
3,000 metric ton of paddy milled per year is considered adequate for operating the
new furnace. On an average, for every metric ton of paddy milled, the hunk content
is 20 per cent. At present, the hunk resulting during the milling operations is sold at
a price of 50 per metric ton. Once the new furnace is installed hunk will be
diverted for own use. ‘White Ash’ which constitutes about 5 percent of the hunk
burnt in the new furnace, will be collected in a separate ash-pit as it has
considerable demand in the refractory industry. It can be sold very easily at a price
of 1,500 per metric ton.
The new furnace will require a motor of 15 HP, whose cost is not included in 1
lakh, the capital cost of the furnace. A 15 HP motor is lying idle with the polishing
section of the mill which can fetch an amount of 3,000 on sale. It has a net book
value of 5,000.The motor can be used for the new furnace. At the end of the ten
years, it can be scrapped at zero residual value. All the assets of the company are in
the same block. Depreciation will be on straight line basis and the same is assumed
to be acceptable for tax purpose as well. Applicable tax rate is 35 per cent and cost
of capital is 12 per cent.

Formulate the incremental net after-tax cash flows associated with the replacement
project. Also calculate the project’s NPV.Give your recommendation.

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