3.EF232. FIM IL II Solution CMA September 2022 Exam.
3.EF232. FIM IL II Solution CMA September 2022 Exam.
3.EF232. FIM IL II Solution CMA September 2022 Exam.
Intermediate Level II
Subject: EF232. Financial Management
Model Solution
Solution of the Question 1
(i) (a)
(ii) (a)
(iii) (b)
(iv) (b)
(v) (c)
(vi) (c)
(vii) (d)
(viii) (d)
(ix) (d)
(x) (e)
Solution of the Question 2
(a) False. The operating break-even point is the point at which operating profits equal ZERO
(revenues equal operating costs).
(b) True.
(c) False. A call provision allows the ISSUER of a security to demand repayment of the principal.
(d) True.
(e) False. The security market line (SML) describes the relationship between a security's expected
return and systematic risk.
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(c)
D0 = Tk. 1.80/share
rs = 12%
(i) Zero growth:
P0 =D1/rs = (D1 = D0 = Tk. 1.80)/0.12 = Tk. 15/share
(ii) Constant growth, g = 5%
D1 = D0 × (1 + g) = Tk. 1.80 × (1 + 0.05) = Tk. 1.89/share
P0 = D1/(rs – g) = Tk. 1.89/(0.12 – 0.05) = Tk. 27/share
(iii) Variable growth, N = 3, g1 = 5% for years 1 to 3 and g2 = 4% for years 4 to infinity
D1 = D0 × (1 + g1)1 = Tk. 1.80 × (1 + 0.05)1 = Tk. 1.89/share
D2 = D0 × (1 + g1)2 = Tk. 1.80 × (1 + 0.05)2 = Tk. 1.98/share
D3 = D0 × (1 + g1)3 = Tk. 1.80 × (1 + 0.05)3 = Tk. 2.08/share
D4 = D3 × (1 + g2) = Tk. 2.08 × (1 + 0.04) = Tk. 2.16/share
P3 = D4/(rs – g2) = Tk. 2.16/(0.12 – 0.04) = Tk. 27/share
P0 = D1/(1 + rs)1 + D2/(1 + rs)2 + D3/(1 + rs)3 + P3/(1 + rs)3
= Tk. 1.89/(1+0.12)1 + Tk. 1.98/(1+0.12)2 + Tk. 2.08/(1+0.12)3 + Tk. 27/(1+0.12)3
= Tk. 23.97/Share
(d)
(i) Dividend cover = Earnings available to equity holders/Ordinary dividend
= (40,000(1 – 0.25) – 5,400)/6,750
= 24,600/6,750 = 3.64 times
(ii) Earnings per share = Earnings available to equity holders/No. of ordinary shares
= 24,600/15,000 = Tk. 1.64
(iii) Price-earnings ratio = Price/EPS = 45/1.64 = 27.44 times
Comment: Since the NPV of the project is positive, the value of the firm will increase when the project
is implemented. The project should therefore be accepted for implementation.
Workings:
1. Discount rate
The real rate of return is estimated using the Fisher’s equation as under:
1+𝑖=(1+𝑟)(1+ℎ)
Nominal rate, i = 25%
Inflation rate, h = 15%
Therefore, the real rate of return is 8.7%
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2. Discount factor for equal cash flows occurring every year from year 6 to infinity
The equal annual cash flow of Tk. 30,000 from year 6 to infinity is first discounted as a perpetuity to
obtain the terminal value at end of year 5. The terminal value is then discounted as a single amount to
obtain the PV at time zero: The aggregate discount factor is therefore 7.575.
(ii) Project selection under single period capital rationing
1. If projects are independent and divisible:
When a firm faces capital rationing for a single period and projects are independent and divisible,
funds may be allocated to projects based on the profitability index rankings.
Project Investment NPV PI = NPV/Investment Rank
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(iii) Practical ways of dealing with capital constraints so as not to lose opportunities to further
increase the value of the company further include the following:
(1) Seek joint venture partners with which to share projects investment requirement
(2) Use licensing or franchising arrangement with other entities to get the product produced
and sold. The firm will earn royalties while avoiding financing of the investment
requirements.
(3) Contract out parts of the project to subcontractors who would finance the project in advance.
(4) Seek alternative financing such as venture capital and asset securitization.
(b)
i. Cost of retained earnings = rr = [Tk.1.26(1 + 0.06)]/ Tk.40 + 0.06
= 9.35%
ii. Cost of new common stock = rs = [Tk.1.26(1 + 0.06)]/ Tk.40.00 - Tk.7.00) + 0.06
= 10.06%
iii. Cost of preferred stock = rp = Tk.2.00/ (Tk.25.00 - Tk.3.00)
= 9.09%
iv. rd = 5.98%
ri = 5.98% (1- 0.40) = 3.59%
= THE END =
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