SOLUTION FOR CA FINAL SFM NOV 15 PAPER (PRACTICAL QUESTIONS) BY CA PRAVIIN MAHAJAN

Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

Q1a A bank enters into a forward purchase TT covering an export bill for Swiss francs 1,00,000 at ₹ 32.4000 due on 25th April and covered itself for same delivery in the local inter bank market at ₹ 32.4200. However on 25th March, exporter sought for cancellation of contract as the tenor of the bill is changed In singapore market, swiss Francs were quoted against US dollars as under :

5 Marks

Spot USD 1 = Sw.Fcs 1.5076/1.5120 One month forward 1.5150/1.5160 Two month forward 1.5250/1.5270 Three month forward 1.5415/1.5445 And in the inter bank market US dollars were quoted as under: Spot USD 1 = ₹ 49.4302/.4455 Spot/April .4100/.4200 Spot/May .4300/.4400 Spot/June .4500/.4600 Calculate the cancellation charges payable by the customer if exchange margin required by the bank is 0.10% on buying and selling Comment - Simple ques of Cancellation of forward contract . DONE IN CLASS Ans

Bank made forward contract to purchase SF 1,00,000 @ ₹ 32.40 on 25th april. On 25th march customer approached bank to cancell contract. For cancellation bank will sell 1,00,000 $ to customer at one month forward rate For cancellation Bank will sell SF 1,00,000 at ₹ 𝑆𝐹

=

₹ $

=

(49.4455 +0.4200 +

=

₹ 32.947

x

$ 𝑆𝐹 0.1 100

x 49.8655)

1 1.5150

x

Statement of cancellation charges payable by customer Purchase of 1,00,000 SF by bank @ 32.40

b.

32,40,000

Sale of 1,00,000 Sf by bank to customer @ 32.947 32,94,700 Gain to bank payable by customer 54,700 The following data is available for a bond Face value ₹ 1,000 Coupon rate 11% Years to maturity 6 5 marks Redemption value ₹ 1,000 Yield to maturity 15% (Round off your answer to 3 decimals ) Calculate the following in respect of the bond 1. Current market price 2. Duration of the bond 3. Volatality of the bond 4. Expected market price if increase in required yield is by 100 basis points 5. Expected market price if decrease in required yield is by 75 basis points 1

CA PRAVIIN MAHAJAN SFM CLASSES

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Solution to CA FINAL SFM – NOV 15 by Comment : Simple question of bond duration. Q38, Ans. Year 1 2 3 4 5 6 1. 2.

3. 4.

5.

c.

CA PRAVIIN MAHAJAN

pg 8.7,Nov 05. DONE IN CLASS

Statement of Expected MP and duration of bond Cash flows Factor15% PV Year PV x year 110 0.870 95.7 1 95.7 110 0.756 83.16 2 166.32 110 0.658 72.38 3 217.14 110 0.572 62.92 4 251.68 110 0.497 54.67 5 273.35 110 + 1000 0.432 479.52 6 2877.12 848.35 3881.31 Current market price of bond is present value of all future cash outflows in form of interest and redemption value i.e 473.635 Duration of bond

volatality of bond

𝑃𝑉 𝑋 𝑇𝑖𝑚𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 3881.31 = 848.35 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑏𝑜𝑛𝑑 1 + 𝑦𝑡𝑚

=

4.575 years 4.575 1.15

= 3.98 %

For 1% change in ytm there is 3.98% change in price. If YTM increases, market price decreases IF YTM increases by 100 basis points i.e 1% MP will decrease by 3.98% So MP will be 848.35 – 0.0398 of 848.35 = 814.59 If YTM decrease by 75 basis points i.e 0.75%, MP will increase by 3.98 x 0.75= 2.985 % 848.35 + 2.985 % of 848.35 = 873.67

Mr Dayal is interested in purchasing equity share of ABC Ltd which are currently selling @ ₹ 600 each. He expects that price of share may go upto ₹ 780 or may go down to ₹ 480 in three months. The chances of occuring such variations are 60% and 40% respectively. A call option on shares of ABC Ltd can be excersised at the end of three months with a strike price of ₹ 630. 1. What combination of share and option should Mr dayal select if he wants a perfect hedge? 2. What should be the value of option today (the risk free rate is 10% p.a) 5 marks 3. What is the expected rate of return on option. Comment : It is the simple question of binomial model same as Q 42 of derivatives of our

book. Since probability of high price and low price is given, so vl use risk neutralisation model. But hedge ratio is computed acc to binomial model. DONE IN CLASS

2

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Solution to CA FINAL SFM – NOV 15 by

Ans

1.

Hedge ratio

2.

Value of option

𝑈−𝐸 𝑈−𝐿

=

780 − 630 780 − 480

CA PRAVIIN MAHAJAN

= 0.5 or 50%

𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑝𝑡𝑖𝑜𝑛 𝑎𝑡 ℎ𝑖𝑔ℎ 𝑝𝑟𝑖𝑐𝑒 𝑋 𝑝𝑟𝑜𝑏.𝑜𝑓 ℎ𝑖𝑔ℎ 𝑝𝑟𝑖𝑐𝑒 + 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑝𝑡𝑖𝑜𝑛 𝑎𝑡 𝑙𝑜𝑤 𝑝𝑟𝑖𝑐𝑒 𝑋 𝑝𝑟𝑜𝑏 𝑜𝑓 𝑙𝑜𝑤 𝑝𝑟𝑖𝑐𝑒 1+ 𝑟 𝑛

=

𝑢 − (1+ 𝑟)𝑛 𝑢− 𝐿

=

1.3 − 1.025 1.3 − 0.8

Prob of high price

=

0.45

Value of option =

(780 − 630 ) 0.45 + 1.025

Prob of low price

3.

= 0.55

0 𝑋 0.55

= 65.85

expected rate of return on option= 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑐𝑎𝑙𝑙 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 𝑝𝑎𝑖𝑑 𝑜𝑛 𝑐𝑎𝑙𝑙

x 100

(780 − 630 ) 0.6 87.8

+

0 𝑋 0.4

=

2.5 3

x 12 = 10%

If risk is neutralised then return on option is equal to risk free return i.e 10% d

XYZ an indian firm, will need to pay JAPANESE YEN (JY) 5,00,000 on 30th June. In order to hedge the risk . involved in foreign currency transaction, the firm is considering two alternative methods i.e forward market cover and currency options contract. On 1st april, following quotations (JY/INR) are made available Spot 3 months forward 1.9516/1.9711 1.9726/1.9923 The prices for forex currency option are as follows Strike price JY 2.125 Call option (June) JY 0.047 Put option (June) JY 0.098 For excess or balance of JY covered, the firm would use forward rate as future spot rate You are required to recommend cheaper hedging alternative for XYZ.

5 marks

Comment : This is the question of currency option with INDIRECT QUOTE. Q 91 c, pg 3.23 . If students are habitual of coverting direct quote into indirect quote, answer will not be correct. So it is utmost importance that student should be able to do and read indirect quote as it is. DONE IN CLASS Ans

XYZ, an indian firm has to buy 5,00,000 JY on 30th june Since quote is JY/₹, relevant rate is bid rate Co. has 2 options

3

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Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

1. Hedge through currency options Call option gives right to buy ₹ Put option gives right to sell ₹ Since co. has to buy JY (sell ₹) so co. will buy put option JY to be bought 5,00,000 Re to be sold

5,00,000 2.125

= 2,35,294.12 ₹

Premium JY 0.098 / ₹ sold Statement of payment Premium payable in JY 2,35,294.12 x 0.098 Premium payable in ₹ 23,059 / 1.9516 ₹ paid for purchase of 5,00,000 JY Total payment

23,059 JY ₹ 11,815 ₹ 2,35,294.12 2,47,109.12

Note : since lot size is not given so there is no unhedged JY 2. Hedge through forward market Co. will book a forward contract today to buy 5,00,000 JY on 30th june @ JY 1.9726/₹ Co. will pay 5,00,000/1.9726 = ₹ 2,53,472.57 Q2a The following information is provided relating to the acquiring Company Eltd and the target company H ltd. Particulars Number of shares (FV ₹ 10 each) Market capitalisation PE ratio (Times) Reserves and surplus in ₹ Promoters Holding (No. of shares)

E Ltd ₹ 20 lakhs 1000 Lakhs 10.00 600.00 Lakhs 9.50 Lakhs

H Ltd ₹ 15 lakhs 1500 Lakhs 5.00 330.00 Lakhs 10.00 Lakhs

The Board of directors of both the companies have decided to give a fair deal to the shareholders. Accordingly, the weights are decided as 40%, 25% and 35% respectively for earnings, book value and market price of share of each company for swap ratio. Calculate the following:

10 Marks

1. 2. 3. 4. 5.

Market price per share, earning per share and Book value per share Swap ratio Promoters holding percentage after acquisition EPS of E Ltd after acquisition of H Ltd Expected market price per share and Market capitalisation of E Ltd after acquisition assumingPE ratio of E ltd remains unchanged 6. Free flow market capitalisation of merged firm. Comment : Simple question of Merger and acquisition. Q8 pg 4.3. DONE IN CLASS

4

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Solution to CA FINAL SFM – NOV 15 by Ans

1.

CA PRAVIIN MAHAJAN

MP per share E H

Mkt cap / no. of shares 1000 lakh/20 lakh = 1500 lakh/ 15 lakh =

50 100

Exch ratio 2:1

EPS

MP/PE ratio 50/10 100/5

5 20

Exch Ratio 4:1

E H Book Value per share E H

sh cap + Res & sur / No. of shares 200 + 600 / 20 = 40 150 + 330 / 15 = 32

2.

Swap ratio

3.

Promoters holding percentage after acquisition Shares of E ltd after acquisition Shares held by promoters of E ltd before acq Shares issued to promoters of H ltd In acq Total promoters holding

5.

6.

Exch ratio 0.8:1

WEarn ExchEarn + WBV ExchBV + WMP ExchMP 0.4 x 4 + 0.25 x 0.8 + 0.35 x 2 = 2.5 : 1 No. of shares issued = 15 lakh x 2.5 = 37.5 lakh

% of promoters holding after acq 4.

= =

Post merger EPS

57.5 lakh 9.50 lakh 10 x 2.5 = 25 lakh 34.5 lakh 34.5 57.5

= 60%

=

earnings after acq/ No. of sh after acq

=

5 𝑋 20 𝑙𝑎𝑘ℎ + 20 𝑋 15 𝑙𝑎𝑘ℎ 57.5 𝑙𝑎𝑘ℎ

= 6.96

Post merger MP assuming PE ratio after Merger of E is same i.e 10 = Post merger PE x Post merger EPS = 10 x 6.96 = 69.6 Post merger Market cap = 69.6 x 57.5 = 4002 lakh Free float market cap of merged firm = Total market cap – Promoters holding = 4002 - 34.5 x 69.6 = 1600.8

Q2b Mr A will need ₹ 1,00,000 after 2 years for which he wants to make one time necessary investment now. He has a choice of 2 types of bonds. Their details are below: Bond X Bond Y Face value ₹ 1000 ₹ 1000 6 Marks Coupon 7% payable annually 8% payable annually Years to maturity 1 4 Current price ₹ 972.73 ₹ 936.52 Current yield 10% 10% Advise Mr A whether he should invest all his money in one type of bond or he should buy both the bonds and if, so, in which quantity. Assume that there will not be any call risk or default risk 5

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Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

Comment : Very simple question of BOND IMMUNISATION. Extensively covered in class Q46, pg 8.8. DONE IN CLASS Ans2b duration of liability is 2 years Duration of bond X Duration of Bond Y

1070 𝑋 0.9091 972.73

= 1 yr

80 x 0.909 x 1 + 80 x 0.826 x 2 + 80 X 0.751 x 3 + 1080 x 0.683 x 4 936.52 72.72 + 132.16 + 180.24 + 2950.56 936.52

=

3335.68 936.52

= 3.562

For immunisation Duration of liablity portfolio i.e 2 should match with duration of bond portfolio Duration of bond portfolio is weighted average of duration of each bond in portfolio W X D X + WY D Y = 2 X . 1 + (1 - x ) 3.562 = 2 X + 3.562 - 3.562 x = 2 2.562x = 3.562 – 2 X =

1.562 2.562

= 0.61

Thus investment in Bond X is 61% and in Bond Y is 39% Amount to be invested today if 1,00,000 is required after 2 yrs and required rate of return is 10% 1,00,000 x 0.826 = 82,600 Investment in bond X

=

82,600 x 0.61 = 50,386 No.of units of bond X = 50,386/972.73 = 51.50 units

Investment in Bond Y

=

82,600 x 39 = 32,214 No. of units of Bond Y = 32,214/936.52 = 34.39 units

Q3a On 1st April, 2015 an investor has a portfolio consisting of eight securities as shown below Security A B C D E F G H 6

Market price 29.40 318.70 660.20 5.20 281.90 275.40 514.60 170.50

No. of shares 400 800 150 300 400 750 300 900

β value 0.59 1.32 0.87 0.35 1.16 1.24 1.05 0.76

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Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

The cost of capital for the investor is 20% p.a continuosly compounded. The investor fears a fall in the prices in the prices of the shares in the near future. Accordingly, he approaches you for the advice to protect the interest of his portfolio. You can make use of the following information 1. The current Nifty value is 8500 8 Marks 2. Nifty futures can be traded in units of 25 only 3. Futures for may are currently quoted at 8700 and Futures for june are being quoted at 8850 You are required to calculate : i. The beta of his portfolio ii. The theoretical value of the futures contracts expiring in may and june (Given e0.03= 1.03045, e0.04= 1.04081, e0.05 = 1.05127) iii. The number of Nifty contracts that he would have to sell if he desires to hedge until june in each of the following cases: (A) His total portfolio (B) 50% of his portfolio (C) 120% of his portfolio Comment : Lengthy but very simple and basic question of Derivatives. Q97 pg2.9. similar to May 13. DONE IN CLASS Ans

i.

Statement of Portfolio β Security

Market price

A B C D E F G H

29.40 318.70 660.20 5.20 281.90 275.40 514.60 170.50

No. of shares 400 800 150 300 400 750 300 900

Portfolio β =

ii.

7

Value of share 11,760 2,54,960 99,030 1560 1,12,760 2,06,550 1,54,380 1,53,450 9,94,450 1095832.3 9,94,450

Theoretical value of futures

= CMP ert

value of May futures

= = = =

β value

Value x β

0.59 1.32 0.87 0.35 1.16 1.24 1.05 0.76

6938.4 336547.2 86,156.1 546 1,30,801.6 2,56,122 1,62,099 1,16,622 1095832.3

= 1.102

8500 e0.20 x 2/12 8500 e0.03 8500 x 1.03045 8758.825

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Solution to CA FINAL SFM – NOV 15 by Value of June futures

iii.

= = = =

CA PRAVIIN MAHAJAN

8500 e0.20 x 3/12 8500 e0.05 8500 x 1.05127 8935.795

Current market price of june future 8850 Each nifty contract is of 25 units No. of contracts to be sold if A. Full hedge is needed Value of Nifty futures sold No. of Nifty units sold No. of NIFTY contracts B. 50% hedge is needed Value of Nifty futures sold No. of Nifty units sold No. of NIFTY contracts C. 120% hedge is needed Value of Nifty futures sold No. of Nifty units sold No. of NIFTY contracts

b.

= = =

9,94,450 x 1.102 = 10,14,339 10,14,339 / 8850 = 114.62 114.62 / 25 = 4.585

= = =

9,94,450 x 1.02 x .5 = 5,07,169.5 5,07,169.5 / 8850 = 57.31 57.31 / 25 = 2.2924

= = =

9,94,450 x 1.02 x 1.2 = 12,17,206.8 12,17,206.8 / 8850 = 137.54 137.54/ 25 = 5.50

The finance manager of ABC corporation is analyzing firms policy regarding computers which are now being leased on yearly basis on rental amounting to ₹ 1,08,000 per year. The computers can be bought for ₹ 5,00,000. The purchase would be financed by 16% and the loan is repayable in 4 equal annual installments. On account of rapid technological progress in the computer industry, it is suggested that a 4-year economic life should be used instead of a 10-year physical life. It is estimated that the computers would be sold for ₹ 2,00,000 at the end of 4 years. 8 marks The company uses the straight line method of depreciation . Corporate tax rate is 35%. a. Whether the equipment be bought or be taken on lease. b. Analyze the financial viability from the point of view of the lessor, assuming 14% cost of capital. c. Determine the minimum lease rent at which lessor would break even. Comment : Lengthy but simple question of leasing

Q5 Pg 7.2. DONE IN CLASS

8

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Solution to CA FINAL SFM – NOV 15 by Ans

CA PRAVIIN MAHAJAN

ABC corporation is analysing its policy of leasing or purchasing a computer costing ₹ 5,00,000 If computers are taken on lease Company will pay annual lease rent of ₹ 1,08,000 Statement of cash outflow if asset is taken on lease Particulars Amount period factor PV 16(1-0.35)=10.4% Lease Rent 1,08,000 1-4e 3.143 3,39,444 Tax saving on lease rent (37,800) 1-4e 3.143 (1,18,805) PV of cash outflow 2,20,639 If asset is purchased Co. will purchase the asset by borrowing from bank @ 16%, repayable in 4 equal annual installments Amount of each installment Installment x factor = loan Inst x 2.798 = 5,00,000 Inst = 1,78,699 Statement of Principal and interest Installment Interest Principal loan o/s tax sav on int 1,78,699 80,000 98699 4,01,301 28,000 1,78,699 64,208 1,14,491 2,86,810 22,473 1,78,699 45,890 1,32,809 1,54,001 16,062 1,78,699 24,698 1,54,001 8644 Statement of cash outflow if asset is purchased Particulars Amount period factor 10.4% PV Installment 1,78,699 1-4e 3.143 5,61,651 Tax saving on interest 28,000 1e 0.906 (25,368) 22,473 2e 0.820 (18,428) 16,062 3e 0.743 (11,934) 8,644 4e 0.673 (5,817) Tax saving on dep 5,00,000 − 2,00,000 x 4

Salvage value

Ii.

9

0.35 26,250 2,00,000

1-4e

3.143

(82,504)

4e

0.673

(1,34,600) 2,83,000

Since cash outflow is lower if asset is taken on lease, so leasing is better Evaluation of proposal from point of view of lessor if expected rate of return is 14% Statement of NPV Particulars Amount period Factor14% Pv Asset purchased 5,00,000 0 1 (5,00,000) Lease rent recd Net of tax 1,08,000 x .65 70,200 1-4e 2.914 2,04,563 Tax sav on depn 26,250 1-4e 2.914 76,493 Salvage value 2,00,000 4e 0.592 1,18,400 (1,00,544) Since NPV is negative, so leasing is not feasible

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Solution to CA FINAL SFM – NOV 15 by iii.

CA PRAVIIN MAHAJAN

Minimum lease rentals for lessor to break even at 14% Statement of NPV Particulars Amount period Asset purchased 5,00,000 0 Lease rent recd Net of tax X x .65 0.65x 1-4e Tax sav on depn 26,250 1-4e Salvage value 2,00,000 4e

Factor14% 1

Pv (5,00,000)

2.914 2.914 0.592

1.8941x 76,493 1,18,400 0

1,94,893 + 1.8941x = 5,00,000 X = Q4a

3,05,107 1.8941

= 1,61,083

XYZ ltd, a company based in India, manufactures very high quality modern furniture and sells to a small number of retail outlets in India and Nepal. It is facing tough competition. Recent studies on marketability of products have clearly indicated that customer is now more interested in variety and choice rather than exclusivity and exceptional quality. Since the cost of quality wood in India is very high, the company is reviewing the proposal for import of woods in bulk from Nepalese supplier. The estimate of net Indian ₹ and Nepalese currency (NC) cash flows for this proposal is shown below: Net cash flows (in Millions) Year 0 1 2 3 NC -25,000 2,600 3,800 4,100 Indian ₹ 0 2,869 4,200 4,600 The following information is relevant : 8 marks i. XYZ evaluates all investments by using discount rate of 9% p.a. All nepalese customers are invoiced in NC. NC cash flows are converted to Indian (₹) at the forward rate and discounted at the Indian rate. ii. Inflation rates in Nepal and India are expected to be 9% and 8% p.a respectively. The current exchange is ₹ 1 = NC 1.6 Assuming that you are the finance manager of XYZ Ltd, calculate the NPV and Modified IRR of the proposal. You may use the following values with respect to discount factor ₹ 1 @ 9% Year 1 2 3 Present Value 0.917 0.842 0.772 Future Value 1.188 1.090 1 Comment : Simple question of fischer effect, foreign exchange.

Q122, Pg 3.35, May 13. DONE IN CLASS Ans

10

Question is silent if nepalese and Indian cash flows are real or money cash flows. So it can be assumed Cash flows given are Real cash flows . Alternatively it can be assumed that cash flows given are Money cash flows

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Solution to CA FINAL SFM – NOV 15 by I

CA PRAVIIN MAHAJAN

Assuming cash flows Given are Real cash flows

NC Real CF -25,000 2600 3800 4100

Inflation9% 1 1.09 (1.09)2 (1.09)3

Statement of Money cash flows NC Money CF ₹ Real CF -25,000 0 2834 2869 4515 4200 5310 4600

Inflation8% 1 1.08 (1.08)2 (1.08)3

₹ Money CF 0 3099 4899 5795

Statement of conversion of NC cash flows into ₹ cash flows Year NC CF Rate Indian CF 0 -25,000 1.6 -15,625 1

2834

1.09

1.6 x 1.08

1755 2770

2

4515

1.6 x

3

5310

1.6 x

Particulars Cash Flows Cash Inflows

(1.09)2 (1.08)2 (1.09)3 (1.08)3

3228

Statement of NPV Amount period 15,625 0

Factor 9% 1

PV (15,625)

1755 3099 4854

1

0.917

4451

2770 4899 7669

2

0.842

6457

3228 5795 9023

3

0.772 NPV

6966 2249

Modified IRR IRR assumes that all intermediate cash flows of project are reinvested at the rate of IRR. To rectify this flaw of IRR Modified IRR is computed. Modified IRR assumes that all positive cash flows are reinvested at cost of cap -

-

Compute future value of cash flows assuming cash flows are reinvested at cost of capital Invested for remaining period in the project

Maturities

4854 earned at the end of 1st year invested for 2 years 4854 (1.09)2 7669 earned at the end of 2nd year invested for 1 year 7669 (1.09) 9023 earned at the end of 3rd year not reinvested

5766 8359 9023 23,148

Investment(1+r)N = Sum of all maturities 15,625 (1+r)3 = 23,148 11

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Solution to CA FINAL SFM – NOV 15 by

R

=

3

23,148

√15,625

CA PRAVIIN MAHAJAN

- 1

R

=

14%

II

Alternatively Assuming Cash flows given are Money cash flows Statement of conversion of NC cash flows into ₹ cash flows NC CF Rate Indian CF -25,000 1.6 -15,625

Year 0 1

2600

2

3800

3

4100

Particulars Cash Flows Cash Inflows

1.09

1.6 x 1.08

1610

1.6 x (1.08)2

2331

(1.09)2 (1.09)3

1.6 x (1.08)3

2492

Statement of NPV Amount period 15,625 0

Factor 9% 1

PV (15,625)

1610 2869 4479

1

0.917

4107

2331 4200 6531

2

0.842

5499

2492 4600 7092

3

0.772 NPV

5475 (544)

Modified IRR Invested for remaining period in the project 4479 earned at the end of 1st year invested for 2 years 4479 (1.09)2 6531 earned at the end of 2nd year invested for 1 year 6531 (1.09) 7092 earned at the end of 3rd year not reinvested -

Maturities 5321 7119 7092 19532

Investment(1+r)N = Sum of all maturities 15,625 (1+r)3 = 19,532 R R

12

= =

3

19,532

√15,625

- 1

7.73%

CA PRAVIIN MAHAJAN SFM CLASSES

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Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

Q4b Mr X on 1.7.2012 during the initial public offer of a mutual fund invested ₹ 1,00,000 at face value of ₹ 10. On 31.03.2013, the MF declared a dividend of 10% when Mr X calculated that his holding period rate of return was 115%. On 31.3.2014, MF again declared a dividend of 20%. On 31.3.2015, Mr X redeemed all his investment which had accumulated to 11,296.11 units when his holding period return was 202.17% Calculate The NAV as on 31.03.2013, 31.03.2014, 31.03.2015

8 marks

Comment : This is a typical ques of Mutual Fund which is Q2 of our book. This ques also came in nov 13, Q1d P21. Only difference is that in this ques Holding period rate of return is given instead of annual yield, making this ques much simpler Ans: 1.07.12--------9 m----------31.03.13--------------12 M-----------31.03.14------------12m-----31.3.15 10,000 units @10 10% div 20% div HPRR – 115% HPRR – 202.17% 11,296.11 units NAV on 31.03.13 HPRR on 31.03.13 =

=

115%

𝑑𝑖𝑣 + (𝑐𝑙 𝑁𝐴𝑉 − 𝑜𝑝 𝑁𝐴𝑉) 𝑂𝑝 𝑁𝐴𝑉

= 1.15

1 + ( 𝑐𝑙 𝑁𝐴𝑉 − 10) 10

= 1.15

Cl NAV (NAV on 31.03.13)

= 20.5

NAV on 31.03.14 All dividend received is reinvested Units purchased on 31.03.13

10,000 20.5

Total units on 31.03.13 Dividend received on 31.03 14 Total units on 31.03.14 Units purchased on 31.03.14

= 487.80 = 10,487.80 = 10,487.8 x 10 x 0.2 = 20,976 = 11,296.11 units = 11,296.11 – 10,487.8 = 808.31

NAV on 31.03.14

=

20,976 808.31

= 25.95

NAV on 31.03.15 HPRR on 31.03.15

=

202.17%

Value of investment on 1.7.12 Return on investment Value of investment on 31.03.15 Number of units on 31,03,15

=

NAV on 31.03.15

=

13

= =

1,00,000 2,02,170 3,02,170 11,296.11 3.02,170 11,296.11

= 26.75

CA PRAVIIN MAHAJAN SFM CLASSES

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Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

Q5a ABC Ltd., a US Firm will need £ 5,00,000 in 180 days. In this connection, the following information is available: Spot rate 1£ = $ 2.00 180 days forward rate of £ as of today is $ 1.96 Interest rates are as follows US UK 180 days deposit rate 5.0% 4.5% 180 days borrowing rate 5.5% 5.0% A call option on £ that expires in 180 days has an exercise price of $ 1.97 and a premium of $ 0.04 ABC Ltd. has forecasted the spot rates for 180 days as below: Future rate Probability $ 1.91 30% $1.95 50% $ 2.05 20% Which of the following strategies would be cheaper to ABC Ltd? i. ii. iii. iv.

8 Marks

Forward contract A money market hedge A call option contract No hedging option Comment : Simple question of currency options.Q95 pg 3.24. DONE IN CLASS

Ans

US firm has to buy £5,00,000 after 180 days $

Since quote is £ , relevant rate is Ask rate Company has following options 1. Hedge through currency options Company will buy call options today, to buy 5,00,000 £ after 180 days @ $ 1.97 / £. Statement of payment Premium paid ($ 0.04 / £) Amount paid ( 5,00,000 x 0.04 )

20,000 $

Due date EP MP

$ 1.97 / £ 1.91 x 0.30 + 1.95 x 0.5 + 2.05 x 0.20 = $ 1.958 MP < EP , call will not be exercised US firm will purchase £ from market @ $ 1.958 / £ Amount paid 5,00,000 x 1.958 2. Money market hedge Process ($ borrow, deposit £) 1. Deposit present value of 5,00,000 £, co. will deposit 5,00,000 1.0225 14

CA PRAVIIN MAHAJAN SFM CLASSES

9,79,000 $ 9,99,000 $

£4,88,998

9871 255 244

Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

2. To deposit £4,88,998 co. will borrow $ $ to borrowed is ascertained is ascertained by converting £4,88,998 @ spot rate of $ 2 / £ $ borrowed 4,88,998 x 2 = 3. $ payable after 180 days @ 5.57 9,77,996 x 1.0275

$ 9,77,996

$ 10,04,891

3.. Forward market hedge Co. will book a forward contract today to buy 5,00,000 £ after 180 days @ 1.96 / £ $ payable 5,00,000 x 1.96 $ 9,80,000 4.. No Hedging Co. will buy 5,00,000 £ after 180 days at spot after 180 days of $ 1.958 / £ $ payable 5,00,000 x 1.958

$ 9,79,000

Since amount payable is least if no hedging is done, so no hedging is better. Q5b On 1st April, an open ended scheme of Mutual fund had 300 lakh units outstanding with Net assets value (NAV) of ₹ 18.75, At the end of April, it issued 6 lakh units at openning NAV plus 2% load, adjusted for dividend equalisation. At the end of May, 3 lakh units were repurchased at openning NAV less 2% exit load adjusted for dividend equalisation. At the end of june, 70% of its available income was distributed. In respect of april-june quarter, the following additional information are available: ₹ in lakh Portfolio value appreciation 425.47 Income of april 22.950 8 MARKS Income for May 34.425 Income for June 45.450 You are required to calculate i. Income available for distribution ii. Issue price at the end of april iii. Repurchase price at the end of May and iv. NAV as on 30th June. COMMENT : Childish question of mutual fund. QUES BASED ON NAV AND ENTRY AND EXIT LOAD. DONE IN CLASS Ans

i.

ii.

15

Income available for distribution is income of april, may and june 22.95 + 34.425 + 45.45 = 102.825 Income distributed = 102.825 x 0.7 = 71.9775 Issue price at the end of april = Op NAV + 2% = 18.75 + 0.02 x 18.75

CA PRAVIIN MAHAJAN SFM CLASSES

9871 255 244

Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

= 19.125 = Op NAV – 2 % = 18.75 – 0.02 x 18.75 = 18.375

iii.

Repurchase price

iv.

NAV as on 30th June Value of Net assets on 1st April 300 lakh x 18.75 + cash received on issue of 6 lakh units 6 x 19.125 - cash paid on repurchase of 3 lakh units 3 x 18.375 + Income of april, may and june - income distributed + appreciation in value of portfolio Net assets at end of june (after adj of changes in cash and Appreciatin in value of investments No. of units at the end of june 300 + 6 – 3 NAV at end of june

5625 lakh 114.75 lakh (55.125 lakh) 102.825lakh (71.9775 lakh) 425.47 lakh 6140.9425 303 lakh 20.267

Q6a XYZ Ltd wants to purchase ABC Ltd by exchanging 0.7 of its share for each share of ABC Ltd. relevant financial data are as follows: Equity share outstanding 10,00,000 4,00,000 EPS )₹) 40 28 Market price per share (₹) 250 160 10 MARKS i. ii.

Illustrate the impact of merger on EPS of both the companies The management of ABC Ltd has quoted a share exchange ratio of 1:1 for merger. Assuming PE ratio of XYZ Ltd will remain unchanged after the merger, what will be the gain from merger for ABC Ltd What will be the gain / loss to the share holders of XYZ Ltd? Determine the maximum exchange ratio acceptable to shareholders of XYZ Ltd

iii. iv.

Comment : Again utmost simple ques of Merger. Examiner aiways use one point in ques, which we extensively discussed and proved in class, i.e PE ratio after merger is given Ans

i.

Exchange ratio proposed by XYZ Ltd 0.7:1 No. of shares issued to shareholders of ABC Ltd = 4,00,000 x 0.7 = 2,80,000 Statement of Impact On EPS of share holders of both companies XYZ ABC Pre Merger EPS 40 28 Post Merger EPS 40 x 10 lakh + 28 x 4 lakh 1 x 0.7 x 40 12.80 lakh = 28 = 40 Thus if exchange ratio is 0.7:1, Post and pre merger EPS of share holders of both companies will remain same

16

CA PRAVIIN MAHAJAN SFM CLASSES

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Solution to CA FINAL SFM – NOV 15 by ii.

CA PRAVIIN MAHAJAN

If exchange ratio is 1:1 and PE ratio of XYZ remain same No. of share issued 4,00,000 512 𝑙𝑎𝑘ℎ 14 𝑙𝑎𝑘ℎ

Post merger EPS

= 36.57

EPS to Share holder of ABC 1 x 1 x 36.57 = 36.57 EPS of shareholder of ABC increases by 36.57 – 28 = 8.57 per share Total increase in EPS 4 lakh x 8.57 = 34.28 lakh Post merger MPS

=

Post merger PE x Post Merger EPS

=

250 40

x 36.57

=

228.5625

Post merger Price to SH of ABC = 1 X 1 X 228.5625 = 228.5625 Wealth of Share holder of ABC also increased by (228.5625 – 160) = 68.5625 per share Total increase in wealth 4 lakh x 68.5625 = 274.25 lakh iii.

Gain or loss to shareholder of XYZ (if exchange ratio is 1:1) Pre merger EPS 40 Post merger EPS 36.57 Reduction in EPS per share 3.43 Total reduction in earnings 3.43 x 10 lakh = 34.30 lakh Pre merger MPS Post Merger MPS Reduction in MPS per share Reduction in total wealth of SH of XYZ

iv.

250 228.5625 21.4375 10 lakh x 21.4375 = 214.375 lakh

Maximum exchange ratio acceptable to Share holders of XYZ Post Merger PE 6.25 Post mrger Value of Firm = Total earnings x Post merger PE = 512 lakh x 6.25 = 3200 lakh Value Retained by XYZ (its pre merger value) = 10 lakh x 250 = 2500 lakh Value given to SH of ABC = 3200 – 2500 lakh = 1300 lakh Shares given to ABC = 1300 / 250 = 5.2 lakh Max exchange ratio

=

5.2 4

= 1.3 :1

Q6b X Ltd is a shoes manufacturing company, it is all equity financed and has a paid up capital of ₹ 10,00,000 (₹ 10 per share) X Ltd has hired Swastika consultants to analyse the future earnings . The report of Swastika consultants states as follows: i. The earnings and dividend will grow at 25% for the next 2 years ii. Earnings are likely to grow at the rate of 10% from 3rd year and onwards iii. Further , if there is a reduction in earnings growth, DP ratio will increase to 50% 17

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Solution to CA FINAL SFM – NOV 15 by

CA PRAVIIN MAHAJAN

The other data related to the company are as follows: 6 MARKS Year EPS(₹) Net Dividend per share(₹) Share price (₹) 2010 6.30 2.52 63.00 2011 7.00 2.80 46.00 2012 7.70 3.08 63.75 2013 8.40 3.36 68.75 2014 9.60 3.84 93.00 You may assume that the tax rate is 30% ( not expected to change in future) and post tax cost of capital is 15%. By using the dividend valuation model , calculate i. Expected market price per share ii. PE Ratio. Comment : Simple question of dividend. Based on current market price is present value of all future dividends

Ans i.

Current market price is present value of all future dividends

Year 2015 2016 2017

Statement of EPS and Dividend EPS 9.6 (1.25) = 12 12(1.25) = 15 15 (1.1) = 16.5

Year 2015 - 1 2016 - 2 2017 - 3 2

Dividend per share 3.84(1.25) = 4.8 4.8 (1.25) = 6 50% of 16.5 = 8.25

Statement of CMP Cash flow Factor 15% 4.8 0.870 6 0.756 8.25 = 0.15 − 0.10

165

0.756

PV 4.176 4.536 124.74 133.452

ii.

18

PE ratio

=

𝑀𝑃 𝐸𝑃𝑆

=

133.452 9.6

= 13.90125 times

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