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Uttar Pradesh
India 201303
ASSIGNMENTS
PROGRAM: MBA IB
SEMESTER-II
Subject Name
Study COUNTRY
Roll Number (Reg.No.)
Student Name
Ombe
INSTRUCTIONS
a) Students are required to submit all three assignment sets.
ASSIGNMENT
Assignment A
Assignment B
Assignment C
DETAILS
Five Subjective Questions
Three Subjective Questions + Case Study
Objective or one line Questions
MARKS
10
10
10
b)
c)
d)
e)
Signature
Date
________________________13-JUN-2015_________
Assignment B
Assignment C
Assignment A
Ques 1. What is the need of International Financial Management? List out
the difference between domestic Finance & International Finance.
Answer:
As a business grows, so does their awareness of opportunities available in foreign
market. Initially, they may merely attempt to export a product to a particular country or
import supplies from a foreign manufacturer. An understanding of International
Financial Management is crucial to not only the large MNCs with numerous foreign
subsidiaries, but also to the small business engaged in Exporting or Importing.
International business is even important to companies that have no intention of
engaging in International Business. What companies need to know is how their foreign
competition will be affected by movements in Exchange Rates, Foreign Interest rates,
Labour Costs, and Inflation. Such economic characteristics can have an effect on foreign
competitors cost of production and pricing policy. MNCs may have significant foreign
operation driving a high percentage of their sales overseas. The financial managers of
such MNCs must understand the complexities of international finance so that they can
make sound financial and investment decision. In simple words, international financial
management is defined as:
Managing working capital, financing the business, assessing control of foreign Exchange
and political risks and evaluating foreign direct Investment."
3) Different currencies are involved and their relationships change with changing
economic, financial and political developments.
4) The cultural, social and political factors are different in various countries of the
world; adoption to their different environments requires that firms have
different rules for different parts of their operation.
5) The problems of measurement of performances are complicated by the different
circumstances of individual foreign subsidiaries.
6) The terms and conditions of finances and its availability are subject to
continuous change, presenting new opportunities and risks.
7) The proper balance between centralization and decentralization of strategies,
policies and operation is more difficult to achieve in international operation.
Answer:
A
FV = $7,000
FV = $10,000
Discount rate = 9%
Discount rate = 9%
Time = 1yr
Time = 3yrs
PV = FV/(1+i)n
PV = FV/(1+i)n
PV =$7,000/(1+9/100)1
= $10,000/(1+9/100)3
= $7,000(0.9174)
= $10,000(0.7722)
= $6,422
= $7,722
The investor should take on $7000 after one year because it needs minimal initial capital
of $6,422 compared to $10,000 after three years which needs $7,722.
ii) A person would need USD 5000, 6 years from now. How much
should he deposit each year in his bank account, if yearly interest rate is 10
%?
Answer:
Using the formula FVAn = A((1+K)n 1)/k
= $5,000 / 7.71561
= $648.037
The person should deposite $648.037 every
year.
20 Years
Used Life
10 Years
Remaining Life
10 Years
Salvage Value
$ 40,000
140,000
Maintenance Cost
20,000
New Machine
Book Value of Machine
$ 220,000
10 Years
Cost Savings
80,000
Tax Rate
40%
$40,000
= 34,000
Ques 4.
a) You have a choice of accepting either of two
Cash flows
Alternative I (in
Alternative II
USD)
( in USD)
6000
11000
6000
9000
6000
7000
6000
5000
6000
3000
lump sum amount
Year
1
2
3
4
5
at the time
zero
(outflows)
24500
28000
Calculate the payback period and give your opinion that which project is
better.
Answer:
Years (I)
Cash
flows($ Cumulative
US)
0
-24500 (q)
6,000
Year (II)
($US)
Cash
flows Cumulative
($US)
($US)
-28,000(q)
6,000
11,000
11,000
6,000
12,000
9,000
20,000
6,000
18,000
3(p)
7,000
27,000
4(p)
6,000
24,000
5,000
32,000
6,000
30,000
3,000
35,000
Ques 5. Rico Ltd & Sico Ltd are in the same risk class & are identical in all
respects except that the company Rico uses debt while company Sico does
not use debt. The levered firm has USD 900000 debentures carrying 12 %
rate of interest. Both the firms earn 20 % operating profit on their total
assets of value USD 25 lacs. The company is in tax bracket of 35% &
capitalization rate of 15% on all equity shares.
You are required to compute the value of both the firms using Net Income
approach.
Answer:
Debentures
Rate of
Interest
Operating
Profit
Total Assets
Tax Rate
Capitalisation
Rate
Particulars
Operating Profit
Interest Expense
Profit Before Tax
Tax Expense
Profit After Tax
Market Value of Equity
$25,98,667
0
0%
20%
2500000
Tax Rate
Capitalisation
Rate
35%
15%
Particulars
Operating Profit
Interest Expense
Profit Before Tax
Tax Expense
Profit After Tax
Market Value of Equity
Market Value of SICO Ltd. Using Net Income Approach
Amount (in
USD)
500000
0
500000
175000
325000
2166667
$21,66,667
Assignment B
Ques 1.
i)
What are the factors affecting the capital structure of the
company?
Answer:
Internal factors
Cost of Capital: The process of raising the funds involves some cost. While planning the
capital structure, it should be ensured that the use of the capital should be capable of
earning the revenue enough to meet the cost of capital. It should be noted here that the
borrowed funds are cheaper than the equity funds so far as the cost of capital is
concerned. This is because of two reasons. The interest rates (i.e. the form of return on
the borrowed capital) are usually less than the dividend rates (i.e. the form of return on
the equity capital) and the interest paid on borrowed capital is an allowable expenditure
for income tax purposes while the dividends are the appropriate out of the profits.
Risk Factor: While planning the capital structure, the risk factor consideration inevitably
comes into picture. If the company raises the capital by way of borrowed capital, it
accepts the risk in two ways. Firstly, the company has to maintain the commitment of
payment of the interest as well as the installments of the borrowed capital, at a
specified rate and at a predefined time, irrespective of the fact whether there are
profits or losses. Secondly, the borrowed capital is usually the secured capital. If the
company fails to meet its contractual obligations, the lenders of the borrowed capital
may enforce the sale of assets offered to them as security. Hence the risk on the part of
the company is more for debt compared to equity.
Control Factor: While planning the capital structure and more particularly while raising
additional funds, the control factor plays an important role, especially in case of closely
held private limited companies. If the company decides to raise the long term funds by
issuing further equity shares or preference shares, it dilutes the controlling interest of
the present shareholders / owners, as the equity shareholders enjoy absolute voting
rights and preference share holders enjoy limited voting rights. The control factor
usually does not come into the picture in case of borrowed capital unless the lender of
the long term funds, i.e. Banks or financial institutions, stipulate the appointment of
nominee directors on the Board of Directors of the company.
Constitution of Company: While deciding about the capital structure, the constitution of
the company plays an important role. In case of private limited company, the control
factor may be more important while in case of public limited company, cost factor may
be more important.
Stability of Earnings: lf the sales and earnings of the company are not likely to be stable
enough over a period of time and are likely to be subject to wide fluctuation, the risk
factor plays more important role and the company may not be able to have more
borrowed capital in its capital structure as it carries more risk. However, if the earnings
and sales of the company are fairly constant and stable over the period of time, it may
afford to take the risk, where the cost factor or control factor may play important role.
Attitude of the Management: lf the attitude of the management is too conservative; the
control factor may play an important role in capital structure decision. If the policy of
the management is liberal, the cost factor may get more importance.
Objects of Capital Structure Planning: While planning the capital structure, the following
objects of the capital structure planning come into play.
To issue the transferable securities and this can be ensured by listing the
securities on the stock exchange.
To issue the further securities in such a way that the value of shareholding of the
present owners is not affected.
External Factors
General Economic Conditions: While planning the capital structure, the general
economic conditions should be considered. If the economy is in the state of depression,
preference will be given to equity form of capital as it will be involving less amount of
risk. But it may not be possible always as the investors may not be willing to take the
risk. Under such circumstances, the company may be required to go in for borrowed
capital. If the capital market is in boom and the interest rates are likely to decline in
further, equity form of capital may be considered immediately, leaving the borrowed
form of capital to be tapped in future. It may also be possible to raise more equity
capital in boom as the investors may be ready to take risk and to invest.
Level of Interest Rates: If funds are available in the capital market, only at the higher
rates of the interest, the raising of capital in the form of borrowed capital may be
delayed till the interest rates become favorable.
Policy of Lending Institutions: If the policy of term lending institutions is rigid and harsh,
it will be advisable not to go in for borrowed capital, but the equity capital form should
be tapped.
Taxation Policy: Taxation policy of the Government has to be viewed from the angles of
both corporate taxation and as well as individual taxation. The return on borrowed
capital i.e. interest is an allowable deduction for income tax purposes while computing
taxable income of the company, while return on equity capital i.e. dividend is not
considered like that as it is the appropriation out of the taxable profits. As far as
individual taxation is concerned, both interest as well as dividend will be taxable in the
hands of lender of the capital subject to specified deductions available for the purposes.
ii)
Answer:
Calculation of Cost of Preference Share Capital
Particulars
Preference Share Capital
Value Per Share
Rate of Dividend on Preference Share
Floatation Cost
Prefence Dividend Per Year
Cost of Preference Share if issued at 10% Premium
No. of Preference Shares Issued
Price per share @ 10% Premium
Cash inflow by issuing shares
Less: Floatation Cost
Net Proceeds by issuing Preference Capital
Amount
$1,00,000
10
10%
1%
$10,000
10000
$11
$1,10,000
$1,000
$1,09,000
9.17%
$10,000
$9
$90,000
$1,000
$89,000
11.24%
Ques 2. A company has the following amount and specific costs of each
type of capital:
Book Value (
in $)
100000
600000
200000
400000
1300000
Types of Capital
Preference
Equity
Retained Earnings
Debt
Total
Market Value
110000
1200000
380000
1690000
Specific Costs
8%
13%
5%
Specific Cost
Preference Capital
8%
100000
110000
Equity Capital
13%
600000
1200000
200000
Retained Earnings
Debt
5%
400000
380000
Specific Cost
Weights
Preference Capital
8%
Equity Capital*
0.0769
(600000+200000)=80000
13%
Debt
100000
5%
0.6154
400000
0.3077
110000
1200000
380000
0.0651
0.7101
0.2249
10.88%
How are they different? Can you think of a situation where the WACC
would be the same using either of the weights?
Answer:
Calculation of Weighted Average Cost of Capital using market value weights is different
from using book value weights. Since, we know that there is always a difference in the
book value of the equity compared to its market value, which leads to different
Weighted Average Cost of Capital.
WACC using either of the weights could be same only if the market value and the book
value are same. It means that there is no difference in the market value of the Equity,
Preference Capital & Debt compared to its book value.
Output(units)
Fixed Costs (USD)
Variable cost per
unit
Interest on
borrowed funds
Selling price per
unit
Firm A
90000
10000
Firm
B Firm C
35000 200000
16000
2000
0.2
1.5
0.02
4000
8000
0.6
0.1
Answer:
Particulars
Output
Selling Price Per Unit
Sales
Fixed Cost
Variable Cost
Interest on Borrowed Funds
Firm A
90000
0.6
54000
10000
0.2
4000
Firm B
35000
5
175000
16000
1.5
8000
Firm C
200000
0.1
20000
2000
0.02
0
36000
10000
122500
16000
16000
2000
26000
4000
106500
8000
14000
0
22000
98500
14000
Formula
Degree of Operating Leverage =(Contribution Margin/Net Operating
Income) or (Percentage Change in EBIT/Percentage Change in Sales)
Degree of Financial Leverage = (Earning before Interest & Taxes / Earning
before Taxes) or (Percentage change in EPS/Percentage change in EBIT)
Degree of Combined Leverage = (Degree of Operating Leverage * Degree
of Financial Leverage) or (Percentage Change in EPS/Percentage Change
in Sales)
Firm A
Degree of Operating Leverage
Degree of Financial Leverage
Degree of Combined Leverage
Firm B
1.38
1.18
1.64
Firm C
1.15
1.08
1.24
1.14
1
1.14
Case Study
Merck International is a pharmaceutical company. It is not currently selling
its product in India. However it is proposing t establish a manufacturing
facility in India in near future.
The Company to be set up in India is to be a wholly owned affiliate of Merck
International which will provide all funds needed to build the manufacturing
facility. Total initial investment is estimated at Rs.50,000,000. Working
capital requirements estimated at Rs. 5,000,000, would be provided by the
local financial institution at 8 percent per annum, repayable in five equal
installments beginning on 31st December of the first year of operation. In
the absence of this concessional facility, Merck would have financed these
requirements by a loan from its bankers in United States at 15 percent per
annum.
The cost of the entire manufacturing facility is to be depreciated over the
five years period in straight line method basis. At the end of fifth year of its
operation all remaining assets would be taken over by a public corporation
to be designated by the government of India with no compensation.
Sales in Units
Unit Price(Rs)
2,00,000
1,000
2,25,000
1,500
2,50,000
1,800
2,75,000
2,000
3,00,000
2,200
Variable costs are Rs. 600 per unit in year 1 and are expected to rise by
15% each year.
Fixed Cost other than depreciation are Rs. 20 million in year 1 and is
expected to rise by 10% per year.
Other Information:
All profit after tax realized by the affiliate are transferable to the parent
company at the end of each year. Depreciation funds are to be blocked
until the end of year 5. These funds may be invested in local money market
instruments, fetching a tax-free return of 15%. When the operating assets
are turned over a local corporation, the balance of these funds including
interest may be repatriated.
The income tax rate in India is 48% but there are no with holding tax on
transfer of dividends. Dividends received by Merck International in the
United states would be subject to 50% tax.
Calculate the NPV and IRR for the project from the standpoint of the parent
company. What are your recommendations for the proposal?
Answer:
Total initial investment Rs.50, 000,000 Merck International
Working capital (India) Rs.50, 000,000 by commercial institution
in India @ 8% loan
per annum which is payable in 5 equal investments beginning 31st December of the first
year of operation.
OR form USA @ 15% interests.
Depreciation for 5 years @ straight line method basis
After 5 years nationalizing of the project in India with no compensation and all the
remaining assets will be taken.
Year
Sales Unit
Unit price
200,000
1,000
22,5000
1,500
250,000
1,800
275,000
2,000
300,000
2,2000
Year
Sales in Units
Price
200,000
1,000
200,000,000
120,000,000
225,000
1,500
337,500,000
155,250,000
250,000
1,800
450,000,000
198,375,000
275,000
2,000
550,000,000
250,944,375
300,000
22,000
660,000,000
314,821,110
Fixed Costs
20,000,000
60,000,000
22,000,000
160,250,000
24,200,000
22,7425,000
26,620,000
272,435,625
29,282,000
315,998,000
Manufacturing facility=50,000,000
Depreciation =value of manufacturing facility
No of years
50 = 10M
Year
Earning
Depreciation
48% Indian
Net earning
taxation
Merk international
net earnings
60,000,000
10M
24M
26M
13M
160,250,000
10M
(72.12)
78.13M
39.065M
227,425,000
15M
(104.364)
113.061M
56.5305M
272,435,625
15M
(125.9691)
136.466552M
68.23326
315,898,000
10M
(146.83104)
159.0669M
79.53M+67.4233/2
79.5M+33.712M
113.212M
Discounting factor
Present value
Initial investment
1/1.26)5
4.0935M
-45.906
1/1.26)4
15.5M
-30..4065
1/1.26)3
28.26M
-2.1465
1/1.26)2
42.979M
-40.823
1/1.26)1
89.874M
28.26M+42.979M/2=35.6195
IRR=35.6195/180.7055
0.1971135
IRR=19.71%
Assignment C
1: B
21: I
2 :B
22: I
3: D
23: I
4: A
24: II
5: D
25: IV
6: D
26: II
7: C
27: IV
8: C
28: I
9: A
29: III
10: A
30: II
11: B
31: I
12: A
32: II
13: B
33: I
14:D
34: II
15: I
35: II
16: 1V
36: I
17: II
37: I
18: II
38: I
19: IV
39: II
20: I
40: II