Actuarial Society of India EXAMINATIONS

1st June 2003 (p.m.) Subject 108 Finance & Financial reporting
Time allowed: Three Hours INSTRUCTIONS TO THE CANDIDATES 1. Do not write your name anywhere on the answer scripts. You have only to write your Candidates Number on each answer script. 2. Mark allocations are shown in brackets. 3. Attempt all 16 questions, beginning your answer to each question on a separate sheet from question 11 onwards. 4. In addition to this paper you should have available graph paper, Actuarial Tables and an electronic calculator.

AT THE END OF THE EXAMINATION

Hand in both your answer scripts and this question paper

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1.

Sintex Limited made a profit before tax of Rs. 170 million during the year 2002. Throughout 2002, the company carried a secured term loan of Rs. 100 million on which Rs. 12 million interest was paid; and an 8% unsecured loan stock with interest payments of Rs. 20 million. The income cover on the unsecured loan stock was: A. B. C. D. 9.5 6.3 5.3 10.1

(2 marks)

2.

Mintex Limited, a listed company, has a capital structure made up of share capital and debenture stock. If the prevailing interest rates increase, what is likely to happen to the market prices of these financial instruments? A. B. C. D. Share price Debenture price Share price Debenture price Share price Debenture price Share price Debenture price

(2 marks)

3.

Which of the following is NOT a valid reason to use simulation technique in order to evaluate an investment project? I. II. III. The cashflows are uncertain The required rate of return might vary during the life of the project The decision maker requires an accurate forecast A. B. C. D. II only is correct III only is correct II and III only are correct I and III only are correct

(2 marks)

4.

Under the floating charge I II III Specific assets are available to meet investors claims if the company defaults on interest or capital payments. A default by the company will result in the charge crystallizing into a fixed charge The company may, in the usual course of business, realize assets, which are subject to the charge. A B C D II and III only are correct I and II only are correct I only is correct I and III only are correct.

(2 marks)

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5.

Which of the following statements are true? I II III Defensive shares are defined as those whose beta is negative The expected return from the share with a beta of 2.5 is 2.5 times the expected return from a diversified portfolio of shares. Using shares that are entirely uncorrelated (Zero correlation) with one another, it is possible to create a diversified portfolio with an expected volatility of return equal to zero. A. B. C. D. I and II only are true I and III only are true I, II and III are true None of the above statements are true.

(2 marks)

6.

Which of the following would be examples of specific risk for a large domestic house construction company? I II III Interest Rates Inflation Regional Variations in house prices A. B. C. D. I and II only II only II and III only III only

(2 marks)

7.

A company pays corporate tax at the rate of 30%, has no borrowings at present and has a beta of 1.5. If the company issues an unsecured loan stock and uses the proceeds to buy-back one third of the existing equity, the beta of the company will become: A. B. C. D. 2.025 2.565 2.255 1.5 Eurobonds Bank Loans Overdraft Hire Purchase

(2 marks)

8.

Which of the following may NOT ha ve a variable interest rate? A. B. C. D.

(2 marks)

9.

A company contemplates borrowing at regular intervals for the next two years to finance a project, which will take seven years to complete. Which of the following interest rate derivative strategies should the company use to hedge interest rate risk? A. B. C. D. Buy long bond futures contract Sell long bond futures contract Sell short interest rate futures contract Buy short interest rate futures contract 3

(2 marks)

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10.

An equity share may have a low dividend yield because I II III It is perceived to be risky It is cheap Dividends are expected to grow rapidly. A. B. C. D. I and II only are correct III only is correct II and III only are correct None of the above statements are correct

(2 marks)

11a) The following is an extract from the personal finance section of a financial newspaper: Companies should not pay dividends. A zero dividend policy helps companies to grow more rapidly. Evaluate this statement. (4 marks) b) Briefly discuss the factors that can influence the decision on dividend policy of a company. (6 marks) [Total 10 marks] 12. 13. Briefly describe the shortcomings of historic cost accounting during inflationary periods. (6 marks) A company is planning a rights issue for raising additional capital. It is choosing between having the issue underwritten or having a deep discounted issue. List the advantages and disadvantages of the two alternatives to both the company and its shareholders. (9 marks) A manufacturing company is in the process of making a 1 for 4 rights issue at a premium of 250%. The company currently has 20 million shares of Rs.100 face value in issue and the current market price is Rs.450 per share. The company plans to use the cash raised to build a major extension to its factory, thereby doubling production capacity. (a) Calculate the value at which the share price is likely to be after the share becomes ex-rights. (2 marks) (b) Explain, with reasons, the courses of action available to the shareholders, with particular reference to the difference between the rights price and the current market price. (7 marks) (c) Explain whether the share price is likely to settle at the figure calculated in (a) above after the rights issue. (4 marks) (d) Discuss the advantages and disadvantages of financing the extension by issuing loan stock. (5 marks) (e) Discuss the advantages and disadvantages of financing with a commercial mortgage. (4 marks) [Total 22 marks]

14.

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15 a) The following ratios are given for Mintex Company: Net Profit margin ratio Current ratio Return on net worth Total debt to total assets ratio Inventory turnover ratio Complete the following statements Income Statement (Rs. in 000s) Sales Cost of goods sold Operating Expenses EBIT Interest Profit before tax Tax Provision(50%) Profit after tax Balance Sheet (Rs. in 000s) Liabilities Net worth Long Term Debt ? ? Assets Fixed Assets Current Assets Accounts payable Total ? ? Total ? (11 marks) Cash Inventory ? ? 180 Receivables 60.0 Total Current Assets ? ? ? 700 ? 45 ? ? ? 4 percent 1.25 15 percent 0.40 4 percent

Note: The long term debt is perpetual and it carries an interest rate of 15% pa.

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15b) An equity research firm uses the following ratios as key inputs for formulating its equity investment recommendations: (i) Price earning ratio (ii) Gross dividend yield (iii) Net asset value per share Define each of these ratios; and explain how these ratios can be used in formulating appropriate equity investment recommendations. (9 marks) [Total: 20 marks] 16 The following financia l data have been made available to you by Shop and Hop Departmental Stores Limited. Extracts from Profit and Loss Account for the year 2002 (Rs. in 000s) Gross Profit 2160 Depreciation 320 Sales administrative and distribution overheads 560 Interest paid 800 Provision for tax 145 Equity dividends declared 80 Extracts from Balance Sheet December 31, 2001 3200 3495 8000 14800 400 82 21 560 16 32 (Rs. in 000s) December 31, 2002 3200 3750 12160 18400 576 384 86 192 48 96 (7 marks)

Share Capital Free Reserves Long Term Debt Net Fixed Assets Inventory Receivables Cash in bank Bills payable Tax payable Dividends payable (a) (b)

During the year 2002, the company did not sell any of its fixed assets. Prepare the cash flow statement for the year 2002 Prepare a brief note (i) explaining the purpose of a cash flow statement; and (ii) highlighting the key findings based on the cash flow statement in (a). (6 marks) [Total: 13 marks]

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