yp INDIAN INSTITUTE OF TECHNOLOGY KHARAGPUR DEPARTMENT OF HUMANITIES AND SOCIAL SCIENC! END-AUTUMN SEMESTER EXAMNINATION 2015-16 PAPER HS60009: FINANCIAL MANAGEMENT. Max Marks: 50 Date: NOVEMBER 2015, GENERAL INSTRUCTIONS ¥ Answerall the questions. v Time is 180 minutes. Y Marks for each question is indicated against it ¥ Use of non-programmable calculators is permitted. Y PV and FV Tables can be used where ever applicable. ¥ Clarification on any part of the question paper will not be entertained. 1. ABC Ltd wishes to calculate its cost of equity capital using the capital asset pricing model approach. From the information provided to the firm by its investment advisors along with the firms’ own analysis, itis found that the risk-free rate of return equals 10%: the firm’s beta equals 1.50 and the return on the market portfolio equals 12.5%. Compute the cost of equity capital (1 Mark) 2. (A) A perpetual bond carries a coupon rate of 6% and trades at a yield of 5.85% for every $1,000 par value, what will be the price of the perpetual bond if the interest is paid semiannually? (1 Mark) (OR) (B) Infosys issued a bond of $1000 face value for $520 today for a period of ears. Calculate the YTM? (1 Mark) 3. Suppose that an investor makes the following estimates and assumptions for stock XYZ: Required Rate of Return of 10%; Current Dividend of $2 per share: Growth in Dividends of 4% per year; Expected price of the stock at the end of four years is $29.835. Based on these data, calculate the fair price of stock XYZ. (2 Marks) 4. (A) Suppose that dividend per share of a firm is expected to be $1 per share next year and is expected to grow at 6% per year perpetually. The flotation cost is $1 per share (4%). Determine the cost of equity capital, assuming the market price per share is $25 (2 Marks) (OR) (B) Suppose the 10% 10 year $1000 bond is redeemable (callable) in 5 years at a call price of $1050. The bond is currently selling for $950. What is bond’s yield to call? (2 Marks)5. (A) A U.S $1000 bond is redeemable at par in 7 years. What is the selling price of the bond if the purchase price to yield is compounded 10% annually? (2 Marks) (OR) (B) What is the accrued interest on a 7.46% GOI security, maturing on 28-NOV-2017, trading on 7-APR-2015 at an YTM of 6.1081%. The last interest payment date was 28- NOV-2014? (2 Marks) 6. (A) The government is proposing to sell a 5 year bond of Rs.1000 at 8% rate of interest per annum. The bond amount will be amortized equally over its life. If an investor has a minimum required rate of return of 7%, what is the bonds present value for him? (G Marks) (OR) (B) What will be the clean and dirty price of GOI bond 7.46% 2017 on Jan 07, 2003. If the required YTM is 6.11%, the last interest payment date was 28-Aug-2002. Coupon is paid semi-annually, the maturity date is 28-Aug-2017 and the face value is Rs. 100/- (3 Marks) 7. (A) A company issues 11% irredeemable preference shares of the face value of $100 each. Flotation costs are estimated at 5% of the expected sale price. (a) What is the cost, if preference shares are issued at (i) par value, (ii) 10% premium, and (iii) 5% discount? (3 Marks) (OR) (B) A firm sells products for Rs 100 per unit, has variable operating costs of Rs SO per unit and fixed operating costs of Rs 50,000 per year. Show the various levels of EBIT that would result from sale of (i) 1,000 units (ii) 2,000 units and (iii) 3,000 units. (3 Marks) 8. (A) Determine the value of the following risk-free debt instrument, which promises to make the respective payments for next four years when the appropriate annual rates are as shown in the last column, (3 Marks) Year | __Cash Payment (S) | Appropriate Anni ral Rate (%) 7 | 15,000 [ 8 2 17,000 | 85 =3. (1 2n0eo 9 4 21.000 I 95 (OR) (B) Wal-Mart Stores reported the following financial results: Earnings available to common shares $13.400 billion; Dividends paid $3.746 billion, Number of common shares outstanding 3.81 billion, Calculate Wal-Mart Stores’ (i) dividend per share and dividend payout ratio (ii) retention ratio and (iii) Also, show the calculation of dividend payout ratio in terms of dividends per share and earnings per share. (3 Marks)9, (A) A company has 10% perpetual debt of $1,00,000. The tax rate is 35%. Determine the cost of capital (before tax as well as after tax) assuming the debt is issued at (a) par. (b) 10% discount, and (iii) 10% premium. (3 Marks) (OR) (B) Citi Bank offers to syndicate a Eurodollar credit for the government of Poland with the following terms: Principal-$Ibillion; Maturity 7 Years; Interest rate LIBOR+1.5%, reset every six months; syndication fee 1.75%. Calculate (i) The net proceeds to Poland from this syndicated loan and (ii) Assuming that six month LIBOR is currently at 6.35% calculate the effective annual interest cost to Poland for the first six months of this Eurocurrency loan? (3 Marks) 10. (A)Microsoft Corporation issues new 10% bonds of $1,000 face value to be redeemed after 10 years. The bonds are expected to be sold at 5% discount. It will also involve floatation costs of 5% of face value. The company’s tax rate is 35%. What would be the cost of debt? ( Marks) (OR) (B)The financial manager of the ABC Ltd expects that its carnings before interest and taxes (EBIT) in the current year would amount to Rs 10,000. The firm has 5% bonds aggregating Rs 40,000, while the 10% preference shares amount to Rs 20,000, What would be the earnings per share (EPS)? Assuming the EBIT being (i) Rs 6,000, and (ii) Rs 14,000, how would the EPS be affected? The firm can be assumed to be in the 35% tax bracket. The number of outstanding ordinary shares is 1,000. (3 Marks) 11.(A) A firm's common stock just paid a dividend of $8 per share, The firm's dividend is expected to grow at 35% for next 5 years, after which the growth rate will slow down to 8% per year in perpetuity. What is the stock worth if the discount rate is 18%. (4 Marks) (OR) (B) Briefly explain and illustrate the concept of time value of money and its importance in investment (capital budgeting) and financing decisions of a firm? (4 Marks) 12, (A) State and Explain the Proposition I and II of Modigliani and Miller's (MM) Irrelevance Theorem of Capital Structure. Also, discuss the homemade leverage? (4 Marks) (OR) (B) Briefly describe the trade-off theory of capital structure. How does it differ from MM propositions with taxes? (4 Marks) 13, (A) Discuss the Capital Asset Pricing Model (CAPM) with the help of a suitable example and diagram? (4 Marks) (OR) (B) Discuss the dividend relevance approach and dividend irrelevance approach in determining the value of the firm? (4 Marks)14, (A) The total market value of debt carried by IBM is $38,50,000 and there are 5.00.00 shares of preferred stock at a market value of $1/share. Also, there are 10,00,000 shares of common stock outstanding with a market value of $5.50/share. The cost of capital is 8% on borrowing, 10% on preferred stock, and 13% retum on common stock. The company needs to raise $1 million to buy plant and equipment. For these conditions, calculate the weighted average cost of capital (WACC) based on the market value of the capital structure? (5 Marks) (OR) (B) Suppose a firm has a capital structure exclusively comprising of ordinary shares amounting to Rs 10,00,000. The firm now wishes to raise additional Rs 10,00,000 for expansion. The firm has four alternative financial plans: (i) It can raise the entire amount in the form of equity capital (ii) It can raise 50% as equity capital and 50% as 5% debentures. (iii) It can raise the entire amount as 6% debentures. (iv) Itcan raise 50% as equity capital and 50% as 5% preference capital Further assume that the existing EBIT is Rs 1,20,000, the tax rate is 35%, outstanding ordinary shares is 10,000 and the market price per share is Rs 100 under all the four alternatives. Which financing plan should the firm select? (5 Marks) (A) Company X and Company Y are in the same risk class, and are identical in every respect except that company X uses debt, while company Y does not. The levered firm has $9,00,000 debentures, carrying 10% of interest and the capitalization rate for the all- equity company is 15%. Both the firms eam 20% operating profit on their total assets of $15, 00,000, Both the companies face a tax rate of 35%, Assuming perfect capital markets and rational investors compute the following: (i) The value of firms X and Y using the Net Income (NI) Approach. (ii) The value of each firm using the Net Operating Income (NOL) Approach. (iii) Using the NOI Approach, calculate the overall cost of capital (Ko) for firms X and Y (iv)Which of these two firms has an optimal capital structure according to the NOL Approach? Why? (10 Marks) (OR) {B) The Microsoft Corporation must raise $1 million to finance the re-modeling of its corporate headquarters. It plans to do this by increasing the number of shares of preferred and common stock and by issuing 15-year corporate bonds with a face value of $1000 and annual payments at a coupon rate of 9%, The corporation’s long-term debt currently amounts to 20,000 corporate bonds with a current market value of $910/bond. The corporation has 50,000 shares of preferred stock outstanding with a market value of $125/share. The corporation also has 15,00,000 outstanding shares of common stock with a current market value of $45/share. Holders of preferred stock receive annual dividends of $10/share, and holders of common stock receive annual dividends of $4/share. The annual growth rate of common stock is 5%. Flotation costs are 1% for bonds, 2% for preferred stock, and 4.5% for common stock. Microsoft's tax rate is 40%, Calculate the WACC for Microsoft Corporation? (10 Marks)Sealey-Myere-AleR: Sack Maer Pompe! 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