Paper/Subject Code: 86011/Finance: Strategic Financial Management
TYBMS SEM-6
Finance:
Strategic Financial Management
(QP April 2024 with Solutions)
Instructions:
1) All the questions are compulsory
2) Figures to right indicate full marks.
Q.1 (A) Choose correct alternative and rewrite the statement: (Any 8) (8)
1. In case of Loss Asset, provision for NPA should be made ________
a) 15%
b) 25%
c) 40%
d) 100%
2. Relationship between dividend per share and earning per share is _______
a) Price Earnings Ratio
b) Dividend yield ratio
c) Dividend payout ratio
d) intrinsic value per share
3. Net Profit for calculation of EVA is _________
a) NPAT
b) NPBT
c) NOP
d) NOPAT
4. If the firm has Ke <r, the Walter's Model suggests for ________
a) 0% Payout
b) 50% Payout
c) 25% Payout
d) 100% Payout
5. Merger between firms engaged in unrelated types of business activity is ________
a) Horizontal
b) Vertical
c) Conglomerate
d) Reserve
6. Capital Rationing helps in shareholders wealth.
a) Maximizing
b) Minimizing
c) Stabilizing
d) Measuring
7. Pl of a project is the ratio of present value of inflows to ________.
a) Initial cost
b) PV of outflows
c) Total cash inflows
d) Total outflows
8. ________ represents those funds which are required to manage day-to-day business operations.
a) Long term capital
b) Short term capital
c) Working capital
d) None of above
9. Which among the following is short term sources of working capital-financing?
a) Bill discounting
b) Letter of credit
c) Commercial paper
d) All of the above
10. ________ is a schematic representation of several decisions followed by different chances of the occurrence.
a) Sensitivity analysis
b) Probability techniques
c) Risk Adjusted Discounting Rate
d) Decision Tree
Q.1 (B) State whether given statements are True or False: (Any 7) (7)
1. Corporate governance essentially involves balancing of the interests of only shareholders.
Ans: False
2. Dividend policy is decided by the shareholders.
Ans: False
3 MM model deals with relevance of dividend decisions.
Ans: False
4 Preference dividend is deducted from NPAT for calculation of EPS.
Ans: True
5. Standard assets are those assets which do not have any risk.
Ans: False
6. Capital budgeting decisions involves huge investment outlay.
Ans: True
7. In order to protect the earnings available to shareholders, the swap ratio should be based on MPS.
Ans: False
8. MPBF refers to Maximum Permissible Bank Finance.
Ans: True
9 Discounting of bills is converting the bill into cash.
Ans: True
10. Dividend payout ratio refers to that portion of total earnings which is distributed among shareholders.
Ans: True
Q.2A. RT Ltd. has a capital of Rs. 10,00,000 in equity shares of Rs. 100 each. The shares are currently quoted at par. The company proposes to declare a dividend of Rs. 10 per share at the end of the current financial year. The capitalization rate for the risk class of which the company belongs is 12%. Compute market price of the share at the end of the year, if (15)
i) dividend is not declared
ii) dividend is declared
Assuming that the company pays the dividend and has net profits of Rs. 5,00,000 and makes new investments of Rs. 10,00,000 during the period, calculate number of new shares to be issued? Use the MM model.
OR
Q.2B. With the help of following figures, calculate the market price of a share of company by using: (15)
i) Walter's formula
ii) Gordon's formula
|
Earnings per
share (EPS) |
Rs. 10 |
|
Dividend per
Share (DPS) |
Rs. 6 |
|
Cost of
Capital (Ke) |
20% |
|
Internal rate
of return on investment |
25% |
|
Retention
Ratio |
40% |
Q.3A PVR Ltd. is considering a project with the following Cash flows: (15)
|
Year |
Cost of
Plant (Rs.) |
Running
Cost (Rs.) |
Savings
(Rs.) |
|
0 |
12,00,000 |
- |
- |
|
1 |
- |
4,00,000 |
12,00,000 |
|
2 |
- |
5,00,000 |
14,00,000 |
|
3 |
- |
6,00,000 |
11,00,000 |
The cost of capital is 12%. Measure the sensitivity of the project to changes in the levels of plant cost, running cost and savings (considering each factor at a time) such that the NPV becomes zero. The P.V. factors at 12% are as under:
|
Year |
0 |
1 |
2 |
3 |
|
PV factor @
12% |
1 |
0.892 |
0.797 |
0.711 |
Determine the factor which is most sensitive to affect the acceptability of the project?
OR
Q.3B. Mohan Ltd has Rs. 35,00,000 allocated for capital budgeting purposes. The proposals and associated profitability indexes have been determined. (15)
|
Projects |
Initial Investment (Rs.) |
Profitability Index |
|
P |
10,50,000 |
1.22 |
|
Q |
5,25,000 |
0.95 |
|
R |
12,25,000 |
1.20 |
|
S |
15,75,000 |
1.18 |
|
T |
14,00,000 |
1.20 |
|
U |
14,00,000 |
1.05 |
i) Calculate the Net Present Value for each of the projects
ii) Which of the above investments should be undertaken? Assume that projects are indivisible and there is no alternative use of the money allocated for capital budgeting.
Q.4.A Calculate Variance and Standard deviation of the Project A and Project B on the basis of the following information: (15)
|
Possible Event |
Project A |
Project A |
||
|
|
Cash Now (Rs) |
Probability |
Cash Now (Rs) |
Probability |
|
A |
8,000 |
0.10 |
24,000 |
0.10 |
|
B |
10,000 |
0.20 |
20,000 |
0.15 |
|
C |
12,000 |
0.40 |
16,000 |
0.50 |
|
D |
14,000 |
0.20 |
12,000 |
0.15 |
|
E |
16,000 |
0.10 |
8,000 |
0.10 |
OR
Q.4 Siddhesh Ltd. furnishes the following information for the year: (15)
|
Cost sheet |
% of
selling price |
|
Raw material |
40% |
|
Wages |
30% |
|
Overheads |
20% |
|
Total Cost |
90% |
|
Profit |
10% |
|
Selling price |
100% |
Additional Information:
i) Output and sales for the year is 1,20,000 units.
ii) Raw materials remain in stock for one month's consumption
iii) Process period is one month.
iv) Finished goods remain in stock for two months.
v) Credit period allowed by the suppliers of raw material is one month.
vi) Credit period allowed to debtors is two months.
vii) 20% of purchasing will be for cash.
viii) Time lag in payment of wages and Overheads is one month.
ix) Cash and bank balance is to be maintained at Rs. 50,000
x) Selling price is Rs. 15 per unit
You are required to find out:
a) Working Capital Requirement of Siddesh Ltd.
b) value of core current assets Rs. 2,50,000. Maximum Permissible Bank Finance as per Tandon committee assuming the
Q.5 (A) Explain the advantages and disadvantages of XBRL (7)
XBRL (eXtensible Business Reporting Language) is a standard for the electronic communication of business and financial data. It provides a way to enhance the process of collecting, analyzing, and sharing financial information by making it more efficient and standardized. While XBRL has many advantages, it also comes with certain disadvantages. Here's a breakdown:
Advantages of XBRL
Standardization of Financial Reporting: XBRL provides a standardized format for financial data, making it easier for organizations to report and compare information. This uniformity helps improve the consistency and accuracy of financial statements across companies and industries.
Improved Accuracy: Automated data extraction and analysis minimize the risk of errors that can occur in manual data entry. This leads to more accurate financial reporting and a reduction in human errors.
Enhanced Efficiency: The use of XBRL speeds up the data collection and reporting process. Companies can generate and file reports more quickly, saving time and resources compared to traditional methods of reporting.
Better Data Analysis: XBRL allows users to perform more advanced data analysis. Because the data is tagged and structured, it can be easily parsed and analyzed using various software tools. This enables stakeholders, such as investors and analysts, to make more informed decisions.
Improved Transparency and Comparability: XBRL facilitates greater transparency in financial reporting, making it easier for stakeholders to compare financial data across companies and industries. This is especially useful for investors, regulators, and analysts who need to evaluate performance across different entities.
Facilitates Regulatory Compliance: Many regulatory bodies now require reports to be submitted in XBRL format. This makes it easier for companies to comply with these regulations and for regulators to access and analyze the data quickly.
Disadvantages of XBRL
Initial Implementation Costs: The initial setup and adoption of XBRL can be expensive. Companies need to invest in training, software, and technology to integrate XBRL into their reporting systems. Smaller firms, in particular, may find these costs burdensome.
Complexity and Learning Curve: XBRL can be complex to implement and use. Companies must train their staff to understand how to tag data properly, work with XBRL software, and comply with the required standards. This learning curve can be a significant barrier for companies transitioning to XBRL reporting.
Data Quality Concerns: While XBRL can improve the accuracy of data, the quality of the data depends on the accuracy of the tagging and the processes used. If the data is not tagged correctly or if there is inconsistent tagging across reports, it can lead to issues with data interpretation and analysis.
Maintenance and Updates: XBRL taxonomies (the structured dictionary used for tagging data) need to be updated regularly to reflect changes in accounting standards and regulations. This requires ongoing effort and resources to maintain compliance and accuracy.
Software Compatibility Issues: The adoption of XBRL may require companies to upgrade or change their accounting and financial reporting software to be compatible with the XBRL format. This can lead to challenges and potential integration issues with existing systems.
Potential for Misinterpretation: If users are not familiar with how to interpret XBRL data, there is a risk that financial information could be misinterpreted or misused. This may lead to incorrect analyses or decisions based on the data.
Security Concerns: As with any electronic reporting system, there are security risks associated with the digital transmission and storage of financial data. Companies must take precautions to ensure that XBRL data is secure and protected from unauthorized access or breaches.
Q.5 (B) What are the short-term sources of working capital finance? (8)
Short-term sources of working capital finance are financing options that businesses use to meet their short-term operational needs, such as purchasing inventory, paying wages, and managing day-to-day expenses. These sources typically provide quick access to funds and are expected to be repaid within a year or less. Key short-term sources include:
Trade Credit: This is one of the most common sources of short-term finance, where suppliers allow businesses to buy goods or services on credit and pay for them at a later date. Trade credit helps companies manage cash flow by delaying payments until they have sufficient funds.
Bank Overdrafts: A bank overdraft allows a company to withdraw more funds from its current account than it holds, up to a certain limit. It’s a flexible form of borrowing for short-term cash needs, with interest charged only on the amount overdrawn.
Lines of Credit: This is a pre-approved borrowing limit provided by a bank or financial institution that a business can draw upon as needed. Interest is only charged on the amount borrowed, making it a flexible and convenient source of short-term finance.
Commercial Paper (CP): Commercial paper is an unsecured, short-term debt instrument issued by large corporations to raise funds. It typically has a maturity period of up to 270 days and is sold at a discount, with the full face value paid to investors at maturity.
Short-Term Loans: These are loans provided by banks or financial institutions with a repayment period usually less than a year. They can be used for specific working capital needs and often come with a higher interest rate compared to long-term loans.
Factoring: This involves selling accounts receivable to a third party (a factor) at a discount in exchange for immediate cash. It provides instant liquidity and transfers the risk of collection to the factor, although it can be expensive due to service fees.
Invoice Discounting: Similar to factoring, invoice discounting allows a business to receive a percentage of the value of its outstanding invoices from a lender while maintaining control over collections. The balance, minus interest and fees, is paid once the invoices are collected.
Cash Credit: This is a short-term loan provided by banks to businesses based on the value of their current assets, such as inventory and receivables. Cash credit facilities allow businesses to withdraw funds up to a limit and are generally repayable on demand.
Trade Loans: These are short-term loans provided to businesses to finance specific trade-related expenses, such as importing raw materials. Trade loans are often secured by the goods being imported or the trade contract itself.
Merchant Cash Advances: A merchant cash advance is an advance on future credit card sales or business revenue. The business receives a lump sum of cash upfront and repays the advance through a percentage of daily credit card sales or future revenue.
These short-term sources help businesses manage their liquidity and ensure they have the necessary funds to continue operations smoothly. The choice of financing method depends on the business’s financial position, creditworthiness, and specific cash flow needs.
OR
Q.5 C) Write Short Notes on: (Any three) (15)
a. Market Value Added
Market Value Added (MVA) is a financial metric that measures the difference between the market value of a company and the capital invested in it. In other words, MVA shows how much wealth a company has created or destroyed for its shareholders. If the MVA is positive, it indicates that the company has generated value over and above the cost of capital invested by its shareholders. Conversely, a negative MVA suggests that the company's performance has not met the expectations of its investors.
MVA is calculated as:
Where:
- Market Value of the Firm includes the current market price of the company's equity and debt.
- Total Capital Invested refers to the sum of funds raised by the company through debt and equity financing.
MVA is a critical tool for assessing the effectiveness of a company's management in generating shareholder value over time. It reflects how well a firm has performed relative to the expectations of its investors, providing an insight into its long-term financial health and strategic success.
b. NPA and their Provisioning
Non-Performing Assets (NPA) refer to loans or advances given by financial institutions, such as banks, that have not been repaid by the borrower as per the agreed terms. In other words, an NPA is a loan where the principal or interest has been overdue for a specified period, typically 90 days or more. NPAs are a significant concern for banks as they represent assets that are not generating income and can impact financial stability and liquidity.
Provisioning for NPAs is the process by which banks set aside a certain percentage of their income to cover potential losses due to NPAs. This is done to maintain the financial health of the bank and ensure that it has enough reserves to absorb potential losses without affecting its operations. The amount of provisioning depends on the classification of the NPA:
- Standard Assets: These are loans that are performing well and not overdue. Provisioning for these is minimal, usually around 0.25% to 1%.
- Substandard Assets: Loans overdue for 90 days to 1 year. Banks must provision a higher percentage, typically between 10% and 15% of the outstanding amount.
- Doubtful Assets: Loans overdue for more than 1 year and have higher risk factors. Provisioning for these is more significant, ranging from 20% to 100%, depending on the age of the overdue period.
- Loss Assets: These are considered irrecoverable, and banks must make 100% provision for these assets.
Provisioning helps banks stay solvent during periods of economic stress by building a financial buffer. It is also a regulatory requirement in many countries, ensuring that banks can withstand unexpected credit losses and maintain investor and public confidence.
c. Types of Mergers
Types of Mergers refer to the different ways in which companies combine to form a single entity, driven by strategic objectives such as growth, diversification, or increased market share. The main types of mergers include:
Horizontal Merger: This occurs between companies operating in the same industry and at the same stage of production. The aim is usually to increase market share, reduce competition, and achieve economies of scale. For example, when two car manufacturers merge, they can strengthen their position in the automotive industry.
Vertical Merger: Involves the merging of companies at different stages of the production process within the same industry. This type of merger helps streamline operations and create efficiencies by integrating supply chains. For instance, a car manufacturer merging with a parts supplier is a vertical merger that can lead to cost savings and better control over production.
Conglomerate Merger: This type of merger happens between companies that operate in completely different industries. The goal is often diversification, allowing the merged entity to reduce risk by spreading its operations across different markets. An example is a technology company merging with a food and beverage company, expanding its portfolio and reducing dependency on a single market.
Concentric Merger: This involves companies that are in related industries but do not offer the same products or services. The companies merge to create a synergy that enhances their ability to compete in the market. For example, a company making computer hardware merging with one specializing in software solutions to offer comprehensive technology packages.
Market Extension Merger: This type involves companies that sell the same products or services but operate in different geographical areas. Merging allows them to expand their market reach and increase customer base. For instance, a regional clothing retailer merging with a similar company operating in another region can expand its presence and brand recognition.
Product Extension Merger: This happens when companies that sell related but not identical products merge to increase their product lines and market penetration. For example, a company that makes kitchen appliances merging with one that produces small cooking tools expands their product range, attracting a broader consumer base.
These mergers are driven by strategic reasons such as growth, diversification, risk management, and synergy creation. Each type of merger carries specific benefits and challenges, impacting market structure, competition, and regulatory considerations.
d. Commercial Paper
Commercial Paper (CP) is a short-term, unsecured debt instrument issued by corporations to raise funds for short-term financial needs, such as working capital, inventory financing, or bridging cash flow gaps. Typically, commercial papers have maturities ranging from a few days up to 270 days, with most falling between 30 and 90 days. They are usually issued at a discount to their face value, and the investor receives the full face value at maturity, with the difference representing the interest earned.
Commercial papers are typically issued by large, financially stable corporations with high credit ratings, as they do not require collateral. This makes them an attractive option for companies seeking to borrow money at a lower interest rate compared to traditional bank loans. Investors, on the other hand, are often attracted to CPs for their relatively higher yields compared to other short-term investments like Treasury bills, though they come with higher risk due to the lack of government backing.
CPs are usually sold through a direct placement to institutional investors such as banks, mutual funds, and money market funds. To mitigate the risk of default, many issuers maintain a backup credit line with a bank. Regulatory oversight of commercial paper varies by country, but in general, issuing firms are required to have high creditworthiness, and the instruments must comply with specific rules for disclosure and rating.
e. Factors determining working capital requirements
Factors Determining Working Capital Requirements are critical in determining the amount of capital a business needs to finance its day-to-day operations. Adequate working capital ensures a company can maintain its liquidity, meet short-term obligations, and support its operational activities. Key factors that influence working capital requirements include:
Nature of the Business: Companies in industries that have longer production cycles or sales cycles, such as manufacturing, typically require more working capital compared to service-based or retail businesses, which have shorter cycles.
Business Size: Larger companies often need more working capital due to higher volumes of transactions and greater operational complexity, while smaller businesses may require less.
Production Cycle: The length of time it takes for raw materials to be converted into finished goods impacts working capital. Industries with longer production periods need more working capital to fund inventory during the production phase.
Sales Volume and Growth: A company with high sales volume or rapid growth will need more working capital to manage the increased demand for inventory and receivables.
Credit Policy: Companies that extend generous credit terms to customers will need more working capital to manage the lag between the time a sale is made and when payment is received. Conversely, a strict credit policy can reduce the working capital requirement.
Inventory Management: The amount of inventory held impacts working capital. Companies that maintain high inventory levels need more working capital, whereas efficient inventory management that minimizes stock can reduce these needs.
Supplier Terms: Favorable terms with suppliers, such as extended payment periods, can reduce working capital needs, as companies can delay cash outflows.
Seasonal Fluctuations: Businesses that experience seasonal demand spikes need higher working capital during peak seasons to maintain operations and build inventory.
Economic Conditions: Broader economic conditions, such as inflation or a recession, can affect the cost of goods and the availability of credit, impacting working capital requirements.
Cash Conversion Cycle: This is the period it takes for a company to convert its investments in inventory and receivables into cash flows from sales. A shorter cash conversion cycle can reduce working capital needs, whereas a longer cycle requires more working capital to bridge the gap.
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