Financial Management

1. FINANCIAL MANAGEMENT
Time allowed – 2½ hours
Total Marks – 100
[N.B. – The figures in the margin indicate full marks. Questions must be answered in English. Examiner will
take account of the quality of language and of the manner in which the answers are presented.
Different parts, if any, of the same question must be answered in one place in order of sequence.]
Marks
1. (a) What is capital rationing situation? What are the methods used to select capital investment
projects under capital rationing situation? State the steps to be followed to select a project? 5
(b) Raihan has been working as a Financial Analyst in Trans Group. Finance Director of the
company advised him to evaluate following capital investments, project X and Y. Each project
has initial cost of Tk.1,000,000. The cost of capital for each project is 15 percent. The projects’
expected net cash flows will be as follows: 20
Year Project X Project Y
Taka Taka
0 (1,000,000) (1,000,000)
1 650,000 350,000
2 300,000 350,000
3 300,000 350,000
4 100,000 350,000
Cash flows of project `X’ are expressed in real terms while those of project `Y’ are expressed in
nominal terms. The appropriate inflation rate is 4%.
Required:
i) Calculate each project’s payback period, Net Present Value (NPV) and Internal Rate of
Return (IRR).
ii) Which project or projects should be accepted if they are independent?
iii) Which project or projects should be accepted if they are mutually exclusive?
iv) How might a change in the cost of capital (`K’) produce a conflict between the NPV and
IRR ranking of these two projects? Would this conflict exist if `K’ were 5%?
2. (a) “Financing overseas subsidiaries depends on four key factors” – State those factors briefly.
What are the considerations while choosing a country for investment? What are the measures
to take to prevent the exploitation of the country by Multi National Corporation (MNC)? 5
(b) You are considering buying the stocks of two companies while operate in the same industry; they
have very similar characteristics except for their dividend payout policies. Both companies are
expected to earn Tk.6 per share this year. However company D (for dividend) is expected to pay
out all of its earnings as dividends, while company G (for growth) is expected to payout only one-
third of its earnings, or Tk.2 per share. D’s share price is Tk.40. G and D are equally risky.
Required:
Do you agree with following statements? Why or why not? 6
i) An investor in share D will get his or her money back faster because D pays out more of its
earnings as dividends. Thus, in a sense, D is like a short-term bond and G is like a long-
term bond. Therefore, if economic shifts cause returns (on bonds & shares) to increase,
and if the expected streams of dividends from D & G remain constant, shares D and G will
both decline, but D’s price should decline further.
ii) D’s expected and required rate of return is 15. G’s expected return will be higher because
of its higher expected growth rate.
iii) On the basis of the available information, the best estimate of G’s growth rate is 10 per cent.
(c) The following information is provided relating to the acquiring company Efficient Ltd. and the
target company Health Ltd: Dec 31, 2010:
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2. – 2 –
Efficient Ltd. Health Ltd.
No. of shares (F.V. Tk.10 each) 10,000 lakhs 7.5 lakhs
Market Capitalization 500.00 lakhs 750.00 lakhs
P/E ratio (times) 10.00 5.00
Reserves and Surplus 300.00 lakhs 165.00 lakhs
Promoter’s Holding (No. of shares) 4.75 lakhs 5.00 lakhs
Board of Directors of both the companies have decided to give a fair deal to the shareholders
and accordingly for swap ratio the weights are decided as 40%, 25% and 35% respectively for
Earning, Book Value and Market Price of share of each company.
Required:
i) Calculate the swap ratio and also calculate Promoter’s holding % after acquisition. 4
ii) What is the EPS of Efficient Ltd. after acquisition of Health Ltd.? 3
iii) What is the expected market price per share and market capitalization of Efficient Ltd.
after acquisition, assuming P/E ratio of firm Efficient Ltd. remains unchanged. 4
iv) Calculate free float market capitalization of the merged firm. 3
3. (a) A Company belongs to a risk class for which the appropriate capitalization rate is 10%. It currently has
25,000 outstanding shares selling at Tk.100 each. The firm has been contemplating the declaration of
a dividend of Tk.5 per share at the end of the current financial year. The company expected to have
net income of Tk.2,50,000 and has a proposal for making new investment of Tk.5,03,000.
Required:
Prove the assumption that payment of dividend does not affect the value of the firm? 5
(b) Following is the earnings per share (EPS) record of the ABC company Ltd. over the past 10
years:
Year EPS (Tk.) Year EPS (Tk.)
10 20.00 5 12.00
9 19.00 4 6.00
8 16.00 3 9.00
7 15.00 2 -2.00
6 16.00 1 1.00
Required:
(1) Determine the annual dividend paid each year in the following cases:
a) If the firm’s dividend policy is based on a constant dividend pay-out ratio of 50% for all years. 4
b) Pay dividend Tk.8 per share and increase to Tk.10 when earnings exceed Tk.14 per
share for two consecutive years. 4
c) Pay dividend Tk.7 per share each year except when EPS exceeds Tk.14 per share, when
an extra dividend equal to 80% of earnings beyond Tk.14.00 would be paid. 4
(2) Which type of dividend policy will you recommend to the company and why? 3
4. Lip Ltd. is a listed company which operates in the pharmaceutical sector, manufacturing a broad
range of drugs under licence in a number of countries. Around 75% of the book value of Lip’s non-
current assets comprises factories situated outside Bangladesh. In recent years the company has
grown organically but a proposal has now been put forward by the company’s investment bank
that the company might consider the acquisition of a smaller firm. Bengal Ltd. (Bengal), as a route
to both further expansion and diversification of the company’s activities.
Bengal is involved in a different area of the pharmaceutical sector from Lip as it is primarily a
research-driven company involved in the development of new drugs arising from the latest
academic research, often working with research departments of universities and teaching
hospitals to turn the research into commercial reality.
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3. – 3 –
The majority of Bengal’s shares are owned by members of the three founding families, many of
whom still work for the company. They are now considering selling Bengal if a suitable price can
be agreed.
The following financial information has been obtained for Lip, along with comparative information
for Bengal:
Lip Bengal
Forecast earnings in next financial year (Taka million) 7.50 2.00
Shares in issue (million) 12.50 0.75
Current earnings per share (Taka) 0.5625 0.7650
Current dividend per share (Taka) 0.2530 0.50
Share price (Taka) 618.50 n/a
Book value of equity (Taka million) 175.00 22.50
Gearing ratio (debt as a % of market value) 25.00 0
Forecast dividend growth rate pa 3% 6%
Cost of equity 7% n/a
Bengal does not calculate a cost of equity, but the average for listed companies operating in the
same sector is 8%. At this stage, the directors of Lip have identified either a right issue or a floating
rate term loan as the most likely method by which they might finance the purchase of Bengal.
Required:
(a) In your role as a corporate finance manager of Lip, prepare a report for Lip’s directors
providing valuations of Bengal using:
(i) net assets;
(ii) dividends;
(iii) current and forecast earnings (using Lip’s current price-earnings ratio),
and, for each valuation calculated, identify and specific reservations or other issues that you
might wish to bring to the attention of Lip’s directors. 16
(b) Evaluate (without undertaking any calculations) the two potential methods of financing the
purchase of Bengal. 8
(c) Discuss the relative advantages of organic growth and growth by acquisition. 6
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MJ-12