OBE: OPEN BOOK EXAMINATION_A

[This question paper contains XX printed pages.]

Your Roll No: …………………..
Sr. No. of Question paper : XXXX
Unique Paper Code : 12481303

Name of the Paper : Corporate Finance

Name of the Course : B.A (Hons.) Business Economics
Semester : III
Duration : 3 Hours

Maximum Marks : 75

Instructions for candidates:

1. This paper contains 6 questions. Attempt ANY FOUR questions.

2. All questions carry equal marks.

Q1. (a) “The profits focus on the short-term earnings, while the wealth focus on increasing
the overall value of the business entity over time”. Explain.

(b) A public deposit of Rs.1000 is made is made in a company for a period of two years.
The company offers three options: (i) to receive interest at 12% p.a. compounded annually
or (ii) to receive interest at 11.75% p.a. compounded semi-annually or (iii) to receive
interest at 11.50% p.a. compounded quarterly. Which option should be selected?
(9, 9.75)

Q2. (a) Explain the index that measures the ratio between the present value of future cash
flows and the initial investment. Also, explain how it is a useful tool for ranking
investment projects?

(b) The Royal Industries is considering the replacement of one of its moulding machines.
The existing machine is in good operating condition but is smaller than required if the
firm is to expand its operations. The old machine is 5 years old, has a current salvage
value of Rs 30,000 and a remaining depreciable life of 10 years. The machine was
originally purchased for Rs 75,000 and is being depreciated at Rs 5,000 per year for tax
purposes. The new machine will cost Rs 1,50,000 and will be depreciated on a straight
line basis over 10 years, with no salvage value. The management anticipates with the
expanded operations, there will be need of additional net working capital of Rs 30,000.
The new machine will allow the firm to expand current operations and thereby increase
annual sales from Rs 4,00,000 to Rs 4,40,000; annual variable operating cost from Rs.

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 2,00,000 to Rs. 2,10,000. The company tax rate is 55% and its cost of capital is 10%.
Should the company replace its existing machine? (9,9.75)

Q3. (a) Mahindra Co Wants to invest in plant costing ₹15,00,000 and has estimated annual
cash inflows to be generated from this plant as ₹500,000, ₹400,000, ₹400,000, ₹500,000,
₹600,000 during its life of five years . The Cost of capital is 10%. the plant also requires
initial working capital investment of ₹2,00,000. It has a salvage value of ₹150,000. Both
working capital and salvage value will be realized in the last year of the project. Find out
the Payback Period and Net Present Value of the investment proposal.

(b) A company is contemplating an issue of new equity shares. The firm’s equity shares
are currently selling at Rs 125 a share. The historical pattern of dividend payments per
share, for the last 5 years is given:
Year Dividend(Rs)
1 10.80
2 11.66
3 12.60
4 13.60
5 14.69
The flotation cost is expected to be 3% of the current selling price of the shares. You are
required to determine the following:
(i) Growth rate in dividends
(ii) Cost of equity capital assuming growth rate determined under situation (i)
continues forever.
(iii) Cost of new equity shares. (9, 9.75)

Q4. (a) Premji Steels Limited requires Rs.25,00,000 for a new plant. This plant is expected to
yield earnings before interest and taxes of Rs.5,00,000. While deciding about the financial
plan, the company considers the objective of maximizing earnings per share. It has three
alternatives to finance the project - by raising debt of Rs.2,50,000 or Rs.10,00,000 or Rs.
15,00,000 and the balance, in each case, by issuing equity shares.
The company’s share is currently selling at Rs. 150, but is expected to decline to Rs.125 in
case the funds are borrowed in excess of Rs.10,00,000. The funds can be borrowed at the
rate of 10 percent up to Rs.2,50,000, at 15 percent over Rs. 2,50,000 and up to Rs. 10,00,000
and at 20 percent over Rs.10,00,000. The tax rate applicable to the company is 50 percent.
Which form of financing should the company choose?

(b)Determine the indifference points of the financial plans (1) A and B and (2) A and C
formulated by the finance department of the company to finance its capital budget, assuming
50% corporate tax rate:
(A) Issue 1,00,000 equity shares of Rs. 20 per share.
(B) Issue 50,000 equity shares of Rs 20 per share and 10% debentures of Rs
10,00,000.
(C) Issue 50,000 equity shares of Rs 20 per share and 12% preference shares of Rs
10,00,000. (9, 9.75)

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Q.5 (a) From the following selected data determine the value of the firms; P and Q belonging
to the homogeneous risk class under (I) the NI approach, and (II) the NOI approach:
Levered Firm (P) Unlevered firm(Q)
EBIT Rs. 2,00,000 Rs. 2,00,000
Interest at 10% 50,000
Equity capitalisation rate 15%
Corporate tax rate 50%
Which of the following firms has an optimal capital structure under the (I) NI approach
and (II) NOI approach?
(b)An engineering company has a cost of equity capital of 15%. The current market value
of the firm is Rs 30,00,000 (@ Rs 30 per share). Assumes values for I (new investment Rs
9,00,000), E (Earnings Rs 5,00,000) and total dividends (D) (Rs 3,00,000). Show that under
the MM assumptions the payment of dividend does not affect the value of the firm.
(9,9.75)
Q6. (a) “The total working capital requirement is determined by a wide variety of factors and
these factors affect different enterprises differently”. Explain the factors that are involved
in a proper assessment of the quantum of working capital required.

(b) On 1st January, the Managing Director of Naureen Ltd. wishes to know the amount of
working capital that will be required during the year. From the following information
prepare the working capital requirements forecast.

• Production during the previous year was 60,000 units. It is planned that this level of
activity would be maintained during the present year. The expected ratios of the cost
to selling prices are Raw materials 60%, Direct wages 10% and Overheads 20%.
• Raw materials are expected to remain in store for an average of 2 months before
issue to production.
• Each unit is expected to be in process for one month, the raw materials being fed
into the pipeline immediately and the labour and overhead costs accruing evenly
during the month.
• Finished goods will stay in the warehouse awaiting dispatch to customers for
approximately 3 months.
• Credit allowed by creditors is 2 months from the date of delivery of raw material.
• Credit allowed to debtors is 3 months from the date of dispatch.
• Selling price is Rs.5 per unit.
• There is a regular production and sales cycle.
• Wages and overheads are paid with a lag of one month.
• The company normally keeps cash in hand to the extent of Rs.20,000.
(9,9.75)