'ERSITY

C O U R S E O U T L I N E S U M M E R Q U A R T E R 2011

F I N A N C I A L A N A L Y S I S

M B A (Evening) P R O G R A M

Sr. Chapter Final Exam Chapter Headinq No. No. Q. No.

1 . 6 1 Financial Statement Analysis 2. 7 2 Funds Analysis, Cash-Flow Analysis and Financial

Planning 3. 12 3 Capital Budgeting and Estimating Cash Flows 4. 13 4 Capital Budgeting Techniques 5. •14 5 Risk and Managerial Options in Capital Budgeting 6. 15 6 Required Returns and the Cost of Capital 7 . 16 7 Operating and Financial Leverage 8. 17 8 Capital Structure Determination

Recommended Text Book:

. Fundamentals of Financial Management: 1 2 t h Edition by H o m e & Wachowicz; Prentice Hall international

DISTRIBUTION O F M A R K S

Internal Sessional Evaluation External Eval.

Assignments/ Project

Quizzes Class Parti. Attendance

Mid-Term Test

Total Sessional

Terminal Exam

Final • Evaluation

10. 10 5 2 5 5 0 50 100

Final Examination Question Paper Required: 5 Problems out of 8

UNIVERSITY EXAMINATION.

^ s s i r s s s ^ ' student Name: Islamabad - Kohat - Peshawar — Lahore

_ •_. Reg. Nos.

Course Code; \ 4467 Course Title: m nancial Anal ysis Program: E3 tecutive MBA/MBA (Evening) Quarter: ill 2010

This is a th ree-hour examination and consists of problems only. You may a t t empt not more t han live problems.

Q.l Cordillera Carson.Company has the following balance sheet and income statement f or 2003 (in thousands): •

BALANCE SHEET INCOME STATEMENT Cash $ 400 Net sales (all credit) $ 1 2,6.80 Accounts receivable 1,300 Cost of goods sold 8.930

Gross profit $ 3,750 Inventories - 2.100 Selling, general and Current assets $3,800 administration expenses 2,230 Net fixed assets .. 3,320 .Interest expense 460 Total assets $7,120 Profit before taxes $ 1,060

Taxes 390 Accounts payable $ 320 Profit after taxes $ 670 Accruals 260 Short-term loans 1.100 Notes:(i) current period's depreciation is $480 Current liabilities $1,680 (ii) ending inventory for 19x1 was $1,800. Long-teriti debt 2,000

. Net worth 3.440 Total liabilities and net worth $ 7,120

Q.2

On the basis of this information, compute (a) the current ratio, (b) the acid test ratio, (c) the average collection period, (d) the inventory turnover ratio, (e) the debt-to-net worth ratio, Of) the long-term debt to-total-capitalization ratio, (g) the gross profit margin, (h) the net profit margin, (j) die return on equity and (k) Times Interest Earned.

Prepare a cash budget for the Ace Manufacturing Company, indicating receipts and disbursements for May, June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs.20.000. Determine whether or not borrowing will be necessary during the period, and if it is, when and for how much. As of April 30, the firm had a balance of Rs.20,000 in cash.

ACTUAL SALES FORECASTED SALES January February March April

Rs.50,000 50,000 60,000 60,000

May June July August

Rs. 70,000 80,000

100,000 100,000

Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent will be collected equally during the following 2 months (assume no bad-debt loss). Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and 10% in the second month. . ,

Selling, general, and administrative expenses: Rs. 10,000 per month pins 10 percent of sales. All of these expenses are paid during the month of incurrence. Interest payments: A semi-annual interest payment on Rs.l 50,000 of bonds outstanding (12 percent coupon) is paid during July. An annual Rs.50,000 sinking-fund payment is also made at that time. Dividends: A Rs. 10,000 dividend payment will be declared and made in July. Capital expenditures: Rs.40,000 will be invested in plant and equipment in June. Taxes: Income-tax payments of Rs.l ,000 will be made in July.

Q.3 Thoma Pharmaceutical Company may buy an equipment costing $60,000. This equipment is expected to reduce labor costs by $20,000 annually. The equipment has a useful life of 5 years but depreciation will be charged according to the following rates: Year-1 33.33% . ' Year-2 44.45 . Year-3 . . 14.81 . . Year-4 1 7.41 No salvage value is expected at the end. The corporate tax rate for Seema is 38 percent, and its required rate of return is 15 percent. (If profits alter taxes on the project are negative in any year, the firm will offset the loss against other firm income for that year).

REQUIRED: What are the relevant cash flows'?

Q. 4 Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. The company is in 34% tax bracket. Assuming a required rate of return of 14 percent, calculate; i. Pay Back Period ii. Net Present Value . iii. IRR of the project if the cash inflows are as under:

End of years 1 2 4 5 6 7 Cash Inflows (Rs)

5,000 5,000 6,000 6,000 7,000 7,000 7,000

Depreciation Rate

20% .32% 19.20% 11.52% 11.52% 5.76% -

Q.5 The probability distribution of possible, net present values for project X has an expected value of Rs 20,000 arid standard deviation of Rs.l 0,000. Assuming a normal distribution, calculate the probability that the net present value will be zero or less, that it will be greater than Rs.30,000, and that it will be less than Rs.5,000.

Q.6 The Mana Company was recently formed to manufacture a new product. It has the following capital structure in market value terms:

13% Debentures of 2005 Rs.6,000,000 . 12% Preferred stock 2,000,000

Common stock (320,000 shares) 8,000,000 . .. ' MJ-6JL0_Q,M)

The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of business suggests that the required rate o f equity is about 1.7 percent. The Manna Company's debt is currently yielding 13% while its preferred stock is yielding 12%. Compute the firm's present weighted average cost of capital.

Pagc2ol'3

Q.7 The Fazio Pump Corporation presently has 1.1 million shares of common stock outstanding and $S million in debt bearing an interest rate of 10 percent on average. It is considering a $5 million expansion program financed with either common stock at $20 per share being realized(option 1), debt at an interest rate of 1 I percent (option 2), or preferred stock with a 10 percent dividend rate (option 3). Earnings before, interest and taxes (EBIT) after the new funds are raised expected to be $ 6mi|lion, and the company's tax rate is 35 percent.

REQUIRED: a. Determine likely earnings per share after financing for each of the three alternatives. b. What would happen if EBIT were $3 million, $4 million? $8million?

Q.S Stinton Company is presently family owned and has no debt. The Stinton family is considering going public by sell ingsome of their stock in the company. Investment bankers tell them the total market value of the company is $10 million if no debt is employed. In addition to selling stock, the family wishes to consider issuing debt that, for computational purposes, would be perpetual. The debt would then be used to purchase and retire common stock, so that the size of company would stay the same. Based on various valuation studies, the present value of tax-shield benefits is estimated at 22 percent of the amount borrowed when both corporate and personal taxes are taken into account. The company's investment banker has estimated the following present values for bankruptcy costs

.. associated with various levels of debt:

Debt Present Value of Bankruptcy Costs $1,000,000 $ 0

2,000.000 50,000 3,000,000 100,000 4.000,000 200,000 5,000,000 400,000 6,000,000 700,000 7,000,000 1,100,000 8,000,000 1,600,000

Given this information, what amount, of debt should the family choose?

Pope 3 on

This is a three-hour examination and consists of problems only. You may attempt not more than five problems.

Q. 1 Cordillera Carson Company has the following balance sheet and income statement for 2006 (in thousands): "... .

BALANCE SHEET INCOME STATEMENT Cash $ 400 Net sales (all credit) $ 12,680 Accounts receivable 1,300 Cost of goods sold 8,930

Gross profit $ 3,750 Inventories 2.100 Selling, general and Current assets $3,800 administration expenses 2,230 Net fixed assets 3,320 Interest expense 460 Total assets $7,120 Profit before taxes $ 1,060.

Taxes 390 Accounts payable $ 320 Profit after taxes $. 670 Accruals 260 • -

Short-term loans 1,100 Notes:(i) current period's depreciation is $480 Current liabilities $1,680 (ii) ending inventory for 2005 was $1,800 Long-term debt 2,000 Net worth 3..440 Total liabilities and net worth $ 7,120

On the basis of this information, compute (a) the current ratio, (b) the acid test ratio, (c) the average cojlection period, (d) the inventory turnover ratio, (e) the debt-to-net worth ratio, (f) the long-term debt to-total-capitalization ratio, (g) the gross profit margin, (h) the net profit margin, (j) the return on . equity and (k) Times Interest Earned.

Q.2 Prepare a cash budget for the Ace Manufacturing Company, indicating receipts and disbursements for • May, June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs.20,000.

Determine whether or not borrowing will be necessary during the period, and if it is, when and for how much. As of April 30, the firm had. a balance of Rs.20,000 in cash.

ACTUAL SALES FORECASTED SALES January. . Rs.50,000 May Rs. 70,000 February . 50,000 June 80,000 March 60,000 July 1 100,000 April 60,000 August 100,000

o Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent will be collected equally during the following 2 months (assume no bad-debt loss). *

» Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and 10% . in the second month.

Paue I oH

« Selling, general, and administrative expenses: Rs.l 0,000 per month plus 10 percent of sales. All of these expenses are paid during the month of incurrence.

» Interest payments: A semi-annual interest payment on Rs.150,000 of bonds outstanding (12 percent coupon) is paid during July. An annual Rs.50,000 sinking-fund payment is also made at that time.

« Dividends: A Rs.10,000 dividend payment will be declared and made in July, o Capital expenditures: Rs.40,000 will be invested in plant and equipment in June, a Taxes: Income tax payments of Rs. 1,000 will be made in July.

Thoma Pharmaceutical Company may buy an equipment costing $60,000. This equipment is expected to reduce labor costs by $20,000 annually. The equipment has a useful life of 5 years but depreciation will be charged according to the following rates: Year-1 33.33% Year-2 44.45 Year-3 14.81 Year-4 7.41 "No salvage va.lue is expected at the end. The corporate tax rate for Seema is 38 percent, and its required rate of return is 15 percent. (If profits after taxes on the project are negative in any year, the firm will offset the loss against other firm income for that year).

REQUIRED: . On the basis of this information, what are the relevant cash flows?

Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. TJie company is in 34% tax bracket. Assuming a required rate of return of 14 percent, calculate; i. Pay Back Period ii. Net Present Value iii. IRR of the project if the cash inflows are as under:

End of years 1 2 j 4 5 6 7 Cash Inflows (Rs)

5,000 5,000 6,000 6,000 7,000 7,000 7,000

Depreciation Rate

20% 32% 19.20% 11.52% 11.52% 5.76% -

The probability distribution of possible net present values for project X has an expected value of Rs 20,000 and standard deviation of Rs.10,000. Assuming a normal distribution, calculate the probability that the net present value will be zero or less, that it will be greater than Rs.30,000, and that it will be less than Rs.5,000.

The Mana Company was recently formed to manufacture a new product. It has the following capital structure in market value terms:

13% Debentures of 2005 Rs.6,000,000 12% Preferred stock 2,000,000 Common stock (320,000 shares) 8,000,000

; Rs.l 6.000.000

The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of business suggests that the required rate of equity is about 17 percent. The Manna Company's debt is currently yielding 13% while its preferred stock is yielding 12%. Compute the firm's present weighted average cost of capital.

Page 2 of 3

The Fazio Pump Corporation presently has 1.1 million shares of common stock outstanding and $8 million in debt bearing an interest rate of 10 percent on average. It is considering a $5 million expansion program financed with either common stock at $20 per share being realized(option 1), or debt at an interest rate of 11 percent (option 2), or preferred stock with a 10 percent dividend rate (option 3). Earnings before interest and taxes (EBIT) after the new funds are raised expected to be $6million, and the company's tax rate is 35 percent.

REQUIRED: a. Determine likely earnings per share after financing for each of the three alternatives. b. What would happen if EBIT were $3 million, $4 million? $8million?

Stinton Company is presently family owned and has no debt. The Stinton family is considering going public by selling some of their stock in the company. Investment bankers tell them the total market value of the company is $10 million if no debt is employed. In addition to selling stock, the family wishes to consider issuing debt that, for computational purposes, would be perpetual. The debt would then be used to purchase and retire common stock, so that the size of company would stay the same. Based on various valuation studies, the present value of tax-shield benefits is estimated at 22 percent of the amount borrowed when both corporate and personal taxes are taken into account. The company's investment banker has estimated the following present values for bankruptcy costs associated with various levels of debt:

Debt Present Value of Bankruptcy Costs $1,000,000

2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000

$ 0 50,000

100,000 200,000 400,000 700,000

1,100,000 1,600,000

Given this information, what amount of debt should the family choose?

Page J of

n - Lahore

Course Code; FA Course Title:- F

.Program:

TERMIN'AI,' EXAB/IfNATION

'csiiitwaf

This is a (hree-hour examination and consists of problems only. You may attempt not more than five problems*

Q. I The following information is available for a Company: - ;

BALANCE SHEET AS OF DECEMBER 31,2001 (JN THOUSANDS)

Q.2

Cash and marketable securities $500 Accounts payable. $ 'i00 Accounts receivable ? Bank loan 7 Inventories ? Accruals 200 Current assets ? Current liabilities ?

Net fixed assets . ' ? .. Long term debt 2,650 Common stock & retained ea nings

Total assets ? Total liabilities & equity

INCOME STATEMENT FOR 2001 (IN THOUSANDS) Credit sates $8,000

: ; Cost of goods sold •. , ' ? Gross profit • ? Selling & administrative expenses '? Interest expense • . 400 Profit before taxes ? Taxes (44% rate) ___? Profit after taxes ?

OTHER INFORMATION Current.ratio 3 to 1

. Depreciation Rs. 500 ; Net profit margin 7 %

. Total liabilities/shareholders' equity . 1 to 1 Average collection period . 4 5 days •

. Inventory turnover ratio 3 to 1

REQUIRED: Assuming that sates and production are steady throughout a 360-day year, complete the balance sheet and income statement for the Company. Necessary working must be shown.

Prepare a cash budget for the Ace Manufacturing Company, indicating receipt? and disbursements for May, June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs..'A 000. Determine whether or not borrowing will be necessary during the period, and if it is, when and for haw much. As of April 30, the firm had a balance of Rs. 20,000 in cash;

ACTUAL SALES FORECASTED SALES January 'February March April

Rs.50,000 50,000 60,000 60,000

May June July August

Rs. 70,000 80,000

100,000 100.001)

Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent wiH'.U collected equally during the following 2 months (the firm incurs a negligible bad-debt lo.js).

i Paget of3

Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and 10% in the second month. , Selling, general, and administrative expenses: Rs.10,000 per month plus 10 percent of sales. All of these expenses are paid during the month of incuixence. Interest payments: A semi-annual interest payment on Rs.150,000 of bonds outstanding (12 percent coupon) is paid during July. An annual Rs,50,000 sinking-fund payment is also made at that time. Dividends: A Rs.10,000 dividend payment will be declared and made in July. Capilal expenditures! Rs.40,000 will be invested in plant and equipment in June. Taxes: Income tax payments of Rs. 1,000 will be made in July.

The City of San Jose must replace a number of its concrete-mixer trucks with new trucks. It has received two bids and has evaluated closely die performance characteristics of the various trucks. The Rockbuilt truck, which costs $74,000, is top-of-the-line equipment. The truck has a life of eight years, assuming that the engine is rebuilt: in the fifth year. Maintenance costs of $2000 a year are expected in the first four years, followed by total maintenance and rebuilding costs of $13,000 in the fifth year. During the last three years, maintenance costs arc expected to be $4,000 a year. At the end of eight years the truck will have an estimated scrap value of $9,000. A bid front Bulldog Trucks, Inc. is for $59,000 a truck. Maintenance costs for the truck will be higher. In the fust year, they are expected to be $3,000, and this amount is expected to increase by $1,50.0 a year through the eighth year. In the fourth year the engine will need to be rebuilt, and this will cost the company $15,000 in addition to maintenance costs in that year. At the end of eight years the Bulldog truck will have an estimated scrap value of $5,000.

REQUIRED: . • a. What are the relevant cash flows related to the trucks of each bidder?. b. What are the cash-floAV savings each year that can be obtained by going with the more expensive

truck rather than the less expensive one?

Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. The company is in. 3 * 1 % tax bracket. Assuming a required rale of return of 14 percent, calculate; i. Pay Back Period ii. Net Present Value iii. !RR of the project if the cash inflows arc as under:

End of years . 1 2 3 4 5 6 7 Cash Inflows (Rs) 5,000 5,000 0,000 6,000 7,000 7,000 7,000 Depreciation Rate ' 20% 32% 19.20% 11.52% 11.52% 5.76% -

Xonics Graphics, Inc., is evaluating a new technology for ils reproduction equipment. The technology will have a three-year life, will cost $ 1,000, and will have an impact on cash flows that is subject to risk. Manngement estimates that there is a fifty-fitly chance that the technology will either save the company

• $1,000 in the Erst year or save it nothing at all. If nothing at all, savings in the last two years would be zero as well. Even here there is some possibility that in the second year an additional outlay of $300 would be required to convert back to the original process, for the new teclinology may decrease efficiency. Management attaches a 40 percent probability to this occurrence if the hew technology "Bombs out" in the first year. If the technology proves itself in the first year, it is felt that second-year cash flows will be $1,800,1,400, and $1,000, with probabilities of 0.20, 0.60, and 0.20, respectively, hi .the third year, cash flows are expected to be either $200 greater or $200 less than the cash flow in period 2, with an equal chance of occurrence. (Again, these cash flows depend on the cash flow in period 1 being $1,000) i. Set up a tabular version of a probability tree to depict the cash-flow possibilities, and the initial,

conditional, and joint probabilities, if Calculate a net present value for each of the tluee-year possibilities (that is, for each of (he eight

complete branches in the probability tree) using a risk-free rate of 5 percent, iii. Calculate the expected value of net present value for the project represented in the probability tree. IV; What is the risk of the project?

Page 2 of.i

The Manna Company was recently formed to manufacture a new product. It has the R>f!f<whijg capital structure in market value terms:

J 3% Debentures of2005 Rs.6,000.000 12% Preferred stock 2.000,000

. Common stock mQfiJJQfi Ra.U8iwft.nno

The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of business suggests (hat. the required rate of equity is about 17 percent. Compute the firm's fireseul weighted average cost of capital.

Cybernauts, Limited is a new firm dint wishes to determine an appropriate capital Mmpture. It can issue 16% debt or 15% preferred stock. The total caphatization of the company will be $ 5 million and common stock can be sold at $20 per share. The company is expected to have a 50% lax rate (federal plus state). Four possible capital structures being considered are as follows:

EQUITY >%) '. 100

70 . 50 30

I. Construct an EOIT-EPS chart for the four plans. (EBIT is expected to be $ 1 mllJicnj. Which plan is best? Why? •

ii. Calculate the indifference point between plans 1 and 3.

The WB Company and the GH Company are identical in every respect except that the \VB Company is not financially levered, while the GH Company has Rs.2 million in 12 percent bonds ouMtaJiiiR. There are no (axes, and capital markets are assumed to be perfect. The valuation of the two firms is shown as follows: •

PLAN DEBT(%) PREFERRED(%) 1 .0 0 2 30 0 3 50 o 4 50 20

WG Company GH Company

Net operating income Rs. 600,000 Rs. 600,000 Interest on debt 0 Rs. 240.000 Earnings to common shareholders(O-l) Rs. 600,000 • Rs. 360,000 Required equity return •• +.15 + J 6 Market value of stock Rs.4,000,000 Rs.2,250,000 Market value of debt 0 • 2,000,000 Total value of firm Rs.4,000,000 Us.4,250,000 Implied overall capitalization Rate k0 .15 .1412 bebl-to-equity ratio B/S 0 .89

a. You own Rs.22,500 worth of GH stock. Show the process and the amount by which you could reduce your outlay through the use of arbitrage.

b. When will this arbitrage process cease? .

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fIVERSITY , .; Maraatoad Kofeat' - Peshawar - Lahore

Reg. N<o:

T E R M I N A L .EXAMINATION

Course Code; FA 4467

This 3s a tjbires-hour examaraatioin and consists of problems only. Y O M may attenpt act more than, fivs problems. •

Q. 1 The following information is avaiiabie for a Company:

BALANCE SHEET AS OF DECEMBER 31,201.0 (IN THOUSAND^)"'

Casa and marketable secur ities $ 500 Accounts payable S 400 Accounts receivable ? Bank loan ?

Inventories 9 — J -

Accruals 200 Current assets .'•? Current liabilities ?

Nat fixed assets 9 Long term debt 2,650 Common stock & retained earnings 3,750

Total assets 9 Total liabilities & .equity ?

INCOME STATEMENT FOR 2010 (IN THOUSANDS) Credit sales. $ 8,000 Cost of goods sold : 9 Gross profit • 7 Selling & administrative expenses 9 Interest expense 400 Profit before taxes ? Taxes (44% rate) ? Profit after taxes : ' 9

OTHER INFORMATION Current ratio • 3to.l Depreciation Rs. 500 Net profit margin „ - 7 % Total liabilities/shareholders' equity 1 to 1 Average collection period 45 days Inventory turnover ratio 3 to 1

REQUIRED: Assuming that sales and production are steady throughout a 360-day year, complete the balance sheet and income statement-for the Company, Necessary working must be shown.

Q.2 Prepare a cash budget for the Ace Manufacturing Company, indicating receipts and disbursements for May, June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs.20,000. Determine whether or not borrowing will be necessary during the period, and if it is, when and for how much. As of April 30, the firm had a balance of Rs. 20,000 in cash.

• ACTUAL SALES FORECASTED SALES January Rs.50,000 May Rs. 70,000 February 50,000 June 80,000 March 60,000 . - July 100,000 April ' 60,000 August 100,000

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Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent will be collected equally during the following 2 months (the firm incurs a negligible bad-debt loss). Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and 10% in the second month. Selling, general, and administrative expenses: Rs: 10,000 per month plus 10 percent of sales. All of these expenses are paid during the month of incurrence. Interest payments: A semi-annual interest payment on Rs. 150,000 of bonds outstanding (12 percent coupon) is paid during July. An annual Rs,50,000 sinking-fund payment is also made at that time. Dividends: A Rs. 10,000 dividend payment will be declared and made in July. Capital expenditures: Rs.40,000 will be invested in plant and equipment in June. Taxes: Income tax payments of Rs,1,000 will be made in July.

The City of San Jose must replace a number of its concrete-mixer trucks with new trucks. It has received two bids and has evaluated closely the performance characteristics of the various trucks. The Rockbuilt truck, which costs $74,000, is top-of-the-Iine equipment. The truck has a life of eight years, assuming that the engine is rebuilt in the fifth year. Maintenance costs of $2000 a year are expected in the first four years, followed by total maintenance and rebuilding costs of $ 1.3,000 in the fifth year. During the last three years, maintenance costs are expected ro be $4,000 a year. At the end of eight years the truck wili have an estimated scrap value of $9,000. A bid from Bulldog Trucks, Inc. is for $59,000 a truck. Maintenance costs for the truck will be higher. In the first year, they are expected to be $3,000, and this amount is expected to increase by $1,500 a year through the eighth year. In the fourth year the engine will need to be rebuilt, and this will cost the company $15,000 in addition to maintenance costs in that year. At the end of eight years the Bulldog truck will have an estimated scrap value of $5,000.

REQUIRED: a. What are the relevant cash flows related to the trucks of each bidder? b. What are the cash-flow savings each year that can be obtained by going with the more expensive

truck rather than the less expensive one?

Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. The company is in 34% tax bracket. Assuming a required rate of return of 14 percent, calculate; i. Pay Back',Period ii. Net Present Value iii. IRR of the project if the cash inflows are as under:

End of years 1 2 3 4 5 6 7 Cash Inflows (Rs) 5,000 5,000 6,000 6,000 7,000 7,000 7,000 Depreciation Rate 20% 32% 19.20% 11.52% 11.52% 5.76% -

The probability distribution of possible net present values for project X has an expected value of Rs 20,000 and standard deviation of Rs 10,000. Assuming a normal distribution, calculate the probability that the net present value will be zero or less, that it will be greater than Rs 30,000, and that it will be less than Rs 5,000.

The Manna Company was recently formed to manufacture a new product. It has the following capital structure in market value terms:

Rs.6,000,000 2,000,000 8,000,000

The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of business suggests that the required rate on equity is about 17 percent. Compute the firm's present weighted average cost of capital.

13% Debentures of 2005 12% Preferred stock Common stock

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Cyberaauts, Limited is a new firm that wishes to determine an appropriate capital structure. It can issue 16% debt or 15% preferred stock. The total capitalization of the company will be $ 5 million and common stock can be sold at $20 per share. The company is expected to have a 50% tax rate (federal plus state). Four possible capital structures being considered are as follows:

PLAN DEBT(%) PR£FERRED(%) EQUITY(%) 1 0 0 100 2 30 0 70 3 50 6 50 4 50 . 2 0 30

i. Construct an EBIT-EPS chart for the four plans. (EBIT is expected to be $ 1 million), Which plan is best? Why?

ii. Calculate the indifference point between plans 1 and 3.

The WB Company and the GH Company are identical in every respect except i a t the WB Company is not financially levered, while the GH Company has Rs.2 million in 12 percent bonds outstanding. There are no taxes, and capital markets are assumed to be perfect. The valuation of the two firms is shown as follows:

WB Company - GH Company

Net operating income Rs. 600,000 Rs. 600,000 Interest on debt Q Rs. 240.000 Earnings to common shareholders(O-I) Rs. 600,000 Rs. 360,000 Required equity return + .15 + Market value of stock Rs.4,000,000 Rs.2,250,000 Market value of debt ' 0 2,000,000 Total value of firm Rs.4,000,000 Rs.4,250,000 Implied overall capitalization Rate k„ .15 .1412 Debt-to-equity ratio B/S 0 .89

REQUIRED: a. You own Rs.22,500 worth of GH stock. Show the process and the amount by which you could reduce your

outlay through the use of arbitrage. . . b. When will this arbitrage process cease?

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