1. Why wealth maximization is superior to profit maximization in todayâ s context?

Justify
your answer
2. Your grandfather is 75 years old. He has total savings of Rs.80,000. He expec
ts that he
live for another 10 years and will like to spend his savings by then. He places
his savings
into a bank account earning 10 per cent annually. He will draw equal amount each
yearthe
first withdrawal occurring one year from now in such a way that his account bala
nce
becomes zero at the end of 10 years. How much will be his annual withdrawal?
3. What factors affect financial plan?
4. Suppose you buy a one-year government bond that has a maturity value of Rs.10
00.
The market interest rate is 8 per cent. (a) How much will you pay for the bond?
(b) If you
purchase the bond for Rs.904.98, what interest rate will you earn from this inve
stment?
Case Study: (20 Marks)
Deepak Hand tools Private Limited
DHPL is a small sized firm manufacturing hand tools. It manufacturing plan is si
tuated in
Haryana. The companyâ s sales in the year ending on 31st March 2007 were Rs.1000
million (Rs.100 crore) on an asset base of Rs.650 million. The net profit of the
company
was Rs.76 million. The management of the company wants to improve profitability
further. The required rate of return of the company is 14 percent.
The company is currently considering an investment proposal. One is to expand it
s
manufacturing capacity. The estimated cost of the new equipment is Rs.250 millio
n. It is
expected to have an economic life of 10 years. The accountant forecasts that net
cash
inflows would be Rs.45 million per annum for the first three years, Rs.68 millio
n per
annum from year four to year eight and for the remaining two years Rs.30million
per
annum. The plant can be sold for Rs.55 million at the end of its economic life.
The company would need to raise debt to the extent of Rs.200 million. The compan
y has
the following options of borrowing Rs.200 million:
a. The company can borrow funds from a nationalized bank at the interest rate of
14 percent for 10 years. It will be required to pay equal annual installment of
interest and
repayment of principal.
b. A financial institution has offered to lend money to DHPL at 13.5 per annum b
ut it
needs to pay equated quarterly installment of interest and repayment of principa
l.
Questions:
1. Should the company expand its capacity? Show the computation of NPV
2. What is the annual installment of bank loan?
3. Calculate the quarterly installments of the Financial Institution loan
4. Should the company borrow from the bank or from the financial institution?
1. A. What is the cost of retained earnings? (3 Marks)
B. A company issues new debentures of Rs.2 million, at par; the net proceeds bei
ng
Rs.1.8 million. It has a 13.5 per cent rate of interest and 7 years maturity. Th
e
companyâ s tax rate is 52 per cent. What is the cost of debenture issue? What will
be the
cost in 4 years if the market value of debentures at that time is Rs.2.2 million
? (7 Marks)
2. Volga is a large manufacturing company in the private sector. In 2007 the com
pany had
a gross sale of Rs.980.2 crore. The other financial data for the company are giv
en
below: (10 Marks)
Items Rs. In crore
Net worth 152.31
Borrowing 165.47
EBIT 43.17
Interest 34.39
Fixed cost (excluding interest) 118.23
You are required to calculate:
a. Debt equity ratio
b. Operating leverage
c. Financial leverage
d. Combined leverage. Interpret your results and comment on the Volgaâ s debt polic
y
3. Explain Miller and Modigliani Approach to capital structure theory.
4. How to estimate cash flows? What are the components of incremental cash flows
?
5. What are the steps involved in capital rationing?
6. Equipment A has a cost of Rs.75,000 and net cash flow of Rs.20000 per year fo
r six
years. A substitute equipment B would cost Rs.50,000 and generate net cash flow
of
Rs.14,000 per year for six years. The required rate of return of both equipments
is 11 per
cent. Calculate the IRR and NPV for the equipments. Which equipment should be
accepted and why?