PGDM (2017-19) Term – II

END - TERM EXAMINATION

CORPORATE FINANCE
Time: 2 hours Maximum Marks: 40 Weightage: 40%

Full Name of the Student:

Roll No.: Section:

Signature of the Invigilator

INSTRUCTIONS:
1. It’s a Question-cum-Answer Sheet.
2. Answer all questions in the limited space provided.
3. No additional sheets will be provided.
4. Use of a Scientific Calculator only is allowed.

PART A
Either tick mark or round up the correct answer number a, b, c, or d. (10 x 1 = 10 marks)

Answer all the questions.

1) Which of the following is concerned with the relationship between the firm’s EBIT and EPS?

(a) Beta
(b) Operating leverage
(c) Sales revenue
(d) Financial leverage

2) All the following elements are necessary for the computation of the cost of equity shares under
the Gordon’s growth model, except

(a) tax rate

(b) growth rate in dividends or earnings
(c) market price
(d) dividend
3) Beta of Treasury bills is:
(a) +1.0
(b) +0.5
(c) -1.0
(d) 0

𝐷1
4) The constant dividend growth formula 𝑃0 = assumes:
𝑟−𝑔
I) the dividends are growing at a constant rate g forever.
II) r > g
III) g is never negative.
(a) I only
(b) II only
(c) I and II only
(d) III only

5) Which of the following is correct? The cost of capital is

(a) the minimum return that a capital budgeting project must earn for it to be accepted.
(b) the maximum return a project can earn.
(c) the return that a previous project for the firm had earned.
(d) none of the above.

6) Which one of the following statements about bond prices is NOT true?
(a) To compute a bond’s price, one needs to calculate the present value of the bond’s
expected cash flows.
(b) The value, or price, of any asset is the future value of its cash flows.
(c) The required rate of return, or discount rate, for a bond is the market interest rate
called the bond’s yield to maturity
(d) Estimate the expected future cash flows using the coupons that the bond will pay and
the maturity value to be received.

7) Which of the following is correct? If a bond’s coupon rate is equal to the market rate, then the
bond will sell
(a) at a price equal to its face value.
(b) at a price greater than its face value.
(c) at a price less than its face value.
(d) None of the above are true.

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8) Which of the following is correct? To accept a capital project when using NPV,
(a) the project NPV should be less than zero.
(b) the project NPV should be greater than zero.
(c) both a and b.
(d) none of the above.

9) Which of the following is correct? The internal rate of return is

(a) the discount rate that makes the NPV greater than zero.
(b) the discount rate that makes the NPV equal to zero.
(c) the discount rate that makes the NPV less than zero.
(d) both a and c.

10) You, in analyzing a stock, find that its value exceeds its current market price. This suggests
that you think
(a) the stock should be sold
(b) the stock is a good buy
(c) dividends are not likely to be declared
(d) management is probably not trying to maximize the price per share

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 PART B

1) For which kind of firms would you use Dividend Growth Model to find its value? (1 mark)

2) Between bonds and stocks, which one would you prefer to invest in and why? (2 marks)

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3) What are the key features or characteristics of Capital Budgeting decisions? (2 marks)

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 PART C

1) Smaran Jewelers expects to pay dividends (per share) of Rs. 0.60, Rs. 0.90, Rs. 2.40, and
Rs. 3.50 during the next four years. Beginning in the fifth year, the dividend is expected to
grow at a rate of 4 percent, and at the end of ninth year at a rate of 7 percent indefinitely. If
investors require a 20 percent return to purchase Smaran’s stock, what is the current value
of the company’s stock? (4 marks)

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2) Kevin Rogers is interested in buying a five-year bond that pays a coupon interest rate of
10 per cent per annum. The coupon interest is paid every six months. The current market
rate for similar bonds is 8.8 per cent per annum. What should be the current price of this
bond? (3 marks)

3) Shana Norrita wants to buy five-year zero coupon bonds with a face value if Rs1000. Her
opportunity cost is 8.5 per cent. Assuming annual compounding, what would be the
current market price of these bonds? (1 mark)

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4) Your company is considering a project whose cash flows are as follows:

Year Cash Flow (Rs.)

0 -1000,000
1 100,000
2 200,000
3 300,000
4 600,000
5 300,000

The cost of capital is 20 percent

Calculate:
a) Payback period
b) Net Present Value
c) Internal Rate of Return (1+2+4 = 7 marks)

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 5) The Gamma Products Corporation has the following capital structure, which it considers
optimal:

Bonds, 7% (now selling at par) Rs. 300,000

Preferred stock, $5.00 240,000
Common stock 360,000
Retained Earnings Rs.1,200,00

Dividends on common stock are currently Rs. 3 per share and are expected to grow at a
constant rate of 6 percent. Market price of common stock is Rs. 40, and the preferred stock
is selling at Rs. 50. Floatation cost on new issues of common stock is 10 percent. The
interest on bonds is paid annually. The company’s tax rate is 40 percent.

Calculate:
(a) the cost of bonds;
(b) the cost of preferred stock;
(c) the cost of retained earnings (or internal equity);
(d) the cost of new common stock (or external equity); and
(e) the weighted average cost of capital. [6 marks]

OR

Modern Limited has the following book value capital structure:

Equity capital (25 million shares, Rs.10 par) Rs.250 million

Preference capital, 10 percent (800,000 shares, Rs.100 par) Rs. 80 million
Retained earnings Rs. 50 million
Debentures 14 percent (2,000,000 debentures, Rs.100 par) Rs.200 million
Term loans, 14 percent Rs. 220 million Rs.800 million

The next expected dividend per share is Rs.3.00. The dividend per share is expected to grow at
the rate of 10 percent. The market price per share is Rs.260. Preference stock, redeemable after 8
years, is currently selling for Rs.90 per share. Debentures, redeemable after 5 years, are selling
for Rs.105 per debenture. The tax rate for the company is 34 percent.
Calculate the weighted cost of capital using market value proportions (6 marks)

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 6) Spark Limited is considering three financing plans. The key information is as follows:
 Total funds to be raised, Rs. 200,000
 Financing plans:

Plans Equity (%) Debt (%) Preference (%)

A 100 - -
B 50 50 -
C 50 - 50

 Cost of debt 8 percent; cost of preference shares 8 percent.

 Tax rate, 35 percent.
 Equity shares of the face value of Rs. 10 each will be issued at a premium of
 Rs. 10 per share
 Expected EBIT, Rs. 80,000.

Determine for each plan:

(i) Earnings per share (EPS)
(ii) Financial BEP, and
(iii) Indicate which plan is the best and why.
(iv) Draw EBIT-EPS chart. [4 marks]

OR

TOR most recently sold 100,000 units at Rs7.50 each; its variable operating costs are Rs3.00 per unit,
and its fixed operating costs are Rs250,000. Annual interest charges total Rs80,000, and the firm has
8,000 shares preference shares outstanding which pay Rs5 as annual dividend. It currently has 20,000
shares of equity shares outstanding. Assume that the firm has a 40% tax rate.
a) Using the current Rs750,000 level of sales as a base, calculate the firm’s degree of operating
leverage (DOL).
b) Using the EBIT associated with the Rs750,000 level of sales as a base, calculate the firm’s
degree of financial leverage (DFL). (2+2=4 marks)

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 Space for Rough Work

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