TRIBHUVAN UNIVERSITY Full Marks: 100

FACULTY OF MANAGEMENT Pass Marks: 50

Office of the Dean Time: 4 Hrs 
Model Question 2020
MBS / Second Semester / FIN 510: Financial Management
Candidates are required to answer all the questions in their own words as far as practicable.
Figures in brackets indicate full marks.

Group "A"
Case Analysis

1. Carefully read the following case and analytically answer the questions given below: [30]
Mohan Sharma was brought in as assistant to Himalaya Company’s Chairman, who had the task of
getting the company back into a sound financial position. Company’s 2018 and 2019 balance sheets and
income statements, together with projections for 2020, are shown in the following tables. Also the tables
show the 2018 and 2019 financial ratios, along with industry average data. The 2020 projected financial
statement data represent company’s best guess for 2020 results, assuming that some new financing is
arranged to get the company into sound position.
Balance Sheets of Himalaya Company
Assets 2018 2019 2020
Cash Rs 9,000 Rs 7,282 Rs 14,000
Short-term investments 48,600 20,000 71,632
Accounts receivable 351,200 632,160 878,000
Inventories 715,200 1,287,360 1,716,480
Total current assets Rs 1,124,000 Rs 1,946,802 Rs 2,680,112
Gross fixed assets Rs 491,000 1,202,950 Rs 1,220,000
Accumulated depreciation (146,200) (263,160) (383,160)
Net fixed assets Rs 344,800 Rs 939,790 Rs 836,840
Total assets Rs 1,468,800 Rs 2,886,592 Rs 3,516,952
Liabilities and Equity 2018 2019 2020
Accounts payable Rs 145,600 Rs 324,000 Rs 359,800
Notes payable 200,000 720,000 300,000
Accruals 136,000 284,960 380,000
Total current liabilities Rs 481,600 Rs 1,328,960 Rs 1,039,800
Long-term debt Rs 323,432 Rs 1,000,000 Rs 500,000
Common stock (100,000 shares) 460,000 460,000 1,680,936
Retained earnings 203,768 97,632 296,216
Total equity Rs 663,768 Rs 557,632 Rs 1,977,152
Total Liabilities and equity Rs 1,468,800 Rs 2,886,592 Rs 3,516,952
 Income Statements of Himalaya Company
2018 2019 2020
Sales Rs 3,432,000 Rs 5,834,400 Rs 7,035,600
Less: Cost of goods sold Rs 2,864,000 Rs 4,980,000 Rs 5,800,000
Other expenses 340,000 720,000 612,960
Depreciation 18,900 116,960 120,000
Total operating costs Rs 3,222,900 Rs 5,816,960 Rs 6,532,960
EBIT Rs 209,100 Rs 17,440 Rs 502,640
Less Interest expenses 62,500 176,000 80,000
EBT Rs 146,600 (Rs 158,560) Rs 422,640
Less Taxes (40%) 58,640 (63,424) 169,056
Net income Rs 87,960 (Rs 95,136) Rs 253,584
Other data:
Stock price Rs 8.50 Rs 6.00 Rs 12.17
Shares outstanding 100,000 100,000 250,000
EPS Rs 0.88 (Rs 0.951) Rs 1.014
DPS Rs 0.22 Rs 0.11 Rs 0.22
Tax rate 40% 40% 40%
Book value per share Rs 6.638 Rs 5.576 Rs 7.909
Lease payments Rs 40,000 Rs 40,000 Rs 40,000
Ratio Analysis
Financial Ratios 2018 2019 2020 Industry
Average
Current ratio 2.3 1.5 ---- 2.5
Quick ratio 0.8 0.496 ---- 1.2
Inventory turnover 4.8 4.5 ---- 5.5
Days sales outstanding 37.3 39.6 ---- 40 days
Fixed assets turnover 10.0 6.2 ---- 6.5
Total assets turnover 2.3 2.0 ---- 2.5
Debt ratio 54.8% 80.7% ---- 50.0%
Times interest earned 3.3 0.1 ---- 6.2

Profit margin 2.6% –1.6% ---- 3.6%

Basic earning power 14.2% 0.6% ---- 17.8%
ROA 6.0% –3.3% ---- 9.0%
ROE 13.3% –17.1% ---- 17.9%
Price/earnings (P/E) 9.7 –6.3 ---- 16.2
Price/cash flow 8.0 27.5 ---- 7.6
Market/book 1.3 1.1 ---- 2.9
Mohan examined monthly data for 2019 (not given in the case), and he detected an improving pattern
during the year. Monthly sales were rising, costs were falling, and large losses in the early months had
turned to a small profit by December. Thus, the annual data looked somewhat worse than final monthly
data. Also, it appeared to be taking longer for the advertising program to get the message across, for the
new sales offices to generate sales, and for the new manufacturing facilities to operate efficiently. In
other words, the lags between spending money and deriving benefits were longer than company’s
managers had anticipated. For these reasons, Mohan and the chairman see hope for the company-
provided it can survive in the short run.
Mohan must prepare an analysis of where the company is now, what it must do to regain its financial
health, and what actions should be taken. Your assignment is to help him answer the following questions.
a. Why are ratios useful? What are the five major categories of ratios?
 b. Calculate the 2020 current and quick ratios based on the projected balance sheet and income
statement data. What can you say about the company’s liquidity position in 2018 and 2019, and
as projected for 2020? We often think of ratios being useful (1) to managers to help run business,
(2) to bankers for credit analysis, and (3) to stockholders for stock valuation. Would these
different types of analysts have an equal interest in the liquidity ratios?
c. Calculate the 2020 inventory turnover ratio, days sales outstanding (DSO), fixed assets
turnover, and total assets turnover. How Does Company’s utilization of assets stack up against
that of other firms in its industry?
d. Calculate the 2020 debt ratio and times-interest-earned. How does company compare with
the industry with respect to financial leverage? What can you conclude from these ratios?
e. Calculate the 2020 profit margin, basic earning power, return on assets, and return on equity.
What can you say about these ratios?
f. Calculate the 2020 price/earnings ratio, price/cash flow ratio and market/book ratio. Do these
ratios indicate that investors are expected to have a high or low value of the company?
Group "B"

Long Answer Questions

Answer any THREE questions: [3  15 = 45]

2. Why do you think that value maximization is an appropriate objective of the firm? Does it lead to
maximization of the wealth of shareholders? Does an attempt by the management to maximize value of
the firm benefit the society? Explain.
3. Nowadays, everyone is looking for a quick bite. At present there are many companies offering a variety
of ready to eat snacks. But there have been many reports cautioning us about the unhygienic and
unhealthy constituents in these snacks. The growing demand of snacks among youth and children and
the absence of a healthier alternative, caught your attention. With the vision of providing better and
healthier snacks you launched you own company “Healthy Snacks Pvt. Ltd”. There are two mutually
exclusive business proposals: Project A and Project B. You have to evaluate these proposals and find
the better proposal.
Project A, the proposal of setting up company’s own manufacturing plant involves initial investment of
Rs 25, 00,000. Project B, the proposal of outsourcing the production to another firm, involves an initial
investment of Rs 15,00,000. The market analyst forecasted the following cash flow estimates for two
projects over four years of period.
Cash Flow After Tax
Year
Project A Project B
1 Rs 9,00,000 Rs 7,00,000
2 9,00,000 5,00,000
3 9,00,000 3,50,000
4 9,00,000 400,000
Depreciation, salvage values, net working capital requirements, and tax effects are all included in these
cash flows. Based on the subjective risk assessments, both projects have risk characteristics that require
a return of 10 percent. You must now determine which of the projects should be accepted.
a. What do you mean by the payback period? Calculate the payback period for Project A and B.
According to the payback criterion, which project do you accept? [4]
b. What do you mean by the term net present value (NPV)? Determine the NPV of each project.
According to NPV, which project should be accepted? [6]
c. Define the term internal rate of return (IRR). What is each project’s IRR? According to IRR,
which project should be accepted? Explain. [5]
 4. Consider the probability distribution of alternative rates of return associated with Stock S and Stock T
given in the following table

Rate of Return
State of economy Probability
Stock S Stock T
1 0.3 20% 0%
2 0.4 15 40
3 0.3 10 40
a. Calculate the expected return and standard deviation of Stock S and Stock T.
b. If you form a portfolio of Stock S and Stock T comprising 60 percent wealth in Stock S and the
rest in Stock T, calculate the risk and return of your portfolio. Are you able to diversify the risk
forming the portfolio?
c. Calculate risk minimizing weight of Stock S and Stock T. Compare risk and return of minimum
variance portfolio with risk and return of the portfolio formed in part ‘b’.

5. On January 1, 2018, the total assets of the Shikhar Company were Rs 270 million. The firm’s present
capital structure, which follows, is considered to be optimal. Assume that there is no short-term debt.
Long-term debt Rs 135,000,000
Common equity 135,000,000
Total liabilities and equity Rs 270,000,000
New bonds will have a 10 percent coupon rate and will be sold at par. Common stock,
currently selling at Rs 250 a share, can be sold to net the company Rs 225 a share.
Stockholders’ required rate of return is estimated to be 12 percent, consisting of a dividend
yield of 4 percent and an expected growth rate of 8 percent. Retained earnings are estimated
to be Rs 13.5 million. The marginal tax rate is 40 percent. Assuming that all asset expansion
(gross expenditures for fixed assets plus related working capital) is included in the capital
budget, the rupee amount of the capital budget, ignoring depreciation, is Rs 135 million.
a. To maintain the present capital structure, how much of the capital budget must Shikhar
finance by equity? How much of the new equity funds needed must be generated
internally? Externally?
b. Calculate the cost of each of the equity components.
c. Calculate the WACC (1) below and (2) above the break in the MCC schedule. [4+5+6]

Group "C"

Short Answer Questions

Answer any FIVE questions: [5  5 = 25]

6. What are the financing policies of current assets? How long-term and short-term funds are used under
aggressive financing policy?
7. How do you measure business risk and financial risk? Explain.
8. Describe the concept of behavioural finance.
9. Himalayan Export Limited issued a 15-year, 10% annual coupon bond 5- years ago. Market interest rate
since the bond issued had been increased significantly. Today, the market interest rate on similar risk
class bond is 12%. What is the bond’s current price? How does market interest rate affect the value of a
bond?
10. Himalaya Herbal Company’s common stock just paid a dividend of Rs 60 a share. The dividend is
expected to grow at constant rate 6 per year for ever. Investors’ required rate of return is 15 percent. Also
calculate dividend yield and capital gain yield for the first year.
11. Mega Printing Company has the following shareholders' equity account:
Common stock (100,000 shares @ Rs 100) Rs 10,000,000
Additional paid-in capital 5,000,000
Retained earnings 15,000,000
Shareholders' equity Rs 30,000,000
The current market price of the stock is Rs 300 per share.
a. What will happen to this account and to number of shares outstanding if company declares a 20
percent stock dividend?
b. In the absence of an informational or signaling effect, what would be new selling price of
common stock after the 20 percent stock dividend?