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SFM Super 100 Part 1 Questions

1) The merger is acceptable to company X if the probability of the merger being beneficial is more than 70%. 2) The merger is not acceptable to company Y shareholders at a combined P/E of 8 based on the calculations. 3) If the swap ratio is 2:1 and P/E is 8, the price of the combined entity would be Rs. 22 and shareholders of company Y would make a loss.

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0% found this document useful (0 votes)
127 views26 pages

SFM Super 100 Part 1 Questions

1) The merger is acceptable to company X if the probability of the merger being beneficial is more than 70%. 2) The merger is not acceptable to company Y shareholders at a combined P/E of 8 based on the calculations. 3) If the swap ratio is 2:1 and P/E is 8, the price of the combined entity would be Rs. 22 and shareholders of company Y would make a loss.

Uploaded by

anand kachwa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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CA FINAL

STRATEGIC FINANCIAL
MANAGEMENT

SUPER 100 PART 1


Questions

-Sanjay Saraf Sir

Powered by -
SFM SUPER 100 PART 1

Question 1.

The following information is available for company X and Y:


Company X Y
Profit after tax Rs.120 crore Rs.45 crore
Number of outstanding shares 35 crore 10 crore
Market price per share Rs.22 Rs.35
Company X is planning to acquire company Y. The acquisition is expected to be done
through swap of stocks in which 2 shares of company X will be given for every share
of company Y.
The management of X makes a projection that the combined entity will have an
expected P/E ratio of 8 with a standard deviation of 2. The shareholders of company
X will accept the merger if the probability of the merger being beneficial is more than
70%.
You are required to
a. State whether the merger is acceptable to X.
b. State whether the merger is acceptable to Y at a combined P/E of 8. Show all the
necessary calculations.
c. Price of the combined entity if the swap ratio is 2:1 and P/E is 8. Also calculate the
gain or loss to the shareholders of company Y.

Sanjay Saraf Sir

1
SFM SUPER 100 PART 1

Question 2.

The following are the details regarding the borrowing requirements of two
companies:
Company Requirement Rate offered
Fixed Floating
A Fixed rate dollars 9% PLR + 3%
B Floating rate dollars 10% PLR + 5%
Both companies need an amount of $ 10 million for a period of 4 years. The interest
rates on the floating rate loans are reset annually. The current PLR for various
maturities is as follows:
Maturity (Years) PLR (%)
1 5.0
2 5.5
3 6.5
4 7.0
Company B bought an interest rate cap at 11.25%.
You are required to
a. Show how the two companies can reduce their borrowing costs by doing a swap.
Assume that they share the total gain from the swap in the ratio of 1:1.
b. Calculate the cost of dollar funds to the companies assuming that the
expectations theory holds good.

Sanjay Saraf Sir

2
SFM SUPER 100 PART 1

Question 3.

The income statement of Ramkish Industries Ltd. for the year ending March 31, 2001
is as follows:
(Rs.Crore)
Sales 500
Gross margin (25%) 125
Selling, general administration & Financing expenses (15%) 75
Profit before tax (10%) 50
Income tax (30% of PBT) 15
Net profit 35
The abridged balanced sheet of the company as on March 31, 2001 is as follows:
(Rs. crore)
Liabilities Assets
Equity 250 Fixed Assets 175
Current Assets 175
250 250
The analyst of the company made the following projections regarding the company in
the near future:
 The sales will remain constant at Rs.500 crore.
 The gross profit margin and selling and general expenses as a percentage of sales
remain constant at 25% and 15% respectively. Similarly profit before tax will
remain at 10% of sales and the income tax rate will continue at 30%.
 Depreciation charge will be equal to the new investments made by the company.
 The asset turnover ratios will remain constant.
The company is evaluating a new marketing strategy. If the strategy is adopted, the
sales of the company are expected to increase by 10% every year for the next five
years and then remain constant. The margins, the turnover ratios, the capital
structure, and the discount rate (presently at 20%) are expected to remain the same.
You are required to determine the value that can be expected to be generated by the
new strategy and recommend whether the strategy should be adopted.
Sanjay Saraf Sir

3
SFM SUPER 100 PART 1

Question 4.

Quantum Jump Ltd. is planning to acquire Unique Products Ltd. in order to expand its
installed capacity. The company will then be in a position to cater to increasing
demand for its products and services. The projected equity related cash flows of M/s.
Quantum Jump Ltd. before and after merger is given below:
(Rs. in mn)
Year 1 2 3 4 5
Projected Cash flow before Acquisition 15.6 17.2 18.8 22.6 24.9
Projected Cash flow after Acquisition 20.3 24.4 29.6 35.9 42.8
The cash flows are expected to grow at a rate of 6% beyond year 5 if M/s. Unique
Product is not acquired and at the rate of 8% if the acquisition takes place. The other
relevant data relating to the two companies is given below:
Company Quantum Jump Ltd. Unique Products Ltd.
No. of outstanding shares (mn) 20 10
Market Price (Rs.) 30.00 25.00
Book Value (Rs.) 28.00 21.00
The cost of equity is 17%.
You are required to find out
a. The maximum exchange ratio that the management of Quantum Jump Ltd. can
offer to the shareholders of Unique Products Ltd. so that the present value of its
equity related cash flows is at least 20% more than existing level.
b. Whether the exchange ratio offered by Quantum Jump as calculated in sub part
(a) above will be acceptable to the shareholders of Unique Products Ltd. if their
present value of premerger cash flows is Rs.125 millions?

Sanjay Saraf Sir

4
SFM SUPER 100 PART 1

Question 5.

SRT Ltd., a market leader in automobile industry, is planning to diversify into other
businesses that have recently been opened up by the GOI for private sector. In the
meanwhile, the CEO of the company wants to get his company valued by a merchant
banker, as he is not satisfied with the current market price of his scrip.
He approached a merchant banker with a request to take up valuation of his
company with the following data for the year ended 2000:
Share Price Rs. 66 per share
Outstanding debt 1934 crore
Number of outstanding shares 75 crore
Net income 17.2 crore
EBIT 245 crore
Interest expenses 218.125 crore
Capital expenditure 234.4 crore
Depreciation 234.4 crore
Working capital 44 crore
Growth rate 8% (from 2001 to 2005)
Growth rate 6% (beyond 2005)
Free cash flow 240.336 crore (year 2005 onwards)
The capital expenditure is expected to be equally offset by depreciation in future and
the debt is expected to decline by 30% by 2005.
Required:
Estimate the value of the company and ascertain whether the ruling market price is
undervalued as felt by the CEO based on the foregoing data. Assume that the cost of
equity is 16%, and 30% of debt repayment is made in the year 2005.

Sanjay Saraf Sir

5
SFM SUPER 100 PART 1

Question 6.

CDE Ltd. (a soft drink manufacturer) is considering the acquisition of RZB Ltd. (a
bottling company) having its operations in four metros of India in a stock-for-stock
transaction in which RZB would receive Rs. 85.50 for each share of its common stock.
CDE Ltd. does not anticipate any change in its P/E multiple after the merger and opt
to value the target company (RZB Ltd.) conservatively by assuming no earnings
growth due to synergy. The following information is available regarding both the
companies:
CDE Ltd. RZB Ltd.
Earnings available for common stock 20.5 lakh 15.65 lakh
Number of shares of common outstanding 1,20,000 25,000
MPS (Market price per share) Rs. 65.50 Rs. 75.30
You are required to work out:
a. Purchase price premium
b. Exchange ratio
c. Postmerger EPS of the united companies
d. Postmerger share price
e. Post merger equity ownership distribution.

Sanjay Saraf Sir

6
SFM SUPER 100 PART 1

Question 7.

Vex Ltd. is considering buying Sita Ltd. The target company (Sita Ltd.) is a small
pharmaceutical company that develops molecules that are licensed to branded
pharmaceutical companies in India. Development costs are expected to generate
negative cash flows during the initial two years of the forecast period @ 7.5 lakh and
4 lakh, respectively. Income by way of licensing fees is likely to generate positive cash
flows during year 3-5 of the forecast period @ 6 lakh, 8 lakh and 10 lakh, respectively.
Due to the emergence of competitive products, cash flow is expected to grow @ 4%
annually after the 5th year. The discount rate for the first five years is estimated to
be 15% and then to drop to 10% beyond the 5th year. In addition, the present value
of the estimated synergy is Rs.18 lakh.
You are required to calculate the minimum and maximum purchase prices for Target
Company.

Sanjay Saraf Sir

7
SFM SUPER 100 PART 1

Question 8.

Consider the following information of M/s Lakadawala & Co. as a Target Company.
Short-term assets 30 lakh
Long-term assets 120 lakh
Short-term liabilities 20 lakh
Long-term liabilities 45 lakh
Goodwill (included in the total assets) 20 lakh
No. of Shares outstanding 5.10 lakh
M/s Daruwalla & Co (another Target Company), which belongs to the same industry
as Lakadawala & Co and having approximately the same size, customer strength, and
profitability was recently sold at a price that equated to four times its BPS.
Required:
Estimate the implied market value of M/s. Lakadawala & Co. using Book Value Per
Share (BPS) as a measure of value.

Sanjay Saraf Sir

8
SFM SUPER 100 PART 1

Question 9.

Star Ltd. is a firm operating in the textile industry. It is planning to takeover Mercury
Ltd., another company operating in the same industry. The summarized balance
sheet of Mercury Ltd. as on December 31, 2001 is as follows:
Liabilities Amount (Rs) Assets Amount (Rs)
Equity Share Capital 10,00,000 Land and Buildings 9,00,000
(50,000 shares @ Rs.20)
Retained Earnings 2,75,000 Plant and Machinery 5,60,000
11% Debentures 4,00,000 Cash 75,000
Current Liabilities 1,25,000 Debtors 1,00,000
Inventories 1,65,000
18,00,000 18,00,000
The following additional information is also available:
Star Ltd is required to discharge the debentures at a premium of 10%, takeover the
liability in respect of sundry creditors and pay Rs.11 in cash and issue one share of
Rs.10 in Star Ltd. (at the current market price of Rs.12) in exchange for one share of
Mercury Ltd.
Star Ltd. is also expected to shell out Rs.2,00,000 for goodwill. Dissolution expenses,
amounting to Rs.50,000, was agreed to be shared by both the target and the acquirer
in the ratio of 1:1.
Inventories are expected to realize Rs 2,00,000 and the expected collection from
debtors is Rs.1,00,000.
It is expected that the cash inflows after taxes accruing to the merged firm would be
@ Rs.2,50,000/year for six years. The market value of land and buildings and plant
and machinery would be Rs.10 lakhs and Rs.4,00,000 respectively, at the end of the
6th year.
The cost of capital of Mercury Ltd is 12%.
Required:
a. Estimate the cost of acquisition for Star Ltd. on payment basis.
b. If you were the financial advisor of the company, would you recommend
acquisition of Mercury Ltd. Substantiate your recommendations.
Sanjay Saraf Sir

9
SFM SUPER 100 PART 1

Question 10.

Alpha Inc. and Beta Inc are two firms manufacturing gearboxes for two wheelers. The
two firms are contemplating a merger. Alpha Inc. intends to issue just enough
number of shares to ensure that the earnings per share of the merged firm is Rs.3.5.
Required:
a. Complete the table given below:
Alpha Inc. Beta Inc. Merged firm
Earnings per share Rs.2.5 Rs.4 Rs.3.5
Price per share Rs.40 Rs.36 ?
Price-earnings ratio ? ? ?
Total earnings Rs.4,50,000 Rs.5,25,000 ?
Total market value Rs.40,00,000 Rs.45,00,000 ?
b. Determine the rate of exchange of the shares
c. Estimate the cost incurred by Alpha Inc. if, as a result of the merger, the synergy is
Rs.28,00,000

Sanjay Saraf Sir

10
SFM SUPER 100 PART 1

Question 11.

Atlantic Pharmaceutical Ltd. has hired a financial consultant to value the company.
The Pharma industry has been very stable for quiet some time and the firms that
operate in the industry are similar in size and have similar product/market mix
characteristics.
A study of similar sized companies that are comparable to Atlantic reveal the
following data
(Rs in lakhs)
Aqua Indigo Pacific Atlantic
Market Value 250 200 230 ?
Book value 200 200 150 200
Replacement Value 300 275 250 250
Revenues 250 260 300 275
Net income 18 16 14 15
Required:
Using the comparable company approach, value the equity of Atlantic Inc.

Sanjay Saraf Sir

11
SFM SUPER 100 PART 1

Question 12.

The following are the details on two potential merger candidates, Blue and Green in
2001:
Particulars Blue Green
Revenues Rs.4,400.00 Rs.3,125.00
Cost of Goods Sold (without Depreciation) 87.50% of Revenue 89.00% of Revenue
Depreciation Rs.200.00 Rs.74.00
Tax Rate 35.00% 35.00%
Working Capital 10% of Revenue 10% of Revenue
Market Value of Equity Rs.2,000.00 Rs.1,300.00
Outstanding Debt Rs.160.00 Rs.250.00
Both firms are in a steady state and are expected to grow at 5% a year in the long-
term. Capital spending is expected to be offset by depreciation. The beta for both the
firms is 1, and both firms are rated BBB, with an interest rate on their debt of 8.5%.
(The Treasury bond rate is 7 % and the risk premium is 5.5 %.)
As a result of the merger, the combined firm is expected to have a cost of goods sold
of only 86% of total revenues. The combined firm does not plan to borrow additional
debt.
Required:
a. Estimate the value of Green, operating independently.
b. Estimate the value of Blue, operating independently.
c. Estimate the value of the combined firm, with no synergy.
d. Estimate the value of the combined firm, with synergy.
e. Estimate the worth of the operating synergy.

Sanjay Saraf Sir

12
SFM SUPER 100 PART 1

Question 13.

The total value (equity + debt) of two companies, X Ltd. and Y Ltd. are expected to
fluctuate according to the state of the economy
State of the economy Probability Value of X Value of Y
Rapid growth 0.25 72 115
Slow growth 0.55 52 75
Recession 0.20 38 60
Firm ‘X’ and Firm ‘Y’ currently have a debt of Rs.42 lakhs and Rs.8 lakhs, respectively.
If the two companies were to merge, assuming that there would be no operational
synergy as a result of the merger, calculate the expected value of debt and equity of
the merged company.
Also explain the reasons for any difference that exists from the expected values of
debt and equity, if they do not change.

Sanjay Saraf Sir

13
SFM SUPER 100 PART 1

Question 14.

Venus Ltd. has an issued capital of 1,00,000 Rs.10 ordinary shares. Net assets
(excluding goodwill) are Rs.12,50,000 and annual earnings average Rs.7,50,000. The
company is valued by the stock market at a P/E ratio of 4. Another company Mercury
Ltd. has an issued capital of 50,000 ordinary shares. Net assets (excluding goodwill)
are Rs.17,50,000 and annual earnings average Rs.2,00,000. The shareholders of
Mercury Ltd. accept an all equity offer from Venus Ltd. valuing each share in Mercury
Ltd. at Rs.20.
You are required to estimate:
a. Earnings and assets per share of Venus before the acquisition of Mercury Ltd.
b. Earnings and assets per share of Venus after the acquisition of Mercury Ltd.
c. Increase or decrease in the EPS and APS for Mercury Ltd due to the merger.

Sanjay Saraf Sir

14
SFM SUPER 100 PART 1

Question 15.

Escorts Multimedia Ltd. is considering the acquisition of Prudential Advertising Ltd. in


a stock-for-stock transaction in which Prudential Advertising Ltd. would receive
Rs.84.30 for each share of its common stock. The Escorts Multimedia Ltd. does not
expect any change in its P/E multiple after the merger and chooses to value the
Prudential Advertising Ltd. conservatively by assuming no earnings growth due to
synergy.
You are provided with the following information:
Particulars Escorts Prudential
Multimedia Ltd. Advertising Ltd.
Earnings available for common stock (Rs.) 2,81,500 62,500
Outstanding shares (Nos.) 1,12,000 18,750
Market price per share (Rs.) 56.25 62.50
You are required to
a. Calculate
i. Post-merger share price
ii. Post-merger equity ownership distribution
iii. Purchase price premium.
b. Comment on the decision taken by the Escorts Multimedia Inc.

Sanjay Saraf Sir

15
SFM SUPER 100 PART 1

Question 16.

Harrison Corporation plans to acquire Erricson Corporation. The following


information is available
Particulars Harrison Corporation Erricson Corporation
Total current earnings, E Rs.50 million Rs.20 million
Number of outstanding shares, S 20 million 10 million
Market price per share, P Rs.30 Rs.20
a. What is the maximum exchange ratio (ER1) acceptable to the shareholders of
Harrison Corporation if the P/E ratio of the combined entity is 12 and there is no
synergy gain?
b. What is the minimum exchange ratio acceptable (ER2) to the shareholders of
Erricson Corporation if the P/E ratio of the combined entity is 11 and there is a
synergy benefit of 5%.
c. Assuming that there is no synergy gain, at what level of P/E multiple will the lines
ER1 and ER2 intersect?

Sanjay Saraf Sir

16
SFM SUPER 100 PART 1

Question 17.

Est Corporation is considering a merger with the Reebock Company. Reebock is a


publicly traded company, and its current beta is 1.10. Reebock has barely been
profitable, so it has paid only 20% in taxes over the last several years. Additionally,
Reebock uses little debt, having a market value debt ratio of just 25%. If the
acquisition is made, Est plans to operate Reebock as a separate, wholly owned
subsidiary. Est would pay taxes on a consolidated basis, and thus the tax rate would
increase to 40%. Additionally, Est would increase the debt capitalization in the
Reebock subsidiary to a market value of 40% of assets. Est's acquisition department
estimates that Reebock, if acquired, would generate the following net cash flows to
Est's shareholders:
Year Net Cash Flow
1 Rs.12,00,000
2 Rs.14,00,000
3 Rs.16,50,000
4 Rs.18,00,000
5 and beyond Constant growth @ 5%
These cash flows include all acquisition effects. The current risk-free rate is 5.6% and
the expected return on the market is 12%.
a. What rate should be used to discount the given cash flows?
b. What is the rupee value of Reebock to Est?
c. Reebock has 12,00,000 common shares outstanding. What is the maximum price
per share that Est should offer to Reebock? If the tender offer is accepted at this
price, what would happen to Est's stock price?

Sanjay Saraf Sir

17
SFM SUPER 100 PART 1

Question 18.

Gillete Financial Services Ltd., is planning to acquire Ebit Chartered Services Ltd. in
order to expand its market share so that Gillete Financial Services Ltd., will there be
in a position to cater to growing demand for its products and services. The forecasted
equity related cash flows of Gillete Financial Services Ltd., before and after merger is
given below:
(Rs.in lakhs)
Year 1 2 3 4 5
Projected cash flow before acquisition 22.6 23.4 23.9 24.6 25.2
Projected cash flow after acquisition 23.1 24.0 24.8 25.3 26.2
The cash flows are expected to grow @ 7% beyond year 5 if Elbit Chartered Services
Ltd. is not acquired and @ 9% if acquisition takes place. The other relevant data
pertaining to the above companies is given below:
Company Gillete Financial Elbit Chartered
Services Ltd. Services Ltd.
Number of outstanding shares 18,00,000 7,00,000
Market price (Rs.) 26.00 19.00
Book value (Rs.) 23.50 17.50
The cost of equity is 16%.
You are required to find out
a. The maximum exchange ratio that the management of Gillete Financial Services
Ltd., can offer to the shareholder of Elbit Chartered Services Ltd., so that the
present value of its equity related cash flows is atleast 17% higher than the
existing level.
b. Whether the exchange ratio offered by Gillete Financial Services Ltd, as calculated
in sub-part (a) above will be acceptable to the shareholders of Elbit Chartered
Services Ltd, if the present value of pre-merger cash flows is Rs.105 lakhs.

Sanjay Saraf Sir

18
SFM SUPER 100 PART 1

Question 19.

As a financial analyst you have been asked by the management of Leased Circuits
Ltd., which produces and sells computer software to estimate the value of their firm.
The Leased Circuits had revenues of Rs.20 lakhs for the financial year ending 2003, on
which it made earnings before interest and taxes of Rs.2 lakhs. The firm had debt
outstanding of Rs.10 lakhs, on which pre-tax interest expenses amounted to Rs.1
lakh. The book value of equity is Rs.10 lakhs. The average beta of publicly traded
firms that are in the same business is 1.30 and the average debt-equity ratio is 0.2
(based upon the market value of equity). The market value of equity of these firms is,
on average, three times the book value of equity. All firms in this industry are in 35%
tax bracket. Capital expenditures amounted to Rs.1 lakh during the financial year
ended 2003, and is twice the depreciation charge in that year. Both items are
expected to grow at the same rate as revenues for the next five years, and to offset
each other in steady state.
The revenues of Leased Circuits Ltd., are expected to grow @ 20% a year for the next
five years, and @ 5.0% after that. Net income is expected to increase @25% a year
for the next five years, and @ 5% p.a. after that. The 365 T-bill rate is 5.5% p.a. return
on market is 11%.
You are required to estimate the following for leased circuits Ltd.
a. The cost of equity
b. The cost of capital
c. The value of the management's stake using
i. The firm approach and
ii. The equity approach.

Sanjay Saraf Sir

19
SFM SUPER 100 PART 1

Question 20.

Sunil Bansal, a computer engineer in Stockholm decides to remit 1 million of Swedish


kroners by SWIFT to his father Ajay Bansal on June 30, 2003 to purchase a flat in
Kolkatta. A foreign bank in Kolkatta offered a rate of Rs.5.90 / Skr to Ajay Bansal.
However Ajay Bansal requested his banker (a private sector bank) to get a better
rate. The branch manager contacted his dealings office at Mumbai for the rate. The
dealer in Mumbai has the option to cover the transaction through Bahrain or
Singapore. The spot exchange rates at Mumbai, Bahrain and Singapore markets on
June 30, 2003 are given below.

Mumbai : Rs / US $ : 47.20 / 22
Rs / £ : 75.95 / 97
Bahrain : Skr / £ : 12.7532 / 39
Singapore : Skr / $ : 7.9652 / 62

You are required to determine, which market the dealer should opt to cover the
position. Assume that an exchange margin of 0.005 paise is to be loaded in the rate.
Calculate the gain or loss to the customer if he relies on the rate quoted by his
banker. Show your working nearest to the rupee.

Sanjay Saraf Sir

20
SFM SUPER 100 PART 1

Question 21.

Mr. Robinson, an Australian investor is very much interested in investing Rs.1 million
in the pharmaceutical sector in India. He decides to invest in the scrip of Morepen
Labs Ltd. which is listed on BSE and the details of scrip are given below
Beta of the security : 1.65
Variance of returns : 25(%)2
Appreciation of Australian dollar against rupees is 3% with a variance of 10(%)2.
Return on BSE index is 12% annualized and return on long dated Indian Government
securities is 6.5%. Assume that the correlation between the return on the scrip and
Rs / AUS$ exchange rate is zero.
You are required to estimate the expected return and risk of Mr. Robinson, if his
holding period is one year.

Sanjay Saraf Sir

21
SFM SUPER 100 PART 1

Question 22.

A multinational company in Germany has surplus funds of Euro 2 million for three
months. The treasury manager wants to toy with the idea of investing funds in
currencies other than that of the home currency. He has collected the following
information on the exchange rates and interest rates:
$ / Euro spot 1.1410 / 12
3 months forward 20 / 19
£/$ spot 0.6217 / 19
3 months forward 13 / 14
3 months interest rates (pa)
$ : 2.6% / 2.8%
£ : 3.00% / 3.6%
Euro : 3.2% / 3.4%
You are required to determine, in which market the MNC should invest to have more
returns, without exposing the investment to exchange risk.

Sanjay Saraf Sir

22
SFM SUPER 100 PART 1

Question 23.

You are given the following information by your banker:


Exchange rates
Rs./Euro Spot 42.38/42
Rs./$ 1 month forward 48.66/86
Euro/$ 1 month forward 1.1485/95
Interest rates
Rs.(%) Euro (%)
1 month 8 – 9 p.a. 3 – 3.36 p.a.

i. You are required to determine the boundaries for 1 month forward Rs./Euro to
prevent any possibility of covered interest arbitrage.
ii. If the one month forward Rs./Euro rate is 42.24/28, then verify whether there is
any scope for triangular currency arbitrage in the forward rates. Also show how
arbitrage profit can be made.

Sanjay Saraf Sir

23
SFM SUPER 100 PART 1

Question 24.

An Indian Company based at Mumbai needs short term funds of Rs.50 million for a
period of 3 months. The company collected the following information from its
banker:
Rs./$ Rs./£
Spot 48.50/55 74.05/10
3 months forward 45/50 85/90
3 months Interest rates (p.a.)
Rs : 9%
$ : 4%
£ : 6%
You are required to calculate the annualized effective cost of borrowing,
a. If the company borrows in USD and
i. Covers the exchange rate risk through forward market
ii. Keeps the position open and spot rate after 3 months turns out to be Rs/$
48.90/95.
b. If the company borrows in pounds and
i. Covers the exchange rate risk through forward market
ii. Keeps the position open and spot rate after 3 months turns out to be Rs/£
74.75/80.

Sanjay Saraf Sir

24
SFM SUPER 100 PART 1

Question 25.

A Foreign Institutional Investor from U.K. proposes to invest £ 1 million in an


emerging market. After a careful analysis of future prospects, India and Hong Kong
are short listed. For the next year, which is also the holding period for the FII,
expected rates of returns are 15% and 12% in Indian and Hong Kong markets
respectively. Withholding tax rates applicable on the returns earned are 15% in India
and 12% in Hong Kong. Other information available with the FII includes:
Current exchange rates
Rs./£ 69.50/70
HK $/£ 11.15/18
Expected inflation for the next year
U.K. – 2%
India – 4%
Hongkong – 3%
You are required to find out the rate of return in India and Hong Kong in £ terms.
Assume purchasing power parity holds good in both the countries.

Sanjay Saraf Sir

25

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