QUESTION NO.

1 -:

19 1998 19 19
99 97 96
Dividend per share ` 1.5 ` 1.2
1.6 8 1.42 6
2
Payout rate (DPS/EPS) 53.8% 65.8 39.3 39.
% % 4%
Earnings per share ` 2.4 3.61 3.2
EAT/No. of shares 3.0 0
1
Book Value per share ` 17.6 17.9 15.
19.1 8 1 65
8
Rate of Return on Enquiy 15.9% 13.6 20.3 20.
% % 4%
Effective Tax rate 67% 5 61 39
0 % %
%
Rate of Return on Assets 13.2% 14.9 17.2 18.
% % 1%
Profit Margin (EBIT 7.7% 8.3 9.9 10.
Sales) % % 3%

Analyze above ratios.

Q
QUESTION NO. 2 -:

Following are data for Anand Products (Rs in lakhs)

1998 1998
Assets 4000 Revenues 9600
Short term Liabilities 250 Operating Exp. 2950
EBIT 850
8% Debenture 1750 Interest 250
10% Bonds 300 EBT 700
Common Stock (` 10 par) 2500 Taxes 100
Surplus 200 Dividend 50

a) Find out the following ratios:

 i)Asset turnover
ii)
Effective interest rate
iii)
Effective tax rate
iv)
Debt/equity ratio
v)Dividend payout rate
b) What growth rate of EBIT can be expected

SOLUTION -:

a) Ratios:
i) Asset Turnover = Revenues/Assets
= 9600/4000 = 2.4

ii) Effective Interest Rate on Debentures

= Interest/Value of Debentures
= 250/1750 = 14.29%

iii) Effective Tax Rate = Taxes/EBT

= 100/700 = 14.29%

iv) Debt/Equity Ratio = Total Debt/Shareholders' Equity

= (1750 + 300)/2500 = 1.4

v) Dividend Payout Ratio = Dividends/Net Income

= 50/200 = 25%

b) Expected growth rate of EBIT

Using DuPont Analysis formula:
Growth Rate = ROE x Asset Turnover
= (Net Income/Equity) x (Revenue/Assets)
= (200/2500) x (9600/4000)
= 19.2%
So, the expected growth rate of EBIT based on the given financial information is 19.2%.

QUESTION NO. 3 -: (WRONG QUESTION LEAVE IT)

A naive investor wants to analyze the capital structure of a company. He has the following
information ABC Company.

1990 1995 1998

Long-term debt (11%) 32.27 19.46 21.19
Preferred stock (10%) 0.18 0.18 0.14
Common stock (Par ` 10) 0.01 0.14 12.6
Capital surplus 8.67 4.35 4.19
Retained earnings 43.93 80.31 128.2
Dividend paid 3.005 3.684 10.08
The present price of the share in Mumbai stock market is ` 450. There is a rumour in the
market that the ABC Company may issue bonus shares shortly. The investor wants the
answers for the following

b) Is there any ground for such rumour ?

c) Is the capital structure sound?
d) Is it proper to purchase the shares?

Analyze the given data and advise him.

QUESTION NO. 4 -:

Mahima wants to invest in the one of the three companies given below. She is very particular
about the current financial position of the company. She believes that no company should
be considered for investment unless it has a good current financial position. You are asked
to examine the following data and choose a company for her by ranking alternatives
available.

Current financial analysis of X, Y, Z companies

Ratio X Y Z
1998 1999 1998 1999 1998 1999
Current Ratio 2.1 2.5 2.0 2.26 2.71 2.53
Acid test Ratio 1.27 1.42 1.38 1.50 1.90 1.76
Composition of current assets %
Cash 18 18 54 49 44 44
Receivables 68 66 34 46 53 52
Inventory 45 47 33 35 31 31
Other Current Assets 4 4 9 10 2 3
Net sales to inventory 3.90 3.77 4.45 4.23 5.65 5.25
Net sales to working Capital 3.29 2.97 3.10 2.81 2.87 2.85

SOLUTION -:
QUESTION NO. 5 -:

An investor wants to make his investment in “A” company based on his analysis of the
balance sheet and the income statement. The details are given below:

Balance Sheet of “A” company -

1999 (` in million)
Current assets 400
Fixed assets 1000
Total assets 1400
Current liabilities 200
Long-term liabilities 600
(@9% interest)
Net worth 600
Total liabilities and
Net worth 1400
1999 1998
(Rs in millions)
Sales 1,920 1,740
Less: Cost of goods sold 1,200 1,000
Gross profit 720 740
Less: Operating expenses 640 600
EBIT 80 140

Income statement of “A” company

Assume that, “A” company pays ` 54 million per year as interest expense, is in the 30% tax
bracket and pays out 40 per cent of its after-tax earnings as cash dividends. Carry out the
financial analysis and find out the answer for the following questions:
 a) What is the reason for the fall in the EBIT in 1999?
b) What is the rate of growth of earnings if the company does not raise

Common size income percentage= EACH VALUE/Sale

Percentage change = [{(value of 1999yr – value of 1998yr)}/ value of 1998yr] *100
 QUESTION NO. 6 -:

Let us consider a portfolio with four securities having the following characteristics, calculate
portfolio return and risk.

Security Returns (%) Proportion of investment

A 14 0.2
B 19 0.3
C 13 0.1
D 20 0.4

Same solution as ques no. 7 with changed values.

QUESTION NO. 7 -:

Calculate the expected return and variance of a portfolio comprising two securities,
assuming that the portfolio weights are 0.75 for security 1 and 0.25 for security 2. The expected
return for security 1 is 15 per cent and its standard deviation is 12 per cent, while the expected
return and standard deviation for security 2 are 24 per cent and 20 per cent respectively. The
correlation between the two securities is 0.6.

SOLUTION =

Expected Portfolio return = ∑ W iRi

= (15*0.75) + (24*0.25) = 7.5 + 6 = 11.5

QUESTION NO. 8 -:

Consider two securities, P and Q, with expected returns of 25 per cent and 23 per cent
respectively, and standard deviation of 35 per cent and 52 per cent respectively. Calculate the
standard deviation of a portfolio weighted equally between the two securities if their
correlation is -0.9.

QUESTION NO. 9 -:
A portfolio is constituted with four securities having the following characteristics:

Security Return (per cent) Proportion of investment

P 17.5 0.15
Q 24.8 0.25
R 15.7 0.45
S 21.3 0.15

Calculate the expected return of the portfolio.

QUESTION NO. 10 -:
An investor owns a portfolio composed of five securities with the following
characteristics:

Random error term standard

Security Beta Proportion
deviation (per cent)

1 1.35 5 0.10

2 1.05 9 0.20

3 0.80 4 0.15

4 1.50 12 0.30

5 1.12 8 0.25

If the standard deviation of the market index is 20 per cent, what is the total risk of the portfolio?
QUESTION 10.2 -:

Security J has a beta of 0.75 while security K has a beta of 1.45. Calculate the expected return for
these securities, assuming that the risk-free rate is 9 per cent and the expected return of the market
is 12 per cent.

The Capital Asset Pricing Model (CAPM) can be used to calculate the expected return for securities
based on their beta, the risk-free rate, and the expected market return. The CAPM formula is:
QUESTION NO. 11 -:

A security pays a dividend of 4.85 and sells currently at 85. The security is expected to sell at ` 90
at the end of the year. The security has a beta of 1.15. The risk-free rate is 5 per cent and the
expected return on market index is 14 per cent. Assess whether the security is correctly
priced
To assess whether a security is correctly priced, we need to calculate (a) the expected return as
per CAPM formula, (b) the estimated return on the security based on the dividend and increase
in price over the holding period.

SOLUTION -:

1) Expected Return as per CAPM:

CAPM Formula: Expected Return = Risk Free Rate + Beta * (Market Return - Risk Free
Rate)

Expected Return = 5% + 1.15 * (14% - 5%)

= 5% + 1.15 * 9%
= 5% + 10.35%
= 15.35%

2) Return on security =
Return on security = [Dividend + (Ending price – Starting price)] / Starting price
= [4.85 + (90-85)]/ 85 = 11.58

Since the Expected Return as per CAPM (15.35%) is higher than the Rate of return on
security (11.58%), the security is underpriced currently.

Therefore, based on the calculations, the security is not correctly priced - it is currently
underpriced.

QUESTION NO. 12 -:

The following data are available to you as portfolio manager: Calculate r

Security Estimated return (per cent) Beta Standard deviation (per cent)
A 20 2.0 30
 B 35 1.5 35

SOLUTION -:

Security A:
Estimated Return = 20%
Beta = 2.0
Standard Deviation = 30%

Security B:
Estimated Return = 35%
Beta = 1.5
Standard Deviation = 35%

To calculate the required rate of return (r):

1) Calculate expected market return:

Let's assume risk free rate (Rf) is 5%

Market risk premium = 10%
Expected market return = Rf + Market risk premium = 5% + 10% = 15%

2) Use the Capital Asset Pricing Model (CAPM) formula:

Required Return (r) = Rf + Beta * (Expected Market Return - Rf)

For Security A:
r = 5% + 2.0 * (15% - 5%) = 5% + 2.0 * 10% = 5% + 20% = 25%

For Security B:
r = 5% + 1.5 * (15% - 5%) = 5% + 1.5 * 10% = 5% + 15% = 20%

Therefore, based on the CAPM, the required rates of return are:

Security A: 25%
Security B: 20%
QUESTION NO. 13 -:

Estimate the Sharpe Ratio (SR) and Treynor Ratio (TR) for evaluating three Mutual
Funds A, B, and C, we will need the following information:

The average annual return of each mutual fund.

The standard deviation of returns for each mutual fund.
The beta of each mutual fund with respect to the market (market risk premium =
Market return - Rf).

Mutual Fund A:
Average Return = 19%
Standard Deviation = 13%
Beta = 1.6

Mutual Fund B:
Average Return = 16%
Standard Deviation = 14%
Beta = 0.9

Mutual Fund C:
Average Return = 28%
Standard Deviation = 14%
Beta = 1.5

SOLUTION -:

Risk free rate (Rf) = Let's assume it's 5%

To calculate Sharpe Ratio and Treynor Ratio:

1) Sharpe Ratio = (Average Return - Rf) / Standard Deviation

Fund A SR = (19% - 5%) / 13% = 1.07

Fund B SR = (16% - 5%) / 14% = 0.78
Fund C SR = (28% - 5%) / 14% = 1.64
2) Treynor Ratio = (Average Return - Rf) / Beta

Fund A TR = (19% - 5%) / 1.6 = 0.08

Fund B TR = (16% - 5%) / 0.9 = 0.12
Fund C TR = (28% - 5%) / 1.5 = 0.15

Ranking:
For Sharpe Ratio - Fund C, Fund A, Fund B
For Treynor Ratio - Fund C, Fund B, Fund A

The best performing fund based on both ratios is Fund C.

QUESTION NO. 14 -:

Prioritize the best from the following information and rank them . Consider following
information regarding three Mutual Funds A, B, C. Calculate Sharpe Ratio, Treynor Ratio, and
rank them . Rf = 10%
Mutual Fund - A, B, C ; Average annual return AR(%) - 20 , 22 , 18; Standard deviation SD(%) -
23, 24 , 25 ; Beta - 0.8 , 0.9 , 1.2

SOLUTION -:

1) Calculate Sharpe Ratio:

Sharpe Ratio = (Average Return - Risk Free Rate) / Standard Deviation

Fund A:
Sharpe Ratio = (20% - 10%) / 23% = 0.43
Fund B:
Sharpe Ratio = (22% - 10%) / 24% = 0.5
Fund C:
Sharpe Ratio = (18% - 10%) / 25% = 0.32

2) Calculate Treynor Ratio:

Treynor Ratio = (Average Return - Risk Free Rate) / Beta

Fund A:
Treynor Ratio = (20% - 10%) / 0.8 = 12.5
Fund B:
Treynor Ratio = (22% - 10%) / 0.9 = 13.33
Fund C:
Treynor Ratio = (18% - 10%) / 1.2 = 6.66

3) Rank the funds:

Based on Sharpe Ratio:

Fund B > Fund A > Fund C
Based on Treynor Ratio:
Fund B > Fund A > Fund C

Therefore, the overall ranking is:

1) Fund B
2) Fund A
3) Fund C

Fund B would be ranked the best choice, followed by Fund A then Fund C.
QUESTION NO. 15 -:

You are an investment advisor assisting an investor in choosing between two securities, X
and Y, for potential investment. Security X has expected returns of 6%, 8%, 10%, and 15%
with corresponding probabilities of 0.1, 0.3, 0.4, and 0.2, respectively. Security Y has
expected returns of -2%, 8%, and 17% with probabilities of 0.2, 0.5, and 0.3, respectively.
Calculate the expected returns and standard deviations for both securities and provide your
analysis on which investment option might be more suitable based on risk and return
considerations.

SOLUTION -:

1) Calculate expected returns and standard deviations for Securities X and Y:

For Security X:
Expected Return = (0.1 * 6%) + (0.3 * 8%) + (0.4 * 10%) + (0.2 * 15%)
= 0.6% + 2.4% + 4% + 3%
= 10%

Variance = (0.1 * (6%-10%)^2) + (0.3 * (8%-10%)^2) + (0.4 * (10%-10%)^2) + (0.2 * (15%-

10%)^2)
= 0.1 * 4 + 0.3 * 4 + 0.4 * 0 + 0.2 * 25
= 0.4 + 1.2 + 0 + 5
= 6.6

Standard Deviation = √Variance = √6.6 = 2.58%

For Security Y:
Expected Return = (0.2 * -2%) + (0.5 * 8%) + (0.3 * 17%)
= -0.4% + 4% + 5.1%
= 8.7%

Variance = (0.2 * (-2%-8.7%)^2) + (0.5 * (8%-8.7%)^2) + (0.3 * (17%-8.7%)^2)

= 0.2 * 114.49 + 0.5 * 0.49 + 0.3 * 68.89
= 43.81

Standard Deviation = √Variance = √43.81 = 6.6%

2) Analysis: Security X has a higher expected return (10% vs 8.7%) but lower risk (standard
deviation of 2.58% vs 6.6%). Therefore, based on risk-return considerations, Security X would
be a more suitable investment option.
QUESTION NO. 16 -:

i) You are considering buying a stock with a beta of 0.73. If the risk-free rate of
return is 6.9 percent, and the expected return for the market is 12.2 percent,
what should the expected rate of return be for this stock?

ii) If the risk-free rate is 6.9%, the market risk premium is 7.0%, and the
expected return on Security J is 29.4%, what is the beta for Security J?

iii) You are considering buying a stock with a beta of 2.05. If the risk-free rate of
return is 6.9 percent, and the market risk premium is 10.8 percent, what should
the expected rate of return be for this stock?

iv) You are holding a stock that has a beta of 2.4 and is currently in equilibrium.
The required return on the stock is 20.4% and the return on a risk-free asset is
8%. What would be the return on the stock if the stocks beta increased to 3.3
while the risk-free rate and market return remained unchanged?

SOLUTION NO -:

i) Expected return for stock with beta of 0.73:

Expected Return = Risk-free rate + Beta * (Market Return - Risk-free rate)
= 6.9% + 0.73 * (12.2% - 6.9%)
= 6.9% + 0.73 * 5.3%
= 6.9% + 3.889%
= 10.789%

ii) Beta for stock with expected return of 29.4%:

Given: Risk-free rate = 6.9%
Market risk premium = 7.0%
Expected return = 29.4%

Using CAPM:
Expected Return = Risk-free rate + Beta * (Market Return - Risk-free rate)
29.4% = 6.9% + Beta * 7.0%
22.5% = Beta * 7.0%
Beta = 22.5%/7.0% = 3.21

iii) Expected return for stock with beta of 2.05:

Given: Risk-free rate = 6.9%
Market risk premium = 10.8%
Beta = 2.05

Expected Return =
 = 6.9% + 2.05 * 10.8%
= 6.9% + 22.44%
= 29.34%

iv) Expected return if beta increases to 3.3:

Given: Current beta = 2.4
Required return = 20.4%
Risk-free rate = 8%

Using CAPM:
20.4% = 8% + 2.4 * (Market Return - 8%)
Market Return = 13.17%

New beta = 3.3

Expected Return = 8% + 3.3 * (13.17% - 8%) = 25.061%.