SFM Compiler Part 1 by CA Rahul Malkan PDF

CA-FINAL
SFM – COMPILOR
PART - I
INDEX
No. Chapter Name Page No.
1 Financial Policy & Corporate Strategy 1–3
2 Security Analysis 4–8
3 Equity & Corporate Valuations 9 – 68
4 Bond Analysis & Valuations 69 – 105
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SFM COMPILER Financial Policy & Corporate Strategy
CHP - 1 FINANCIAL POLICY & CORPORATE

STRATEGY
Question 1 :
May 2018 - Paper
Explain the interface of Financial Policy and Strategic Management
Solution :
The interface of strategic management and financial policy will be clearly understood if we appreciate
the fact that the starting point of an organization is money and the end point of that organization is
also money. No organization can run an existing business and promote a new expansion project
without a suitable internally mobilized financial base or both i.e. internally and externally mobilized
financial base.
Sources of finance and capital structure are the most important dimensions of a strategic plan. The
need for fund mobilization to support the expansion activity of firm is very vital for any organization.
The generation of funds may arise out of ownership capital and or borrowed capital. A company may
issue equity shares and / or preference shares for mobilizing ownership capital and debenture to
raise borrowed capital.
Policy makers should decide on the capital structure to indicate the desired mix of equity capital and
debt capital. There are some norms for debt equity ratio.
However this ratio in its ideal form varies from industry to industry. Another important dimension of
strategic management and financial policy interface is the investment and fund allocation decisions.
A planner has to frame policies for regulating investments in fixed assets and for restraining of current
assets. Investment proposals mooted by different business units may be divided into three groups.
One type of proposal will be for addition of a new product, increasing the level of operation of an
existing product and cost reduction and efficient utilization of resources through a new approach and
or closer monitoring of the different critical activities. Dividend policy is another area for making
financial policy decisions affecting the strategic performance of the company. A close interface is
needed to frame the policy to be beneficial for all. Dividend policy decision deals with the extent of
earnings to be distributed as dividend and the extent of earnings to be retained for future expansion
scheme of the organization. It may be noted from the above discussions that financial policy of a
company cannot be worked out in isolation of other functional policies.
It has a wider appeal and closer link with the overall organizational performance and direction of
growth. As a result preference and patronage for the company depends significantly on the financial
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Financial Policy & Corporate Strategy SFM COMPILER
policy framework. Hence, attention of the corporate planners must be drawn while framing the
financial policies not at a later stage but during the stage of corporate planning itself.
Question 2 :
Nov 2018 - Paper
How different stakeholders view the financial risk?
Solution :
The financial risk can be viewed by different stakeholders as follows:
(i) From shareholder’s and lender’s point of view: Major stakeholders of a business are equity
shareholders and they view financial gearing i.e. ratio of debt in capital structure of company
as risk since in the event of winding up of a company they will be least be given priority. Even
for a lender, existing gearing is also a risk since company having high gearing faces more risk
in default of payment of interest and principal repayment.
(ii) From Company’s point of view: From company’s point of view if a company borrows
excessively or lend to someone who defaults, then it can be forced to go into liquidation.
(iii) From Government’s point of view: From Government’s point of view, the financial risk can be
viewed as failure of any bank (like Lehman Brothers) or down grading of any financial
institution leading to spread of distrust among society at large. Even this risk also includes
willful defaulters. This can also be extended to sovereign debt crisis.
Question 3 :
Nov 2019 - Paper
Discuss briefly the key decisions which fall within the scope of financial strategy
Solution :
The key decisions falling within the scope of financial strategy include the following:
1. Financing decisions : These decisions deal with the mode of financing or mix of equity capital
and debt capital.
2. Investment decisions: These decisions involve the profitable utilization of firm's funds
especially in long-term projects (capital projects). Since the future benefits associated with
such projects are not known with certainty, investment decisions necessarily involve risk. The
projects are therefore evaluated in relation to their expected return and risk.
3. Dividend decisions: These decisions determine the division of earnings between payments to
shareholders and reinvestment in the company.
4. Portfolio decisions: These decisions involve evaluation of investments based on their
contribution to the aggregate performance of the entire corporation rather than on the
isolated characteristics of the investments themselves.
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SFM COMPILER Financial Policy & Corporate Strategy
Question 4 :
May 2020 - RTP
How financial goals can be balanced vis-à-vis sustainable growth?
Solution :
The concept of sustainable growth can be helpful for planning healthy corporate growth. This concept
forces managers to consider the financial consequences of sales increases and to set sales growth
goals that are consistent with the operating and financial policies of the firm. Often, a conflict can
arise if growth objectives are not consistent with the value of the organization's sustainable growth.
Question concerning right distribution of resources may take a difficult shape if we take into
consideration the rightness not for the current stakeholders but for the future stakeholders also. To
take an illustration, let us refer to fuel industry where resources are limited in quantity and a judicial
use of resources is needed to cater to the need of the future customers along with the need of the
present customers. One may have noticed the save fuel campaign, a demarketing campaign that
deviates from the usual approach of sales growth strategy and preaches for conservation of fuel for
their use across generation. This is an example of stable growth strategy adopted by the oil industry
as a whole under resource constraints and the long run objective of survival over years. Incremental
growth strategy, profit strategy and pause strategy are other variants of stable growth strategy.
Sustainable growth is important to enterprise long-term development. Too fast or too slow growth
will go against enterprise growth and development, so financial should play important role in
enterprise development, adopt suitable financial policy initiative to make sure enterprise growth
speed close to sustainable growth ratio and have sustainable healthy development.
Question 5 :
Nov 2020 (New) - RTP
Explain key decisions that fall within the scope of financial strategy.
Solution :
The key decisions falling within the scope of financial strategy are as follows:
1. Financing decisions: These decisions deal with the mode of financing or mix of equity capital
and debt capital.
2. Investment decisions: These decisions involve the profitable utilization of firm's funds
especially in long-term projects (capital projects). Since the future benefits associated with
such projects are not known with certainty, investment decisions necessarily involve risk. The
projects are therefore evaluated in relation to their expected return and risk.
3. Dividend decisions: These decisions determine the division of earnings between payments to
shareholders and reinvestment in the company.
4. Portfolio decisions: These decisions involve evaluation of investments based on their
contribution to the aggregate performance of the entire corporation rather than on the
isolated characteristics of the investments themselves.

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Security Analysis SFM COMPILER
CHP - 2 SECURITY ANALYSIS
Question 1 :
Nov 2008 - Paper
The closing value of Sensex for the month of October, 2007 is given below:
Date Closing Sensex Value
1.10.07 2800
3.10.07 2780
4.10.07 2795
5.10.07 2830
8.10.07 2760
9.10.07 2790
10.10.07 2880
11.10.07 2960
12.10.07 2990
15.10.07 3200
16.10.07 3300
17.10.07 3450
19.10.07 3360
22.10.07 3290
23.10.07 3360
24.10.07 3340
25.10.07 3290
29.10.07 3240
30.10.07 3140
31.10.07 3260
You are required to test the week form of efficient market hypothesis by applying the run test at 5%
and 10% level of significance.
Following value can be used :
Value of t at 5% is 2.101 at 18 degrees of freedom
Value of t at 10% is 1.734 at 18 degrees of freedom
Value of t at 5% is 2.086 at 20 degrees of freedom.
Value of t at 10% is 1.725 at 20 degrees of freedom.
Solution :
Date Closing Sensex Movement N1 N2 R
1 2800
3 2780 - 1 1
4 2795 + 1
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SFM COMPILER Security Analysis
5 2830 + 2 2
8 2760 - 2 3
9 2790 + 3
10 2880 + 4
11 2960 + 5
12 2990 + 6
15 3200 + 7
16 3300 + 8
17 3450 + 9 4
19 3360 - 3
22 3290 - 4 5
23 3360 + 10 6
24 3340 - 5
25 3290 - 6
29 3240 - 7
30 3140 - 8 7
31 3260 + 11 8
1. N1 = No of “+” Signs = 11
2. N2 = No of “-” Signs =8
3. r = No of runs =8
2𝑛𝑛1𝑛𝑛2 2𝑥𝑥11𝑥𝑥8
4. µ (Average) = 𝑛𝑛1+𝑛𝑛2 + 1 = 11+8
+1 = 10.26
(µ−1)𝑥𝑥(µ−2) (10.26−1)𝑥𝑥(10.26−2)
5. σ (SD) =� 𝑛𝑛1+𝑛𝑛2−1
=� 11+8−1
= 2.06
- 2.06 +2.06
8.2 10.26 12.32

@ 1 SD @ 1 SD
Note :
1. If the no of runs to less – we can predict the market – market is inefficient
2. If the no of runs are too high – we can predict the market – market is inefficient
3. If the no of runs are average – we cannot predict the market – market is efficient.
RUN TEST
1. 5% Run test
Degree of freedom = N1 + N2 – 1 = 11 + 8 – 1 = 18% degree of freedom
At 5% test, At 18% degree of freedom, t = 2.101
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Lower limit = µ − 𝑡𝑡(σ) = 10.26 – 2.101(2.06) = 5.93

Upper Limit = µ + 𝑡𝑡(σ) = 10.26 + 2.101(2.06) = 14.58
5.93 10.26 14.58

@ 2.101 SD @ 2.101 SD
Note :
1. Runs below 5.93 are low no of runs and above 14.58 are high number of runs, i.e we
can predict the market, i.e the market is inefficient.
2. Runs between 5.93 and 14.58 are average number of runs, i.e we cannot predict the
market, i.e market is efficient
3. We have 8 runs in the data, which is between 5.93 and 14.58 which indicates that the
market is efficient, i.e we cannot predict the market.
2. 10 % Run test
Degree of freedom = N1 + N2 – 1 = 11 + 8 – 1 = 18% degree of freedom
At 10 % test, At 18% degree of freedom, t = 1.734
Lower limit = µ − 𝑡𝑡(σ) = 10.26 – 1.734 (2.06) = 6.69

Upper Limit = µ + 𝑡𝑡(σ) = 10.26 + 1.734 (2.06) = 13.83
6.69 10.26 13.83

@ 1.734 SD @ 1.734 SD
Note :
1. Runs below 6.69 are low no of runs and above 13.83 are high number of runs, i.e we
can predict the market, i.e the market is inefficient.
2. Runs between 6.69 and 13.83 are average number of runs, i.e we cannot predict the
market, i.e market is efficient
3. We have 8 runs in the data, which is between 6.69 and 13.83 which indicates that the
market is efficient, i.e we cannot predict the market.
Question 2 :
Nov 2009 - Paper / May 2017 – RTP / Nov 2019 (New) – PAPER
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200X were as
follows :
Days Date Day Sensex
1 6 THU 14522
2 7 FRI 14925
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SFM COMPILER Security Analysis
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 15222
6 11 TUE 16000
7 12 WED 16400
8 13 THU 17000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 18000
Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days simple
moving average of Sensex can be assumed as 15,000. The value of exponent for 30 days EMA is 0.062.
Give detailed analysis on the basis of your calculations.
Solution :
Date 1 2 3=1–2 4 5
Sensex EMA for Previous 3 x 0.062 EMA
Day 2 +/- 4
6 14522 15000 (478) (29.636) 14970.364
7 14925 14970.364 (45.364) (2.812) 14967.55
10 15222 14967.55 254.45 15.776 14983.32
11 16000 14983.32 1016.68 63.034 15046.354
12 16400 15046.354 1353.646 83.926 15130.28
13 17000 15130.28 1869.72 115.922 15246.203
17 18000 15246.203 2753.797 170.735 15416.938
Conclusion – The market is bullish. The market is likely to remain bullish for short term to medium
term if other factors remain the same. On the basis of this indicator (EMA) the investors/brokers can
take long position.
Question 3 :
Nov 2020 (New) – RTP
Explain various “Market Indicators”.
Solution :
The various market indicators are as follows:
(i) Breadth Index: It is an index that covers all securities traded. It is computed by dividing the
net advances or declines in the market by the number of issues traded. The breadth index
either supports or contradicts the movement of the Dow Jones Averages. If it supports the
movement of the Dow Jones Averages, this is considered sign of technical strength and if it
does not support the averages, it is a sign of technical weakness i.e. a sign that the market
will move in a direction opposite to the Dow Jones Averages. The breadth index is an addition
to the Dow Theory and the movement of the Dow Jones Averages.
7|Page
(ii) Volume of Transactions: The volume of shares traded in the market provides useful clues on
how the market would behave in the near future. A rising index/price with increasing volume
would signal buy behaviour because the situation reflects an unsatisfied demand in the
market. Similarly, a falling market with increasing volume signals a bear market and the prices
would be expected to fall further. A rising market with decreasing volume indicates a bull
market while a falling market with dwindling volume indicates a bear market. Thus, the
volume concept is best used with another market indicator, such as the Dow Theory.
(iii) Confidence Index: It is supposed to reveal how willing the investors are to take a chance in
the market. It is the ratio of high-grade bond yields to low-grade bond yields. It is used by
market analysts as a method of trading or timing the purchase and sale of stock, and also, as
a forecasting device to determine the turning points of the market. A rising confidence index
is expected to precede a rising stock market, and a fall in the index is expected to precede a
drop in stock prices. A fall in the confidence index represents the fact that low-grade bond
yields are rising faster or falling more slowly than high grade yields. The confidence index is
usually, but not always a leading indicator of the market. Therefore, it should be used in
conjunction with other market indicators.
(iv) Relative Strength Analysis: The relative strength concept suggests that the prices of some
securities rise relatively faster in a bull market or decline more slowly in a bear market than
other securities i.e. some securities exhibit relative strength. Investors will earn higher returns
by investing in securities which have demonstrated relative strength in the past because the
relative strength of a security tends to remain undiminished over time.
Relative strength can be measured in several ways. Calculating rates of return and classifying
those securities with historically high average returns as securities with high relative strength
is one of them. Even ratios like security relative to its industry and security relative to the
entire market can also be used to detect relative strength in a security or an industry.
(v) Odd - Lot Theory: This theory is a contrary - opinion theory. It assumes that the average
person is usually wrong and that a wise course of action is to pursue strategies contrary to
popular opinion. The odd-lot theory is used primarily to predict tops in bull markets, but also
to predict reversals in individual securities.

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SFM COMPILER Equity Analysis & Valuation
CHP - 3 EQUITY ANALYSIS AND VALUATION
Question 1
Nov 2008 - RTP / Nov 2011 – RTP / May 2015 - RTP
The total market value of the equity share of Raheja Company is Rs.90,00,000 and the total value of
the debt is Rs.60,00,000. The treasurer estimated that the beta of the stock is currently 1.9 and that
the expected risk premium on the market is 12 per cent. The treasury bill rate is 9 per cent.
Required :
(1) What is the beta of the Company’s existing portfolio of assets?
(2) Estimate the Company’s Cost of capital and the discount rate for an expansion of the company’s
present business.
Solution :
1) Beta of Company’s existing Portfolio
β Assets = β Liabilities
β Liabilities = Wt β Equity + wt β Debt
Since β Debt is not given to us, we assume it to be Zero
Equity = 90,00,000
Debt = 60,00,000
Total = 1,50,00,000
Therefore, β Assets = 1.9 x 90/150 = 1.14
2) Cost of Capital
Ke = Rf + β (RM – Rf)
Ke = Cost of Capital
Rf = Risk Free Rate
RM = Market Return
Rm – RF = Market Risk Premium
Therefore, 𝐾𝐾𝑒𝑒 = 9% + 1.14 x 12% = 22.68%
Question 2
Nov 2008 RTP / Nov 2018 (New) - RTP
Truly Plc presently paid a dividend of £1.00 per share and has a share price of £. 20.00.
(i) If this dividend were expected to grow at a rate of 12% per annum forever, what is the firm’s
expected or required return on equity using a dividend-discount model approach?
(ii) Instead of this situation in part (i), suppose that the dividends were expected to grow at a rate
of 20% per annum for 5 years and 10% per year thereafter. Now what is the firm’s expected,
or required, return on equity?
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Equity Analysis & Valuation SFM COMPILER
Solution :
1. Dividend are expected to grow at 12% PA forever
𝑫𝑫𝑫𝑫 𝟏𝟏(𝟏𝟏.𝟏𝟏𝟏𝟏)
IV = 𝑹𝑹𝑹𝑹−𝑮𝑮 20 = 𝑹𝑹𝑹𝑹−𝟎𝟎.𝟏𝟏𝟏𝟏 20Re – 2.4 = 1.12 therefore Re 17.6%.
2. Dividend are expected to grow @20% for 5 years and 10% thereafter
To calculate Re, we will have to use the concept of IRR. Lets use the discounting rate of 18%
and 20%.
Stage 1 : First 5 years

Years Dividend PV @ 18% PV @ 20%
1 1.2 1.012 1
2 1.44 1.034 1
3 1.728 1.052 1
4 2.0736 1.070 1
5 2.48832 1.088 1
Total 5.256 5
Stage 2 :
PV @ 18% PV @ 20%
𝑫𝑫𝑫𝑫 𝟐𝟐.𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒(𝟏𝟏.𝟏𝟏) 𝟐𝟐.𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒(𝟏𝟏.𝟏𝟏)
IV5 = 𝑹𝑹𝑹𝑹−𝑮𝑮 = =
𝟎𝟎.𝟏𝟏𝟏𝟏−𝟎𝟎.𝟏𝟏𝟏𝟏 𝟎𝟎.𝟐𝟐𝟐𝟐−𝟎𝟎.𝟏𝟏𝟏𝟏
= Rs 34.2144 = 27.37152
𝑰𝑰𝑰𝑰𝑰𝑰 𝟑𝟑𝟑𝟑.𝟐𝟐𝟐𝟐𝟐𝟐𝟐𝟐 𝟐𝟐𝟐𝟐.𝟑𝟑𝟑𝟑𝟑𝟑𝟑𝟑𝟑𝟑
IV0 = (𝟏𝟏+𝑹𝑹𝑹𝑹)𝟓𝟓 = =
(𝟏𝟏.𝟏𝟏𝟏𝟏)𝟓𝟓 (𝟏𝟏.𝟐𝟐)𝟓𝟓
= 14.955 = 11
Total IV (Stage 1 + 2) = 20.211 = 16
Since IV @ 18% is 20.211, which is close to 20, we can safely assume that Re is a bit higher than 18,
Lets say 18.1%. We can also calculate the same by interpolation formula.
+ 𝑵𝑵𝑵𝑵𝑵𝑵
IRR = LR + Ʃ𝑵𝑵𝑵𝑵𝑵𝑵
x x difference of rate
(Rs.20.23 + Rs.20)
K = 18% + × 1%
Rs.20.23 - Rs.17.89
Rs.0.23
= 18% + × 1%
Rs.2.34
= 18% + 0.10%
= 18.10%
10 | P a g e
Question 3
May 2009 – RTP / Nov 2014 – Paper – 6 Marks / May 2016 - Paper
An investor is holding 2000 shares of X ltd. Current year dividend rate is Rs. 2 per share. Market price
of the share is Rs. 30 each. The investor is concerned about several factors are likely to change during
the next financial year as indicated below :
Current Year Next Year
Dividend paid / anticipated per share (Rs.) 2 1.8
Risk free rate 12% 10%
Market Risk Premium 5% 4%
Beta Value 1.3 1.4
Expected growth 9% 7%
In view of the above, advise whether the investor should buy, hold or sell the shares.
Solution :
Current Year Next Year

Re = Rf + β(Rm – Rf) 12 + 1.3(5) = 18.5% 10 + 1.4(4) = 15.6%
IV = D1 2 (1.09 ) 1.8 (1.07 )
= =
Re - g 0.185 − 0.09 0.156 − 0.07
= Rs.22.95 /sh. = Rs.22.40/sh.
Question 4
May 2009 Paper – 6 Marks / Nov 2013 – RTP / Nov 2014 – RTP / May 2016 – Paper / May 2020
(New) - RTP
Calculate the value of share from the following information:
Profit of the company Rs. 290 crores
Equity capital of company Rs. 1,300 crores
Par value of share Rs. 40 each
Debt ratio of company 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share Rs. 47
Depreciation per share Rs. 39
Change in Working capital Rs. 3.45 per share
Solution :
FCFE1
IV =
Ke - g
FCFE = PAT – NI (Net Investment)
PAT = 290 Crores
PAT/Shares i.e EPS =
11 | P a g e
No of shares = 1300 / 40 = 32.5 Crores

PAT 290
EPS = = = Rs. 8.923 per share
No.of shares 32.5
NI = [(Capital Spending – Depreciation) + ∆ Working Capital] (1 – 0.27)
= [(47 – 39) + 3.45] (1-0.27)
= 11.45 (1 – 0.27)
= 8.3585
FCFE = 8.923 – 8.3585 = 0.5645
Re = Rf + β (RM – Rf)
= 8.7 + 0.1 (10.3– 8.7) = 8.86%
0.5645 (1.08 )
IV = = Rs.70.89 / shares
0.0886 − 0.08
Question 5
Nov 2009 – RTP / May 2010 – Paper – 12 Marks / Nov 2013 - RTP
Consider the following operating information gathered from 3 companies that are identical except
for their capital structures:
P Ltd. Q Ltd. R Ltd.
Total invested capital € 100,000 € 100,000 € 100,000
Debt/assets ratio 0.80 0.50 0.20
Shares outstanding 6,100 8,300 10,000
Before-tax cost of debt 14% 12% 10%
Cost of equity 26% 22% 20%
Operating income,(EBIT) € 25,000 € 25,000 € 25,000
Net Income € 8,970 € 12,350 € 14,950
Tax rate 35% 35% 35%
(a) Compute the weighted average cost of capital, WACC, for each firm.
(b) Compute the Economic Value Added, EVA, for each firm.
(c) Based on the results of your computations in part b, which firm would be considered the best
investment? Why?
(d) Assume the industry PIE ratio generally is 15 x. Using the industry norm, estimate the price
for each share.
(e) What factors would cause you to adjust the PIE ratio value used in part d so that it is more
appropriate?
Solution :
(a)
14(1 – 0.35) 12(1 – 0.35) 10(1 – 0.35)
Kd = i(l – t)
9.1 7.8 6.5
Ke 26% 22% 20%
12 | P a g e
= 9.1 × 0.8 + 26 × = 7.8 × 0.5 + 22 × = 6.5 × 0.2 + 20 ×

Kc = w + Ke + w + Kd
0.2 = 12.48% 0.5 = 14.9% 0.8 = 17.3%
(b)
EVA = NOPAT – Kc 25000 (1 – 0.35)
16250 16250
NOPAT = EBIT – Tax = 16250
100000 × 12.48% = 100000 ×14.9% = 100000 × 17.3% =
Kc = Capital × Kc
12480 14900 17300
EVA 3770 1350 –1050
(c) EVAP > EVAQ > EVAR; Thus, P Ltd. would be considered the best investment. The result should
have been obvious, given that the firms have the same EBIT, but WACCP < WACCQ < WACCR.
(d)
Net income € 8,970 € 12,350 € 14,950
Shares 6,100 8,300 10,000
EPS € 1.470 € 1.488 € 1.495
Stock price: P/E = 15x € 22.05 € 22.32 € 22.425
(e) Given the three firms have substantially different capital structures, we would expect that
they also have different degrees of financial risk. Therefore, we might want to adjust the P/E
ratios to account for the risk differences.
Question 6
Nov 2009 – RTP / Nov 2010 – Paper – 8 Marks / May 2011 – Paper – 8 Marks / Nov 2015 - RTP
Associated Advertising Agency (AAA) just announced that the current financial year’s income
statement reports its net income to be Rs.12,00,000. AAA’s marginal tax rate is 40 percent, and its
interest expense for the year was Rs.15,00,000. The company has Rs.80,00,000 of invested capital,
of which 60 percent is debt. In addition, AAA tries to maintain a weighted average cost of capital
(WACC) near 12 percent.
(a) Compute the operating income, or EBIT, AAA earned in the current year.
(b) What is AAA’s Economic Value Added (EVA) for the current year?
(c) AAA has 5,00,000 equity share outstanding. According to the EVA value you computed in part
b, how much can AAA pay in dividends per share before the value of the firm would start to
decrease? If AAA does not pay any dividends, what would you expect to happen to the value
of the firm?
Solution :
(a) Taxable income =Net income/(1- 0.40)
Taxable income= (Rs. 12,00,000)/(1- 0.40) = Rs. 20,00,000
13 | P a g e
EBIT = Taxable income + Interest

= Rs. 20,00,000 + Rs. 15,00,000
= Rs. 35,00,000
(b) EVA = EBIT(1- T)- (WACC X Invested capital)
= Rs. 35,00,000(1- 0.40)- (0.12 X Rs. 80,00,000)
= Rs. 21,00,000 - Rs. 9,60,000
= Rs. 11,40,000
(c) EVA dividend = (Rs. 11,40,000)/500,000 = Rs. 2.28.
If AAA does not pay a dividend, we would expect the value of the firm to increase because it
will achieve higher growth, hence a higher level of EBIT. If EBIT is higher, then, all else equal,
the value of the firm will increase. (This assumes the firm has positive NPV projects in which
to invest.)
Question 7
Nov 2009 Paper – 6 Marks / Nov 2012 – Paper – 8 Marks / May 2016 – RTP / May 2019 (New) –
Paper / May 2020 (Old) – RTP
Following Financial data are available for PQR Ltd. for the year 2008 :
(Rs. in lakh)
8% debentures 125
10% bonds (2007) 50
Equity shares (Rs. 10 each) 100
Reserves and Surplus 300
Total Assets 600
Assets Turnovers ratio 1.1
Effective interest rate 8%
Effective tax rate 40%
Operating margin 10%
Dividend payout ratio 16.67%
Current market Price of Share 14
Required rate of return of investors 15%
You are required to:
(i) Draw income statement for the year
(ii) Calculate its sustainable growth rate
(iii) Calculate the fair price of the Company's share using dividend discount model, and
(iv) What is your opinion on investment in the company's share at current price?
Solution :
(i) Income Statement :
Sales
Asset turnover ratio = = 1.1
Assets
Total Assets = Rs. 600
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Turnover Rs. 600 lakhs × 11 = Rs. 660 lakhs

Interest
Effective interest rate = = 8%
Liabilities
Liabilities = Rs. 125 lakhs+50 lakhs = 175 lakh
Interest =Rs. 175 lakhs× 0.08 = Rs. 14 lakh
Operating Margin = 10%
Hence operating cost = (1-0.10) Rs. 660 lakhs = Rs. 594 lakh
Dividend Payout = 16.67%
Tax rate = 40%
Income statement (Rs. Lakhs)
Sale 660
Operating Exp 594
EBIT 66
Interest 14
EBT 52
Tax @ 40% 20.80
EAT 31.20
Dividend @ 16.67% 5.20
Retained Earnings 26.00
(ii) G = br
G = Growth
b = Retention Ratio
r = ROE
PAT 31.20
ROE = = = 7.8%
Equity 100 + 300
Retention Ratio = 100 – 16.67 = 83.33%
Growth = 83.33 x 7.8% = 6.5%
D1
(iii) IV =
Re - g
D = 5.2/10 = 0.52 per share
Ke = 15%
G = 6.5%
0.52 + 6.5%
IV = = Rs.6.51 per share
0.15 − 0.065
(iv) Since the current market price of share is Rs.14, the share is overvalued. Hence the investor
should not invest in the company.
Question 8
Nov 2009 - Paper – 6 Marks
A firm had been paid dividend at Rs.2 per share last year. The estimated growth of the dividends from
the company is estimated to be 5% p.a. Determine the estimated market price of the equity share if
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the estimated growth rate of dividends (i) rises to 8%, and (ii) falls to 3%. Also find out the present
market price of the share, given that the required rate of return of the equity investors is 15.5%.
Solution :
D1 2(1.05)
Current IV = = = Rs.20/share
Re - g 0.155 − 0.05
D1 2(1.08)
IV (growth rate = 8%) = = = Rs.28.8 /share
Re - g 0.155 − 0.08
D1 2 (1.03)
IV (growth rate = 3%) = = = Rs.16.48 /share
Re - g 0.155 − 0.03
Note : IV and growth share direct relationship. Higher the growth, higher the share price and vice
versa.
Question 9
May 2010 - RTP
ABC (India) Ltd., a market leader in printing industry, is planning to diversify into defense equipment
businesses that have recently been partially opened up by the GOI for private sector. In the
meanwhile, the CEO of the company wants to get his company valued by a leading consultants, as he
is not satisfied with the current market price of his scrip.
He approached a consultant with a request to take up valuation of his company with the following
data for the year ended 2009:
Share Price Rs.66 per share
Outstanding debt 1934 lakh
Number of outstanding shares 75 lakh
Net income 17.2 lakh
EBIT 245 lakh
Interest expenses 218.125 lakh
Capital expenditure 234.4 lakh
Depreciation 234.4 lakh
Working capital 44 lakh
Growth rate 8% (from 2010 to 2014)
Growth rate 6% (beyond 2014)
Free cash flow 240.336 lakh (year 2014 beyond)
The capital expenditure is expected to be equally offset by depreciation in future and the debt is
expected to decline by 30% by 2014.
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 2014.
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Solution :
1) EBIT 245
– Int. 218.125
EBT 26.875
– Tax 9.675
EAT 17.2
9.675
2) Tax rate = 26.875 × 100 = 36%
218.125
3) % Interest = 1934 × 100 = 11.28%
4)
Kc for 1st 5 years Kc beyond 5 yrs.
Ke = 16% Ke = 16%
Kd = 11.28(1 – 0.36) = 7.22% Debt = 1934 × 0.7 = 1353.8
MV of equity = 75 × 66 = Rs. 4950 Equity = 4950
Debt = 1934 Total 6303.8
Total = 6884 4950 1353.8
Kc = 6303.8× 16% + 6303.8× 7.22% = 14.11%
4950 1934
Kc = 6884 × 16 6884+ × 7.22 = 13.53%
5)
Stage 1
2009 2010 2011 2012 2013 2014 2015
1) NOPAT
EBIT 245 264.6 285.768 308.629 333.32 359.98
245 × (8%)
-Tax (30%)
NOPAT 169.34 182.89 197.5 213.32 230.39
2) NI
CS-Dep. - - - - -
∆WC 3.52 3.801 4.11 4.43 4.79
(44 × 8%)
NI 3.52 3.801 4.11 4.43 4.79
FCFF 165.82 179.089 193.39 208.89 225.6 240.336
DF 0.881 0.776 0.683 0.602 0.530
DCF 146.08 138.97 132.09 125.75 119.56
Total = 662.45
6) Stage 2
FCFF6 240.336
V5 = =
Ke - g 0.1411 − 0.06
= 2963.45
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V0 = 2963.45 × 0.530 = 1570.6298

7) Total value of firm = 662.45 + 1570.6298 = 2233.0798
Less Value of debt 1934
Value of 299.0798
299.0798
Value of equity = Rs.3.9877 /share
75
Question 10
Nov 2010 - RTP
From the following data compute the value of business using EVA method.
Current Period Projected Periods
2010 2011 2012
Total Invested Capital 90,00,000 1,00,00,000 1,10,00,000
Adjusted NOPAT 12,60,000 14,00,000 16,00,000
WACC 8.42%
Capital Growth (g) is projected = 6.5% per year after 2012.
Solution :
Valuation Equation
EVAt = NOPATt – (Total Invest Capitalt x WACCt)
EVA1 = Rs.14,00,000 – (Rs.1,00,00,000 X 0.0842) = Rs.5,58,000
EVA2 = Rs.16,00,000 – (Rs.1,10,00,000 X 0.0842) = Rs.6,73,800
Total Valuation Equation
 
 
558000 673800  673800 (1 + 0.065 ) 
= + +
1.0842 (1.0842 )2  0.0842 − 0.065 
 
(1.0842 )
2
 
= Rs.5,14,665 + Rs.5,73,207 + Rs.3,17,95,128 + Rs.90,00,000
= Rs.4,18,83,000
Question 11
Nov 2010 – RTP / Nov 2011 – Paper – 8 Marks
Using the chop shop approach ( or break up value approach ) assign a value for Cranberry Ltd. Whose
stock is currently trading at a total market price of €4 million. For Cranberry Ltd. The accounting data
set forth three business segments consumer wholesale, retail and general centers. Data for the firms
three segments are as follows :
Business Segment Segment Segment
Segment sales assets operating income
Whole sale €225,000 €600,000 €75,000
Retail €720,000 €500,000 €150,000
General €2,500,000 €4,000,000 €700,000
Industry data for pure play firms have been compiled and are summarized as follows :-
18 | P a g e
Business Capitalization/Sales Capitalization Capitalization /

Segment Assets Operating Income
Wholesale 0.85 0.7 9
Retail 1.2 0.7 8
General 0.8 0.7 4
Solution :
Wholesale
Sales 225000 × 0.85 = 191250
Assets 600000 × 0.7 = 420000 428750 (avg.)
Op.Inc. 75000 × 9 = 675000
Retail
Sales 720000 × 1.2 = 864000
Assets 500000 × 0.7 = 350000 804666.67
Op.Inc. 150000 × 8 = 1200000
General
Sales 2500000 × 0.8 = 2000000
Assets 4000000 × 0.7 = 2800000 2533333.33
Op.Inc. 700000 × 4 = 2800000 __________
Total 3766750
Question 12
Amal Ltd. has been maintaining a growth rate of 12% in dividends. The company has paid dividend
@ Rs.3 per share. The rate of return on market portfolio is 15% and the risk free rate of return in the
market has been observed as10% . The beta co-efficient of the company’s share is 1.2. You are
required to calculate the expected rate of return on the company’s shares as per CAPM model and
the equilibrium price per share by dividend growth model.
Solution :
Re = Rf + β(Rm – Rf)
= 10 + 1.2 (15 – 10)
= 10 + 6 = 16%
D1
IV =
Re - g
3 x (1.12)
= 0.16 - 0.12 = Rs.84/share
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Question 13
May 2011 – RTP / Nov 2012 – Paper – 4 Marks
Calculate Economic Value Added (EVA) with the help of the following information of Hypothetical
Limited:
Financial leverage : 1.4 times
Capital structure : Equity Capital Rs.170 lakhs
Reserves and surplus : Rs.130 lakhs
10% Debentures : Rs.400 lakhs
Cost of Equity : 17.5%
Income Tax Rate : 30%.
Solution :
EBIT 140 1.4
– Int 40 0.4
EBT 100 1.0
40
EBIT = 0.4× 1.4 = 140
NOPAT = EBIT (1 – t) = 140(1 – 0.3) = 98
Ke = 17.5%
Kd = 10(1 – 0.3) – 7%
300 400
WACC = × 17.5 + × 7%
700 700
∴Cost of capital = 700 × 11.5% = 80.5
EVA = 98 – 80.5 = 17.5
Question 14
Nov 2008 – RTP / May 2011 – RTP / May 2011 - Paper – 8 Marks / May 2012 – Paper / Nov 2013 –
Paper – 8 Marks / Nov 2018 (New) - Paper
A share of Voyage Ltd. is currently quoted at, a price earning of 8 times. The retained earnings per
share being 45% is 5 per share. Compute
(i) The company’s cost of equity, if investors expect annual growth rate of 15%
(ii) If anticipated growth rate is 16% p.a, calculate the indicated market price, with same cost of
capital.
(iii) If the company’s cost of capital is 20% and the anticipated growth rate is 19% p.a. calculate
the market price per share, assuming other conditions remaining the same.
Solution :
Retained Earning = Rs.5 = 45%
 5 
∴Earnings = Rs.11.11  
 45% 
∴Dividend = Rs.6.11 (11.11 – 5) (Since Dividend is calculated from Earnings it should be
20 | P a g e
taken as D 1 )
P.E. ratio =8
MPs = EPS × P.E. = 11.11 × 8
= Rs.88.88/share
A) Re = ?, if g = 15%
D1
IV =
Re - g
6.11
∴88.88 = ∴Re = 21.87%
Re - 0.15
B) If g = 16%
6.11
∴IV = = Rs.104.08/share
0.2287 − 0.16
C) If Re = 20%, g = 19%
6.11
∴IV = = Rs.611/share
0.20 − 0.19
Question 15
Nov 2011 - Paper - 5 Mark
A company has a book value per share of Rs. 137.80. Its return on equity is 15% and follows a policy
of retaining 60 percent of its annual earnings. If the opportunity cost of capital is 18 percent, what is
the price of its share?[adopt the perpetual growth model to arrive at your solution].
Solution :
EPS = 137.80 x 15% = 20.67
Dividend = 20.67 x 40% (Retention is 60%) = 8.268
G = br
= 60 x 15% = 9%
D1
IV =
Re - g
8.27
= = Rs.91.89/share
0.18 − 0.09
Question 16
May 2012 - RTP
The following data pertains to XYZ Inc. engaged in software consultancy business as on 31 December
2010
$ Million
Income from consultancy 935.00
EBIT 180.00
Less : Interest on Loan 18.00
EBT 162.00
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Tax @ 35% 56.70

105.30
Liabilities Amount Assets Amount
Equity share (10 million shares of Rs.10 100 Land and Building 200
each)
Reserves 325 Computers & Software 295
Bank Loan 180 Current Assets :
Creditors 180 Debtors 150
Bank 100
Cash 40
785 785
With the above information and following assumption you are required to compute
(a) Economic Value Added®
(b) Market Value Added.
Assuming that:
(i) WACC is 12%.
(ii) The share of company currently quoted at Rs. 50 each
Solution :
1) EVA = NOPAT – Cost of Capital
NOPAT = EBIT (1 – t)
= 180 (1 – 0.35)
= 117
Kc = Capital = 100 + 325 + 180 = 605
= 605 × 12% = 72.6
EVA = 117 – 72.6 = 44.4
2) MVA
MV BV
Equity Capital 500 100
Reserves - 325
Debt 180 180
Total 680 605
MVA = MV – BV
= 680 – 605
= 75
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Question 17
May 2012 - RTP
Following informations are available in respect of XYZ Ltd. which is expected to grow at a higher rate
for 4 years after which growth rate will stabilize at a lower level:
Base year information:
Revenue - Rs. 2,000 crores
EBIT - Rs. 300 crores
Capital expenditure - Rs. 280 crores
Depreciation - Rs. 200 crores
Information for high growth and stable growth period are as follows:
High Growth Stable Growth
Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and 20% Capital expenditure are
Depreciation offset by depreciation
Risk free rate 10% 9%
Equity beta 1.15 1
Market risk premium 6% 5%
Pre tax cost of debt 13% 12.86%
Debt equity ratio 1:1 2:3
For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm?
Solution :
1)
Satge 1 Ke Stage 2 Kc
Re = Rf + β(Rm – Rf) Re = 9 + 1 (5) = 14%
= 10 + 1.15 (6) Kd = 12.86 (1 – 0.3) = 9%
= 16.9% 2 3
Kc = 5 x 9 + 5 x 14 = 12%
Kd = i (1 – t) = 13 (1 – 0.3)
= 9.1%
Kc = Kc 0.5 x 9.1 + 0.5 x 16.9
= 13%
2) Stage 1
Base 1 2 3 4 5
1) NOPAT
EBIT 300 360 432 518.4 622.08 684.288
(300 + 20%) (622.08 + 10%)
-Tax (30%) 103 129.6 155.52 186.62 205.286
NOPAT 252 302.4 362.88 435.46 479
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2) Net
Invest
Capital Sp 280
–Dep 200 - - - -
i) 80 96 115.2 138 165.8 Nil
(80 + 10%)
Revenue 2000 2400 2880 3456 4147.2 4561.92
(2000 + 20%) (4147.2 + 10%)
WC 500 600 720 864 1036.8 1140.48
ii) ∆WC 100 120 144 172.8 103.68
NI(i +ii) 196 235.2 282 338.6 103.68
FCFF = (NOPAT – 56 67.2 80.88 96.856 375.32
NI)
PV @ 13% 49.56 52.61 56.05 59.4
Total = 217.63
3) Stage 2
FCFF5 375.32
V4 = = 0.12 - 0.1 = 18766
Kc - g
18766
V0 = = 11509.54
(1.13)4
Total = Stage 1 + Stage 2
= 217.63 + 11509.54 = Rs.11727.17
Question 18
May 2012 – RTP / Nov 2018 (New) - RTP
AB Limited’s shares are currently selling at Rs.130 per share. There are 10,00,000 shares outstanding.
The firm is planning to raise Rs.2 crores to Finance new project.
Required
What is the ex-right price of shares and value of a right, if.
(i) The firm offers one right share for every two shares held.
(ii) The firm offers one right share for every four shares held.
(iii) How does the shareholder’s wealth change from (i) to (ii)? How does right issue increase
shareholder’s wealth.
Solution :
1. Firm offer one right share for 2 shares held
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10,00,000
No of shares to be issued = = 5,00,000 shares
2
2,00,00,000
Subscription Price = = Rs. 40 / shares
5,00,000
Ex Right Price =
(10,00,000 × 130) + 2,00,00,000 = Rs.100
15,00,000
Value of Right = 100 – 40 = Rs. 60/share
2. Firm offer one right share for 2 shares held

10,00,000
No of shares to be issued = = 2,50,000 shares
4
2,00,00,000
Subscription Price = = Rs.80 / shares
2,50,000
13,00,00,000 + 2,00,00,000
Ex Right Price = = Rs.120
12,50,000
Value of Right = 120 – 80 = Rs. 40/share
3. Calculation of effect of right issue on shareholders wealth (Assuming he is holding 100 shares)
One share for 2 held One share for 4 held
Value of shares after right 15000 15000
(150 x 100) (125 x 120)
Less cost of right 2000 2000
(50 x 40) (25 x 80)
Net Value after right 13000 13000
Value before right 13000 13000
(100 x 130) (100 x 130)
Effect of right issue NIL NIL
Question 19
May 2012 - Paper - 6 Marks
In December, 2011 AB Co.'s share was sold for Rs. 146 per share. A long term earnings growth rate
of 7.5% is anticipated. AB Co. is expected to pay dividend of Rs. 3.36 per share.
(i) What rate of return an investor can expect to earn assuming that dividends are expected to
grow along with earnings at 7.5% per year in perpetuity?
(ii) It is expected that AB Co. will earn about 10% on book Equity and shall retain 60% of earnings.
In this case, whether, there would be any change in growth rate and cost of Equity?
25 | P a g e
Solution :
(i) According to Dividend Discount Model approach the firm’s expected or required return on
equity is computed as follows:
D
Re = 1 + g
P0
Where
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
3.36
Therefore Ke = 146 + 7.5 = 9.80%
(ii) With rate of return on retained earnings (r) 10% and retention ratio (b) 60%, new growth rate
will be as follows:
g = br i.e.
= 0.10 x 0.60 = 0.06
Accordingly dividend will also get changed and to calculate this, first we shall calculate
previous retention ratio (b1) and then EPS assuming that rate of return on retained earnings
(r) is same.
With previous Growth Rate of 7.5% and r =10% the retention ratio comes out to be:
0.075 =b1 X 0.10
b 1 = 0.75 and payout ratio = 0.25
With 0.25 payout ratio the EPS will be as follows:
3.36 = 13.44
0.25
With new 0.40 (1 – 0.60) payout ratio the new dividend will be
D 1 = 13.44 × 0.40 = 5.376
5.376
Accordingly new Ke will be ke = 146 + 6.0 Ke = 9.68%
Question 20
Nov 2012 – RTP / May 2018 (New) - RTP
BRS Inc deals in computer and IT hardwares and peripherals. The expected revenue for the next 8
years is as follows
Years Sales Revenue ($ Million)
1 8
2 10
3 15
4 22
5 30
6 26
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7 23
8 20
st
Summarized financial position as on 31 March 2012 was as follows
Liabilities Amount Assets Amount
Equity Stocks 12 Fixed Assets (Net) 17
12% Bond 8 Current Assets 3
20 20
Additional Information:
(a) Its variable expenses is 40% of sales revenue and fixed operating expenses (cash) are
estimated to be as follows:
Period Amount ($ Million)

1 – 4 years 1.6
5 – 8 years 2
(b) An additional advertisement and sales promotion campaign shah be launched requiring
expenditure as per following details:
1 year 0.50
2-3years 1.50
4-6years 3.00
7-8years 1.00
(c) Fixed Assets are subject to depreciation at 15% as per WDV method.
(d) The company has planned capital expenditure for the coming 8 years as follows
1 0.50
2 0.60
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00
(e) Investment in working capital to be 20% of Revenue
(f) Applicable tax rate for the company is 30%
(g) Cost of Equity is estimated to be 16%
(h) The free cash flows of the firm is expected to grow at 5% per annum after 8 years
With above information you are required to determine the
(i) Value of the firm
(ii) Value of Equity
27 | P a g e
Solution :
1) Working note for depreciation
Year 1 2 3 4 5 6 7 8
Assets Op. 17 14.875 13.15375 12.881 13.074 14.088 14.1 13.26
+ Cap.sp. 0.5 0.6 2 2.5 3.5 2.5 1.5 1
Assets 17.5 15.475 15.15375 15.381 16.57 16.588 15.6 14.26
- Dep. 2.625 2.32125 2.273 2.3071 2.486 2.488 2.34 2.139
Assets Clo. 14.875 13.15375 12.881 13.074 14.088 14.1 13.26 12.121
2) Kc = 16%
Kd = i(1 – t)
= 12(1 – 0.3)
= 8.4%
12 8
WACC = 20 × 16% + 20 × 8.4%
= 12.96%
3) Calculation for NOPAT

Year 1 2 3 4 5 6 7 8
Sales 8 10 15 22 30 26 23 20
VC 3.2 4 6 8.8 12 10.4 9.2 8
FC 1.6 1.6 1.6 1.6 2 2 2 2
Adv. 0.5 1.5 1.5 3 3 3 1 1
Dep. 2.625 2.32125 2.2730 2.3071 2.4860 2.488 2.34 2.139
EBIT 0.075 0.58 3.627 6.2929 10.514 8.112 8.46 6.861
tax (30%)
NOPAT 0.0525 0.405 2.538 4.405 7.359 5.678 5.922 4.8027
4) Calculation for Net Investments

Year 1 2 3 4 5 6 7 8
Cap. Sp. 0.5 0.6 2 2.5 3.5 2.5 1.5 1
-Dep. 2.625 2.32125 2.273 2.3071 2.4860 2.488 2.34 2.139
(2.125) (1.72125) (0.2730) 0.1929 1.012 0.01 (0.84) (1.139)
+∆WC 1.6 2 3 4.4 6 5.2 4.6 4
NI (0.525) 0.27875 2.727 4.5929 7.014 5.212 3.76 2.861
5) FCFF
Year 1 2 3 4 5 6 7 8
(NOPAT – 0.5775 0.13225 (0.189) (0.1879) 0.345 0.466 2.162 1.9417
NI)
28 | P a g e
PV @ 0.511 0.0989 (0.131) (0.115) 0.188 0.224 0.921 0.732

12.96%
Total = 2.4305
FCFF9
6) V8 = Kc - g
1.9417(1.05)
=
0.1296 − 0.05
= 25.612
25.612
V0 (Stage 2) = = 9.66
(1.1296)8
7) Value of firm = Stage I + Stage II

= 2.4305 + 9.6607
= 12.0912
= 12.09
Value of equity = Value of Firm – Value of Debt
= 12.09 – 8
= 4.09
Question 21
Nov 2012 Paper – 8 Marks
Tiger Ltd. is presently working with an Earning before Interest and Taxes (EBIT) of Rs.90 lakhs. Its
present borrowings are as follows
Rs.in lakhs
12% term Loan 300
Working Capital Borrowings
From Bank at 15% 200
Public Deposit at 11% 100
The sales of the company are growing and to support this, the company proposes to obtain additional
borrowing of Rs.100 lakhs expected to cost 16%.The increase in EBIT is expected to be 15%.
Calculate the change in interest coverage ratio after the additional borrowing is effected and
comment on the arrangement made.
Solution :
1) Calculation of Present Interest Coverage Ratio
Present EBIT = Rs.90 lakh
Interest charges (present) Rs.in lakhs
Term loan @ 12% 36.00
Bank Borrowing @ 15% 30.00
Public Deposit @ 11% 11.00
29 | P a g e
77.00
EBIT
Present Interest Coverage Ratio = Inerest Charges
Rs.90 lakhs
=
Rs.77 lakhs
= 1.169
2) Calculation of Revised Interest Coverage Ratio

Revised EBIT (115% of Rs.90 lakh) Rs.103.50 lakh
Proposed Interest Charges
Existing Interest Charges 77.00 lakh
(+) Additional charges
(16% of Additional Borrowing i.e. 100 lakhs 16.00 lakh
Total 93.00 lakh
Rs.103.50 lakhs
Revised Interest Coverage Ratio =
Rs.93.00 lakhs
= 1.113
Change in interest coverage ratio = 1.169 – 1.113 = 0.056
Note : Decrease in interest coverage ratio is adverse for entity.
Question 22
On the basis of the following information :
Current dividend (Do) = Rs.2.50
Discount rate (k) = 10.5%
Growth rate (g) = 2%
(i) Calculate the present value of stock of ABC Ltd.
(ii) Is its stock overvalued if stock price is Rs.35, ROE = 9% and EPS = Rs.2.25? Show detailed
calculation.
Solution :
(i) Present Value of the stock of ABC Ltd. is :
2.50(1.02)
V0 = = Rs.30/-
0.105 − 0.02
(ii) Value of stock under the PE Multiple Approach :
Particulars
Actual Stock Price Rs.35.00
Return on equity 9%
EPS Rs.2.25
PE Multiple (1/Return on Equity) = 1/9% 11.11
Market Price per Share Rs.25.00
30 | P a g e
Since, Actual Stock Price is higher, hence it is overvalued.
(iii) Value of the Stock under the Earnings Growth Model :

Particulars
Actual Stock Price Rs.35.00
Return on equity 9%
EPS Rs.2.25
Growth Rate 2%
Market Price per Share [EPS × (1 + g)]/(K e – g) Rs.32.79
= Rs.2.25 × 1.02/0.07
Since, Actual Stock Price is higher, hence it is overvalued.
Question 23
May 2014 - Paper – 5 Marks
MNP Ltd. has declared and paid annual dividend of Rs. 4 per share. It is expected to grow @ 20% for
the next two years and 10% thereafter. The required rate of return of equity investors is 15%.
Compute the current price at which equity shares should sell.
Note: Present Value Interest Factor (PVIF) @ 15%:
For year 1 = 0.8696;
For year 2 = 0.7561
Solution :
Stage 1 : Explicit Stage
Year Dividend PV of Dividend (15%
1 4.80 4.17408
2 5.76 4.355136
Total 8.529216
Stage 2 : Horizon Stage
D3 5.76 + 10%
IV 2 = = 0.15 - 0.1 = 126.72
Re − g
IV 0 = 126.72 x 0.7561 = 95.812992
Total IV = Stage 1 + Stage 2 = 8.529216 + 95.812992 = Rs.104.342208
Question 24
May 2014 Paper – 8 Marks / Nov 2020 (New) - RTP
Following information is given in respect of WXY Ltd., which is expected to grow at a rate of 20% p.a.
for the next three years, after which the growth rate will stabilize at 8% p.a. normal level, in
perpetuity.
For the year ended March 31, 2014
Revenues Rs. 7,500 Crores
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Cost of Goods Sold (COGS) Rs. 3,000 Crores

Operating Expenses Rs. 2,250 Crores
Capital Expenditure Rs. 750 Crores
Depreciation (included in COGS Rs. 600 Crores
& Operating Expenses)
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at 20% p.a.
and capital expenditure net of depreciation will grow at 15% p.a. From year 4 onwards, i.e. normal
growth period revenues and EBIT will grow at 8% p.a. and incremental capital expenditure will be
offset by the depreciation. During both high growth & normal growth period, net working capital
requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
Required: Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC methodology.
The PVIF @ 15 % for the three years are as below:
Year T1 T2 T3
PVIF 0.8696 0.7561 0.6575
Solution :
Working Note 1 :
FCFF = NOPAT – NI
(i) NOPAT = EBIT (I – t)
Year 1 Year 2 Year 3 Year 4
Revenue 9000.00 10800.00 12960.00 13996.80
Less : COGS 3600.00 4320.00 5184.00 5598.72
Less : Operating Expenses 1980.00 2376.00 2851.20 3079.30
Less : Depreciation 720.00 864.00 1036.80 1119.74
EBIT 2700.00 3240.00 3888.00 4199.04
Less : Tax (30%) 810.00 972.00 1166.40 1259.71
NOPAT 1890.00 2268.00 2721.60 2939.33
(ii) Net Investment = Capital Spending – Depreciation + Change in Working Capital
Base Year 1 Year 2 Year 3 Year 4

Capital Spending – Dep 172.50 198.38 228.13 –
Rev. 7500 9000 10800 12960 13996.80
Working Capital 1875 2250 2700 3240 3499.2
∆ Working Capital 375 450 540 259.2
(iii) FCFF
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Year 1 Year 2 Year 3 Year 4

NOPAT – NI 1342.50 1619.62 1953.47 2680.13
Stage 1 : Explicit
Year FCFF PV @ 15%
1 1342.50 1167.44
2 1619.62 1224.59
3 1953.47 1284.41
Total 3676.44
Stage 2 : Horizon Stage
FCFF4 2680.13
V3 = = 0.15−0.08 = 38287.57
Kc − g
38287.57
V0 = (1.15)3
= Rs.25174.08 Crore
Total Value of Firm
= Stage 1 + Stage 2 = 3676.44 + 25,174.70 = Rs.28,851.14 Crores
Question 25
RST Ltd.’s current financial year's income statement reported its net income as Rs.25,00,000. The
applicable corporate income tax rate is 30%.
Following is the capital structure of RST Ltd. at the end of current financial year:
Rs.
Debt (Coupon rate = 11%) 40 lakhs
Equity (Share Capital + Reserves & Surplus) 125 lakhs
Invested Capital 165 lakhs
Following data is given to estimate cost of equity capital:
Rs.
Beta of RST Ltd. 1.36
Risk –free rate i.e. current yield on Govt. bonds 8.5%
Average market risk premium (i.e. Excess of return on
market portfolio over risk-free rate) 9%
Required:
(i) Estimate Weighted Average Cost of Capital (WACC) of RST Ltd.; and
(ii) Estimate Economic Value Added (EVA) of RST Ltd
Solution :
(i) WACC
Cost of Equity as per CAPM
ke = Rf + β (Rm – Rf)
= 8.5% + 1.36 x 9%
= 8.5% + 12.24%
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= 20.74%
Cost of Debt
kd = 11%(1 – 0.30) = 7.70%
125 40
WACC = Wt Ke + Wt Kd = 20.74 x 165 + 7.70 x 165 = 17.58%
(ii) Economic Value Added
Net Profit Before Tax = 35,71,429 (25,00,000 × 100 / 70)
Add Interest = 4,40,000
EBIT = 40,11,429
EVA = Nopat – Kc (Amount
Nopat = EBIT (1 – t) = 40,11,429 (1-0.3) = 28,08,000
Kc (Amount) = 125,00,000 + 40,00,000) x 17.58% = 29,00,700
EVA = 28,08,000 – 29,00,700 = - 92,700
Question 26
Nov 2011 – RTP / May 2015 – RTP
ABC Ltd. has divisions A,B & C. The division C has recently reported on annual operating profit of
Rs.20,20,00,000. This figure arrived at after charging Rs.3 crores full cost of advertisement
expenditure for launching a new product. The benefits of this expenditure is expected to be lasted
for 3 years.
The cost of capital of division C is 11% and cost of debt is 8%.
The Net Assets (Invested Capital) of Division C as per latest Balance Sheet is Rs.60 crore, but
replacement cost of these assets is estimated at Rs. 84 crore.
You are required to compute EVA of the Division C.
Solution :
First necessary adjustment of the data as reported by historical accounting system shall be made as
follows:
Rs.
Operating Profit 20,20,00,000
Add: Cost of unutilized Advertisement Expenditures 2,00,00,000
22,20,00,000
Invested Capital (as per replacement cost) is Rs. 84 crore.
Accordingly, EVA = Operating Profit – (Invested Capital x Cost of Capital)
= Rs. 22,20,00,000 – Rs. 84 crore x 11%
= Rs. 22.2 crore – Rs. 9.24 crore
= Rs. 12.96 crore
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Question 27
Nov 2011 – RTP / Nov 2015 – RTP
Two companies A Ltd. and B Ltd. paid a dividend of Rs. 3.50 per share. Both are anticipating that
dividend shall grow @ 8%. The beta of A Ltd. and B Ltd. are 0.95 and 1.42 respectively.
The yield on GOI Bond is 7% and it is expected that stock market index shall increase at annual rate
of 13%. You are required to determine:
(a) Value of share of both companies.
(b) Why there is a difference in the value of shares of two companies.
(c) If current market price of share of A Ltd. and B Ltd. are Rs. 74 and Rs. 55 respectively. As an
investor what course of action should be followed?
Solution :
(a) First of all we shall compute Cost of Capital (Ke) of these companies using CAPM as follows:
Ke = Rf + β (RM – Rf)
Ke (A) = 7.00% + (13% -7%)0.95
= 7.00% + 5.70% = 12.7%
Ke (B) = 7.00% + (13% -7%)1.42
= 7.00% + 8.52% = 15.52%
(b) Value of shares
D1 3.5 + 8%
Va = Re - g = 0.127 - 0.08 = Rs. 80.43
D1 3.5 + 8%
Vb = Re - g = 0.1552 - 0.08 = Rs. 50.27
(c) The valuation of share of B Ltd. is lower because systematic risk is higher though both have
same growth rate.
(d) If the price of share of A Ltd. is Rs.74, the share is undervalued and it should be bought. If
price of share of B Ltd. is Rs.55, it is overvalued and should not be bought.
Question 28
Nov 2015 – Paper / May 2019 (Old) – RTP / May 2020 (Old) - RTP
X Ltd is a shoe manufacturing company. It is all equity financed and has a paid up capital of Rs.
10,00,000 @ 10 per share)
X Ltd. has hired swastika consultants to analyse the future earnings. The report of swastika
consultants states as follows :
(i) The earnings and dividend will grow at 25% for next two years
(ii) Earnings are likely to grow at the rate of 10% from 3rd year and onwards
(iii) Further, if there is reduction in earnings growth, dividend payout ratio will increase to 50%
The other data related to the company are as follows
Year EPS (Rs.) Dividend Per share (Rs.) Share Price (Rs.)
2010 6.30 2.52 63.00
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2011 7.00 2.80 46.00

2012 7.70 3.08 63.75
2013 8.40 3.36 68.75
2014 9.60 3.84 93.00
You may assume that the tax rate is 30% (not expected to change in future) and post tax cost of
capital is 15%
By using the Dividend Valuation Model, Calculate
(i) Expected Market Price per share
(ii) P.E. Ratio
Solution :
1) Stage 1 : Explicit Stage
On the basis of the information given, the following projection can be made:
Year EPS (Rs.) DPS (Rs.) PV of DPS @15%
2015 12.00 4.80 4.176
(9.60 x 125%) (3.84 x 125%)
2016 15.00 6.00 4.536
(12.00 x 125%) (4.80 x 125%)
2017 16.50 8.25* 5.429
(15.00 x 110%) (50% of Rs. 16.50)
14.141
*Payout Ratio changed to 50%.
Stage 2 : Horizon
After 2017, the perpetuity value assuming 10% constant annual growth is:
D4 = Rs. 8.25 × 110% = Rs. 9.075
D4 9.075
IV3 = Ke - g = 0.15 - 0.10 = 181.50
181.50
Iv0 = (1.15)3 = 119.43
Total IV = Stage 1 + Stage 2 = 14.141 + 119.43 = 133.57
MPS
2) PE Ratio =
EPS
133.57
=
9.60
= 13.91 times
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Question 29
May 2016 – Paper
XYZ Ltd. paid a dividend of 2 for the current year. The dividend is expected to grow at 40% for the
next 5 years and at 15% per annum thereafter. The return on 182 days T-bills is 11% per annum and
the market return is expected to be around 18% with a variance of 24%.
The co-variance of XYZ's return with that of the market is 30%. You are required to calculate the
required rate of return and intrinsic value of the stock.
Solution :
Covariance of Market return and Security return
β = Variance of Market return
30%
β = 24% = 1.25
Expected return = R f + β(R m − R f )
= 11% + 1.25(18% - 11%)
= 11% + 8.75%
= 19.75%
Intrinsic Value
Year Dividend (Rs.) Present Value (Rs.)
1 2.80 2.34
2 3.92 2.73
3 5.49 3.19
4 7.68 3.73
5 10.76 4.37
16.36
10.76(1.15)
IV 5 = 0.1975−0.15 = Rs.260.51
260.51
IV 0 = = 105.79
(1.1975)5
Intrinsic Value = Rs.16.36 + Rs.105.79
= Rs.122.15
Question 30
May 2016 – Paper
Kanpur Shoe Ltd. is having sluggish sales during the last few years resulting in drastic fall in market
share and profit. The marketing consultant has drawn out a new marketing strategy that will be valid
for next four years. If the new strategy is adopted, it is expected that sales will grow @ 20% per year
over the previous year for the coming two years and @ 30% from the third year. Other parameters
like gross profit margin, asset turnover ratio, the capital structure and the rate of Income tax @ 30%
will remain unchanged. Depreciation would be 10% of the net fixed assets at the beginning of the
year. The targeted return of the company is 15%.
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The financials of the company for the just concluded financial year 2015-16 are given below:
Income Statement Amount (Rs.)
Turnover 2,00,000
Gross margin (20%) 40,000
Admin, Selling & Distribution expense (10%) 20,000
PBT 20,000
Tax (30%) 6,000
PAT 14,000
Balance Sheet Information

Fixed Assets 80,000
Current Assets 40,000
Equity Share Capital 1,20,000
You are required to assess the incremental value that will accrue subsequent to the adoption of the
new marketing strategy and advise the Board accordingly.
PV @ 15% for 1, 2 & 3 years are: 0.870, 0.756, 0.658 respectively.
Solution :
1) Value of firm before strategy
PAT(FCFE) 14000
Vf = = = 93,333.33
Re 0.15
2) Value of firm after strategy
A) Stage 1
Year 1 2 3 4
PAT 16800 20160 26208 34070.4
(14000 + 20%) (20160 + 30%)
- NI 24000 28800 51840 67392
(120000 × (24,000 × 1.2) (120000 × 1.2 × (51840 × 1.3)
20%) 1.2 × 1.3 –
172800)
FCFE (7200) (8640) (25632) (33,321.6)
PV @ 15% (6260.87) (6533.08) (16853.46) (19051.73)
Total = (48,699.14)
B) Stage 2
FCFE 5 (PAT) 34070.4
Vf 4 = = = 227136
Re 0.15
227136
Vf 0 = = 129865.75
(1.15) 4
Total= 129865.75 – 48699.14 = 81,166.61
3) Value of strategy
= Value of firm after strategy = 81166.61
= Value of firm before strategy = 93333.33
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–12166.72
Note : Since value of strategy is negative it should not be implemented.
Question 31
Nov 2011 – Paper / May 2017 – RTP / May 2020 (New) - RTP
ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They want to know
the value of the new strategy. Following information relating to the year which has just ended, is
available:
Income Statement Rs.
Sales 20,000
Gross Margin (20%) 4,000
Administration, Selling & Distribution expenses (10%) 2,000
PBT 2,000
Tax (30%) 6000
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Equity 12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years. The gross
margin ratio, Assets turnover ratio, the Capital structure and the income tax rate will remain
unchanged.
Depreciation would be at 10% of net fixed a ssets at the beginning of the year.
The Company’s target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.
Solutions :
Value of Strategy
= Value of strategy firm After Strategy – Value of firm Before strategy
= 8,643.31 – 9,333.33 = - Rs 690.01 decision
Decision : Since the value of strategy is negative the firm should not implement the strategy.
A. Value of the firm before the strategy

𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 (𝑃𝑃𝑃𝑃𝑃𝑃) 1400
Vf = 𝑅𝑅𝑅𝑅
= 15%
= Rs 9,333.33
B. Value of the firm after the strategy

Stage 1 :
Years 1 2 3 5
FCFE
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1. PAT 1,680 2016 2419.2 2,419.2

(1400 + 20) (1,680 + 20%) (2016 + 20%) (constant)
2. NI 2400 2880 3456 Nil
(12,000 x 20%) (2,400 + 20%) (2880 + 20%) (no change)
FCFE (1 – 2) (720) (864) (1036.8) 2419.20
PV @15% (626.09) (653.31) (681.71)
Total (1961.11)
Stage 2
𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹4 2419.20
Vf3 = 𝑅𝑅𝑅𝑅
= 15%
= Rs 16,128
16,218
Vf0 = (1.15)3 = 10,604.42
Total Stage 1 + Stage 2 = 10,604.42 – 1961.11 = Rs 8643.31
Question 32
May 2017 – RTP / May 2018 (New) - Paper
Sunrise Limited last year paid dividend of Rs.20 per share with an annual growth rate of 9%. The risk-
free rate is 11% and the market rate of return is 15%. The company has a beta factor of 1.50.
However, due to the decision of the Board of Director to grow inorganically in the recent past beta is
likely to increase to 1.75.
You are required to find out under Capital Asset Pricing Model
(i) The present value of the share
(ii) The likely value of the share after the decision.
Solution :
The value of Cost of Equity with the help of CAPM
Ke = R f + β(R m - R f )
With the given data the Cost of Equity using CAPM will be:
Ke = 0.11 + 1.5(0.15 – 0.11)
Ke = 0.11 + 1.5(0.04)
= 0.17 or 17%
The value of share using the Growth Model:
D0 (1+g)
P = Ke −g
20(1+0.09)
P = 0.17−0.09
21.80
P = 0.08
= Rs.272.50
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However, if the decision of the Board of Directors is implemented, the beta factor is likely to
increase to 1.75.
Therefore,
Ke = 0.11 + 1.75(0.15 – 0.11)
Ke = 0.11 + 1.75(0.04)
= 18%
The value of share using the Growth Model:
D0 (1+g)
P = Ke −g
20(1+0.09)
P = 0.18−0.09
21.80
P = 0.09
= Rs.242.22
Question 33
May 2011 – RTP / May 2017 – RTP
Given below is the Balance Sheet of S Ltd. as on 31.3.2008:
Liabilities Rs. (in lakhs) Assets Rs. (in lakhs)
Share capital 100 Land and building 40
(share of Rs.10)
Reserves and surplus 40 Plant and machinery 80
Long Term Debts 30 Investments 10
Stock 20
Debtors 15
Cash at bank 5
Total 170 Total 170
You are required to work out the value of the Company's, shares on the basis of Net Assets method
and Profit-earning capacity (capitalization) method and arrive at the fair price of the shares, by
considering the following information:
(i) Profit for the current year Rs.64 lakhs includes Rs.4 lakhs extraordinary income and Rs.1 lakh
income from investments of surplus funds; such surplus funds are unlikely to recur.
(ii) In subsequent years, additional advertisement expenses of Rs.5 lakhs are expected to be
incurred each year.
(iii) Market value of Land and Building and Plant and Machinery have been ascertained at Rs.96
lakhs and Rs.100 lakhs respectively. This will entail additional depreciation of Rs.6 lakhs each
year.
(iv) Effective Income-tax rate is 30%.
(v) The capitalization rate applicable to similar businesses is 15%.
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Solution :
Rs.in Lakhs
Net Assets Method
Assets: Land & Buildings 96
Plant & Machinery 100
Investments 10
Stocks 20
Debtors 15
Cash & Bank 5
Total Assets 246
Less: Long Term Debts 30
Net Assets 216
Value per share
1,00,00,000
(i) Number of shares 10
= 10,00,000
(ii) Net Assets Rs.2,16,00,000
Rs.2,16,00,000
10,00,000
= Rs.21.6
Profit – Earning Capacity Method Rs.in lakhs

Profit before tax 64.00
Less : Extraordinary income 4.00
Investment income (not likely to recur) 1.00 5.00
59.00
Less : Additional expenses in forthcoming years
Advertisement 5.00
Depreciation 6.00 11.00
Expected earnings before taxes 48.00
Less: Income - tax @ 30% 14.40
Future maintainable profits (after taxes) 33.60
Value of business
33.60
Capitalisation factor = 0.15
= 224
Value per share

224
10
= Rs.22.40
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Fair Price of share Rs.

Value as per Net Assets Method 21.60
Value as per Profit earning capacity (Capitalisation) method 22.4
21.6+22.4
Fair Price = Rs.22/sh.
2
Question 34
Nov 2017 – RTP
T Ltd. Recently made a profit of Rs.50 crore and paid out Rs.40 crore (slightly higher than the average
paid in the industry to which it pertains). The average PE ratio of this industry is 9. As per Balance
Sheet of T Ltd., the shareholder’s fund is Rs.225 crore and number of shares is 10 crore. In case
company is liquidated, building would fetch Rs.100 crore more than book value and stock would
realize Rs.25 crore less.
The other data for the industry is as follows:
Projected Dividend Growth 4%
Risk Free Rate of Return 6%
Market Rate of Return 11%
Average Dividend Yield 6%
The estimated beta of T Ltd. is 1.2. You are required to calculate valuation of T Ltd. using
(i) P/E Ratio
(ii) Dividend Yield
(iii) Valuation as per:
a) Dividend Growth Model
b) Book Value
c) Net Realizable Value
Solution :
(i) Rs.50 crore x 9 = Rs.450 crore
0.80
(ii) Rs.50 crore x 0.06 = Rs.666.70
= 0.060.80
(iii) (a) Ke = 6% + 1.2 (11% - 6%) = 12%
𝟒𝟒𝟒𝟒 𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜 𝐱𝐱 𝟏𝟏.𝟎𝟎𝟎𝟎
Value of firm = 𝟎𝟎.𝟏𝟏𝟏𝟏−𝟎𝟎.𝟎𝟎𝟎𝟎
= Rs.520 crore
(b) Rs.225 crore
(c) Rs.225 crore + Rs.100 crore – Rs.25 crore = 300 crore
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Question 35
Nov 2017 – Paper
Sea Rock Ltd. has an excess cash of Rs.30,00,000 which it wants to invest in short-term marketable
securities.
(i) Expenses resulting to investment will be Rs.45,000. The securities invested will have an annual
yield of 10%. The company seeks your advice as to the period of investment so as to earn a
pre-tax income of 6%.
(ii) Also find the minimum period for the company to break-even its investment expenditure.
Ignore time value of money
Solution :
(i) Pre-tax Income required on investment of Rs.30,00,000 is Rs.1,80,000.
Let the period of Investment be ‘P’ and return required on investment Rs.1,80,000
(Rs.30,00,000 x 6%)
Accordingly,
10 P
(Rs.30,00,000 x 100x 12) – Rs.45,000 = Rs.1,80,000
P = 9 months
(ii) Break-Even its investment expenditure

10 P
(Rs.30,00,000 x 100x 12) – Rs.45,000 = 0
P = 1.80 months
Question 36
May 2018 – RTP
SAM Ltd. has just paid a dividend of Rs.2 per share and it is expected to grow @ 6% p.a. After paying
dividend, the Board declared to take up a project by retaining the next three annual dividends. It is
expected that this project is of same risk as the existing projects. The results of this project will start
coming from the 4th year onward from now. The dividends will then be Rs.2.50 per share and will
grow @ 7% p.a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of at least Rs.2,000 p.a. from this
investment.
Show that the market value of the share is affected by the decision of the Board. Also show as to how
the investor can maintain his target receipt from the investment for first 3 years and improved
income thereafter, given that the cost of capital of the firm is 8%.
Solution :
D1
Value of share at present = K
e −g
2(1.06)
= 0.08−0.06 = Rs.106
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However, if the Board implement its decision, no dividend would be payable for 3 years and the
dividend for year 4 would be Rs.2.50 and growing at 7% p.a. The price of the share, in this case, now
would be:
2.50 1
P0 = 0.08−0.07 × (1+0.08)3 = Rs.198.46
So, the price of the share is expected to increase from Rs.106 to Rs.198.45 after the announcement
of the project. The investor can take up this situation as follows:
Expected market price after 3 years 𝟐𝟐.𝟓𝟓𝟓𝟓 Rs.250.00
= 𝟎𝟎.𝟎𝟎𝟎𝟎−𝟎𝟎.𝟎𝟎𝟎𝟎
Expected market price after 2 years 𝟐𝟐.𝟓𝟓𝟓𝟓 𝟏𝟏 Rs.231.48

× (𝟏𝟏+𝟎𝟎.𝟎𝟎𝟎𝟎)
𝟎𝟎.𝟎𝟎𝟎𝟎−𝟎𝟎.𝟎𝟎𝟎𝟎
Expected market price after 1 years 𝟐𝟐.𝟓𝟓𝟓𝟓 𝟏𝟏 Rs.214.33

x (𝟏𝟏+𝟎𝟎.𝟎𝟎𝟎𝟎)𝟐𝟐
𝟎𝟎.𝟎𝟎𝟎𝟎−𝟎𝟎.𝟎𝟎𝟎𝟎
In order to maintain his receipt at Rs.2,000 for first 3 year, he would sell
10 shares in 1st year @ Rs.214.33 for Rs.2,143.30
st
9 shares in 1 year @ Rs.231.48 for Rs.2,083.32
st
8 shares in 1 year @ Rs.250 for Rs.2,000.00
At the end of 3rd year, he would be having 973 shares valued @ Rs.250 each i.e. Rs.2,43,250. On
these 973 shares, his dividend income for year 4 would be @ Rs.2.50 i.e. Rs.2,432.50.
So, if the project is taken up by the company, the investor would be able to maintain his receipt of at
least Rs.2,000 for first three years and would be getting increased income thereafter.
Question 37
May 2010 – RTP / May 2018 (New) – Paper
Herbal World is a small, but profitable producer of beauty cosmetics using the plant Aloe Vera.
Though it is not a high-tech business, yet Herbal's earnings have averaged around Rs.18.5 lakh after
tax, mainly on the strength of its patented beauty cream to remove the pimples.
The patent has nine years to run, and Herbal has been offered Rs.50 lakhs for the patent rights.
Herbal's assets include Rs.50 lakhs of property, plant and equipment and Rs.25 lakhs of working
capital. However, the patent is not shown in the books of Herbal World. Assuming Herbal's cost of
capital being 14 percent, calculate its Economic Value Added (EVA).
Solution :
EVA = NOPATA – WACC x Capital Employed.
Capital Employed Rs.lacs
Property, etc. 50
Working Capital 25
Patent Value 50
Effective or Invested Capital 125
WACC x CE = 14% x Rs.125 lacs = Rs.17.5 lacs
EVA = Rs.18.5 lacs – Rs.17.5 lacs = Rs.1 lac
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Question 38
May 2010 – RTP / Nov 2010 – Paper / May 2014 – RTP / Nov 2014 – RTP / May 2018 (New) – Paper
/ Nov 2019 (New) – RTP / Nov 2019 (Old) - RTP
An established company is going to be de merged in two separate entities. The valuation of the
company is done by a well-known analyst. He has estimated a value of Rs.5,000 lakhs, based on the
expected free cash flow for next year of Rs.200 lakhs and an expected growth rate of 5%. While going
through the valuation procedure, it was found that the analyst has made the mistake of using the
book values of debt and equity in his calculation. While you do not know the book value weights he
used, you have been provided with the following information:
(i) The market value of equity is 4 times the book value of equity, while the market value of debt
is equal to the book value of debt,
(ii) Company has a cost of equity of 12%,
(iii) After tax cost of debt is 6%.
You are required to advise the correct value of the company.
Solution :
FCFF1
Value of the Company = ,
Kc − g
200
5000 =
Kc − 0.05
Kc = 9%
We do not know the weights the analyst had taken for arriving at the cost of capital. Let w be the
proportion of equity. Then, (1-w) will be the proportion of debt.
Kc = 9 = w x 12 + (1-w) x 6
9 = 6 + 6w
6w =3
Hence w = 3/ 6 = 0.5 = 50 % or 1:1
The weights are equal i.e. 1:1 for equity and debt.
The correct weights should be market value of equity : market value of debts.
i.e. 4 times book value of equity : book value of debts. i.e. 4:1 equity : debt
Revised Kc = 4/5 x 12 + 1/5 x 6= 10.8 %
200
Revised value of the company = 10.8−5 = 200 / 5.8% = 3448.28 lacs.
Question 39
Nov 2014 – Paper / May 2018 (New) – Paper
The risk free rate of return is 5 percent. The expected rate of return on the market portfolio is 11
percent. The expected rate of growth in dividend of X Ltd. is 8 percent. The last dividend paid was
Rs.2.00 per share. The beta of X Ltd. equity stock is 1.5
(i) What is the present price of the equity stock of X Ltd.?
(ii) How would the price change when
46 | P a g e
• The inflation premium increases by 3 percent?

• The expected growth rate decreases by 3 percent?
• The beta decreases to 1.3?
Solution :
(i) Present Price of Stock
Re = Rf + β(Rm - Rf)
= 5 + 1.5(11 - 5)
= 5 + 9= 14%
D1 2.00(1.08)
IV = Re - g = 0.14−0.08 = Rs.36/share
(ii) Inflation premium = 3%

Rf = 5 x 1.03 = 5.15%
g = 8 – 3 = 5%
β = 1.3
Re = 5.15 + 1.3(11 – 5.15) = 12.755%
D1 2.00(1.05)
IV = Re - g = 0.12755−0.05 = Rs.27.81/share
Question 40
May 2018 (Old) – Paper
Constant Engineering Ltd. has developed a high tech product which has reduced the Carbon emission
from the burning of the fossil fuel. The product is in high demand. The product has been patented
and has a market value of Rs.100 Crore, which is not recorded in the books. The Net Worth (NW) of
Constant Engineering Ltd. is Rs.200 Crore. Long term debt is Rs.400 Crore. The product generates a
revenue of Rs.84 Crore. The rate on 365 days Government bond is 10 percent per annum. Bond
portfolio generates a return of 12 percent per annum. The stock of the company moves in tandem
with the market. Calculate Economic Value added of the company.
Solution :
EVA = NOPAT – Kc.
= 85 – 75.95
= Rs.8.05 Cr.
a) Kc
Total Investments
Rs. Cr.
Net Worth 200
Long Term debt 400
Patent Rights 100
700
47 | P a g e
Kc = wtKe + wtKd
300 400
= × 12 + × 10 = 10.85%
700 700
∴ke = 700 × 10.85% = 75.95
b) NOPAT = Rs.85 Crore
Question 41
Nov 2018 (Old) – RTP
Pragya Limited has issued 75,000 equity shares of Rs.10 each. The current market price per share is
Rs.24. The company has a plan to make a rights issue of one new equity share at a price of Rs.16 for
every four share held.
(i) Calculate the theoretical post-rights price per share;
(ii) Calculate the theoretical value of the right alone;
(iii) Show the effect of the rights issue on the wealth of a shareholder, who has 1,000 shares
assuming he sells the entire rights @ Rs6.4/share; and
(iv) Show the effect, if the same shareholder does not take any action and ignores the issue.
Solution :
(i) Calculation of theoretical Post-rights (ex-right) price per share:
𝐌𝐌𝐌𝐌+𝐒𝐒𝐒𝐒
Ex-Right Value = � 𝐍𝐍+𝐑𝐑
�
Where,
M = Market price,
N = Number of old shares for a right share
S = Subscription price
R = Right share offer
(𝟐𝟐𝟐𝟐 𝐱𝐱 𝟒𝟒)+(𝟏𝟏𝟏𝟏 𝐱𝐱 𝟏𝟏)
=� 𝟒𝟒+𝟏𝟏
� = Rs.22.40
(ii) Calculation of theoretical value of the rights alone:

= Ex-right price – Cost of rights share
= Rs.22.40 – Rs.16
= Rs.6.40
(iii) Calculation of effect of the rights issue on the wealth of a shareholder who has 1,000 shares
assuming he sells the entire rights:
Rs.
(a) Value of shares before right issue 24,000
(1,000 shares × Rs.24)
(b) Value of shares after right issue 22,400
(1,000 shares × Rs.22.40)
48 | P a g e
Add: Sale proceeds of rights renunciation

(250 shares × Rs.6.40) 1,600
24,000
There is no change in the wealth of the shareholder even if he sells his right.
(iv) Calculation of effect if the shareholder does not take any action and ignores the issue:
Rs.
Value of shares before right issue 24,000
(1,000 shares × Rs.24)
Value of shares after right issue 22,400
(1,000 shares × Rs.22.40)
Loss of wealth to shareholders, if rights ignored 1,600
Question 42
May 2013 – Paper / Nov 2018 (Old) – RTP
X Limited, just declared a dividend of Rs.14.00 per share. Mr. B is planning to purchase the share of
X Limited, anticipating increase in growth rate from 8% to 9%, which will continue for three years. He
also expects the market price of this share to be Rs.360.00 after three years.
You are required to determine:
(i) the maximum amount Mr. B should pay for shares, if he requires a rate of return of 13% per
annum.
(ii) the maximum price Mr. B will be willing to pay for share, if he is of the opinion that the 9%
growth can be maintained indefinitely and require 13% rate of return per annum.
(iii) the price of share at the end of three years, if 9% growth rate is achieved and assuming other
conditions remaining same as in (ii) above.
Calculate rupee amount up to two decimal points.
Year 1 Year 2 Year 3
FVIF @ 9% 1.090 1.188 1.295
FVIF @ 13% 1.130 1.277 1.443
FVIF @ 13% 0.885 0.783 0.693
Solution :
1. The maximum amount Mr B. should pay for shares, if he requires a rate of return of 13% PA
Stage 1 :
Years Dividend (Growth of 9%) PV @ 13%
1 15.26 13.50
2 16.63 13.02
49 | P a g e
3 18.13 12.56
Total 39.08
Stage 2 :
IV3 = 360
𝟑𝟑𝟑𝟑𝟑𝟑
IV0 = (𝟏𝟏.𝟏𝟏𝟏𝟏)𝟑𝟑 = 249.50
Total IV = 39.08 + 249.50 = 288.58
2. The maximum price Mr. B will be willing to pay for share, if he is of the opinion that the 9%
growth can be maintained indefinitely and requires 13% rate of return
𝑫𝑫𝑫𝑫 𝟏𝟏𝟏𝟏(𝟏𝟏.𝟎𝟎𝟎𝟎)
IV = 𝑹𝑹𝑹𝑹−𝑮𝑮 = 𝟎𝟎.𝟏𝟏𝟏𝟏−𝟎𝟎.𝟎𝟎𝟎𝟎 = Rs 381.5 per shares
3. The price of the share at the end of 3 years, if 9% growth rate is achieved and assuming other
conditions remaining same in (ii) above
𝑫𝑫𝑫𝑫 𝟏𝟏𝟏𝟏.𝟏𝟏𝟏𝟏(𝟏𝟏.𝟎𝟎𝟎𝟎)
IV3 = 𝑹𝑹𝑹𝑹−𝑮𝑮 = 𝟎𝟎.𝟏𝟏𝟏𝟏−𝟎𝟎.𝟎𝟎𝟎𝟎
= Rs 494.0425 per shares
Question 43
Nov 2018 (Old) – Paper
Eager Ltd. has a market capitalization of Rs.1,500 crores and the current market price of its share is
Rs.1,500. It made a PAT of 200 crores and the Board is considering a proposal to buy back 20% of the
shares at a premium of 10% to the current market price. It plans to fund this through a 16% bank
loan. You are required to calculate the post buy back Earnings Per Share (EPS). The company’s
corporate tax rate is 30%
Solution :
A. Market Cap = 1500
B. MPS = 1500
C. No (Cap/MPS) = 1 crore
D. No. of shares to be brought back = 1 x 0.2 = 0.2 crore
E. Funds needed = 0.20 x 1650 (1500 + 10%) = 330 crore
F. Interest post tax = 330 x 16% x 70% = 36.96
G. PAT after buy back = 200 – 36.96 = 163.04
PAT 163.04
H. EPS = No
= 0.8
= Rs.203.80
50 | P a g e
Question 44
A company has an EPS of Rs.2.5 for the last year and the DPS of Rs.1. The earnings is expected to
grow at 2% a year in long run. Currently it is trading at 7 times its earnings. If required rate of return
is 14%, compute the following:
(i) An estimate of the P/E ratio using Gordon growth model.
(ii) The Long term growth rate implied by the current P/E ratio.
Solution :
1. PE using Gordon growth
D1 1(1.02)
IV = R = 0.14−0.02 = 8.5
e −g
MPS 8.5
PE = EPS
= 2.5 = 3.4 times
2. Current PE = 7 times
∴MPS = 2.5 x 7 = 17.5
Assuming market is at equilibrium
1(1+g)
17.5 = 0.14−g
2.45 – 17.5g = 1 + 1g
1.45 = 18.5g
∴g = 7.84%
Question 45
AMKO limited has issued 75,000 equity shares of Rs.10 each. The current market price per share is
Rs.36. The company has a plan to make a rights issue of one new equity share at a price of Rs.24 for
every four shares held.
(i) Calculate the theoretical post rights price per share
(ii) Calculate the theoretical value of the rights alone.
Solution :
75000
1. No. of shares to be issued = 4
= 18750
2. Priced at Rs.24
(75000 x 36)+(18750 x 24)
3. Ex Right Price = 75000+18750
27,00,000+4,50,000
= 93,750
= Rs.33.6
4. Value of Right = 33.6 – 24

= 9.6
51 | P a g e
Question 46
Nov 2012 – Paper – 8 Marks / Nov 2016 – Paper / Nov 2018 (New) – RTP / May 2019 (Old) - Paper
Eagle Ltd. reported a profit of Rs.77 lakhs after 30% tax for the financial year 2016-17. An analysis of
the accounts revealed that the income included extraordinary items of Rs.8 lakhs and an
extraordinary loss of Rs.10 lakhs. The existing operations, except for the extraordinary items, are
expected to continue in the future. In addition, the results of the launch of a new product are
expected to be as follows:
Rs.in lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10
(i) CALCULATE the value of the business, given that the capitalization rate is 14%.
(iii) CALCULATE the market price per equity share, assuming Eagle Ltd.‘s share capital being
comprised of 1,00,000 13% preference shares of Rs.100 each and 50,00,000 equity shares of
Rs.10 each and the P/E ratio being 10 times.
Solution :
(i) Computation of Business Value
Rs.in lakhs
Profit before tax (77/1-0.30) 110
Less: Extraordinary income (8)
Add: Extraordinary losses 10
112
Profit from new product Rs.in lakhs
Sales 70
Less: Material costs 20
Labour costs 12
Fixed costs 10 (42) 28
140.00
Less: Taxed @ 30% 42.00
Future Maintainable Profits after taxes 98.00
Relevant Capitalisation Factor 0.14
Value of Business (Rs.98/0.14) 700
(ii) Computation of Market Price of Equity Share

Future Maintainable profits (After Tax) Rs.98,00,000
Less: Preference share dividends 1,00,000 shares of Rs.100 @ Rs.13,00,000
13%
52 | P a g e
Earnings available for Equity Shareholders Rs.85,00,000

No. of Equity Shares 50,00,000
𝐑𝐑𝐑𝐑.𝟖𝟖𝟖𝟖,𝟎𝟎𝟎𝟎,𝟎𝟎𝟎𝟎𝟎𝟎 Rs.1.70
Earnings per share = 𝟓𝟓𝟓𝟓,𝟎𝟎𝟎𝟎,𝟎𝟎𝟎𝟎𝟎𝟎
PE ratio 10
Market Price per share Rs.17
Question 47
Nov 2018 (New) – Paper
Income statement for the year ended 31st March, 2018
Particulars Amount
Sales 40,000
Gross Profit 12,000
Administrative Expenses 6,000
Profit Before Tax 6,000
Tax @ 30% 1,800
Profit After Tax 4,200
Balance sheet as on 31st March, 2018

Particulars Amount
Fixed Assets 10,000
Total 16,000
Equity share capital 15,000
Sundry Creditors 1,000
Total 16,000
The company is contemplating for new sales strategy as follows
1. Sales to grow by 30% per year for next 4 years
2. Assets turnover ratio, net profit ratio and tax rate will remain the same
3. Depreciation will be 15% of value of Asset at the beginning of the year
4. Required rate of return for the company is 15%
Evaluate the viability of new strategy
Solution :
1. Value of firm before strategy
𝐅𝐅𝐅𝐅𝐅𝐅𝐅𝐅 𝐏𝐏𝐏𝐏𝐏𝐏 𝟒𝟒𝟒𝟒𝟒𝟒𝟒𝟒
VF = 𝐊𝐊 𝐞𝐞
= 𝐊𝐊 𝐞𝐞
= 𝟏𝟏𝟏𝟏%
= Rs.28,000
2. Value of firm after strategy
Stage 1
53 | P a g e
Year 1 2 3 4 5
PAT 5460 7098 9227.4 11995.62 11995.62
- NI 4500 5850 7605 9886.5 -
(⧍ in capital Employed)
FCFE 960 1248 1622.5 2109.12 11995.62

PV @ 15% 834.78 943.67 1066.82 1205.90 -
Total = 4051.17
Stage 2
𝐅𝐅𝐅𝐅𝐅𝐅𝐅𝐅 (𝐏𝐏𝐏𝐏𝐏𝐏) 𝟏𝟏𝟏𝟏𝟏𝟏𝟏𝟏𝟏𝟏.𝟔𝟔𝟔𝟔
VF4 = 𝐊𝐊 𝐞𝐞
= 𝟎𝟎.𝟏𝟏𝟏𝟏
= 79,970.8
𝟕𝟕𝟕𝟕𝟕𝟕𝟕𝟕𝟕𝟕.𝟖𝟖
VF0 = (𝟏𝟏.𝟏𝟏𝟏𝟏)𝟒𝟒
= 45,723.56
Total IV = 4,051.17 + 45,723.56 = 49,774.73
3. Value of Strategy = 49,774.73 – 28,000
= 21,774.74
Note: Since the value of strategy is positive we should implement the strategy.
Question 48
May 2019 (New) – RTP
Seawell Corporation, a manufacturer of do-it-yourself hardware and housewares, reported earnings
per share of € 2.10 in 2013, on which it paid dividends per share of €0.69. Earnings are expected to
grow 15% a year from 2004 to 2008, during this period the dividend payout ratio is expected to
remain unchanged. After 2018, the earnings growth rate is expected to drop to a stable rate of 6%,
and the payout ratio is expected to increase to 65% of earnings. The firm has a beta of 1.40 currently,
and is expected to have a beta of 1.10 after 2018. The market risk premium is 5.5%. The Treasury
bond rate is 6.25%.
(a) What is the expected price of the stock at the end of 2018?
(b) What is the value of the stock, using the two-stage dividend discount model?
Solution :
1) Calculation of Re
(a) Stage 1
Re = Rf + β(Rm – Rf)
= 6.25 + 1.14(5.5) = 13.95%
Stage 2
= 6.25 + 1.1(5.5) = 12.3
(b) Stage 1
Year EPS DPS @32.857% PV @13.95%
2014 2.415 0.7935 0.696
54 | P a g e
2015 2.777 0.9125 0.703

2016 3.194 1.049 0.709
2017 3.673 1.207 0.716
2018 4.224 1.388 0.722
3.546
(c) Stage 2
4.224 × 1.06 × 0.65
Vf 18 = = 46.195
0.123 − 0.06
46.196
Vf 13 = = 24.045
(1.1395)5
(d) Total IV = 24.045 + 3.546
= 27.59
2) Calculation of Payout Ratio

0.69
= × 100 = 32.857%
2.10
Question 49
Nov 2014 – Paper / May 2019 (New) – RTP
The valuation of Hansel Limited has been done by an investment analyst. Based on an expected free
cash flow of Rs.54 lakhs for the following year and an expected growth rate of 9 percent, the analyst
has estimated the value of Hansel Limited to be Rs.1800 lakhs. However, he committed a mistake of
using the book values of debt and equity. The book value weights employed by the analyst are not
known, but you know that Hansel Limited has a cost of equity of 20 percent and post tax cost of debt
of 10 percent. The value of equity is thrice its book value, whereas the market value of its debt is
ninetenths of its book value. What is the correct value of Hansel Ltd?
Solution :
FCFF1
1) Vf =
Kc − g
54
1800 =
Kc − 0.09
∴Kc = 12%
2) Let the wt for debt be x
∴Equity =1–x
10x + 20(1 – x) = 12
10x + 20 – 20x = 12
∴x = 0.8
1–x = 0.2
3) The above were book value with the market value wts shall be
55 | P a g e
Debt 0.8 × 0.9 = 0.72

Equity 0.2 × 3 = 0.6
1 1.32
4) Kc based on market value wts
0.6 0.72
= 20 × + 10 × = 14.545%
1.32 1.32
FCFF1 54
5) Vf = = = Rs.973.85
Kc − g 0.14545 - 0.09
Question 50
May 2019 (New) – Paper
Compute Economic Value Added (EVA) of Goodluck Ltd. From the following information :
Profit & Loss Statement
Particulars Rs. In Lakhs
(a) Income -
Revenue from Operations 2,000
(b) Expenses -
Direct Expenses 800
Indirect Expenses 400
(c) Profit before interest & tax (a - b) 800
(d) Interest 30
(e) profit before tax (c - d) 770
(f) Tax 231
(g) Profit after tax (e - f) 539
Balance Sheet
Particulars Rs. In Lakhs
Equity and Liabilities :
(a) Shareholders' Fund -
Equity Share Capital 1,000
Reserves & Surplus 600
(b) Non - Current Liabilities -
Long Term Borrowings 200
(c) Current Liabilities 800
Total 2,600
Assets :
(a) Non - Current Assets 2,000
(b) Current Assets 600
Total 2,600
56 | P a g e
Other Information :
(1) Cost of Debts is 15%.
(2) Cost of Equity (i.e. shareholders’ expected return) is 12%
(3) Tax Rate is 30%
(4) Bad Debts Provision of Rs.40 lakhs is included in indirect expenses and Rs.40 lakhs reduced
from receivables in current assets.
Solution :
EVA = NOPAT – Kc
= 609 – 217.86
= Rs.391.14 lakhs
W.N.1. NOPAT = EBIT – Tax + Non Cash Expenses

= 800 – 231 + 40 = 609
W.N.2. Kc(%)
Capital Invested Amt. Cost
Equity (1,000 + 600) 1,600 12%
Debt 200 15%
1,600 200
Kc = × 12 + × 15% (1 – 0.3) = 11.84%
1,800 1,800
W.N.3. Kc (Amt.)
= 1,800 + 40 (No Cash Expense) × 11.84% = 217.86
Question 51
The shares of G Ltd. Are currently being traded at Rs.46. The company published its results for the
year ended 31st March 2019 and declared a dividend of Rs.5. The company made a return of 15% on
its capital and expects that to be the norm in which it operates. G Ltd. Also expects the dividends to
grow at 10% for the first three years and thereafter at 5%.
You are required to advise whether the share of the company is being traded at premium or discount.
PVIF @ 15% for the next 3 years is 0.870, 0.756 and 0.658 respectively.
Solution :
1) Stage 1
Year Div PV @15%
1 5.5 4.78
2 6.05 4.57
3 6.655 4.38
57 | P a g e
13.73
2) Stage 2
D4 6.655(1.05)
IV 3 = = = 69.8775
Re − g 0.15 − 0.05
69.8775
IV 0 = = 45.95
(1.15)3
Total IV = 45.95 + 13.73 = 59.68
Advise : Since MP = 46, the stock is under priced and investor should go long.
Question 52
ABB Ltd. has a surplus cash balance of Rs.180 lakhs and wants to distribute 50% of it to the equity
shareholders. The company decides to buyback equity shares. The company estimates that its equity
share price after re-purchase is likely to be 15% above the buyback price. If the buyback route is
taken.
Other information is as under:
1. Number of equity shares outstanding at present (Face value Rs.10 each) is Rs.20 lakhs.
2. The current EPS is Rs.5.
You are required to calculate the following:
I. The price at which the equity shares can be re-purchased, if market capitalization of the
company should be Rs.400 lakhs after buy back.
II. Number of equity shares that can be re-purchased.
III. The impact of equity shares re-purchase on the EPS, assuming that the net income remains
unchanged.
Solution :
(i) Let P be the buyback price decided by ABB Ltd.
Market Capitalisation after Buyback
400 lakhs = 1.15P (Original Shares – Shares Bought Back)
 50% of 180 lakhs 
=  20lakhs − 
 P 
= 23 lakhs × P – 90 lakhs × 1.15
= 23 lakhs P – 130.50 lakhs
Again, 23 lakhs P – 130.50 lakhs
or 23 lakhs P = 400 lakhs + 130.50 lakhs
503.50
or P = = Rs.21.89 per share
23
(ii) Number of Shares to be Bought Back :-
Rs. 90 lakhs/ 21.89 = 4.111 lakhs (Approx.) or 411147 shares
(iii) Shares after buyback
58 | P a g e
= 20 lakhs – 4.111 lakhs = 15.889 lakhs

or 20,00,000 – 4,11,147 = 15,88,853 shares
∴EPS = 5 × 20 lakhs/ 15.889 lakhs = Rs.6.29
Thus, EPS of ABB Ltd., increases to Rs.6.29.
So, EPS of ABB Ltd. is increased by Rs.1.29 (6.29 – 5.00)
Question 53
Equity of KGF Ltd. (KGFL) is Rs.410 Crores, its debt is worth Rs.170 Crores. Printer Division segments
value is attributable to 74%, which has an Asset Beta (β P ) of 1.45, balance value is applied on Spares
and Consumables Division, which has an Asset beta (β SC ) of 1.20 KGFL Debt beta (β D ) is 0.24.
You are required to calculate :
(i) Equity Beta (β E ).
(ii) Ascertain Equity Beta (β E ). If KFG Ltd. decides to change its Debt Equity position by raising
further debt and buying back of equity to have its Debt Equity Ratio at 1.90. Assume that the
present Debt Beta (β D1 ) is 0.35 and any further funds raised by way of Debt will have a Beta
(β D2 ) of 0.40.
(iii) Whether the new Equity Beta (β E ) justifies increase in the value of equity on account of
leverage?
Solution :
A) βA = βL
βA = 1.45 ×74% + 1.2 × 26% = 1.385
βL = 1.385
βL = w + βE + w + βD
170 410
1.385 = × 0.24 + βE
580 580
1.314655 = 0.70689655 β E
∴β E = 1.860
B) β E = ? New Debt : Equity = 1.90, β D = 0.35 New β D = 0.40
Existing capital = 580
Existing Debt = 170
New Debt Equity = 1.9 : 1
1.9
New Debt = 580 × = 380
2.9
New funds revised by debt = 380 – 170 = 210.
170 210
βD = × 0.35 + × 0.4 = 0.38
380 380
Total Capital Remains at 580
β L = 1.385
β L = wtβ E + wtβ D
59 | P a g e
200 380
1.385 = × βE + × 0.38
580 580
β E = 3.29
C) Since β E will increase cost of equity i.e. Re will also increase, it will decrease the value of
equity.
Question 54
An investor is considering purchasing the equity shares of Lx Ltd., whose current market price (CMP)
is 150. The company is proposing a dividend of Rs.6 for the next year. LX is expected to grow @ 18
per cent per annum for the next four years. The growth will decline linearly to 14 per cent per annum
after first four years. Thereafter, it will stabilize at 14 per cent per annum infinitely. The required rate
of return is 18 per cent per annum.
You are required to determine :
(i) The intrinsic value of one share
(ii) Whether it is worth to purchase the share at this price
t 1 2 3 4 5 6 7 8
PVIF (18, t) 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266
Solution :
Stage 1 :
Years Growth Dividend PVIF @18% PV
1 - 6 0.847 5.082
2 18% 7.08 0.718 5.082
3 18 % 8.35 0.609 5.082
4 18% 9.86 0.516 5.082
5 17% 11.54 0.437 5.043
6 16% 13.38 0.370 4.9506
7 15% 15.39 0.314 4.83246
8 14% 17.54 0.266 4.66564
Total 34.7767
Stage 2 :
𝑫𝑫𝑫𝑫 𝟏𝟏𝟏𝟏.𝟓𝟓𝟓𝟓(𝟏𝟏.𝟏𝟏𝟏𝟏)
IV8 = 𝑹𝑹𝑹𝑹−𝑮𝑮 = 𝟎𝟎.𝟏𝟏𝟏𝟏−𝟎𝟎.𝟏𝟏𝟏𝟏
= 499.89
IV0 = 499.89 x 0.266 = 132.97
Total IV = 34.7767 + 132.97 = 167.7467

Note : Since IV is greater than the current market price of Rs 150, the stock is underpriced in market
and therefore investor should go long.
60 | P a g e
Question 55
Nov 2019 (New) – RTP
Mr. A is thinking of buying shares at Rs.500 each having face value of Rs.100. He is expecting a bonus
at the ratio of 1 : 5 during the fourth year. Annual expected dividend is 20% and the same rate is
expected to be maintained on the expanded capital base. He intends to sell the shares at the end of
seventh year at an expected price of ` 900 each. Incidental expenses for purchase and sale of shares
are estimated to be 5% of the market price. He expects a minimum return of 12% per annum.
Should Mr. A buy the share? If so, what maximum price should he pay for each share? Assume no tax
on dividend income and capital gain.
Solution :
P.V. of dividend stream and sales proceeds
Year Dividend / Sale PVF (12%) PV (Rs.)
1 Rs.20/- 0.893 17.86
2 Rs.20/- 0.797 15.94
3 Rs.20/- 0.712 14.24
4 Rs.24/- 0.636 15.26
5 Rs.24/- 0.567 13.61
6 Rs.24/- 0.507 12.17
7 Rs.24/- 0.452 10.85
7 Rs.1026/- (Rs.900 x 1.2 x 0.95) 0.452 463.75
Rs.563.68
Less : Cost of Share (Rs.500 x 1.05) Rs.525.00
Net gain Rs.38.68
Since Mr. A is gaining Rs.38.68 per share, he should buy the share.
Maximum price Mr. A should be ready to pay is Rs.563.68 which will include incidental expenses. So
the maximum price should be Rs.563.68 x 100/105 = Rs.536.84
Question 56
Following information is available of M/s.TS Ltd.
(Rs. in crores)
PBIT 5.00
Less : Interest on Debt. (10%) 1.00
PBT 4.00
Less : Tax @ 25% 1.00
PAT 3.00
No. of outstanding shares of Rs.10 each 40 lakh
EPS (Rs.) 7.5
Market price of share (Rs.) 75
P/E Ratio 10 Times
61 | P a g e
TS Ltd. Has an undistributed reserves of Rs.8 crores. The company requires Rs.3 crores for the
purpose of expansion which is expected to earn the same rate of return on capital employed as
present. However, if the debt to capital employed ratio is higher than 35%, then P/E ratio is expected
to decline to 8 Times and rise in the cost of additional debt to 14%. Given this data which of the
following options the company would prefer, and why?
Option (i) : If the required amount is raised through debt, and
Option (ii) : If the required amount is raised through equity and the new shares will be issued at a
price of Rs.25 each.
Solution :
1. Calculation of New EBIT
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 𝟓𝟓
ROCE = 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 x 100 = 𝟒𝟒+𝟖𝟖+𝟏𝟏𝟏𝟏 x 100 = 22.73%
Revised EBIT = 22 + 3 x 22.73% = 5.6825

2. Capital Structure
Existing Option 1 = Debt Option 2 : Equity
Equity 4 4 4 + 1.2
Reserves and surplus 8 8 8 + 1.8
10% Debt 10 10 10
14% Debt - 3 -
Total 22 25 25
A. Debt option
𝟏𝟏𝟏𝟏+𝟑𝟑
Debt – Equity ratio = 𝟐𝟐𝟐𝟐
x 100 = 52%
PE Ratio = 8 times and New debt rate = 14%
B. Equity option
𝟏𝟏𝟏𝟏
Debt – Equity ratio = 𝟐𝟐𝟐𝟐 x 100 = 40%
PE Ratio = 8 times and Issue price = 25
𝟑𝟑 𝒄𝒄𝒄𝒄
No of shares to be issued = 𝟐𝟐𝟐𝟐
= 12 lakh shares
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3. Income statement
Option 1 Option 2
Debt option Equity Option
EBIT 5.6825 5.6825
Less Interest 1.42 1
EBT 4.2625 4.6825
Less Tax (25%) 1.065625 1.170625
EAT 3.196875 3.511875
No of shares 40 lakh 52 lakh
EPS 7.99 6.75
PE Ratio 8 8
MPS Rs 63.9375 / share Rs 54 / share
Decision : M/s TS Ltd. should opt for option 1.
Question 57
Mr.X, a financial analyst, intends to value the business of PQR Ltd. In terms of the future cash
generating capacity. He has projected the following after tax cash flows :
Year : 1 2 3 4 5
Cash flows (Rs. in lakhs) 1,760 480 640 860 1,170
th
It is further estimated that beyond 5 year, cash flows will perpetuate at a constant growth rate of
8% per annum, mainly on account of inflation. The perpetual cash flow is estimated to be Rs.10,260
lakh at the end of the 5th year.
Required :
(i) What is the value of the firm in terms of expected future cash flows, if the cost of capital of
the firm is 20%.
(ii) The firm has outstanding debts of Rs.3,620 lakh and cash / bank balance of Rs.2,710 lakh.
Calculate the shareholder value per share if the number of outstanding shares is 151.50 lakh.
(iii) The firm has received a takeover bid from XYZ Ltd. of Rs.225 per share. Is it a good offer?
[Given : PVIF at 20% for year 1 to Year 5 : 0.833, 0.694, 0.579, 0.482, 0.402]
Solution :
1) Value of firm
Stage 1
Year CF PV @ 20%
1 1,760 1,466.67
2 480 333.33
3 640 370.37
4 860 414.74
5 1,170 470.20
63 | P a g e
3055.31
Stage 2 :
CF6 10,260(1 + 0.08)
V5 = = = 92,340
Kc − g 0.20 − 0.08
92,340
V0 = = 37,109.375
(1.2) 5
Total Value of firm = 3,055.31 + 37,109.375
= 40,164.685
2) Value / Share
V − VDebt 40,164.685 − 3,620
= F =
No.of share 151.50
= 241.22/Sh.
3) Takeover bid is than value/share and therefore we should not accept the offer.
Question 58
XY Ltd., a Cement manufacturing company has hired you as a financial consultant of the company.
The Cement Industry has been very stable for some time and the cement companies SK Ltd. and AS
Ltd. are similar in size and have similar product market mix characteristic. Use comparable method
to value the equity of XY Ltd. In performing analysis, use the following ratios :
(i) Market to book value (ii) Market to replacement cost
(iii) Market to sales (iv) Market to Net income
The following data are available for your analysis :
SK Ltd. AS Ltd. XY Ltd.
Market Value 450 400
Book Value 400 300 250
Replacement Cost 600 550 500
Sales 550 450 500
Net Income 18 16 14
Solution :
Market value of XY using comparable method
1) Market to Book Value
450
SK = × 100 = 112.5%
400
400
AS = × 100 = 133.33%
300
64 | P a g e
112.5 + 133.33
Average = = 122.92%
2
∴MV of XY = 250 ×122.92% = 307.3
2) Market value to Replacement Cost

450
SK = × 100 = 75%
600
400
AS = × 100 = 72.73%
550
75 + 72.73
Average = = 73.86%
2
XY = 500 × 73.86% = 369.3
3) Market to Sales
450
SK = × 100 = 81.82%
550
400
AS = × 100 = 88.89%
450
81.82 + 88.89
Average = = 85.355%
2
XY = 500 × 85.355% = 426.775
4) Market to Net Income

450
SK = × 100 = 2,500%
18
400
AS = × 100 = 2,500%
16
Average = 2,500%
XY = 14 × 2,500% = 350
307.3 + 369.3 + 426.775 + 350

5) Average MV of XY =
4
= 363.34375
Question 59
The current EPS of M/s.VEE Ltd. is Rs.4. The company has shown an extraordinary growth of 40% in
its earnings in the last few years. This high growth is likely to continue for the next 5 years after which
growth rate in earnings will decline from 40% to 10% during the next 5 years and remain stable at
10% thereafter. The decline in the growth rate during the five year transition period will be equal to
65 | P a g e
linear. Currently, the company’s pay-out ratio is 10%. It is likely to remain the same for the next five
years and from the beginning of the sixth year till the end of the 10th year, the pay-out will linearly
increase and stabilize at 50% at the end of the 10th year. The post tax cost of capital is 17% and the
PV factors are given below :
Years 1 2 3 4 5 6 7 8 9 10
PVIF @17% 0.855 0.731 0.625 0.534 0.456 0.390 0.333 0.285 0.244 0.209
You are require to calculate the intrinsic value of the company’s stock based on expected dividend.
If the current market price of the stock is Rs.125, suggest if it is advisable for the investor to invest in
the company’s stock or not.
Solution :
Stage 1 :
Year GR. EPS PO DPS PV @ 17%
1 40 5.6 10 0.56 0.48
2 40 7.84 10 0.78 0.57
3 40 10.976 10 1.0976 0.69
4 40 15.37 10 1.54 0.82
5 40 21.51 10 2.15 0.98
6 34 28.83 18 5.19 2.02
7 28 36.90 26 9.59 3.19
8 22 45.02 34 15.30 4.36
9 16 52.22 42 21.92 5.35
10 10 57.44 50 28.71 6.00
24.46
Stage 2 :
D11 28.71(1.10)
V 10 = = = 451.16
Re− g 0.17 − 0.10
451.16
V0 = = 93.86
(1.17)10
Total IV = 24.46 + 93.86 = Rs.118.32/Sh.
Question 60
You are interested in buying some equity stocks of RK Ltd. The company has 3 divisions operating in
different industries. Division A captures 10% of its industries sales which is forecasted to be Rs.50
crore for the industry. Division B and C captures 30% and 2% of their respective industry’s sales, which
are expected to be Rs.20 crore and Rs.8.5 crore respectively. Division A traditionally had a 5% net
66 | P a g e
income margin, whereas divisions B and C had 8% and 10% net income margin respectively. RK Ltd.
has 3,00,000 shares of equity stock outstanding, which sell at Rs.250.
The company has not paid dividend since it started its business 10 years ago. However from the
market sources you come to known that RK Ltd. will start paying dividend in 3 years time and the
pay-out ratio is 30%. Expecting this dividend, you would like to hold the stock for 5 years. By analyzing
the past financial statements, you have determined that RK Ltd’s required rate of return is 18% and
that P/E ratio of 10 for the next year and on ending P/E ratio of 20 at the end of the fifth year are
appropriate.
Required :
(i) Would you purchase RK Ltd. equity at this time based on your one year forecast?
(ii) If you expect earnings to grow @15% continuously, how much are you willing to pay for the
stock of RK Ltd.?
Ignore taxation.
PV Factors are given below :
Years 1 2 3 4 5
PVIF @18% 0.847 0.718 0.609 0.516 0.437
Solution :
1) Computation of Earning Per Share
Division Margin Amount
A 50 × 10% × 5% 25,00,000
B 20 × 30% × 8% 48,00,000
C 8.5 ×2% × 10% 1,70,000
74,70,000
74,70,000
EPS = = Rs.24.90/-
3,00,000
2) Market price at Year end

= 24.90 × 10 = Rs.249
249
PV of MP = = Rs.211.01
1.18
Note : We should not but the share since it is currently available in market at Rs.250.
3) Maximum price at which share should be purchased

Stage 1 :
Year EPS Div. PV @ 18%
1 28.64 – –
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2 32.93 – –
3 37.87 11.36 6.92
4 43.55 13.07 6.74
5 50.08 15.02 6.56
20.22
Stage 2:
15.02(1.15)
IV 5 = = Rs.575.77/Sh.
0.18 − 0.15
575.77
IV 0 = = 251.61
(1.18) 5
Total IV = 20.22 + 251.61 = Rs.271.83/Sh.

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SFM COMPILER Bond Analysis & Valuation
CHP - 4 BOND ANALYSIS AND VALUATION
Question 1
Nov 2008 – RTP / Nov 2011 – RTP / Nov 2012 – RTP / May 2016 - RTP
The following data are available for a bond
Face value Rs.1,000
Coupon Rate 15%
Years to Maturity 6
Redemption value Rs.1,000
Yield to maturity 17%
What is the current market price, duration and volatility of this bond? Calculate the expected market
price, if increase in required yield is by 75 basis points.
Solution :
(1) Current Market Price = PV of Coupons + PV of Redemption
= 150 (PVIFA 17%) + 1,000 (PVIFA 17,6)
= 150 (3.589) + 1,000 (0.390)
= 538.35 +390 = 928.35
(2) Duration
Year Cash flow P.V. @ 17% wx
(x) (w)
1 150 .855 128.25 128.25
2 150 .731 109.65 219.3
3 150 .624 93.60 280.8
4 150 .534 80.10 320.4
5 150 .456 68.40 342
6 1150 .390 448.50 2691
928.50 3981.75
D=
∑ wx = 3981.75 = 4.288 yrs.
∑ w 928.50
Duration 4.288
3. Volatility = YTM Factor = 1.17 = 3.67
4. The expected market price if increase in required yield is by 75 basis points.
= Rs.928.35 – (3.67 × 0.75%) = Rs.902.797
Note : Yield increase market rise decreases.
69 | P a g e
Bond Analysis & Valuation SFM COMPILER
Question 2
Nov 2008 – RTP
The Investment portfolio of a REG EPF Trust is as follows:
Government Bond Coupon Rate Purchase rate Duration
(F.V. Rs.100 per Bond) (Years)
G.O.I. 2008 11.68 106.50 3.50
G.O.I. 2012 7.55 105.00 6.50
G.O.I. 2017 7.38 105.00 7.50
G.O.I. 2024 8.35 110.00 8.75
G.O.I. 2034 7.95 101.00 13.00
Face value of total Investment is Rs.5 crores in each Government Bond.
Calculate actual Investment in portfolio.
What is a suitable action to churn out investment portfolio in the following scenario?
1. Interest rates are expected to lower by 25 basis points.
2. Interest rates are expected to raise by 75 basis points.
Also calculate the revised duration of investment portfolio in each scenario.
Solution :
Calculation of Actual investment of Portfolio
Security Purchase price Investment
(Rs. in lakhs)
G.O.I. 2008 106.50 532.50*
G.O.I. 2012 105.00 525.00
G.O.I. 2017 105.00 525.00
G.O.I. 2024 110.00 550.00
G.O.I. 2034 101.00 505.00
Total 2,637.50
5 × 106.5 = 532.50
3.5 + 6.5 + 7.5 + 8.75 + 13.00
Average Duration = = 7.85
5
Suitable action to churn out investment portfolio in following scenario.
To reduce risk and to maximize profit or minimize losses.
(1) Interest rates are expected to be lower by 25 basis points in such case increase the average
duration by purchasing GOI 2034 and Disposing of GOI 2008.
39.25 − 3.5 + 13.00
Revised Average Duration shall be = = 9.75 years
5
(2) Interest rates are expected to rise by 75 basis points in such case reduce the average duration
by (*) Purchasing GOI 2012 and disposing of GOI 2034.
39.25 − 13.00 + 3.50
Revised Average Duration shall be = = 6.55 years
5
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(*) Purchasing of GOI 2008 is not beneficial as maturity period is very short and 75 basis points is
comparatively higher change.
Question 3
Nov 2008 Paper – 4 Marks / Nov 2009 – RTP / Nov 2016 - RTP
The following is the Yield structure of AAA rated debenture:
Period Yield (%)
3 months 8.5%
6 months 9.25
1 year 10.50
2 years 11.25
3 years and above 12.00
(i) Based on the expectation theory calculate the implicit one-year forward rates in year 2 and
year 3.
(ii) If the interest rate increases by 50 basis points, what will be the percentage change in the
price of the bond having a maturity of 5 years? Assume that the bond is fairly priced at the
moment at Rs.1,000.
Solution :
(i) Implicit rate of Interest for Year 2 and Year 3
(1 + r2)2
For Year 2 = (1 + r1) – 1
(1.1125)2
= (1.1050) - 1 = 12%
(1 + r3) 3
For Year 3 = (1 + r1) (1 + f2) – 1
(1.12)3
= (1.1125)2 – 1 = 13.52%
(ii) If fairly priced at Rs.1000 and rate of interest increases to 12.5% the percentage charge will
be as follows:
1000(1 12)5
Price = (1.125) 5 = Rs.978
1000 – 978
% Change = 1000 x 100 = 2.2%
Question 4
Nov 2008 – Paper – 6 Marks / Nov 2009 – RTP / May 2012 – RTP / May 2018 (New) - RTP
XL Ispat Ltd. Has made an issue of 14 % non – convertible debentures on Jan 1, 2007. These
debentures have a face value of Rs.100 and is currently traded in the market at a price of Rs.90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31.
Interest payments for the first 3 years will be paid in advance through post-dated cheques while for
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the last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par
on December 31, 2011 at the end of 5 years.
Required
i. Estimate the current yield at the YTM of the Bond.
ii. Calculate the duration of the NCD
iii. Assuming that intermediate coupon payments are, not available for reinvestment calculate
the realized yield on the NCD.
Solution :
𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄𝒄 𝟕𝟕 𝟏𝟏𝟏𝟏
1. A) Current yield = 𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴𝑴 𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑 x 100 = 𝟗𝟗𝟗𝟗 x 100 x 𝟔𝟔
= 15.56%
𝒊𝒊+(𝑭𝑭𝑭𝑭−𝑷𝑷)/𝒏𝒏 𝟕𝟕+(𝟏𝟏𝟏𝟏𝟏𝟏−𝟗𝟗𝟗𝟗)/𝟏𝟏𝟏𝟏
B) YTM = (𝑭𝑭𝑭𝑭+𝑷𝑷)/𝟐𝟐
= (𝟏𝟏𝟏𝟏𝟏𝟏+𝟗𝟗𝟗𝟗)/𝟐𝟐
= 8.42% for 6 months i.e 16.84% PA
2. Duration
Period Cash Flow PV @ 8.42% WX
1 7 6.456 6.456
2 7 5.955 11.91
3 7 5.492 16.476
4 7 5.066 20.264
5 7 4.673 23.365
6 7 4.310 25.86
7 7 3.975 27.825
8 7 3.666 29.328
9 7 3.382 30.438
10 7 + 100 47.675 476.75
Total 90.65 668.672
Ʃ𝒘𝒘𝒘𝒘 𝟔𝟔𝟔𝟔𝟔𝟔.𝟔𝟔𝟔𝟔𝟔𝟔
Duration = Ʃ𝒘𝒘
= 𝟗𝟗𝟗𝟗.𝟔𝟔𝟔𝟔
= 7.37 period of 6 months i.e 3.69 years
3. If intermediate coupon are not available for reinvestment then the total will be available at
the end of 5 years. It will function like a ZCB Bond.
𝟏𝟏𝟏𝟏𝟏𝟏 𝟏𝟏𝟏𝟏𝟏𝟏 𝟏𝟏
90 = (𝟏𝟏+𝒓𝒓)𝟏𝟏𝟏𝟏 therefore r = ( 𝟗𝟗𝟗𝟗 )𝟏𝟏𝟏𝟏 = 6.38% for 6 months i.e 12.76% PA
Question 5
May 2009 – RTP / Nov 2011 - RTP
A 9% 5 years bond is issued in the market at Rs.90 and redemption price Rs.105. For an investor with
marginal income tax rate of 30% and capital gain tax 10% (assuming no indexation), what is the post-
tax yield to maturity ?
72 | P a g e
Solution :
I = 100 × 9% × 0.7 = 6.3
CGT = (105 – 90) × 10% = 1.5
F = 105 – 1.5 = 103.5
F–P 103.5 – 90
I+ n 6.3 + 5
YTM = F + P = 103.5 + 90 = 9.30%
2 2
Question 6
May 2009 – Paper – 6 Marks / May 2020 (Old) - RTP
ABC Ltd. has Rs.300 million, 12 per cent bonds outstanding with six years remaining to maturity. Since
interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a Rs.300 million
issue of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bond will be Rs.6
million and the call premium is 4 per cent. Rs.9 million being the unamortized portion of issue cost
of old bonds can be written off no sooner the old bonds are called off. Marginal tax rate of ABC Ltd.
is 30 per cent. You are required to analyse the bond refunding decision.
Solution :
Initial Cash Movements
A) Net proceeds of fresh issue (300 – 6) 294
B) Redemption of old bonds (312)
C) Tax shield on bond premium (12 × 30%) 3.6
D) Tax shield on unamortised portion of issue cost (9 × 0.3) 2.7
(11.7)
Recurring Cash Flows

Old New
A) Post tax coupon 25.2 21
B) Tax shield on unamortized discount, floating cost 0.45 0.3
1 1
(9 × × 0.3) (6 × × 0.3)
6 6
24.75 20.7
4.05
= 4.05 × PVIFA (7%, 6)
= 4.05 × 4.767
= 19.30
Net Savings = 19.3
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– 11.7
7.6
Since the decision is Positive we should go ahead with bond refunding decision
Question 7
May 2009 Paper – 20 Marks
(a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity.
Both the bonds have a face value of Rs.1,000 and coupon rate of 8% (with annual interest
payments) and both are selling at par. Assume that the yields of both the bonds fall to 6%,
whether the price of bond will increase or decrease? What percentage of this
increase/decrease comes from a change in the present value of bond’s principal amount and
what percentage of this increase/decrease comes from a change in the present value of
bond’s interest payments?
(b) Consider a bond selling at its par value of As. 1.000, with 6 years to maturity and a 7% coupon
rate (with annual interest payment), what is bond’s duration?
(c) If the YTM of the bond in (b) above increases to 10%, how it affects the bond’s duration?
And why?
(d) Why should the duration of a coupon carrying bond always be less than the time to its
maturity?
Solution :
A) Since bond is trading at par, redeemable at pat
CY = YTM = Coupon = 8%
5 Yr. Bond
Yield P.V. of coupon + P.V. of redemption = Bond
8% 319.42 + 680.88 = 1000
(80 × 3.99) (1000 × 0.681)
6% 336.99 + 747 = 1090
(80 × 4.212) (1000 × 0.747)
Change 17.57 66.42 83.99
%∆ 20.92% 79.08% 100%
20 Yr Bond
Yield P.V. of coupon + P.V. of redemption = Bond
8% 786 + 214 = 1000
(80 × 9.818) (1000 × 0.214)
6% 917.6 + 312 = 1229.6
(80 × 11.47) (1000 × 0.312)
Change 131.6 98 229.6
%∆ 57.32% 42.68% 100%
CY
B) D = YR × AF × YTM Factor + (1 – YR)n  YTM = 1
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= 4.767 × 1.07 = 5.1 yrs.

C) D = 4.8 yrs. = 4.356 × 1.1
Question 8
Nov 2009 Paper - 4 Marks
An investors is considering the purchase of the following Bond:
Face value Rs.100
Coupon rate 11%
Maturity 3 years
(i) If he wants a yield of 13% what is the maximum price he should be ready to pay for?
(ii) If the Bond is selling for Rs.97.60, what would be his yield?
Solution :
Value of bond = P.V. of coupons + P.V. of redemption
= 11 × PVIFA (13%, 3) + 100 × PVIF (13%, 3)
= Rs.95.27/-
F–P 100 – 97.6
I+ n 11 + 3
YTM = F+P = 100 + 97.6 = 11.94%
2 2
Question 9
May 2010 RTP
Phototech plc has in issue 9% bonds which are redeemable at their par value of £100 in five years’
time. Alternatively, each bond may be converted on that date into 20 ordinary shares of the
company. The current ordinary share price of Phototech plc is £4·45 and this is expected to grow at
a rate of 6·5% per year for the foreseeable future. Phototech plc has a cost of debt of 7% per year.
Required:
Calculate the following current values for each £ 100 convertible bond:
(i) market value; (ii) floor value; (iii) conversion premium.
Solution :
(a) Calculation of market value of each convertible bond
Expected share price in five years’ time = £4·45 x(1·065)5 =£6·10
Conversion value = £6·10 x 20 =£122
Compared with redemption at par value of £100, conversion will be preferred
The current market value will be the present value of future interest payments, plus the
present value of the conversion value, discounted at the cost of debt of 7% per year.
Market value of each convertible bond = (£ 9 x 4·100) + (£ 122 x 0·713)
= £123·89
(b) Calculation of floor value of each convertible bond
75 | P a g e
The current floor value will be the present value of future interest payments, plus the present
value of the redemption value, discounted at the cost of debt of 7% per year.
Floor value of each convertible bond = (£ 9 x 4·100) + (£ 100 x 0·713)
= £108·20
(c) Calculation of conversion premium of each convertible bond
Current conversion value = £ 4·45 x 20 =£89·00
Conversion premium = £123·89–£89·00 =£34·89
This is often expressed on a per share basis,
i.e.£34·89/20 =£1·75 per share
Question 10
May 2010 RTP
On 1 June 2003 the financial manager of Gadgets Corporation’s Pension Fund Trust is reviewing
strategy regarding the fund. Over 60% of the fund is invested in fixed rate long-term bonds. Interest
rates are expected to be quite volatile for the next few years.
Among the pension fund’s current investments are two AAA rated bonds:
1) Zero coupon June 2018
2) 12% Gilt June 2018 (interest is payable semi-annually)
The current annual redemption yield (yield to maturity) on both bonds is 6%. The semi-annual yield
may be assumed to be 3%. Both bonds have a par value and redemption value of $100.
Required:
Estimate the market price of each of the bonds if interest rates (yields):
(i) increase by 1%; (ii) decrease by 1%.
[Given PVF (2.5%, 30) = 0.4767, PVF (3%, 30) = 0.412, PVF (3.5%,30) = 0.3563]
Solution :
1) Current Market Price
$100
A) ZCB = = 41.73 $
(1.06)15
B) 12% Semi Annual Coupon Bond

Coupon = 100 × 12% × 6/12 = 6
Period = 15 years i.e. 30 period of 6 months
IV = PV of coupon + PV of Redemption
= 6 × PVIFA (3%, 30) + 100 × PVIF (3%, 30)
= 117.60 + 41.20 = $ 158.80
2) If Market Rate increase by 1% (i.e. YTM increases by 1%)
$100
A) ZCB = = Rs.36.25 (Price fall)
(1.07)15
B) 12% Semi Annual Bond
Coupon = 6, Period = 30 Period
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Yield = 3% + 0.5(1/2) = 3.5%

IV = PV of Coupon + PV of Redemption
= 6 × PVIFA(3.5%, 30) + 100 × PVIF (3.5%, 30)
= 110.35 + 35.63 = Rs.145.98 (Price fall)
3) If market falls by 1% (YTM falls by 1%)
$100
A) ZCB = = $ 48.10 (Price Rises)
(1.05)15
B) 12% Semi Annual Bond
Coupon = $6
Period = 30 Period of 6 months
Yield = 3 – 0.5(1.2) = 2.5%
IV = 6 × PVIFA (2.5%, 30) + 100 × PVIF (2.5%, 30)

= 125.58 + 47.67 = Rs.173.25/Bond
4) Conclusion : Bond Price falls with Risk in YTM are Bond Price Risk with falls in YTM.
Question 11
May 2010 Paper – 8 Marks / Nov 2015 - RTP
Consider the following data for government securities
Face value Interest (Rate %) Maturity (Years) Current Price (Rs.)
1,00,000 0 1 90,000
1,00,000 10.5 2 98,000
1,00,000 11.0 3 98,500
1,00,000 11.5 4 98,900
Calculate the forward interest rates.
Solution :
100000
Bond A 90000 = (1 + r )
01
100000
r01 = 90000 – 1 = 11.11%
10500 110500
Bond B 98000 = (1 + r ) + (1 + r )2+
01 02
110500
98000 – 9450.1 = (1 + r )2
02
1
 110500 
r02 =  88549.9 2 – 1 = 11.71%
 
11000 11000 11000
Bond C 98500 = (1 + r ) + (1 + r )2 + (1 + r )3
01 02 03
11000
98500 – 9900.1 – 8814.72 = (1 + r )3
03
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1
 111000 
r03 =  79785.183 1 = 11.64%
 
11500 11500 11500 111500
Bond D 98900 = (1 + r ) + (1 + r )2 + (1 + r )3 + (1 + r )4
01 02 03 04
111500
98900 – 10350.1 – 9215.39 – 8264.91 = (1 + r )4
04
 111500 1
r04 =  71069.64 – 1
 
= 11.92%
Term Structure
Bond Maturity Rate
A 1 11.11
B 2 11.71
C 3 11.64
D 4 11.92
(1.1171)2
f 12 = 1.1111 ) – 1 = 12.31%
(1.1164)3
f 13 =  1.1171  – 1 = 11.90%
 
4 1
(1.1192) 
f 14 =  1.1111  3 – 1 = 12.19%
 
(111.64)3
f 23 = (111.71)2 – 1 = 11.5%
1
 (1.1192)4 
f 24 =  (1.1171)2  2 – 1 = 12.13%
 
(1.1192) 4
f 34 = (1.1164)3 – 1 = 12.76%
Question 12
Nov 2010 - RTP
NewChem Corporation has issued a fully convertible 10% debenture of Rs.10,000 face value,
convertible into 20 equity shares. The current market price of the debenture is Rs.10,800, whereas
the current market price of equity share price is Rs.480.
You are required to calculate (i) the conversion premium and (ii) the conversion value.
Solution :
As per the conversion terms 1 Debenture = 20 equity share (known as the conversion ratio.)
The conversion terms can also be expressed as: 1 Debenture of Rs.500 = 1 equity share.
(i) The conversion premium measures how much more expensive it is to buy the convertible
debenture than the underlying equity share.
(ii) The cost of buying Rs.500 debenture (one equity share) is:
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108
Rs.500 x 100 = Rs.540
Comparing this with the cost of buying one equity share from market at Rs.480.
Thus, conversion premium is therefore:
540 – 480
480 x 100 = 12.5%
Therefore, it is more expensive to buy the debenture and get it converted, than to purchase
one equity share directly.
(iii) The conversion value is calculated as the market value of equity shares that is equivalent to
one unit of the convertible debenture.
Conversion value = conversion ratio X MPS (equity shares)
= 20 x Rs.480
= Rs.9,600
From this calculation of conversion value, the conversion premium may also be calculated as
below:
10800 – 9600
9600 x 100 = 12.5%
Question 13
Calculate Market Price of:
(i) 10% Government of India security currently quoted at 110 but interest rate is expected to go
up by 1 %.
(ii) A bond with 7.5% coupon interest. Face Value 10,000 & term to maturity of 2 years, presently
yielding 6% interest payable half yearly.
Solution :
Assuming Bond to be perpetual
Coupen
i) Yield = MP
10
∴ = 110
= 0.09%
New Yield = 9.09 + 1 = 10.09%
10
New Price = 10.09%
= Rs.99.11/-
ii) Value = P.V. of coupons + P.V. of redemption
= 375 × PVIFA (3%, 4) + 10000 × PVIF(3%, 4)
= 10278.78
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Question 14
May 2011 - RTP
ABC Ltd. has the following outstanding Bonds.
Bond Coupon Maturity
Series X 8% 10 Years
Series Y Variable changes annually comparable 10 Years
To prevailing rate
Initially these bonds were issued at face value of Rs.10,000 with yield to maturity of 8%.
Assuming that:
(i) After 2 years from the date of issue, interest on comparable bonds is 10%, then what should
be the price of each bond?
(ii) If after two additional years, the interest rate on comparable bond is 7%, then what should
be the price of each bond?
(iii) What conclusions you can draw from the prices of Bonds, computed above.
Solution :
Here we shall compare two bonds, one with fixed copoun rate and another as per with prevailing
interest rate.
(i) After 2 Years passed (8 years remaining) Value of Bond Series – X
= Rs.800 PVIAF (10% ,8) + Rs.10,000 PVIF (10%, 8)
= Rs.4,268 + Rs.4,665 = Rs.8,933
Since Bond-Series Y has a variable interest rates, so the interest amount will increase and
decrease with the movement of interest rates. As given presently rate of interest is 10%, the
value of Bond will be:
= Rs.1,000 PVIAF (10%, 8) + Rs.10,000 PVIF (10%, 8)
= Rs.5,335 + Rs.4,665 = Rs.10,000
(ii) After 2 additional years at the yield rate of 7%, the value of Bond shall be as follows:
Bond-Series X
= Rs.800 PVIAF (7%, 6) + Rs.10,000 PVIF (7%, 6)
= Rs.3,813 + Rs.6,663
= Rs.10,476
Bond-Series Y
= Rs.700 PVIF (7%, 6) + Rs.10,000 PVIF (7%, 6)
= Rs.700 x 4.767 + Rs.10,000 x 0.666
= Rs.3,337 + Rs.6,663 = Rs.10,000
(iii) From above prices it can be concluded that price of Bond-Series X moves inversely with
change in interest rate. Whereas, the price of Bond Series Y does not fluctuate, reason being
its interest (coupon) adjusted according to change in interest rates.
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Question 15
May 2011 - RTP / Nov 2018 - RTP
Pet feed plc has outstanding, a high yield Bond with following features:
Face Value £ 10,000
Coupon 10%
Maturity Period 6 Years
Special Feature Company can extend the life of Bond to 12 years.
Presently the interest rate on equivalent Bond is 8%.
(a) If an investor expects that interest will be 8%, six years from now then how much he should
pay for this bond now.
(b) Now suppose, on the basis of that expectation, he invests in the Bond, but interest rate turns
out to be 12%, six years from now, then what will be his potential loss/gain.
Solution :
(i) If the current interest rate is 8%, the company will not extent the duration of Bond and the
maximum amount the investor would ready to pay will be:
= £ 1,000 PVIAF (8%, 6) + £ 10,000 PVIF (8%, 6)
= £ 1,000 x 4.623 + £ 10,000 x 0.630
= 4,623 + 6,300
= £ 10,925
(ii) If the current interest rate is 12%, the company will extent the duration of Bond. After six
years the value of Bond will be
= £ 1,000 PVIAF (12%, 6) + £ 10,000 PVIF (12%, 6)
= 4,111 + 5,070
= £ 9,177
Thus, potential loss will be £ 9,177 - £ 10,925 = £1,748
Question 16
Nov 2011 - RTP
M Ltd. has to make a payment on 30th January, 2011 of Rs.80 lakhs. It has surplus cash today, i.e.
31st October, 2010; and has decided to invest sufficient cash in a bank's Certificate of Deposit
scheme offering an yield of 8% p.a. on simple interest basis. What is the amount to be invested now?
Solution :
Calculation of Investment Amount
Amount required for making payment on 30th January, 2011= Rs.80,00,000
Investment in Certificates of Deposit (CDs) on 31st October, 2010
Rate of interest = 8% p.a.
No. of days to maturity = 91 days
Interest on Rs.1 of 91 days
(Rs.1 × 0.08 × 91/365) = 0.0199452
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Amount to be received for Re. 1

(Rs.1.00 + Rs.0.0199452) = 1.0199452
Calculation of amount to be invested now to get Rs.80 lakhs after 91 days:
Rs.80,00,000
= Rs.1.0199452
= Rs.78,43,558.65
Question 17
The six months forward price of a security is Rs.208.18. The rate of borrowing is 8 percent per annum
payable at monthly rates. What will be the spot price?
Solution :
Calculation of spot price
 r
The formula for calculating forward price is: A = P 1 + nmn
 
Using the above formula,
208.18
P= = 200
(1.0067 )6
8
r= = 0.67% per month.
12
Hence, the spot price should be Rs.200.
Question 18
Pineapple Ltd has issued fully convertible 12 percent debentures of Rs. 5,000 face value, convertible
into 10 equity shares. The current market price of the debentures is Rs.5,400. The present market
price of equity shares is Rs. 430.
Calculate:
(i) the conversion percentage premium, and
(ii) the conversion value
Solution :
(i) The conversion value can be calculated as follows:
Conversion value = Conversion ratio X Market Price of Equity Shares
= 10 × Rs.430 = Rs.4300
(ii) Conversion Premium %
5400 − 4300
= × 100
4300
= 25.58%
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Question 19
Nov 2011 - Paper – 8 Marks / May 2019 (New) - RTP
Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for valuing
bonds:
Credit Rating Discount Rate
AAA 364 T Bill rate + 3% Spread
AA AAA + 2% Spread
A AAA + 3% Spread
He is considering to invest in AA rated, Rs.1,000 face value bond currently selling at Rs.1,025.86. The
bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The
next interest payment is due one year from today and the bond is redeemable at par. (Assume the
384 day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z Should he invest in the bond?
Also calculate the current yield and the Yield to Maturity (YTM) of the bond.
Solution :
AA Rated yield 9 + 3 + 2 = 14%
1) Value of bond = P.V. of coupons + P.V. of redemption
= 150 × PVIFA (14%, 5) + 1000 × PVIF(14%, 5)
= 150 × 3.433 + 1000 × 0.519
= Rs.1034.36/-
Current MP = Rs.1025.86/-
2) The bond is trading cheap, therefore the investor should go long.
Coupen
CY = MP × 100
150
= 1025.86 × 100
= 14.62%
F–P
I+ n
3) YTM = F+P
2
1000 – 1025.86
150 + 5 144.828
= 1000 + 1025.86 = 1012.93
2
= 14.3%
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Question 20
Nov 2012 – RTP / May 2013 – RTP / May 2015 – RTP / Nov 2016 – RTP / May 2018 - RTP
The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued by JAC
Ltd. at Rs.1000.
Market Price of Debenture Rs.900
Conversion Ratio 30
Straight Value of Debenture Rs.700
Market Price of Equity share on the date of Conversion Rs.25
Expected Dividend Per Share Rs.1
You are required to calculate:
(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio of Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favourable income differential per share
(g) Premium pay back period
Solution :
(a) Conversion Value of Debenture
= Market Price of one Equity Share X Conversion Ratio
= Rs.25 X 30 = Rs.750
(b) Market Conversion Price
Market Price of Convertible Debenture 900
= Convertion Ratio = 30 = Rs.30
(c) Conversion Premium per share
= Market Conversion Price – Market Price of Equity Share
= Rs.30 – Rs.25 = Rs.5
(d) Ratio of Conversion Premium
Conversion Premium Per Share 5
= Market Price of Equity Share = 25 = 20%
(e) Premium over Straight Value of Debenture
Market Price of Convertible Bond 900
= Straight Value of Bond - 1 = 700 - 1 = 28.6%
(f) Favourable income differential per share
Coupon Interest from Debenture – Convertion Ratio – Dividend Per Share
= Convertion Ratio
85 – 30 – 1
= 30 = Rs.1.833
(g) Premium pay back period
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Conversion Premium Per Share 5

= Favaourable Income Differential Per Share = 1.833 = 2.73 years
Question 21
Calculate the Current price and the Bond equivalent yield (using simple compounding) of a money
market instrument with face value of Rs.100 and discount yield of 8% in 90 days. Take 1 year 360
days.
Solution :
1) Current price
100
IV =
1.08
= 92.59
2) Bond Equivalent Yield
100 – V 300
BEY = V x Days of Maturity
100 – 92.59 360
BEY = 92.59 x 90 = 32%
Question 22
M/s. Earth Limited has 11% bond worth of Rs.2 crores outstanding with 10 years remaining to
maturity.
The company is contemplating the issue of a Rs.2 crores 10 year bond carring the coupon rate of 9%
and use the proceeds to liquidate the old bonds.
The unamortized portion of issue cost on the old bonds is Rs.3 lakhs which can be written off no
sooner the old bonds are called. The company is paying 30% tax and it's after tax cost of debt is 7%.
Should Earth Limited liquidate the old bonds?
You may assume that the issue cost of the new bonds will be Rs.2.5 lakhs and the call premium is 5%.
Solution :
1. Initial outlay
A) Redemption of old Bonds (2,00,00,000 × 1.05) (2,10,00,000)
B) Tax shield on POR (2,00,00,000 × 0.5 × 30%) 3,00,000
C) Issue of New Bonds (2,00,00,000 – 2,50,000) 1,97,50,000
D) Tax on unamortised portion of issue cost of old bonds.
(3,00,000 × 30%) 90,000
Net (8,60,000)
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2. Future Cash Flows

New Old
Post tax Interest (12,60,000) (15,40,000)
(18,00,000 × 70%) (22,00,000 × 70%)
Amortisation of Issue Cost 7,500 9,000
(2,50,000 / 10 × 30%) (3,00,000 / 10 × 30%)
Net 12,52,500 15,31,000
Saving 2,78,500
× PVI FA (7% 10 yrs) – 19,56,068
3. Net Savings = 19,56,068 – 8,60,000 = 10,96,068
Question 23
May 2014 - RTP
Mr. A is planning for making investment in bonds of one of the two companies X Ltd. and Y Ltd. The
detail of these bonds is as follows:
Company Face Value Coupon Rate Maturity Period
X Ltd. Rs.10,000 6% 5 Years
Y Ltd. Rs.10,000 4% 5 Years
The current market price of X Ltd.’s bond is Rs.10,796.80 and both bonds have same Yield To Maturity
(YTM). Since Mr. A considers duration of bonds as the basis of decision making, you are required to
calculate the duration of each bond and you decision.
Solution :
To calculate duration of bond we need YTM.
i + (FV - P)/n
YTM =
(FV + P)/2
600+(10,000 - 10796.80)/5
=
(10,000 + 10796.80)/2
600 − 159.36
=
10398.4
= 4.2%
Duration of X Ltd.’ s Bond

Year Cash Flows P.V @ 4.2% Wx
1 600 575.82 575.82

2 600 552.60 1105.20
3 600 530.34 1591.02
4 600 508.98 2035.92
5 10600 8,629.46 43147.30
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Total 10,797.20 48455.26
D =
∑ wx =
48455.26
= 4.49 Yrs.
∑w 10797.20
Duration of Y Ltd.’s Bond

Year Cash Flows P.V @ 4.2% Wx
1 400 383.88 383.88
2 400 368.40 736.8
3 400 353.56 1060.68
4 400 339.32 1357.28
5 10400 8466.64 42333.2
Total 9,911.80 45871.84
D =
∑ wx =
45871.84
= 4.628 Yrs.
∑w 9911.8
Decision: Since the duration of Bond of X Ltd. is lower hence it should be preferred.
Question 24
May 2014 - Paper – 8 Marks / May 2017 - RTP /
GHI Ltd., AAA rated company has issued, fully convertible bonds on the following terms, a year ago:
Face value of bond Rs.1,000
Coupon (interest rate) 8.50%
Time to Maturity (remaining) 3 years
Interest Payment Annual, at the end of year
Principal Repayment At the end of bond maturity
Conversion ratio (Number of shares per bond) 25
Current market price per share Rs.45
Market price of convertible bond Rs.1175
AAA rated company can issue plain vanilla bonds without conversion option at an interest rate of
9.5%.
Required: Calculate as of today:
(i) Straight Value of bond.
(ii) Conversion Value of the bond.
(iii) Conversion Premium.
(iv) Percentage of downside risk.
(v) Conversion Parity Price.
t 1 2 3
PVIF0.095,t 0.9132 0.8340 0.7617
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Solution :
(i) Straight Value of Bond
= Rs.85 x 0.9132 + Rs.85 x 0.8340 + Rs.1085 x 0.7617 = Rs.974.96
(ii) Conversion Value
= Conversion Ratio x Market Price of Equity Share
= Rs.45 x 25 = Rs.1,125
(iii) Conversion Premium
Conversion Premium = Market Conversion Price - Market Price of Equity Share
1175
= 25 – Rs.45 = Rs.2
(iv) Percentage of Downside Risk
1,175 – 974.96
= 974.96 x 100 = 20.52%
(v) Conversion Parity Price
Bond Price
= No of shares on Conversion
1175
= 25 = Rs.47
Question 25
On 31st March, 2013, the following information about Bonds is available
Name of Security Face Value Maturity Date Coupon Rate Coupon Date
Zero Coupon st
10,000 31 March, 2023 N.A N.A
T – Bill 1,00,000 20th June, 2013 N.A N.A
10.71% GOI 2023 100 31st March, 2023 10.71 31st March
10% GOI 2018 100 31st March, 2018 10.00 31st March & 31st October
Calculate
1. If 10 years yield is 7.5% p.a. What price the Zero coupon Bond would fetch on 31st March,
2013?
2. What will be the annualized yield if the T – bill is traded @98,500?
3. If 10.71% GOI 2023 Bond having yield to maturity is 8%, what price would it fetch on April 1,
2013 (after coupon payment on 31st March?
4. If 10% GOI 2018 Bond having yield to maturity is 8%, what price would it fetch on April 1, 2013
(after coupon payment on 31st March?
Solution :
1. Value of Zero Coupon Bond for 10 years yield @ 7.5%
10,000
(1.075)10 = Rs.4,852
2. Annualized yield
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(FV – P) 360
BEY = P x Days of Maturity
10000 – 98500 361
BEY = 98500 x 81 = 6.86%
3. Value of GOI 2023 Bond
= PV of Coupons + PV of Redemption
= 10.71 PVAF (8%, 10) + 100 PVF (8%, 10)
= 10.71 x 6.71 + 100 x 0.4632
= Rs.118.18
4. Value of GOI 2018 Bond
= PV of Coupons + PV of Redemption
= 5 PVAF (4%, 10) + 100 PVF (4%, 10)
= 5 x 8.11 + 100 x 0.6756 = Rs.108.11
Question 26
Nov 2015 Paper – 5 Marks / May 2018 (Old) - RTP
The following data is available for a Bond
Face Value Rs.1000
Coupon Rate 11%
Years to Maturity 6
Redemption Value Rs.1,000
Yield to Maturity 15%
(Round of your answers to 3 decimals)
Calculate the following with respect to the Bond
1. Current Market Price
2. Duration of Bond
3. Volatility of Bond
4. Expected market price if increase in required yield is by 100 basis points.
5. Expected market price if decrease in required yield is by 75 basis points.
Solution :
1. Current Price of the Bond
= PV of Coupon + PV of Redemption
= 110 x PVAF (15%, 6) + 1,000 x PVF (15%, 6)
= 110 x 3.7845 + 1,000 x 0.4323
= 416.29 + 432.3 = 848.59
2. Duration of the Bond
Year Cash Flows P.V @ 15% Wx
1 110 95.70 95.70
2 110 83.16 166.32
3 110 72.38 217.14
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4 110 62.92 251.68

5 110 54.67 273.35
6 1110 479.52 2877.12
Total 848.35 3881.31
D =
∑ wx =
3881.31
= 4.575 Yrs.
∑w 848.35
3. Volatility of the Bond
Duration 4.570
= YTM Factor = 1.15 = 3.974 yrs.
4 Expected market price if increase in required yield is by 100 basis points.
= 848.35 x 3.974% = 33.162
Market Price will decrease as Market price and yield are inversely related.
Hence the expected market price = 848.35 – 33.162 = Rs.801.318
5. Expected market price if decrease in required yield is by 75 basis points.
= 848.35 x 75% of (3.974) = 24.87
Market Price will increase as Market price and yield are inversely related.
Hence the expected market price = 848.35 + 24.87 = Rs.859.35
Question 27
Nov 2015 – Paper – 6 Marks
Mr A will need Rs.1,00,000 after 2 years for which he wants to make one time necessary investment
now. He has choice of 2 types of bonds. The details of which are as follows.
Bond X Bond Y
Face Value Rs.1000 Rs.1000
Coupon 7% Payable annually 8% Payable annually
Years to maturity 1 4
Current Price Rs.972.73 Rs.936.52
Current Yield 10% 10%
Advice Mr. A whether he should all his money in one type of bond or he should buy both the bonds
and if so, in which quantity?
Assume that there will be no call risk or default risk?
Solution :
Duration of Bond X
1 1070 .909 972.63 972.63
Total 972.63 972.63
D =
∑ wx =
972.63
= 1 yrs.
∑w 972.63
90 | P a g e
Duration of Bond Y
1 80 72.72 72.72
2 80 66.08 132.16
3 80 60.08 180.24
4 1080 737.64 2950.56
Total 936.52 3335.68
D =
∑ wx =
3335.68
= 3.56 yrs.
∑w 936.52
Let a be the investment in bond X and therefore investment in Bond Y will be (1-a)
Since the required duration is 2 years, the proportion of investment in each security shall be
calculated as follows
2 = a x 1 + (1-a) 3.563
A = 0.61
B = 1 – 0.61 = 0.39
Therefore, the proportion of investment shall be 61% in X and 39% in Y
Amount of Investments
1,00,000
Bond X = = 82,644.63
(1.1)2
= 82,644.63 × 0.61
= Rs.50,413
Bond y = 82,644.63 – 50413
= Rs.32,232
Question 28
May 2016 Paper / May 2020 (New) - RTP
Bright Computers Limited is planning to issue a debenture series with a face value of Rs.1,000 each
for a term of 10 years with the following coupon rates:
Years Rates
1–4 8%
5–8 9%
9 – 10 13%
The current market rate on similar debenture is 15% p.a. The company proposes to price the issue
in such a way that a yield of 16% compounded rate of return is received by the investors. The
redeemable price of the debenture will be at 10% premium on maturity. What should be the issue
price of debenture?
PV @ 16% for 1 to 10 years are: .862, .743, .641, .552, .476, .410, .354, .305, .263, .227 respectively.
91 | P a g e
Solution :
Present Value of Debenture
Year Cash Outflow (Rs.) PVF @ 16% Present Value (Rs.)
1–4 80 2.798 223.84
5–8 90 1.545 139.05
9 – 10 130 0.490 63.70
10 1100 0.227 249.70
676.29
Question 29
Nov 2016 – Paper / May 2019 (Old) - RTP
A Ltd. has issued convertible bonds, which carries a coupon rate of 14%. Each bond is convertible into
20 equity shares of the company A Ltd. The prevailing interest rate for similar credit rating bond is
8%. The convertible bond has 5 years maturity. It is redeemable at par at Rs.100.
The relevant present value table is as follows.
Present Value 𝒕𝒕𝟏𝟏 𝒕𝒕𝟐𝟐 𝒕𝒕𝟑𝟑 𝒕𝒕𝟒𝟒 𝒕𝒕𝟓𝟓
PVIF0.14,t 0.877 0.769 0.675 0.592 0.519
PVIF0.08,t 0.926 0.857 0.794 0.735 0.681
You are required to estimate:
(Calculations be made upto 3 decimal places)
(i) Current market price of the bond, assuming it being equal to its fundamental value,
(ii) Minimum market price of equity share at which bond holder should exercise conversion
option; and
(iii) Duration of the bond.
Solution :
(i) Current Market Price of Bond
Time CF PVIF *% PV (CF) PV (CF)
1 14 0.926 12.964
2 14 0.857 11.998
3 14 0.794 11.116
4 14 0.735 10.290
5 114 0.681 77.634
ƩPV (CF) i.e. P0 = 124.002
Say Rs.124.00
(ii) Minimum Market Price of Equity shares at which Bondholder should exercise conversion
option:
124.00
20.00
= Rs.6.20
92 | P a g e
(iii) Duration of the Bond

Year Cash Flow PV @ 8% Wx
1 14 12.964 12.964
2 14 11.998 23.996
3 14 11.116 33.348
4 14 10.290 41.16
5 114 77.634 388.17
124.002 499.638
D=
∑ Wx =
499.638
= 4.029 yrs.
∑W 124.002
Question 30
May 2017 - RTP
G holds securities as detailed herein below:
Security Face Value Numbers Coupon Maturity Annual
(Rs.) Rate (%) Years Yield (%)
Bonds A 1,000 100 9 3 12
Bond B 1,000 100 10 5 12
Preference shares C 100 1,000 11 * 13*
Preference shares C 100 1,000 12 * 13*
* Likelihood of being called (redeemed) at a premium over par.
Compute the current value of G’s portfolio.
Solution :
Computation of current value of G’s portfolio
(i) 100 Nos. Bond A, Rs.1,000 par value, 9% Bonds maturity 3 years:
Rs.
Current value of interest on bond A
1-3 years: Rs.9000 × Cumulative P.V. @ 12% (1-3 years) 21,618
= Rs.9000 × 2.402
Add: Current value of amount received on maturity of Bond A

End of 3rd year: Rs.1,000 × 100 × P.V. @ 12% (3rd year) 71,200
= Rs.1,00,000 × 0.712
92,818
(ii) 100 Nos. Bond B, Rs.1,000 par value, 10% Bonds maturity 5 years: Current value of interest
on bond B
1-5 years: Rs.10,000 × Cumulative P.V. @ 12% (1-5 years)
= Rs.10,000 × 3.605 36,050
93 | P a g e
Add: Current value of amount received on maturity of Bond B

End of 5th year: Rs.1,000 × 100 × P.V. @ 12% (5th year) 56,700
= Rs.1,00,000 × 0.567 92,750
(iii) 100 Preference shares C, Rs.1,000 par value, 11% coupon

11% x 1000Nos.x Rs.100 11,000
13%
= 0.13
Rs.84,615
(iv) 100 Preference shares D, Rs.1,000 par value, 12% coupon

12% x 1000Nos.x Rs.100 12,000
13%
= 0.13
Rs.92,308
Total current value of his portfolio [(i) + (ii) + (iii) + (iv)] 3,62,491
Question 31
May 2017 - Paper
Bank A enter into a Repo for 14 days with Bank B in 10% Government of India Bonds 2018 @ 5.65%
for Rs.8 crore. Assuming that clean price be Rs.99.42 and initial Margin be 2% and days of accrued
interest be 262 days. You are required to determine
(i) Dirty Price
(ii) Repayment at maturity (consider 360 days in a year)
Solution :
(a) Dirty Price
Clean price + Interest accrued
10 262
= 99.42 + 100 x 100 x 360
= 106.70
(b) First leg (Start Proceed)
Dirty Price 100−Initial Margin
= Nominal Value x 100
x 100
106.70 100−2
= Rs.8,00,00,000 x 100
x 100
= Rs.8,36,52,800 or, rounded off to Rs.8,36,53,000
(c) Second leg (Repayment at Maturity)
No.of days
= Start Proceed x �1 + Repo rate x 360
�
14
= Rs.8,36,53,800 x �1 + 0.0565 x 360
�
= Rs.8,38,36,804
94 | P a g e
Question 32
May 2017 - Paper
RC Ltd. is able to issue commercial paper of Rs.50,00,000 every 4 months at a rate of 15% p.a. The
cost of placement of commercial paper issue is Rs.2,000 per issue. RC Ltd. is required to maintain line
of credit Rs.2,00,000 in bank balance. The applicable income tax rate for RC Ltd. is 30%. What is the
cost of funds (after taxes) to RC Ltd. for commercial paper issue? The maturity of commercial paper
is four months.
Solution :
Rs.
Issue Price 50,00,000
Less: Interest @ 15% for 4 months 2,50,000
Issue Expenses 2,000
Minimum Balance 2,00,000
45,48,000
2,52,000(1−0.30) 12
Cost of Funds = 45,48,000
x 4
x 100
5,29,200
= 45,48,000 x 100 = 11.636%
Question 33
May 2017 - Paper
P Ltd. has current earnings of Rs.6 per share with 10,00,000 shares outstanding. The company plans
to issue 80,000, 8% convertible preference shares of Rs.100 each at par. The preference shares are
convertible into 2 equity shares for each preference share held. The equity share has a current market
price of Rs.42 per share.
Calculate:
(i) What is preference share's conversion value?
(ii) What is conversion premium?
(iii) Assuming that total earnings remain the same, calculate the effect of the issue on the basic
earnings per share (A) before conversion (B) after conversion.
(iv) If profits after tax increases by Rs.20 Lakhs what will be the basic EPS, (A) before conversion
and (B) on a fully diluted basis?
Solution :
(i) Conversion value of preference share
Conversion Ratio x Market Price
2 × Rs.42
= Rs.84
(Or Rs.67,20,000)
95 | P a g e
(ii) Conversion Premium

(Rs.100/Rs84)–1 = 19.05%
(Or Rs.12,80,000 or Rs.16 per share)
(iii) Effect of the issue on basic EPS
Rs.
Before Conversion
Total (after tax) earnings Rs.6 x 10,00,000 60,00,000
Dividend on Preference Shares 6,40,000
Earnings available to equity holders 53,60,000
No. of shares 10,00,000
EPS 5:36
On diluted Basis
Earnings 60,00,000
No. of shares (10,00,000 + 1,60,000) 11,60,000
EPS 5:17
(iv) EPS with increase in Profit

Rs.
Before Conversion
Earnings 80,00,000
Dividend on Preference Shares 6,40,000
Earnings for equity shareholders 73,60,000
EPS 7:36
On diluted Basis
Earnings 80,00,000
EPS 6:90
Question 34
May 2018 Paper
A bond is held for a period of 45 days. The current discount yield is 6 per cent per annum. It is
expected that current yield will increase by 200 basis points and current market price will come down
by Rs.2.50.
Calculate:
(i) Face value of the Bond and
(ii) Bond Equivalent Yield
Solution :
1. Bond with discount yield of 6% matures in 45 days
96 | P a g e
45
Therefore, yield of 45 days = 6 x 365 = 0.7397%
So the Present value of the bond today

PV = 𝑥𝑥/1.007397 = 0.9927x
2. If yield increases by 2% price falls by Rs.2.5

A. So at 8% yield price will be 0.9927x – 2.5
B. Also with discount yield of 8% maturing in 45 days
45
The yield for 45 days shall be = 8 x 365 = 0.9863%
So the Present value of the bond today

PV = 𝑥𝑥/1.009863 = 0.9902x
3. So 0.9927x – 2.5 = 0.9902x

Therefore x = 1000 ------- Face Value = 1000
Question 35
Sabanam Ltd. has issued convertible debentures with coupon rate 11%. Each debenture has an
option to convert to 16 equity shares at any time until the date of maturity. Debentures will be
redeemed at Rs.100 on maturity of 5 years. An investor generally requires a rate of return of 8% p.a.
on a 5-year security. As an advisor, when will you advise the investor to exercise conversion for given
market prices of the equity share of
(i) Rs.5,
(ii) Rs.6
(iii) Rs.7.10.
Cumulative PV factor for 8% for 5 years : 3.993
PV factor for 8% for year 5 : 0.681
Solution :
Investor wants a return of 8%
On Investment
‫؞‬IV of Bond
= PV of coupon + PV of Redemption
= 11 × PVIFA (8%, 5) + 100 × PVIFA (8%, 5)
= 112.023
For investor to break even and convert share the price would be
= 112.023 / 16 = Rs.7.
The Investor should convert at price of Rs.7.10/share
97 | P a g e
Question 36
Nov 2013 – Paper / Nov 2018 – Paper
Sonic Ltd. issued 8% 5 year bonds of Rs.1,000 each having a maturity of 3 years. The present rate of
interest is 12% for one year tenure. It is expected that forward rate of interest for one year tenure is
going to fall by 75 basis points and further by 50 basis points for next year. This bond has a beta value
of 1.02 and is more popular in the market due to less credit risk.
Calculate:
(i) Intrinsic Value of bond
(ii) Expected price of bond in the market
Solution :
Discounting rates
Year Forward Rate
1 12%
2 11.25%
3 10.75%
A. IV of Bond = PV of future cash flow

Year CF PV
1 80 71.43 -@12%
2 80 64.21 -@12%, 11.25%
3 1080 782.64 -@12%, 11.25%, 10.75%
918.28
B. Expected value of Bond = 918.20 x 1.02 = Rs.936.6456
Question 37
Nov 2016 – RTP / Nov 2018 (New) - Paper
Tangent Ltd. is considering calling Rs.3 crores of 30 years, Rs 1,000 bond issued 5 years ago with a
coupon interest rate of 14 per cent. The bonds have a call price of Rs 1,150 and had initially collected
proceeds of Rs.2.91 crores since a discount of Rs 30 per bond was offered. The initial floating cost
was Rs.3,90,000. The Company intends to sell Rs.3 crores of 12 per cent coupon rate, 25 years bonds
to raise funds for retiring the old bonds. It proposes to sell the new bonds at their par value of
Rs.1,000. The estimated floatation cost is Rs.4,25,000. The company is paying 40% tax and its after
tax cost of debt is 8 per cent. , As the new bonds must first be sold and then their proceeds to be
used to retire the old bonds, the company expects a two months period of overlapping interest during
which interest must be paid on both the old and the new bonds. You are required to evaluate the
bond retiring decision. [PVIFA 8%,25= 10.675]
Solution :
Part 1 : Initial Cash Flows
98 | P a g e
1 Redemption of Old Bonds 3,45,00,000 Outflow

(30000000 / 1000 x 1150)
2 Tax Shield on POR of OLD Bonds 18,00,000 Inflow
(45,00,000 x 40%)
3 Issue of New Bonds 2,95,75,000 Inflow
(3,00,00,000 - 4,25,000)
4 Tax shield on unamortised floatation cost on old bonds 4,30,000 Inflow
(9,00,000 + 3,90,000) x 25/30 x 40%)
5 Post tax overlapping interest 4,20,000 Outflow
(3,00,00,000 x 14% x 2/12 x 60%)
NET -31,15,000
Part 2 : Recurring Cash Flows

OLD NEW
1 Post Tax Coupon 25,20,000 21,60,000
OLD = 30000000 x 14% x 60%
New = 30000000 x 12% x 60%
2 Tax Shield on Amortization 17,200 6800
of floatation cost/Discount
OLD = (900000 + 390000)/30 )x40%
New = 425000 / 25 x 40%
NET 25,02,800 21,53,200
Difference of Old and New 3,49,600

PVIFA for 25 years 37,31,980
NET Cash flows of Part 1 and Part 2 6,16,980
Since the cash flows are positive we should go ahead with the project.
Question 38
Nov 2018 (New) - Paper
The following data are available for three bonds A, B and C. These bonds are used by a bold portfolio
manager to fund an outflow scheduled in 6 years. Current yield is 9%. All bonds have face value of
Rs.100 each and will be redeemed at par. Interest is payable annually.
Bond Maturity (Years) Coupon Rate
A 10 10%
B 8 11%
C 5 9%
(i) Calculate the duration of each bond.
(ii) The bond portfolio manager has been asked to keep 45% of the portfolio money in Bond A.
Calculate the percentage amount to be invested in bonds B and C that need to be purchased
to immunize the portfolio.
99 | P a g e
(iii) After the portfolio has been formulated, an interest rate change occurs, increasing the yield
to 11%. The new duration of these bonds are : Bond A = 7.15 Years, Bond B = 6.03 Years and
Bond C = 4.27 years.
Is the portfolio still immunized ? Why or why not ?
(iv) Determine the new percentage of B and C bonds that are needed to immunize the portfolio.
Bond A remaining at 45% of the portfolio.
Present values be used as follows :
PV T1 T2 T3 T4 T5
PVIF0.09 0.917 0.842 0.772 0.708 0.650
PV T6 T7 T8 T9 T10
PVIF0.09 0.596 0.547 0.502 0.460 0.4224
Solution :
A) Duration of each bond
D=
∑ wx
∑w
Bond A
Year CF PV @ 9% Wx
1 10 9.17 9.17
2 10 8.42 16.84
3 10 7.72 23.16
4 10 7.08 28.32
5 10 6.50 32.5
6 10 5.96 35.75
7 10 5.47 38.29
8 10 5.02 40.16
9 10 4.60 41.4
10 110 46.47 464.7
106.61 730.3
730.3
D= = 6.85 year
106.61
Bond B
Year CF PV @ 9% Wx
1 11 10.09 10.09
2 11 9.26 18.52
3 11 8.49 25.47
4 11 7.79 31.16
5 11 7.15 35.75
100 | P a g e
6 11 6.56 39.39
7 11 6.02 42.14
8 11 55.71 445.66
111.07 648.15
648.15
D= = 5.84 year
111.07
Bond C
Year CF PV @ 9% Wx
1 9 8.26 8.26
2 9 7.56 15.12
3 9 6.95 20.85
4 9 6.38 25.52
5 109 70.84 354.2
100 423.95
423.95
D= = 4.24 year
100
B) Interest Immunization
Step 1 : Duration of liability = 6 years
Step 2 : To immunize to school match
DA = DL = 6 years
Step 3 : Duration of each Bond
DA = 6.85 years
DB = 5.84 years
DC = 4.24 years
Step 4 : Proportion of funds to be invested in each bond.
i.e. (6.85 × 0.45) + (5.84 × x) + (4.24 × (0.55 – x) = 6
= 3.0825 + 5.84x + 2.332 – 4.24x = 6
1.6x = 0.5855
0.5855
∴x = = 0.366
1 .6
∴0.55 – 0.366 = 0.184
C) New Duration of Assets (Bonds)

= 7.15 × 0.45 + 6.03 × 0.366 + 4.27 × 0.184
= 6.20 years
Note : The portfolio is no longer immunized as duration of bonds is immunized to 6.2 years.
101 | P a g e
D) New Proportion of funds to be invested

= (7.15 × 0.45) + (6.03 × x) + (4.27 × (0.55 – x) = 6
= 3.2175 + 6.03x + 2.3485 – 4.27x = 6
1.7x = 0.434
∴x = 0.25
i.e. 0.55 – 0.25 = 0.30
Question 39
Nov 2008 – Paper / Nov 2015 – RTP / Nov 2017 – RTP / May 2019 (Old) - RTP
The data given below relates to a convertible bond:
Face value Rs.250
Coupon rate 12%
No. of shares per bond 20
Market price of share Rs.12
Straight value of bond Rs.235
Market price of convertible bond Rs.265
Calculate:
(i) Stock value of bond.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) The conversion parity price of the stock.
Solution :
(i) Stock value of Bond
= Conversion Rates × M.P. of share
= 20 × 12 = Rs.240
(ii) Conversion premium
= M.P. of Bond – Stock value of Bond
= 265 – 240 = Rs.25
(iii) Conversion parity price
M.P.of Bond 265
= = = 13.25
Conversion Ratio 20
(iv) % downside risk
265 - 235
= × 100 = 12.766%
235
Question 40
Nov 2019 (New) – RTP / Nov 2019 (Old) - RTP
A hypothetical company ABC Ltd. issued a 10% Debenture (Face Value of Rs.1000) of the duration of
10 years is currently trading at Rs.850 per debentnure. The bond is convertible into 50 equity shares
being currently quoted at Rs.17 per share.
102 | P a g e
If yield on equivalent comparable bond is 11.80%, then calculate the spread of yield of the above
bond from this comparable bond.
The relevant present value table is as follows.
Present Values t1 t2 t3 t4 t5 t6 t7 t8 t9 t 10
PVIF 0.11, t 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352
PVIF 0.13, t 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295
Solution :
Conversion Price = Rs.50 x 17 = rs.850
Intrinsic Value = Rs.850
Accordingly the yield (r) on the bond shall be:
Rs.850 = Rs.100 PVAF (r, 10) + Rs.1000 PVF (r, 10)
Let us discount the cash flows by 11%
850 = 100 PVAF (11%, 10) + 1000 PVF (11%, 10)
850 = 100 x 5.890 + 1000 x 0.352
= 91
Now let us discount the cash flows by 13%
850 = 100 PVAF (13%, 10) + 1000 PVF (13%, 10)
850 = 100 x 5.426 + 1000 x 0.295
= –12.40
Accordingly, IRR
90.90
11% + × (13% –11%)
90.90 − (−12.40)
90.90
11% + ×( 13% –11%)
103.30
= 12.76%
The spread from comparable bond = 12.76% – 11.80% = 0.96%
Question 41
Nov 2019 (Old) - Paper
(a) The nominal value of 10% Bonds issued at par by M/s. SK Ltd. is Rs.100. The bonds are
redeemable at Rs.110 at the end of year 5.
(i) Determine the value of bond if required yield is :
(a) 8% (b) 9% (c) 10% (d) 11%
(ii) When will the value of the bond be highest?
Give below are Present Value Factors :
Year 1 2 3 4 5
PV Factor @8% 0.926 0.857 0.794 0.735 0.681
PV Factor @9% 0.917 0.842 0.772 0.708 0.650
PV Factor @10% 0.909 0.826 0.751 0.683 0.621
PV Factor @11% 0.901 0.812 0.731 0.659 0.593
103 | P a g e
Solution :
1) IV of Bond = PV of Coupon + PV of Redemption
a) If TM = 8%
IV = 10 × PVIFA(8%, 5) + 110 × PVIF(8%, 5)
= 39.93 + 74.91 = 114.84
b) If YTM = 9%
IV = 10 × PVIFA(9%, 5) + 110 × PVIF (9%, 5)
= 38.89 + 71.50 = 110.39
c) If YTM = 10%
IV = 10 × PVIFA(10%, 5) + 110 × PVIF (10%, 5)
= 37.90 + 68.31 = 106.21
d) If YTM = 11%
IV = 10 × PVIF(11%, 5) + 110 × PVIF (11%, 5)
= 36.96 + 65.23 = 102.19
2) Value of Bond will be highest when YTM is lowest. i.e. @ 8% YTM value = Rs.114.84
Question 42
Today being 1st January 2019, Ram is considering to purchase an outstanding Corporate Bond having
a face value of Rs.1,000 that was issued on 1st January 2017 which has 9.5% Annual Coupon and 20
years of original maturity (i.e. maturing on 31st December 2027). Since the bond was issued, the
interest rates have been on downside and it is now selling at a premium of Rs.125.75 per bond.
Determine the prevailing interest on the similar type of Bonds if it is held till the maturity which shall
be at Par.
PV Factors :
1 2 3 4 5 6 7 8 9
6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592
8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500
Solution :
Prevailing interest rate can be found by interpolation using concept of
Year CF PV @ 6% PV @ 8%
1 95 89.62 87.96
2 95 84.55 81.45
3 95 79.76 75.41
4 95 75.25 69.83
5 95 70.99 64.66
6 95 66.97 59.87
7 95 63.18 55.43
8 95 59.60 51.33
9 1000 + 95 648.13 547.77
1238.05 1093.71
–CP 1125.75 1125.75
112.3 (32.04)
104 | P a g e
NPV
IRR = LR + ×Diff. of rate
∑ NPV
112.3
=6+ × 2 = 7.556%
144.34
Question 43
The following data is available for NNTC bond:
Face value : Rs.1000
Coupon rate : 7.50%
Years to maturity : 8 years
Redemption Value : Rs.1000
YTM: 8%
Calculate:
(i) The current market price, duration and volatility of the bond.
(ii) The expected market price if there is a decrease in required yield by 50 bps.
Solution :
Working Note :
Year CF PV @ 8% WX
1 75 69.44 69.44
2 75 64.30 128.6
3 75 59.54 178.62
4 75 55.13 220.52
5 75 51.04 255.2
6 75 47.26 283.56
7 75 43.76 306.32
8 1000 + 75 580.79 4646.32
971.26 6088.58
1) CP = Rs.971.26
2) D=
∑ WX = 6088.58 = 6.2687 years.
∑ W 971.26
D 6.2687
3) Volatility (MD) = = = 5.8%
1 + YTM 1.08
4) New price if yield decrease by 50 bps.

971.26 + (0.5 × 5.8%) = Rs.999.42

105 | P a g e

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CA-FINAL

1 Financial Policy & Corporate Strategy 1–3

2 Security Analysis 4–8

3 Equity & Corporate Valuations 9 – 68

4 Bond Analysis & Valuations 69 – 105

CHP - 1 FINANCIAL POLICY & CORPORATE

CHP - 2 SECURITY ANALYSIS

8.2 10.26 12.32

Lower limit = µ − 𝑡𝑡(σ) = 10.26 – 2.101(2.06) = 5.93

5.93 10.26 14.58

Lower limit = µ − 𝑡𝑡(σ) = 10.26 – 1.734 (2.06) = 6.69

6.69 10.26 13.83

CHP - 3 EQUITY ANALYSIS AND VALUATION

Stage 1 : First 5 years

Current Year Next Year

No of shares = 1300 / 40 = 32.5 Crores

= 9.1 × 0.8 + 26 × = 7.8 × 0.5 + 22 × = 6.5 × 0.2 + 20 ×

EBIT = Taxable income + Interest

Turnover Rs. 600 lakhs × 11 = Rs. 660 lakhs

V0 = 2963.45 × 0.530 = 1570.6298

Business Capitalization/Sales Capitalization Capitalization /

Tax @ 35% 56.70

2. Firm offer one right share for 2 shares held

Period Amount ($ Million)

3) Calculation for NOPAT

4) Calculation for Net Investments

PV @ 0.511 0.0989 (0.131) (0.115) 0.188 0.224 0.921 0.732

7) Value of firm = Stage I + Stage II

2) Calculation of Revised Interest Coverage Ratio

Since, Actual Stock Price is higher, hence it is overvalued.

(iii) Value of the Stock under the Earnings Growth Model :

Cost of Goods Sold (COGS) Rs. 3,000 Crores

(ii) Net Investment = Capital Spending – Depreciation + Change in Working Capital

Base Year 1 Year 2 Year 3 Year 4

Year 1 Year 2 Year 3 Year 4

2010 6.30 2.52 63.00

2011 7.00 2.80 46.00

Balance Sheet Information

A. Value of the firm before the strategy

B. Value of the firm after the strategy

1. PAT 1,680 2016 2419.2 2,419.2

Total Stage 1 + Stage 2 = 10,604.42 – 1961.11 = Rs 8643.31

Profit – Earning Capacity Method Rs.in lakhs

Value per share

Fair Price of share Rs.

(ii) Break-Even its investment expenditure

Expected market price after 2 years 𝟐𝟐.𝟓𝟓𝟓𝟓 𝟏𝟏 Rs.231.48

Expected market price after 1 years 𝟐𝟐.𝟓𝟓𝟓𝟓 𝟏𝟏 Rs.214.33

• The inflation premium increases by 3 percent?

(ii) Inflation premium = 3%

(ii) Calculation of theoretical value of the rights alone:

Add: Sale proceeds of rights renunciation

Loss of wealth to shareholders, if rights ignored 1,600

Total IV = 39.08 + 249.50 = 288.58

4. Value of Right = 33.6 – 24

(ii) Computation of Market Price of Equity Share

Earnings available for Equity Shareholders Rs.85,00,000

Balance sheet as on 31st March, 2018

FCFE 960 1248 1622.5 2109.12 11995.62