The Institute of Cost and Management Accountants of Bangladesh

Professional Level-IV
401. Financial Management
Knowledge Assessment Test

Question No. 01
(a) What are the key ratios for Financial Statement analysis, Budgeting and Profit planning?
(b) Explain the significance and limitations of ratio analysis?
(c) Using the information and the form given below, compute the balance sheet items for a firm having
a sale of Tk. 3,600,000.
Sales/Total assets 3
Sales/Fixed assets 5
Sales/Current assets 7.5
Sales/Inventories 20
Sales/Debtors 15
Current ratio 2
Total assets/Net worth 2.5
Debt/Equity 1

Balance sheet
Liabilities Tk. Assets Tk.
Net worth Fixed Assets
Long-term debt Inventories
Current Liabilities Debtors
Liquid assets
Total current assets
Total Liabilities Total assets

Question No. 02
(a) What are the characteristics of operating and financial lease?
(b) Distinguish between operating lease and financial lease.
(c) A company is planning to acquire a machine costing Tk. 500,000. Effective life of the machine is 5
years. The company is considering two options. One is to purchase the machine by lease and the
other is to borrow Tk. 500,000 from its bankers at 10% interest p. a. The principal amount of loan
will be paid in 5 equal installments to be paid annually. The machine will be sold at Tk. 50,000 at the
end of 5th year. Other information are given below:
i) Principal, interest, lease rentals are payable on the last day each year.
ii) The machine will be fully depreciated over its effective life.
iii) Tax rate is 30% and after tax cost of capital is 8%.

Required: Compute the lease rentals payable which will make the firm indifferent to the loan option.

Question No. 03
(a) XYZ Ltd. is considering merger with ABC Ltd. XYZ Ltds shares are currently traded at TK. 20. It has
250,000 shares outstanding and its earnings after tax (EAT) amount to TK. 500,000. ABC Ltd. has
125,000 shares outstanding; its current market price is TK. 10 and its EAT are TK. 125,000. The
merger will be effected by means of a stock swap (exchange). ABC Ltd. has agreed to a plan under
which XYZ Ltd. will offer the current market value of ABC Ltds shares.

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 Requirement:
i) What is the pre-merger earning per share (EPS) and P/E ratios of both the companies?
ii) If ABC Ltds P/E ratio is 6.4 what is the current market price? What is the exchange ratio? What
will XYZ Ltds post merger EPS be?
iii) What should be the exchange ratio; if XYZ Ltds pre-merger and post-merger EPS are to be the
same?

(b) A company currently has 200,000 outstanding shares selling for Tk. 100 each. The cost of capital of
the company is 10 percent. The company is expecting a profit of Tk. 3,000,000 in the next year and
also thinking for declaring dividend of Tk. 15 per share. The company has an investment opportunity
of Tk. 4,000,000. How much a shareholder will get at the end of first year according to M. M.
Hypothesis of the requirement given below?
i) What will be the price of the share in the next year if dividend is paid?
ii) What will be the price of the share in the next year if dividend is not paid?
iii) How many new shares must be issued to finance the new investment if dividend is paid?
iv) How many new shares must be issued if no dividend is paid?

Question No. 04
(a) What are the working capital policies of a Firm?
(b) A newly formed company has applied for a short term loan for financing its working capital
requirements. As a financial analyst you are requested by the bank to prepare a projection of the
requirements of working capital of the company applied for. Add 10% to your estimated figure to
cover unforeseen events. The information about the projected income statement of the company is
as below:
Particulars Amount (Tk.)
Sales 2,100,000
Less: Cost of goods sold 1,530,000
Gross Profit 570,000
Less: Selling & Administrative Expenses 270,000
Profit before Tax 300,000
Provision for Tax 100,000
Cost of goods sold has been derived as follows:
Material used 840,000
Plus: Wages & Manufacturing 625,000
Plus: Depreciation 235,000
17,00,000
Less: Stock of finished goods (10% of goods produced not yet sold) (1,70,000)
Cost of Goods Sold 15,30,000

The table given above relate only to the goods that have been finished and not to those in process;
goods equal to 15 percent of the years production (in terms of physical units) are in process , requiring
on an average, full materials but only 40 percent of the other expenses. The company believes in
keeping two months consumption of material in stock.
All expenses are paid one month in arrear; suppliers of material extend 1 months credit; sales are at
20 percent cash and the rest at two months credit; 70 percent of the income tax has to be paid in
advance in quarterly installments. You make other such assumptions as you deem necessary for the
projecting working capital requirements.

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Question No. 05
Mita Corporation is interested in measuring the cost of each specific type of capital as well as the
weighted average cost of capital. Historically, the firm has raised capital in the following manner:

Source of capital Weight (%)

Long-term debt 30
Preferred Stock 20
Common Stock equity 50

The tax rate of the firm is 40%. The needed financial information and data are as follows:

Debt: Mita can raise an unlimited amount of debt by selling TK. 1,000 par value, 8% coupon interest
rate, 20-years bonds on which annual interest payments will be made. To sell the issue, an average
discount of TK. 30 per bond has to be given. There is an associated floatation cost of TK. 30 per bond.

Preferred Stock: The firm can sell 8% preferred stock at its TK. 95 per-share par value. The cost of issuing
and selling the preferred stock is expected to be TK. 5 per share. An unlimited amount of preferred
stocks can be sold under these terms.

Common Stock (New issue): The current price of Mitas common stock is TK. 90 per share. The cash
dividend is expected to be TK. 7 per share next year. The cash dividend has grown at a rate of 6%, and it
is expected that the dividend will continue at this rate for foreseeable future. The stock must be
underpriced by TK. 7 per share and floatation costs are expected to be approximately TK. 5 per share.
Mita can sell an unlimited amount of new common stocks under these terms.

Common Stock (Retained earnings): The firm expects to have available TK. 100,000 of retained earnings
in this coming year. Once the retained earnings are exhausted, the firm will use new common stock
equity financing.

Required:
(i) Calculate the specific cost of each source of financing.
(ii) Calculate the single break point associated with the firms financial situation. This point results
from the exhaustion of the firms retained earnings.
(iii) Calculate the weighted average cost of capital associated with total financing bellow the break
point calculated in part (ii) above.
(iv) Calculate the weighted average cost of capital associated with total financing above the break
point calculated in part (ii) above.

Question No. 06
Explain the following statements:
(a) There is a trade-off between risk and return
(b) Investment is well-grounded and carefully planned speculation
(c) Financial risk is a function of financial leverage
(d) The single index model results in a substantial reduction in inputs required for portfolio analysis
(e) CAPM postulates the nature of the relationship between the expected return and the systematic
risk of a security

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Question No. 07
The total values (equities and debt) of two companies PENDEN and TULEN are expected to fluctuate
according to the state of company.

Economic State
Recession Slow growth Rapid Growth
Probability 0.15 0.65 0.20
Total Values:
Penden (Tk. in millions) 42 55 75
Tulen (Tk. in millions) 63 80 120

Penden currently has Tk. 45 million of debt and Tulen Tk. 10 million of debt. Recently the directors of
the two companies have met to consider the possibility of a merger.

Required:
(a) If the two companies were to merge and assuming that no operational synergy occurs as a result of
merger, calculate the expected value of debt and equity of the merged company. Explain the reason
for any differences that exist form the expected values of debt and equity if they do not merge.
(b) Discuss the advantages and disadvantages of growth by agreed acquisition or merger as compared
with growth by internal (or organic) investment.

Q. No. 08
A public limited company has the following capital structure:
Common share (40,000 shares) Tk. 4,000,000
10% Preference share 1,000,000
14% Debentures 3,000,000
Total Tk. 8,000,000

The share of the company sells for Tk. 200. It is expected that the company will pay next year a dividend
of Tk. 20 per share which will grow at 7 percent for ever. Assume a 30 percent tax rate.

Required:
(a) Compute weighted average cost of capital based on existing capital structures.
(b) Compute the new weighted average cost of capital if the company raises an additional Tk. 2,000,000
debt by issuing 15% debenture. This would result in increasing the expected dividend to Tk. 30 and
leave the growth rate unchanged, but the price of share will fall to Tk. 150 per share.
(c) Compute the cost of capital if in (b) above growth rate increases to 10 percent.

Q. No. 09
(a) Explain in brief the effect on the price of a call option if the value of one of the following variables
changes while others remain constant:
(i) Dividend
(ii) Exercise price
(iii) Time to expiration and
(iv) Volatility of stock price

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(b) Suppose the spot exchange rate between Bangladeshi taka and USD is 75:1 and 2-year interest rates
in Bangladesh and the United States are 8% and 6% respectively. Assume you have the borrowing
capacity of USD 2,000 or equivalent Bangladeshi taka.
Required:
(i) Based on the above information, calculate the 2 years forward exchange rate of taka per US
dollar.
(ii) If the two-year forward exchange rate in the market turns to be BDT 81.2 per US dollar, how
much can you profit from arbitraging?
(iii) How would your strategy change if the forward exchange rate turns to be BDT 77.50 per USD?
How much would be the profit from arbitraging if your borrowing capacity remains same?

Q. No. 10
(a) The chief financial officer of Adobe Systems, a growing software manufacturing firm, has
approached you for some advice regarding the beta of his company. He subscribes to a service
which estimates Adobe Systems beta each year and he has noticed that the beta estimates have
gone down every year since 1991: 2.35 in 1991 to 1.40 in 1995. He would like the answers to the
following questions:
(i) Is this decline in beta unusual for a growing firm?
(ii) Why would the beta decline over time?
(iii) Is the beta likely to keep decreasing over time?
(b) Sally Industries (SI) has decided to replace a major piece of industrial equipment and must now
decide how to finance the acquisition. The equipment costs $690,000 to purchase and install and is
expected to have a useful life of five years. At that time it will be sold on the open market and is
expected to have a salvage value of $200,000. As this equipment is involved in SIs main line of
business, the asset class is expected to always contain assets and to have a positive balance.
One financing alternative is a bank loan at the rate of 7% per annum, which is consistent with
current debt. Another alternative is to lease the equipment for $200,000 per year for five years with
the payments at the start of each year. The corporate tax rate is 40%. If SI leases the asset, it will not
be responsible for maintenance and insurance costs of $40,000 per annum due at year end, but it
will have the same basic operating costs as if it had purchased the equipment. If the firm purchases
the equipment, it will be entitled to an investment tax credit of 5% of the purchase price.
Required:
i) Calculate the net value to leasing this piece of equipment; specifically, calculate and identify the
initial investment outlay and the equivalent loan.
ii) Summarize your analysis and recommend how SI should finance its equipment acquisition.

Q. No. 11
OXLY Inc. had 750,000 outstanding common shares, and paid $5 per share in dividends last year. The
current share price is $30. For the past five years, OXLY maintained a policy of paying out 80% of
earnings as cash dividends. Exhibit FS1 contains the projected balance sheet for OXLY for the upcoming
year end, assuming no dividends. Earnings after tax are projected at $4.5 million.

Exhibit FS 1
OXLY Inc.
Projected Balance Sheet (assuming no dividends)
December 31, 20XX
Assets
Current assets

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 Cash $ 6,000,000
Accounts receivable 1,200,000
Inventories 1,750,000
8,950,000
Equipment 2,570,000
Land 1,580,000
$13,100,000
Liabilities and shareholders' equity
Current liabilities
Accounts payable 1,700,000
Notes payable 650,000
2,350,000
Long-term debt 2,500,000
Common shares 750,000
Retained earnings 7,500,000
$13,100,000
Required:
(a) If OXLY maintains its steady 80% cash dividend payout policy, what is the total cash dividend payout
and what dividend payment will a holder of 100 common shares receive? What is OXLYs total-debt-
to-total-equity ratio following the payout?
(b) Suppose that OXLY retains all of its cash in order to finance a purchase of a large piece of real estate
that it will use for future development of a new manufacturing plant. Instead of a cash dividend, the
company will pay a 20% stock dividend. Assess the impact of a stock dividend as follows:
i) What will the holder of 100 common shares receive?
ii) How will the balance sheet change, given the stock dividend, and what is the total-debt-to-total-
equity ratio if earnings are projected to be unchanged after the real estate purchase?
iii) What can this same shareholder expect to receive in cash dividends next year if OXLY returns to
its steady 80% cash dividend payout policy?
(c) Suppose that OXLY has no investment plans and would like to pay out 80% of its earnings to
shareholders in the form of a share repurchase this year, and then return to its policy of paying cash
dividends in future years. Earnings are projected to be unchanged. Assess the impact of a share
repurchase as follows:
i) Calculate the number of shares OXLY can repurchase if the share price remains at $30.
ii) Calculate the number of shares that will remain outstanding.
iii) In the next year, when cash dividends are resumed, calculate per share dividend and the
amount of dividends the original or former holder of 100 shares will receive.
(d) Referring to your calculations in parts (a) to (c), briefly explain which of the three policies would be
most attractive to OXLYs shareholders.

Q. No. 12
(a) Answer true or false to the following statements, with a brief justification in favor of your answer.
(i) A stock that sells for less than book value is undervalued.
(ii) If a company's return on equity drops, its price/book value ratio will generally drop more than
proportionately, i.e., if the return on equity drops by half, the price/book value ratio will drop by
more than half.
(iii) A combination of a low price-book value ratio and a high expected return on equity suggests
that a stock is undervalued.

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 (iv) Other things remaining equal, a higher growth stock will have a higher price-book value ratio
than a lower growth stock.
(v) In the Gordon Growth model, firms with higher dividend payout ratios will have higher
price/book value ratios.
(b) Before Chysler merged to become DaimlerChrysler AG, they were presented with a takeover bid of
$55 per share by MGM billionaire Kirk Kerkorian and former Chrysler chairman Lee Iacocca. Kirk
Kerkorian was a stockholder in Chrysler and an experienced takeover financier who apparently
found Chrysler to be a good buy. Chrysler rejected the offer, however, stating that the firm was not
for sale. Further, many experts felt that Kerkorian could not come up with the $20 billion necessary
to complete the deal.
After Chrysler rejected Kirk Kerkorian's bid of $55 per share, Kerkorian decided to have his people
repeat the analysis of the firm's financial performance over the two most recent years to determine
if he should increase his bid in this friendly takeover attempt. To measure the financial performance
of Chrysler over the past two years, key financial ratios have been computed. To help in this
endeavor, Chrysler's financial ratios along with the industry average are given below.

Financial Ratios
This year Last year
Chrysler Industry Chrysler Industry
Liquidity
Net Working Capital $9,527 $5,056 $8,321 $4,892
Current Ratio 1.48 1.78 1.44 1.69
Quick Ratio (Acid Test) 1.26 1.55 1.26 1.51
Activity
Inventory Turnover 9.29 7.41 11.32 7.58
Average Age of Inventory 0.026 0.021 0.031 0.021
Average Collection Period 13.56 22.8 11.68 23.4
Fixed Asset Turnover 4.22 1.54 4.72 1.62
Total Asset Turnover 0.99 0.89 1.05 0.91
Debt
Debt 80% 75% 78% 77%
Times Interest Earned 4.47 6.4 7.22 7.0
Profitability
Gross Profit Margin 22% 24% 27% 28%
Net Profit Margin 3.9% 4.7% 6.7% 4.9%
Return on Total Assets 3.8% 4.6% 7.1% 4.7%
Return on Equity 18.9% 20.7% 32.7% 33.8%

Required:
a) Compare Chrysler's ratios to the industry's average. Comment on Chrysler's strengths and
weaknesses by ratio category.
b) Should Kerkorian have pursued the purchase of Chrysler?
c) If Kerkorian did not want to takeover Chrysler, what other reasons might he have had for trying to
convince other people that Chrysler was a takeover candidate?

Q. No. 13
(a) Stock A has a required return of 10 percent. Its dividend is expected to grow at a constant rate of 7
percent per year. Stock B has a required return of 12 percent. Its dividend is expected to grow at a

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 constant rate of 9 percent per year. Stock A has a price of Tk. 25 per share, while Stock B has a price of
Tk. 40 per share. Which of the following statements is most correct?
i. The two stocks have the same dividend yield.
ii. If the stock market were efficient, these two stocks should have the same price.
iii. If the stock market were efficient, these two stocks should have the same expected return.
iv. Statements i. and iii. are correct.

(b) ABC Company is expected to pay a dividend of Tk. 1 per share at the end of the year, and that dividend is
expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market
risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price?

(c) A portfolio consists of two assets, the expected returns and standard deviations of returns of which are
listed in the table below:
Particulars Asset A Asset B
Expected Return 8% 10%
Standard Deviation 16% 20%

Calculate:
i) The expected return for a portfolio which is equally weighted between two assets.
ii) The correlation coefficient for the two-asset portfolio, assuming that the covariance is 32.
iii) The variance of returns for the equally weighted portfolio, assuming a covariance of 32.
iv) The standard deviation of returns for the equally weighted portfolio.
v) The simple weighted standard deviation of the portfolio and comment on the scale of risk reduction.

Q. No. 14
(a) What major steps are involved in the capital budgeting process?
(b) Sonar Bangla Limited is considering investment of Tk. 50,000 in a new machine with an expected life
of five years. The machine will have no scrap value at the end of five years. It is expected that 20,000
units will be sold each year at a selling price of Tk. 3.00 per unit. Variable production costs are
expected to be Tk. 1.65 per unit, while incremental fixed costs, mainly the wages of a maintenance
engineer, are expected to be Tk. 10,000 per year. Sonar Bangla Limited uses a discount rate of 12%
for investment appraisal purposes and expects investment projects to recover their initial
investment within two years.
Required:
i. Explain why risk and uncertainty should be considered in the investment appraisal process.
ii. Calculate and comment on the payback period of the project.
iii. Evaluate the sensitivity of the projects net present value to a change in the following project
variables:
a) Sales Volume;
b) Sales Price;
c) Variable Cost;
And discuss the use of sensitivity analysis as a way of evaluating project risk.
iv. Upon further investigation it is found that there is a significant chance that the expected sales
volume of 20,000 units per year will not be achieved. The sales manager of Sonar Bangla Limited
suggests that sales volumes could depend on expected economic states that could be assigned
the following probabilities:
Economic States Poor Normal Good
Probability 0.3 0.6 0.1

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 Annual Sales Volume (Units) 17,500 20,000 22,500
Calculate and comment on the expected net present value of the Project.

Q. No. 15
(a) During the last few years, Arafat Industries has been too constrained by the high cost of capital to
make many capital investments. Recently, though, capital costs have been declining, and the
company has decided to look seriously at a major expansion program that had been proposed by
the marketing department. Assume that you are an assistant to Mr. Mobarak Ali, the Chief Financial
Officer. Your first task is to estimate Arafat cost of capital. Mobarak has provided you with the
following data, which he believes may be relevant to your task:
i) The firm's tax rate is 40 percent.
ii) The current price of Arafat 12 percent coupon, semiannual payment, non-callable bonds with
15 years remaining to maturity is Tk. 1,153.72. Arafat does not use short-term interest-bearing
debt on a permanent basis. New bonds would be privately placed with no flotation cost.
iii) The current price of the firms 10 percent, Tk. 100 par value, quarterly dividend, perpetual
preferred stock is Tk. 116.95. Arafat would incur flotation costs equal to 5 percent of the
proceeds on a new issue.
iv) Arafat common stock is currently selling at Tk. 50 per share. Its last dividend (d0) was Tk. 4.19,
and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future.
Arafat beta is 1.2; the yield on t-bonds is 7 percent; and the market risk premium is estimated
to be 6 percent. For the bond-yield-plus-risk premium approach, the firm uses a 4 percentage
point risk premium.
v) Arafat target capital structure is 30 percent long-term debt, 10 percent preferred stock, and 60
percent common equity.
To structure the task somewhat, Jones has asked you to answer the following questions:
(i) What sources of capital should be included when you estimate Arafats weighted average cost
of capital (WACC)?
(ii) What is the market interest rate on Arafat debt and its component of cost of debt?
(iii) What is the Arafat's cost of preferred stock?
(iv) What is the estimated cost of equity using the discounted cash flow (DCF) approach?
(v) What is Arafat weighted average cost of capital (WACC)?
(vi) What factors influence Arafat composite WACC?
(vii) Should the company use the composite WACC as the hurdle rate for each of its projects?

Q. No. 16
(a) What are types of project risks? How is each type of risk used?
(b) What is overtrading?
(c) Mina Chocolate Limited has annual credit sales of Tk. 15 million and allows 90 days credit. It is
considering introducing a 2% discount for payment within 15 days, and reducing the credit period to
60 days. It estimates that 60% of its customers will take advantage of the discount, while the volume
of sales will not be affected. The company nance working capital from an overdraft at a cost of
10%. Is the proposed change in policy worth implementing?
(d) Chadni Chawk Limited has annual credit sales of Tk. 4.5 million. Credit terms are 30 days, but its
management of trade receivables has been poor and the average collection period is 50 days, with
0.4% of sales resulting in bad debts. A factor has offered to take over the task of debt administration
and credit checking, at an annual fee of 1% of credit sales. Chadni Chawk Limited estimates that it
would save Tk. 35,000 per year in administration costs as a result. Due to the efficiency of the factor,

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 the average collection period would fall to 30 days and bad debts would be eliminated. The factor
would advance 80% cent of invoiced debts at an annual interest rate of 11%. Chadni Chawk Limited
currently finances trade receivables from an overdraft costing 10% per year.

If credit sales occur smoothly throughout the year, determine whether the factors services should be
accepted?

Q. No. 17
(a) What is Put Call Parity relationship?
(b) The current price of the Lucky Company Stock is Tk. 50, and the 6-month forward price is Tk. 52.
What is the amount of money that needs to be lent today to mimic the profit of outright purchase
after 6 months? Assume that the annual continuously compounded risk free rate is 5%.
(c) A dealer has just entered into a short forward position. The underlying asset is currently traded at
Tk. 100 and the 1-year forward price is Tk. 105. Assuming an annual effective rate of 3%, find the
number of 100 zero-coupon bonds that the dealer has to buy to hedge his position.
(d) You are given that the ABC Stock price is traded at Tk. 45 now and the 3-month forward price is Tk.
46.80.If the ABC stock pays a dividend of Tk. 0.50 after 1 month and is traded at Tk. 46.80 after 3
months, what is the profit of long forward?
(e) Calculate the value of a call option using the Black and Scholes model given the following
information:
Current market price of share(s) Tk. 50
Volatility (standard deviation) 0.62
Exercise price (E) Tk. 50
Risk free (RF) rate 7%
Time of expiration (t) 5 years
If an investor wants to buy a put with same exercise price and expiration date as call option, what
will be the value of call option?

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