Question One:

a.) Estimation of Capital Requirements:

“Financial managers must make estimations with regard to capital requirements of the company. This will depend upon expected costs
and profits and future programs and policies of a concern. Estimations have to be made in an adequate manner which increases the
earning capacity of the enterprise” (Financial Management).

b.) Determination of Capital Composition:

“Once the estimations have been made, the capital structure has to be decided” (Financial Management). Thus the Finance Decision is an
important function.

Capital structure is how a firm finances its overall operations and growth by using different sources of funds. Maximization of shareholders'
wealth is the prime objective of a financial manager. The same will be achieved if an optimal capital structure is designed for the company.
Planning a capital structure is a complex and qualitative process. It involves balancing the shareholders' expectations (risk and returns) and
capital requirements of the firm.

“The determination of capital composition involves short-term and long-term debt equity analysis. This will depend upon the proportion
of equity capital that a company is possessing and additional funds which have to be raised from outside parties” (Financial
Management).

c.) Choice of Sources of Funds

“For additional funds to be procured, a company has many choices like-

 i. Issues of Shares and Debentures
ii. Loans to be taken from banks and financial institutions
iii. Public Deposits to be drawn like in the form of bonds” (Financial Management).

The choice of source of funds will depend on relative merits and demerits of each source and the period of financing (Financial
Management).

d.) Disposal of Surplus:

The Dividend Decision is another Finance Function which is to be analyzed in relation to the financing decision of the firm.

Two alternatives are available in dealing with profits of a firm as mentioned above:

1. Profits can be distributed to the shareholders in the form of dividends.

2. Profits can be retained in the business itself.

The decision as to which course of action should be followed depends largely on the significant dividend decision; the dividend-pay-out ratio, i.e.
what proportion of net profits should be paid out to the shareholders. The decision ultimately depends upon the preference of the shareholders’
investment opportunities available to the firm.

The Dividend decision has a great influence on the market prize of the share.
 1. So the dividend policy is to be determined in terms of its impact on shareholder's value.
2. The optimum dividend policy is one which maximizes the value of shares and wealth of the shareholders.
3. The financial manager should determine the optimum pay-out ratio (the proportions of net profit to be paid out to the shareholders).

e.) Management of Cash:

“The finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of
electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials, etc”
(Financial Management).

f.) Financial Controls:

“The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be
done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc.” (Financial Management).

Question Two:
 a.) Calculate the Payback Periods for Project L and Project S and state your decision:

Payback Method Project L

Year Investment Rs. Cashflows Rs. Cumulative Cash Inflow
0 -400,000
1 20,000 -380,000
2 50,000 -330,000
3 50,000 -280,000
4 750,000 470,000 4 years

Number of months required:

12
450,000 =
months
470,000 = ?

12 12.53
× 470,000 =
450,000 months

The Payback Period for Project L is 4 years

 Payback Method Project S
Investment Cashflows
Year Cumulative Cash Inflow
Rs. Rs.
0 -22,000
1 20,000 -2,000
2 10,000 8,000 1 years and 4 months
3 6,000 14,000
4 1,000 15,000

Number of months required

12
10,000 =
months
2,000 = ?

12
× 2,000 = 2.4 months
10,000

The Payback Period for Project S is 1 year and 2.4 months

Decision: According to the Payback Period Method, Project L takes4 years to cover the initial investment. However, Project S takes only 1
year. Therefore, the company should select Project S because it takes a lower Payback Period compared to Project L.

b.) Net Present Value:

Net Present Value Project L

Net Cash
Year Discounting Factor (10%) Discounting Net Cash Flow Accumulated Discounting Net Cash Flow
Flow
0 -400,000 1 -400,000 -400,000
1 20,000 0.909 18,180 -381,820
2 50,000 0.826 41,300 -340,520
3 50,000 0.751 37550 -302,970
4 750,000 0.683 512,250 209,280
Total Net Present Value = 209,280

Net Present Value Project S

Net Cash
Year Discounting Factor (10%) Discounting Net Cash Flow Accumulated Discounting Net Cash Flow
Flow
0 -22,000 1 -22,000 -22,000
1 20,000 0.909 18,180 -3,820
2 10,000 0.826 8,260 4,440
3 6,000 0.751 4,506 8,946
4 2,000 0.683 1,366 10,312
Total Net Present Value = 23,698
Decision: Project L must be selected as an implemented project because the Net Present Value of Project L (+209,280) is higher than the Net
Present Value of Project S 23,698/-according to the investment appraisal.

c.) Internal Rate of Return (Interpolation Method):

Internal Rate of Return (IRR) Interpolation Method

Project L

Net Cash Discounting Factor

Year Discounting Net Cash Flow Accumulated Discounting Net Cash Flow
Flow (12%)
0 1
(400,000) (400,000) (400,000)
1 0.893 17,860
20,000 (382,140)
2 0.797 39850
50,000 (342,290)
3 0.712 35,600
50,000 (306,690)
4 0.636 477,000
750,000 170,310

Net Present Value at 12% Discount Rate is 170,310

Net Present Value at 10% Discount Rate is 209,280
Internal Rate of Return (Interpolation Method) for Project L:

[𝐿𝑜𝑤 𝑟𝑎𝑡𝑒 𝑁𝑃𝑉 × (𝐻𝑖𝑔ℎ 𝑅𝑎𝑡𝑒% − 𝐿𝑜𝑤 𝑅𝑎𝑡𝑒%)]

𝐼𝑅𝑅% = 𝐿𝑜𝑤 𝑅𝑎𝑡𝑒% +
[𝐿𝑜𝑤 𝑅𝑎𝑡𝑒 𝑁𝑃𝑉 + 𝐻𝑖𝑔ℎ 𝑅𝑎𝑡𝑒 𝑁𝑃𝑉]

[𝟐𝟎𝟗, 𝟐𝟖𝟎 × (12% − 10%)]

𝐼𝑅𝑅% = 10% +
[𝟐𝟎𝟗, 𝟐𝟖𝟎 + 𝟏𝟕𝟎, 𝟑𝟏𝟎]

[𝟐𝟎𝟗, 𝟐𝟖𝟎 × 0.02]

𝐼𝑅𝑅% = 10% +
[379,590]

[4,185.6]
𝐼𝑅𝑅% = 0.1 +
[379,590]

𝐼𝑅𝑅% = 0.111

𝑰𝑹𝑹% = 𝟏𝟏. 𝟏%

Project L is 11.1%
 Internal Rate of Return (IRR) Interpolation Method

Project S

Net
Discounting Discounting Net Cash
Year Cash Accumulated Discounting Net Cash Flow
Factor (12%) Flow
Flow
0 -22,000 1 -22,000 (22,000)
1 20,000 0.893 17,860 (4,140)
2 10,000 0.797 7970 3,830
3 6,000 0.712 4,272 8,102
4 2,000 0.636 1272 9374

The Net Present Value at 12% Discount Rate is 9,374

The Net Present Value at 10% Discount Rate is 23,698

Internal Rate of Return (Interpolation Method) for Project S:

[𝐿𝑜𝑤 𝑟𝑎𝑡𝑒 𝑁𝑃𝑉 × (𝐻𝑖𝑔ℎ 𝑅𝑎𝑡𝑒% − 𝐿𝑜𝑤 𝑅𝑎𝑡𝑒%)]

𝐼𝑅𝑅% = 𝐿𝑜𝑤 𝑅𝑎𝑡𝑒% +
[𝐿𝑜𝑤 𝑅𝑎𝑡𝑒 𝑁𝑃𝑉 + 𝐻𝑖𝑔ℎ 𝑅𝑎𝑡𝑒 𝑁𝑃𝑉]

[𝟐𝟑, 𝟔𝟗𝟖 × (12% − 10%)

𝐼𝑅𝑅% = 10% +
(𝟐𝟑, 𝟔𝟗𝟖 + 𝟗, 𝟑𝟕𝟒)

473.96
𝐼𝑅𝑅% = 10% +
33,072

𝐼𝑅𝑅% = 0.1 + (−0.01987)

𝐼𝑅𝑅% = 0.001

𝑰𝑹𝑹% = 𝟎. 𝟏%

The Internal Rate of Return (Interpolation Method) of Project S is 0.1%

Decision: According to the Internal Rate of Return (Interpolation Method) Project L must be selected

Question Three: What is the expected rate of return for Stock x and Stock Y?

a.) 𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑹𝒂𝒕𝒆 𝒐𝒇 𝑹𝒆𝒕𝒖𝒓𝒏 𝒇𝒐𝒓 𝑺𝒕𝒐𝒄𝒌 𝑿 = (𝟎. 𝟏 × −𝟐𝟎) + (𝟎. 𝟒 × 𝟐𝟎) + (𝟎. 𝟐 × 𝟑𝟎) + (𝟎. 𝟐 × 𝟒𝟎) + (𝟎. 𝟏 × 𝟖𝟎)

= −𝟐 + 𝟒 + 𝟔 + 𝟖 + 𝟖 = 𝟐𝟒%

The Expected Rate of Return for Stock X is 24%

𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑹𝒂𝒕𝒆 𝒐𝒇 𝑹𝒆𝒕𝒖𝒓𝒏 𝒇𝒐𝒓 𝑺𝒕𝒐𝒄𝒌 𝒀 = (𝟎. 𝟏 × 𝟒) + (𝟎. 𝟒 × 𝟏𝟒) + (𝟎. 𝟐 × 𝟐𝟒) + (𝟎. 𝟐 × 𝟑𝟎) + (𝟎. 𝟏 × 𝟑𝟐)

= 𝟎. 𝟒 + 𝟓. 𝟔 + 𝟒. 𝟖 + 𝟔 + 𝟑. 𝟐 = 𝟐𝟑. 𝟔%

The Expected Rate of Return for Stock B is 23.6%

b.) Standard Deviation of Expected Returns for Stock X

 = 0.1(−0.2 − 0.24)2 + 0.4(0.2 − 0.24)2 + 0.2(0.3 − 0.24)2 + 0.2(0.4 − 0.24)2 + 0.1(0.8 − 0.24)2 = 0.44056

𝜎𝐴 = √0.44056 = 0.663 = 𝟔𝟔. 𝟑𝟒%

The Standard Deviation of Expected Returns for Stock X is 66.34%

Standard Deviation of Expected Returns for Stock Y

𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑹𝒂𝒕𝒆 𝒐𝒇 𝑹𝒆𝒕𝒖𝒓𝒏 𝒇𝒐𝒓 𝑺𝒕𝒐𝒄𝒌 𝒀 = (𝟎. 𝟏 × 𝟒) + (𝟎. 𝟒 × 𝟏𝟒) + (𝟎. 𝟐 × 𝟐𝟒) + (𝟎. 𝟐 × 𝟑𝟎) + (𝟎. 𝟏 × 𝟑𝟐)

𝜎𝑩2 = 0.1(0.04 − 0.236)2 + 0.4(0.14 − 0.236)2 + 0.2(0.24 − 0.236)2 + 0.2(0.30 − 0.236)2 + 0.1(0.32 − 0.236)2 = 0.00136

𝜎𝐵 = √0.0452028 = 0.2126 = 𝟐𝟏. 𝟐𝟔%

The Standard Deviation of Expected Returns for Stock Y is 21.26%

c.) Which stock would you consider to be riskier? Why?

Stock X is riskier because the Standard Deviation of Expected Returns for Stock X is higher than that of Stock Y. Therefore, Stock Y should be
selected because it has a lower rate of Standard Deviation Expected Return.
Question 4.

60 to 80 = 10 years

Interest Rate: 11%

= 𝟓𝟎, 𝟎𝟎𝟎 × 𝟏𝟎

= 𝟓𝟎𝟎, 𝟎𝟎𝟎

[(𝟏 + 𝒊)𝒏 − 𝟏]
𝑭𝒖𝒕𝒖𝒓𝒆 𝑽𝒂𝒍𝒖𝒆 = 𝑨
[𝒊]

[(𝟏 + 𝟎. 𝟏𝟏)𝟑𝟎 − 𝟏]
𝟓𝟎𝟎, 𝟎𝟎𝟎 = 𝑨
[𝟎. 𝟏𝟏]

[𝟐𝟐. 𝟖𝟗 − 𝟏]
𝟓𝟎𝟎, 𝟎𝟎𝟎 = 𝑨
[𝟎. 𝟏𝟏]
𝟓𝟎𝟎, 𝟎𝟎𝟎 = 𝑨[𝟏𝟗𝟗]

𝑨[𝟏𝟗𝟗] = 𝟓𝟎𝟎, 𝟎𝟎𝟎

𝟓𝟎𝟎, 𝟎𝟎𝟎
𝑨=
𝟏𝟗𝟗

𝑨 = 𝟐, 𝟓𝟏𝟐. 𝟓𝟔

𝑨 = 𝑹𝒔. 𝟐, 𝟓𝟏𝟐

Question Five:

a.)
i. What is the current value of the stock?
Constant Growth DDM:
𝑑𝑜 (1 + 𝑔)
𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
𝑟𝑒 − 𝑔
2(1 + 0.04)
𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
0.08 − 0.04
2.08
𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 =
0.04
𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 = 52

ii.) What will the stock be worth in 5 years?

 Dividend per share = Rs.2
Growth Rate of Dividend = 4%
Stock Worth in 5 years:
𝟐 × (𝟏. 𝟎𝟒)𝟓 = 𝟐. 𝟒𝟑 𝑹𝒖𝒑𝒆𝒆𝒔

b.)

𝑺𝒕𝒐𝒄𝒌 𝑾𝒐𝒓𝒕𝒉 𝒊𝒏 𝟑 𝒚𝒆𝒂𝒓𝒔 = 𝟐(𝟏. 𝟏)𝟑 =2.662

𝑫𝟑 (𝟏 + 𝒈𝟐 )
÷ (𝒓 + 𝟏)𝟑
𝒓 − 𝒈𝟐

𝟐. 𝟔𝟔𝟐(𝟏 + 𝟎. 𝟎𝟒)
= ÷ (𝟎. 𝟏𝟎 + 𝟏)𝟑
𝟎. 𝟏𝟎 − 𝟎. 𝟎𝟒
 [𝟐. 𝟔𝟔𝟐(𝟏. 𝟎𝟒)]
= ÷ (𝟏. 𝟏)𝟑
[𝟎. 𝟏 − 𝟎. 𝟎𝟒]

𝟐. 𝟕𝟔𝟖
= ÷ 𝟏. 𝟑𝟑𝟏 = 𝟑𝟓
𝟎. 𝟎𝟔

35 Rupees ok

c.)
i.) What is the current price?

𝒅(𝟏 + 𝒈)
=
𝒓−𝒈
𝟐. 𝟐𝟎(𝟏. 𝟏𝟐)
=
𝟎. 𝟏𝟑 − 𝟎. 𝟏𝟐
𝟐. 𝟒𝟔𝟒
= = 𝟐𝟒𝟔. 𝟒 𝑹𝒖𝒑𝒆𝒆𝒔
𝟎. 𝟎𝟏