FINANCIAL MANAGEMENT

Time allowed 3 hours

Total marks 100

[N.B. Figures in the margin indicate full marks. Questions must be answered in English. All workings are to be
submitted. Examiner will take account of the quality of language and of the manner in which the answers are
presented. Different parts, if any, of the same questions must be answered in one place in order of sequence.]

Marks

1. (a) What are the three types of project risk? Which type of project risk is theoretically the most
relevant? Why? 4
(b) High electricity costs have made Farmer Corporations chicken plucking machine economically
worthless. Only two machines are available to replace it. The international Plucking Machine (IPM)
model is available only on a lease basis. The lease payment will be Tk 65,000 per year for five years,
due at the beginning of each year. This machine will save Farmer Tk 15,000 per year through
reductions in electricity costs. As an alternative, Farmer can purchase a more energy efficient machine
from Basic Machine Corporation (BMC) for Tk 330,000. This machine will save Tk 25,000 per year
in electricity costs. A local bank has offered to finance the machine with Tk 330,000 loan. The interest
rate on the loan will be 10% on the remaining balance and will require five annual principal payments
of Tk 66,000. Farmer has a target debt-to-asset ratio of 67%. Farmer is in the 34% tax bracket. After 5
years, both machines will be worthless. The machine will be depreciated on a straight line basis.
Requirements:
(i) Should Farmer lease the IPM machine or purchase the more efficient BMC machine? 6
(ii) Does your answer depend on the form of financing for direct purchase? 2
(iii) How much debt is displaced by this lease? 3

2. (a) Discuss four reasons why organisations may decide on a policy of strategic divestment. 3
(b) LTP Company is aggressively pursuing an organic growth strategy but is beginning to be
somewhat frustrated by the slow pace of growth. It has decided to consider acquisition targets.
It has identified a UAE company that is willing to discuss a potential takeover if the price of
BDT 10 Billion (in cash and/or in shares) is met. LTP Companys Investment department has
confirmed that there are no significant concerns to impede the takeover. LTP Companys Board
of Directors are of the opinion that the BDT 10 Billion price is acceptable to them. The only
decision to be made is whether the purchase consideration should be cash and/or share.
Requirement:
As a Finance Manager, prepare a briefing note for the Board of LTP Company outlining the
attractions and drawbacks of both cash and share as purchase consideration. 6
(c) Discuss five factors a company is likely to consider in determining its dividend policy. 5
(d) Best Metal Limiteds management are contemplating a strategy of diversification in order to
spread the risk inherent in the property development industry. They have employed a firm of
management consultants to research the financial viability of investing in shares of companies
in the construction industry.
They have received a report from the management consultants containing the following
executive summary:
Portfolio theory indicates that your ability to spread the unsystematic risk by developing a portfolio
of shares of companies in two industries can only benefit the risk profile of your business. However,
the concern is in relation to the extent to which risk can be diversified, as the coefficient of
correlation between the property development and construction industries stands at plus (+0.8).
Best Metal Limiteds management are experiencing difficulty understanding this summary.

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 Requirement:
Assist as a Finance Manager to Best Metal Limiteds management by preparing a briefing note
which explains the following terms:
- Portfolio Theory
- Systematic Risk and Unsystematic Risk
- Co-efficient of Correlation (as it relates to the two stock/investment portfolio) 6

3. (a) Assuming that share repurchase by the Company is allowed in Bangladesh, Ridwan Co. Ltd. is
evaluating an extra dividend versus a share repurchase. In either case, Tk 11,000 would be
spent. Current earnings are Tk 1.40 per share and the stock currently sells for Tk 58 per share.
There are 2,000 shares outstanding.
Requirements:
(i) Evaluate the two alternatives in terms of the effect on the price per share of the stock and
shareholders wealth. 4
(ii) What will be the effect on Ridwans EPS and PE ratio under the two different scenarios? 3
(iii) In the real world, which of these actions would you recommend? Why? 2
Ignore taxes and other imperfections in answering the first two questions.
(b) You should assume that the current date is 30 June 2017
You work in the finance team at PTE Electronics Company, which is a Bangladesh based
Company. The Company operated exclusively in Bangladesh for more than 10 years; but its
board recently decided to expand its operations by looking overseas for new contracts.
PTE is ready to submit a tender bid for a contract with a Company located at Japan local
currency which is . The margin is set very low due to the chance of repeat business and market
penetration. The following summary information has been prepared:
Total costs plus margin BDT 12.420 million
Tender bid on 30 June 2017 at the current spot rate of 1.2165/BDT 15.109 million
PTEs board understands that the successful bidder will be announced on 31 July 2017. If PTE wins
the bid then work would start on that date and the board estimates that it would be completed on 30
September 2017 when payment would be received from the Japanese Company.
The board is concerned that the /BDT exchange rate has changed quite significantly over the past
three months and that if this trend continues then it could have an impact on the profitability of the
contract. The board would like, therefore, to consider hedging against exchange rate risk
immediately on 30 June 2017, even though the outcome of the tender bid is not yet decided.
The spot /BDT exchange rate over the past three months is summarised below:
Exchange rate (/BDT) at 31March 2017 1.1150 1.1463
at 30April 2017 1.1373 1.1692
at 31 May 2017 1.1600 1.1926
at 30 June 2017 1.1832 1.2165
You have been asked to advise PTEs board and the following information has been made available
to you at the close of business on 30 June 2017:
BDT interest rate (lending) 3.2% pa
BDT interest rate (borrowing) 4.2% pa
Yen interest rate (lending) 2.6% pa
Yen interest rate (borrowing) 3.4% pa
Three-month over the counter (OTC) put option on BDT, exercise price (/BDT) 1.2150
Three-month over the counter (OTC) call option on BDT, exercise price (/BDT) 1.1818
Three-month forward contract premium (/BDT) 0.0025-0.0020
Forward contract arrangement fee (per Yen converted) BDT 0.002
Relevant OTC option premium (per Yen converted) BDT 0.012

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 Requirements:
(i) Estimate the spot rate on 30 September 2017 on the assumption that the /BDT exchange rate
continues to change at the same rate as for the period 31March to 30 June 2017. 2
(ii) On the assumption that PTEs tender bid is successful:
(1) Calculate PTEs BDT receipt on 30 September 2017 using your answer to part (i) above.
(2) Calculate PTEs BDT receipt on 30 September 2017 if it uses
a forward contract
a money market hedge
an OTC currency option 6
(iii) With reference to your calculations in part (ii) above, discuss the issues that should be taken
account of by PTEs board when considering whether it should hedge the Japan contract,
assuming the tender bid is successful. 5
(iv) Explain the implications for PTE of using each of the hedging instruments in part (ii) (2) above
if its tender bid is unsuccessful. 4
(v) Explain the principle of interest rate parity (IRP) and, given the information provided above,
calculate the forward rate of exchange on 30 September 2017 using IRP, commenting on your
result. You should use the average current spot and borrowing/lending rates for the purposes of
this calculation. 4

4. (a) What is the primary difference between the MIRR and the regular IRR? What is the multiple
IRR problem and what condition is necessary for that to occur? 5
(b) Shatil Corporation manufactures fine furniture. The company is deciding whether to introduce a
new mahogany dining room table set. The set will sell for Tk 6,100 including a set of eight
chairs. The company feels that sales will be 1800, 1950, 2500, 2350 and 2100 sets per year for
the next five years respectively. Variable costs will amount to 45% of sales, and fixed costs are
Tk 1.9mn per year. The new tables will require inventory amounting to 10% of sales, produced
and stockpiled in the year prior to sales. It is believed that the addition of the new table will
cause loss of 250 tables per year of the oak tables the company produces. These tables sell for
Tk 4,500 and have variable costs of 40% of sales. The inventory for this oak table is also 10%
of sales. Shatil currently has excess production capacity. If the company buys the necessary
equipment today, it will cost Tk 18mn. However, the excess production capacity means the
company can produce the new table without buying new equipment. The company controller
has said that the current excess capacity will end in two years with current production. This
means that if the company uses the current excess capacity for the new table, it will be forced to
spend the Tk 18mn in two years to accommodate the increased sales of its current products. In
five years, the new equipment will have a market value of TK 3.1mn if purchased today and Tk
7.4mn if purchased in two years. The equipment is depreciated on a seven year MACRS
schedule. The company has a tax rate of 40% and the required return for the project is 11%.
Requirements:
(i) Should Shatil undertake the new project? 8
(ii) Can you perform an IRR analysis on this project? How many IRRs would you expect to find? 2
(iii) How would you interpret the profitability index? 2
(c) Deshi Pictures Limited (DPL) is planning to produce a big budget film based on Liberation
War 1971. The companys Planning team has to date spent BDT 1 Million researching the
commercial elements and costs associated with producing and marketing the proposed film.
The findings of the research are given below:

BOX Office Projections Year 2 Year 3 Year 4

Movie Viewers 200,000 120,000 60,000
The company will receive BDT 300 per cinema viewer throughout the three years. This will
reduce to BDT 250 in any year that the movie is viewed by in excess of 100,000 viewers.

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The movie will be made in year 1 of the proposal and released for viewing/sale/download for a
three year period commencing in year 2.
The company also forecasts that 15,000 DVDs of the movie will be sold in year 2 and will be
reduced by 20% in each of subsequent two years at an initial price of BDT 250 in year 2,
reducing by BDT 50 per year thereafter in order to prolong sales.
In addition, it is anticipated that the movie may be downloaded at a cost to the purchaser of
BDT 500 per download. The hosting website E-B-Movies commission schedule is as follows:
Commission Schedule 1 25,000 25,001-100,000 100,001+
Commission % 15% 20% 25%
DPL expects that the following number of downloads will be sold in each year.
Projected Downloads Year 2 Year 3 Year 4
Number of Downloads 50,000 150,000 20,000
The movie will incur the following promotional costs:
Projected Promotional Year 2 Year 3 Year 4
Costs
Print Media 5,000,000 3,000,000 2,000,000
Premier Event 2,000,000 - -
DVD Posters 500,000 500,000 -
Internet Adverts 750,000 500,000 500,000
The cost of producing this movie will be as follows:
A famous director has been selected. This director will be paid BDT 5 Million immediately and
a commission of 2.5% of all gross revenues accruing to DPL. This commission is to be paid
one year after the revenues accrue to DPL.
The cost of the movie cast will be:
Forecast Acting Costs Number Cost per Actor/Actress (BDT)
Lead 3 1,500,000
Support 20 200,000
Extras 250 25,000
Equipment costing BDT 15 Million will be purchased at the outset of the production. It will be
resold when the movie is completed at the end of year 1 for estimated sales proceeds of BDT 8
Million.
DPLs Finance Director has asked you to use the companys Weighted Average Cost of Capital
(WACC) for the purpose of determining the projects Net Present Value. You have discerned
the following information in relation to the companys various sources of finance:
DPLs Finance Structure Face Value (BDT Million)
Ordinary Shares (BDT 2 per Share) 15
20% Preference Shares (BDT 1 per Share) 5
8% Irredeemable Loan Stock 4
The ordinary shares are trading at BDT 3.50 ex dividend, whilst the preference shares are
trading at BDT 2.40. The recently confirmed preference dividend of BDT 0.20 per share has
not been paid as yet. The loan stock is trading at par ex int.
The most recent dividend paid on DPLs ordinary shares was BDT 0.40 per share. The average
annual rate of growth of dividend in ordinary shares is 8%, which is likely to continue for some
years to come. DPL pays Income Tax at an effective rate of 19%.
Requirement:
Advise Deshi Pictures Limited, based on strictly net present value criteria, whether or not it
should embark on the production of the proposed movie. 18

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