Module Two

PROBLEMS
1. Determine the future values utilizing a time preference rate of 9 per cent:
(i) The future value of Rs 15,000 invested now for a period of four years.
(ii) The future value at the end of five years of an investment of Rs 6,000 now and of an investment
of Rs 6,000 one year from now.
(iii) The future value at the end of eight years of an annual deposit of Rs 18,000 each year.
(iv) The future value at the end of eight years of annual deposit of Rs 18,000 at the beginning of each
year.
(v) The future values at the end of eight years of a deposit of Rs 18,000 at the end of the first four
years and withdrawal of Rs 12,000 per year at the end of year five through seven.
2. Compute the present value of each of the following cash flows using a discount rate of 13 per cent:
(i) Rs 2,000 cash outflow immediately.
(ii) Rs 6,000 cash inflow one year from now.
(iii) Rs 6,000 cash inflow two years from now.
(iv) Rs 4,000 cash outflow three years from now.
(v) Rs 7,000 cash inflow three years from now.
(vi) Rs 3,000 cash inflow four years from now.
(vii) Rs 4,000 cash inflow at the end of each of the next five years.
(viii) Rs 4,000 cash inflow at the beginning of each of the next five years.
3. Determine the present value of the cash inflows of Rs 3,000 at the end of each year for next 4 years
and Rs 7,000 and Rs 1,000 respectively at the end of years 5 and 6. The appropriate discount rate is 14
per cent.
4. Assume an annual rate of interest of 15 per cent. The sum of Rs 100 received immediately is
equivalent to what quantity received in ten equal annual payments, the first payment to be received one
year from now. What could be the annual amount if the first payment were received immediately?
5. Assume a rate of interest of 10 per cent. We have a debt to pay and are given a choice of paying Rs
1,000 now or some amount X five years from now. What is the maximum amount that X can be for us
to be willing to defer payment for five years?
6. Assume that you are given a choice between incurring an immediate outlay of Rs 10,000 and having to
pay Rs 2,310 a year for 5 years (first payment due one year from now); the discount rate is 11 per cent.
What would be your choice? Will your answer change if Rs 2,310 is paid in the beginning of each year
for 5 years?
7. Compute the present value for a bond that promises to pay interest of Rs 150 a year for thirty years and
Rs 1,000 at maturity. This first interest payment is paid one year from now. Use a rate of discount of 8
per cent.
8. 10.Using an interest rate of 10 per cent, determine the present value of the following cash flow series:
End of period Cash-flow (Rs)
0 – 10,000
1–6 (each period) + 2,000
7 – 1,500
8 + 1,600
9–12 (each period) + 2,500
9. Find the rate of return in the following cases:
(i) You deposit Rs 100 and would receive Rs 114 after one year.
(ii) You borrow Rs 100 and promise to pay Rs 112 after one year.
(iii) You borrow Rs 1,000 and promise to pay Rs 3,395 at the end of 10 years.
(iv) You borrow Rs 10,000 and promise to pay Rs 2,571 each year for 5 years.
10. Jai Chand is planning for his retirement. He is 45 years old today, and would like to have Rs 3,00,000
when he attains the age of 60. He intends to deposit a constant amount of money at 12 per cent at each
year in the public provident fund in the State Bank of India to achieve his objective. How much money
should Jai Chand invest at the end of each year for the next 15 years to obtain Rs 3,00,000 at the end of
that period?
Module Two
PROBLEMS
1. An asset has the following possible returns with associated probabilities:
Possible returns 20% 18% 8% 0 –6%
Probability 0.10 0.45 0.30 0.05 0.10

Calculate the expected rate of return and the standard deviation of the rate of return.
2. Securities X and Y have the following characteristics:
Security X Security Y
Return Probability Return Probability
30% 0.10 –20% 0.05
20% 0.20 10% 0.25
10% 0.40 20% 0.30
5% 0.20 30% 0.30
–10% 0.10 40% 0.10
You are required to calculate (a) the expected return and standard deviation of return for each security
and (b) the expected return and standard deviation of the return for the portfolio of X and Y, combined
with equal weights.
3. The distribution of returns for share P and the market portfolio M is given below:
Returns (%)
Probability P M
0.30 30 –10
0.40 20 20
0.30 0 30
You are required to calculate the expected returns of security P and the market portfolio, the
covariance between the market portfolio and security P and beta for the security.

Module Three
PROBLEMS
1. The following are the net cash flows of an investment project:
Cash Flows (Rs)
C0 C1 C2
– 5,400 + 3,600 + 14,400
Calculate the net present value of the project at discount rates of 0, 10, 40, 50 and 100 per cent.
2. A machine will cost Rs 100,000 and will provide annual net cash inflow of Rs 30,000 for six years.
The cost of capital is 15 per cent. Calculate the machine’s net present value and the internal rate of
return. Should the machine be purchased?
3. A project costs Rs 81,000 and is expected to generate net cash inflow of Rs 40,000, Rs 35,000 and Rs
30,000 over its life of 3 years. Calculate the internal rate of return of the project.
4. The G.K. Company is evaluating a project with following cash inflows:
Cash Flows (Rs)
C1 C2 C3 C4 C5

1,000 800 600 400 200

The cost of capital is 12 per cent. What is the maximum amount the company should pay for the
machine?
5. Consider the following three investments:
Cash Flows (Rs)
Projects C0 C1 C2

X – 2,500 0 + 3,305
Y – 2,500 + 1,540 + 1,540
Z – 2,500 + 2,875 0
The discount rate is 12 per cent. Compute the net present value and the rate of return for each project.
6. You want to buy a 285 litre refrigerator for Rs 10,000 on an instalment basis. A distributor is
prepared to sell the refrigerator on instalments. He states that the payments will be made in four
years, interest rate being 12 per cent. The annual payments will be as follows:

Rs
Principal 10,000
Four year of interest at 12%, i.e., Rs 10,000 × 0.12 × 4 4,800
14,800
Annual payments (Rs 14,800 ÷ 4) 3,700
What rate of return is the distributor earning? If your opportunity cost of capital is 14 per cent will you
accept the offer? Why?
7. Compute the rate of return of the following projects:
Cash Flows (Rs)
Projects C0 C1 C2 C3

X – 20,000 + 8,326 + 8,326 + 8,326

Q – 20,000 0 0 + 24,978
Which project would you recommend? Why?
8. A firm is considering the following two mutually exclusive investments:
Cash Flows (Rs)
Projects C0 C1 C2 C3

A – 25,000 + 15,000 + 15,000 + 25,640

B – 28,000 + 12,672 + 12,672 + 12,672
The cost of capital is 12 per cent. Compute the NPV and IRR for each project. Which project
should be undertaken? Why?
9. You have an opportunity cost of capital of 15 per cent. Will you accept the following investment?
Cash Flows (Rs)
C0 C1

+ 50,000 – 56,000
10. Is the following investment desirable if the opportunity cost of capital is 10 per cent:
Cash Flows (Rs)
C0 C1 C2 C3 C4

+ 100,000 – 33,625 – 33,625 – 33,625 – 33,625

11. Consider the following two mutually exclusive investments:
Cash Flows (Rs)
 Projects C0 C1 C2 C3

A – 10,000 + 12,000 + 4,000 + 11,784

B – 10,000 + 10,000 + 3,000 + 12,830
(a) Calculate the NPV for each project assuming discount rates of 0, 5, 10, 20, 30 and 40 per cent; (b)
draw the NPV graph for the projects to determine their IRR, (c) show calculations of IRR for each
project confirming results in (b). Also, state which project would you recommend and why?
12. For Projects X and Y, the following cash flows are given:
Cash Flows (Rs)
Projects C0 C1 C2 C3

X – 750 + 350 + 350 + 159

Y – 750 + 250 + 250 + 460
(a) Calculate the NPV of each project for discount rates 0, 5, 8, 10, 12 and 20 per cent. Plot these on
an PV graph.
(b) Read the IRR for each project from the graph in (a).
(c) When and why should Project X be accepted?
(d) Compute the NPV of the incremental investment (Y – X) for discount rates, 0, 5, 8, 10, 12 and 20
per cent. Plot them on graph. Show under what circumstances would you accept X?
13. The following are two mutually exclusive projects.
Cash Flows (Rs)
Projects C0 C1 C2 C3 C4

I – 25,000 + 30,000
II – 25,000 0 0 0 43,750

Assume a 10 per cent opportunity cost of capital. Compute the NPV and IRR for each project.
Comment on the results.
14. Consider the following projects:
Cash Flows (Rs)
Projects C0 C1 C2 C3 C4

A – 1,000 + 600 + 200 + 200 + 1,000

B – 1,000 + 200 + 200 + 600 + 1,000
C – 1,300 + 100 + 100 + 100 + 1,600
D – 1,300 0 0 + 300 + 1,600
(a) Calculate the payback period for each project.
(b) If the standard payback period is 2 years, which project will you select? Will your answer be
different if the standard payback is 3 years?
(c) If the cost of capital is 10 per cent, compute the discounted payback for each project? Which
projects will you recommend if the standard payback is (i) 2 years; (ii) 3 years?
(d) Compute the NPV of each project? Which projects will you recommend?
15. A machine will cost Rs 10,000. It is expected to provide profits before depreciation of Rs 3,000 each in
years 1 and 2 and Rs 4,000 each in years 3 and 4. Assuming a straight-line depreciation and no taxes,
what is the average accounting rate of return? What will be your answer if the tax rate is 35 per cent?

Module Three
PROBLEMS
1. A company has assets of Rs 1,000,000 financed wholly by equity share capital. There are 100,000
shares outstanding with a book value of Rs 10 per share. Last year’s profit before taxes was Rs
250,000. The tax rate is 35 per cent. The company is thinking of an expansion programme that will
cost Rs 500,000. The financial manager considers the three financing plans: (i) selling 50,000 shares at
Rs 10 per share, (ii) borrowing Rs 500,000 at an interest rate of 14 per cent, or (iii) selling Rs 500,000
of preference shares with a dividend rate of 14 per cent. The profit before interest and tax are estimated
to be Rs 375,000 after expansion.
You are required to calculate: (a) the after-tax rate of return on assets, (b) the earnings per share.
2. A company is considering to raise Rs 200,000 to finance modernisation of its plant. The following
three financing alternatives are feasible: (i) The company may issue 20,000 shares at Rs 10 per share,
(ii) The company may issue 10,000 shares at Rs 10 per share and 1,000 debentures of Rs 100
denomination bearing a 14 per cent rate of interest. (iii) The company may issue 5,000 shares at Rs 10
per share and 1,500 debentures of Rs 100 denominations bearing a 14 per cent rate of interest.
If the company’s profits before interest are (a) Rs 5,000, (b) Rs 12,000, (c) Rs 25,000, what are the
respective earnings per share, rate of return on total capital and rates of return on total equity capital,
for each of the three alternatives? Which alternative would you recommend and why? If the corporate
tax rate is 35 per cent, what are your answers to the above questions? How do you explain the
difference in your answers?

Module Four
PROBLEMS
1. The Ess Kay Refrigerator Company is deciding to issue 2,000,000 of Rs 1,000, 14 per cent 7-year
debentures. The debentures will have to be sold at a discount rate of 3 per cent. Further, the firm will
pay an underwriting fee of 3 per cent of the face value. Assume a 35% tax rate.
Calculate the after-tax cost of the issue. What would be the after-tax cost if the debenture were sold at
a premium of Rs 30?
2. A company issues new debentures of Rs 2 million, at par; the net proceeds being Rs 1.8 million. It has
a 13.5 per cent rate of interest and 7 year maturity. The company’s tax rate is 52 per cent. What is the
cost of debenture issue? What will be the cost in 4 years if the market value of debentures at that time
is Rs 2.2 million?
3. A company has 100,000 shares of Rs 100 at par of preference shares outstanding at 9.75 per cent
dividend rate. The current market price of the preference share is Rs 80. What is its cost?
4. A firm has 8,000,000 ordinary shares outstanding. The current market price is Rs 25 and the book
value is Rs 18 per share. The firm’s earnings per share is Rs 3.60 and dividend per share is Rs 1.44.
How much is the growth rate assuming that the past performance will continue? Calculate the cost of
equity capital.
5. A company has 5,000,000 ordinary shares outstanding. The market price of the share is Rs 96 while
the book value is Rs 65. The firm’s earnings and dividends per share are Rs 10 and Rs 7 respectively.
The company wants to issue 1,000,000 shares with a net proceeds of Rs 80 per share. What is the cost
of capital of the new issue?
6. A company has paid a dividend of Rs 3 per share for last 20 years and it is expected to continue so in
the future. The company’s share had sold for Rs 33 twenty years ago, and its market price is also Rs
33. What is the cost of the share?
7. A firm is thinking of raising funds by the issuance of equity capital. The current market price of the
firm’s share is Rs 150. The firm is expected to pay a dividend of Rs 3.55 next year. The firm has paid
dividend in past years as follows:
Year Dividend per Share (Rs)
2003 2.00
2004 2.20
2005 2.42
2006 2.66
2007 2.93
2008 3.22
The firm can sell shares for Rs 140 each only. In addition, the flotation cost per share is Rs 10.
Calculate the cost of new issue.
8. A company is considering the possibility of raising Rs 100 million by issuing debt, preference capital,
and equity and retaining earnings. The book values and the market values of the issues are as follows:
(Rs in millions)
Book Value Market Value
Ordinary shares 30 60
Reserves 10 —
Preference shares 20 24
Debt 40 36
100 120
The following costs are expected to be associated with the above-mentioned issues of capital. (Assume
a 35 per cent tax rate.)
(i) The firm can sell a 20-year Rs 1,000 face value debenture with a 16 per cent rate of interest. An
underwriting fee of 2 per cent of the market price would be incurred to issue the debentures.
(ii) The 11 per cent Rs 100 face value preference issue fetch Rs 120 per share. However, the firm will
have to pay Rs 7.25 per preference share as underwriting commission.
(iii) The firm’s ordinary share is currently selling for Rs 150. It is expected that the firm will pay a
dividend of Rs 12 per share at the end of the next year, which is expected to grow at a rate of 7 per
cent. The new ordinary shares can be sold at a price of Rs 145. The firm should also incur Rs 5 per
share flotation cost.
Compute the weighted average cost of capital using (i) book value weights (ii) market value weights.
9. A company has the following long-term capital outstanding as on 31 March 2008: (a) 10 per cent
debentures with a face value of Rs 500,000. The debentures were issued in 2003 and are due on 31
March 2010. The current market price of a debenture is Rs 950. (b) Preference shares with a face value
of Rs 400,000. The annual dividend is Rs 6 per share. The preference shares are currently selling at Rs
60 per share. (c) Sixty thousand ordinary shares of Rs 10 par value. The share is currently selling at Rs
50 per share. The dividends per share for the past several years are as follow:
Year Rs Year Rs
2003 2.00 2000 2.80
2004 2.16 2001 3.08
2005 2.37 2002 3.38
2006 2.60 2003 3.70
Assuming a tax rate of 35 per cent, compute the firm’s weighted average cost of capital.
10. A company is considering distributing additional Rs 80,000 as dividends to its ordinary shareholders.
The shareholders are expected to earn 18 per cent on their investment. They are in 30 per cent tax and
incur an average brokerage fee of 3 per cent on the reinvestment of dividends received. The firm can
earn a return of 12 per cent on the retained earnings. Should the company distribute or retain Rs
80,000?
11. The Keshari Engineering Ltd has the following capital structure, considered to be optimum, on 31 June
2008.
Rs in million
14% Debt 93.75
10% Preference 31.25
Ordinary equity 375.00
Total 500.00
The company has 15 million shares outstanding. The share is selling for Rs 25 per share and the
expected dividend per share is Rs 1.50, which is expected to grow at 10 per cent.
The company is contemplating to raise additional funds of Rs 100 million to finance expansion. It can
sell new preference shares at a price of Rs 23, less flotation cost of Rs 3 per share. It is expected that a
dividend of Rs 2 per share will be paid on preference. The new debt can be issued at 10 per cent rate of
interest. The firm pays taxes at rate of 35 per cent and intends to maintain its capital structure.
You are required (i) to calculate the after-tax cost (a) of new debt, (b) of new preference capital, and
(c) of ordinary equity, assuming new equity comes only from retained earnings which is just sufficient
for the purpose, (ii) to calculate the marginal cost of capital, assuming no new shares are sold, (iii) to
compute the maximum amount which can be spent for capital investments before new ordinary shares
 can be sold, if the retained earnings are Rs 700,000, and (iv) to compute the marginal cost of capital if
the firm spends in excess of the amount computed in (iii). The firm can sell ordinary shares at a net
price of Rs 22 per share.
12. The following is the capital structure of X Ltd as on 31 December 2008.
Rs in million
Equity capital (paid up) 563.50
Reserves and surplus 485.66
10% Irredeemable Preference shares 56.00
10% Redeemable Preference shares 28.18
15% Term loans 377.71
Total 1,511.05
The share of the company is currently selling for Rs 36. The expected dividend next year is Rs 3.60 per
share anticipated to be growing at 8 per cent indefinitely. The redeemable preference shares were
issued on 1 January 2003 with twelve-year maturity period. A similar issue today will be at Rs 93. The
market price of 10% irredeemable preference share is Rs 81.81. The company had raised the term loan
from IDBI in 2003. A similar loan will cost 10% today.
Assume an average tax rate of 35 per cent. Calculate the weights average cost of capital for the
company using book-value weights.