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CA FINAL (Nov 2024)

GROUP I – PAPER 2
ADVANCED FINANCIAL MANAGEMENT
SUGGESTED ANSWERS
(Series 1)

PART – I (MCQs)

MCQ – 2 marks each

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.
C B A A D D B B C D A A C C B

PART – II (Descriptive Answers)

1 (a) Calculation of annual rate of return to each of the investors

Mrs. Charu Plan A – Dividend Reinvestment

Date Investm Divi Dividend Reinvested NAV Units Closing Units

ent dend [Closing Units x Face ∑ Units
% value of ₹ 10 x Div. %]
01.04.2015 1,00,000 10.00 10,000 10,000.00
28.07.2019 20 20,000.00 30.70 651.47 10,651.47
31.03.2020 70 74,560.29 58.42 1,276.28 11,927.75
30.10.2023 40 47,711.00 42.18 1,131.13 13,058.88
15.03.2024 25 32,647.20 46.45 702.85 13,761.73
24.03.2025 40 55,046.92 48.10 1,144.43 14,906.16

Particulars Amount in ₹
Redemption value on 31.07.2025 [14,906.16 x 53.75] 8,01,206.10
Less: Security Transaction Tax (STT) is 0.2% (1,602.41)
Net amount received 7,99,603.69
Less: STCG tax @10% on 6,340 [1,144.43 (53.64 – 48.10)] (634.00)
Net of tax 7,98,969.69
Less: Investment (1,00,000.00)
Net Gain 6,98,969.69

6,98,969.69 12
Annual average return (%) = x x 100 = 67.64%
1,00,000 124

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 Mr. Anand Plan B – Bonus

Date Units Bonus units Total Units NAV

01.04.2015 10,000 10,000 10
31.03.2020 12,500 22,500 31.05
31.03.2024 7,500 30,000 20.05
24.03.2025 7,500 37,500 19.95

Particulars Amount in ₹
Redemption value on 31.07.2025 [37,500 x 22.98] 8,61,750.00
Less: Security Transaction Tax (STT) is 0.2% (1,723.50)
Net amount received 8,60,026.50
Less: STCG tax @10% on 22,350 [7,500 x (22.93 – 19.95)] (2,235.00)
Net of tax 8,57,791.50
Less: Investment (1,00,000.00)
Net gain 7,57,791.50

7,57,791.50 12
Annual average return (%) = x x 100 = 73.33%
1,00,000 124
Mr. Bacchan Plan C – Growth

Particulars Amount in ₹
Redemption value on 31.07.2025 [10,000 x 82.07] 8,20,700.00
Less: Security Transaction Tax (STT) is 0.2% (1,641.40)
Net amount received 8,19,058.60
Less: Short term capital gain tax @10% Nil
Net of tax 8,19,058.60
Less: Investment (1,00,000.00)
Net gain 7,19,058.60

7,19,058.60 12
Annual average return (%) = x x 100 = 69.59%
1,00,000 124

1 (b) (i) Calculation of initial outlay: ₹ (million)

a. Face value 300
Add: Call premium 12
Cost of calling old bonds 312
b. Gross proceed of new issue 300
Less: Issue costs 6
Net proceeds of new issue 294
c. Tax savings on call premium and unamortized cost [0.30 (12 + 9)] 6.3
So, Initial outlay = ₹ 312 million – ₹ 294 million – ₹ 6.3 million = ₹ 11.7 million

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 (ii) Calculation of net present value of refunding the bond: ₹ (million)
Saving in annual interest expenses [300 x (0.12 – 0.10)] 6.00
Less: Tax saving on interest and amortization [0.30 x {6 + (9 – 6)/6}] 1.95
Annual net cash saving 4.05
PVIFA (7%, 6 years) 4.766
∴ Present value of net annual cash saving ₹ 19.30 million
Less: Initial outlay ₹ 11.70 million
Net present value of refunding the bond ₹ 7.60 million
Decision: The bonds should be refunded

2 (a) (i) Expected cash flows:

Year Net cash flows P.V. PV @ 10%

0 (4,00,000 x 1) = (-) 4,00,000 1.000 (-) 4,00,000
1 to 4 (1,00,000 x 0.3 + 1,10,000 x = 1,09,000 3.170 3,45,530
0.5 + 1,20,000 x 0.2)
5 [1,09,000 + (20,000 x 0.3 + = 1,52,000 0.621 94,392
50,000 x 0.5 + 60,000 x 0.2)]
NPV = 39,922

(ii) ENPV of the worst case

1,00,000 x 3.790 = ₹ 3,79,000
20,000 x 0.621 = ₹ 12,420
ENPV of the worst case = (-) 4,00,000 + 3,79,000 + 12,420 = (-) ₹ 8,580
ENPV of the best case = (-) 4,00,000 + 1,20,000 x 3.790 + 60,000 x 0.621 = ₹ 92,060
(iii) (a) Required probability = 0.3
(b) Required probability = (0.3)5 = 0.00243
(iv) The base case NPV = (-) 4,00,000 + (1,10,000 x 3.79) + (50,000 x 0.621) = ₹ 47,950
ENPV = 0.30 x (-) 8580 + 0.5 x 47950 + 92060 x 0.20 = ₹ 39,813

(v) Risk adjusted out of cost of capital of X Ltd. = 10% – 1% = 9%

NPV

Year Expected net cash flow PV @ 9%

0 (-) 4,00,000 1.000 (-) 4,00,000
1 to 4 1,09,000 3.240 3,53,160
5 1,52,000 0.650 98,800
ENPV = 51,960

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 Therefore, the project should be accepted.

2 (b) Final settlement amount shall be computed by using formula:

(N) (RR – FR) (dtm/DY)
=
[1 + RR (dtm/DY)]
Where,
N = the notional principal amount of the agreement;
RR = Reference Rate for the maturity specified by contract prevailing on contract
settlement date;
FR = Agreed-upon Forward Rate; and
dtm = maturity of the forward rate, specified in Months
DY = Applicable basis of months
Accordingly,
(i) If actual rate of interest after 6 months happens to be 8.60%
(₹ 50 crore) (0.086 – 0.083) (3/12)
=
[1 + 0.086 (3/12)]
(₹ 50 crore) (0.003) (0.25) 3,75,000
= = = ₹ 3,67,107
1.0215 1.0215
Thus, banker will pay a sum of ₹ 3,67,107 to P Ltd. and actual effective interest rate for
P Ltd. shall be as follows:

Interest on loan for 3 months @ 8.60%

Less: Gain on FRA (8.60% – 8.30%) (0.30%)
Actual Effective Interest Rate 8.30%

(ii) If actual rate of interest after 6 months happens to be 7.80%

(₹ 50 crore) (0.0780 – 0.0830) (3/12)
(iii) =
[1 + 0.0780 (3/12)]
(₹ 50 crore) (–0.005) (0.25) –6,25,000
= = = –₹ 6,13,046
1.0195 1.0195
Thus P Ltd. will pay banker a sum of ₹ 6,13,046 and actual effective interest rate for P
Ltd. shall be as follows:

Interest on loan for 3 months @ 7.80%

Add: Loss on FRA (8.30% – 7.80%) 0.30%
Actual Effective Interest Rate 8.30%

3 (a) Forward Market Cover

Hedge the risk by buying Can$ in 1 and 3 months’ time will be:
July = 10,10,000 x 0.9301 = US$ 9,39,401
Sept. = 7,05,000 x 0.9356 = US$ 6,59,598

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 Option Contracts
July Payment = 10,10,000/50,000 = 20.20
September Payment = 7,05,000/50,000 = 14.10
Company would like to take out 20 contracts for July and 14 contracts for September
respectively. Therefore costs, if the options were exercised, will be:

July Sept.
Can$ US$ Can$ US$
Covered by Contracts 10,00,000 9,40,000 7,00,000 6,65,000
Balance bought at spot rate 10,000 9,301 5,000 4,678
Option Costs:
Can$ 50,000 x 20 x 0.0102 10,200 –
Can$ 50,000 x 14 x 0.0164 – 11,480
Total cost in US$ of using Option 9,59,501 6,81,158
Contract

Decision: As the firm is stated as risk averse and the money due to be paid is certain, a fixed
forward contract, being the cheapest alternative in the both the cases, would be
recommended.

3 (b) (i) Computation of Business Value

₹ Lakhs ₹ Lakhs
Profit before tax [77/(1 – 0.30)] 110
Less: Extraordinary income (8)
Add: Extraordinary losses 10
112
Profit from new product
Sales 70
Less: Material costs 20
Labour costs 12
Fixed costs 10 (42) 28
140.00
Less: Taxes @ 30% 42.00
Future Maintainable Profit after taxes 98.00
Relevant Capitalisation Factor 0.14
Value of Business (₹ 98/0.14) 700

(ii) Determination of Market Price of Equity Share

Future maintainable profits (After Tax) ₹ 98,00,000

Less: Preference share dividends 1,00,000 shares of ₹ 100 @ 13% ₹ 13,00,000
Earnings available for Equity Shareholders ₹ 85,00,000

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 No. of Equity Shares 50,00,000
Earnings per share (₹ 85,00,000/50,00,000) ₹ 1.70
PE ratio 10
Market price per share ₹ 17

4 (a) (i) Swap Ratio

Gross NPA 5:40 i.e. 5/40 x 30% 0.0375

CAR 5:16 i.e. 5/16 x 28% 0.0875
Market Price 12:96 i.e. 12/96 x 32% 0.0400
Book Value Per Share* 12:120 i.e. 12/120x 10% 0.0100
0.1750

Thus for every share of Weak Bank, 0.1750 share of Strong Bank shall be issued.
*Calculation of Book Value Per Share

Particulars Weak Bank (W) Strong Bank (S)

Share Capital (₹ Lakhs) 150 500
Reserves & Surplus (₹ Lakhs) 80 5,500
230 6,000
Less: Preliminary Expenses (₹ Lakhs) 50 –
Net Worth or Book Value (₹ Lakhs) 180 6,000
No. of Outstanding Shares (Lakhs) 15 50
Book Value Per Share (₹) 12 120

(ii) No. of equity shares to be issued:

₹ 150 lakh
= x 0.1750 = 2.625 lakh shares
₹ 10
(iii) Balance Sheet after Merger
Calculation of Capital Reserve

Book Value of Shares ₹ 180.00 lakh

Less: Value of Shares issued ₹ 26.25 lakh
Capital Reserve ₹ 153.75 lakh

Balance Sheet

₹ lakh ₹ lakh
Paid up Share Capital 526.25 Cash in Hand & RBI 2,900.00
Reserves & Surplus 5,500.00 Balance with other banks 2,000.00
Capital Reserve 153.75 Investment 20,100.00
Deposits 48,000.00 Advances 30,500.00
Other Liabilities 3,390.00 Other Assets 2,070.00

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 57,570.00 57,570.00

(iv) Calculation CAR & Gross NPA % of Bank ‘S’ after merger
Total Capital
CAR/CRWAR =
Risky Weighted Assets

Weak Bank Strong Bank Merged

CAR (Given) 5% 16%
Total Capital ₹ 180 lakh ₹ 6,000 lakh ₹ 6,180 lakh
Risky Weighted Assets ₹ 3,600 lakh ₹ 37,500 lakh ₹ 41,100 lakh

₹ 6,180 lakh
CAR/CRWAR = = 15.04%
₹ 41,100 lakh
Gross NPA
GNPA Ratio = x 100
Gross Advances

Weak Bank Strong Bank Merged

GNPA (Given) 40% 5%
Gross Advances ₹ 3,500 lac ₹ 27,000 lac ₹ 30,500 lac
Gross NPA ₹ 1,400 lac ₹ 1,350 lac ₹ 2,750 lac

₹ 2,750 lakh
GNPA = x 100 = 9.02%
₹ 30,500 lakh

4 (b) Particulars of Securities Cost (₹) Dividend (₹) Capital gain (₹)
Gold Ltd. 10,000 1,725 –200
Silver Ltd. 15,000 1,000 1,200
Bronze Ltd. 14,000 700 6,000
GOI Bonds 36,000 3,600 –1,500
Total 75,000 7,025 5,500

Expected rate of return on market portfolio

Dividend Earned + Capital appreciation
= x 100
Initial investment
₹ 7,025 + ₹ 5,500
= x 100 = 16.7%
₹ 75,000
Risk free return
Simple average of Betas* = (0.6 + 0.8 + 0.6 + 0.01)/4 = 0.50
*Since Simple average return of the portfolio is given in question.
Average return = Risk free return + Average Betas (Expected return – Risk free return)
15.7 = Risk free return + 0.50 (16.7 – Risk free return)
Risk free return = 14.7%
Expected Rate of Return for each security is
Rate of Return = Rf + B (Rm – Rf)

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 Gold Ltd. = 14.7 + 0.6 (16.7 – 14.7) = 15.90%
Silver Ltd. = 14.7 + 0.8 (16.7 – 14.7) = 16.30%
Bronze Ltd. = 14.7 + 0.6 (16.7 – 14.7) = 15.90%
GOI Bonds = 14.7 + 0.01 (16.7 – 14.7) = 14.72%

5 (a) (1) Second Leg = Start Proceed x (1 + Repo rate x No. of days/360)
₹ 2,00,31,759 = ₹ 2,00,06,750 x (1 + Repo rate x 9/360)
1.00125 = (1 + Repo rate x 9/360)
Repo Rate = 5%
Dirty Price 100 – Initial Margin
(2) First Leg (Start Proceed) = Nominal Value x x
100 100
Dirty Price 100 – 1.25
₹ 2,00,06,750 = ₹ 2,00,00,000 x x
100 100
10,003.375 = 98.75 x Dirty Price
Dirty Price = ₹ 101.30
(3) Dirty Price = Clean Price + Interest Accrued
240
101.30 = Clean Price + 100 x x 6%
360
Clean Price = ₹ 97.30

5 (b) Proforma profit and loss account of the Indian software development unit

₹ ₹
Revenue 60,00,00,000
Less: Costs:
Rent 18,75,000
Manpower (400 x 80 x 10 x 365) 14,60,00,000
Administrative and other costs 15,00,000 14,93,75,000
Earnings before tax 45,06,25,000
Less: Tax @ 30% 13,51,87,500
Earnings after tax 31,54,37,500
Repatriation amount (in rupees) 31,54,37,500
Repatriation amount (in dollars) $ 52,57,292

Advise: The USA based Company should charge minimum $ 47,42,708 ($ 1,00,00,000 – $
52,57,292) from prospective buyer.
Note: Withholding tax is not deducted since company is eligible for tax credit.

5 (c) Yes, Venture Capital Financing is unique manner of financing a Startup as it possesses the
following characteristics:

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 (i) Long time horizon: The fund would invest with a long time horizon in mind.
Minimum period of investment would be 3 years and maximum period can be 10
years.
(ii) Lack of liquidity: When VC invests, it takes into account the liquidity factor. It
assumes that there would be less liquidity on the equity it gets and accordingly it
would be investing in that format. They adjust this liquidity premium against the price
and required return.
(iii) High Risk: VC would not hesitate to take risk. It works on principle of high risk and
high return. So, high risk would not eliminate the investment choice for a venture
capital.
(iv) Equity Participation: Most of the time, VC would be investing in the form of equity of
a company. This would help the VC participate in the management and help the
company grow. Besides, a lot of board decisions can be supervised by the VC if they
participate in the equity of a company.

6 (a) (i) Personal earnings of Mr. Alex = R1 = 15%

Mutual Fund earnings = R2
1
R2 = x R1 + Recurring expenses (%)
1 – Initial expenses (%)
1
R2 = x 15% + 2% = 17.96%
1 – 0.06
Mutual Fund earnings = 17.96%
(ii) Net financial benefit to Mr. Alex if he invests his portfolio in Fund:
Present Income of Mr. Alex

₹ Lakhs
Annual Professional Income (A) 40.00
Portfolio Value 50.00
Income on his Portfolio @15% (B) 7.50
Total Income (A) + (B) 47.50

Expected Income of Mr. Alex after investing the Portfolio in Multi-cap Fund:

₹ Lakhs
Annual Professional Income (A) 40.00
Additional Professional Income (B) 4.00
Portfolio Value 50.00
Income on his Portfolio @13% (C) 6.50
Total Income (A) + (B) + (C) 50.50

It is advisable to invest in Multi-cap Mutual Funds and devote the time on profession.
He will get net benefit of ₹ 3 Lakhs (₹ 50.50 – ₹ 47.50)

6 (b) For calculating probability of financial difficulty, we shall calculate the area under Normal

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 Curve corresponding to the Z Score obtained from the following equation (how many SD is
away from Mean Value of financial difficulty):
x–µ
z=
σ
–1.00 crore – 2.00 crore
=
1.60 crore
= –1.875 say 1.875
Corresponding area from Z Score Table by using interpolation shall be found as follows:

Z Score Area under Normal Curve

1.87 0.4693
1.88 0.4699
0.01 0.0006

0.0006
The corresponding value of 0.005 Z score = 0.005 x = 0.0003
0.01
Thus the Value of 1.875 shall be = 0.4693 + 0.0003 = 0.4696
Thus the probability the company shall be in financial difficulty is 3.04% (50% –
46.96%).

6 (c) The various steps in securitization mechanism are discussed as below:

(i) Creation of Pool of Assets
The process of securitization begins with creation of pool of assets by segregation of
assets backed by similar type of mortgages in terms of interest rate, risk, maturity and
concentration units.
(ii) Transfer to SPV
Once assets have been pooled, they are transferred to Special Purpose Vehicle (SPV)
especially created for this purpose.
(iii) Sale of Securitized Papers
SPV designs the instruments based on nature of interest, risk, tenure etc. based on pool
of assets. These instruments can be Pass Through Security or Pay Through Certificates.
(iv) Administration of assets
The administration of assets in subcontracted back to originator which collects
principal and interest from underlying assets and transfer it to SPV, which works as a
conduct.
(v) Recourse to Originator
Performance of securitized papers depends on the performance of underlying assets
and unless specified in case of default they go back to originator from SPV.
(vi) Repayment of funds
SPV will repay the funds in form of interest and principal that arises from the assets
pooled.
(vii) Credit Rating to Instruments
Sometime before the sale of securitized instruments credit rating can be done to

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assess the risk of the issuer.

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