fl~►--.:; ; ._ .

; i i i i i
1vi n/! these e(]_11 :i tio11 s, tl w vall1 e nf 1l ,1t1< I ' lOtnn <J .1. 1<,<i ,11 11 I 0 .. 1<1 M
c •;• r~l:;
S:'c;;_;
....aliliiiiliilliiil lliiiiliillliliiii liiiaiil..__..,. .___illiillliiiiioii__.iiiiiiiiilliiliiiiili~ ~
tyliilV al~u.a..

I t'',p1 •1 tiv« •ly

n
ti_o_
...tnc.l

011 s\ n/!ly, t he 0;; ol

1 i11vcs t11w11l of II a 11 d C is 2,u,r>'½i ,ind '. l(U -i % 1 t• c, pi •• 1ivi ·ly .
,I
ccor' ,

~ ..
I ..
u-d . is contcmpb ttn g calltn g ~ 3 crorcs of 30 yc;:i rs, { 1,000 hond is-;ue<l S yectrs ago
51i~ nd1 1 · ·
1"
i11 .,-r,1P ·~i • • rerest I-ate O f 14· -
per cent. 1·11 e ho nds have ;.i ca ll pri ce of { 1 140 and had 1111t1ally
1.1
_ . _ . _ ,
~ 1 1011 , n
~I t ct1111 . ,ds ot { 2.91 ct o1es due to a discoun t of'{ 30 r er bond . The initial flo atin g co,;t was. {
i1 l1 . roc.:ee . d II
11· -red P C n,pany in te n s to se '{ 3 crores of 12 per cent coupon rate 25 years bond s to rai. se
Jl l'l, rn e o . '
,,, 000. . .· g the old bond s. It pro poses to se ll the new bond s at th eir par value of'{ 1,000. 1. he
, i,tl, . rctt •,n . . . .
_;•~ 01 ti·on cos t 1s ~ 4,00,000 . Th e co mpany 1s pay 111 g 40% tax an d its after tax cost of debt 1s 8
~w_, noata~ ew bonds must- first . the
. ,~red be sold and their proceeds , then used to retire old bonds, .
.,t1 il • p.s t 11e 11 .
interest must be paid on
t· . cent- ts a two months penod of overlappin g interest du ring wh ic h
it'1 e)(pec . . ..
I panY d new bond s. What 1s the feas1b1hty of refundin g bonds?
-0111 Id an
' the o
1,rth

Art swer
d'
d refun mg
~pV for bOO - -- - - - - - - - - - -- - - - - - - - - - - - - - - - - :l~

37,31,980
cash flow savings (W.N. 2) (3,49,600 x PVIFA 8%,25) i.e. 10.675
f annua1 29,20,000
pVO . . I investmen t (W.N. 1)
. 1n1t1a 8,11,9 80
~es 5·

~ on, Refunding of bonds is recommen ded as NPV is positive.

Recornrn
k
·ng Notes:
wor I
•tial investmen t:
(l} JOI .
(a) Call premmm
Before tax (1,140 - 1,000) x 30,000 42,00,000
16.80.000 25,20,000
Less tax @ 40%
4,0 0,0CY0
(b) Floatation cost
(c) Overlapping interest
7,0 0,000
Before tax (0.14 x 2/12 x 3 crores)
2.80.000 4,20,000
Less tax @ 40%
(d) Tax saving on unamortis ed discount on old bond
(3,00,000)
(25 / 30 X 9,00,000 X 40%)
___.
(e) Tax savings from unamortis ed Floatation
x 40% ) (1.20.000)
......-- x 3,60,000
Cost of old bond (25/30
29.20.000

BY CA AJAY AGARWAL (AIR-1)

AIRlCA Career Institute (ACI)
Page 5.51
 u ...... u, ny V

"
iiiiiiiiiiiiliiiiiiiiiiiiiiiiiiiiiiiiliiiiiiiiiiijjiiiiiiii_..;;a;ii5ii..-;;;;iiiiiiiii_,._._.___.__..;aiiiiiii,......-...-...-...-;16iiiijjiii.;ii__.iiiiiil~
er ~~.
a1~ l
~ :

(2) Annual cash now savings:

42,00,000
Oh\ bo1HI
J..6,80,00Q
Int eres t cost (0.14 x 3 crorcs )
li)
Less t:1x @ ~,0% . , .• of ct isr ount
1
T<1x s.1vi ngs fr om ,1111° 111 S,ll on
lIi)
l(O,Q() ,000 /3 0) X 40% 1 • f flot1t ation cost
1
(ii i) Tax savin gs from nnio r u s::it. on°
1(3,60,000 /3 0) X 40%1 nd
Annual a lter tax cos t payment u nd e r old Bo (A)
36,00,000
(b) New bond 3
(i) Inter est cost before tax (O.lZ x crores) 14,40,000.

Less tax @ 40%

(ii) Tax savin gs from amorti sation of noatation cost

l( 4,00,000/ 25) x 40%]

Annu al after tax payment und er new Bond (B)

An n ual Cash Flow Saving (A) - (B)

Question V\ ~
51 3"fo million, 12 per cent bonds outstanding with six years remaining to maturity. S
ABC Ltd. hast
n IS
interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a t 300 mil\io . '"~
of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bond will be t 6 mil\io •~
the call premium is 4 per cent. t 9 mi\~ on being the uoamor>ized portion of issue cost of old bon£,!n1
be wntten off no sooner the old boncls are called off. Marginal tax rate of ABC Ltd. is 30 per cent ~"
are reqmred to analyse the bond refunding decision. · Yo,
Note, Present all amounts int million '1 fc,•, J
f c}
'·1/~ ' /), , \)';,· ,,::...J •~
l '.;.,-( ~ ~
'I . b,,.
I "\ ,L- ' '\_; - ) l_..\,;;:..i,..
Answer ,A\) J '-...., ()

(i) Calculation of initial outlay: A<) ~ (., ''"I l :) ~ ~ mil\ioo]

300
a. Face value
Add: Call premium ~ ~ ;o\ n ~+Lr n 4-
'ih\: ,,, u
Jll
b.
Cost of calling old bonds
Gross proceed of new issue
5\, ~IL , 300
Q
Less: Issue costs
Net proceeds of new issue 294

Sc. I Tax
. . savings on call pr em1um
. an d unamortized cost [0.30 (12 + 9)] 6.3
o, rnt1aJ outlay = ~ 312 m1·1 rwn - ~ 294 m1lhon
. . - ~ 6.3 million=~ 11.7 million

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.52
,,~
r . ,~
.--~
, ~------ .
---, . ,
~.;~~
,1:it• 011
. of net present va luc of refund I"JC t 1l (' hmul :
S.cu,ll y Vulu otlon

( ( mflllrm J
1
01tc . 1111 unl interest
t'xpcnses [ ] OO x (O 1., 0 r,/JO
g In a , .,._ _ · ,. , I o) I
11! s.1" 111
•avi ng on 1ntc 1t st :rnd ,Hn orti;,.allnn IO .·rn
. X ( () I (,)I(,) I L2J
1 . . f,t~ s ( ')

csS· I ne , t cas h s,ivin g 1,Q,!J

I,
1113 )
A'l' ,A(J70,nL 6 years 1.7/'Vi
,,vlf al11 Cof n et ann11 r1 I t'.1s h s:ivln g C l 'J W mllli'ln
~ent v
JfC ~
·. I ·ti ~l outlay J J 1.70 miJJJrJ.ll
•. 1n 1 • •
~L-s~· v:i lu e of refun d in g th e bo nd 1.L.6il m1JlJOJl
resent
NPr p nds should be refu nded
• f (1 C 1)0

clS'"11·
l

~ ,r10J1
52
JoW relates to a convertibl e bond :
a11e• oiven l)e
(p f<10 ~ 250
1h"
aiue 12%
cev
f.1 rate
20
011
couP per bond
f shares ~ 12
NO· 0 . of share
r price ~ 235
~3rKC 1ue of bond
. ht va ~ 265
5tra g . f convertible bond
1
t price o
~1arKe
uJate:
calc k value of bond
sroc
[i) ntage of downsid e risk
The perce
[ii) version premium
The con
[iii) ersion parity price of the stock
T he conv
[iV)

sWer
~11 k Jue or conversion value of bond
(i) StOC va
::: 12 X 20 :: ~ 240
ntage of the downsid e risk
(ii) perce
~ 265 - { z3S X 100 = 11.32%
~
worthless.
This ratio gives the percenta ge price decline experien ced by the bond if stock becomes

(iii) conversion Premium

Market Price - Conversion Value x 100
Conversion Value

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.53
Si7;;;;;;s van ~
rt

~ 26S - t 2/40
~
2 /4 0 x 1on - 1n,112'1/.1

(iv) Conversion Pnrily Price

Hond Pr irl'
No . n l Sh c1n:•s nn Co n VL'rsio n
~ 26S
2. 0 = ~ l 3 .2 S
., . . . . :{ I '3 25 from { 12 th e investo r will
l hi s 111dic'c1tcs 1h,1l if th e pri ce o l s hares r ises to · · e th a t ~ 1.2 5 (3t .1 3.25 - neith ~r
. . ·t Obse rv '{ 12 00)
nor lose 011 buyin g th e bond anc.l cxcrcts tn g 1 · · · ls l( ~1 1,
of ~ 12, th e Co nversion Premi11111 . l.1~,i

Question 53
· · II tibl e bonds on the following terms a
GHI Ltd ., AAA ra ted compa ny has iss ued, fu Y co nver ' Year ani:,O·
- - ~ 1,00 0 .
Face value of bond 8.5%
Coupon (interest rate)
3 years
Time to Maturity (re mai ning)
Ann ual, at the end of
Interest Payment Year
At the end of bond ll1
Principal Repayment aturity
25
Conversion ratio ( Number of shares per bond)
~ 45
Current market price per share
~ 1,175
Market p ri ce of co nvertible bond
AAA rated company can issue plain vanilla bonds without conversion option a t an interest rate of 9.s0;,
0

Required: Calculate as of today: ·

(i) Straight Val ue of bond

(ii) Conversion Value of the bond
(iii) Co nversion Premium
(i v) Percentage of downside risk
(v) Conve rsion Parity Price
t 1 2 3

PVIF (0.095, t) 0.9132 0.8340 0.7617

Answer
( i) 5traight VaJue of Bond
= { 85 X 0.9132 + { 85 X 0.8340 + "{ 1,085 X 0.7617 = 3t 974.96
(ii) Conversion VaJue
= Conversion Ratio n x M a r k et p n•ee of Equity Sha re ="{ 45 x 25 - "{ 1,125

BY CA AJAY AGARWAL (AIR-1)

AIRlCA Career Institute (ACI)
Page 5.51
f:17·----·~. ·--- ' '* -e - ,

Security Va Jua t1°!!,

premium
,vc rston
- r:
(OI 75 - { 1,l Z:> X 100 = 4.44°/ii
)
(Iii tl.1 125
0,
~ f oownside Risk
r age o
ell•
per' 11s-~74·~6 x 100 = 17.02%
111'1 { 1, 175
0,
/ . parity Price
,version .
, •)
co• Bond Pnce
v- ~
( , ·e- 0~"n rCnonnvvPerrs<. 11nonn
----
of S,a1
~ NO·
,,1175 _ {47
~
~ 25
-

a•''ri~ { a is related to 8.5% Fully Convertible (into Equity shares) Debentures issued by /AC
f0Jlow1rig
r11e 1 ooo.
rt ' ~ 900
~ttP . f Debenture
rice o
-ker P 30
~1a1 . Ratio
rs1on
conve of Debenture ~ 700
. ht Value
5rra 1g . f Equity share on the date of Conversion ~ 25
r price o
~1arke . .dend Per Share 'U
. ecred 01v1
£~P . ed to calculate:
are requ1r
you . n Value of Debenture
convers10
(a) k t Conversion Price
Mar e
[b) . n Premium per share
ConverSIO
(c) . f Conversion Premium
) Ratio o
(d . over Straight Value of Debenture
Premium
(e) ble income differential per share
[Q favoura

(g) Premium payback period

Answer
(a) Conversion Value of Debenture
=Market Price of one Equity Share x Conversion Ratio

=US X 30 = ~ 750

(b) Market Conversion Price

Market Price of Convertible Debenture
=- - - - - -- - - - -- -
Conversion Ratio

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.55
 WWW
- . ........ ~
◄ "l
_ &iiilliai_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _s
,,,,__ .;;.·. ct:•:.
c .;. 'ty
r1!!; \, -~"'
vti1 l

:rn
~ I
(c) Con,•t'r"'in11 P1·l'lllil1111 per s ll ,ir<'
= M,irk('t Cnnv<'1·sin11 Pr i1 t' M.1rkl'l l'rl cl' of l·:q111l y Sir .in•
= ~ :rn { 2S = ~ S

(d) Ra t in of Cn11ve1-s 10 11 P rc 111 ium

= Co1n-crs1011 pn.~mium p er · s ll ,,n.! = ~_S = 2 0 %,
Marke l Price of Equ i ty Slwre 'f 25

( e) Premium over St raig h t V.iluc o f De be nture

= l\far-k e t Price of Co n V('rl ibl e Bo_12d _ J = '{ 900 _1 = 2 8 .6%
St,-aight Va lue or Bond 'f 700

(t) Favourable inco me di ffe rentia l p er s ha re

Coupon Interest fro m Debe ntu,-e - Conversion Ratio x Dividend Per Share
=
Conversion Ra tio
~ 85 - 30 X ~ 1
= - - - - - = ~1.83 3
30
(g) Prem ium payback period
_ Conversion pre mium per share '{ 5
= - - - = 2.73 years
- Favo urab le Income Differential Per Share 'f 1.833

Question 55
A convertible bond with a face value of 'f 1,000 is issued at 'f 1,350 with a coupon rate of IO.So/,
conversion rate is 14 shares per bond. The current market price of bond and share is 'f 1,47S an~· l'li,
. h . . I 7 { Br
res pectively_What 1st e premium over convers10n va ue. .

Answ er
Conversion rate is 14 sha res per bond.
Market price of sha re = 'f 80
Conversion Value= 14 x 'f 80 = '{ 1,120
Market price of bond= 'f 1,475
Premiu m over Conversion Value= ('f 1,475 - '{ 1,120)/'f 1,120 = ('f 355/~ 1,120) x 100 = 31.70%

Question 56
Saranam Ltd. has iss ued co nvertible d e bentures with coupon rate 12%. Each debenture has an option
to convert to 20 e quity s hares at a ny tim e until the date of maturity. Debentures will be redeemed at ;
100 on maturity of 5 years . An investor generally r e quires a rate of return of 8% p.a . on a 5 ye~
security. A s a n investor wh e n will you exer cis e conversion for given market prices of the equity shan
of (i) 't 4, (ii) 'f 5 a nd (i ii) 'f 6.
BY CA AJAY AGARWAL (AIR-1)
AJR1CA Career Institute (ACI)
Page S.lf
 rr-----:~:----:~-.-------------~S~(•~c•~•f'~l~y•~V!a,~u~a~t:'":"
for 8% for 5 yea rs: :tr)<):l
rrictor
, pv ' e-tr 5: 0.68 1
1·vi; ror y
1.il .so/I'
ti" (0 1
i ,or
I ,tl
1'1 not converted Its vnlnc Is ns und er:
,,,,c( ,es 3re
1 PVF @ 8 01,,
111• ,, 11C'
I . 11•
l' 3.99 3 17.916
0.613 1 68. 100

- ------

No. of Shares
116.016

Total
20 ~ 80
20 uoo
20 ~ 120

arket price is ~ 6 conversion should not be exercised

s the m .
i,111es
~ence,
t instruments
(
e
01157
esti T-bill of face value of~ 100 at a yield of 6%. What was the issue price?
Q0 91-daY
~SI sold a

AO
swer price be
X
he issue .
Lett fthe issue of the T-b11ls:
,che rerrns o
B) 365
100 - xx -xlOO
6% = ~ 91

6~91 ~X :: (100-X)
½rsoo
0J496X :: 100 - X
o.
~ :: { 98.53
x=1.01496

QuestioftS'B
zco. LtdY ect commercial paper worth~ 10 crores as per following details :
Dateofissue: 16th January, 202 2
Date of maturity: 17111 April, 2022

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.57
 - -~., f
<
No. of d:1_
vs :
..,._lililiiiiii____ __iiiiiiil_llilliiiiiiiiiilllii-----iiiiiiiliiiiliiii....iliiiiii-iiilii.aliiiliilll~s~·c~·c~u:r!!,;
~iliiiiiiiiiiii&iiiiiiii_ _ _ _ _
ityv
1
-~l
'J I " ll ~II
Interest r:l tt' J 2. 04'¼> p .;1 \
~i\7h ,H W;iS th e net .1mo11nt nYcivc d hy th e compan y on iss ue of Cl' ? (ChJrge
s of interrn edi -
1gn ored)
ttry '}]
1,1
No t e : Provide ~nswC'r in~ crores
'

Answer
The co rnpan y h ad issued co mmercial pap e r worth~ 10 cr ores
No. of days involves = 91 d ays
Interest 1·ate applica bl e= 12.04 % p.a.
~ 10 Crores
Price= - - - - - - - -- - = '{ 9 .70857 Crores
1 + ( 12.04% X 91 / 365)
So, Net amoun t received at the t ime of issue:~ 9.70857 Crores

Questio n 59
M Ltd. has to make a paymen t on 30th January, 2022 of~ 80,00,00 0. It has
surplus cash tocta .
October , 2021 ; and has decided to invest sufficien t cash in a bank's Certific
ate of Depos i~·~·e.31
offering a yield of 8 % p.a. on simple interest basis. What is the amount to be
invested now? Che~,
Note: Assume 365 days in a year

Answer
Calculat ion of Investm ent Amoun t
Amount requ ired for making paymen t on 30 th January, 2022 = ~ 80,00,00 0
Investm ent in Certifica tes of Deposit (CDs) on 31 st October , 2021
Rate of interest = 8% p .a.
No. of days to maturity = 91 days
Calcula t ion of amount to be invested now to get~ 80,00,00 0 after 91 days:
'{ 80,00,00 0
= 1 + (0. 08 X 91/365) = '{
78 3 559
,4 ,

Questio {C:O t
A money nla'rket instrum ent with face value of~ 100 a nd discoun
t yield of 6% will mature in 45 days
You are required to calc ul ate:
(i) Current price of th e instrum ent
(ii) Bond equivale nt yield
(iii) Effectiv e annua l return
Note: Assume 360 days in a year

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institut e (ACI)
Page 5.Si
 - Srt urlf y Valu.aUon

. / ' _ oftheBond
/ ;.- _ t price
,,t eflt 60
~~ Cliff x 3 J X I 00
100 - ' X r.: '
4
11) ~ 1oo _1
t,')1!
c: x 1oo == ( I oo - x)
, 4-,, I

i, ' 6 ooo
1'
."' 99.25
' ~~ •.r-i tent yield
q"' ,,..
1,d c 360
6° 99.25 X - X 100 = 6.045% p.a.
(ill ,oo - ~ · 45
~ 1/q9.Z5
nual return
. ,ean
.::"'ect•'
i,11 0604 5 X, 45/360))360/45 - 1 = 6.207% pa
..
(iii) ~ (0,
~ I1

...,.1 ,
QII
e5001 b.
d
·red has excess cash of'{ 20 lakhs, which it wants to invest in short term marketable
L1n1 1 . .
ier\a!l s relating to mvestment will be'{ 50,000.
,~011 t . £xpense
Llrine 5· . vested will have an annual yield of 9%.
sef ·rjeS 1n
...,ese curl ks your a dvice
.
v· anYsee
fhr c0111 P eriod of investment so as to earn a pre-tax income of 5%. (discuss)
35
ro the P
0) . . um period for the company to breakeven its investment expenditure overtime value of
the rn1n1m
(iil oneY•
111

Afl5wer come required on investment of'{ 20,00,000

pre-taX In
(ij eriod of Investment be 'P' and return required on investment '{ 1,00,000 ('{ 20,00,000 x
Let the P
5%)
Accordingly,
(~ 0,00,000 X 90/o X p/12) - { 50,000 = { 1,00,000
2
p:: 10 months
eak-Even its investment expenditure
(iQ Br
(~20,00,000 X 90/o X p/12) - { 50,000 = 0
p:: 3.33 months

Questio&
AXY Ltd. is able to issue commercial paper of'{ 50,00,000 every 4 months at a yield rate of 12. 5% p.a.
Thecost of placement of commercial paper issue is '{ 2,500 per issue. AXY Ltd. is required to maintain
line of credit~ 1,50,000 in bank balance. The applicable income tax rate for AXY Ltd. is 30%. What is the

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.59
, - --_..~~
~
y~y :11,."<t 1111 ;'
i5iiilliiiiiiiiili.-11a1iiii1a~.-.-----------.----a11---------~S:_:c';•c~·u~r~i~l~
ii
11
cos \ of fu nd s (.,fter t.1:,.. ,,s ) tn AXY I.Id . tn, , nn11 111 ,n l. 1l p ,1pcr h s 11C.! I Th e rn at rlty or co mm e rci) 1 1 ~
four m onlh s. · P: 1) ~r I,

Answer
Since Co mm t?rda l P,,per is ., di sru 11nl i n ~trunH!tll , ii s h~II he Iss ued al di scounted pri ce. Acr-,Jr 11
;rns w (•r sh,,11 he as follow,;. ·, ' r1 PJ I

50, 00,000
Issue Pi-ice = l ( i:-o = ~ 48,00,0 00
+ 12 .."1 1/b x4 / 12)

Issue Price
Less : Issue Expenses
Less: Mini mum Balance
Ne t Amount Received
(2,00,000 + 2,50 0) (1 - 0.3 0) 1 2 100 - 9 150/c0
Cost or Funds= 46,47,5 00 x4 x - ·
Note : Interest Expense= 't 50,00,000 - 't 48,00,000 = ~ 2,00,000

Question 63 -S/1
Bank A enter int(J) a Repo for 14 days with Bank 8 in 10% Government of India Bonds 2028 @ 5_ 650
.
S B crore. Assuming that clean price (the price that does not have accrued interest) be , 9 9 41 fo, ~
initial Margin be 2 % and days of accrued interest be 2 6 2 days. You are required to determine · '>1

(i) Dirty Price

(ii ) Repayment at maturity
(Consid er 360 days in a year)

Answer
(i) Dirty Price
= Clean Price + Interest Accrued
= 99 .42 + (100 X 10% X 262/360) = 106.70

(ii) First Leg (Start Proceeds)

- N • V Dirty Price 100 - Initial Margin
- omina 1 a Iue x - - - - x _ _ _ __ ___::::...__
100 100

= '{ 8,00,00,000 X 106.70 X 100 - 2 ~ 8,36,52,800

100 100
Second Leg (Repayment at Maturity)
= Start Proceed x (1 + Re po rate x No. of d ays/36O)
= ~ 8,36,52,800 X (1+ 0.0565 X 14/360) = ~ 8,38,36,604

f BY CA AJAY AGARWAL (AIR-1)

AIRlCA Career Institute (ACI)
Page 5.61
fT"·_-_~:--~~~-._~
. . , _:a_w....._·__- .-
7_.... ~ ~~ ..- --
-"'- -~ ~0,#~,.Jf
S\!curl•y Vtiluatlon

~ , tiO
,1·~ jtl ()
a•11,1''·i''~
f r111:1I 100
Is ovnilnhic ofM / s. TS 1.td.

( f In crore,)
fO . ,.,.~f!i
(I Il, ~.()()

P'. oclltf10% ) 1.00

i-- nl1 on
I'" .• p,tt ,res1
J\.00
l,c-~·
.,s1· i s% l 00
I . 'f,l~ @
l,C~ -· 3.00
. sha res of~ 10 eac h
I .
rA1
f 01115
til lld1ng 40 \akhs

~o- o 7.5
cp~ ({) . of share (~) 75
i; pr 1ce
-}(et
1 10 Times
~lB
. r~tiO
p/t - distributed reserves of~ 8 crores. The compa ny requires ~ 3 crores for the pur-pose of
an un
~ rd -has . his expected to earn the same rate of return on cap ital employed as present . However,
fS µ;ins1on
· ,.vh!C d . . h. h · ·
apital employe ratio is 1g er than 35%, then P/E rat io is expected to decline to 8 Times
e,!e debt to c cost of additional debt to 14%. Given this data wh ich of the follow ing o ptions the
if u• I
•n the
d rise Jd prefer, and why?
aJl wou
c0ll'lPanY f he required amount is raised through debt, and
opti011 (?:. :f :he required amount is raised through equity and the new sha r es will be issued at a price
option (il)· of :t zs each.
II amounts in '{ crores in 4 decimals .
. present a
Note.

AJlS"'er
king Notes
wor Jation of Return on Capital Employed (ROCE)
(1) calcU
l in crores

Capital Employed:
Share Capital ('{ 10 x 40 lakhs) 4

Reserves 8

Debt(~ 1 er. x 100/10) 10

22

PBIT s I

ROCE 22.73% I

(2) Revised PBIT

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.61
 ---- ~<
iiiiiiiiiiiiliiiiiiiiiiiiiiiiiiiiii-.;;;;iiiiiiillilliiilil-.,_.iaiii_ _ ._ _ _ _ _ _ _ _ _ _ _ _ _ _ _lilii&_.lliiililiilliiiiiiiiiiii~S~'C~'C~l~Ir~
itt
y \!ill ~
~I\,
111
Existing L 1pil.1l F mplow d ~

Additi o1ul
<~
Revised Ca pit ,111-:mJ'lnyt' d
RO CE
RC'\'iscct PHIT

New Debt / Equit y

Exist 1ng Dcht

Addihona l Und er Opti o n (i)
Total Debt
Total Equity
13
New Debt t o Cap ital Employed Ra tio = 25 = 0,52

So, P / E Ra tio to be reduced to 8 tim es

l 4) Debt to Capita l Employed Ratio in Option (ii)

10
= - = 0.40
25
So, p / E Ratio to be reduce d to 8 times in this case also
(5) Number of additional sha r es to be issued in case of Option (ii)
Funds to be raised = ~ 3 crore
Price per share = ~ 25
No. of additional shares to be issued ~ 3 crore/~ 25 = 12 lakhs
Option (i) Option (i~
Particulars
5.6825 5.6825~
PBJT (Revised) (~ Crore)
Less: Interest on Debt 1.42 1.00

PBT (~ Crore) 4.2625 4.6825

1.0656 1.1706
--------
Tax@ 25% (~ Crore)
PAT(~ Crore) 3.1969 3.511 9

I
No. of shares outstanding
EPS
P /E Ratio
40lakhs
~ 7.99
8
52 lakhs
'{ 6.75
8
-
-------

New Share Price '{ 63.92 '{ 54.00

Decis ion:
Since the MPS is expected to be more in the case of addition a l financing done through debt . Hence
Option (i) is preferred .

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.61
 Security Va .lu ution

11 6
5 ,t o
f ' A/s. Sunc1ry l.td . as on 3 1-o:1-2on , 1 11
1• • • ~ o nw •i :
,
,10 5t1e i;
,S cC ~ 111 lakhs !\ss<'l's
ail I i11
,Jl•I' lln l:ikhs
f11t 111.1c5 :mo r·1
' X(' I 1J\ ',', r' I ',
(,()()
,11!1 ,,,.1 1 200 l11 wnto 1y
11• .c.,111 'j()()
(L
~11.l ,t•5 '1·00 Hc1·elv,1hl c.,
HO
r••~-ti'' ,fJll I•oil ll :rno Ca s h
60
/ fl I ,1:~n
111!· 11 ' 200
I' fer' ·s·ions
1
_111 ,1 ·I . ~ pI-o\1
', 1,400 Total
,~Jl Il,,· ' 1,400
1
1'~ 600 lakhs. Th e sales are ex pected l 0 ,
( .
11,1 r wc1s . ., gro w by 20% durin g the year. The profit
f'1 _i1,e ye_a d pay-o ut rat10 ate ex pected to be 4% ;i nd 50% respect ively .
. Jt'' li"'detl .
~1\•':111 .,11cl c i1rther desires t~1at du~111g th_ e cu~~~nt year Sa les to Short Term Loan and Payables and
111,tf'r 1P;1t1Y f d be in the ratio of 4.3. Ratio of fix ed assets to Long Term Loans should be 1.5. Debt
c1111 11 oLil d15
f J1t' -1~10 11 s shou id not excee . .
11 . e·
f'I , , 1w ttO determin •
~ljl ,Ji n . -ed to
1tll
ereQ f External Fund Requirement (EFR)
Jr ., t o
\'tll) Jll 0 '-' 11
fhe a be raised from Short Term, Lon g Term and Equity fund s.
1 unt to1110
(i r11e a aunts in t lakhs in 2 decimals.
(it) rail am
. presen
~lite,

05wer funds Requirement (EFR):

~ ~ernal
') f,. ~
(I ,,..--------- ___________ ___________ __ (l___
in lakhs)
___:___ __::

~ s (t 600 + 20% of~ 600) 720 .00

£>-'Peete
margin @ 4% 28.80
profit
_ d payout ratio@ 50% 14.40
DiVlden
to be ploughed back (A) 14.40
Balance
.. funds required (t 1,400 - t 200*) x 0.20 (B) 240.00
Add1t1ona 1
Balance to_be_met __ from
__ external
___ source
___ (B _
- A)_ _ _ _ _ _ _ __ _ _--1._ __ __
225.60
__

les & Provisions shall also be increased proportionately with increase in sales.
•As Paya b
t to be raised from different sources with following conditions:
(ill AJIIOllfi
, Sales to short term loans and payables & provisions 4:3
Ratio of fixed assets to long term loans 1.5
Debt equity ratio should not exceed 1.5
(1) Amount to be raised from short term funds:
:
(l in lakhs)
l
New amount of short-term loans and payables & provision (720 x 3/ 4) 540

BY CA AJAY AGARWAL (AIR-1)

AIR1CA Career Institute (ACI)
Page 5.63
 ~~ ~---~
~

iiiliii------_;_s~·e~c!u~r!it~y~y~~ lt1.- ·~
liiiiiiiiiiiiiiiillliiiiliiii-a. .-.iiiiiil_iiiiiiiiillilliiiiiiiai. . .lliiiil_ _..,._ _ _iiiilili___ .. . .

~
~ 111

Less : Exi~ti n~ Amn1111l Pl slwrt tcr111 lo.111 ~ ,nul p.1y.1hl e.., & provi si on
S11(J
~ mount to he r,1ised from short t1 •n n fund ~ 111

(2) Amount to he rnis<'d from t.ong term funds:

'-- 1
New fi xed .issds ( { (JOO+ 2 0 ¾> o f'{ 600)

New lo11g-tcrm lo;i11 s ({ 72 0/ 1.5 )

Less: Existing long -term loa ns

Amount to be rdiscd fro m Long te r111 fund s

(3) Amount to be raised from equity funds:

__:_-______-----t---~ la~

Amount to be raised from external sources 225-~()S)

Less: Amount to be raised from short term funds 40.ori

Less: Amoun t to be raised from Long term funds so. 0~

Balance amount to be raised from equity funds 1os.Go

Question ~ 66
The direcr-srs J- Implant Inc. wishes to make an equity issue to finance a$ 10 million expans ion sch
which has an exp ected Net Present Value of$ 2.2 million and to re-finance an existing $ 6 millio 15 elll~
Bonds due for maturity in 5 years' time. For early redemption of these bonds there is a $ 3,; ~ 0
penalty charges. The Co. has also obtained approval to suspend these pre-emptive rights and ITlak,OOi1
15 million placement of shares which will be at a price of$ 0.5 per share. The floatation cost of _ea
will be 4% of Gross proceeds. Any surplus funds from issue will be invested in ID Rs which is cu rrentl
issue

yieldi ng 10% per yea r. Y

The Present capital structure of Co. is as under:

,;:---;:--:;---:-::-:-----:----:------- --- - -- - - - + - - - - - .$'000

Ord inary Share ($ 1 per share) 7,ooo

Share Premium
10,soo

Free Reserves
zs,soo
43,000

15% Term Bonds 6,000

11 % Debenture (2015-2023) 8,000

Current
10%. sharebeprice
It ma is$ 2 per s h are an d d e b enture price is $ 103 per debenture. Cost of capital of Co.Ii
furthe
about the p;oposed r pfrfes udmefd that st~ck market is semi -strong form efficient and no informatioi
use un s rom the issue has be d ·1 b .
to calculate expected shaO . f en ma e avai a le to the pubhc. You are require(
re pnce o company once full details of the placement and to which the finanCI

BY CA AJAY AGARWAL (AIR-1)

AIRlCA Career Institute (ACI)
Page 5.~
 Sec urit y Valm1tlon

nnoun ccd.
,,,t.il re ct f ryea r 5 = 0.62 1; PV/\F (n) 10% lor :i ye, 11 11
pC l @ 10t}{1 o
'\ .7'J I
t ll .t{f (l
t!' , pv
~ 1)1 .
C

"r
, l hl' s h;m' prlr t• s hnuld , l! n1 r , 11 Ply r!•ft 1 11 ,,w I l
, for111 of ·',. 10 ck .m;irkct
y
..,~c I. . • . . , ,. Pv,,nt I n orm,1 1 011
i"'
r"
-0 11g
.s11 d pu 1 1c <t l' ·ly -
1 v;t ilt1b lc 1ml11d111 g l111pl.111l In c. <'X p,111 -; 1011 <; c I H•n 11 ,
'
111,1,·r•cl f
"rnp 111111 ri t 1w tPrm
,111 1 ~ C
,l ' S (11
111 . ,t 1•
~1•11
~.: t value($ 2 x 70,00,000) ' l /1-0,IJO,OO<l
1,, . ~~ art<e
Ill- •isti 11 g t has an expected N PV i L2,00,000
(.'.i,t' c)'. esttnell
I ,~, jll\l
$ 1,50,00,000
, .-1,c ne . Ne"" tssuc
1 d. ol
r~e , ($ 6,00,000 )
lfil
t .;t .
,co- ly redemption:
!S'''l Rt of ear
, f8e 11 e ooo ($ 60,00,000 x 15%) x 3.791 34,11,900
p\ 0 r of$9,00 ,
11
,1ere5 ayment in 5 years($ 60,00,000 x 0.621) 37,26, 000
pV of ReP
Add: 71,3 7,900
tion Cost Now (60,00,000)
. Reden1P
, ,sS· (3,50,000) 7,87,900
.,e ltY charges
s· pena
Le5 · Market value 3, 13,87,900
d rota 1
£_,pecte es (30 million + 7 million) 3,70,00,000
of shar
r,Jeif No- share Price of Company $ 0.848
I~pected

estion@; .
QU . has Equity Capital of~ 12 Lakhs, total Debt of~ 8 Lakhs, and annual sales of~ 30 Lakhs .
I dustnes .
AB n lly exclusive proposals are under consideration for the next year. The de tails of the
Two inutua
l are as under:
proposa s
Proposalno.1 Proposalno.2
particulars_ _ - - - - - - - - -- - - --t------- - ---------,r---------------,
~ Assets to Sales Ratio 0.667 0. 62
Target
et Profit Margin (%) 4 5
Targe t N
Target Debt Equity Ratio (DER) 2:3 4:1

Target Retention Ratio (of Earnings) 0.75

Annual Dividend (~ in Lakhs) 0.30

NewEquity Raised (~ in Lakhs) 1

Proposal no. 1 is based on the assumption that AB Industries is maintaining same Capital, Assets and
Sales in the next year.
Youare required to calculate sustainable growth rate for both the proposals.
Note: Consider amount in ~ lakhs upto 3 decimals

BY CA AJAY AGARWAL (AIR-1)

AIRlCA Career Institute (ACI)
Page 5.65
 -~~..,,~
.•iiiliiiiiiiiliiiial'iiiliiliiiliiiiiia_

Answ er
_.._ _ _iiiii&i &iiiiii iiiiiiiii i.--ii& liiiiiiii
il-iiiiii lliiiiiii ii-iiiiii l~-.. . .
Secu rity y
.--liiiiiiiili...___~~~l~l\tt
~
~

Su stain able Growth Rate unde r Pro=

p~o-s a_1_1_ _ _ _ _ _ _ _ _ _ _ _ __ __
~---
1 Sales 7 {30L<t~
Total Asse ts ~ 30 Lakh s x 0.667 { 20 La¼
Net Profi t ~ 30 Lakh s x 4% { 1.20 La~hs
ROE 1.20 Lakhs x
100
12 Lakhs
100;.0
Susta inabl e Grow th Rat e= ROE x Reten tion Ratio =
10% x 0.75 = 7.S0%
Sust aina ble Grow th Rate unde r Prop osal 2
New Equi ty=~ 12 Lakh s + ~ 1 Lakh = ~ 13 Lakhs
Since Targ et Debt Equit y Ratio is 4:1
Henc e, New Debt =~ 13 Lakh s x 4 = ~ 52 Lakhs
Total Asse ts =~ 13 Lakh s + ~ 52 Lakh s = ~ 65 Lakhs
Targ et Asse ts to Sales Ratio (Give n)
Sales
0,62
~ 65 Lakh s/0.6 2
Net Profi t ~ 104.8 39 Lakhs
~104.8 39 Lakhs x 5%
ROE ~ 5.24 2 Lakhs
S.242 Lakh s
----x100
13 Lakhs 40.323%
Rete ntion Ratio S.242 Lakh s - 0.30 Lakh s
S.242 Lakh s 0.943
Susta ina ble Gro w th Rate = ROE x Reten tion Ratio
= 40.32 3% x 0.943 = 38.02 4%

BY CA AJAY AGARWAL (AIR -1)

AIR1 CA Care er Insti tute (ACI)