MS-42

MANAGEMENT PROGRAMME

Term-End Examination

December, 2009

MS-42 : CAPITAL INVESTMENT ANDFINANCING DECISIONS

Time : 3 hours Maximum Marks : 100(Weightage 70%)

Note :

Attempt any five questions.

All questions carry equal marks.

Present value tables will be provided, if asked for.

Use of calculators is allowed.

What do you understand by Divestiture ? Explainits salient features and distinguish it fromspin-offs and Carve - outs. How would youundertake financial assessment of a divestitureproposition ? Explain.

(a) Why do the companies prefer stabledividend policy ? Explain the three formsin which stability may be maintained whiledistributing dividends.

MS-42

1 P.T.O.

(b) Distinguish between a fixed rate bond anda floating rate bond. How is the rate ofinterest determined in case of a floating ratebond ? If you have to make a choicebetween the two, which one would youprefer and why ? Explain giving reason.

What do you understand by securitisation ofassets ? Explain the process of securitisation andits advantages to the various parties. What typesof assets are suitable for securitisation ? Explain.

The following figures are made available to you :

Rs.Net profit for the year interest onsecured Debentures at 15% p.a.

(Debentures were issued 3 monthsafter the commencent of the year)

Income Tax at 35% andDividend Distribution Tax

Profit after tax.

No. of equity shars (Rs. 10 each)

Market Price of equity share

16,87,500

8,43,750

8,43,750

1,00,000

109.70

The company has accumulated revenue reservesof Rs. 12,00,000. The company is examming aproject requiring an investment of Rs. 10,00,000.This investment is expected to earn the same rateof return as funds already employed. You areinformed that a debt equity ratio (debt divided by

18,00,000

•1,12,500

MS-42 2

debt plus equity) higher than 60% will cause theprice earning ratio to come down by 25% and theadditional rate of interest on additionalborrowings will cost the company 300 basis pointsmore than on their current borrowings on secureddebentures. You are required to advise the companyon the probable price of the equity share, if

the additional investments were to be raisedby way of loans, or

the additional investments were to be raisedby way of equity.

What do you understand by work BreakdownStructure (WBS) ? In what ways may WBS beused as a key document to monitor and control aproject ? Explain.

Explain the Decision Tree Analysis as a riskanalysis technique. When is it used in capitalbudgeting decisions ? Explain.

7. Distinguish between any four of the following :

Horizontal Merger and Vertical Merger.

Differential Voting Rights Equity Shares andRights Shares.

Cost of equity shares and cost of retainedearnings.

Commercial Paper and Commercial Bill ofexchange.

(e) Bank Rate and Prime Lending Rate.

MS-42

3 P.T.O.

8. A company is currently consideringmodernisation of a machine originally costingRs. 50,000 (current book value zero). However,it is in good working condition and can be soldfor Rs. 25,000.

Two choices are available. One is torehabilitate the existing machine at a total costof Rs. 1,80,000 and the other is to replace theexisting machine with a new machine costingRs. 2,10,000 and requiring Rs. 30,000 to instal.The rehabilitated machine as well as the newmachine would have a six year life and no salvagevalue. The projected after tax profits under thevarious alternatives are :

Expected After Tax Profits

YearExistingMachine

RehabilitatedMachine

NewMachine

Rs. Rs.1 2,00,000 2,20,000 2,40,0002 2,50,000 2,90,000 3,10,0003 3,10,000 3,50,000 3,50,0004 3,60,000 4,00,000 4,10,0005 4,10,000 4,50,000 4,30,0006 5,00,000 5,40,000 5,10,000

The firm is taxed at 35%. The company uses thestraight line depreciation method and the same isallowed for tax purposes. Ignore block assetsconcept. The cost of capital is 12%. Advise thecompany whether it should rehabilitate theexisting machine or should replace it with newmachine. Also state the situation in which thecompany would like to continue with the existingmachine.

- o 0 o -

MS-42 4