SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 1 of 6

STRATEGIC FINANCIAL MANAGEMENT [S5] – STRATEGIC LEVEL-2

Marks
Question No. 1
Expected Return on Equity (ROE):
Return on equity may be computed as follows:
Rs. ‘000’
Tight Moderate Relaxed
Sales 100,000 100,000 100,000
Current assets (% of sales  Sales) 45,000 55,000 70,000 0.75
Fixed assets 50,000 50,000 50,000 0.75
Total assets 95,000 105,000 120,000 0.75
Debt (60% of assets) 57,000 63,000 72,000 0.75
Equity 38,000 42,000 48,000 0.75
Total equity and liabilities 95,000 105,000 120,000 0.75
EBIT (20%  Rs.100 million) 20,000 20,000 20,000 0.75
Interest (15%) 8,550 9,450 10,800 0.75
Earnings before taxes 11,450 10,550 9,200 01
Taxes (30%) 3,435 3,165 2,760 01
Net income 8,015 7,385 6,440 01
Return on equity (Net income ÷ equity x 100) 21.10% 17.58% 13.42% 01

Question No. 2
(a) Estimated Equation for the Security Market Line (SML):
r̂x = 0.1(7%) + 0.2(9%) + 0.4(11%) + 0.2(13%) + 0.1(15%)
= 0.7% + 1.8% + 4.4% + 2.6% + 1.5% = 11% 02
rRF = 6% (given), therefore, the SML equation is
ri = rRF + (rM - rRF)β = 6% + (11% – 6%)β = 6% + (5%)β 02

(b) Required Rate of Return for Next Period:

First, determine the fund’s beta, βF. The percentage of funds invested in each stock.
Stocks Percentage
A (Rs.320 ÷ 1,000) 0.32
B (Rs.240 ÷ 1,000) 0.24
C (Rs.160 ÷ 1,000) 0.16
D (Rs.160 ÷ 1,000) 0.16
E (Rs.120 ÷ 1,000) 0.12 03

βF = 0.32(0.5) + 0.24(1.35) + 0.16(1.65) + 0.16(1.0) + 0.12(1.48)

= 0.16 + 0.32 + 0.26 + 0.16 + 0.18 = 1.08 02
Next, use βF = 1.08 in the SML determined in part (a) above:
r̂x = 6% + (11% - 6%)1.08 = 6% + 5.4% = 11.4% 01

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stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or treated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.
 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 2 of 6
STRATEGIC FINANCIAL MANAGEMENT [S5] – STRATEGIC LEVEL-2
Marks
Question No. 3
(a) Market Price per Share, if the Shares are Repurchased:
Net income = Rs.4,000,000 ; Shares = 2,000,000
P0 = Rs.32 per share ; Repurchase = 20%
Repurchase = 0.2 x 2,000,000 shares = 400,000 shares 01
Repurchase amount = 400,000 shares x Rs.32 per share = Rs.12,800,000 01
Rs.32 per shares
P/E ratio = = 16 0.5
Rs.2 per shares

Net income Rs.4,000,0 00

EPS – Old = = = Rs.2.00 per share 01
Shares 2,000,000 shares
Rs.4,000,000 Rs.4,000,0 00
EPS – New = = = Rs.2.50 per share 1.5
2,000,000 - 400,000 1,600,000 shares
Price – New = EPS–New x P/E ratio = Rs.2.50 per share x 16 = Rs.40 per share 02

(b) (i) Effect on Shareholders’ Equity Account and Number of Shares Outstanding with a 20%
‘Small-percentage’ Stock Dividend:
Rupees
Share capital (Rs.10 per share) 4,800,000 0.75
Share premium 7,200,000 0.75
Retained earnings 12,000,000 0.75
Total shareholders’ equity 24,000,000 0.75

Present number of shares (Rs.4,000,000 ÷ Rs.10 per share) 400,000

20% stock dividend (400,000 x 0.20) 80,000
Number of shares outstanding – after stock dividend (400,000 + 80,000) 480,000 02

(ii) Per Share Market Price after a 20% Stock Dividend:

The total market value of the firm before the stock dividend is Rs.24 million (Rs.60 x
400,000 shares). 1.5
Market price per share after the stock dividends is Rs.50 per share (Rs.24 million ÷
480,000 shares). 1.5

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or treated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.
 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 3 of 6
STRATEGIC FINANCIAL MANAGEMENT [S5] – STRATEGIC LEVEL-2
Marks
Question No. 4
(a) Minimum Level of Earnings before Interests and Taxes (EBIT):
Existing debt = Rs.160 million
Interest rate on existing debt = 9%
Interest expenses = Rs.160 million x 0.09 = Rs.14.4 million 01
No of shares outstanding = 12 million
EBIT - Rs.14.4million
Old capital structure = 01
12 million
Additional debt = Rs.250 million – Rs.160 million = Rs.90 million 01
Market price per share = Rs.75
No. of shares re-purchase with Rs.90 million
= = 1.2 million shares
additional debt Rs.75 per share 01
No. of shares outstanding after
= 12 million – 1.2 million = 10.8 million shares 01
re-purchase
Interest expenses on additional debt = Rs.90 million x 0.12 = Rs.10.8 million 01
Total interest expenses after raising
= Rs.14.4 million + 10.8 million = Rs.25.2 million 01
additional interest
EBIT - Rs.25.2million
EPS under the new capital structure = 01
10.8 million
EBIT - Rs.14.4million EBIT - Rs.25.2million
Break-even EBIT = =
12 million 10.8 million
10.8 million (EBIT – Rs.14.4 million) = 12 million (EBIT – Rs.25.2 million) 0.5
10.8 EBIT – 155.52 = 12 EBIT – 302.4 0.5
12 EBIT – 302.4 = 10.8 EBIT – 155.52 0.5
12 EBIT – 10.8 EBIT = 302.4 – 155.52 0.5
1.2 EBIT = 146.88 0.5
146.88
EBIT = = Rs.122.4 million 1.5
1.2

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or treated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.
 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 4 of 6
STRATEGIC FINANCIAL MANAGEMENT [S5] – STRATEGIC LEVEL-2
Marks
(b) Decision-Making for Acceptance of Offer with an Initial Investment of Rs.200 million:
Equity multiplier = 1 + Debt-to-equity ratio = 1 + 0.7 = 1.7 0.5
0.7
Debt = = 0.41 01
1.7
1.0
Equity = = 0.59 01
1.7
Weighted average cost of
= E/V x Ke + D/V Kd (1 – t)
capital (WACC)
= (0.59)(0.13) + (0.41)(0.055) = 0.0767 + 0.02255
= 0.09925 OR 9.925% 01
WACC + Adjustment factor = 9.925% + 2% = 11.925% 01
14 million
Present value (PV) = 0.5
WACC - 0.05
14 million
= = Rs.202.16 million 02
0.11925 - 0.05
Benefit = PV – Cost of investment
= Rs.202.16 million – Rs.200 million Rs.2.16 million 01

The company will have benefit of Rs.2.16 million. As the initial investment is Rs.200 million and
PV is Rs.202.16 million, so the company should take the project.

Question No. 5
(a) Calculation of Net Present Value (NPV):
Rs. ‘000’
Years 0 1 2 3 4
Cost of machinery (1,500.00) – – – – 0.5
Advertising expense (per year) – (250.00) (250.00) (250.00) (250.00) 0.5
Sales (Rs.110 x 15,000) – 1,650.00 1,650.00 1,650.00 1,650.00 01
Materials (W-1) – (562.50) (562.50) (562.50) (562.50) 01
Labour (Rs.27.50 x 15,000) – (412.50) (412.50) (412.50) (412.50) 01
Redundancy cost saving 1,150.00 – – – – 01
Overheads (W-2) – (262.50) (262.50) (262.50) (262.50) 01
Net cash flow (350.00) 162.50 162.50 162.50 162.50 01
Discount factor (at 10%) (W-3) 1.000 0.909 0.826 0.751 0.683
Present value (PV) (350.00) 147.713 134.225 122.038 110.988 01
Net present value (NPV) 164.964 02

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or treated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.
 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 5 of 6
STRATEGIC FINANCIAL MANAGEMENT [S5] – STRATEGIC LEVEL-2
Marks
Workings:
Rupees
W-1: Materials:
Cost per unit:
Without material ‘Zee’ (Rs.32.50 – Rs.10.00) 22.50
Replacement cost 15.00
Cost per unit 37.50
Total material cost (15,000 x Rs.37.50) 562,500 01
W-2: Overheads:
Total overheads (Rs.42.50 x 15,000) 637,500
Depreciation (Rs.1,500,000 ÷ 4) (375,000)
Cash flow 262,500 01
W-3: Discount Factor:
WACC [(12% x 50%) + (8% x 50%)] 10% 01

(b) (i) Viability of Project, if Sales of Medicine achieves the level of 12,000 Packets per Year:
Rs. per packet
Sales price 110.00
Less: Variable cost:
Material 37.50
Labour 27.50
Overheads (Rs.262,500 ÷ 15,000) 17.50 (82.50)
Contribution margin 27.50 02

Rupees
Net cash flow over 4 years [as calculated in part (a) above] 162,500
Contribution margin lost due to reduction in sales
[Rs.27.50 x (15,000 units – 12,000 units)] (82,500)
80,000 02
Cumulative discount factor (at 10%) 3.169
PV 253,520
Cash flow in Year-0 (350,000)
NPV (96,480) 03
Decision: The project is not viable. 01

(b) (ii) Viability of Project, if Advertising Expense is increased to Rs.312,500 per Year:
Rupees
Net cash flow over 4 years 162,500
Increase in advertising expense (Rs.312,500 – Rs.250,000) 62,500 0.5
100,000 0.5
Cumulative discount factor (at 10%) 3.169 0.5
PV 316,900 0.5
Cash flow in Year-0 350,000 0.5
NPV (33,100) 0.5
Decision: The project should not be accepted as NPV is negative. 01

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or treated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.
 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 6 of 6
STRATEGIC FINANCIAL MANAGEMENT [S5] – STRATEGIC LEVEL-2
Marks
Question No. 6
(a) (i) Replacement Cost Value:
Rupees
Total equity 908,200
Land and buildings (Rs.1,000,000 – Rs.651,600) 348,400 01
Furniture and fixtures (Rs.200,000 – Rs.521,280) (321,280) 01
Motor vehicles (Rs.250,000 – Rs.130,320) 119,680 01
Inventory and work-in-progress (Rs.1,100,000 – Rs.1,031,800) 68,200 01
1,123,200 01

(ii) Realisable Value:

Rupees
Total equity 908,200
Land and buildings (Rs.550,000 – Rs.651,600) (101,600) 01
Furniture and fixtures (Rs.250,000 – Rs.521,2800 (271,280) 01
Motor vehicles (Rs.100,000 – Rs.130,3200) (30,320) 01
Inventory and work-in-progress (Rs.1,140,000 – Rs.1,031,8000) 108,200 01
Accounts receivable (Rs.1,490,000 x 0.020) (29,800) 01
583,400 01

(iii) Dividend Valuation Model:

Looking at dividend growth over the past 5 years, we have dividend of Rs.41,000 and
Rs.50,000 for year 2015 and 2019 respectively. If the annual growth rate in dividends
is ‘g’:
Rs.50,000
(1 + g)4 = = 1.2195 01
Rs.41,000
1 + g = 1.0508
g = 0.0508, say 5% 01
Dividend in year 2015
Market value ex-dividend =
0.12 - g
50,000(1.05)
= 01
0.07
= Rs.750,000 01

(b) Acceptance of Viable Project on the basis of Profitability Index:

Present Value (PV) Net Present Profitability Index
Investment
Project of Cash Flows Value (NPV) [Present value ÷
(Rs. in million)
(Rs. in million) (Rs. in million) Investment]
X 2,000 2,100 100 (2,100 ÷ 2,000) 1.05 01
Y 1,500 1,440 (60) (1,440 ÷ 1,500) 0.96 01
Z 1,000 1,080 80 (1,080 ÷ 1,000) 1.08 01

The company should accept project ‘Z’ because the profitability index is highest and we can
accept only one project being mutually exclusive project. 02

THE END

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or treated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.