FINANCIAL MANAGEMENT

Question No. 1

(a) Explain the Capital Asset Pricing Model, its relationship to the SML, and the major forces causing
shifts in the SML. 2
(b) You are a portfolio manager of National Investment Company (NIC). You are examining the
investment plan for future 2020 to 2023 periods. There are three assets in your hand with expected
return for 4 years as follows:

Year Assets X Asset Y Asset Z

2020 16% 17% 14%
2021 17 16 15
2022 18 15 16
2023 19 14 17
Using these assets you have isolated the three investment alternatives shown in the following:
Alternative1: 100% of assets X
Alternative 2: 50% of Assets X and 50% of assets Y
Alternative 3: 50% of Assets X and 50% of assets Z
Requirements:
i. Calculate the expected return over the 4-year period for each of the three alternatives; 3
ii. Calculate the standard deviations of returns over the 4-year period for each of the three
alternatives; 3
iii. Use your findings in parts (i) and (ii) to calculate the co-efficient of each of the three alternatives; 2
iv. On the basis of your findings, which of the three investment alternatives do you recommend and
why? 3

Answer to the Question No. 1 (a)

graphical depiction of the CAPM is SML, which shifts over time in response to changing inflationary
expectations and/or changes in investors risk aversion. Changes in inflationary expectation result in
parallel shift in the SML. Increasing risk aversion result in a steepening in the slope of the SML.
Decreasing risk aversion reduces the slope of the SML. Although it has some shortcomings, the CAPM
provides a useful conceptual frame work for evaluating and linkin risk and return.

Answer to the Question No. 1 (b)

(i)
Expected portfolio return:
Alternative-1 (100% of X)
Return= 16%+17%+18%+19%/4= 17.5%
Alternative 2: (50% of X + 50% of Y)

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 Asset X Asset Y Portfolio return
2020 16% X0.50= 8% 17x0.50= 8.5% 16.5%
2021 17X0.50= 8.5% 16x0.50= 8% 16.5%
2022 18%x0.50= 9% 15x0.50= 7.5% 16.55
2023 19X0.50=9.55 14x0.50=7.0% 16.5%
Average Portfolio return= 16.5+165.5+16.5+16.5/4= 16.5%
Alternative 3 :(50% of X + 50% of Z)

Asset X Asset Z Portfolio return

2020 16% X0.50= 8% 14x0.50= 7% 15%
2021 17X0.50= 8.5% 15x0.50= 7.5% 16%
2022 18%x0.50= 9% 16x0.50= 8% 17%
2023 19X0.50=9.5% 17x0.50=8.5% 18%
Average Portfolio return= 15+16+17+18/4= 16.5%
(ii)

Standard deviation:

Alternative-1

Sq root of {(16%-17.5)2+(17%-17.5%)2+(18%-17.5%)2+ (19%-17.5%)}/4-1

Square root of {(1.5)2+(-.50)2+(0.5)2+(1.5)2}/3

Square root of (+.000225+.000025+0.000025+0.000225)/3
Square root of 0.0005/3=01291= 1.291%

Alternative-2

Sq root of {(16.5%-16.5)2+(16.5%-16.5%)2+(17%-16.5%)2+( 16.5%-16.5%)}/4-1

Square root of {(0)2+(0)2+(0)2+(0)2}/3
Square root of (0)/3=0

Alternative-3

Sq root of {(15%-16.5)2+(16%-16.5%)2+(18%-17.5%)2+ (18%-16.5%)}/4-1

Square root of {(1.5)2+(-.50)2+(0.5)2+(1.5)2}/3
Square root of (+.000225+.000025+0.000025+0.000225)/3
Square root of 0.0005/3=01291= 1.291%

(iii)

Co-efficient of variation:

CV1= 1.291/17.5%= 0.0738

CV2= 0/16.5%=0%

CV3= 1.291/16.5%=0.0782

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(iv)

Summary:

Portfolio return Standard deviation Coefficient of variation

Alternative-1 17.5% 1.291 .0738
Alternative-2 16.5% 0 0
Alternative-3 16.5% 1.291 0.782
Because the assets have different expected returns, the coefficient of variation should be used to
determine the best portfolio. Alternative 3, with positively correlated assets, has the highest coefficient of
variation and therefore, is the riskiest. Alternative 2 is the best choice, it is perfectly negatively correlated
and therefore, has the lowest coefficient of variation.
Question No. 2

Islam Brothers Limited (IB) is a manufacturer of retail goods. It has a financial year end of 31 December.
Much of - its main suppliers are based in west part of India and a major customer is
based in east part of India.
IB has two large contracts due for settlement at the end of March 2020 and, because of the scale of these
contracts, its board is considering whether or not to hedge against the possibility of an adverse move of
taka against the Indian Rupee before the end of March 2020. Details of the two contracts are shown
below:
Receipt due from Indian customer on 31 March 2020 300 Million.
Payment due to Indian supplier on 31 March 2020 375 Million
You work for IB and have been asked to advise the board on the implications of hedging these two
contracts. The information below in Table 1 has been gathered on 31 December 2019:

Table 1
Spot rate ( / ) 0.8700- 0.8930
Relevant over the counter (OTC) currency option, exercise price ( / ) 0.8689
Three month forward contract premium / ) 0.0018-0.0015
OTC currency option cost (per Rupee converted) 0.018
Forward contract arrangement fee (per Rupee converted) 0.0058
Rupee interest rate (borrowing) 11.0% pa
Rupee interest rate (lending) 7.0% pa
Taka interest rate (borrowing) 8.0% pa
Taka interest rate (lending) 5.0% pa
Requirements:
(a) Using the information above, and assuming that the spot rate on 31 March 2020 will be: 1. either
0.853 - 0.876/
2. or 0.9049 - 0.9289/

- a forward contract
- a money market hedge
- an over-the-counter currency option. 9

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(b)
transactions on 31 March 2020, showing supporting calculations. 8

Answer to the Question No. 2 (a)

Due in To pay Net (to pay)

300,000,000 375,000,000 ( 75,000,000)

Forward contract 750,000/(0.8700-.0018) ( 86,385,625)

plus : Cost (0.0058% x 75,000,000) ( 435,000)
( 86,820,625)

Money Market Hedge

Lend in Rupee 75,000,000 73,710,074
1.0175

Convert @ spot rate 73,710,074 84,724,223

0.8700

Borrow in Taka 84,724,223 x 1.02 ( 86,418,707)

Option (@ exercise price) 75,000,000/0.8689 ( 86,316,032)

plus: Cost (1.8% x 75,000,000) ( 1,350,000)
( 87,666,032)

Option @31st March spot rate (1) 75,000,000/0.853 (87,924,971)

plus: Cost (1.8% x 75,000,000) ( 1,350,000)
( 89,274,971)
Option exercised

Option @31st March spot rate (2) 75,000,000/0.9049 ( 82,882,086)

plus: Cost (1.8% x 75,000,000) ( 1,350,000)
( 84,232,086)
Option not exercised

Answer to the Question No. 2 (b)

ADVICE
Spot on March 31st 0.853 0.9049 Average
No hedge (87,924,971) (82,882,086) (85,403,529)
OTC option (OTC) (87,666,032) (84,232,086) (85,949,059)
Money market hedge (MMH) (86,418,707) (86,418,707) (86,418,707)
Forward contract (FC) (86,820,625) (86,820,625) (86,820,625)
Cost @ current spot 0.87 (86,206,897)
Cost @ spot 0.853/ (87,924,971)
Cost @ spot 0.9049/ (82,882,086)

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Thus a strengthening of Taka would lead to a fall in the cost of the net payment.
The markets suggest a weakening of taka (premium on rupee), however.
MMH and FC give fixed cost MMH is cheaper ( 86,419 k compared to 86,821)
OTC option is expensive unless Taka does strengthen.
What the FC and the MMH
are fixed and for wrong amount.

Question No. 3

SW is a well established retailer of gymnasium equipment. The company's key market is in Dhaka.
Extracts from the company's most recently published annual report (as at 31 December 2019) are shown
below:
BDT '000 BDT'000 BDT'000
Non-current assets 3,518
Current assets
Inventories 3,780
Trade receivables 3,668 7,448
Total assets 10,966

Ordinary shares (50p) 980

Retained earnings 1,954
Total equity 2,934
Non-current liabilities:
8% Debentures (redeemable in 2024) 2,550
Current liabilities:
Trade payables 2,870
Other payables 372
Short-term borrowings 2,240 5,482
Total liabilities 8,032
10,966
SW's finance director has calculated that the company needs to raise BDT 1,827,777 of additional long-
term funds to provide finance for the following three matters:
Over the past three years, SW's annual revenue has changed very little and so its senior
management is now considering extending operations into Chattogram and Sylhet. This would
necessitate expenditure of BDT 950,000 on new buildings and vehicles at the company's existing
distribution centre.
SW's short-term borrowings comprise only a bank overdraft and the company is under pressure
from its bank to reduce that overdraft (which has stayed close to its current level for the past
eighteen months) to BDT 2 million.
Its trade suppliers are unhappy that they have to wait, on average, 45 days to receive payment and
would like this figure reduced by ten days.
You are a member of SW's finance team and have been asked to prepare workings that would aid
management in their decision. Other information relevant to the situation is:
SW's total revenue (2019) BDT 28.5m
SW's net margin (2019) before interest costs 3%
Bank overdraft interest rate (fixed) 17.5%

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Dividends per share (2019) 5p
Earnings per share (2019) 9.25p
Gearing using book values: debt / (debt + equity) (2019) 46.5%
SW's marketing director believes that the expansion into Chattogram and Sylhet will generate additional
revenue of BDT 6m in 2020 and, because of the impact of fixed costs, it is estimated that the net margin
on these extra sales (before interest costs) would be 5%. SW's management estimates that the 2019
dividend per share will be maintained in 2020.
You have been advised that, for the additional long-term funds, senior management wishes to use either
(i) A rights issue, with the new shares priced at about 20% below the current market value of BDT
1.55 per share; or
(ii) An issue of irredeemable debentures with a coupon rate of 10%. Currently investors expect a 12%
return on similar debentures in the market.
The corporation tax rate is 30%. SW's management has assumed that there will be no additional working
capital requirements associated with the additional revenue.
Requirements:
(a) Demonstrate how SW's finance director calculated the long-term funding requirement of BDT
1,827,777. 2
(b) Assuming that SW needs to raise BDT 1,827,777, calculate:
(i) Its projected earnings per share figure for 2020 if it raises those funds by (a) a rights issue or
(b) a debenture issue. 5
(ii) SW's projected gearing figure at the end of 2020 if it raises those funds by (a) a rights issue or
(b) a debenture issue. 5
(c) Based on your workings in (b) above, recommend, with reasons, which, if either, method of long-
term funding SW's senior management should choose. 3
(d) Comment on the assumption made by SW's management that there would be no additional working
capital requirements associated with the additional revenue. 3

Answer to the Question No. 3 (a)

Finance to be raised BDT

New assets 950,000
Reduction in overdraft (2,240 2,000) 240,000
Reduction in payables (2,870,000 × 10/45) 637,777
1,827,777

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Answer to the Question No. 3 (b)

(i)

Rights issue Debenture issue

Earnings per share (BDT 420,700/3,434,014) BDT 0.123
BDT 0.136
(BDT 267,167/1,960,000)
BDT BDT
Sales 34,500,000 34,500,000
Net margin (BDT 28.5m × 3%) 855,000 855,000
(BDT 6m × 5%) 300,000 300,000
1,155,000 1,155,000

Interest Current debentures (8% × BDT 2,550) 204,000 204,000

New debentures (12% × BDT 1,827,777) 0 219,333
Bank overdraft (BDT2m × 17.5%) 350,000 350,000
(554,000) (773,333)
Profit before taxation 601,000 381,667
Taxation (30%) (180,300) (114,500)
Profit after tax/Earnings 420,700 267,167

WORKING 1
Rights issue (BDT 1,827,777/[ BDT 1.55 20%]) 1,474,014 shares
Plus existing shares (BDT 980,000/BDT 0.50) 1,960,000 shares
Total 3,434,014 shares

(ii)
Rights issue Debenture issue
Gearing % (see Working 2) (BDT 2,550,000/BDT 7,560,777) 33.7% 58.5%
(BDT4,377,777/BDT 7,480,944)

WORKING 2
Profit after tax/earnings (part (a)) 420,700 267,167
Dividends Existing shares (5p × (980/BDT 0.50)) (98,000) (98,000)
New shares (5p × 1,474,014) (73,700) 0
Retained profit 249,000 169,167

Rights issue Debenture issue

Total long term funds at 31/12/19 BDT 5,484,000 BDT 5,484,000
Plus: New long term funds raised 2020 1,827,777 1,827,777
Plus: Retained profit 2020 249,000 169,167
Total long term funds at 31/12/20 BDT 7,560,777 BDT 7,480,944
Total geared funds at 31/12/20 BDT 2,550,000 BDT 4,377,777
(BDT2,550,000 + BDT
1,827,777)

Note: an alternative calculation in this gearing calculation, i.e. using the nominal value of the new
debentures issued (BDT 2,193,332 see below), would not have been penalised.

10% Debenture issue (BDT 1,827,777 X 12%/10%) = BDT 2,193,332 nominal value

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Answer to the Question No. 3 (c)

SW's current earnings per share figure is 9.25 paisa. This is significantly lower than both of the forecast
earnings per share figures for the forthcoming year.

The debentures issue will lead to a higher earnings per share figure for shareholders than the rights issue
of shares.

Debenture issue: the risks associated with this issue are greater than those associated with the rights issue.
The level of gearing under the debenture issue option might be considered far too high in relation to the
expected returns. The interest cover ratio under this option of 1.49 (BDT 1,155,000/773,333) is also low.
From the company viewpoint, the level of interest payments under this option will prove a burden unless
profits can be maintained at a high level.

Do the existing debenture holders have any collateral, e.g. on the company's non-current assets? Will the
new debenture holders expect something similar? Is there potential conflict here? Is there sufficient
security for these borrowings the current book value of the assets is only BDT 3,518,000 (plus new
assets of BDT 950,000). What is the market value of the non-current assets?

Rights issue: although the EPS is less than for the debenture issue, it will be higher than in 2019. The
level of gearing is much lower than under the debenture issue option. Also it gives a lower level of
gearing than the current one. The interest cover ratio of 2.08 is higher than that for the debenture issue.
Shareholders may find it difficult to raise the required finance to subscribe to the issue because the rights
issue equates to 75% (1,474,014/1,960,000) of the existing shares in issue. This may limit the potential
success of the issue.

Answer to the Question No. 3 (d)

Working capital typically comprises inventories, trade receivables, bank/cash and trade payables.
Contrary to management's view, SW's expansion into northern Chattogram and Sylhet is likely to affect
its level of working capital required as follows:

It would be prudent to carry sufficient additional inventory to avoid the embarrassment of a 'stock out'
(which could cause a loss of customers in the future). With inventory, SW must strike a balance between
the costs of 'stock outs', ordering costs and holding costs.

To encourage potential new customers in Chattogram and Sylhet to buy its products, SW would be
unwise not to offer credit terms on its 'new' sales thus the level of trade receivables will increase.

In contrast SW should continue with its policy of purchasing goods on credit and, once the ten day
adjustment has been made to the creditors' payment period, the expansion of trade means that the level of
trade payables will increase, which will reduce SW's working capital investment.

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Question No. 4

In the fashion world, marketing strategies are prerequisite for success. Sam Hassan is an over ambitious
challenging entrepreneur owning a casual wear company, Yellow Fashion Wear (YFW). During 2019,
YFW rocketed to Taka 100 million in sales after 10 years in business. Its fashion line covered the young
man and woman from head to toe with shirts, trousers, hats, sweaters, dresses, blouses, skirts, pants,
sweatshirts, socks, and shoes, etc. In major big cities there are Yellow shops in every super market and
streets..

securities analysts speculated that Yellow could not keep up the pace. They warned that competition is
fierce in the fashion industry and that the firm might encounter little or no growth in the future. They
estimated that stockholders also should expect no growth in future dividends.
Contrary to the conservative analysts, Sam Hassan believed that the company could maintain a constant
annual growth rate in dividends per share of 6% in the future, or possibly 8% for the next two years and
6% thereafter. Hassan based his estimates on an established long-term expansion plan into USA and
European markets. Venturing into these markets was expected to cause the risk of the firm, as measured
by the risk premium on its stock, to increase immediately from 8.8% to 10%. Currently the risk free rate
is 6%.
I

analysts and the aggressive predictions of the company founder, Mr. Hassan.
You have compiled the following 2019 financial data to aid your analysis.
Data items 2019 value
Earnings per share (EPS) Tk. 6.25
Price per share of common stock Tk.40.00
Book value of common stock equity Tk.60,000,000
Total common shares outstanding 2,500,000
Common stock dividend per share Tk.4.00

Requirements:
a. 2
b. 2
c.
foreign markets (USA and Europe) as planned? 2
d. If the securities analysts are correct and there is no growth in future dividends, what will be the
value per share of Yellow Stock? 2
e.
maintain a constant annual 6% growth rate in future dividends? 2
f. he value per share of Yellow stock should the firm
maintain a constant annual 8% growth in dividend per share over the next 2 years and 6%
thereafter? 3
g. Compare the price of stock values found under different methods above. Which valuation method
do 4

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Answer to the Question No. 4

This problem focuses on the valuation of the firm. The students explore various methods of valuation
including price earning multiple with growth models.
(a)
Book value per share= 60,000,000/2,500,000= Tk. 24 per share
P/E ratio: Tk. 40/Tk. 6.25= 6.4
(b)
r on equity: Rf+ risk premium
=6+8.8=14.8%
(c)
Return on equity= 6%+10%= 16%; as risk premium rises, the required rate of return also rises.
(d)
Zero growth= P0=D1/re= 4.00/.16=Tk. 25
(e)
Constant growth:
P0= Dt/(re-g)=4.00x1.06/(.16-0.06)=4.24/10=42.40
(f)
Variable growth model:
PV off dividends= P0=PV of dividends during initial growth period + PV of price of stock at the
end of growth period.
Year t D0 1.08t D1 1/1.16 PV of
dividends
2020 1 4.0 1.080 4.32 0.8621 3.72
2021 2 4.0 1.165 4.67 0.7432 3.47
Tk. 7.19

PV of price of stock at the end of initial growth period

(g)
D2019= 4.67X (1+0.06)=4.95
P2020=4.95+ (0.16-.06)= 49.50
PV of stock at the end of year 2
PV= P2x (1/1.16)2
= PV=49.50X(0.7432)= Tk. 36.79

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Sum of PV of dividends PV price of stock at the end= 7.19 + 36.79= Tk. 43.08

Valuation method Per share

Market Value Tk. 40.00
Book value Tk. 24.00
Zero growth Tk. 25.00
Constant growth Tk. 42.40
Variable growth Tk. 43.98

The book value has no relevance to the true value of the firm. Of the remaining methods, the most value
is given by the zero-growth model. Wary analysts may advise paying no more than Tk. 25 per share, yet
this is hardly more than book value. The most optimistic prediction, the variable growth model, results in
a value of Tk. 43.98, which is not far from the market value. The market is obviously not as cautious
alysts are.

Note also the P/E ratio and required return confirm one another. The inverse of the P/E is 1/6.25= 0.16.
This is also measure of required return to the investor. Therefore, the inverse of the P/E (16%) and sum of
the risk free rate and risk premium are identical. The market appears to be pricing in the expectation that
the company will expand to overseas market.

Question No. 5

Best Hotels Limited is a listed company which owns a chain of hotels around the country. The
management of Best Hotels are investigating a BDT 195 million potential investment in the real estate
business which would be a diversification from its mainstream business. The investment would involve
the construction and management of a Shopping Mall. An initial investment payment of BDT 120 million
is payable immediately and the reminder upon completion of the Shopping Mall at the end of year one.
The operations would commence immediately after completion of the Mall. The Shopping Mall is
expected to operate for a period of 13 years after which a major investment would be required. The
residual value at the end of its life cycle (after 14 years from now) is projected to be BDT 45 million after
tax. The rental charges would be based on the floor area.
Type of floor area Number of shops Monthly rent per shop
Medium 40 BDT 65,000
Large 30 BDT 180,000

for Large. During the subsequent years, the shop occupancy would be at full capacity. Annual operating
costs are expected to be 45% of the annual revenue.
The corporate tax rate is 37.5% per year.
Requirements:
(a) Evaluate the proposed investment in the Real Estate Business using the Net Present Value method.
Assume the cost of capital is 13% per year. 10
(b) Assuming the role of a Financial Consultant, write a brief report to the management of Best Hotels
Ltd, discussing the non-financial factors that should be considered before the decision to diversify
into the real estate business is made. 5

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Answer to the Question No. 5 (a)

Net present value

Year 0 1 2 3 to 14 14

Investment cost (120) (75) - - 45

Revenue (W.1) - - 44.64 96 -
Operational - - (20.09) (43.2) -
costs @45%
Cash flow (120) (75) 24.55 52.8 45
before tax
Taxation - - (9.21) (19.8) -
@37.5 %
Net cash flow (120) (75) 15.34 33 45
Discount 1.000 0.885 0.783 4.634 0.181
@13%
Present values (120) (66.38) 12.02 152.92 8.15
NPV (13.29)

Based on the NPV computation, the proposed investment should not be undertaken because it gives a
negative NPV of (BDT 13.29m)

Workings:

1. Revenue Year one of operations

Medium = 40 x 60% x BDT 65, 000 x 12 = BDT 18, 720,000

Large = 30 x 40% x BDT 180, 000 x 12 = BDT 25, 920,000
Total BDT 44, 640,000

Revenue after Year one of operations

Medium = 40 x BDT 65, 000 x 12 = BDT 31, 200,000
Large = 30 x BDT 180, 000 x 12 = BDT 64, 800, 000
Total BDT 96, 000,000

2. Annuity under NPV (13%)

Year 3 to 14 Annuity value at Y2 = 5.918

Present Value Factor of Y2 Value = 0.783
PV of Revenue for Year 3 to 14 = 4.634

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Answer to the Question No. 5 (b)

To : Best Hotel Management

From : Financial Consultant
Date : December, 2019

Subject : Report on the proposed Shopping Mall Investment

The report discusses non financial factors that could be considered when making the decision of investing
in the shopping mall. The decision to invest in a major project must be evaluated using both financial and
non-financial information. From the financial perspective, using the NPV approach, the investment shows
that it cannot add value to the shareholders wealth. Non-financial considerations will include the strategic
fit of the investment with the company and its future plans.

Non- financial information

The methods used to evaluate the proposed investment from the financial perspective are subject to
considerable inaccuracy. For instance the operating costs are assumed to be 45% of revenue throughout
the investment life but prices and cost changes according to the economic conditions. The accuracy of the
discount rate estimate is subjective considering it is based on industrial averages.

Its might be important not to rely on a single estimate of net present value and Management should
consider using Sensitivity analysis or simulations. This analysis could be used to ascertain the impact of
changes of key cash flow variables as rent charges, shop occupancy on the NPV. It might also be
important to consider the real options.

The strategic importance of the investment must be established as it will influence to a large extent the

running a real estate business. It might be better to consider first the opportunities within the hotel
industry before diversifying into a foreign business. The hotel must also consider recruiting appropriate
skilled labour force that can run the shopping mall. The hotel should also thoroughly investigate the
competition in the real estate business and the likely reaction of competitors if it enters this new market.
The Hotel should consider the possibility of acquiring an already established business for quicker entry
into the market and also reducing competition in a way.

-sd-/
Financial consultant

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Question No. 6

SBN, one of the largest plant wholesalers in Bangladesh, was poised for expansion. Through strong
profitability, a conservative dividend policy, and some recent realized gains in real estate, SBN has a
strong cash position and was searching for a target company to acquire. The executive members on the
acquisition search committee had agreed that they preferred to find a firm in a similar line of business
rather than one that would provide broad diversification. It would be their first acquisition, and they
preferred to stay in a familiar line of business. Abdur Rahman, Director of Marketing, had identified the
targeted lines of business through exhaustive market research.
Mr. Rahman had determined that the servicing of plants in large commercial offices, hotels, zoos, and
theme parks would complement the existing wholesale distribution business. Frequently SBN was
requested by its large clients to bid on a service contract. However, the company was neither staffed nor
equipped to enter this market. Mr. Rahman was familiar with the major plant service companies in the
places nearing Dhaka and had suggested GPC as an acquisition target because of its significant market
share and excellent reputation.
GPC had successfully commercialized a market that had been dominated by small local contractors and in
house landscaping departments. Beginning with a contract from one of the largest theme parks in the
last 8 years.GPC had also been
selected because of its large portfolio of long term service contracts with several major DSE listed
companies. These contracted clients would provide a captive customers base for the wholesale
distribution of SBN plants products.
In a conference Mr. Rahman offered a proposal for merger to the GPC President. GPC President had

current balance sheet. These data are presented in Table-1 and Table-2.
The CFO of SBN had estimated the incremental cash after taxes from the acquisition would be
Tk.18,750,000 for year 1 and 2; Tk. 20,500,000 for year 3; Tk. 21,750,000 for year 4; Tk. 24,000,000 for
year 5; and Tk. 25,000,000 for years 6 through 30. He also estimated that the company should earn a rate
of return of at least16% on an investment of this type. Additional financial data are given in Table-3.
TABLE -1
GPC Earning records
Year EPS Year EPS
2011 2.20 2015 2.85
2012 2.35 2016 3.00
2013 2.45 2017 3.10
2014 2.60 2018 3.30
TABLE-2
GPC Balance sheet (31 December, 2018) (Figures in Taka)
Assets Liabilities and equity
Cash 2,500,000 Current liabilities 5,250,000
Accounts receivable 1,500,000 Mortgage payable 3,125,000
Inventories 7,625,000 Common stock 15,625,000
Land 7,475,000 Retained earning 9,000,000
Fixed assets net 13,900,000
Total assets 33,000,000 Total liabilities and equity 33,000,000

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 TABLE-3
SBN and GPC Financial data (December 31, 2018)
Earnings available for common stock (Tk.) 35,000,000 15,246,000
Number of shares of Common stock 10,000,000 4,620,000
Market price per share (TK.) 50 30*
*estimated by SBN
Requirements:
a. What is the maximum price SBN offer GPC for a cash acquisition? (assume relevant time horizon
for analysis is 30 years). 5
b. If SBN planned to sell bonds to finance 80% of the cash acquisition price found in part 1, how
might issuance of each of the following bonds affect the firm?. Describe pros and cons of each
bond such as: straight bond, convertible bond, bonds with stock purchase warrant attached. 3
c. What is the ratio of exchange in a stock swap acquisition if SBN pays Tk. 30 per share of GPC?
Explain why? 2
d. What effect will this swap of stock have on the EPS of the original share holders of SBN and GPC?
Explain why? 3
e.
premerger assets, what effect might this growth have on the EPS of the merged firm over the long
run? 3
f. What impact would GPC, being a foreign based company, have on the foregoing analysis? Describe
the added regulations, costs, benefits, and risks that are likely to be associated with such an
international merger. 4

Answer to the Question No. 6 (a)

Acquisition of GPC by SBN

Students are asked to evaluate a proposed acquisition by means of either a cash transaction or a stock
swap. The effects on the short and long term earnings per share should be calculated and other proposals
to achieved the merger to be discussed;

Price for cash acquisition of GPC

year Incremental cash flow Discount rate 16% Present value

1 18,750,000 0.8621 16,164,375
2 18,750,000 0.7432 13,935,000
3 20,500,000 0.5523 11,322,150
4 21,750,000 0.4761 10,355,175
5 24,000,000 0.4104 9,849,600
6-30 25,000,000 2.9029 72,572,500
134,198,800

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The maximum price SBN should offer Tk. 134,198,800 for a cash acquisition. Net amount of Tk 125,
823,800 to be paid after adjustment of liabilities Tk 8,375,000
125,823,800.

Answer to the Question No. 6 (b)

Straight bond:

Financing such a large portion of the acquisition with straight bonds will dramatically increase the
financial risk of the firm. The management of SBN must be very comfortable that the combined firm is
able to generate adequate cash to service its debt. The coupon rate on these bonds could also be quite
high. The potential benefit to the SBN owners is the magnified return on equity that could result from
leverage.

Convertible bond

Initially, convertible will provide much of the same concern as straight bonds because financial leverage
will increase. These are two benefits to convertible bonds not available with straight bonds. First is that
the coupon rate will be lower. Investors will value the conversion feature and will be willing to pay more,
thus reducing the cost, for the convertible bond. The second advantage is that the leverage will decrease
as conversion occurs, assuming the benefits of the acquisition ultimately proves favourable and the value
of the firm increases by the merger. The drawback is the potential dissolution of ownership that will occur
if and when the bonds are converted.

Bonds with stock purchase warrant attached- The benefits and disadvantages of this security mix are
similar to those of a convertible bond. However, there is one major difference. The attached warrant may
eventually be used to supply the firm with additional equity capital. This inflow of capital will lower the
financial risk of the firm and generate additional funds. There will still be the dissolution of ownership
potential.

Answer to the Question No. 6(c)

Rate of exchange= Tk. 30/Tk. 50=0.60

Answer to the Question No. 6 (d)

swap.
Exchange of stock should increase Tk. 3.93, an increase from Tk. 3.50.
Calculation:
New SBN shares required 4,620,000X.060= 2772,000 Total SBN shares10,000,000+2,772,000
=12,772,000
EPS for SBN= 35,000,000+15,246,000/12,772,000=Tk. 3.95
EPS for GPC Tk. 3.93X.60= Tk. 2.36

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The decrease of EPS for GPC can be explained by looking at the price/earnings ration for SBN and the
P/E ratio based on the price paid for GPC.
SBN GPC
Price per share Tk. 50 (market) Tk. 30 (price paid)
EPS premerger Tk. 3.50 Tk. 3.30
P/E Ratio 14.29 9.09
EPS post merger Tk. 3.93 Tk. 2.36

When the P/E ratio paid is less than the P/E ra

Answer to the Question No. 6 (e)

Over the long run, the EPS of the merged firm would probably not increase. Usually the earnings
than those resulting from the acquiring

Answer to the Question No. 6 (f)

If GPC was a foreign based company would impact in many areas of the foregoing analysis. Regulations
that apply to international operations tend to complicate the preparation of financial statements for
foreign based subsidiaries. Certain factors influence the risk and return characteristics of a MNC,
particularly economic and political risks. These are two forms of political risks macro; which involves all
foreign firms in the country and micro, which involves only a specific industry, individual firm, or
corporation from a particular country. International cash flows can be subject to a variety of factors,
including
cash flow, the usual business and financial risks, currency and political actions of host governments, and
local capital market conditions. Foreign exchange risks can also complicate international cash
management.

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