I FTNANCIAL MANAGEMENT

Nov- Dec 2012

Answer: I (a)

The modified internal rate of return (MI RR)

The modified internal rate of return (Mt I RR that would result without the assumption that project
RR) is the
we; identified the
ilffi;;;;il;iir,. rm rate. in "o*puiing the rRR to. the NpV criterion, is to allow
assumption of reinvestme; # ;;;iH" p*trJt"t ,,iitt tt IRR. A way to resolve this problem
is "
known as the modified internal rate of retum'
the specification of the r.inu"r,*rnt rate. The modification

Advantages of MIRR

There are two broad advantages of MIRR' These are-

it will not provide decision making

l.' It avoids any potcntial problcms with nrultiple IRRs, and additionally.
with the NPV decision
;;;i;;;;;#ing mutually exclusive projects that conilicts
opportunity cost of capital, which is
2. In MIR& it is assumed that cash flows are reinvested at the project's
consistent with NPV calculations.

Disadvantages ofIllRR
rate of return but because of its size'
l. MIRR may lead an investor to rejeCt a project which has a lower
generates a large increase in wealth

.High return project with a short life may be preferred over a lower return project with a
longer life
2.

Answer: I(b)
,playing the float, means witing a check knowing you have insuffrcient funds and hoping you can make a
transfers and payment systems available
deoosit before the check clears. i'he delays involvel in the various fund
use of these delays for managing short term financing by local companies'
-a,n.
Companies fund managa of Treasury Manager's can manage its working
capital considering these financial
risks and liquidity risk.

Answer: 1 (c)
Amount in Thousand Taka
a) Net present value evaluation
Year I 1 34
Sales revenue 1,575 1,654 l,'736 1,823
(37)
Selling costs (32) (3 3) (3 s)

Variable costs (624) (64e) (67s) (702)

Before-tax cash flows 9t9 972 1,a26 1,084

Taxation at30o/o {276) (2e2) (308) (32s)

Tax benefits 263 197 t48 443

After -tax cash flows 919 9s9 931 924 li8

(11) (12) (12) (13)
Working capital
Project cash flows
lo8 ---w' --qq- -lil- --IlE-

\:u
 Discount at lAo/o 0.909 0.826 0.751 0.62t
_-._..11t____ t
Present values
825 782 690 622 .73

PV ofcash flows
2,992
Working capital: (250)
Initial investment: (3,500)
Net present value: (758)

The NPV is negative, with a value of minus Tk.758,000

and Project A is therefore not financially acceptable.

lVorkings
Year I 2 34
Selling price fik./unit) 2. t00 2,205 2.315 2.431
Sales volume (units/year) 750,000 750,000 750,000 750,000
$ales revalue Tk./years) 1,575,000 1,653,750 1,736,250 1,923,250

Yerr 1 2 34
Sclling cost (Taka/unit) 0,042 0,044 0.046 0,049
Sales volume (units/year) 750,000 750,000 750,000 750,000
Selling cost (Tk./years) 31,500 33,000 34,500 36,75A

Yerr I t
3 4
Variable cost (Tk,/unit) 0,832 0.865 0.900 0.936
Sales volume (units/year) 750,000 750,000 750,000 750,000
Variable cost (Tk./years) 624,,0A0 649,75A 675,000 702,000

Year Capital allowance (Tk.) 30YoTax benefit (Ik.) Year taken

I 975,000 262,s00 2
2 656,250 I 96,875 3
3
492,196 147,656 4
4 1,476,562* 442,969 5
*This figure includes
the balancing allowance

Capital Allowance/Depreciation
@ 2|%pa on reducing balance

Year Working capital(tk.) Incremental investment (Th)

I 250,000
2 261,250
tLzs;
3
273,006
I 1,759
4 295,292
5 12,2965
2gg,l30
12,8

t-r g
Alternutive N PV evalu stion

An alternative approach to evaluating the NPV of project A is to subtract and add back the capital allowances,
which are not cash flows.

Year I ) 3 4 5
Tk.000 Tk. 000
Tk.000 Tk.000 Tk.000

Before-tax cash flows: 919 972 1,026

Capital allowances (87s) (6s6) (4e2) (1,477)

Taxable profit. 44 316 534 (3e3)

Taxation 3) (I (e5) (160) il8

After-tax profit 44 303 439 (563) 118

Add capital allowances 875 656 492 1,477

After-tax cash flows 919 959 gv 924

The evaluation will then proceed as earlier.

b) The dlrectorst vlews on investment appraisal are discussed in turn.

Both payback and return on capital employed (ROCE) are inferior to discounted cash flow (DCF) methods such
as nei piesent value (NPV) and internal rate of return (lRR). Payback ignores the time value of money and cash
flows outside of the payback period. ROCE uses profit instead of cash flow.
Both payback and ROCE have di{ficulty in justiffing the target value used to determine acceptability
Why, for example, use a maximum payback period of two years? DCF methods use the weighted average cost
ofcapital ofan investing the basis ofcvaluation, or a projcct-specific cost ofcapital, andboth can bejustified on
academic grounds.

The company should also clarify why either method can be used, since they assess different aspects of an
investment project,

Evaluation over a four-year planning period

Using a planning period or a specified investrnent appraisal time horizon is a way of reducing the uncertainty
associated with investrnent appraisal, since this increases with project life. However, it is Imporant to determine
the expected life of an invesfine,nt project if at all possible, since evaluation over the whole life of a project may
help a company avoid sub-optimal inves&nent decisions. In the case of Beta Ltd. for examplq a furdrer year of
opaation may lead to Project A generating a positive NPV,

Scrap value is ignored

termirl-l value must be included in the evaluation ofa project since it is a cash'
Scrap value, salvage value or
inflow. Igroring scrap value will reduce' the NPV and may lead to rejection of an otherwise acceptable
investment project.

Working capital recovery is ignored

If an investment project ends, then working capital can be recovered and it must be included' in the evaluation
of an investmart project, since it is a cash inflow. In the case of Beta Ltd., the directors' decision to ignore
working capital recovery means igrroring a fourth year cash inflow of Tk.298, I 30.
A balancing allowance is claimed at the end of the fourth year of operation

,,.vG
 A balancing alrowance is claimed at the end ofthe fourth year
ofoperation
Intoducing a balancing allowance which can only be claimed
when allowed by the taxation autirorities will
distort the taxation of the investment appraisal, If ii is anticipat.a
tr,ri u pro3ect wltt ,ortin*Gfond the fourth
year, including a balancing allowancJ in the evaluation
will overstaie cash inflows and hence the Npv,
potentially leading to incorrect investment decisions
Ueing muJe.

c) Calculation ofproject Specific Cosr ofEquity ofproject -

B

The first step is to ungear. the equity beta of Beta Ltd.

This removes the effect of the financial risk of the
company on the value of.its equity beta. It is usual to
assume tt,1t-it e beta of debt is zero and hence the
ungearing formula is as follows:

Ba=peVe/(Ve+Vd(l-T))
Substituting, the asset beta = Ba = 1.5 x 90/(90 + (0.7 x 30))
= 1.216
U sin g percentages : asset beta = pa 1.5 x (7 5+ (0.7 x 25)) = 1.216
= 75 I

The asset beta of Beta Ltd. reflects only the business risk
of the new business area.

stage is to regear the asset beta into an equity

beta that reflects the financial risk of the investing
ffifr:
Reananging the ungearing formula used earlier gives.
pa = pa (Ve + Vdfl T))/Ve
-
submitituting, the i:quiry'bera =
Be = r.2 r6 x (r g0 + (0.7 x 4s)) lrg0 = r.429
This regeared equify beta can be inserted in the capital
asset pricing model equation to give a project
cost ofequity: specific

Ke = E(ri) = Rf + pe(E(rm) - Rf)

Substituting, cos t of equity = Ke 4 + (1.429 x 6)
= =12.6y0

Answer: 2 (a)
a) Real option

A real option is the right but not the obligation to undertake

certain business initiatives, such as deferring,
abandoning, expanding, t?g*g, or c^onhaJting a,garita]
inu.stm"nt-f.op",. Eo, example, the opportunity
invest in the expansion of i firm's factory, oi to
alternativety to r.ii-ri"'[.,ory, is a real
respectively' Real options.are generally distinguished call or put option,
from convcntion.ol tin*ciut options in that tfiey
typically traded as securities and do not urru-ily involve are not
a..irions on'un'underllng asset that is kaded as
financial security. a

b) Option of Detay

when a firm has exclusive rights to aproject or product

for. a specific period, it can delay taking
product until a later date' A traditionaiinvestment this project or
analysis just anr*.rl tir" question of whether
"good" one iftaken today' Thus, the fact that a proiect the project is a
does-not pur, *rrt* today (because its
or its IRR is less than its hurdle rate) does not *.* tt Npv is negative,
ut irr. ;grJ# rt ir pi";ecr are not valuable.

UU
c) Option to expand

investments in
The option to expand exists when hrms invest in projects which allow them to make further
not worth undertaking'
further or to enter new markets. The initial project rnuy b" found in terms of its NPV as
may positive and the project
However when the option to expand is taken into account, the NPV become
premium required to acquire the option to expand'
worthwhile. The initiai investment may be seen as the

d) Option to abandon
year of its lifetime' the
Wbereas raditional capital budgeting analysis assumes that a project.will operate in each
firm may have the option to-ceale a project during its if". mit option is known as abandon
option'
projects life for some
Abandorunent options, which are the righi to-sell the ru-rh flo*t over the reminder
of the
salvage value.

e) Option to redeploY

than the
The option to redeploy exists when the company can use its productive assets- for activities.other
to another will happen if the PV of cash flows from the new actiYity
original use. The switcl from one activity
will exceed the costs ofswitching. The oition to abandon is a special case ofan option to redeploy'

Answer: 2 (b)
just focus on inventory, but
l. Focus on the all the components of cash to cash conversion cycle - Don't
develop a coordinated approach to inventory, receivables and payables.

Focus on collection and skong AR management. Extend credits cautiously by weighing

the business
2.
need. Follow-up closely on collecting cash, tltis is the kcy sourcc ofcash.

3. Focus on inventory managcmcnt ' Simple cuts may aflect custom.er service' A complete overhaul of
-term gains.
demand and produition planning and safety inventory levels will lcad to longu
and
Extend supplier credit intelligently -simply delaying payment may lead to worse supply relationships
purr'* liquidity problems to suppliers. Agrecments with supplier may be possible, but payment
*ry
may have to be advanced to suppliers in serious houble.
5. Manage and Expedite receivables -the focus should be on specific customer highlighting customers who
may bi changing their payment practices. Timely and accurate invoicing helps avoid delays.

6. Audit receivables and payables transactions - Transactions must be settled at the right amounts) the
correct tax paid and the right discounts allowed and received'
1 Consider alternate supply chain financing options - Receivables can be used as collateral for'short term
credit and early payment discounts for customers may be necessary.
Ensure framework for managing supply chain risk is robust - Be aware not only of suppliers who
are in
8.
touble, but also problems with frnancial institutions which may be granting letters of credit.

9. Eliminate fixed costs - possible means include sale and leaseback, contract manufacturing and third party
warehouse,

r0, Think beyond four walls - Consider the implications of actions or manage one part of working capital on
the rest oithe value chain. Ernergency measures rnay, be required to support important suppliers.

t-r q
 Answer:2(c) (i)

Cash operating cycle

ft" t"sh operating cycle is the average length of time between payrng
trade payables and receiving cash from
trade receivables' It is the sum ofthJavera-ge inventory
noraing plrlo'a the average production period and the
average tade receivables credit period, less'the
ane.age trade-payables credit period. using working capital
ratios, the cash operating cycle is ihe sum of the inventofo
the accounts payable days.
,r**!ilr.ri"d
and the accounts reJeivable days, less

The relationship between the cash operating cycle and

the level of investment in working capital is that an
insrease in the length of thecash opeiating.!rt" *ltt
increase the level of investment in working capital length
of the cash operating cycle dependi on working capitalpolicy i,
,ctution to the level of investment in working
capital and on the nahue ofthe business operatiins otu .orprry

Working capital poticy

companies with the same business operations may have difrerent

levels of investment in working capital as a
result of adopting different working capital policier A,
trade receivables than a.conservative poticy ana so will
;;;;;r;plii"y
ur", lower levels of iirventory and
IeaJto a sr,irie, cash operating cycle. A conservative
policy on the level of investment in- worting capital in
contrast with higher levels of invcntory and trade
receivables will lead to a longer cash opcrating-cycle.

The higha cost of the longa cash operating cycle wiil

lead to a decrease in profitability while also decreasing
risk, for example the risk of running out of iiu.rto.y.

Nsture of iusiness operations

companies with different business operations will have.difrerent

cash operating cycles, There may be little need
for inventory for example in a company suppllng business
may have very high levels of inventory, somi companies
,.iui..r, ;;ii:
company selling consumer goods
"
may op.Lt.'piirurily'witih .urr, iui.r-rrpecially if
ttrey sell direct to the consumer, while other companies
may't .r. ,r*f,ntial levels of trade receivables as a
result of offering trade credit to other companies.

Answer: 2G) Gt) Cash Operadng Cf,cle of Botd Ltd.

Inventory days = 365 x 4,500/16,400 = I00 dalr

Trade receivables days = 365 x 3,500/21,300
= 60 dayr
Trade payables days = -365 x 3,000/16,400 = 67 days

Cash opuating cple = 100 + 60 - 67 = 93 days

Answen 3

NFs Ltd' is looking to raise Tk'200m in cash in order to

aquire a competitor. Any recommendation as to
sourcoof finance to be used. by th.e company must take account or itie the
iecent financial performance at the
position *d its .*p..ted financiat p"io..-r. rr, tr,. n t*1, pr"s*uuiy un*
ffI|rlY;,,iffffir1ffffi]al
Recent fi nancial performance

The recent financial poformance of NFS Ltd' will

be taken into account by potential provider
becauseit will help then to form an opinion as to the of finance
gliv
,nuv b. facing. Analj'si' "rir,.
*oo"ug.**t running the company and the
u,.
i"lffi1|l*Tf*|,*: '"''r-v "r '...,,t !.rfo.*un.. "r Nps iiJ'gives the

t' 6-
!

Year ' 2009 2010 20t1 zAD

Operating profit Tk.4l.7m Tk.43.3m Tk.50.lm Tk.56'7m

Net profit margin 34% 34% 32% 30%

7 times 7 times 4 times 3 times
lnterest coverage ratio
Revenue growth 3.5% 23.0% 20.9%
Operating profrt growth 3.80/o 15,7% l3?%
Finance charges growth 3.3% 101.6% 30,4%
Profit after tax growth 4.A% 1.2% 0.8%

Geometric average growth in tumover = (159.31122'610j1 ' I= 15'60/'

Geometric average operating profit growth = (56.7141'Tt'33 'l = lO'8%

which grew by 23% in 201 I and by

One positive feature indicated by this analysis is the govvth in revenue,
2l%n2012.

Slightly less positive is the gro'*th in operating profit, which was I 6% in 201
I and 13% in 2012' Both years
in'revenue growth and opeiating profit growth, than 2010' One query here is why
were significantly better
control of operating and other costs
6"rating profit is so much-lower than gou'th in ieuenue.
Better
;;h;; the financial risk of NFS Ltd'
i-,ight irnprou" op"iuting profit substantially and decrease

The interest coverage ratio has declined

The growing financial risk ofthe company is a clear cause for concern.
*rt irithe period under review t u, reached a dangerous level in 2a0. Tlne increase in operating profit
l.u, "na which have kipled over the period under
y.a, has dearly been less than ttre increase in financi charges,
"".f, is not known, but the high level' of financial.risk must be
review. The reason for tfre iurgr increase in' debt
provide the Tk'200m in cash that is needed'
considered in selecting an apprJpriate source offinance to

Current finencial Position

The current financial position of NFS Ltd. will be considered by potential providers of !1q".
in their
the current financial position of NFS Ltd. shows the
assessment of the finaniial risk of the company. Analysis of
following:

Debt/equity ratio: long-term deb/total equity = 100 x (100/221) = 45%

Debt equity/ratio including short-term bono$'ings = 100 x ((100 + 160)1221) = ll8%

the interest coverage ratio
The debVequity ratio based on long-term debt is not particular-ly hiqhl However,
ttrat the short'term
iigi
i'Oi..t.a a teuet of financial rlrt *O it is clear from the financial position Btatement
short'term bonowings
iono*ing, oiff tOO1n are greeter than the long-tem bonowings of Tk.l00m. In fact,
sccount for 62% of ttre debt burden of NFS Ltd.
high enough
If we include the short-term borrowings, the debt/equity ratio inoeases to 1i 8%, which is certainly
also at higher interest rate (8%) *ran the long-term
to be a cause for concern, The short-term bonowings are a
borrou'ings sccount for 68% of the finance charges in the
borrowings (6%) andas a result, interest on short-term
income statement. It should also be noted that the long-term bonowings are bonds that are repayable -in 2014.

NFS Ltd. needs therefore to plan for theredemption and refinancing of Tk.l00m
of debt in fwo years time, a
factor that cannot be igrored when selecting a suitable source of finance to
provide the Tk.200m of cash needed.

' (-";
 Recommendation of suitable finaneing method

There are stong indications that it would be

unwise for NFS Ltd. to raise the Tk.200m
means of debt finance for example the low of cash required by
interest coverage ratio and the high level
of gearing.
If no further debt is raised, the interest coverage
ratio would i*prove after the acquisition due to
level of operating profit, i.e..(567m tzs;yli.8 the increased
= 4.5 fi;;.
A;:r*,.g ,r,., Tk.200 in of 8% debr is raised, the
t' rts+-ziii8.s + r6) = 2.4 rin,es uno i,. debt/equity *i;; ;;;id
iltffU?'iTEbf;;:it$#" increase to

If convertible debt were

used the.increase in gearing and the
decrease in interest coverage would continue
until conversion occurre4 assuming that theiompany's onry
share p.ice increased sufficiently for conversion
attactive to bondholders' once coniersion o..rrrrd, to be
thc debr .upr"iry urure company would increase
to the liquidation of the convertible debt and due both
tofte issuing of neri o.ainu.y sharesio bond holders.
In the paiod
risk orthe.orpriy u"n ."r*.Juvg."rins u,J;;;;;;Ji.ou.,rg.
Hli":,:T:f,n1ili]f;1'nnancial *oura

If NFs Ltd' were able to.,se equity finance, tfrl^i1]3res!

debvequitv ratio would falt to t ob x'Qaotdii goverage ratio wourd increase to 4.5 times and the
+ 200) = 6z%.ai,fi"ril ,h. debt/equity
side' this would fall if some of the shorrteil ratio is stiil on the high
bonowings *.." uur. toi" paid ofl although
the recent financial
[*trtrnil1:]1,;,1d;:ll#ilfJ,JilJJ;;;:;J;';:"J'iilJi-0,.,;f;;;il;-trrJcu,"nt rong.

However' since the t:itiy l-ras not paid. any dividend for at Ieast
four years, it is unlikely that current
shareholders" would be^reciptive to
".igrr[-'i"".,"*[*'t,r.y'T.'r"
forttrcoming in the near fut,re. Acquisition ror*ded that dividends wourd be
needed to support dividend payments. A
ii
the comperitor ,,uy L. the;onry way
of generating the cash flows
were to seek to raise equity finance via a placing -- - " *
similar negative view rorro ue taten by
new shareholders if NFS Ltd.
or a"puuric issu..

Sale and leaseback ofnon-current assets

could be considered, although the nature
assets is not known' The financial position ,tut.rr.nt and quality ofthe non-current
indicates *,ot rviis Ltd. has Tk. 300m
assets' Tk' 100m of long-term^borro*irgr of non-currant
and Tk.l60m orrtrori-L,n borrowings.
secured on som" of the existing non-.o.r"n, since its borrowings are
i*:yrj:-" assets, rhere appears to be limited
scope for sare and

venhue capital could also be considered,

but it^is unlikely that such finance would
ac,uisition and no business case has u".n prouia.a be available for an
for the proposed acquisition

while combinations of
!:T.:best.n"'i';
courd- arso o. o:10:,,:9r the. overail.impression
is that NFS Ltd. is in poor
,T,frXl*:'th
and, despite its iirJy;#;il;il"#il;30. in cash,r,r, i,ir.ar,, acquire its

b) when a new issue of bon-ds is made by a company, the

interest rate on the bonds will be influenced
are specific to the companv, and bv factors
that ietate to the economic enyironment
lljTi:i:..'t
Company-specific factors

issue of bonds will depend upon such

ffill?t"ilJ*;lffitT,firew factors as the risk associated with
the

The risk associated with the-company

n'ill be assessed by considering the ability
of the company to meet interest
and trenci itizuttue cash flows ura prontuuiri,r,lr
ffi#:lt#,:rlture' *.1
as its ablity to redeem the bond

where an issue of new bonds is backed by

security, the interest rate charged
on the issue will be lower than for
HJxiTfl,[[1,H1]*.b;Xliffi:l,b,n*.; ;;;;;;;;;;iil,u,,",,
s,ch as ,and or b:i,,iings,

Bo
Economic enrtronment faetors

rates suggests' that

As far as the duration of a new issue of bends is concemed, the term struchre of interest
short-term debt is usually cheaper than long'-term debt, so that the yield curve slopes upwargt *t! increasing
term to matgrity. The longer the duration oian issue of new bonds, thaefore, the higher will be the interest rate
by reference to liquidity preference theory,
charged. The shape of the yield curve, which can be explained
expeitations theory and market segmortation theory, will be independent of any specific company'
rates in the
The rate ofinterest chargcd on a new issue ofbonds will also dcpend on the general level.ofinterest
financial system. This is influenced by the general level of economic activity in a given, country such as
economic growth
*n"ifr" thl economy is in recession (when iiterest rates tend to fall) or experiancinq ra^pid
The general level of interest rates is also
(when intaest rates are rising as capiial availability is decreasing).
or the central bank. For example' interest
influenced by monetary poliJy aecislons taken by ihe govemment
rates may b, inorur.i'- in order to exert downward on demand and hence decrease inflationary
lr.rrut.
pressures in an economy.

strong form
c) The three forms of capital market efficiency are weak from, semi-strong form and
the different kinds of
effieiency. The three forms of efficiency ."n b" distinguished by considering
information that are reflected insccurity prices.

Weak form elliclency

to reflected
This refers to a situation here securities tading on a capital market (e,g. shares and bonds) are shown
it predict security prices by
;;[r-t past information. If a capital market iI weak form eflicieat, is not possible to
share price movements in the past. There is no conelation between share price movements in successive
studying
periods and in fact, share prices appear to be follo*'ing a random walk'

Semi-strong form efliciencY

past ancl public

This refers to a situation where securities trading on a capital muket are shown to reflect all
information. If a capital market is semi-strong form eflicient, it is not possible' to make above average
(abnormal) returns Uy stuAying information in the public domain (this.inctudes past information), because the
pri"e, of sr.*ities move qri"tly and accurately to reflect new information as it becomes available.
Strong form elliciency
If a capital market is described as strong form efficient, the prices of securities Eading on the market reflect all
information, whether past public or privite. It is not possible for this form of capital market efficiency to exist in
the real *oild, rin., it is-always possible for an individual with access to relevant information which is not
public to benefit from it by buying and selling securities.

Answer:4(a)
prices at a faitr
Swaps are essentially zergsum transactions, which are to say that in both cases the market sets
levei and neither pariy has any substantial bargain or loss at thc momcnt the deal is shuck. Cunotcy swaps are
s*aps of obligations to pay cash flows in one cwrcncy for obligations to pay in another curency'
For example, in the currency swap, the s*ap rate is some average of the market expectation of what the
exchange iate will be over ttre tite of the r*ap. In the interest rate swap, the rates are set as the fair floating
and
fixed raltes for the creditor, taking into account the creditworthiness of the counterparties. We can actually price
swaps fairly once we know how to price forward contracts. Assume that, the firm swapped LIBOR
plus 50 basis
points for a 9 per cent fixed ratc, all on a principal an1ou,1t of USD 100 million. This is equivalort to a series of
iorward confiacts extending out the life of the swap, 'ln year l, for example having made the swap, the firm is in
the same position that it would be if it had sold a forward contract entitling the buyer to receive LIBOR plus 5Q
basis points on USD 100 million in return for a fixed paymcnt of USD 9 million (9 per ccnt on USD 100
miltion). Similarly, the currency swap can also be viewed as a series of forward conhacts.

B)
 Answer:4(b)

To calculate ttre price of the share we shafl

use the constant growth modcr:

p_ EPsx(l-b)x(r+e)
Ke -g
Where: Ke is the cost ofequity, calculated
based on CAPM
B = retcntion ratio therefore 1-6 = 61y16sn6 pa;ut
ratio
Before the financial reconsfuction we have:

EPS = Tt<. 2,00, ! = 0.5, g = 0.08085

Beta (Be) = 0.978

Ke = 5% + 0.978 X6yo= 10,g68%

As the price of the share is:

n 2X0,5X0+0,08085
'= ----JE;-
0.10868 _ 0.08 = Tk' 38'838

After linancial reconstruction we have:

EPS = Tk, 2, ts 0.5, g = 0.0874; pe I.094
=
Ke= SYo+ 1.094 x6yo= ll.564%
h 2X0.5X(1+0.0874)
r = _____= = Tk.
"r! iE.g3u
Jv!uJu
0.11564 _ 0,0874
As a result ofthe financiar reconstructing the
share price decreased by r percent.

Answer :4(c)
a) (i) using the model, th^e prige-9f NN Ltd. win be rhe presenr
1l:ld:lq.s".*11
expected tuture dividlnd', i,;. 1!1e. varue of its
G-oi ibpxd;;i;orj ='ilir",* per share oi rk.z.ss per share
Number of ordinary shares = 5010.5
= l00m shares
Value of NN Co = l00rn x 7.55 = Tk. 755m
ii) Net rsset vatue of NN Ltd. = ,oia assets less totar riabliries = r43 - 29 - 20 -
calculating net asset value, prefeienr;;;. 25 =Tk.69m in
capital is inctuJea with long-term
considered to be prior charge capital. liabilities, as it is
The after-tax
cost of debt of NMLtrr. can bc foun<r
?
The annual after-tax interest payment
by rincar inrcrprration
= 7 x (t 0.25) = I i O.ls:;.;.;;
_
;;;;..,
Year Cash flow (Tk.) Sy, Discount factor Present value (Tk.)
0
(103.s0) 1.000 (r 03.s0)
t-6
5.25 s.076 26.65
6
100 0.746 74.60
Year
Cash flow (Tk,) 4% Discount factor
Present value (Tk.)
0
(103.50)
1.000 (103.50)
l-6
5,25 5.242
6 27.52
100 0.790 79.00

Bt
After-tax cost of dcbt = 4 + [(l x 3,02)/(3.02 +2.25)]= 4 i' 0.57 = 4.60/o

c) Annual preference dividend = 8o/ox 50 paisa = 4 paisa per sharc

Cost of preference shares = 100 x (4167) = 6%

Number of ordinary shares = 50/0'5 = l00m sharcs
Market value of equitY = Ve = l00m shares x 8'30 = Tk'830m
Number of preference shares = 2510'5 = 50m shares
' Market value of preference shares - Vp = 0'67 x 5Orn = Tk'3'35m

Marketvalueoflong-termborrowings=Vd=20x103.501i00=Tk.20.7m
(830 + 33'5 + 2A'71= Tk'884'
Total market value of company = (Ve + Vd Vp) =
+

WACC = (KeVc + KpVp + Kd(t 'T)Vd)/(Vc + Vp + Vd)

= (12 x 830+ 6 x 33.5 + 4.6x20.7)1884'2= 1l'6%

pollcy of a stack exchrnge

d) A number of factors should bc considered in formulating thc dividend
listed somPanY, as follows.

Profitabiliry
of after-tax profit. A Company cannot
Companies need to remain profitable and dividends are a disfribution
consistently pay dividends higher than its profit after tax' A healthy
level of retained earnings is needed to
finance the continuing business needs of the company'

Liquidity
company to its shareholdels' A
Altiiougb a dividend is a disribution of profit it is a cash palment by.the
;-.rp;t**t thaefore ensure it has sufliiient cash to puy u ptopot.d dividend and *rat palng I dividend will
not iompromise day-to'day cash financing needs'

Legal and othcr restrictions

A dividend and only be paid out in accordance with statutory requirements, such as the requirement in the
Bangladesh for dividends'to be paid out of accumulated net realised
profits. There may also be restrictions on
diviiend payments imposed by, for examplc, restrictivc covenants in bond issue documcnts.

The need for finance

There is a close rclationship bctween invcsknent, financing and rlividcnd dccisions and the dividcnd decision must
-onlpuny.
consider the investrnent plans and frnancing needs of the A large investment programme' for examplq
will require a large amorurt of finance, and the need lbr extemal finance can be rcduced if dividcnd increases are
kept in check Slmiiariy, the decision to increase dividcnds may reduce retained eamings to the extent where
exiernal finance is 'needed in order to meet investment nceds.
The level of linancial risk
If financiat risk is high, for cxarnple cJuc to a high lcvcl of gcaring arising fi'om a substartial lcvcl
of debt
fin*.., maintainilg a-low level of dividend poyrn.nts can result in a high levcl of retained earnings, which will
r.au". g.uring by i-ncreasing the levcl of rsscrves. The cash flow from a highcr lcvel of retained eamilrgs can

also be used to decrease the amount of debt being canicd by a company'

The signalling effect of dividend

available
In a semi-strong form efficient market, inlormation availablc to directors is more substantial than that
to shareholders, so that information asynmetry exists. This is one of the causes of the agency problem' If
dividend dccisions convey ncw information to the markct, they can havc a signalling effcct concerning the
current position of the company and its future prospecls. Tlic signalling cffcct also depends on thc dividcnd
expectations in thc markct. A'.orpony shoulJ thcrcforc considcr thc likcly effcct on sharc prices of
the
announcement of a proposed dividcnd.

Bt