FINANCIAL MANAGEMENT

ASSIGNMENT

SUBMITTED TO
Prof. Javed Akhter
Prof.Mohd. Khalid Azam

Submitted by
Mohd Saad
20MBAA29
GK4839
QUESTION 1

XYZ ltd. is in the business of supplying equipment on lease. The cost of equipment is Rs.
1600000. It is expected to have a useful life of 5 years with a salvage value of Rs. 200000 after
the expiry of 5 years. Tax rate is 35% and the cost of capital is 20%. The equipment is in
depreciation block of 20%. What will be the breakeven lease rentals? If the supplier wants to
earn Rs. 200000 as profit what will be the lease rentals then?
Cost Of Equipment: 160000

Useful life: 5 years

Salvage value: 5 years

Depreciation: 20%

Tax rate: 35%

Cost of capital: 20%

(i) Calculate break even lease rental

Year Depreciation WDV

1 3,20,000 12,80,000

2 2,56,000 10,24,000

3 2,04,800 8,19,200

4 1,63,840 6,55,360

5 1,31,072 5,24,288

PV of Tax Benefit on Depreciation

Tax Benefit (0.35) PV Factor =

Depreciation Amount *Tax Rate*1 rupee value
@20%
320,000*0.35*0.833 93,296
256,000*0.35*0.694 62,182.40
204,000*0.35*0.579 41,340.60
163,840*0.35*0.482 27639.80
131,072*0.35*0.402 18441.83
Total ₹242,900.63
hiii
• PV of tax saving on Short-Term Capital loss at the end of 5th year = (524,288-200,000) *0.35*0.402

= ₹45,627.32

• PV of Salvage Value to be received at the end of 5th year=200,000*0.402

= ₹80,402
• Required Total PV after Tax Lease Rental= Cost of Equipment – PV of Salvage Value – PV of tax shield
on Depreciation –PV of tax saving on short term capital

= 1,600,000-80,402-242,900.63-45,627.32

= ₹1,231,070.05

• Divided by present value interest factor of annuity (PVIFA) for 5th year @20%

=1,231,070.05/2.990

• After Tax Lease Rental = ₹411,729.114

• Break Even Lease Rental = 411,729.114 / (1-0.35) = ₹633,429.40

(ii) Lease Rental to Earn a Profit of 200,000

• Required Total PV after Tax Lease Rental=1,231,070.05+200,000 = ₹1,431,070.05
• Divided by present value interest factor of annuity (PVIFA) for 5th year @20%
=1,431,070.05 / 2.990

• After Tax Lease Rental

=₹478,618.74
• Lease Rental to be charged for earning Profit of 200,000
=478,618.74 / (1-0.35)
=₹736,336.52

QUESTION 2

A limited company borrows from a commercial bank Rs 1000000 at 12% rate of interest
to be paid in equal annual end-of-year instalments. What would be the size of the
instalments? Assume the repayment period is 5 years.

SOLUTION
Principal Amount = ₹1,000,000

Annuity Factor = (1-(1+r)-n) / r

Where, r = interest rate annually = 0.12(12%)
N = number of years = 5 years
AF = (1-(1+0.12)-5) / 0.12
AF = 3.6048
Installment = Principal Amount / Annuity Factor

= 1000000/3.6048
= ₹277,408

QUESTION 3
X company earns Rs 5 per share, is capitalized at a rate of 10% and has a rate of return on
investment of 18%. According to Walter’s model, what should be the price per share at 25%
dividend payout ratio? Is this the optimum payout ratio according to Walter?
SOLUTION

Formula: Price Per Share

P = (D/Ke) + [(E-D)*(r/Ke) ]/Ke
Where,
P = Price Per Share =?
D = Dividend Per Share =10% of Dividend Pay Out Ratio (Where DP Ratio = 40%, So D = 2.5)

r = Internal Rate of Return =18%

E = Earning Per Share =₹5

Ke =Required rate of return =10%

P = (2.5/0.10) + [(5-2.5)*(0.18/0.1) ]/0.1

P = 25+(4.5/0.1)

P = 25+45 = 70
P = 70

Here, (r>Ke) (18%>10%)

According to Walter Model when the return on investment is more than the required rate of return, price
per share increases as the dividend pay-out ratio decreases.
Question 4

Write a short note on the irrelevance theory of dividend.

• The dividend irrelevance theory suggests that a company’s dividend payments

don't add value to a company’s stock price.
• The dividend irrelevance theory also argues that dividends hurt a company since
the money would be better reinvested in the company.
• The
theory has merits when companies take on debt to honor their dividend
payments instead of paying down debt to improve their balance sheet. • The
dividend irrelevance theory suggests that a company’s declaration and payment of
dividends should have little to no impact on the stock price. If this theory holds true, it
would mean that dividends do not add value to a company’s stock price.
• The premise of the theory is that a company's ability to earn a profit and grow its business
determines a company's market value and drives the stock price; not dividend payments.
Those who believe in the dividend irrelevance theory argue that dividends don't offer any
added benefit to investors and, in some cases, argue that dividend payments can hurt the
company's financial health.