Mid Term-FM-II-Suggested Solutions to Questions

Q.1 (10 marks)

A. Suppose you deposited Rs. 2,00,000 in a, investment scheme that earns an annual
compound interest of 12%, what would be the value of money in the savings account after 3,
5 and 10 years? What will be the effective rate for each of the years. (4 Marks)

Solution
Initial Deposit Amount 200000

Values based on Year

Rate of Interest 12% Value as end of Year Effective Rate
3 (1.12) ^ 3 1.40 2,80,986 13.50%
5 (1.12) ^ 5 1.76 3,52,468 15.25%
10 (1.12) ^ 10 3.11 6,21,170 21.06%

Therefore the Values as the end of 3, 5 and 10 will be

Check
Investment Amount Maturity TotalEarning Average Perannum Average/Investment as %
3 200000 2,80,986 80,986 26,995.20 13.50%
5 200000 3,52,468 1,52,468 30,493.67 15.25%
10 200000 6,21,170 4,21,170 42,116.96 21.06%

B. Explain the concept of cost of capital. How the cost of capital of any business is
determined and what factors impact the cost of capital (3 Marks)

Solution

Concept

Cost of capital is the minimum rate of return or profit a company must earn before generating
value. It's calculated by a business's accounting department to determine financial risk and
whether an investment is justified

How calculated

It is weighted average cost from all sources duly adjusted for any tax benefit or tax charge.
Capture any example here.

Factors impacting WACC

 Economic Situation
 Tax rates
 Capital Structure and weights of debt, equity
 Expected return levels
 Market return levels
 Risk levels
Mid Term-FM-II-Suggested Solutions to Questions

C. As a Head of Research and Development in a pharmaceutical company, what are the

various types of Financial decisions that you are expected to make? What kind of information
you need to effectively decide in the best financial interest of the company. Explain with
suitable illustrations from the Industry. (3 Marks)

Solution

 Budgeting for the R & D Department

 Performance parameters and linkage to Financial Incentives-technical input
 Cost at every stage of research
 Procurement decisions
 Outsourcing of any R&D Activity
 Time of R&D and the estimate of the resources required
 Technical inputs related to R&D cost for the company
 Benchmarking and changes to R&D performance based on peer comparison

Q.2 (10 marks)

A. Arya, Avanti and Alia have just received a gift letter from their uncle who stays in
Cayman Islands. The Uncle wants to share some part of family inheritance and the total
monetary value of Rs. 90 lacs will be given to all 3 sisters in the manner as tabulated under.
(4 Marks)

Year 3 (2025) 4 (2026) 5 (2027) 6 (2028)

Payment by Uncle Rs. 30 lacs Rs. 20 lacs Rs. 10 Lacs Rs. 30 Lacs

Since the 3 sisters are keen to start a business, they need funds today. They are insisting the
Uncle to pay the entire sum payable over indicated 4 years today itself. So, at discount rate of
14%, how much the Uncle should pay today. If you were to decide the payment manner, does
it make send to receive payment today or should it be received as per above table? Why?

Solution
Mid Term-FM-II-Suggested Solutions to Questions

Year 3
Year 1 Year 2 4 (2026) 5 (2027) 6 (2028)
(2025)
Payment
0 0 30 20 10 30
by Uncle

Discount rate 14%

Discount Factor 0.877 0.769 0.675 0.592 0.519 0.456

Present value - - 20.249 11.842 5.194 13.668

Total Present value 50.95

Recommendation

Unless there is a risk of non-payment involved, the payment can be deferred

based on following factors

1 Alternative investment opportunities

2 How the funds will be used by sisters
3 Any business investment that is likely to generate better returns
Mid Term-FM-II-Suggested Solutions to Questions

B. Based on the cash flow provided as under, calculate NPV, Normal Pay Back Period and
Discounted Payback period (6 Marks)
Initial investment of Rs. 850000 today and cash inflows of Rs. 390000 every year for next 3
years. Assume the discount rate of 12%.

Solution

Discount Rate 12%

Rs DF Discounted Value
0 -850000
1 390000 0.893 3,48,214
2 390000 0.797 3,10,906
3 390000 0.712 2,77,594

Total Present value 9,36,714

Less: Investment -8,50,000
NPV 86,714

NPBP 2 years 2 Months

Balance 70000
Permonth 32500

DPBP 2 years 8 Months

Balance 190880
Permonth 23,132.86

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