SUGGESTED SOLUTIONS/ ANSWERS – SPRING 2018 EXAMINATIONS 1 of 10

STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL

Marks
Question No. 1
(a) Fine Limited
Statement of Changes in Working Capital
for the year ended June 30, 2018
Rupees
2018 2017 Increase Decrease
Current Assets:
Cash 810,700 1,008,180 – 197,480 0.5
Trade receivables 1,463,000 1,543,600 – 80,600 0.5
Short-term investments 1,680,000 2,210,000 – 530,000 0.5
Prepaid expenses 23,100 24,200 – 1,100 0.5
Inventories 2,110,760 1,843,080 267,680 – 0.5
6,087,560 6,629,060 – – 0.5
Current Liabilities:
Trade payables 1,913,120 2,061,740 148,620 – 0.5
Accrued expenses 433,260 202,000 – 231,260 0.5
2,346,380 2,263,740 – – 0.5
Working capital 3,741,180 4,365,320 – – 0.5
Decrease in working capital 624,140 – 624,140 – 0.5
4,365,320 4,365,320 1,040,440 1,040,440 0.5

(b) Fine Limited

Statement of Sources and Uses of Fund
for the year ended June 30, 2018
Rupees
Sources:
Funds from operations [W-4] 1,338,600 0.25
Sale of machinery [W-2] 30,000 0.25
Decrease in working capital [from part (a) above] 624,140 0.25
1,992,740 0.25
Uses:
Redemption of debentures 275,100 0.25
Purchase of machinery [W-2] 627,300 0.25
Cost of building construction [W-2] 662,340 0.25
Payment of dividend [W-4] 200,000 0.25
Payment of tax [W-1] 228,000 0.25
1,992,740 0.25

Working Notes:
W-1: Reserve for Contingencies Account Rupees
To Cash A/c 228,000 By balance b/d 2,134,620 0.5
To balance c/d 2,683,560 By Profit and Loss A/c (bal.figure) 776,940 0.5
2,911,560 2,911,560 0.25

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 tre ated 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 – SPRING 2018 EXAMINATIONS 2 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
W-2: Property, Plant and Equipment (PPE) Account Rupees
To Balance b/d 2,955,560 By Cash A/c 30,000 0.5
To cash A/c (purchase of machinery) 627,300 By Accumulated depreciation A/c 582,100 0.5
To cash A/c (construction of building) 662,340 By Profit and loss A/c (loss) 40,400 0.5
By Balance c/d 3,592,700 0.25
4,245,200 4,245,200 0.25

W-3: Accumulated Depreciation Account Rupees

To buildings and machinery A/c 582,100 By Balance b/d 1,932,360 0.5
To balance c/d 1,632,660 By Profit and Loss A/c 282,400 0.5
2,214,760 2,214,760 0.25

W-4: Calculation of Funds from Operations: Rupees

Increase in Profit and Loss A/c (Rs. 205,000 – Rs. 200,000) 5,000 0.25
Add: Debenture discount written off 28,760 0.25
Premium on retirement of debentures written off (Rs.170,000 ÷ 100 x 3) 5,100 0.25
Depreciation 282,400 0.25
Loss on sale of machinery (Rs. 652,500 – Rs. 582,100 – Rs. 30,000) 40,400 0.25
Dividend 200,000 0.25
Transfer to reserve for contingencies 776,940 0.25
Funds from operation 1,338,600 0.25

Increase in profit and loss account can also be calculated as follows:

Net profit Rs.981,940 – Transfer to reserve for contingencies Rs. 776,940 – Dividend Rs. 200,000 =
Rs. 5,000.

Question No. 2
Revised Profitability Statement (after introducing 2% discount credit policy) Rs. ‘000’
Sales (150,000 x 1.30) 195,000 0.5
Less: Variable cost (112,500 x 1.30) 146,250 0.5
Fixed cost 18,750 165,000 01
30,000 0.5
Less: Discount on sales (195,000 x 0.6 x 0.02) 2,340 0.5
27,660 0.5
Less: Bad debts (195,000 x 0.04) 7,800 0.5
Profit 19,860 0.5

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 tre ated 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 – SPRING 2018 EXAMINATIONS 3 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
Statement showing Revised Investment Rs. ‘000’
Investment in non-current assets 187,500 0.5
Investment in working capital:
Trade receivables [W-1] 9,750 0.5
Inventories (10,000 x 1.30) 13,000 0.5
Cash (3,000 x 1.30) 3,900 0.5
26,650 0.5
Less: Trade payables (7,500 x 1.30) (9,750) 16,900 01
Total Investment 204,400 0.5

Profit 19,860
ROI (Revised) = x 100 = x 100 = 9.72% 01
Total investment 204,400

Profit 18,750
ROI (Existing) = x 100 = x 100 = 8.60% 01
Total investment 218,000

Working Notes: Rs. ‘000’

W-1: Trade receivables:
(a) 60% of customers avail 2% cash discount and takes 10 days to pay
(195,000 x 0.60 x 10/360) 3,250 1.5
(b) 40% of customers takes 1 month to pay (195,000 x 0.40 x 1/12) 6,500 1.5
Total trade receivables balance 9,750 0.5

Analysis:
The revised credit policy will improve the return on investment from 8.6% to 9.72%. Hence the
revised credit policy is suggested for implementation. 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 tre ated 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 – SPRING 2018 EXAMINATIONS 4 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
Question No. 3
(a) To find the monthly interest rate, annual percentage rate (APR) will be divided by 12. The Fisher
equation uses the effective annual rate, so, the real effective annual interest rates, and the
monthly interest rates for each account are:
Stock Account:
(1 + R) = (1 + r)(1 + h)
1 + 0.11 = (1 + r)(1 + 0.04) 0.5
r = 0.0673 or 6.73% 0.5
APR = m[(1 + EAR)1/m – 1]
= 12[(1 + 0.0673)1/12 – 1] 0.5
= 0.0653 or 6.53% 0.5
Monthly rate = APR ÷ 12
= 0.0653 ÷ 12 0.5
= 0.0054 or 0.54% 0.5
Bond Account:
(1 + R) = (1 + r)(1 + h)
1 + 0.07 = (1 + r)(1 + 0.04) 0.5
r = 0.0288 or 2.88% 0.5
APR = m[(1 + EAR) 1/m
– 1]
= 12[(1 + 0.0288)1/12 – 1] 0.5
= 0.0285 or 2.85% 0.5
Monthly rate = APR ÷ 12
= 0.0285 ÷ 12 0.5
= 0.0024 or 0.24% 0.5
The future value of each account will be:
Stock Account:
FVA = C {(1 + r )t – 1] / r}
= Rs.7,000{[(1 + .0054)360 – 1] / .0054]} 0.5
= Rs.7,791,031 0.5
Bond Account:
FVA = C {(1 + r )t – 1] / r}
= Rs.3,000{[(1 + .0024)360 – 1] / .0024]} 0.5
= Rs.1,703,168 0.5
The total future value of the retirement account will be the sum of the two accounts, or:
Account value = Rs.7,791,031 + Rs.1,703,168 0.5
Account value = Rs.9,494,199 0.5

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 tre ated 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 – SPRING 2018 EXAMINATIONS 5 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
To find the monthly interest rate in retirement, same procedure that is used to find the monthly
interest rates for the stock and bond accounts, will be used:
(1 + R) = (1 + r)(1 + h)
1 + 0.09 = (1 + r)(1 + 0.04) 0.5
r = 0.0481 or 4.81% 0.5
APR = m [(1 + EAR)1/m – 1]
= 12[(1 + 0.0481)1/12 – 1] 0.5
= 0.0470 or 4.70% 0.5
Monthly rate = APR ÷ 12
= 0.0470 ÷ 12 0.5
= 0.0039 or 0.39% 0.5
Now to find the real monthly withdrawal in retirement, the present value of an annuity equation
and solving for the payment:
PVA = C({1 – [1/(1 + r)]t } / r )
Rs.9,494,199 = C({1 – [1/(1 + .0039)]300 } / .0039) 0.5
C = Rs.53,882 0.5

(b) The nominal monthly withdrawals will increase by the inflation rate each month. To find the
nominal amount of the last withdrawal, the real withdrawal can be increase by the inflation rate.
The real withdrawal can also be increase by the effective annual inflation rate since we are only
interested in the nominal amount of the last withdrawal. So, the last withdrawal in nominal terms
will be: 0.5
FV = PV(1 + r)t
FV = Rs.53,882(1 + .04)(30 + 25) 0.75
FV = Rs.465,884 0.75

Question No. 4
(a) The income statement for each capitalization plan is:
Rupees
Plan ‘A’ Plan ‘B’ All-equity
Earnings before interests and taxes (EBIT) 1,200,000 1,200,000 1,200,000
Interest 200,000 300,000 – 0.75
Net income (NI) 1,000,000 900,000 1,200,000
Shares outstanding 150,000 110,000 230,000
Earnings per share (EPS) 6.67 8.18 5.22 0.75
Plan ‘B’ has the highest EPS. 0.5

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 tre ated 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 – SPRING 2018 EXAMINATIONS 6 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
(b) Break-even levels of EBIT:
EPS = (EBIT – RDD)/Shares outstanding
EBIT/230,000 = [EBIT – 0.10(Rs.2,000,000)]/150,000 0.5
23EBIT – 15EBIT = Rs.4,600,000 0.5
EBIT = Rs.575,000 0.25
And the break-even EBIT between the all-equity capital structure and Plan ‘B’ is:
EPS = (EBIT – RDD)/Shares outstanding
EBIT/230,000 = [EBIT – 0.10(Rs.3,000,000)]/110,000 0.5
23EBIT – 11EBIT = Rs.6,900,000 0.5
EBIT = Rs.575,000 0.25
The break-even levels of EBIT are the same because of M&M Proposition I. 0.5

(c) Setting the equations for EPS from Plan ‘A’ and Plan ‘B’ equal to each other and solving for EBIT,
we get:
[EBIT– 0.10(Rs.2,000,000)]/150,000 = [EBIT – 0.10(Rs.3,000,000)]/110,000 0.5
11EBIT – Rs.2,200,000 = 15EBIT – Rs.4,500,000 0.5
4EBIT = Rs.2,300,000 0.5
EBIT = Rs.575,000 0.5
This break-even level of EBIT is the same as in part (b) again because of M&M Proposition I.

(d) The income statement for each capitalization plan with corporate income taxes is:
Rupees
Plan ‘A’ Plan ‘B’ All-equity
Earnings before interests and taxes (EBIT) 1,200,000 1,200,000 1,200,000
Interest 200,000 300,000 –
Earnings before taxes (EBT) 1,000,000 900,000 1,200,000 0.75
Taxes 300,000 270,000 360,000 0.75
Net income (NI) 700,000 630,000 840,000 0.75
Shares outstanding 150,000 110,000 230,000
Earnings per share (EPS) 4.67 5.73 3.65 0.75

Plan ‘B’ still has the highest EPS.

We can calculate the EPS as:
EPS = [(EBIT – RDD)(1 – tC)]/Shares outstanding
This is similar to the equation we used before, except now we need to account for taxes. Again,
the interest expense term is zero in the all-equity capital structure. So, the breakeven EBIT
between the all-equity plan and Plan ‘A’ is:
EBIT(1 – t)/Rs.230,000 = [EBIT– 0.10(Rs.2,000,000)](1 – t)/ Rs.150,000
EBIT(1 – 0.30)/ Rs.230,000 = [EBIT – 0.10(Rs.2,000,000)](1 – 0.30)/ Rs.150,000 0.5
0.7EBIT/ Rs.230,000 = 0.7EBIT – Rs.140,000/ Rs.150,000 0.5
10.5EBIT = 16.1EBIT – Rs.3,220,000 0.25
EBIT = Rs.575,000 0.25
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 tre ated 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 – SPRING 2018 EXAMINATIONS 7 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
The break-even EBIT between the all-equity plan and Plan ‘B’ is:
EBIT(1 – 0.30)/ Rs.230,000 = [EBIT – 0.10(Rs.3,000,000)](1 – 0.30)/ Rs.110,000 0.5
0.7EBIT/ Rs.230,000 = 0.7EBIT – Rs.210,000/ Rs.110,000 0.5
7.7EBIT = 16.1EBIT – Rs.4,830,000 0.25
EBIT = Rs.575,000 0.25
And the breakeven between Plan ‘A’ and Plan ‘B’ is:
[EBIT–0.10(Rs.2,000,000)](1–0.30)/Rs.150,000=[EBIT–0.10(Rs.3,000,000)](1–0.30)/ Rs.110,000 0.5
0.7EBIT – Rs.140,000/ Rs.150,000 = 0.7EBIT – Rs.210,000/ Rs.110,000 0.5
7.7EBIT – Rs.1,540,000 = 10.5EBIT – Rs.3150,000 0.5
EBIT = Rs.575,000 0.25
The break-even levels of EBIT do not change because the addition of taxes reduces the income
of all three plans by the same percentage; therefore, they do not change relative to one another. 0.25

Question No. 5
(a) The after-tax cost of debt is:
P0 = Rs.1,080 = Rs.45(PVIFAR%,46) + Rs.1,000(PVIFR%,46)
Try rd = 4%.
B0 = Rs.45× [PVIFA4%,46)] + Rs.1,000 × (PVIF4%,46)
= (Rs.45 x 20.885) + (Rs.1,000 x 0.165) 0.25
= Rs.939.8 + Rs.164.6 0.25
= Rs.1,104.4 0.25
Try rd = 5%.
B0 = Rs.45 x [PVIFA5%,46] + Rs.1,000 x (PVIF5%,46)
= (Rs.45 x 17.880) + (Rs.1,000 x 0.106) 0.25
= Rs.804.6 + Rs.106 0.25
= Rs.910.6 0.25
YTM = 0.04 + (0.05 – 0.04){(1,104.4 – 1,080) ÷ (1,104.4 – 910.6)} 0.5
= 0.04 + (0.01 x 0.126) 0.25
= 4.13% 0.25
= 2 x 4.11% = 8.25% 0.25
The after-tax cost of debt is:
RD = 0.0825(1 – 0.3) = 0.0578 or 5.78% 0.25

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 tre ated 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 – SPRING 2018 EXAMINATIONS 8 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
(b) (i) The book value of debt is the total par value of all outstanding debt, so:
BVD = Rs.70,000,000 + Rs.50,000,000 = Rs.120,000,000 0.5
To find the market value of debt, we find the price of the bonds and multiply by the number of
bonds. Alternatively, we can multiply the price quote of the bond times the par value of the
bonds. Doing so, we find:
MVD = 1.08(Rs.70,000,000) + 0.60(Rs.50,000,000) 0.5
MVD = Rs.75,600,000 + Rs.30,000,000 0.5
MVD = Rs.105,600,000 0.5
The YTM of the zero coupon bonds is:
PZ = Rs.600 = Rs.1,000(PVIFR%,7)
Try rd = 7%.
B0 = Rs.1,000 x (PVIF7%,7)
= Rs.623 0.5
Try rd = 8%.
B0 = Rs.1,000 x (PVIF8%,7)
= Rs.583.5 0.5
YTM = 0.07 + (0.08 – 0.07){(623 – 600) ÷ (623 – 583.5)} 0.5
= 0.04 + (0.01 x 0.579) 0.25
= 7.58% 0.25
So, the after tax cost of the zero coupon bonds is:
RZ = 0.0758(1 – 0.3) = 0.0531 or 5.31% 01

(ii) The after-tax cost of debt for the company is the weighted average of the after-tax cost of
debt for all outstanding bond issues. We need to use the market value weights of the bonds.
The total after tax cost of debt for the company is:
RD = 0.0578(Rs.75.6/Rs.105.6) + 0.0531(Rs.30/Rs.105.6) = 0.0564 or 5.64% 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 tre ated 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 – SPRING 2018 EXAMINATIONS 9 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
Question No. 6
(a) (i) We can find the new borrowings for the company by multiplying the equity investment by the
debt-equity ratio, so we get:
New debt = 1.5(Rs.75,000,000) = Rs.112,500,000 0.5
Adding the new retained earnings, we get:
Maximum investment with no outside equity financing = Rs.75,000,000 + Rs.112,500,000 01
= Rs.187,500,000 0.5

(ii) A debt-equity ratio of 1.5 implies capital structure is 1.5/2.5 debt and 1/2.5 equity. The
equity portion of the planned new investment will be: 0.5
Equity portion of investment funds = 1/2.5(Rs.72,000,000) = Rs.28,800,000 01
This is the addition to retained earnings, so the total available for dividend payments is:
Residual = Rs.75,000,000 – Rs.28,800,000 = Rs.46,200,000 0.5
This makes the dividend per share:
Dividend per share = Rs.46,200,000/12,000,000 shares = Rs.3.85 01
(iii) The borrowing will be:
Borrowing = Rs.72,000,000 – Rs.28,800,000 = Rs.43,200,000 01
Alternatively, we could calculate the new borrowing as the weight of debt in the capital
structure times the planned capital outlays, so:
Borrowing = 1.5/2.5(Rs.72,000,000) = Rs.43,200,000
The addition to retained earnings is Rs.28,800,000, which we calculated in part (ii) above. 01

(iv) If the company plans no capital outlays, no new borrowing will take place. The dividend per
share will be: 01
Dividend per share = Rs.75,000,000/12,000,000 shares = Rs.6.25 01

(b) The market value of the equity is Rs.2,500,000. The price per share is Rs.25, so there are
100,000 shares outstanding. The cash dividend would amount to Rs.500,000/100,000 = Rs.5 per
share. When the stock goes ex-dividend, the price will drop by Rs.5 per share to Rs.20. Put
another way, the total assets decrease by Rs.500,000, so the equity value goes down by this
amount to Rs.2,000,000. With 100,000 shares, the new stock price is Rs.20 per share. After the
dividend, EPS will be the same at Rs.2.50; but the P/E ratio will be Rs.20/2.50 = 8 times. 03
With a repurchase, Rs.500,000/25 = 20,000 shares will be bought up, leaving 80,000. The equity
will again be worth Rs.2,000,000 total. With 80,000 shares, this is Rs.2,000,000/80,000 =
Rs.25 per share, so the price does not change. Total earnings for Sehr Limited must be Rs.2.50 x
100,000 = Rs.250,000. After the repurchase, EPS will be higher at Rs.250,000/80,000 =
Rs.3.125. The P/E ratio, however, will be Rs.25/3.125 = 8 times. 03

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 tre ated 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 – SPRING 2018 EXAMINATIONS 10 of 10
STRATEGIC FINANCIAL MANAGEMENT [C3] – CHARTERED LEVEL
Marks
Question No. 7
(a) 3-month forward rate of US $ is higher (at Rs.121) than the spot rate Rs.120).
This implies that the US $ is at premium.
 Rs. 121  Rs. 120  12
Premium (percentage)  x x 100 = 3.33%
=
 Rs.120  3 1.5
Interest rate differential = 10% – 5% = 5% 0.5
Since interest rate differential (5%) and premium percentage (3.33%) do not match, there are
arbitrage gain possibilities. An arbitrageur can take the following steps in this regard.
 The arbitrageur borrows US $ 150,000 at 5% for 3 months (he borrows in US $ currency, as
it carries lower interest rate). 0.5
 He then converts US $ 150,000 at the spot rate of Rs.120 in the spot market. He gets an
amount of Rs.18,000,000 (US $ 150,000 x Rs.120). 0.5
 He invests Rs.18,000,000 in the money market at 10% interest per annum for 3 months. As a
result of this investment, he obtains interest of Rs.450,000 (Rs.18,000,000 x 3/12 x 10/100). 01
 Total sum available with the arbitrageur, three months from now is Rs.18,450,000 i.e.
Rs.18,000,000 amount invested + Rs.450,000 interest. 01
 Since he would get Rs.18,450,000 after 3 months, he will sell Rs.18,450,000 forward at the
rate of Rs.121. 0.5
 As a result of the forward deal, at the end of 3 months from now, he would get US $
152,479.33, i.e., Rs.18,450,000 ÷ Rs.121. 0.5
 He refunds US $ 150,000 sum borrowed along with interest due on it. The refunded sum is
US $ 150,000 + US $ 1,875 interest i.e., (US $ 150,000 x 3/12 x 5/100) = US $ 151,875. 1.5
 Net gain is US $152,479.33 – US $ 151,875 = US $ 604.33. 01
These arbitrage gain possibilities will cease to exist if the difference in forward rate and spot rate
(in percentage terms) coincides with the interest rate differential (in percentage) of the two
currencies. This principles is useful in determining/predicting forward rates. 0.5

(b) The treasury function needs following information from within and outside the organization to
carry out its tasks:
 From each subsidiary within the group, it will need figures for future cash receipts and
payments, making a distinction between definite amounts and estimates of future amounts.
This information about cash flows will be used to forecast the cash flows of the group, and
identify any future borrowing needs, particularly short-term and medium-term requirements.
Figures should be provided regularly, possibly on a daily basis. 01
 Information will also be required about capital expenditure requirements, so that long-term
capital can be made available to fund it. 01
 Subsidiary Finance Managers should be encouraged to submit information to the Treasury
Department about local market and business conditions, such as prospects for a change in
the value of the local currency and a change in interest rates. 01
 From outside the group, the treasury will need a range of information about current market
prices, such as exchange rates and interest rates, and about which banks are offering those
prices. Large Treasury Departments will have a link to one or more information systems such
as Reuters and Bloomberg. 01
 The Treasury Department should be alert to any favourable market opportunities for raising
new debt capital. The Treasurer should maintain regular contacts with several banks, and
expect to be kept informed of opportunities as they arise. 01
 Where the treasury is responsible for the group’s tax affairs, information will also be needed
about tax regulations in each country where the group operates, and changes in those
regulations. 01

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 tre ated 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.