STRATEGIC FINANCIAL

MANAGEMENT
ASSIGNMENT
 Assignment Questions

Question 1:
A manager in a bank appraising a project found from sensitivity analysis that a project is too
risky with respect to the selling price assumed. To this the Director of the firm stated that he
believed in scenario analysis to make a judgement about the risk of the project and asked the
manager of the bank to consider scenarios rather than sensitivity. Was the Director right in
his suggestion? (10 Marks)

Question 2:
Nurta Pharmaceuticals current earnings per share is Rs. 20, which is distributed to its
shareholders. The required rate of return for the shareholders is 20%, and the market price of
the share is Rs. 100. Nutra Pharmaceuticals has three business opportunities.
Option 1 is to make a product that gives 25% return,
Option 2 is expansion of current product that would give 20%,
Option 3 is to produce a product that would give 15% return.
Assume all products are scale able, mutually exclusive and are funded only through equity.
To fund the projects, the only option is to reduce the dividend payout to 50%, i.e dividend
would reduce from Rs. 20 per share to Rs. 10 per share. The retained part of the dividend
would be used to fund the selected project. Determine the growth rate (g = b*ROE) for each
of the options and the new share price (assuming constant growth). Comment on the new
share price for each of the model (10 Marks)

Question 3a:
Shaurya Ltd issues bonds with a face value of INR 100, coupon rate 5% (annual coupon
payment) that matures in 4 years. Compute the Yield to Maturity (YTM) assuming the
current market price of the bond is INR 96. (5 marks)
Question 3b:
Based on the details given below, compute the profit or loss incurred in the transaction
assuming Mohan purchases one call option contract of Asus Ltd: Number of shares in the
option contract: 100 shares Strike price: Rs. 300 Option cost: Rs.2000 Current market price
of Asus Ltd on option expiry date: Rs.350 (5 marks)
Answer 1
In the field of project evaluation, risk assessment plays an important role in the decision-making
process. Managers and operators often use traditional methods and sensitivity analysis and
scenario analysis to measure the potential impact of various factors on mission outcomes. This
discussion examines the differences between sensitivity analysis and scenario analysis, compares
the benefits of each, and determines whether managers should rely on scenario analysis to assess
project risks.
Gather information about sensitivity analysis and factor analysis:
Sensitivity analysis:
Sensitivity analysis is a quantitative technique used to determine the effect of changes in an
independent variable on a dependent variable. Change one variable while keeping other variables
constant to see the change in results in the final output. In the context of project evaluation,
sensitivity analysis helps to identify the main drivers of the entire work process and to assess the
strength of the effects of the work in the areas of these drivers.
For example, if a bank is evaluating a project, a sensitivity analysis might include how factors
such as promotion costs, production costs, interest rate estimates, and market demand related to
net present value will change (NPV), internal rate of return (IRR) or other relevant financial
metrics. Sensitivity analysis allows managers to identify which variables have the greatest
impact on challenge profitability and calculate the magnitude of that impact under different
circumstances.
Advantages
1. Provides an assessment of robustness: sensitivity analysis requires the study of each variable
and direct variable as a function of intensity. Relationships between variables can be determined.
A higher value will help you make more accurate predictions.
2. Reality Check: Sensitivity assessments allow organizations to determine the probability of
success/failure of a variable. Sensitivity assessments can help you determine whether the
additional revenue will increase by a positive margin.
Scenario Analysis:
However, scenario analysis is a quantitative or quantitative technique used to assess the impact
of different factors on the effectiveness of a project. Unlike sensitivity analysis, which
specializes in changing one variable at a time, scenario analysis considers many variables at once
and analyzes how certain sets of variables will play out in the future.
In scenario analysis, managers develop defined scenarios that describe future economic
conditions, market conditions, the regulatory environment, and other relevant factors. All trends
reflect a unique set of characteristics, including market trends, weak market trends, high demand,
and bear trends. By studying challenge outcomes in all scenarios, drafters can understand
different potential outcomes and their risks and opportunities.
Advantages
1. Better structure of conjecture: Think of scenario evaluation as in chess, where players think
about certain actions that can increase their chances of winning the game. For companies,
managers can achieve good results by applying good guidelines and strategies, but they can also
expect negative results.
2. It leads to efficient allocation of resources. Situational assessment is a prediction about future
conditions, it is easier for company leaders to understand external conditions that may affect
operations.
Managerial Theory Assessment:
Managerial Theory's reliance on scenario analysis rather than sensitivity analysis to assess
distributional risk raises some concerns. Sensitivity analysis is useful for determining the
sensitivity of an effect to changes in individual variables, but interactions and relationships
between two or more variables may be overlooked. Instead, scenario analysis provides a
comprehensive examination of the interaction and evolution of various elements, resulting in a
more holistic view of the mission's risk profile.
Scenario analysis also allows planners to see more diverse potential impacts by considering more
than one possible scenario. This approach recognizes the uncertainty and complexity of the
landscape, where the future is often shaped by many interconnected factors. By considering
unique circumstances, managers can better prepare for contingencies and have stronger options
that outweigh the limited potential benefits.
Scenario analysis also encourages forward thinking by considering not only the current state of
the project, but also how it will evolve over the years in response to changing circumstances.
This proactive approach to threat assessment helps companies anticipate and mitigate potential
threats while maximizing growth.
However, it is important to note that there are barriers to analyzing the situation. Developing
significant and meaningful features requires attention to what is needed in addition to
considerations of dynamic approaches and interactions. In addition, scenario analysis is very
useful and can include some aspects of the curriculum to select and weigh contingencies.
In conclusion, sensitivity analysis and scenario analysis are excellent methods for assessing
project threats and provide unique insights and benefits. Just as sensitivity analysis provides a
basic overview of the sensitivity of a company's results to changes in human variables, scenario
analysis uses the idea of multiple possible and interrelated scenarios of the nature of those
situations to provide a comprehensive, prospective assessment. to provide for the manager's
decision to focus on scenario analysis over risk assessment, this is a prudent approach as it seeks
to understand the complex interactions of factors and take the form of future forces. By adopting
scenario analysis, companies can strengthen their threat management practices, improve their
selection processes, and increase resilience in the face of uncertainty.
Ultimately, the effectiveness of each approach depends on the exact nature of the project, the
nature of the risks involved, and the goals of the one making the choice. Therefore, a balanced
approach that includes elements of sensitivity analysis and scenario assessment is the most
appropriate way to assess the risks of the challenges and make decisions.
Answer 2
Deep Dive into Nutra Pharmaceuticals' Investment Options with Strategic Considerations
Building upon the constant growth model analysis, let's delve deeper into each option for
Nutra Pharmaceuticals by considering not only the new growth rate (g) and resulting share
price but also strategic factors that might influence the decision. This provides a more
comprehensive framework for evaluating each investment opportunity.
Constant Growth Model and Share Price Impact:
We previously established that reducing the dividend payout ratio to 50% leads to a new
dividend per share (DPS) of Rs. 10. This new DPS, along with the constant growth model,
will be used to estimate the new share price for each option.
Growth Rate (g) for Each Option and Strategic Considerations:
1. Option 1 (25% Return):
Growth Rate (g): Assuming an ROE of 25%, the growth rate (g) would be 12.5%.
New Share Price: Rs. 133.33
Strategic Considerations: This option offers the highest potential for share price appreciation
due to the high assumed ROE. However, pursuing a venture with a 25% return might involve
higher risk compared to the other options. Here's a breakdown of key strategic considerations
for Nutra Pharmaceuticals:
Feasibility Assessment: A thorough assessment is essential to determine if achieving a 25%
ROE is realistic. This might involve analyzing competitor performance (e.g., their historical
ROEs in similar ventures), industry benchmarks for ROEs in comparable product categories,
and the company's historical track record in launching new products to assess its internal
capabilities for successful execution.
Risk Management Framework: The company should develop robust risk management
strategies to mitigate potential challenges associated with such an ambitious venture. This
could involve diversification of investments across different product lines or markets to
reduce overall risk exposure, contingency plans to address potential roadblocks, and setting
clear performance metrics to track progress and identify potential red flags early on.
Market Research and Competitive Analysis: In addition to the feasibility assessment,
conducting thorough market research is crucial. This should involve identifying the target
market, analysing customer needs and preferences, and assessing the competitive landscape
to determine the market attractiveness, potential demand for the product, and the company's
ability to achieve a sustainable competitive advantage.
2. Option 2 (20% Return):
Growth Rate (g): Assuming an ROE of 20%, the growth rate (g) would be 10%.
New Share Price: Rs. 100 (remains the same)
Strategic Considerations: This option matches the required rate of return, so the share price
wouldn't see immediate growth. However, it could be strategically beneficial if the product
expansion aligns with the company's long-term goals by considering the following:
Market Expansion Strategy: Does the expansion cater to a new market segment with high
growth potential, or address a growing market need, potentially leading to higher sales and
profitability in the long run? The company should conduct market research to identify
potential customer segments, analyse their needs and preferences, and assess the competitive
landscape to determine the market attractiveness and the company's potential for success.
Synergy with Existing Products: Can the expansion leverage the company' s existing
infrastructure, distribution network, or brand reputation, leading to cost efficiencies and faster
market penetration? Here, the company should evaluate the potential for shared resources
(e.g., manufacturing facilities, sales channels) and brand recognition to streamline the
expansion process, reducing investment requirements and time to market.
Competitive Advantage Analysis: Does the expansion offer a sustainable competitive
advantage over rivals? A competitive analysis is crucial to assess the company's position
relative to its competitors in terms of product differentiation, cost structure, and brand
positioning. This analysis will help determine if the expansion can achieve the targeted 20%
ROE in the face of competition.
3. Option 3 (15% Return):
Growth Rate (g): Assuming an ROE of 15%, the growth rate (g) would be 7.5%.
New Share Price: Rs. 80
Strategic Considerations: This option offers the lowest growth potential and could lead to a
decline in share price. It might only be considered if the new product aligns perfectly with the
existing business, has minimal investment requirements, or offers strategic benefits beyond
short-term financial gains.
Other things to consider are:
Niche Market Targeting: Does the new product target a niche market with high-profit margins
but lower overall sales volume? The company should assess the size and growth potential of
the niche market, along with the pricing power it can command within that niche to
determine.
Strategic Fit: Consider if the new product aligns perfectly with the existing business and
offers strategic benefits beyond short-term financial gains. Analyse potential synergies and
long-term benefits to the company's overall strategy.
Conclusion:
This analysis highlights the importance of combining financial analysis with strategic
considerations when evaluating investment opportunities. While Option 1 offers the highest
potential share price growth, its feasibility and risk require careful assessment. Option 2
might not lead to immediate share price growth, but it could be strategically beneficial if
aligned with the company's long-term goals. Option 3 offers the lowest growth potential and
might only be considered if strategically advantageous. Nutra Pharmaceuticals should
carefully weigh financial metrics alongside these strategic considerations to make an
informed decision that maximizes shareholder value in the long run.
By carefully considering both financial and strategic factors, Nutra Pharmaceuticals can make
an informed decision that maximizes shareholder value in the long run. This balanced
approach will ensure sustainable growth and a strong competitive position in the marketplace.
Answer 3A
Yield to maturity (YTM) is defined as the expected annual return that can be earned on a loan if
it is held to maturity. From a bond investor's point of view, the yield to maturity (YTM) is
simply the expected return that can be earned if the bond is held to maturity and the interest rate
is reinvested after the note is paid in full on time. It is based on the following assumptions:
• Assumption 1 → The rate of return implies that bondholders will hold the debt instrument until
maturity.
• Assumption 2 → All mandatory interest and principal payments are already scheduled.
• Assumption 3 → Coupon payments are invested at the same rate as the yield to maturity
(YTM).
The relationship between current YTM and interest rate risk is inverse. In other words, the higher
the YTM, the less sensitive the bond price is to interest rate adjustments.
Yield to Maturity (YTM) = [Year of Note + (FV – PV)/Year of Compounding Periods] ¼ [(FV +
PV) ¼ 2]
Here,
FV= 100PV = 96
Number of compounding periods = 4 (paid annually)
Interest rate = 5%Therefore annual interest rate = interest rate* FV= 5%*100Interest rate =
5Now enter the value. calculate YTM,
YTM= [5+(100-96)/ 4]/ [(100+96)/2]
YTM= [5+4/4] / [196/2]
YTM= [ 5+1]/ 98YTM= 6/98YTM= 0.0612 approx.
This is because the YTM must be in percentage units.
So, 0.0612*100YTM= 6.12%So in the given scenario the yield to maturity is 6.21%. The YTM
equation (YTM) contains the following inputs.
• Coupon Rate (C): Determined by the bond's coupon interest rate. Or, in "interest rate" terms,
the annual coupon rate is the amount the bond issuer pays the bondholder. Generally, the higher
the coupon rate associated with the bond, the higher the yield, all else being equal.
• Face value (FV): The face value (or nominal value) of a bond is the amount that will be paid to
investors at maturity.
• Present Value (PV): The present value (PV) of a bond is the amount a buyer would be willing
to pay for the bond in the open market as of the current date, based on current market interest
rates, which may be higher (later) ) is lower than the bond's FV, which is based primarily on
market conditions and supply/demand.
• Maturity Date: The default date on which the lender is expected to pay the principal. From
today you can spend as many years as you want until you reach adulthood.
• Number of times compound interest (n): The number of times compound interest is the amount
paid in one year multiplied by the number of years remaining until maturity.
So, the YTM of Shaurya Limited is 6% which is the initial rate of return for the company. As we
know, the higher the yields, the lower the variation in bond prices.
Answer 3B
The term option refers to a financial instrument that is based on the price of an underlying
security, typically stocks, indices, and exchange-traded funds (ETFs). An option contract gives
the buyer the opportunity to buy or sell, depending on the type of option. The contracts they hold
are the underlying assets. Unlike futures, the owner is not always guaranteed to buy or sell the
property if the decision is made.
Each option contract allows the holder to select an expiration date on which to exercise the
option. An option's price is referred to as its exercise price. Options are bought and sold online or
through brokers.
Options are simple financial instruments. These contracts involve a buyer and a seller, with the
buyer paying money for the rights granted by the contract. A call option allows the holder to buy
an asset at a set price within a specified time period. However, call options allow the holder to
bid on an asset at a specified rate for a specified period of time. Each call option has a positive
seller and a weak seller, while the other position has a weak seller and a strong seller. Clients use
other methods to hedge or de-risk their portfolios. Complete the scenario and calculate whether
Mohan won or lost.
In this case, we receive the initial price of the option, which includes the price of 100 shares and
the price of the option. However, the owner receives some money, and the option expires. So
let's find out if the owner made the right decision to buy a piece or not.
The options expiry price is 350 rupees.
The price at which Mohan issues the shares is Rs. 300.The number of shares issued is 100.This
means that Mohan will receive 50 rupees more per share. Option expiration time.
The option price is 2000 rupees.
Therefore, Mohan's initial investment = option price + shares sold
= 2000 + (300*100)
= 2000+ 30000
Initial investment = 32000
Amount received by Mohan when the option expires,
= current expiration date Price* Number of shares = 350*100 = 35000
So total amount received by Mohan on maturity,
= current investment - initial investment= 35000 – 32000
Total amount = 3000
Now, it is clear. Mohan made a total profit of Rs. Option limit is 3000. Looking at the results
Mohan got, we can say that he made the right decision to buy Asus Ltd option. You can make a
good profit when the option expires. This will encourage you to buy options that require more
investment, but with a proper analysis of the options offered and calculate all the features
available at the time of expiration.