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Monday, March 8, 2010

MS42 Capital Investment and Financing Decisions June 2005

MANAGEMENT PROGRAMME

Term-End Examination

June, 2005

MS-42 : CAPITAL INVESTMENT AND FINANCING DECISIONS

Time : 3 hours
Maximum Marks : 100
(Weightage 70%)

Note :
(i) There are three Sections A, B and C in this paper
(ii) Students who have registered for MS-42 prior to July 2004 semester should attempt any five questions from Section A and C.
(iii) Students who have registered for MS-42 for July 2004 Semester and afterwords should attempt any five questions from Section B and C.
(iv) All questions carry equal marks.
(v) Present value tables will be provided, if asked for.

SECTION A

1. Explain the advantages of raising capital through equity shares and discuss the various methods of estimating cost of equity shares.

2. Explain social cost-benefit analysis. How is it applied to assess social desirability of a project ?

3. What is venture capital ? How is it different from seed capital ? Discuss the role of venture capital funds in the industrial development of India.

SECTION B

1. What are the main types of control systems for a project ? Identify some characteristics of a good control system.

2. Discuss various forms of mergers. What are the driving forces for mergers and acquisitions ?

3. What are the 'investment decisions' ? How are they different from financial decisions ? List the factors which influence long-term financial decisions of a firm.

SECTION C

4. Existing capital structure of Z Co. Ltd. is as follows :

        (Rs. in crores)

Paid up Share Capital of Rs. 10 each 10

Reserves and Surplus 15

Debentures bearing 14% interest p.a. 15
--------
40
--------

An expansion programme for the company is under consideration. It requires Rs. 20 crore and promises an increase of Rs. 6 crore in the EBIT from its existing level of Rs. 8 crore.

Three financing alternatives for obtaining the requisite amount of Rs. 20 crore are under consideration.

The first alternative is to issue equity shares of Rs. 10 per share at a premium of Rs. 40 each. Share issue expenses as also underpricing of the issue in comparison to the ruling market price result in net proceeds of Rs. 40 for every new share issued.

The second alternative is to borrow the requisite amount at 15% rate of interest per year

The third alternative is a combination of the first and the second, under which Rs. 10 crore will be borrowed at 15% rate of interest per year and the balance amount obtained by the issue of shares as per the terms indicated in the first alternative.

Applicable Corporate Income Tax it 40%.

You are required to answer the following :

(a) If the expansion programme is to be considered only and in case the EPS increases from its existing level, indicate whether the programme qualifies for consideration.

(b) At what level of EBIT will EPS be equal to zero under each of the financing alternatives?

(c) Determine the point of indifference among the three financing alternatives and the corresponding EPS.

5. (a) What do you understand by Weighted Average Cost of Capital ? How are the weights assigned? Explain the significance of Weighted Average Cost of Capital.

(b) ABC Ltd. has issued 15% debentures of the face value of Rs. 100 each, redeemable at the end of 7 years. The debentures are issued at a discount of 5% and the floatation cosit amounted to 1%. Find out the cost of debentures given that the firm has 50% tax rate.

6. ''Stability in the payment of dividends has a marked bearing on the market price of the shares of a corporate firm." Explain this statement. What other factors are taken into consideration while deciding the dividend payment ? Explain.

7. ABC Pvt. Ltd. is considering the possibility of purchasing a multipurpose machine which costs Rs. 10 lakh. The machine has an expected life of 5 years. The machine generates Rs. 6 lakh per year before depriciation and tax. The management wished to dispose off the machine at the end of 5 years which will fetch Rs. 1 lakh. The depreciation allowable for the machine is 25% on written down value and the company's tax rate is 50%.

The company approaches a Non-Banking Finance Company for a 5 year lease for financing the asset which quoies a rate of Rs. 28 per thousand per month.

The company wants you to evaluate the proposal with the purchase option.

The cost of capital of the company is 12%. For lease option it wants to consider a discount rate of 16%. Give your advice to the company based on calculations.

8. (a) Distinguish between risk and uncertainty in capital investment decisions. Give suitable examples.

(b) Critically evaluates ensitivity analysis as a tool of risk analysis in capital investment decisions.

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