All Math pdf2

1. The Alert Ltd currently pays Rs 3 par share as annual dividend.
Assuming 10 per cent

required rate of return on shares (Ke), compute the value of shares under each of the
following dividend growth rate assumptions:
 Annual rate of growth, zero (0) per cent indefinitely.
 Annual constant rate of growth, 5 per cent to infinity.
 Annual rate of growth, 5 per cent for each of the next 3 years, followed by a constant
annual rate of growth of 4 per cent in years 4 to infinity.
2. Calculate the explicit cost of debt for each of the following situations:
(a) Debentures are sold at par and flotation costs are 5 per cent.
(b) Debentures are sold at premium of 10 per cent and flotation costs are 5 per cent of issue
price.
(c) Debentures are sold at discount of 5 per cent and flotation costs are 5 per cent of issue
price.
Assume: (i) coupon rate of interest on debenturs is 10 per cent; (ii) face value of debentures
is Rs 100; (iii) maturity period is 10 years; and (iv) tax rate is 35 per cent.
3. (a) A company’s debentures of the face value of Rs 100 bear an 8 per cent coupon rate.
Debentures of this type currently yield 10 per cent. What is the market price of debentures
of the company?(b) What would happen to the market price of the debentures if interest
rises to (i) 16 per cent, and (ii) drops to 12 per cent?
(c) What would be the market price of the debentures in situation (a) if it is assumed that
debentures were originally having a 15 year maturity period and the maturity period is 4
years away from now?
(d) Would you pay Rs 90 to purchase debentures specified in situation (c)? Explain.
4. The beta coefficient of Target Ltd is 1.4. The company has been maintaining 8 per cent rate
of growth in dividends and earnings. The last dividend paid was Rs 4 per share. The return
on government securities is 10 per cent while the return on market portfolio is 15 per cent.
The current market price of one share of Target Ltd. is Rs 36.
(a) What will be the equilibrium price per share of Target Ltd?
(b) Would you advise purchasing the share?
5. A mining company’s iron ore reserves are being depleted, and its cost of recovering a
declining quantity of iron ore are rising each year. As a consequence, the company’s
earnings and dividends are declining, at a rate of 8 per cent per year. If the previous year’s
dividend was Rs 10 and the required rate of return is 15 per cent, what would be the current
price of the equity share of the company?
6. The shares of a chemical company are selling at Rs 20 per share. The firm had paid dividend
@ Rs 2 per share last year. The estimated growth of the company is approximately 5 per
cent per year.
(a) Determine the cost of equity capital of the company.
(b) Determine the estimated market price of the equity shares if the anticipated growth rate
of the firm (i) rises to 8 per cent, and (ii) falls to 3 per cent.
7. Assuming no taxes and given the earnings before interest and taxes (EBIT), interest (I) at
10 per cent and equity capitalisation rate (ke) below, calculate the total market value of
each firm.
Firms EBIT I ke (per cent)
X Rs 2,00,000 Rs 20,000 12
Y 3,00,000 60,000 16
Z 5,00,000 2,00,000 15
W 6,00,000 2,40,000 18
Also, determine the weighted average cost of capital for each firm.
8. Company X and Company Y are in the same risk class, and are identical in every respect
except that company X uses debt, while company Y does not. The levered firm has Rs
9,00,000 debentures, carrying 10 per cent rate of interest. Both the firms earn 20 per cent
operating profit on their total assets of Rs 15 lakhs. Assume perfect capital markets, rational
investors and so on; a tax rate of 35 per cent and capitalisation rate of 15 per cent for an all-
equity company.
(a) Compute the value of firms X and Y using the Net Income (NI) Approach.
(b) Compute the value of each firm using the Net Operating Income (NOI) Approach.
(c) Using the NOI Approach, calculate the overall cost of capital (k0) for firms X and Y.
(d) Which of these two firms has an optimal capital structure according to the NOI
Approach? Why?
9. The values of two firms X and Y in accordance with the traditional theory are given below:
10. A company’s current operating income is Rs 4 lakh. The firm has Rs 10 lakh of 10 per cent
debt outstanding. Its cost of equity capital is estimated to be 15 per cent. (a) Determine the
current value of the firm, using traditional valuation approach.
(b) Calculate the overall capitalization rate as well as both types of leverage ratio:(a) B/S
(b) B/V.
(c) The firm is considering increasing its leverage by raising an additional Rs 5,00,000 debt
and using the proceeds to retire that amount of equity. As a result of increased financial
risk, ki is likely to go up to 12 per cent and ke to 18 per cent. Would you recommend the
plan?
11. (a) X company earns Rs 5 per share, is capitalised at a rate of 10 per cent and has a rate of
return on investment of 18 per cent.
According to Walter’s model, what should be the price per share at 25 per cent dividend
payout ratio? Is this the optimum payout ratio according to Walter?
(b) Omega company has a cost of equity capital of 10 per cent, the current market value of
the firm (V) is Rs 20,00,000 (@ Rs 20 per share). Assume values for I (new investment),
Y (earnings) and D (dividends) at the end of the year as I = Rs 6,80,000, Y = Rs 1,50,000
and D = Re 1 per share. Show that under the MM assumptions, the payment of dividend
does not affect the value of the firm.
12. The Apex Company which earns Rs 5 per share, is capitalised at 10 per cent and has a
return on investment of 12 per cent. Using Walter’s dividend policy model, determine
optimum dividend pay out ratio and the price of the share at this pay out. It currently has
1,00,000 shares selling at Rs 100 each. The firm is contemplating the declaration of Rs 5
as dividend at the end of the current financial year, which has just begun. What will be the
price of the share at the end of the year, if a dividend is not declared? What will it be if it
is paid? Answer these on the basis of Modigliani and Miller model and assume no taxes.
13. Expandent Ltd had 50,000 equity shares of Rs 10 each outstanding on January 1. The shares
are currently being quoted at par in the market. The company now intends to pay a dividend
of Rs 2 per share for the current calendar year. It belongs to a risk class whose appropriate
capitalisation rate is 15 per cent. Using Modigliani-Miller model and assuming no taxes,
ascertain the price of the company’s share at it is likely to prevail at the end of the year (a)
when dividend is declared, and (b) when no dividend is declared. (c) Also, find out the
number of new equity shares that the company must issue to meet its investment needs of
Rs 2 lakh, assuming a net income of Rs 1.1 lakh and also assuming that the dividend is
paid.
14. The Asbestos Company belongs to a risk class of which the appropriate capitalisation rate
is 10 per cent. It currently has 1,00,000 shares selling at Rs 100 each. The firm is
contemplating the declaration of a Rs 6 dividend at the end of the current fiscal year, which
has just begun. Answer the following questions based on Modigliani and Miller model and
the assumptions of no taxes.
(a) What will be the price of the shares at the end of the year, if a dividend is not declared?
What will it be if it is declared?
(b) Assuming that the firm pays dividend, has a net income of Rs 10,00,000 and makes new
investments of Rs 20,00,000 during the period, how many new shares must be issued?
15. The earnings per share of a company is Rs 8 and the rate of capitalisation applicable is 10
per cent. The company has before it, an option of adopting (i) 50, (ii) 75 and (iii) 100 per
cent dividend pay out ratio.
Compute the market price of the company’s quoted shares as per Walter’s Model if it can
earn a return of (a) 15, (b) 10 and (c) 5 per cent on its retained earnings.
16. A closely-held plastic manufacturing company has been following a dividend policy which
can maximize the market value of the firm as per Walter’s model. Accordingly, each year
at dividend time, the capital budget is reviewed in conjunction with the earnings for the
period and alternative investment opportunities for the shareholders. In the current year,
the firm reports net earnings of Rs 5,00,000. It is estimated that the firm can earn Rs
1,00,000 if the amounts are retained. The investors have alternative investment
opportunities that will yield them 10 per cent. The firm has 50,000 shares outstanding.
What should be the D/P ratio of the company if it wishes to maximise the wealth of the
shareholders?
17. The following information is supplied to you, about a company:
18. (i) From the following information supplied to you, ascertain whether the firm’s D/P ratio
is optimal according to Walter. The firm was started a year ago with an equity capital of Rs
20 lakh. Number of shares outstanding, 20,000 @ Rs 100 each. The firm is expected to
maintain its current rate of earnings on investment. (ii) What should be the P/E ratio at
which the dividend payout ratio will have no effect on the value of the share?
(iii) Will your decision change if the P/E ratio is 8, instead of 12.5?
19. Hilt share is quoted at Rs 60. Nitin expects the company to pay a dividend of Rs 3 per share,
one year from now. The expected price one year from now is Rs 78.50.
(a) What is the expected dividend yield, rate of price change and holding period yield
(HPY)?
(b) If the beta of the share is 1.5, the risk-free rate is 6 per cent and the market risk premium
is 10 per cent, what is the required rate of return?
(c) What is the intrinsic value of the share? How does it compare with the current market
price?
20. Suppose the required rate of return on a portfolio with beta of 1.2 is 18 per cent and the
risk-free rate is 6 per cent. According to the CAPM:
(a) What is the expected rate of return on the market portfolio?
(b) What is the expected return of a zero beta security?
(c) Suppose you choose to buy a stock Z for Rs 50. The stock is expected to pay Rs 2 as
dividend next year and is hoped to sell at Rs 53. The stock has been evaluated at = – 0.5. Is
the stock fairly priced? What is the implication of including stock Z in the portfolio?
(d) A stock Delta, with beta of 1.5, sells for Rs 50. One year from now, it is expected to
yield a dividend income of Rs 6. What price do investors expect after one year?
21. An investment manager has chanced upon a couple of securities with identical variance of
25 per cent, but zero covariance between their returns.
(a) Calculate portfolio risk when any two securities are combined in equal proportions.
(b) Calculate portfolio risk when any three securities are combined in equal proportions.
(c) Generalise your results for the n-security case and examine its implications for an
insurance company.
22. Consider the following information.
23. Ajay held equity shares of Xenon Ltd. (expected return = 14%, standard deviation = 18%).
Vijay has gifted him shares of identical market value of Year Ltd. (expected return = 20%,
standard deviation = 24%). Determine the risk and return of the securities portfolio held by
Ajay, if the correlation between the returns on the two securities is 0.8.
24. Risk-return features of two securities X and Y are given below:
25. Mr. Azad holds the following portfolio:

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1. The Alert Ltd currently pays Rs 3 par share as annual dividend.

Assuming 10 per cent

25. Mr. Azad holds the following portfolio:

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