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CA FINAL COURSE (Nov 2024)

GROUP I – PAPER 2
ADVANCED FINANCIAL MANAGEMENT
SUGGESTED ANSWERS
(Series 3)

PART – I (MCQs)

MCQ – 2 marks each

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.
B B D C A B A C C A A C A C A

PART – II (Descriptive Answers)

1 (a) (i) Price at which units can be Divested (₹ Crore)

Particulars Unit I Unit II

Reported Profit after Tax (a) 147 140
Reported profit before Tax [(a)/0.70] 210 200
Less: Extra Ordinary Gains 16 8
Add: Extra Ordinary Losses 20 12
214 204
Profit from New Product 56 12
Profit before Tax 270 216
Less: Tax @ 30% 81 64.80
FMP after Tax (b) 189 151.20
PE Ratio 10 12.5
Relevant Capitalization Factor (1/PE Ratio) (c) 10% 8%
Price of Unit [(b)/(c)] 1,890 1,890

(ii) The unit I can be divested as it has lower PE Ratio.

(iii) The amount of borrowing = ₹ 2,000 crore – ₹ 1,890 crore = ₹ 110 crore

1 (b) Shar No. of shares MPS Value of Portfolio % to Beta Portfolio Beta
es (lakhs) (₹ lakhs) total
(a) (b) (c) (d) = (b) x (c) (e) (f) (g) = (e) x (f)
A Ltd. 3.00 500.00 1,500.00 0.30 1.40 0.42
B Ltd. 4.00 750.00 3,000.00 0.60 1.20 0.72

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 C Ltd. 2.00 250.00 500.00 0.10 1.60 0.16
5,000.00 1.00 1.30

(1) Portfolio beta = 1.30

(2) Required Beta = 0.91
Let the proportion of risk free securities for target beta 0.91 = p
0.91 = 0 x p + 1.30 (1 – p)
p = 0.30 i.e. 30%
Shares to be disposed off & risk free to be acquired = ₹ 5,000 x 30% = ₹ 1,500 lakh
(3) Number of shares of each company to be disposed off

Shares % to total Proportionate amount (₹ MPS No. of shares (lakhs)

lakhs)
A Ltd. 0.30 450.00 500.00 0.90
B Ltd. 0.60 900.00 750.00 1.20
C Ltd. 0.10 150.00 250.00 0.60

(4) Number of Nifty Contract to be sold

(1.30 – 0.91) x ₹ 5,000 lakh
= 120 contracts
₹ 8,125 x 200
(5) 2% rise in Nifty is accompanied by 2% x 1.30 i.e. 2.6% rise for portfolio of shares

₹ Lakh
Current Value of Portfolio of Shares 5,000
Value of Portfolio after rise [5,000 x 1.026] 5,130
Mark to Market Margin paid [₹ 8,125 x 200 x 120 x 2%] (39)
Value of the portfolio after rise of Nifty 5,091
% change in value of portfolio [(5,091 – 5,000)/5,000] 1.82%
% rise in the value of Nifty 2%
Beta 0.91

1 (c) When one qualifies for personal credit line based on one’s personal credit efforts. Credit
cards are a good example of this. However, banks are very cautious while granting personal
credit lines. They provide this facility only when the business has enough cash flow to repay
the line of credit. This method is called Personal Credit Lines.
Some other innovative measures to finance a startup are as follows:
(i) Personal financing: It may not seem to be innovative but you may be surprised to
note that most budding entrepreneurs never thought of saving any money to start a
business. This is important because most of the investors will not put money into a
deal if they see that you have not contributed any money from your personal sources.
(ii) Family and friends: These are the people who generally believe in you, without even
thinking that your idea works or not. However, the loan obligations to friends and
relatives should always be in writing as a promissory note or otherwise.

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 (iii) Peer-to-peer lending: In this process group of people come together and lend money
to each other. Peer to peer to lending has been there for many years. Many small and
ethnic business groups having similar faith or interest generally support each other in
their start up endeavors.
(iv) Crowdfunding: Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes use of
the easy accessibility of vast networks of people through social media and
crowdfunding websites to bring investors and entrepreneurs together.
(v) Microloans: Microloans are small loans that are given by individuals at a lower
interest to a new business ventures. These loans can be issued by a single individual or
aggregated across a number of individuals who each contribute a portion of the total
amount.
(vi) Vendor financing: Vendor financing is the form of financing in which a company lends
money to one of its customers so that he can buy products from the company itself.
Vendor financing also takes place when many manufacturers and distributors are
convinced to defer payment until the goods are sold. This means extending the
payment terms to a longer period for e.g. 30 days payment period can be extended to
45 days or 60 days. However, this depends on one’s credit worthiness and payment of
more money.
(vii) Purchase order financing: The most common scaling problem faced by startups is
the inability to find a large new order. The reason is that they don’t have the necessary
cash to produce and deliver the product. Purchase order financing companies often
advance the required funds directly to the supplier. This allows the transaction to
complete and profit to flow up to the new business.
(viii) Factoring accounts receivables: In this method, a facility is given to the seller who
has sold the good on credit to fund his receivables till the amount is fully received. So,
when the goods are sold on credit, and the credit period (i.e. the date upto which
payment shall be made) is for example 6 months, factor will pay most of the sold
amount up front and rest of the amount later. Therefore, in this way, a startup can
meet his day to day expenses.

2 (a) (i) Equity Beta

To calculate Equity Beta first we shall calculate Weighted Average of Asset Beta as
follows:
= 1.45 x 0.74 + 1.20 x 0.26
= 1.073 + 0.312 = 1.385
Now we shall compute Equity Beta using the following formula:
E D (1 – t)
βAsset = βEquity x + βDebt x
E + D (1 – t) E + D (1 – t)
Accordingly,
410 170
1.385 = βEquity x + βDebt x
410 + 170 410 + 170
410 170
1.385 = βEquity x + 0.24 x
580 580

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 βEquity = 1.86
(ii) Equity Beta on change in Capital Structure Amount of Debt to be raised:

Particulars Value
Total Value of Firm (Equity ₹ 410 cr + Debt ₹ 170 cr) ₹ 580 Cr
Desired Debt Equity Ratio 1.90 : 1.00
Desired Debt Level = (Total Value x Debt Ratio)/(Debt Ratio + ₹ 380 Cr
Equity Ratio) (₹ 170 Cr)
Less: Value of Existing Debt
Value of Debt to be Raised ₹ 210 Cr

Equity after Repurchase = Total value of Firm – Desired Debt Value

= ₹ 580 Cr – ₹ 380 Cr
= ₹ 200 Cr
Weighted Average Beta of KGFL:

Source of Investment Weigh Beta of the

Weighted Beta
Finance (₹ Cr) t Division
Equity 200 0.345 β(E = X) 0.345x
Debt – 1 170 0.293 0.35 0.103
Debt – 2 210 0.362 0.40 0.145
580 Weighted Average Beta 0.248 + (0.345x)

ΒAsset = 0.248 + 0.345x

1.385 = 0.248 + 0.345x
0.345x = 1.137
x = 1.137/0.345 = 3.296
βEquity = 3.296
(iii) Yes, it justifies the increase as it leads to increase in the Value of Equity due to
increase in Beta.

2 (b) (i) For finding expected market price first we shall calculate Intrinsic Value of Bond as
follows:
PV of Interest + PV of Maturity Value of Bond
Forward rate of interests
1st Year 12%
2nd Year 11.62%
3rd Year 11.33%
4th Year 11.06%
5th Year 10.80%
₹ 90 ₹ 90 ₹ 90 ₹ 90 ₹ 90
PV of Interest = + + + +
(1 + 0.12) (1 + 0.1162)2 (1 + 0.1133)3 (1 + 0.1106)4 (1 + 0.1080)5

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 = ₹ 90 x 0.8929 + ₹ 90 x 0.8026 + ₹ 90 x 0.7247 + ₹ 90 x 0.6573 + ₹ 90 x
0.5988
= ₹ 80.36 + ₹ 72.23 + ₹ 65.22 + ₹ 59.16 + ₹ 53.89
= ₹ 330.86
₹ 1,000
PV of Maturity Value of Bond =
(1 + 0.1080)5
= ₹ 1,000 x 0.5988 = ₹ 598.80
Intrinsic value of Bond = ₹ 330.86 + ₹ 598.80 = ₹ 929.66
Expected Price = Intrinsic Value x Beta Value
= ₹ 929.66 x 1.10 = ₹ 1,022.63
(ii) The given yield curve is inverted yield curve.
The main reason for this shape of curve is expectation for forthcoming recession when
investors are more interested in Short-term rates over the long term.

2 (c) VAR can be applied

(a) to measure the maximum possible loss on any portfolio or a trading position.
(b) as a benchmark for performance measurement of any operation or trading.
(c) to fix limits for individuals dealing in front office of a treasury department.
(d) to enable the management to decide the trading strategies.
(e) as a tool for Asset and Liability Management especially in banks.

3 (a) Day Principal (₹) MIBOR (%) Interest (₹)

Tuesday 10,00,00,000 7.75 21,233
Wednesday 10,00,21,233 8.15 22,334
Thursday 10,00,43,567 8.12 22,256
Friday 10,00,65,823 7.95 21,795
Saturday & Sunday (*) 10,00,87,618 7.98 43,764
Monday 10,01,31,382 8.15 22,358
Total Interest @ Floating 1,53,740
Less: Net Received 317
Expected Interest @ fixed 1,53,423
Thus Fixed Rate of Interest 0.07999914
Approx. 8%

(*) i.e. interest for two days.

3 (b) Since Commercial Paper is a discount instrument, it shall be issued at discounted price.
Accordingly, answer shall be as follows:
Issue Price = 50,00,000 = ₹ 48,00,000

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 1 + (12.5% x 4/12)

₹
Issue Price 48,00,000
Less: Issue Expenses 2,500
Less: Minimum Balance 1,50,000
Net Amount Received 46,47,500

(2,00,000 + 2,500) (1 – 0.30) 12

Cost of Funds = x x 100 = 9.15%
46,47,500 4
Note: Interest Expense = ₹ 50,00,000 – ₹ 48,00,000 = ₹ 2,00,000

3 (c) The concept of sustainable growth can be helpful for planning healthy corporate
growth. This concept forces managers to consider the financial consequences of sales
increases and to set sales growth goals that are consistent with the operating and
financial policies of the firm. Often, a conflict can arise if growth objectives are not
consistent with the value of the organization's sustainable growth. Question concerning
right distribution of resources may take a difficult shape if we take into consideration the
rightness not for the current stakeholders but for the future stakeholders also. To take an
illustration, let us refer to fuel industry where resources are limited in quantity and a
judicial use of resources is needed to cater to the need of the future customers along with
the need of the present customers. One may have noticed the save fuel campaign, a
demarketing campaign that deviates from the usual approach of sales growth strategy and
preaches for conservation of fuel for their use across generation. This is an example of
stable growth strategy adopted by the oil industry as a whole under resource constraints
and the long run objective of survival over years. Incremental growth strategy, profit
strategy and pause strategy are other variants of stable growth strategy.
Sustainable growth is important to enterprise long-term development. Too fast or too
slow growth will go against enterprise growth and development.
So, financial policy should play important role in enterprise development, adopt suitable
financial policy initiative to make sure enterprise growth speed close to sustainable
growth ratio and have sustainable healthy development.

4 (a) Working Notes:

(i) Decomposition of Funds in Equity and Cash Components

D Mutual Fund Ltd. K Mutual Fund Ltd.

NAV on 31.12.25 ₹ 70.71 ₹ 62.50
% of Equity 99% 96%
Equity element in NAV ₹ 70 ₹ 60
Cash element in NAV ₹ 0.71 ₹ 2.50

(ii) Calculation of Beta

(a) D Mutual Fund Ltd.
Sharpe Ratio = 2 = E(R) – Rf = E(R) – Rf

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 σD 11.25
E(R) – Rf = 22.50
E(R) – Rf 22.50
Treynor Ratio = 15 = =
βD βD
βD = 22.50/15 = 1.50
(b) K Mutual Fund Ltd.
E(R) – Rf E(R) – Rf
Sharpe Ratio = 3.3 = =
σK 5
E(R) – Rf = 16.50
E(R) – Rf 16.50
Treynor Ratio = 15 = =
βK βK
βK = 16.50/15 = 1.10
(iii) Decrease in the Value of Equity

D Mutual Fund Ltd. K Mutual Fund Ltd.

Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes down 7.50% 5.50%

(iv) Balance of Cash after 1 month

D Mutual Fund Ltd. K Mutual Fund Ltd.

Cash in hand on 31.12.25 ₹ 0.71 ₹ 2.50
Less: Expense per month ₹ 0.25 ₹ 0.25
Balance after 1 month ₹ 0.46 ₹ 2.25

NAV after 1 month

D Mutual Fund Ltd. K Mutual Fund Ltd.

Value of Equity after 1 month
70 x (1 – 0.075) ₹ 64.75 –
60 x (1 – 0.055) – ₹ 56.70
Cash Balance 0.46 2.25
65.21 58.95

4 (b) (i) The optimal hedge ratio to minimize the variance of Hedger’s position is given by:
σS
H=ρ
σF
Where,
σS = Standard deviation of ΔS (Change in Spot Prices)
σF = Standard deviation of ΔF (Change in Future Prices)
ρ = coefficient of correlation between ΔS and ΔF
H = Hedge Ratio

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 ΔS = change in Spot price
ΔF = change in Future price
Standard deviation of ΔS = = 4% and

Standard deviation of ΔF = = 6% and

0.04
H = 0.75 x = 0.5
0.06
(ii) Since the company is long position in Spot (Cash) Market it shall take Short Position
in Future Market.
(iii) Since contact size of one contract is 1,000 Kg,
10,000 Kgs
No. of contract to be short = x 0.50 = 5 Contracts
1,000 Kgs
Amount = 10,000 x ₹ 534 x 0.50 = ₹ 26,70,000

4 (c) Yes, risk in each stage is different stage of Venture Capital financing and so risk perception
and activity to be financed as per indicative Risk matrix is given below:

Financial Period (Funds Risk Activity to be financed

Stage locked in years) Perception
Seed 7-10 Extreme For supporting a concept or idea or R&D for
Money product development and involves low
level of financing.
Start Up 5-9 Very High Initializing prototypes operations or
developing products and its marketing.
First Stage 3-7 High Started commercials production and
marketing.
Second 3-5 Sufficiently Expanding market and growing working
Stage high capital need though not earning profit.
Third Stage 1-3 Medium Market expansion, acquisition & product
development for profit making company.
Also called Mezzanine Financing.
Fourth 1-3 Low Facilitating public issue i.e. going public.
Stage Also called Bridge Financing.

5 (a) (i)

Security No. of Market Price (1) x (2) % to total ß wx

shares Per Share (w) (x)
(1) (2)
VSL 10,000 50 5,00,000 0.4167 0.9 0.375
CSL 5,000 20 1,00,000 0.0833 1 0.083
SML 8,000 25 2,00,000 0.1667 1.5 0.250

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 APL 2,000 200 4,00,000 0.3333 1.2 0.400
12,00,000 1 1.108

Portfolio beta = 1.108

(ii) Required Beta 0.8
It should become (0.8/1.108) 72.2 % of present portfolio
If ₹ 12,00,000 is 72.20%,portfolio should be (₹ 12,00,000 x 100/72.20) = ₹ 16,62,050
Additional investment in zero risk should (₹ 16,62,050 – ₹ 12,00,000) = ₹ 4,62,050
Revised Portfolio will be

Security No. of Market Price (1) x (2) % to ß wx

shares Per Share total (x)
(1) (2) (w)

VSL 10,000 50 5,00,000 0.3008 0.9 0.271

CSL 5,000 20 1,00,000 0.0602 1 0.060
SML 8,000 25 2,00,000 0.1203 1.5 0.180
APL 2,000 200 4,00,000 0.2407 1.2 0.289
Risk free asset 46,205 10 4,62,050 0.2780 0 0
16,62,050 1 0.800

(iii) To increase Beta to 1.2

Required beta 1.2
It should become (1.2/1.108) 108.30% of present beta
If ₹ 2,00,000 is 108.30%, the total portfolio should be
(₹ 12,00,000 x 100/108.30) = ₹ 11,08,033 say ₹ 11,08,030
Additional investment should be (–) 91,967 i.e. Divest ₹ 91,970 of Risk Free Asset
Revised Portfolio will be

Security No. of Market Price (1) x (2) % to ß wx

shares Per Share total (x)
(1) (2) (w)
VSL 10,000 50 5,00,000 0.4513 0.9 0.406
CSL 5,000 20 1,00,000 0.0903 1 0.090
SML 8,000 25 2,00,000 0.1805 1.5 0.271
APL 2,000 200 4,00,000 0.3610 1.2 0.433
Risk free asset –9,197 10 –91,970 –0.0830 0 0
11,08,030 1 1.20

Portfolio beta = 1.20

5 (b) (i) Initial Investment

IRR = 16% (Given)

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 At IRR, NPV shall be zero, therefore
Initial Cost of Investment = PVAF (16%, 5) x Cash Flow (Annual)
= 3.274 x ₹ 57,500
= ₹ 1,88,255
(ii) Net Present Value (NPV)
Let Cost of Capital be X, then
16 – X
x 100 = 60%
X
X = 10%
Thus NPV of the project = Annual Cash Flow x PVAF (10%, 5) – Initial Investment
= ₹ 57,500 x 3.791 – ₹ 1,88,255
= ₹ 2,17,982.50 – ₹ 1,88,255
= ₹ 29,727.50
(iii) Annual Fixed Cost
Let change in the Fixed Cost which makes NPV zero is X. Then,
₹ 29,727.50 – 3.791X = 0
X = ₹ 7,841.60
Let original Fixed Cost be Y then,
Y x 7.8416% = ₹ 7,841.60
Y = ₹ 1,00,000
Thus Fixed Cost is equal to ₹ 1,00,000.
(iv) Estimated Annual Units of Sales
₹ 60
Selling Price per unit = = ₹ 200
100% – 70%
Annual Cash Flow + Fixed Cost
= Sales Value
P/V Ratio
₹ 57,500 + ₹ 1,00,000
= ₹ 2,25,000
0.70
₹ 2,25,000
Sales in Units = = 1,125 units
₹ 200
(v) Break Even Units
Fixed Cost ₹ 1,00,000
= = 714.285 units
Contribution Per Unit ₹ 140

6 (a) (i) Incremental Cash Outflows

$ Million
Cost of Plant and Machinery 500.00
Working Capital 50.00
Less: Release of existing Working Capital (15.00)

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 535.00

(ii) Incremental Cash Inflow after Tax (CFAT)

(a) Generated by investment in India for 5 years

$ Million
Sales Revenue (5 Million x $ 80) 400.00
Less: Variable Cost (5 Million x $ 20) (100.00)
Less: Fixed Cost (30.00)
Less: Depreciation ($ 500Million/5) (100.00)
EBIT 170.00
Less: Taxes @ 35% (59.50)
EAT 110.50
Add: Depreciation 100.00
CFAT (1-5 years) 210.50

(b) Cash flow at the end of the 5 years (Release of Working Capital) = $ 35.00 million
(c) Cash generation by exports (Opportunity Cost)

$ Million
Sales Revenue (1.5 Million x $ 80) 120.00
Less: Variable Cost (1.5 Million x $ 40) (60.00)
Contribution before tax 60.00
Less: Tax @ 35% (21.00)
CFAT (1-5 years) 39.00

(d) Additional CFAT attributable to Foreign Investment

$ Million
Through setting up subsidiary in India 210.50
Less: Through Exports in India (39.00)
CFAT (1-5 years) 171.50

(iii) Determination of NPV

Year CFAT ($ Million) PVF @ 12% PV ($ Million)

1-5 171.50 3.6048 618.22
5 35 0.5674 19.86
PV of Inflows 638.08
Less: Initial Outflow (535.00)
NPV 103.08

Since NPV is positive, the proposal should be accepted.

6 (b) Date Closing Index Sign of Price Change

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 1.10.23 2800
3.10.23 2780 –
4.10.23 2795 +
5.10.23 2830 +
8.10.23 2760 –
9.10.23 2790 +
10.10.23 2880 +
11.10.23 2960 +
12.10.23 2990 +
15.10.23 3200 +
16.10.23 3300 +
17.10.23 3450 +
19.10.23 3360 –
22.10.23 3290 –
23.10.23 3360 +
24.10.23 3340 –
25.10.23 3290 –
29.10.23 3240 –
30.10.23 3140 –
31.10.23 3260 +

Total of sign of price changes (r) = 8

No of Positive changes = n1 = 11
No. of Negative changes = n2 = 8

Since too few runs in the case would indicate that the movement of prices is not random. We
employ a two-tailed test the randomness of prices.
At 10% level of significance at 18 degrees of freedom
Lower limit
= 10.26 – 1.734 x 2.06 = 6.688
Upper limit
= 10.26 + 1.734 x 2.06 = 13.832
As seen r lies between these limits. Hence, the market exhibits weak form of efficiency.
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*For a sample of size n, the t distribution will have n–1 degrees of freedom.

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