ANCE

COMMERCE & LAW PROGRAM DIVISION (CLPD)

CA-FINAL (G-1)
NOV. - 2014 (ATTEMPT)

Total number of questions : 7 | Time allowed : 3 hours

| Maximum Marks : 100 | Date : 09-11-2014

PAPER- 2
SUBJECT : STRATEGIC FINANCIAL MANAGEMENT
NOTE

1. Question No. 1 is compulsory. Answer any five questions from the remaining six questions.
2. Working notes should form part of the answers.

Disclaimer Clause : These solutions are prepared by expert faculty team of RESONANCE. Views
and answers provided may differ from that would be given by ICAI due to difference in assumptions
taken in support of the answers. In such case answers as provided by ICAI will be deemed as final.

CA-FINAL # 1

ANCE

1.

(a)

Sol.

(a)

1.

(b)

Sol.(b) (i)

(ii)

Edclweiss Bank Ltd. sold Hong Kong dollar 2 crores value spot to its customer at ` 8.025 and
covered itself in the London market on the same day, when the exchange rates were
US $ 1 = HK $ 7.5880 7.5920
Local interbank market rates for US $ were
Spot US $ 1 = ` 6O.70 61.00
Calculate the cover rate and ascertain the profit or loss on the transaction, Ignore brokerage.
[ 5 Marks ]
To cover in London Market, bank will buy HKD 2 crore, for this ask rate will be require
`
1
US$
`
=

= 61.00
= 8.0390
US$
7.5880
HKD
HKD
Hence rate will be ` 8.0390/HK$
Calculation of profit and loss
Sale
2 crore 8.025
=
16.05 crore
Buy
2 crore 8.0390
=
16.078 crore
Net loss
0.028 crore
Hence net loss will be ` 2,80,000
Wonderland Limited has cash of ` 20 lakhs. which it wants to invest in short term marketable
securities. Expenses relating to investment will be ` 50,000.
The securities invested will have an annual yield of 9%
The company seeks your advice
(i)
as to the period of investment so as to earn a pre-tax income of 5%.
(ii)
the minimum period for the company to break even its investment expenditure
over time value of money.
[ 5 Marks ]
Investment in security
=
` 20,00,000
Rate of return
=
9 % p.a.
Expenses
=
50,000
Hence to get a return of 5 % company should invest for a period
n
Investment Requierd return = I Rate
Expenses
12
n
20,000,00 5 % = 20,00,000 9 %
50,000
12
1,80,000
1,00,000 + 50,000 =
n
12
150000
n=
= 10 months
15000
Minimum break even period will be
Return
=
cost
2000000 9 %

1.

n
12

n
12

50,000

50,000

1,80,000

Note:

n
=
3.33 months
It is assumed that investment expenses is in additional to the amount of investment, Hence calulation
have been made considering ` 20 lakhs as net investment.

(c)

Elrond Limited plans to acquire Doom Limited. The relevant financial details of the two firms prior to
the merger announcement are :
Elrond
Doom
Limited
Limited
Market price per share
` 50
` 25
Number of outstanding shares
20 lakhs
10 Iakhs
The merger is expected to generate gains, which have a present value of ` 200 lakhs. The exchange
ratio agreed to is 0.5.
What is the true cost of the merger from the point of view of Elrond Limited ?
[ 5 Marks ]

CA-FINAL # 2

ANCE

Sol.

1.

(c)

(d)

True Cost of Merger will be net Consideration paid

=
Number of share Post merger MPS
=
10 lakhs 0.5 58
=
290 lakhs
Calcuation of Post merger MPS
Pre merger value of Elrond Limited
=
20 lakhs 50
Pre merger value of Doom Limited
=
10 lakhs 25
Gains from merger
Total
Post merger number of shares
=
20 lakhs + 5 lakhs

= 1000 lakhs
= 250 lakhs
= 200 lakhs
= 1,450 lakhs
= 25 lakhs

Post merger MPS

= 58

Goldilocks Ltd. was started a year back with equity capital of ` 40 lakhs, The other details are as
under :
Earnings of the company
` 4,00,000
Price Earnings ratio
12.5
Dividend paid
` 3,20,000
Number of Shares
40,000
Find the current market price share. Use Walters Model.
Find whether the company's D/P ratio is optimal, use Walter's formula.

Sol.

(d)

[ 5 Marks ]

The EPS of the firm is ` 10 (i.e., ` 4,00,000/40,000). The P/E Ratio is given at 12.5 and the cost of
capital, ke, may be taken at the inverse of P/E ratio. Therefore, ke is 8 (i.e., 1/12.5). The firm is
distributing total dividends of ` 3,20,000 among 40,000 shares, giving a dividend per share of ` 8.00.
the value of the share as per Walters model may be found as follows:

D (E D)
k
e

=
ke

0.10

8
(10 8)
0.08

=
0.08

131.25

The firm has a dividend payout of 80% (i.e., ` 3,20,000) out of total earnings of ` 4,00,000. since,
the rate of return of the firm, r, is 10% and it is more than the ke of 8%, therefore, by distributing
80% of earnings, the firm is not following an optimal dividend policy. The optimal dividend policy for
the firm would be to pay zero dividend and in such a situation, the market price would be

D (E D)
k
e

=
ke

0.10

0
(10 0)
0.08

=
0.08

156.25

So, theoretically the market price of the share can be increased by adopting a zero payout.
2.

(a)

Sol.

(a)

The valuation of Hansel Limited has been done by an investment analyst. Based on an expected
free cash flow of ` 54 lakhs for the following year and an expected growth rate of 9 percent. the
analyst has estimated value of Hansel Limited to be ` 1800 lakh. However, he committed a mistake
of using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that Hansel limited
equity of 20 percent and post tax cost of debt of 10 percent. The market of equity thrice its book
value, whereas the market value of its debt is nine-tenths of its book value. What is the correct value
of Hansel Ltd ?
[ 6 Marks ]
Calculation of wrong KO taken by analyst

CF
Value = K g
O
54
1800 = k 0.09
0
KO = 0.12 or 12 %
CA-FINAL # 3

ANCE

Let us assume
book value of debt = x
then book value weight of equity = 1 x
Hence KO =

(kd wd) (ke we )

wd we

12
12

10 x 20 (1 x )
x (1 x )
= 10 x + 20 20 x
=

8
= 0.80
10
wd = 0.80
we = 1 0.80 = 0.20
Correct value of weights will be

9
= 0.72
10
we = 0.20 3 = 0.60

wd = 0.80

Hence revised k 0 will be

kd wd ke we
wd we
10 0.72 20 0.60
7.2 12
=
= 14.5454
0.72 0.60
1.32
Hence correct value will be

CF
54
value = k g =
= 973.78
0
.
145454
0.09
0
2.

(b)

Gretel Limited setting up a project for manufacture of boats at a cost of ` 300 lakhs. It shore
(Area A) decide whether to locate the plant in next to the sea in a inland area wIth no access
to any waterway (Area B). If the project is located in Area B then Gretel Limited receives a cash
of ` 20 Iakhs from the Central Government. Besides. the taxable profits to the extent 20%
exempt for 10 years in Area B. The project envisages a borrowing ` 200 lakhs in either case.
The rate of interest per annum is 12% in Area A and 10% in Area B.
The borrowing of principal has to be repaid in 4 equal installments beginning from the end of the
4th year.
With the help of the following information. are required suggest the proper location for the
project to CEO of Gretel Limited. Assume straight line depreciation with residual value, income
tax 50% and required of return 15%.
[ 10 Marks ]
Earnings before Depreciation, Interest and Tax (EBDIT)
(` In lakhs)
AreaA
AreaB
1
(6)
(50)
2
34
(50)
3
54
10
4
74
20
5
108
45
6
142
100
7
156
155
8
230
190
9
330
230
10
430
330
The PVIF @ 15% for 10 year are as below :
Year
1
2
3
4
5
6
7
8
PVIF 0.87
0.76
0.66
0.57
0.50
0.43
0.38
0.33
Year

9
0.28

10
0.25

CA-FINAL # 4

ANCE

Sol.(b) 1.

Computation of Interest
Detail
(For Area A) Opening Principal
Less: Repayment
Closing Principal
Interest @ 12% (on Opening
Balance)
(For Area
B) Interest @ 10%

2.

Computation of Future Cash Flow & NPV

Nature

(For Area A) EBDIT

Less:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

200
200
200
200
150
100
50
(0)
(0)
(0)
(50)
(50)
(50)
(50)
200
200
200
150
100
50
0
24
24
24
24
18
12
6
20
20
20
20
15
10
5

300
Depreciation =10

Yr 1

Yr 2

Yr 3

Yr 4

Yr 5

Yr 6

Yr 7

Yr 8

Yr 9

Yr 10

(6)

34

54

74

108

142

156

230

330

430

(30)

(30)

(30)

(30)

(30)

(30)

(30)

(30)

(30)

(30)

EBIT

(36)

24

44

78

112

126

200

300

400

Less:

Interest (WN1)

(24)

(24)

(24)

(24)

(18)

(12)

(6)

EBT

(60)

(20)

20

60

100

120

200

300

400

Less:

Tax @ 50%

50

60

100

150

200

(60)

(20)

20

60

50

60

100

150

200

Add:

Depreciation

30

30

30

30

30

30

30

30

30

30

(30)

10

30

50

90

80

90

130

180

230

EAT
CFAT
Less:

Principal

Net cash flow

DF @ 15% as given
DCF

(50)

(50)

(50)

(50)

(30)

10

30

40

30

40

130

180

230

0.87

0.76

0.66

0.57

0.5

0.43

0.38

0.33

0.28

0.25

(26.1)

7.6

19.8

20

12.9

15.2

42.9

50.4

57.5

Total DCF
Less:

Initial Investment

200.2
(Net of Loan Amount) (300 200)

100

NPV
(For Area B) EBDIT
Less:

Less:

(50)

(50)

10

20

45

100

155

190

230

330

300
Depreciation 10

(30)

(30)

(30)

(30)

(30)

(30)

(30)

(30)

(30)

(30)

EBIT

(80)

(80)

(20)

(10)

15

70

125

160

200

300

(20)

(20)

(20)

(20)

(15)

(10)

(5)

(100)

(100)

(40)

(30)

60

120

160

200

300

Interest (WN1)
EBT

Less:

Tax @ 50%
EAT

Add:

Depreciation
CFAT

Less:

100.2

Principal

Net cash flow

DF @ 15% as given
DCF

28

80

120

(70)

(70)

(28)

(21)

42

84

132

120

180

30

30

30

30

30

30

30

30

30

30

(40)

(40)

30

72

114

162

150

210

(50)

(50)

(50)

(50)

(40)

(40)

(41)

(20)

22

64

162

150

210

0.87

0.76

0.66

0.57

0.5

0.43

0.38

0.33

0.28

0.25

(34.8)

(30.4)

1.32

(23.37)

(10)

9.46

24.32

53.46

42.0

52.5

Total DCF
Less:

Initial Investment
NPV

74.32
(30020020)

80.0
(5.68)

Since, NPV of Area A is greater than NPV of Area B the CEO shall locate the Project in Area A which
is more beneficial.
Note: (1)
Losses of the project are carry forward to next profitable year and set off there and
accordingly calculated the tax amount.
(2)
Subsidy is assumed in promoters contribution nature.
(3)
Equity point of you is taken hence loan cash flows are considered.
CA-FINAL # 5

ANCE

3.

(a)

Gibralter Limited has imported 5000 bottles of shampoo at landed cost in Mumhai.of US $ 20
each The company has the choice for paying for the goods immediately or in 3 months time. It
has a clean overdraft limit where 14% p.a.rate of interest is charged.
[ 8 Marks ]
Calculate which the following method would he cheaper to Gibralter Limited.
(i)
Pay in 3 months time with interest @ 10% and cover risk forward for 3 months.
(ii)
Settle now at a current spot rate and pay interest of the overdraft for 3 months.
The rates are as follow :
Mumbai `/$ spot
:
60.25 60.55
3 months swap
:
35/25

Sol.

(a)

(i)

(ii)

Pay in 3 months time

Landed cost 5,000 20
Add : Interest @ 10 %
Total payment
convesrion in ` @ 60.30
Pay immediately
landed cost 5,000 20
convesrion in ` @ 60.5
Add :Interest @ 14 %

=
=
=
=

1,00,000
2,500
1,02,500
` 61,80,750

=
=
=
=

1,00,000
60,55,000
2,11,925
` 62,66,925

Advice : It is better for Gibralter Limited to pay in 3 months time because it will be chepaer.
3.

(b)

The risk free rate of return Rf is 9 percent. The expected rate of return on the market portfolio Rm
is 13 percent. The expected rate of growth for the dividend of Platinum Ltd. is 7 percent. The
last dividend paid on the equity stock of firm A was ` 2.00. The beta Platinum Ltd. equity stock
is 1.2.
(i)
What is the equilibrium price of the equity stock of Platinum Ltd. ?
(ii)
How would the equilibrium price change when

The inflation premium increases by 2 percent ?

The expected growth rate increases by 3 percent ?

The beta of Platinum Ltd. equity rises to 1.3 ?

[8 Marks ]

Sol.

(b)

(i)

Price

D1
ke g

D1

D0 ( 1 + g)

=
=
=
=
=

2 (1 + 0.07) = 2.14
RF + (Rm RF)
9 + (13 9) 1.20
13.8 or 0.138
0.07

Price

2.14
= ` 31.47
0.138 0.07

ke

(ii)

Revised k e will be
RF + (RM RF) B

9 + ((13 9) + 2) 1.30
=
16.8
g
=
0.10
D1
=
2(1 + 0.10) = 2.20
Hence

D1
2.10
=
= ` 30.88
ke g
0.168 0.10
Alternatively effect of each component on price can be shown seprately
price

Note:

CA-FINAL # 6

ANCE

4.

(a)

Beanstalk Ltd. manages its accounts receivable internally by its sales and credit department.
The cost of sales ledger administration stands at `10 crores annually. The company has a
credit policy of 2/10. net 30. Past experience of the company has been that on an average 40
percent of the customers avail of the discont by paying within 10 days while the balance of the
receivables are collected on average 90 days after the invoice date. Bad debts of the company
are currently 1.5 percent of total sales. The projected sales for the next year are ` 1000 corores.
Beanstalk Ltd.. finances its investment in debtors through a mix of bank credit and own long
term funds in the ratio of 70 : 30. The current cost of bank credit and long term funds are 13
percent and 15 percent respectively.
With escalating cost associated with in house management of debtors coupled with the
need to unburden the management with the sales promotion, the Company is examining the
possibility of outsourcing its factoring service for managing its receivable and has two
proposals on hand with a guaranteed payment within 30 days.
The main elements of the Proposal 1 from Finebank Factors Ltd. are:

Advance, 88 percent and 84 percent for the recourse and non recourse arrangements.
Discount charge in advance. 21 percent for with recourse and 22 percent without
recourse.
Commission. 4.5 percent without recourse and 2.5 percent with recourse.

The main elements of the Proposal II from Roughbank Factors Ltd. are :

Advance, 84 percent with recourse and percent without recourse respectively.

Discount charge upfront without recourse 21 percent and with recourse 20 percent.

Commission upfront, without recourse 3.6 percent and with recourse 1.8 percent.

The opinion of the Chief Marketing Manager is that inthe context of the factoring arrangement.
his staff would be able exclusively focus on sales promotion which would result in additional
sales of 10% of projected sales. Kindly advice as a financial consultant on the alternative
proposals. What advice would you give ? Why
[ 12 Marks ]
Sol.(a) 1.

Proposal I - Factoring from Finebank Factors Ltd

Details

1.

With Recourse

Without Recourse

15
[1000 1.5%]

21.91

21.91

8.00
(1000 40 % 2 %)

8.00
(1000 40 % 2 %)

25.00
(1000 2.5%)

45.00
(1000 4.5%)

Interest to factor
on advance

15.40
(1000 88% 21% 30/360)

15.40
(100084%22%30/360)

Interest on own
fund

1.50
(1,000 12 % 15% 30/360)

2
(1000 16 % 15% 30/360)

(11.99)

(17.49)

Benefits
(1) Bad Debts
(2)

Saving in interest

(3)

Discount

Costs
Factoring
commission

Net Benefit/cost

CA-FINAL # 7

ANCE

2.

Proposal II - Factoring from Roughbank Factors Ltd

1. Benefits
(1) Bad Debts

(2) Saving in
(3) Discount
Costs
Factoring
commission
Interest to factor on
advance
Interest on own
fund

Without Recourse

With Recourse

Details

15
[1000 1.5%]

21.91
8.00
(1000 40 % 2 %)

21.91
8.00
(1000 40 % 2 %)

18.00
(1000 1.8%)

36.00
(1000 3.6%)

14.385
12.73
(1000 84% - 18) 21% 30/360
(100080% - 36) 20%1/12
2.225
2.5
(1000 16% + 18) 15% 30/360 (1000 20% + 36) 15% 30/360

Net Benefit/cost

(4.70)

(6.32)

Note 1: Saving in Interest

= Average Debtors due WACC = 161.11 13.60% = ` 21.91 Crores
Note 2: Calculation of Average Debtors

TYPE
Average O/s

Total Credit Sales = 1000 Crores

I: 40% repaying within 10 Days i.e. ` 400 II: 60% repaying within 90 Days i.e. ` 600
400
600
10 days = ` 11.11 Crores
90 days = ` 150.00 Crores
360
360

Total
Debtors O/s

11.11 + 150.00 = ` 161.11 Crores

Note 5: WACC for Debtors funding

Details
Equity
Bank Credit

Ratio

%
0.30
0.70

Product
15
13

4.50
9.10
13.60

Note: Benefit due to increase in sales are same in all cases Hence ignored for decision making
purpose. If such benefit higher than 4.70 crore then we should accept factoring from rough
bank with recourse.
(b)

Cinderella Mutual Fund has the following assets in Scheme Rudolf at the clsoe of business on
31st March, 2014.
Company

No. of Shares

Market Price Per Share

Nairobi Ltd.

25000

Dakar Ltd.

35000

` 300

Senegal Ltd.

29000

` 380

Cairo Ltd.

40000

` 500

20

The total number of units of Scheme Rudolf are 10 lacs. The Scheme Rudolf has accrued
expenses of ` 2,50,000 and other liabilities of ` 2,00,000. Calculate the NAV per unit of the
Scheme Rudolf.
[4 Marks]
CA-FINAL # 8

ANCE

Sol.

(b)

Calculation of NAV Per unit

Particulars
Nairobi Ltd.
Dakar Ltd.
Senegal Ltd.
Cairo Ltd.

25000 20
35000 300
29000 380
40000 500

Amount
5, 00,000
10,50,000
1,10,20,000
2,00,00,000
4,20,20,000

Less : Liabilities
Accrued Expenses
Other Liabilities

2,50,000
2,20,000

Net Assets

415,50,000

No. of units

10,00,000

NAV
5.

(a)

Sol.

(a)

41.55

Buenos Aires Limited has 10 lakh equity shares outstanding at the beginning of the year 2013.
The current market price per share is ` 150. The company is contemplating a dividend of ` 9
per share. The rate of capitalization. appropriate to its risk class, is 10%.
(i)
Based on MM approach. calculate the market price of the share of the company when:
(1)
Dividend is declared
(2)
Dividend is not declared
(ii)
How many new shares are to be issued by the company. under both the above options,
if the Company is planning to invest ` 500 lakhs assuming a net income of ` 200
lakhs by the end of the year ?
[ 8 Marks ]
(i)
(1)
If dividend is declared
P1
= P0 (1 + ke) D1
= 150 (1.10) 9
= 156
(2)
If dividend not declared
P1
= P0 (1 + ke) D1
= 150 (1.10) 0
= 165
(ii)
Calculation of new share to be issued
(1)

=
=

(2)

=
=
or

(b)

I (E nD1 )
P1
500 (200 10 9)
= 2.5 lakh or 2,50,000 shares
156
500 (200 10 0)
165
1.818 lakh shares
1,81,818.18 shares

Odessa Limited has proposed to expand its operations for which it requires funds of $ 15
million, net of issue expenses which amount to 2% of the issue size. It proposed to raise the
funds though a GDR issue. h considers the following factors in pricing the issue :
(i)
The expected domestic market price of the share is ` 300
(ii)
3 shares underly each GDR
(iii)
Underlying shares are priced at 10% discount to the market price
(iv)
Expected exchange rate is ` 60/$
You are required to compute the number of GDR's to be issued and cost of GDR to Odessa
Limited, if 20% dividend is expected to be paid with a growth rate of 20%.
[ 8 Marks ]
CA-FINAL # 9

ANCE

Sol.

(b)

2.

1.

Basics

(a) Fund Requirem ent

= 15 m illion USD

(b) Issue Cost

= 2% of Issue size

(c) Issue Size

No. of GDR to Issue

(a)
(b)
(c)
(d)

MPS of 1 Share
Issue Price of 1 Share
Issue Price of 1 GDR
Hence, Issue Price of 1 GDR (in INR)

(e) Issue Price of 1 GDR (in USD)

No. of GDR
3.

Note:

Sol.

(a)

810
= 13.5 USD
60

15.31 million 13.5 = 1.134 million

Ke

D1
g 100
Po

D1

Po
g

=
=

(100 20%) 3
60
13.50
20%

=1
= 13.50
= 0.20

0.20 100

= 27.41%
13.50

Face value of each share is assumed as 100

Ke

(a)

= ` 300
= 300 10% discount = 270
= 3 Shares
= 3 270 = 810

Cost of GDR
(a)

6.

15 m illion
15 . 31 m illion USD
(100 2 %)

Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited has 5

lakh shares having market value of ` 40 per share while Cabbage Limited has 3 lakh shares
having market value of ` 25 per share. The EPS for Cabbage Limited and Cauliflower Limited
are ` 3 per share and ` 5 per share respectively. The managements of both the companies are
discussing two alternatives for exchange of shares as follows:
(i)
In proportion to relative earnings per share of the two companies.
(ii)
1 share of Cauliflower Limited for two shares of Cabbage Limited.
Required :
(i)
Calculate the EPS after merger under both the alternatives.
(ii)
Show the impact on EPS for the shareholders of the two companies under both the
alternatives.
[ 10 Marks ]
Alternative 1 : Exchange in prportion of relative EPS
3
= 0.6 : 1
5
No. of share to be issued

Exchange Ratio =

Total no. of share

Calculation of post merger EPS
EAT of caulifower Ltd. (5 L 5)
EAT of Cabbage Ltd. (3L 3)
Post Merger earning
- New no. of shares
Post merger EPS
Impact on EPS.

=
=
=
=

3,00,000 0.6
180000
5,00,000 + 1,80,000
6,80,000
25,00,000
9,00,000
34,00,000
6,80,000
5

CA-FINAL # 10

ANCE

Caulifower Ltd. Cabbage Ltd.

Post Merger

3
(5 0.6)

()

Pre Merger

Nil

Nil

Alternative 2 : 1 share for every 2 share

Exchange Ratio
No. of share to be issued
Total no. of share

1
= 0.5 : 1
2

3,00,000 0.5

1,50,000

5,00,000 + 1,50,000

6,50,000

Calculation of post-merger EPS

=

Post merger earning

34,00,000
Post merger shares = 6,50,000 = 5.2307

Impact on EPS
Cauliflower
Post merger

Cabbage

5.2307

2.6153

(5.2307 0.5)
() Pre merger
Impact on EPS
6.

(b)

5.00

3.00

0.2307

(0.3847)

An investor is holding 5,000 shares of X Ltd. Current year dividend rate is ` 3/share. Market of
the share ` 40 each. The investor is concerned about several which are likely to change during
the next financial year as indicated below :
Current

Next

Year

Year

2.5

12%

10%

Market Risk Premium

5%

4%

Beta Value

1.3

1.4

Expected growth

9%

7%

Dividend paid/anticipated per share (`)

Risk free rate

[ 6 Marks ]

In view of the above. advise whether the investor should buy. hold or sell the shares.
Sol.

(b)

As per CAPM Model E(RP)

Under changing factos
E(RP)

RF + (Rm RF)

10 + 4 1.4

15.6

According to gordon model value of share should be

P

=
=
=

D1
k eg
2.5
0.156 0.07
29.069

Idealy value should be 29.069, where as actual market price is ` 40 Hence investor should sell
the share.
CA-FINAL # 11

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7.

Write short notes on any four of the following :

[ 4 4 = 16 Marks ]
(a)
What are the signals that indicate that is time for an investor to exit a mutual fund scheme ?

Sol.

(a)

Signals highlighting the exit of the investor from the mutual fund scheme
(1)

When the mutual fund consistently under performs the broad based index, it is high
time that it should get out of the scheme.

(2)

When the mutual fund consistently under performs its peer group instead of it being at
the top. In such a case, it would have to pay to get out of the scheme and then invest
in the winning schemes.

(3)

When the mutual fund changes its objectives e.g. instead of providing a regular income
to the investor, the composition of the portfolio has changed to a growth fund mode
which is not in tune with the investors risk preferences.

(4)

When the investor changes his objective of investing in a mutual fund which no longer is
beneficial to him.

(5)

When the fund manager, handling the mutual fund schemes, has been replaced by a
new entrant whose image is not known.

7.
Sol.

(b)
(b)

What is cross border leasing? State objectives.

Cross-border leasing is a leasing agreement where lessor and lessee are situated in different
countries. This raises significant additional issues relating to tax avoidance and tax shelters. It
has been widely used in some European countries, to arbitrage the difference in the tax laws of
different countries.
Cross-border leasing have been in practice as a means of financing infrastructure development
in emerging nations. Cross-border leasing may have significant applications in financing
infrastructure development in emerging nations - such as rail and air transport equipment,
telephone and telecommunications, equipment, and assets incorporated into power generation
and distribution systems and other projects that have predictable revenue streams. A major
objective of cross-border leases is to reduce the overall cost of financing through utilization by the
lessor of tax depreciation all owances to reduce its taxable income, The tax savings are passed
through to the lessee as a lower cost of finance. The basic prerequisites are relatively high tax rates
in the lessors country, liberal depreciation rules and either very flexible or very formalistic rules
governing tax ownership.

7.
Sol.

(c)
(c)

Explain Take over by reverse bid.

Generally, a big company takes over a small company. When the smaller company gains control of
a larger one then it is called Take-over by reverse bid. In case of reverse take-over, a small company
takes over a big company. This concept has been successfully followed for revival of sick industries.
The acquired company is said to be big if any one of the following conditions is satisfied:
(i)

The assets of the transferor company are greater than the transferee company;

(ii)

Equity capital to be issued by the transferee company pursuant to the acquisition

exceeds its original issued capital, and

(iii)

The change of control in the transferee company will be through the introduction of
minority holder or group of holders.

Reverse takeover takes place in the following cases:

(1)
When the acquired company (big company) is a financially weak company
(2)

When the acquirer (the small company) already holds a significant proportion of shares
of the acquired company (small company)

(3)

When the people holding top management positions in the acquirer company want to
be relived off of their responsibilities.
The concept of take-over by reverse bid, or of reverse merger, is thus not the usual
case of amalgamation of a sick unit which is non-viable with a healthy or prosperous
unit but is a case whereby the entire undertaking of the healthy and prosperous company
is to be merged and vested in the sick company which is non-viable.
CA-FINAL # 12

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7.

(d)

What are the risks to which foreign exchange transactions are exposed ?

Sol.

(d)

A firm dealing with foreign exchange may be exposed to foreign currency exposures. The
exposure is the result of possession of assets and liabilities and transactions denominated in
foreign currency. When exchange rate fluctuates, assets, liabilities, revenues, expenses that
have been expressed in foreign currency will result in either foreign exchange gain or loss.
A firm dealing with foreign exchange may be exposed to the following types of risks:
(i)

Transaction Exposure: A firm may have some contractually fixed payments and
receipts in foreign currency, such as, import payables, export receivables, interest
payable on foreign currency loans etc. All such items are to be settled in a foreign
currency. Unexpected fluctuation in exchange rate will have favourable or adverse impact
on its cash flows. Such exposures are termed as transactions exposures.

(ii)

Economic Exposure: Economic exposure measures the probability that fluctuations

in foreign exchange rate will affect the value of the firm. The intrinsic value of a firm is
calculated by discounting the expected future cash flows with appropriate discounting
rate. The risk involved in economic exposure requires measurement of the effect of
fluctuations in exchange rate on different future cash flows.

7.

(e)

Explain the term insider Trading and why Insider Trading is punishable ?

Sol.

(e)

The word insider has wide connotation. An outsider may be held to be an insider by virtue of
his engaging himself in this practice on the strength of inside information.
Insider trading practices are lawfully prohibited. The regulatory bodies in general are imposing
different fines and penalties for those who indulge in such practices. Based on the
recommendation of Sachar Committee and Patel Committee, SEBI has framed various
regulations and implemented the same to prevent the insider trading practices. Recently SEBI
has made several changes to strengthen the existing insider Trading Regulation, 1992 and new
Regulation as SEBI (Prohibition of Insider Trading) Regulations, 2002 has been introduced.
Insider trading which is an unethical practice resorted by those in power in corporates has
manifested not only in India but elsewhere in the world causing huge losses to common investors
thus driving them away from capital market. Therefore, it is punishable.

CA-FINAL # 13