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8/10/2019 AFM Back End Term

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Roll number..........................

MBA IV Trimester

End Trimester, (November- 2014)

Paper NameAdvanced Financial Management

Paper Code403 FM

Maximum Time: 03 Hours Maximum Marks: 40

Note: All questions are compulsory.

1. Attempt one line question (1* 6=6)

1.1How can a newly established firm be known as an Adequately Capitalized Firm?

1.2If the Current market Price of Bond is same as the maturity Amount of Bond, what could

you say about the valuation of the Bond?

1.3What do you mean by DSCR? Why is it important for Banks?

1.4

Define all the Components of Cost of Holding Cash?

1.5

What do you mean by Dividend Re-investment plan?

1.6What is the Relationship between DOL, DFL and DTL in case of pure equity Firm?

2. Short answer type (Attempt any three out of five) (3*3= 9)

2.1Explain the MM Approach of Capital Structure?

2.2

The following figures relate to two companies : (Rs. in lakhs)

X Ltd. Z Ltd.

Sales 700 1,200

Variable Costs 500 700

Contribution 200 500

Fixed Costs 150 400

EBIT 200 400

Interest 100 200

Profit before Tax 100 200

A. Calculate the Operating, Financial and Combined Leverage for the 2 companies.


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B. Comment on the relative risk position of them

2.3Explain the Phased Growth Model of Stock Valuation?

2.4A company generates $10,000 per month excess cash, which it intends to invest in short-

term securities. The interest rate it can expect to earn on its investment is 5% pa. The

transaction costs associated with each separate investment of funds is constant at $50.

(a)What is the optimum amount of cash to be invested in each transaction?

(b)How many transactions will arise each year?

(c)What is the cost of making those transactions per Annum?

(d)What is the opportunity cost of holding cash per Annum?

2.5 Explain different methods of Stock Repurchase?

3.

Long answer type ( any two out of three)

(2*7.5=15)

3.1

Explain Miller-orr Model of Cash Management with an Example?

3.2

Explain the Walters Model and Gordons Model of Dividend Policy?

3.3Explain Net Operating Income Approach of Capital Structure with Suitable Graph?

4. Case study (10 marks)

Share Buybacks: A Win-win Situation?

Indian companies have been witnessing a large cash build-up average cash reserves with

the BSE Sensex constituents increased from ~Rs 325.7 crore to ~Rs 6,000 crore, a staggering

CAGR of 38.2 per cent during 20052013.

With huge piles of cash, India Inc. now faces a double dilemma. On the one hand, the global

recession is a thing of the past and, on the other, domestic economic growth and activity are

expected to remain benign over the medium term.

A large cash build-up, without adequate avenues to invest the excess cash, leaves companies

with two primary options to return money to shareholders: a cash dividend or a stockbuyback.

Given the long-term signaling impact of a cash dividend whereby shareholders start

expecting future dividends on the basis of the current dividend, a stock buyback may be the

preferred method of rewarding shareholders. Analysing the empirical data for the 50 recent

buybacks in India (amounting to Rs 25,000 crore) and their relative performance over a six-

month period after the buyback was announced, throws up some results.

On an average, buyback of shares was offered at a premium of ~25 per cent


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Mean adjusted return (mean return of the stocks over and above the Sensex return) for

the data was ~10 per cent, while the median return was roughly -3 per cent

The huge difference between the mean and the median was due to the fact that while

some stocks produced returns of more than 100 per cent, others underperformed

sensex and lost value over time

A closer look at some of the recent largest outperformers and underperformers reveals: DCM

Shrirams and Infinite Computer Solutions buybacks stand out as successful programmes,

while that of JBF Industries and Sinclairs Hotels werent very successful.

The single most critical factor that separated the successful vs. not so successful programme

was timing. While managers at DCM Shriram and Infinite Computer Solutions managed to

invest in their own stocks when the stocks (on a P/E multiple basis) seemed undervalued,their counterparts at JBF and Sinclairs Hotels misread the markets and initiated buybacks at a

time when valuations were sky high, i.e., overvalued.

In conclusion, a buyback decision may always seem like an attractive option when

management has excess cash on hand. But the reality is not all buybacks are destined to be

successful. Success or failure of any buyback depends largely on getting the choice of your

investment timing right. Well, its not an easy choice to make.

With huge piles of cash, India Inc. now faces a double dilemma on the one hand, the

global recession is a thing of the past and, on the other, domestic economic growth and

activity is expected to remain benign over the medium term, meaning neither do you need a

war chest to stay afloat nor that growth opportunities are abundant.

The million dollar question is what do you do with such deep pockets then? A large cash

build-up, without adequate avenues to invest the excess cash, leaves companies with two

primary options to return money to shareholders: a cash dividend or a stock buyback. Given

the long-term signaling impact of a cash dividend whereby shareholders start expecting future

dividends on the basis of the current dividend, it would seem that a stock buyback may be the

preferred method of rewarding shareholders.

- Being a Future Manager do you agree with the following Strategy of Share Buyback?

Explain?

- Can the Restructuring of Capital Structure be the other alternative in case of high

Cash Reserves? Explain?

- What impacts more on Value of Firm Capital Restructuring, Share Buyback or Stock

Dividends? Explain?


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- Do Companies Fail in Cash Management when it comes to such high Cash Reserves?

Explain?

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