MS-42

MANAGEMENT PROGRAMME
Term-End Examination
December, 2009
MS-42 : CAPITAL INVESTMENT AND
FINANCING DECISIONS
Maximum Marks : 100
(Weightage 70%)

Time : 3 hours

Note :
Attempt any five questions.
All questions carry equal marks.
Present value tables will be provided, if asked for.
Use of calculators is allowed.
What do you understand by Divestiture ? Explain
its salient features and distinguish it from
spin-offs and Carve - outs. How would you
undertake financial assessment of a divestiture
proposition ? Explain.

(a) Why do the companies prefer stable

dividend policy ? Explain the three forms
in which stability may be maintained while
distributing dividends.
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(b) Distinguish between a fixed rate bond and

a floating rate bond. How is the rate of
interest determined in case of a floating rate
bond ? If you have to make a choice
between the two, which one would you
prefer and why ? Explain giving reason.
What do you understand by securitisation of
assets ? Explain the process of securitisation and
its advantages to the various parties. What types
of assets are suitable for securitisation ? Explain.
The following figures are made available to you :
Rs.
Net profit for the year interest on
18,00,000
secured Debentures at 15% p.a.
(Debentures were issued 3 months

1,12,500
after the commencent of the year)
16,87,500
Income Tax at 35% and
Dividend Distribution Tax
Profit after tax.
No. of equity shars (Rs. 10 each)
Market Price of equity share

8,43,750
8,43,750
1,00,000
109.70

The company has accumulated revenue reserves

of Rs. 12,00,000. The company is examming a
project requiring an investment of Rs. 10,00,000.
This investment is expected to earn the same rate
of return as funds already employed. You are
informed that a debt equity ratio (debt divided by
MS-42

debt plus equity) higher than 60% will cause the

price earning ratio to come down by 25% and the
additional rate of interest on additional
borrowings will cost the company 300 basis points
more than on their current borrowings on secured
debentures. You are required to advise the company
on the probable price of the equity share, if
the additional investments were to be raised
by way of loans, or
the additional investments were to be raised
by way of equity.
What do you understand by work Breakdown
Structure (WBS) ? In what ways may WBS be
used as a key document to monitor and control a
project ? Explain.
Explain the Decision Tree Analysis as a risk
analysis technique. When is it used in capital
budgeting decisions ? Explain.
7.

Distinguish between any four of the following :

Horizontal Merger and Vertical Merger.
Differential Voting Rights Equity Shares and
Rights Shares.
Cost of equity shares and cost of retained
earnings.
Commercial Paper and Commercial Bill of
exchange.
(e) Bank Rate and Prime Lending Rate.

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8.

A company is currently considering

modernisation of a machine originally costing
Rs. 50,000 (current book value zero). However,
it is in good working condition and can be sold
for Rs. 25,000.
Two choices are available. One is to
rehabilitate the existing machine at a total cost
of Rs. 1,80,000 and the other is to replace the
existing machine with a new machine costing
Rs. 2,10,000 and requiring Rs. 30,000 to instal.
The rehabilitated machine as well as the new
machine would have a six year life and no salvage
value. The projected after tax profits under the
various alternatives are :
Expected After Tax Profits
Existing Rehabilitated
New
Year
Machine
Machine
Machine
Rs.
Rs.
1
2,00,000
2,20,000
2,40,000
2
2,50,000
2,90,000
3,10,000
3
3,10,000
3,50,000
3,50,000
4
3,60,000
4,00,000
4,10,000
5
4,10,000
4,50,000
4,30,000
6
5,00,000
5,40,000
5,10,000
The firm is taxed at 35%. The company uses the
straight line depreciation method and the same is
allowed for tax purposes. Ignore block assets
concept. The cost of capital is 12%. Advise the
company whether it should rehabilitate the
existing machine or should replace it with new
machine. Also state the situation in which the
company would like to continue with the existing
machine.
-o0o-

MS-42