FORE School of Management, New Delhi
Post Graduate Diploma in Management (FMG-30/IMG-15/FM-04/BDA-02/FPM-03)
End Term Examination Term- 2 (2021-2022)
Course Name: Corporate Finance
Time: 2 Hours Max Marks: 100
Instructions: a. This question paper contains 3 Pages
b. Possession and use of cell phone is prohibited
c. Scientific calculator can be used.
d. Be brief and to the point in the response
e. State assumptions made, if any
f. Answer all questions
g. Marks are indicated in the right hand parenthesis against
each question.
h. Answers should be rounded to 2 nearest decimal points
wherever required.
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Q. 1(A). Empire Limited needs ₹10,00,000 to build a new factory which will yield EBIT of
₹150000 per year. The company has to choose between two alternative financing plans: 75
percent equity and 25 per cent debt or 50 per cent equity and 50 per cent debt. Under the first
plan shares can be sold at ₹50 per share, and the interest on debt will be 14 per cent. Under the
second plan shares can be sold for ₹40 per share and the interest rate on debt will be 16 per
cent. Which plan is better and why? Assume a tax rate of 35 percent. (10 Marks)
Q. 1(B). For XYZ limited the following data is given:
EBIT ₹ 200
Contribution ₹400
Interest ₹ 100
If the company’s sales are expected to decline by 5 per cent, determine DOL, DFL and DCL.
What do you interpret from your answer about the risk of the firm? (10 Marks)
Q. 2(A). ABC Company has the following shareholder’s equity account: (10 Marks)
Common stock ($8 par value) $2,000,000
Additional paid-in capital 1,600,000
Retained Earnings 8,400,000
Shareholders’ equity $12,000,000
The current market price is $60 per share.
1. What will happen to this account and to the no. of shares outstanding with a:
a) 20% stock dividend b) 2:1 stock split
2. In the absence of signalling effect what price should the stock sell after the stock
dividend?
3. What will you expect the price to be if there were a signalling effect?
Q. 2(B). Zenith Electronics repurchased 1 million of 14 million shares outstanding at $98 a
share. Immediately before the before the announcement, market price was $91. After the
repurchase, the price went to $105. (10 Marks)
a. What would explain this rise if there was no other information concerning the company
or stock?
b. Was the offer price by the company the correct repurchase price?
Q. 3(A). Sysco Corporation currently has an all- cash credit policy. It is considering making a
change in the credit policy by going to terms of net 30 days. The required rate of return is 0.95
percent per month. Below are the details of current and new policy of the firm.
Current Policy New Policy
Price per unit $289 $296
Cost per unit $226 $229
Unit Sales per month 1,105 1,125
Based on the above information, what do you recommend? Should the company adopt a new
credit policy? (15 Marks)
Q. 3(B). Indicate the effect (Increase/Decrease/No Change) of the following will have on the
cash and operating cycle of the firm: (10 Marks)
Sr. Cash Operating
No Cycle Cycle
1 The terms of cash discount offered to customers are made less - -
favourable.
2 The cash discount offered by suppliers are increased; thus - -
payments are made earlier.
3 An increased number of customers begin to pay in cash instead - -
of with credit.
4 A greater percentage of raw material purchases are paid for - -
with credit.
5 More finished goods are produced for inventory instead of for - -
order.
Q. 4. SRK company has a debt to equity ratio of 2:3. The company’s bonds with face value of
₹1,000 pay a 10% coupon (annual), mature in 20 years, and sell for ₹850.64. The company
stock beta is 1.2 and the risk-free rate is 10%. The market return is given as 15%. The
company’s marginal tax rate is 40%. You need to compute the WACC of the firm.
. (20 Marks)
Q. 5. Seagate Limited is a steel manufacturing company which have a turnover of 543 Million
Rupees. Recently, Mr. Ramanujan joined the Seagate Limited as a CEO. Mr. Ramanujan is a
technically-educated CEO (Technically educated CEO means when CEO has less knowledge
of finance and have graduate and post-graduate degrees in engineering/operations/natural
sciences). Mr. Ramanujan explored the opportunities for firm and planning for expansion
which will require huge amount of funds. Mr. Ramanujan had a meeting with finance manager
(Mr. Kamath) to suggest the better financing for upcoming projects. Mr. Kamath suggests that
firm can raise funds by issuing equity/debt or mix of equity and debt. Mr. Kamath has also
highlighted that firm should consider the outcome of previous fund raising sources on firm’s
share price, investor and firm value. Some of the previous records are following.
a. Firm has experienced a high increment in its share price when raise funds through debt
in 2017.
b. Firm has also experienced that share price fall when raise funds through equity in 2019.
c. Firm share price falls when firms raised huge amounts of funds by using debt in 2020.
d. Firm also reported a decline in agency cost when firm raised funds through debt.
e. Firm did not used any external finance while used internal funds to finance projects in
2015.
f. Firm was also about to be bankrupt in 2009 when it was failed to pay interest and
principal of loan.
Considering the above-mentioned previous records, Mr. Kamath proposed to Mr. Ramanujan
that firm should raise funds by issuing mix of debt and equity. Now, Mr. Ramanujan has to
finalize the decisions but this will not be easy for him because he is a technically educated
CEO. You have to help Mr. Ramanujan as an external finance manager to understand the role
of debt and equity issue on firm’s share price/firm value. Additionally, you have to cover that
what firm will lose or gain if its issue more debt over equity. Further, is it necessary to raise
funds or firms can use their internal funds to finance opportunities. Considering the above-
mentioned case, you have to provide the fundamentals of capital structure which will help Mr.
Ramanujan to take final decision. (15 Marks)
