Description

Strategic Financial Management

September 2024 Examination

 

 

Q1.  Oxford Corporation is evaluating a new project that requires an initial investment of INR 15,00,000. The project is expected to generate cash flows over the next five years, but there is considerable risk surrounding these cash flows due to market volatility. Based on the company’s analysis, the following information is available:

• The initial investment is INR 15,00,000
• The expected cash flows from the project for each year are as follows: Year 1: INR 4,00,000

Year 2: INR 5,00,000

Year 3: INR 6,00,000

Year 4: INR 7,00,000

Year 5: INR 8,00,000

• The discount rate for the project is 10% and the Risk adjusted discount rate is 20%

1. Determine the Net Present Value (NPV) using the Risk adjusted discount rate.
2. Can the project be accepted, if the risk adjusted discount rate is increased to 25% (10 Marks)

Ans 1.

Introduction

In the realm of strategic financial management, evaluating the viability of investment projects is crucial for sustaining corporate growth and financial health. One of the primary tools used for this purpose is the Net Present Value (NPV) method, which helps in assessing the profitability of a project by discounting future cash flows to their present values using a specified rate that incorporates risk. This analysis considers a hypothetical scenario involving Oxford Corporation, which is contemplating a significant investment in a new project. Given the project’s associated risks and expected future cash flows, the evaluation becomes particularly complex as it involves adjusting the discount rate to account for market volatility. The decision to proceed with the investment hinges on whether the calculated NPV is positive, indicating that the project’s returns exceed its costs under varying levels of risk.

Concept and Application

The purpose of calculating NPV is to determine whether the projected earnings (in present dollars) exceed the anticipated costs (also in present dollars). A positive NPV suggests that

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Q2. The board of directors of Varun Limited are deliberating over its dividend policy. As a financial analyst, you’ve been tasked with providing recommendations regarding dividend policy that align with the company’s goals and objectives. Considering the various factors influencing dividend policy decisions, analyze and provide recommendations for Varun Limited’s dividend policy.    (10 Marks)

Ans 2.

Introduction

Dividend policy remains a central topic in corporate finance, directly impacting investor satisfaction and influencing future investment opportunities. For Varun Limited, setting the right dividend policy is crucial to aligning with its strategic goals and maximizing shareholder value. A company’s dividend policy not only reflects its current financial health but also signals its future growth prospects and operational stability to the market. As a financial analyst, recommending an appropriate dividend policy involves a thorough analysis of the company’s earnings stability, cash flow situation, growth opportunities, and shareholders’ preferences. These factors collectively guide the formulation of a policy that supports the company’s long-term objectives while maintaining financial flexibility and

 

Q3a. Digital Gadgets Ltd pays INR 10 as annual preference dividend and has the required rate of return as 12%. Compute the market price of the preference shares of Digital Gadgets Ltd? Will you buy this share if it is currently selling at INR 80 per share?    (5 Marks)

Ans 3a.

Introduction

The valuation of preference shares is an essential aspect of investment decisions, providing insights into the appropriateness of the market price relative to expected returns. Digital Gadgets Ltd offers an annual preference dividend of INR 10, with a required rate of return of 12%. Analyzing whether these shares are a viable investment option at their current market price requires understanding the theoretical price and comparing it with the actual market price.

Concept and Calculation

Preference shares are a type of hybrid financing instrument that exhibits characteristics of

 

 

Q3b. Call Option on stock of Arvind Ltd. having expiration date of 31 Dec 2024 at a Strike price (K) of Rs.2500 is available at an option premium of Rs.200. Compute the profit/loss when the spot price is INR 2800 on 31 Dec 2024.  (5 Marks)

Ans 3b.

Introduction

Options are financial derivatives that provide the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price before a specified date. A call option gives the holder the right to buy the asset. Here, we evaluate the profit or loss of a call option on Arvind Ltd.’s stock, with a strike price of INR 2500 and an option premium of INR 200, given that the spot price on the expiration date is INR 2800.

Concept and Calculation

Options Terminology: