Description

Corporate Finance

Sep 2026 Examination

 

Q1 An Indian consumer electronics company is considering a major investment in a new automated manufacturing line and an in-house R&D center for smart appliances. The proposal requires a large upfront outlay and is likely to reduce reported profits for the next two years due to depreciation, training costs, and development expenses. However, management expects better product quality, lower defect rates, stronger brand positioning, and higher cash flows over the next seven years. Some board members prefer postponing the project to protect short-term earnings, while others argue it can strengthen competitive advantage and improve shareholder wealth in the long run. Applying the concept of wealth maximization, how should the CFO evaluate and justify this investment decision using risk, time value of money, and long-term shareholder value considerations instead of relying only on short-term profit impact? (10 Marks)

Ans 1.

Introduction

This consumer electronics company’s automation and R&D investment illustrates the classic tension between short-term reported earnings and long-term shareholder wealth maximization. Applying wealth maximization as the guiding principle, rather than short-term profit protection, gives the CFO a coherent framework for justifying this investment using risk, time value of money, and long-term value creation, directly addressing the board’s

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Q2 Investment Requirements: An investor must accumulate exactly Rs.1,50,00,000 at the end of 12 years to meet a liability. Investment Structure: the investment policy permits the following structure only – an immediate deposit today, equal annual end-of-year deposits for years 1 to 8, no deposits in years 9 and 10, equal annual beginning-of-year deposits in years 11 and 12. Interest Rates: the account earns 9% nominal for the first 5 years compounded quarterly, 8.4% effective annually for the next 4 years, and a force-equivalent annual rate such that money doubles in 8 years for the final 3 years. Deposit Structure: the annual end-of-year deposit from years 1 to 8 must be 1.5 times the immediate deposit; each beginning-of-year deposit in years 11 and 12 must be 80% of the annual end-of-year deposit. Objective: Determine the immediate deposit and the common annual end-of-year deposit required, showing all time-value equivalences across changing compounding conventions. (10 Marks)

Ans 2.

Introduction

This problem requires determining an immediate deposit and a related annual deposit that together accumulate to a specified future liability, across three distinct interest rate regimes and a mixed pattern of end-of-year and beginning-of-year deposits. Applying time value of money principles consistently across changing compounding conventions is essential to solving this correctly.

Concept and Application

Understanding the Deposit and Rate Structure

The twelve-year horizon is divided into three distinct interest rate periods, requiring every

 

Q3(A) Expansion Financing Overview: Company is evaluating its marginal weighted average cost of capital for a Rs.300 crore expansion. Target Market-Value Mix: Equity 50%, Debt 35%, Redeemable Preference Shares 15%. Available Retained Earnings: Rs.72 crore. New Equity Issuance: new equity, if issued beyond retained earnings, will be sold at Rs.480 per share, flotation cost on issue price 4%, current dividend Rs.24 per share, expected dividend growth 7% for the next 3 years and 5% perpetually thereafter. Debt Financing: existing debt can be raised up to Rs.90 crore through 10-year debentures, coupon rate 9%, issued at 96% of face value, flotation cost on face value 2%; any debt beyond this limit will require secured borrowing at an effective pre-tax yield of 11.2%. Preference Shares: issued at Rs.95 net proceeds per Rs.100 face value, dividend 10%, redeemable at par after 8 years. Corporate Tax Rate: 30%. Objective: Compute the marginal WACC applicable to the full Rs.300 crore expansion, identifying the breakpoint at which the cost of equity and/or debt changes and using the appropriate cost for each financing tranche. (5 Marks)

Ans 3A.

Introduction

Computing marginal WACC for this Rs 300 crore expansion requires identifying breakpoints where the cost of equity or debt changes due to exhausting cheaper financing sources, then applying the correct marginal cost for each financing tranche within the target capital structure.

Concept and Application

Why Marginal WACC Requires Breakpoints

As a firm raises more capital, cheaper internal sources like retained earnings and existing

 

 

Q3(B) Project Cash Flows: Year 0: -Rs.140 crore, Year 1: Rs.32 crore, Year 2: Rs.46 crore, Year 3: -Rs.18 crore, Year 4: Rs.54 crore, Year 5: Rs.68 crore. Financial Assumptions: Finance Rate 13%, Reinvestment Rate 10%. Reinvestment Details: Year 4 inflow will be reinvested for only half a year at the reinvestment rate. The firm plans a terminal distribution midway through Year 5. All other positive cash flows will be reinvested to the terminal date at the stated annual reinvestment rate on an effective basis. Objective: Compute the project’s MIRR to the terminal date at the end of Year 5. Treat the negative cash flows at Years 0 and 3 appropriately under the finance rate. (5 Marks)

Ans 3B.

Introduction

Computing MIRR for this project requires discounting negative intermediate cash flows back to time zero at the finance rate, compounding positive cash flows forward to the terminal date at the reinvestment rate, then solving for the single rate that equates these two values over the project horizon.

Concept and Application

Why MIRR Differs from IRR