# Model Question answer of Corporate Finance

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We will look after the TU BBS 4th year Model Question answer of Fundamentals of Corporate Finance.

## Model Question answer of Corporate Finance

Year: BBS 4th Year

Subject: Corporate Finance

Subject Code: FIN 250

Full Time: 100

Time: 3 hrs

Candidates are required to give their answers in their onw words as far as practicable.

### Group A

Brief Answer Question ( Attempt all questions ) (10*2 = 20 )

1. Define corporate social responsibility with example.

2. What do you mean by agency problem? List out the parties involved in agency problem.

3. What are the three different ways capital is transferred between savers and borrowers?

4. What is yield curve?

5. Differentiate between primary market and secondary markets. Answer: CLICK HERE

6. Why does a firm include call provision in bond issue?

7. Why is preferred stock is called hybrid security?

8. A call option on birat Company’s stock has a market price of Rs. 7. The stock sells for Rs. 30 a share, and the option has an exercise of Rs. 25 a share. What is the exercise value of the call option.

Given:

Market price of call option: Rs. 7

Market price of stock (S) = Rs. 30

Exercise price (X) = Rs. 25

The exercise value of call option is given by:

Vc = Max [ (S-X) or 0]

= Max [ ( Rs. 30 – Rs. 25) or 0]

= Max [ (Rs. 5 or 0 )]

= Rs. 5

9. What will be annual installment for the loan Rs. 500,000 if the interest rate is 10% and that the loan period is 3 years.

Given:

Amount of loan = Rs. 500,000

Interest rate (i) = Rs. 10%

Maturity (n) = 3 years

Annual installment for the loan is given by:

PMT = (Amount of loan/ PVIFA,10%, 3 years)

= (Rs. 500,000/ 2.4869)

= Rs. 201,053.52

10. The shikhar Company needs to raise Rs. 20 million to finance its expansion into new market. The company will sell shares of equity via a general cash offering to raise the needed funds. The offer price is Rs. 90 per share and the company’s underwriters charge 5 precents spread. How many shares need to be sold.

= Given,

Funds to be raised = Rs. 20,000,000

Offer price per share: Rs. 90

Underwriter’s spread: 0.05* Rs. 90 = Rs. 4.5

Net proceed per share = Rs. 90- Rs. 4.5 = Rs. 85.5

Number of shares to be issued = ( Funds to be raised / Net proceed per share )

= ( Rs. 20,000,000 / Rs. 85.5 )

= 233918.13 shares

### Group B

Descriptive Answer Question ( Attempt any five questions )

11. What do you mean by multinational corporation? Describe the reasons for corporation going global?

12. Is synergy a valid rationale for merger? Describe several situations that might produce synergistic gains.

13. Assume that the real risk free rate is Rs. 3.5 percent and default risk premium is zero. The nominal rate of interest on 1year bond is 5 percent and that on on comparable risk 2 year bond is 6 percent and a 3 year bond is 9 percent, which includes the maturity risk premium of Rs. 1.5 percent.

a. Using the expectation theory, forecast the interest rate on a 1 year bond during the third year.

b. What is the expected inflation rate in year 1, 2 and 3?

c. Comment on the causes why average interest rate is different from interest rate in year 2 and 3.

14. Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has Rs. 20 million in assets, has Rs. 4 million of EBIT, and is in the 40% tax bracket. firm HL, however, has a debt ratio of 50% and pays 12% interest on its debt, whereas LL has a 30% debt ratio and pays only 10% interest on its debt.

a. Calculate the rate of return on equity (ROE) for each firm.

b. Observing the HL has a higher ROE, LL’s treasure is thinking of raising debt ratio from 30% to 60% even though that would increase LL’s interest rate on all debt to 15%. Calculate the new ROE for LL.

15. Himalayan Herbal Company’s 2012 financial statements are shown below:

Balance sheet as of December 31, 2012 (000)

Income Statement for year ended December 31, 2012 (000)

a. Assume that the company was operating at full capacity in 2012 with regard to all items except fixed assts . Fixed assets in 2012 were being utilized to only 75% of capacity. By what percentage could 2013 sales increase over 2012 sales without the need for an increase in fixed assets?

b. Now suppose 2023 sales increase by 25% over 2012 sales. How much additional external capital will be required? Assume that the company cannot sell any fixed assets and any required financing is borrowed as notes payable.

16. Suppose a vacationing American tourist, Mr Ralp flies from New work to London, then on to Munich, and finally back to new work. When he arrives at London he knew U.S dollar is \$ 1.5944 per pound from the foreign exchange listing. He exchange \$2000 for pound and spend 754.339 from the British pounds while there in London. Then he went to France and exchanged his remaining British pound for french francs. He observed indirect quotation between francs and dollars in FF 4.9675.

a. What is the cross rate between pounds and francs? How much hw would receive in francs for \$ 500.

b. After completing his visit in France and he arrives in Germany and need German marks. The dollar basis quotes are FF 4.9675 per dollar and DM 1.4033 per dollar. What is the cross rate between marks and francs? If he had FF 2000 remaining, how much marks he would receive.

c. Finally he returns to New York after vacation ends. If he holds 50 marks and need dollar, what is the indirect quote rate of dollar per mark? What amount of dollar he would receive?

### Group C

Analytical Answer Questions ( Attempt any two questions )

17. What are the reasons companies might use risk management technique? How should derivates be used in risk management? Explain.

18. Sunlight Sailboats estimates that due to the seasonal nature of its business. It will require an additional Rs. 2,000,000 of cash for the month of July. Sunlight has three options available to provide the needed funds. It can

a. Establish a one year line of credit for Rs. 2,000,000 with a commercial bank. The commitment fee will be 0.5%, and the interest charge on the used fund will be 15% per annum. The minimum time the funds can be used is 30 days.

b. Forego the July trade discount of 2/10, net 40 on Rs. Rs. 2,000,000 of account payable.

c. Issue Rs. 2,000,000 of 60 day commercial paper at a 14 percent per annum interest rate. Since the funds are required for only 30 days, the excess funds ( 2,000,000) can be invested in 12% per annum marketable securities for the month of August. The total transaction fee on purchasing and selling the marketable securities is 05% of the fair value.

i. Which financial arrangement results in the lowest rupees costs?

ii. Is the source with the lowest expected cost necessarily the source to select? Why or why not?

19. The stock of the national corporation is selling for Rs. 50 per share. The company the issue rights to subscribe to one new share at Rs. 40 for each right share held.

a. What is the theoretical value of a right when the stock is selling rights on?

b. What is the theoretical value of one right of stock when it goes ex-rights?

c. What is the theoretical value of a right when the stock sells ex-rights at Rs. 50?

d.

Hence, these are the Model Question answer of Corporate Finance .