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1 First Edition : May 2018 Published By : Directorate of Studies The Institute of Cost Accountants of India CMA Bhawan, 12, Sudder Street, Kolkata 700 016 Copyright of these study notes is reserved by the Institute of Cost Accountants of India and prior permission from the Institute is necessary for reproduction of the whole or any part thereof. Work Book Directorate of Studies, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) STRATEGIC FINANCIAL MANAGEMENT FINAL GROUP I II PAPER 14 INDEX Sl. No. Section A : Investment Decisions Page No. 1 Investment Decisions, Project Planning and Control 1 16 2 Evaluation of Risky Proposals for Investment Decisions 17 27 3 Leasing Decisions 28 34 Section B : Financial Markets and Institutions 4 Institutions in Finance Markets 35 36 5 Instruments in Financial Markets 37 47 6 Capital Markets 48 50 7 Commodity Exchange51 53 Section C : Security Analysis & Portfolio Management 8 Security Analysis & Portfolio Management 54 66 Section D : Financial Risk Management 9 Financial Risks 67 - 69 10 Financial Derivatives Instruments for Risk Management 70 79 11 Financial Risk Management in International Operations 80 - 88 Work Book.

2 Strategic Financial Management Directorate of Studies, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 1 Study Note 1 Investment Decisions, Project Planning and Control 1. Choose the correct alternative: (i) If the cost of an investment is 25000 and it results in a net cash inflow of `1800 per annum forever, the Net Profitability Index of the investment is _____(assume a discount rate of 8%) a) b) (-) c) d) (ii) A project has the following cash flows: Year 0 1 2 3 Cash Flow (` Lakh) -25 30 -15 40 If discount rate is 20%, then the NPV of the project is_____ a) b) c) d) (iii) A project with an initial investment of 100 lakhs and life of 10 years generates cash flows after tax (CFAT) of 20 lakh per annum.

3 The Payback Reciprocal is _____ a) 25% b) 20% c) 10% d) 30% (iv) The NPV of a 5 year project is 250 lakh and PVIFA at 10% for 5 years is The Equivalent Annual Benefit of the project is _____ a) ` lakh b) ` c) ` lakh d) ` lakh (v) For an investment project, the following information is available. Annual Cost Savings = ` 4,00,000; IRR = 15%; Useful life = 4 years; PVIFA (15%, 4) = The Payback Period is _____ a) years b) years c) years d) years Work Book: Strategic Financial Management Directorate of Studies, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 2 (vi) The following information is available in case of an investment proposal: NPV at discounting rate of 10% = ` 1250 and NPV at discounting rate of 11% = ` (-) 200.

4 The IRR of the proposal is_____ a) b) c) d) (vii)The Profitability Index of a project is and its cost of investment is ` 250000. The NPV of the project is _____ a) ` 75,000 b) ` 80,000 c) ` 70,000 d) ` 65,000 (viii) From the following information calculate the MIRR of the project. Initial Outlay ` 50000, cost of capital 12% , Life of the project 4 years, Aggregate future value of cash flows ` a) b) c) d) Answer: Question No. i ii iii iv v vi vii viii Answer b c b a a b c a 2. An oil company proposes to install a pipeline for transport of crude from wells to refinery. Investments and operating costs of the pipeline vary for different sizes of pipelines (diameter).

5 The following details have been conducted: (a) Pipeline diameter (in inches) 3 4 5 6 7 (b) Investment required (` lakhs} 16 24 36 64 150 (c) Gross annual savings in operating costs before depreciation (` lakhs) 5 8 15 30 50 The estimated life of the installation is 10 years. The oil company's tax rate is 50%. There is no salvage value and straight line rate of depreciation is followed. Calculate the net savings after tax and cash flow generation and recommend there from, the largest pipeline to be installed, if the company desires a 15% post-tax return. Also indicate which pipeline will have the shortest payback. The annuity PV factor at 15% for 10 years is Work Book: Strategic Financial Management Directorate of Studies, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 3 Solution: (1) Determination of CFAT (` lakhs) Pipeline Diameter (inches) Gross savings Savings after tax Depreciation Tax shield on depreciation Total cost savings (CFAT) (2) 50% (4) X 50% (3) + (5) (1) (2) (3) (4) (5) (6) 3 5 4 8 5 15 6 30 7 50 (2) Payback Period in years Inches ` lakhs Years 3 16 4 24 5 36 6 64 7 150 Therefore, Pipeline diameter of 6 inches has shortest payback period.)

6 (3) Determination of NPV (` lakhs) Pipeline dia. (inches) CFAT for 10 years PV factor @15% 10 Years Total PV Cash Outflow NPV 3 16 4 24 4 36 6 64 7 150 Suggestion - Pipeline of 6 inches diameter has highest NPV and it is recommended for installation. 3. Five Projects M, N, O, P and Q are available to a company for consideration. The investment required for each project and the cash flows it yields are tabulated below. Projects N and Q are mutually exclusive. Taking the cost of capital @ 10%, which combination of projects should be taken up for a total capital outlay not exceeding `3 lakhs on the basis of NPV and Benefit-Cost Ratio (BCR)?

7 (`) Project Investment Cash flow No. of years @10% M 50,000 18,000 10 N 1,00,000 50,000 4 O 1,20,000 30,000 8 P 1,50,000 40,000 16 Q 2,00,000 30,000 25 Work Book: Strategic Financial Management Directorate of Studies, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 4 Solution: Total capital outlay < ` lakh Computation of net present value and Benefit-Cost Ratio for five Projects (`) Project Investment Cash flow No. of years. @ 10% NPV BCR (PV/Investment M 50,000 18,000 10 1,10,610 60,160 N 1,00,000 50,000 4 1,58,500 58,500 O 1,20,000 30,000 8 1,60,050 40,050 P 1,50,000 40,000 16 3,12,960 1,62,960 Q 2,00,000 30,000 25 2,72,310 72,310 Statement Showing Feasible Combination of Projects and their NPV, BCR Feasible combination of projects Investment (`) NPV (`) Rank BCR Rank (i) M, N and P 3,00,000 2,82,070 1 1 (ii) M, N and O 2,70,000 1,59,160 4 4 (iii) O & P 2,70,000 2,03,010 3 3 (iv) M & Q 2,50,000 1,32,920 5 5 (v) N&P 2,50,000 2,21,460 2 2 (vi))

8 N&Q 3, 1,30,810 6 6 Comment - The optimum combination of projects, is Projects M, N and P with total investment of ` lakhs since it has highest NPV & BCR of ` 2,82,070 and respectively. Hence, the same should be taken up. 4. S Ltd. has ` 10,00,000 allocated for capital budgeting purposes. The following proposals and associated profitability indexes have been determined: Project Amount (`) Profitability Index 1 3,00,000 2 1,50,000 3 3,50,000 4 4,50,000 5 2, 6 4,00,000 Which of the above investments should be undertaken? Assume that projects are indivisible and there. Is no alternative use of the money allocated for capital budgeting. Work Book: Strategic Financial Management Directorate of Studies, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 5 Solution: Statement Showing Ranking NPV of Projects Project Amount (`) Profitability Index PV of Cash inflow NPV (1) (2) (3) (4) = (2)*(3) (5)=(4)-(2) 1 3,00,000 366000 66000 2 1,50,000 142500 (-)7500 3 3,50,000 420000 70000 4 4,50,000 531000 81000 5 2,00,000 240000 40000 6 4,00,000 420000 20000 Selection of projects.

9 Under NPV method (assuming the projects are indivisible and there is no alternative use of unutilized amount), projects 3, 4 and 5 which will give a combined NPV of ` 191000 with no unutilized amount, should be selected. (Detailed calculation of different alternative combinations must be given as per the previous problem.) 5. GFM produces two products - a main product Cp and a co-product Dg. For their main product Cp there is a 100% buy back arrangement with their foreign collaborators. Recently GFM doubled their capacity and with this their production capacity for the co-product Dg increased to 10,000 MT per annum. Fortunately, there was an unprecedented increase in demand for Dg and price too has increased significantly to ` 1000 per tonne.

10 However with delicensing and liberalisation, more and more units for manufacturing Cp and Dg are being set up in the country. GFM, therefore, anticipates stiff competition for Dg from next financial year. For maintaining sales at current level ( , 10,000 MT per year) GFM will have to drop the price by ` 50 per MT every year for the next 5 years when prices are likely to stabilise at pre-boom level of ` 750 per MT. The Vice-President (Marketing} who, sensing this situation, has just completed a market study, suggests that the Company revive and earlier project for converting Dg into Dp grade and starting with 1,000 MT from next year increase production of Dp in stages of 1,000 MT every year by correspondingly reducing Dg.)