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Question 2 (a) The following information pertain to CMC Limited: Number of Equity Shares 20,00,000 Book Value of 10% Convertible Debentures ₹ 1,00,00,000 Book Value of 12% Bank Term Loan ₹ 25,00,000 Market Price of Equity Share ₹ 55 Market Value of 10% Convertible Debenture ₹ 108 Face Value of Equity Share ₹ 10 Face Value of 10% Convertible Debenture ₹ 100 Beta coefficient of Equity shares of CMC Ltd. 1.5 Risk free rate of return 4.5% Equity risk Premium 9% Rate of taxation 30% The company expects that the share prices will rise in future at an average rate of 6% per annum. The 10% convertible debentures of 100 each will be converted in six years' time into equity shares of the company in the ratio of 1: 4 (4 equity shares for each debenture). The market value of 12% bank term loan is at par. You are required to calculate: (i) Cost of Equity Share Capital by applying Capital Asset Pricing Model (CAPM) Approach (ii) Cost of Convertible Debenture by using approximation method, (iii) Cost of Bank Term Loan (iv) Weighted Average Cost of Capital using Market Value weights (1+2+1+3=7 Marks) (b) The following information pertain to MSD Limited for the year ending 31st March, 2024: Particulars Number of days Raw material storage period 61 days Work-in -progress conversion period 20 days Finished goods storge period 30 days Debt collection period 45 days Creditors payment period 60 days The annual operating cost (including depreciation of ₹ 4,80,000) was ₹ 60,00,000. Assume 360 days in a year. You are required to calculate: (i) Operating cycle period (ii) Number of operating cycles in a year (iii) Amount of working capital required for the company (1 + 1 + 1 = 3 Marks) FINANCIAL MANAGEMENT AND STRATEGIC MANAGEMENT

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Detailed Solution & Explanation

(a) (i) Cost of equity share RF = 4.5% Rm – Rf = 9% Β = 1.5 Using CAPM, Ke = Rf + β (Rm – Rf) = 4.5% + 1.5 (9%) = 18% (ii) Cost of convertible debenture (based on Market Value) Price of share after 6 years = 55 (1+0.06)6 = ₹ 78.018 Redemption Value of Debenture (RV) = 78.018 × 4 = 312.07 (RV) NP = 108 (MV) n = 6 Kd =       RV –NP INT(1– t)+ n ×100 (RV –NP) 2 = (312.07-108) 10 (1-0.3)+ 6 ×100 (312.07+108) 2 = 7+34.012×100 210.035 Kd = 19.52% (iii) Cost of bank term loan Kd = I (1 – t) = 12% (1-0.3) = 8.4% (iv) Calculation of Weighted Average Cost of Capital (WACC) using Market Value Weights Source (`) in lakhs Weight Cost of Capital after tax WACC Equity Share Capital 11,00,00,000 0.892 0.180 0.1606 10% Convertible Debenture 1,08,00,000 0.088 0.195 0.0171 12% Bank Term Loan 25,00,000 0.020 0.084 0.0017 Total 12,33,00,000 1 0.1794 WACC = 17.94% Alternative Solution to Part (ii) and (iv) (ii) Cost of convertible debenture Price of share after 6 years = 55 (1+0.06)6 = ₹ 78.018 Redemption Value of Debenture (RV) = 78.018 × 4 = 312.07 (RV) NP = 100 n = 6 Kd =       RV –NP INT(1– t)+ n ×100 (RV –NP) 2 = (312.07-100) 10 (1-0.3)+ 6 ×100 (312.07+100) 2 = 7+35.345×100 206.035 FINANCIAL MANAGEMENT AND STRATEGIC MANAGEMENT Kd = 20.55% (iv) Calculation of Weighted Average Cost of Capital (WACC) using Market Value Weights Source (`) in lakhs Weight Cost of Capital after tax WACC Equity Share Capital 11,00,00,000 0.892 0.180 0.1606 10% Convertible Debenture 1,08,00,000 0.088 0.205 0.0180 12% Bank Term Loan 25,00,000 0.020 0.084 0.0017 Total 12,33,00,000 1 0.1803 WACC = 18.03% (b) (i) Net Operating Cycle Period = R + W + F + D – C Where, R = Raw material storage period. W = Work-in-progress holding period. F = Finished goods storage period. D = Debtors collection period. C = Credit period availed. = 61 + 20 + 30 + 45 – 60 = 96 days (ii) Number of Operating Cycles in the Year = 360 Operating Cycle Period = 360 96 = 3.75 times (iii) Amount of Working Capital Required = Annual Operating Cost Number of Operating Cycles = ₹ 60,00,000 3.75 = ₹ 16,00,000 Alternative Solution on cash cost basis to Part (ii) (iii) Amount of Working Capital Required = Annual Operating Cost Number of Operating Cycles = ₹ 60,00,000-₹ 4,80,000 3.75 = ₹ 14,72,000

Key Concepts to Understand

Depreciation

Allocation of the cost of a tangible fixed asset over its useful life due to wear and tear, efflux of time, or obsolescence.

Working Capital

The excess of current assets over current liabilities, representing the short-term liquidity available to a business for its day-to-day operations. Positive working capital indicates good short-term financial health.

Debentures

Long-term debt instruments issued by a company to the public for raising loan capital, carrying a fixed rate of interest (coupon rate) payable regardless of profit. Debenture holders are creditors, not owners, of the company.

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