Grand TEST 1 June 24 with Solution SAUD TARIQ

CFAP 4 Business Finance Decisions

ST Academy
Certified Finance and Accounting Professional Stage Examination
March 10, 2024
1 Hour 10 Minutes – 37 marks
Additional reading time – 5 minutes

CFAP 4 - Business Finance Decisions (Grand Test 1)

Question 1)
Multan Sultan (MS) is considering the launch of a product called Miswak. Following information
has been gathered in this regard:
(i) MS will need to spend Rs. 250 million on purchasing and installing the plant for the
manufacturing of Miswak. At the end of year 4, the plant’s resale value is expected to be Rs. 65
million. The plant will be subjected to accounting/tax depreciation at 25% using the reducing
balance method.
(ii) MS estimates immediate working capital requirement to be Rs. 75 million. A 15% increase,
inclusive of inflation, in the working capital requirement (based on the previous balance) is
anticipated at the start of years 2, 3, and 4. However, only 60% of the working capital is
expected to be realised at the project’s end. The remaining balance would be written off as
unsaleable inventory at the end of year 4.
(iii) Sales of Miswak are expected to be 30,000 units per annum, remaining constant over a 4-
year period. The selling price is estimated to be Rs. 4,000 per unit.
(iv) Raw material requirements for the year, along with current inventory details, are as follows:

Raw Material
BW SB
Annual requirement for Miswak (kg) 3,000 1,200
Current inventory (kg) 1,500 1,200
Cost per kg Rs. 550 Rs. 4,200
Contribution margin if used on other products (per kg) Rs. 200 Rs. 1,500
(v) SB will not be available in the market until the end of the first year. Further, it is also used in
another product, requiring 600 kg for the year. However, that product will be discontinued
at the end of the year. SB is not used in any other product and can be sold in the market at
50% of its cost.
(vi) MS estimates an annual labour requirement of 30,000 semi-skilled labour hours at Rs.150
per hour and 10,000 skilled labour hours at Rs. 250 per hour.
(vii) The annual fixed cost (excluding depreciation) is estimated to be Rs. 1.8 million.
(viii) The applicable tax rate would be 30%. Taxes will be payable or refundable in the year in
which the tax liability or asset arises.
(ix) All revenues and costs are quoted in today’s rate. Annual inflation is estimated to be 11%
and will apply to all revenues and costs (except where specified) from the first year onwards.
(x) MS’s cost of capital is 22%.

Required:
Compute internal rate of return (IRR) of Miswak and advise whether MS should introduce it.
(Assume that all cash flows arise at the end of each year unless specified otherwise.) (17 Marks)

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 Grand TEST 1 June 24 with Solution SAUD TARIQ
CFAP 4 Business Finance Decisions
ST Academy
Question 2)
The Share Capital and Term Finance Certificates (TFCs) of Zalmi Ltd (ZL) are listed on the
Karachi Stock Exchange. An extract from the company’s latest balance sheet as on
December 31, 2023 is as follows:
Rs. in million
Ordinary share capital of Rs. 10 each 1,200
Revenue reserves 1,050
Other reserves 450
Total Equity 2,700
6% TFCs of Rs. 100 each 1,785
Short term loan – At KIBOR + 3% 240
Total debt and equity 4,725

6 years TFCs were issued on January 1, 2023. The coupon rate is 6% payable annually
and the expected IRR is 10%. These TFCs were issued to fund a medium term project.
The prevailing commercial rate for similar risk bonds is KIBOR plus 2%. The accounting
policy of the company states that TFCs and other Held to Maturity Liabilities are carried
at the amortized cost.

KIBOR is currently 9% which can be considered as risk free. RL has an equity beta value
of 1.6 with market equity premium of 6.25%. The rate of income tax is 35%.
The dividend paid in the year 2023 was 12.5% and current year’s dividend will be paid
shortly. The dividend is expected to grow at a constant rate of 10%.

Required: Compute WACC as at December 31, 2023. (12)

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 Grand TEST 1 June 24 with Solution SAUD TARIQ
CFAP 4 Business Finance Decisions
ST Academy
Question 3)
STA Group has two Segments i.e. BFD and MSA 2. The board of directors is presently
considering to separate both divisions. In the opinion of the board, the demerger would
increase operational efficiency and enhance value for shareholders. The proposed scheme of
demerger is as follows:
i. Both divisions would be listed separately on the stock market.
ii. For every 100 shares in STA, a shareholder would receive 60 shares in BFD and 40
shares in MSA 2. Similarly, a person holding 100 Term Finance Certificates (TFCs),
would be given 60 TFCs in BFD and 40 TFCs in MSA 2.

Information relating to STA:

a) Details of STA’s equity and TFCs as per latest financial statements:
Rs in m
Share capital (Rs. 10 each) 50
Reserves 130
10% Term finance certificates (Rs. 100 each) 115
(repayable after 10 years at par)

b) Current market prices of STA’s shares and TFCs are Rs. 30 and Rs. 110 respectively.
c) The cost of capital and equity beta of STA are 10% and 1.15 respectively.
d) Information regarding supermarket industry and hotel industry:

BFD Industry MSA 2 Industry

Average equity beta 1.25 0.9
Average debt equity ratio 30:70 20:80

e) The risk free rate of return is 9% per annum and the market return is 15% per annum.
f) Applicable income tax rate is 30%.

Required: Compute WACC of both divisions BFD and MSA 2 (8 marks)

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 Grand TEST 1 June 24 with Solution SAUD TARIQ
CFAP 4 Business Finance Decisions
ST Academy
SOLUTIONS WITH MARKING PLAN
Question 1) Multan Sultan
Detailed Video Solution available below (Yes… Solution is same !!):

https://youtu.be/5wkC9i7n9Uc?si=M8HIWoCtY6ao4ncc
Solution:

Marks

(1)
(2)
(7)
(1)
(0.5)
(0.5)
(0.5)
(0.5)

(1)

(1)

(1)

(1)
1 Mark for mentioning conclusion as well 17

Breakup of Marks and Working of above mentioned figures:

(2 Marks for Working Capital Adjustment…. 0.5 Mark for each Year x 4 Years = 2 Marks)

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 Grand TEST 1 June 24 with Solution SAUD TARIQ
CFAP 4 Business Finance Decisions
ST Academy
Breakup of 7 Marks

(0.5)

(1)

(0.5)
(0.5)
(1)
(0.5)
(0.5)
(0.5)
(0.5)
(1)

(0.5)

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 Grand TEST 1 June 24 with Solution SAUD TARIQ
CFAP 4 Business Finance Decisions
ST Academy
Question 2) Zalmi Ltd
1st Jan 2023 Bond issue date
➢ Coupon Rate = 6%
➢ IRR= Market Rate = 10%
➢ NPV of Bond will be 0 zero at 10% Discount Rate

At 1st Jan 2023

Year Cash flow DF (10%) PV (= Market Value)
Interest 1-6 6 4.355 26.13
Redemption 6 x 0.564 0.564𝑥
Total MV = 100
Because it is deep
discount bond

Equation = 26.13 + 0.564 𝑥 = 100

𝑥= Redemption value = 130.98 (3 Marks)
Computation of Market Value as at Closing Date:
Year Cash flow DF (11%) PV (= Market Value)
Interest 1-5 6 3.696 22.18
Redemption 5 130.98 0.593 77.67
Total MV = 99.85

Market Value of Debt = 1,785 * 99.85/100 = 1,782.3 m (2 Marks)

Ke = 9% + 1.6 (6.25) = 19% (1 Mark)

Last year’s Dividend (10*12.5%) = 1.25

Current year’s dividend = 1.25*1.1 = 1.375 (1 Mark)
Dividend next year = 1.375 * 1.1
d 1.375∗1.1
For E PO = 𝐾𝑒−𝑔 Po = 19%−10%

Share price = 16.81 /Share

(ex-dividend)
MV Of Equity = 16.81 * 120 = 2023.2 m (2 Marks)
E = 2,017.2 Ke = 19%
D1= 1,782.3 Kd1 (1-t) = 7.15% (11*0.65) (0.5 Mark)
D2 (Short Term Loan) = 240 Kd2 (1-t) = 7.8% (12*0.65) (0.5 Mark)

WACC = (19*2023.2) + (7.15*1782.3) + (7.8*240) = 13.1% (2 Marks for formula)

2023.2 + 1782.3 + 240
(TOTAL 12 Marks)
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 Grand TEST 1 June 24 with Solution SAUD TARIQ
CFAP 4 Business Finance Decisions
ST Academy
Solution 3) STA Group
Marks Distribution:
E (MV of Equity) 0.5 Mark Each for BFD & MSA 2 (Total 1 Mark)
D (MV of Debt) 0.5 Mark Each for BFD & MSA 2 (Total 1 Mark)
Kd (1-t) 2 Marks for IRR Calculation
Ungear (Computation of Asset Beta) 1 Mark Each for BFD & MSA 2 (Total 2 Mark)
Re-Gear (Computation of Equity Beta) 0.5 Mark Each for BFD & MSA 2 (Total 1 Mark)
Computation of WACC 0.5 Mark Each for BFD & MSA 2 (Total 1 Mark)

Solved in ICAP Software (Please Note that CAF 8 is actually MSA 2 in below Solution)

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