Unit 4 Business Finance PYQ’s 27th June 2025

The correct answer is – C, D and E Only

Key Points

• Discounted Cash Flow (DCF) Techniques
  • Discounted cash flow techniques consider the time value of money, which is critical in capital budgeting.
  • These methods incorporate future cash inflows and outflows, discounted to present value.
  • Examples of DCF techniques include:
    • Net Present Value (NPV): Calculates the difference between the present value of cash inflows and outflows over a project’s life.
    • Internal Rate of Return (IRR): Identifies the discount rate that equates the net present value of cash inflows to zero.
    • Profitability Index (PI): Measures the ratio of the present value of future cash inflows to the initial investment.
• Options A (Payback Period) and B (Accounting Rate of Return) are not DCF techniques as they do not account for the time value of money.

Additional Information

• Non-Discounted Cash Flow Techniques
  • Payback Period: Measures the time required to recover the initial investment. It does not consider the time value of money, making it less accurate for long-term projects.
  • Accounting Rate of Return (ARR): Calculates the average accounting profit as a percentage of the initial investment. It does not use cash flows or discounting, making it a non-DCF method.
• Importance of DCF Techniques
  • DCF techniques are widely used in capital budgeting because they provide more accurate and reliable evaluations of project viability.
  • They help in comparing projects with different cash flow timings and amounts, ensuring better decision-making.

The correct answer is – 2. A-II, B-I, C-III, D-IV

Key Points

• Nostro Account
  • A Nostro Account is an account that a bank holds in a foreign currency in another bank.
  • For example, an Indian bank’s account in Swiss Francs with a Swiss bank is considered a Nostro Account.
• Vostro Account
  • A Vostro Account is the account that a foreign bank holds with a local bank in the local currency.
  • It represents the foreign bank’s funds held on deposit by the local bank.
• Bid Price
  • The Bid Price is the price at which a currency dealer is willing to buy another currency.
  • This is typically lower than the offer price and is a key part of forex trading.
• Offer Price
  • The Offer Price is the price at which a currency dealer is willing to sell another currency.
  • This is higher than the bid price, and the difference is known as the spread.

Additional Information

• Forex Market
  • The forex market is the largest financial market in the world, where currencies are traded globally.
  • It operates 24/7, and participants include banks, governments, corporations, and individual traders.
• Currency Pair
  • Forex transactions involve trading one currency for another, forming a currency pair (e.g., USD/INR).
  • The first currency is the base currency, and the second is the quote currency.
• Spread
  • The spread is the difference between the bid price and the offer price in forex trading.
  • A smaller spread indicates higher market liquidity, while a larger spread indicates lower liquidity.
• Role of Nostro and Vostro Accounts
  • These accounts help facilitate international trade and foreign exchange transactions between banks in different countries.
  • They ensure smooth cross-border transactions by maintaining balances in foreign and local currencies.

The correct answer is – Option 4: B, A, D, C

Key Points

• B, A, D, C is the correct order for multinational capital budgeting because it aligns logically with the steps required to evaluate a project.
• Step 1: Determine net investment outlay (B)
  • This step involves calculating the initial costs of the project, such as setup expenses, equipment costs, and working capital requirements.
  • It forms the foundation for subsequent analysis as it represents the upfront cash flow.
• Step 2: Estimate net cash flow from the project (A)
  • This step focuses on forecasting future cash flows generated from the project, including revenues, operating costs, and taxes.
  • It is critical to assess the profitability and sustainability of the project over its lifetime.
• Step 3: Identify appropriate discount rate (D)
  • A discount rate is used to adjust future cash flows to their present value, accounting for the time value of money and risk.
  • This rate is typically the cost of capital or required rate of return for the project.
• Step 4: Apply appropriate evaluation technique (C)
  • This step involves using tools such as Net Present Value (NPV), Internal Rate of Return (IRR), or Payback Period to assess the project’s viability.
  • It helps decision-makers determine whether the project is worth pursuing based on objective financial criteria.

Additional Information

• Multinational Capital Budgeting
  • It is the process of evaluating investments or projects conducted in international markets.
  • It considers factors such as exchange rate fluctuations, political risk, and tax implications specific to the host country.
• Importance of Discount Rate (D)
  • The discount rate reflects the opportunity cost of capital and the risk associated with the project.
  • A higher discount rate is applied for projects with greater risk, reducing the present value of future cash flows.
• Evaluation Techniques (C)
  • Net Present Value (NPV): Measures the difference between the present value of cash inflows and outflows.
  • Internal Rate of Return (IRR): Calculates the discount rate at which NPV becomes zero.
  • Payback Period: Determines the time required to recover the initial investment.

The correct answer is -2. B, A, C, D

Key Points

• Commodity Specie Standard
  • This was the earliest exchange rate arrangement, where precious metals like gold and silver were used as the basis for monetary exchange.
  • It relied on the intrinsic value of commodities to establish the exchange rates.
• Gold Standard
  • Introduced later, this system fixed the value of a country’s currency to a specific quantity of gold.
  • It ensured stability in international trade and exchange rates.
• Fixed Parity System
  • Under this system, exchange rates were pegged to a fixed value against major currencies or gold.
  • This system was widely adopted during the Bretton Woods era.
• Floating Exchange Rate
  • The most modern system, where exchange rates are determined by market forces of supply and demand.
  • It allows currencies to fluctuate freely without being fixed to a particular standard.

Additional Information

• Commodity Specie Standard
  • Used in ancient economies where coins made of precious metals represented wealth.
  • It required physical storage and transport of metals, which was inefficient for modern economies.
• Gold Standard Collapse
  • The gold standard became unsustainable due to imbalances in gold reserves and economic shocks like the Great Depression.
  • Countries transitioned to more flexible systems, such as the fixed parity system.
• Bretton Woods System
  • Established in 1944, it pegged currencies to the US dollar, which was backed by gold.
  • This system collapsed in the 1970s due to economic pressures and the inability to maintain fixed exchange rates.
• Floating Exchange Rate System
  • Adopted widely after the Bretton Woods collapse, it allows for automatic adjustments based on economic conditions.
  • This system is prevalent today, with central banks intervening occasionally to stabilize fluctuations.

The correct answer is – Option 3: 0.129

Key Points

• Overall Cost of Capital is calculated using the formula:
  • Overall Cost of Capital = Total Earnings / Total Capital
• Steps to solve:
  • Debenture Interest:
    • Debentures are ₹20,00,000 at 10% interest.
    • Interest = ₹20,00,000 × 10% = ₹2,00,000.
  • Net Income After Interest:
    • EBIT (Earnings Before Interest and Tax) = ₹5,00,000.
    • Net Income = EBIT – Debenture Interest = ₹5,00,000 – ₹2,00,000 = ₹3,00,000.
  • Value of Equity:
    • Value of Equity = Net Income / Equity Capitalisation Rate.
    • Value of Equity = ₹3,00,000 / 16% = ₹18,75,000.
  • Total Capital:
    • Total Capital = Value of Debentures + Value of Equity.
    • Total Capital = ₹20,00,000 + ₹18,75,000 = ₹38,75,000.
  • Overall Cost of Capital:
    • Overall Cost of Capital = EBIT / Total Capital.
    • Overall Cost of Capital = ₹5,00,000 / ₹38,75,000 = 0.129 or 12.9%.
• Hence, the correct answer is Option 3: 0.129.

Additional Information

• EBIT (Earnings Before Interest and Tax):
  • Represents the company’s profitability before deducting interest and taxes.
  • Used as a key input for calculating cost of capital.
• Equity Capitalisation Rate:
  • Represents the rate at which investors expect returns on equity investments.
  • Used to determine the value of equity by dividing net income by this rate.
• Debentures:
  • Debentures are long-term debt instruments issued by companies to raise capital.
  • They carry a fixed interest rate, which is a cost to the company.
• Overall Cost of Capital:
  • Reflects the weighted cost of all sources of capital (debt and equity).
  • It helps evaluate the efficiency of the company’s capital structure.

The correct answer is – 0.1053

Key Points

• Cost of preference shares
  • The formula to calculate the cost of preference shares (Kp) is:
    Kp = (Preference Dividend) / (Net Proceeds from Issue)
  • Preference Dividend = Face Value × Rate of Dividend = ₹100 × 10% = ₹10
  • Net Proceeds = Issue Price = ₹95
  • Substitute the values into the formula:
    Kp = ₹10 / ₹95 = 0.1053 (or 10.53%)
• Thus, the correct answer is 0.1053.

Additional Information

• Preference Shares
  • Preference shareholders have a fixed rate of dividend and preferential rights over equity shareholders for dividend payment and repayment of capital.
  • They do not have voting rights in most cases.
• Cost of Capital
  • The cost of capital is the minimum return that a company must earn to satisfy its investors.
  • It is calculated differently for equity, preference, and debt capital.
• Issue Price
  • If shares are issued at a discount (e.g., ₹95 instead of ₹100), the net proceeds are lower, increasing the cost of capital.
  • This concept is relevant in determining the realistic cost of funds raised through preference shares.

The correct answer is – A-II, B-I, C-IV, D-III

Key Points

• Matching LIST-I (Concept) with LIST-II (Formula):
  • Present Value (A):
    • The formula for Present Value (PV) is Cash Flow ÷ (1 + r)^t.
    • This formula determines the current worth of a future cash flow based on the discount rate (r) and time period (t).
    • Hence, A matches with II.
  • Future Value (B):
    • The formula for Future Value (FV) is Cash Flow × (1 + r)^t.
    • This represents the value of an investment at a future date, considering the rate of return (r) and time period (t).
    • Hence, B matches with I.
  • Future Value of Annuity (C):
    • The formula for Future Value of Annuity is R × FVIFA_i,n.
    • Here, R represents the periodic payment, and FVIFA_i,n is the Future Value Interest Factor for Annuity.
    • Hence, C matches with IV.
  • Present Value of Annuity (D):
    • The formula for Present Value of Annuity is R × PVIFA_i,n.
    • Here, R represents the periodic payment, and PVIFA_i,n is the Present Value Interest Factor for Annuity.
    • Hence, D matches with III.
• The correct matching is: A-II, B-I, C-IV, D-III.

Additional Information

• Present Value (PV):
  • The concept of Present Value is widely used in discounted cash flow analysis to evaluate investment opportunities.
  • It helps in determining whether the current investment is worthwhile given the expected future returns.
• Future Value (FV):
  • Future Value is crucial in compounding interest calculations, helping investors understand how much their money will grow over time.
  • It is an essential concept in personal finance, retirement planning, and long-term investments.
• Future Value of Annuity (FVA):
  • This concept applies to scenarios involving regular payments, such as monthly savings or installment plans.
  • FVA is calculated using the formula: R × FVIFA_i,n, where FVIFA_i,n is determined from standard financial tables.
• Present Value of Annuity (PVA):
  • PVA is used to evaluate the current worth of regular payments expected in the future, such as in loans or pensions.
  • The formula: R × PVIFA_i,n relies on PVIFA_i,n values available in financial tables.