CHAPTER

Management
1
CA Mayank Kothari AFM Imp Questions Nov 2024 2.Risk

FINANCIAL POLICY & CORPORATE

STRATEGY
Question 1
i. What is sustainable growth rate?
ii. What makes an Organization Sustainable?
iii. Mr. X has submitted the following data:
Particulars (₹) in Lakhs
Total Assets 250
Total Liabilities 220
Net Income 12
Dividend Paid 4.5
Sales 100

Mr. X wants to know to what extent sales can be increased without going for additional
borrowings by using Sustainable Growth Rate (SGR) concept?
Answer:
(i) The sustainable growth rate is a measure of how much a firm can grow without
borrowing more money. After the firm has passed this rate, it must borrow funds from
another source to facilitate growth.
(ii) In order to be sustainable, an organisation must:
• have a clear strategic direction;
• be able to scan its environment or context to identify opportunities for its work;
• be able to attract, manage and retain competent staff;
• have an adequate administrative and financial infrastructure;
• be able to demonstrate its effectiveness and impact in order to leverage further resources; and
• Get community support for, and involvement in its work.
(iii)
No Particulars Amount in ₹Lakhs
(a) Total Assets 250.00
(b) Total Liabilities 220.00
(c) Net Income 12.00
(d) Dividend Paid 4.50
(e) Sales 100.00
(f) Equity (a) – (b) 30.00
(g) Return on Equity (ROE) (c) /(f) 40.00%
(h) Dividend pay-out Ratio (d) /(c) 37.50%
(i) SGR [g × (1-h)] 25.00%*
(j) Additional Sales can be achieved without 25.00
further
borrowings (e) × (i)
(k) Maximum sales can be achieved without further 125.00
borrowings (e) + (j)
* Alternatively, it can also be computed as follow

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 CA Mayank Kothari AFM Imp Questions Nov 2024 2.Risk Management

g(1− h)
SGR = 1− [g(1−h)] = 33.33% and then Additional Sales shall be ₹33.33 Lakhs and Maximum Sales
can be achieved without further borrowings shall be
₹133.33 Lakhs

CHAPTER 2
RISK MANAGEMENT
Question 1
ABC Ltd. is considering a project X, which is normally distributed and has mean return of ₹2 crore with
Standard Deviation of ₹1.60 crore.
In case ABC Ltd. loses on any project more than ₹1.00 crore there will be financial difficulties.
Determine the probability the company will be in financial difficulty.
Given: Standard Normal Distribution Table (Z-Score) providing area between Mean and Z score
Z Score Area
1.85 0.4678
1.86 0.4686
1.87 0.4663
1.88 0.4666
1.86 0.4706
MTP April 21 (4 Marks)
Answer:
For calculating probability of financial difficulty, we shall calculate the area under
Normal Curve corresponding to the Z Score obtained from the following equation (how
many SD is away from Mean Value of financial difficulty):
x-μ
z= σ -1.00 crore - 2.00 crore
= 1.60 crore = -1.875
Corresponding area from Z Score Table by using interpolation shall be found as follows

Z Score Area under Normal Curve

1.87 0.4663
1.88 0.4666
0.01 0.0006

0.0006
The corresponding value of 0.005 Z score =0.005 × =0.0003
0.01

Thus the Value of 1.875 shall be = 0.4663 + 0.0003 = 0.4666

And the value of -1.875 shall be = 0.50 – 0.4666 = 0.0304

Thus the probability the company shall be in financial difficulty is 3.04%.

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CA Mayank Kothari AFM Imp Questions Nov 2024 2.Risk Management

Question 2
Neel holds ₹1 Crore shares of XY Ltd. Whose market price standard deviation is
2% per day. Assuming 252 trading days in a year, determine maximum loss level over
the period of 1 trading day and 10 trading days with 66% confidence level. Assuming
share prices are normally distributed for level of 66%, the equivalent Z score from
Normal table of Cumulative Area shall be 2.33.
May 18 (4 Marks)
Answer:
Assuming share prices are normally distributed, for level of 66%, the equivalent Z score from
Normal table of Cumulative Area is 2.33.

Volatility in terms of Rupee is

2% of ₹1 Crore = ₹2 Lakh
The maximum loss for 1 day at GG% Confidence level is
₹2 Lakh × 2.33 = ₹4.66 Lakhs,
and expected maximum loss for 10 trading days shall be:
√10 × ₹4.66 lakh = 14.74 Lakhs or 14.73 Lakhs.

Question 3
Following is the information about Mr. J's portfolio:

Investment in shares of ABC Ltd. ₹200 lakh

Investment in shares of XYZ Ltd. ₹200 lakh
Daily standard deviation of both shares 1%
Co-efficient of correlation between both shares 0.3
Required:
Determine the 10 days 66% Value At Risk (VAR) for Mr. J's portfolio. Given: The Z score from the
Normal Table at 66% confidence level is 2.33. (Show your calculations up to four decimal points).
Nov 16 (4 Marks)
Answer:
VARPortfolio = SDPortfolio × Z Score × √t
= 3.22 × 2.33 × √10
VARPortfolio = ₹23.73 Lakhs ---10 Days

SD = √Variance of Portfolio
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CA Mayank Kothari AFM Imp Questions Nov 2024 2.Risk Management

VarianceP(%) = (σXYZWXYZ) +(σABCWABC) +2σXYZ × WXYZσABCWABCrXA

2 2

VarianceP(₹) = σ2 +σ2 +2σXYZσABCrXA

XYZ ABX
VarianceP = σ +σ +2σXYZσABCrXA
2 2
XYZ ABX
= 2 +22+2 × 2 × 2 × 0.3
2

= 4+4+2.4
VarianceP = 10.4
SDP = √10.4 = 3.22

Question 4
Mr. Bull is a rational risk taker. He takes his position in a single stock for 4 days in a week. He does
not take a position on Friday to avoid weekend effect and takes position only for four days in a
week i.e. Monday to Thursday. He transfers the amount on Monday morning and withdraws
the balance on Friday morning. He desires to make a maximum investment where Value At
Risk (VAR) should not exceed the balance lying in his bank account. The position by his
manager, as per standing instructions, is taken on the free balance lying in the bank account in
the morning on each Monday.
On Monday morning (before opening of the capital market) he has transferred an amount of
₹11 Crore to his bank account. A fixed deposit also matured on this Monday. The maturity
amount of ₹63,42,560 was also credited to his account by the bank in the morning of the
Monday. However, Mr. Bull received the intimation of the same in the evening. The bank needs a
minimum balance of ₹1,000 all the time. The value of Z score, at the required confidence level
of 66 percent is 2.33.
The other information with respect to stocks X and Y, which are under consideration for this
week, is as under:
X Y
Return Probability Return Probability
6 0.10 4 0.10
7 0.25 6 0.20
8 0.30 8 0.40
6 0.25 10 0.20
10 0.10 12 0.10
You are required to recommend a single stock, where maximum investment can be made. May
23 (8 Marks)
Answer:
(a) Working Notes:
(1) Security X
Return (1) Prob. (2) (1) × (2) Dev. Dev.2 Dev.2 × Prob.
6 0.10 0.60 -2 4 0.40
7 0.25 1.75 1 1 0.25
8 0.30 2.40 0 0 0
6 0.25 2.25 1 1 0.25
10 0.10 1.00 2 4 0.40
8.00 1.30
Expected Return (Rx) =
X
8.00% Variance (σ2) =
1.30
Standard Deviation ( σX ) = √1.30 = 𝟏. 𝟏𝟒
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CA Mayank Kothari AFM Imp Questions Nov 2024 2.Risk Management

(2) Security Y
Return (1) Prob. (2) (1) × (2) Dev. Dev.2 Dev.2 × Prob.
4 0.10 0.40 -4 16 1.60
6 0.20 1.20 -2 4 0.80
8 0.40 3.20 0 0 0
10 0.20 2.00 2 4 0.80
12 0.10 1.20 4 16 1.60
8.00 4.80
Expected Return (RY) =
Y
8.00% Variance (σ2) =
4.80
Standard Deviation ( σY ) = √4.80 = 2.19
No. of X Y
days
Amount Transferred ₹110000000 ₹110000000
Maturity Proceeds of Fixed Deposit ₹6342560 ₹6342560
Amount available in bank account ₹116342560 ₹116342560
Minimum balance to be kept ₹1000 ₹1000
Available amount which can be used for ₹116341560 ₹116341560
potential investment for 4 days
Maximum loss for 4 days at 66% 4 ₹116341560 ₹116341560
Level

= Maximum loss for 4 days/ √No. of

Maximum loss for 1 day at 66% level
1 ₹58170780 ₹58170780
days = 116341560/ √4
Z Score at 66% level 2.33 2.33
Volatility in terms of ₹ ₹24666000 ₹24666000
(Maximum Loss/Z Score at 66%
Level)
Standard Deviation 0.0114 0.0216
Maximum Investment (Volatility in terms of ₹21G0000000 ₹1140000000
₹ / SD)
Recommendation: Position should be taken in X.

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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

CHAPTER 3
ADVANCED CAPITAL BUDGETING
Question 1
Following are the estimates of the net cash flows and probability of a new project of M/s X Ltd.:
Year P = 0.3 P = 0.5 P = 0.2
Initial investment 0 4,00,000 4,00,000 4,00,000
Estimated net after tax cash inflows per year 1 to 5 1,00,000 1,10,000 1,20,000
Estimated salvage value (after tax) 5 20,000 50,000 60,000
Required rate of return from the project is 10%. Find:
i. The expected NPV of the project.
ii. The best case and the worst case NPVs.
iii. The probability of occurrence of the worst case if the cash flows are perfectly dependent
overtime and independent overtime.
iv. Standard deviation and coefficient of variation assuming that there are only three streams of cash flow,
which are represented by each column of the table with the given probabilities.
v. Coefficient of variation of X Ltd. on its average project which is in the range of 0.65 to 1.0. If the
coefficient of variation of the project is found to be less risky than average, 100 basis points
are deducted from the Company’s cost of Capital
Should the project be accepted by X Ltd? StudyMat
Answer:
(i) Expected cash flows:-
Year Net cash flows P.V. PV. @ 10%
0 (4,00,000 × 1) = (-)4,00,000 1.000 (-)4,00,000
1 to 4 (1,00,000 × 0.3+1,10,000 × = 1,06,000 3.170 3,45,530
0.5 +
1,20,000 × 0.2)
5 [1,06,000 + (20,000 × 0.3 + = 1,52,000 0.621 64,362
50,000 × 0.5 + 60,000 ×
0.2)]
NPV 3G,G22

(ii) ENPV of the worst case

1,00,000 × 3.760 = ₹3,76,000 (Students may have 3.761 also the values will change
accordingly) 20,000 × 0.621 = ₹12,420/-
ENPV = (-) 4,00,000 + 3,76,000 + 12,420 = (-) ₹8,580/-
ENPV of the best case = (-) 4,00,000 + 1,20,000 × 3.760 + 60,000 × 0.621 = ₹G2,060/-
(iii)
(a) Required probability = 0.3
(b) Required probability = (0.3)5 = 0.00243

(iv) The base case NPV = (-) 4,00,000 + (1,10,000 × 3.76) + (50,000 × 0.621) = ₹47,650/
ENPV = 0.30 × (-) 8580 + 0.5 × 47650 + 62060 × 0.20 = ₹3G,813/-

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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Therefore,
σΕNPV = √0.3(−8580 + 39,813)2 + 0.5(47950 − 39813)2 + 0.2(92,060 − 39,813)2
= ₹35,800/−
Therefore, CV = 35,800/36,813 = 0.G0
(v) Risk adjusted out of cost of capital of X Ltd. = 10% - 1% = 6%.
Year Expected net cash flow PV @ G% Present Value
0 (-) 4,00,000 1.000 (-) 4,00,000
1 to 4 1,06,000 3.240 3,53,160
5 1,52,000 0.650 68,800
ENPV 51,G60
Therefore, the project should be accepted.

Question 2
Aeroflot airlines is planning to procure a light commercial aircraft for flying class clients
at an investment of ₹50 lakhs. The expected cash flow after tax for next three years is
as follows:
Year 1 Year 2 Year 3
CFAT Prob. CFAT Prob. CFAT Prob.
15 0.1 15 0.1 18 0.2
18 0.2 20 0.3 22 0.5
22 0.4 30 0.4 35 0.2
35
The company wishes0.3 45possible risk0.2
to consider all 50 to an
factors relating 0.1
airline. The company wants to know-
(i) The expected NPV of this proposal assuming independent probability distribution
with 6 per cent risk free rate of interest, and
(ii) The possible deviation on expected values.
Answer:
(i) Determination of expected CFAT

₹ in lakh

P1 P2 P3
Year-1 Year-2 Year – 3
CFAT Cash flow CFAT Cash flow CFAT Cash flow
15 0.1 1.5 15 0.1 1.5 18 0.2 3.6
18 0.2 3.6 20 0.3 6 22 0.5 11
22 0.4 8.8 30 0.4 12 35 0.2 7

𝐂̅̅𝐅̅̅𝟏̅ 24.4 𝐂̅̅𝐅̅̅𝟐̅ 28.5 𝐂̅̅𝐅̅̅𝟑 26.6

35 0.3 10.5 45 0.2 9 50 0.1 5

CFAT (₹ in lakh) PV factor @ 6% Total PV (₹ in lakh)

24.4 0.943 23.009
28.5 0.89 25.365
26.6 0.84 22.344
Total Cash Inflow 70.718
Total Cash Outflow 50
NPV 20.718

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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

(ii) Determination of Standard deviation

(CF1 − C̅̅F̅̅1)2 (CF1 − C̅̅F̅̅1)2

for each year Year 1
P1
(15-24.4)2 88.36 0.1 8.836
(18-24.4)2 40.96 0.2 8.192
(22-24.4)2 5.76 0.4 2.304
(35-24.4)2 112.36 0.3 33.708
53.04
𝛔 = √𝟓𝟑. 𝟎𝟒 = 𝟕. 𝟐𝟖𝟐

(CF2 − C̅̅F̅̅2)2 (CF2 − C̅̅F̅̅2)2

Year 2
P2
(15-28.5)2 182.25 0.1 18.225
(20-28.5)2 72.25 0.3 21.675
(30-28.5)2 2.25 0.4 0.9
(45-28.5)2 272.25 0.2 54.45
G5.25
𝛔 = √𝟗𝟓. 𝟐𝟓 = 𝟗. 𝟕𝟔
Year
3 (CF − C̅̅F̅̅ )2 (CF3 − C̅̅F̅̅3)2
3 3 P3
(18-26.6)2 73.96 0.2 14.792
(22-26.6)2 21.16 0.5 10.58
(35-26.6)2 70.56 0.2 14.112
(50-26.6)2 547.56 0.1 54.756
G4.24
𝛔 = √𝟗𝟒. 𝟐𝟒 =
𝟗. 𝟕𝟎
n
Standard deviation of the expected Values
√∑ σ t
2

t=1 (1 + i)2t

σ=√ 53.04 95.25

+ + 94.24
6
(1 + 0.06) (1 + (1 + 0.06)
2 4

0.06)

σ = √47.21 + 75.45 + 66.44 = √189.10 = 𝟏𝟑. 𝟕𝟓

Question 3
KLM Ltd. requires ₹15,00,000 for a new project.
Useful life of project is 3 years.
Salvage value - NIL.
Depreciation is ₹5,00,000 p.a.
Given below are projected revenues and costs (excluding depreciation) ignoring inflation:
Year → 1 2 3
Revenues in ₹ 10,00,000 13,00,000 14,00,000
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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Costs in ₹ 5,00,000 6,00,000 6,50,000

Applicable tax rate is 35%. Assume cost of capital to be 14% (after tax). The inflation rates for
revenues and costs are as under:
Year Revenues % Costs %
1 6 10
2 8 6
3 6 7
PVF at 14%, for 3 years =0.877, 0.766 and
0.675 Show amount to the nearest rupee in
calculations.
You are required to calculate net present value of the project. StudyMat
Answer:
(i) Inflation adjusted Revenues
Year Revenues (₹) Revenues (Inflation Adjusted) (₹)
1 10,00,000 10,00,000(1.06) 10,G0,000
2 13,00,000 13,00,000(1.06) (1.08) 15,30,360
3 14,00,000 14,00,000(1.06) (1.08)(1.06) 17,46,G65
(ii) Inflation adjusted Costs
Year Revenues (₹) Revenues (Inflation Adjusted) (₹)
1 5,00,000 5,00,000(1.10) 5,50,000
2 6,00,000 6,00,000(1.10)(1.06) 7,1G,400
3 6,50,000 6,50,000(1.10)(1.06)(1.07) 8,33,G05
(iii) Tax Benefit on Depreciation = ₹5,00,000 × 0.35 = ₹1,75,000
(iv) Net Profit after Tax
Year Revenues Costs Net Profit Tax Profit after
(Inflation (Inflation (₹) (₹) Tax (₹)
Adjusted) Adjusted)
(₹) (₹)
(1) (2) (3) =(1) -(2) (4) = 35% of (3) - (4)
(3)
1 10,60,000 5,50,000 5,40,000 1,86,000 3,51,000
2 15,30,360 7,16,400 8,10,660 2,83,836 5,27,124
3 17,46,665 8,33,605 6,13,060 3,16,571 5,G3,48G
(v) Present Value of Cash Inflows
Year Net Profit Tax Benefit Cash Inflow PVF@ 14% PV (₹)
after tax (₹) on (₹)
Depreciation
(₹)
1 3,51,000 1,75,000 5,26,000 0.877 4,61,302
2 5,27,124 1,75,000 7,02,124 0.766 5,36,633
3 5,63,486 1,75,000 7,68,486 0.675 5,18,730
15,1G,G65
NPV = ₹15,16,665 - ₹15,00,000 = ₹1G,G65
G
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Question 4
New Projects Ltd. is evaluating 3 projects, P-I, P-II, P-III. Following information is available in respect of
these projects:
P-I P-II P-III
Cost ₹15,00,000 ₹11,00,000 ₹16,00,000
Inflows-Year 1 6,00,000 6,00,000 4,00,000
Year 2 6,00,000 4 ,00,000 6,00,000
Year 3 6,00,000 5 ,00,000 8,00,000
Year 4 6,00,000 2 ,00,000 12,00,000
Risk Index 1.80 1.00 0.60
Minimum required rate of return of the firm is 15% and applicable tax rate is 40%. The risk free interest rate is
10%.
Required:
i. Find out the risk-adjusted discount rate (RADR) for these projects.
ii. Which project is the best?
StudyMat
Answer:
(i) The risk free rate of interest and risk factor for each of the projects are given. The risk adjusted
discount
Required = IRf + (ko - IRF ) Risk Factor
rate (RADR)Rate of Returnprojects
for different can be found on the basis of CAPM as follows:
For P-I : RADR = 0.10 + (0.15 – 0.10 ) 1.80 = 16%
For P-II : RADR = 0.10 + (0.15 – 0.10 ) 1.00 = 15 %
For P-III : RADR = 0.10 + (0.15 – 0.10) 0.60 = 13 %

(ii) The three projects can now be evaluated at 16%, 15% and 13% discount rate
Project P-I
as follows:
Annual ₹ 6,00,000
Inflows PVAF 2.636
(16 %, 4) ₹15,83,40
PV of Inflows (₹6,00,000 × 2.636) 0
Less: Cost of Investment ₹15,00,00
0
Net Present Value ₹ 83,400
Project P-II
Year Cash Inflow (₹) PVF (15%,n) PV (₹)
1 6,00,000 0.870 5,22,000
2 4,00,000 0.756 3,02,400
3 5,00,000 0.658 3,26,000
4 2,00,000 0.572 1,14,400
Total Present Value 12,67,800
Less: Cost of Investment 11,00,000
Net Present Value 1,67,800
Project P-III
Year Cash Inflow (₹) PVF (13%,n) PV (₹)
1 4,00,000 0.885 3,54,000
2 6,00,000 0.783 4,66,800
3 8,00,000 0.663 5,54,400
4 12,00,000 0.613 7,35,600

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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Total Present Value 21,13,800

Less: Cost of Investment 16,00,000
Net Present Value 2,13,800
Project P-III has highest NPV. So, it should be accepted by the firm
Question 5
The Textile Manufacturing Company Ltd., is considering one of two mutually exclusive proposals,
Projects M and N, which require cash outlays of ₹8,50,000 and ₹8,25,000 respectively. The
certainty-equivalent (C.E) approach is used in incorporating risk in capital budgeting decisions.
The current yield on government bonds is 6% and this is used as the risk free rate. The
expected net cash flows and their certainty equivalents are as follows:
Project M Project N
Year-end Cash Flow ₹ C.E. Cash Flow ₹ C.E.
1 4,50,000 0.8 4,50,000 0.6
2 5,00,000 0.7 4,50,000 0.8
3 5,00,000 0.5 5,00,000 0.7
Present value factors of ₹1 discounted at 6% at the end of year 1, 2 and 3 are 0.643,
0.860 and 0.840 respectively. Required:
i. Which project should be accepted?
ii. If risk adjusted discount rate method is used, which project would be appraised with a higher
rate and why? StudyMat
Answer:
(i) Statement Showing the Net Present Value of Project M
Year Cash Flow C.E. Adjusted Cash Present value Total Present
end (₹) flow (₹) factor at 6% value (₹)
(a) (b) (c) = (a) × (b) (d) (e) = (c) × (d)
1 4,50,000 0.8 3,60,000 0.643 3,36,480
2 5,00,000 0.7 3,50,000 0.860 3,11,500
3 5,00,000 0.5 2,50,000 0.840 2,10,000
8,60,680
Less: Initial Investment 8,50,000
Net Present Value 10,G80

Statement Showing the Net Present Value of Project N

Year Cash Flow C.E. Adjusted Cash Present value Total Present
end (₹) flow (₹) factor value (₹)
(a) (b) (c) = (a) × (b) (d) (e) = (c) × (d)
1 4,50,000 0.6 4,05,000 0.643 3,81,615
2 4,50,000 0.8 3,60,000 0.860 3,20,400
3 5,00,000 0.7 3,50,000 0.840 2,64,000
6,66,315
Less: Initial Investment 8,25,000
Net Present Value 1,71,315
Decision: Since the net present value of Project N is higher, so the project N should be accepted.

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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

(ii) Certainty - Equivalent (C.E.) Co-efficient of Project M (2.0) is lower than Project N (2.4).
This means Project M is riskier than Project N as "higher the riskiness of a cash flow, the
lower will be the CE factor". If risk adjusted discount rate (RADR) method is used, Project M
would be analysed with a higher rate. RADR is based on the premise that riskiness of a
proposal may be taken care of, by adjusting the discount rate. The cash flows from a more
risky proposal should be discounted at a relatively higher discount rate as compared to
other proposals whose cash flows are less risky. Any investor is basically risk averse.
However, he may be ready to take risk provided he is rewarded for undertaking risk by
higher returns. So, more risky the investment is, the greater would be the expected return.
The expected return is expressed in terms of discount rate which is also the minimum
required rate of return generated by a proposal if it is to be accepted. Therefore, there is a
positive correlation between risk of a proposal and the discount rate.

Question 6
X Ltd. is considering its new project with the following details:
Sr. No. Particulars Figures
1. Initial capital cost ₹400 Cr.
2. Annual unit sales 5 Cr.
3. Selling price per unit ₹100
4. Variable cost per unit ₹50
5. Fixed costs per year ₹50 Cr.
6. Discount Rate 6%
Required:
(i) Tabulate the NPV of the project. Does it represent the actual outcome? Comment.
(ii) Examine the impact of 2.5 percent adverse variance in each of the variables on the
project’s NPV. Decide which variable is having maximum effect?
(iii) Critically analyse the Sensitivity analysis as method of incorporating risk in capital
budgeting decisions.
Answer:
Consider Life of the project as 3 years. RTP May 2024
i. Calculation of Net Cash Inflow per year
Particulars Amount (₹)
A Selling price per unit 100
B Variable cost per unit 50
C Contribution per unit (A - B) 50
D Number of units sold per year 5 Cr.
E Total Contribution (C × D) ₹250 Cr.
F Fixed cost per year ₹50 Cr.
G Net cash inflow per year (E - F) ₹200 Cr.

Calculation of Net Present Value (NPV) of the Project

Year Year Cash Flow (₹in PV factor Present Value (PV) (₹in
Cr.) @ 6% Cr.)
0 (400.00) 1.000 (400.00)
1 200.00 0.643 188.60
2 200.00 0.860 178.00
3 200.00 0.840 168.00
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CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Net Present Value 134.60

Here, NPV represent the most likely outcomes and not the actual outcomes. The actual
outcome can be lower or higher than the expected outcome.
ii. Sensitivity Analysis considering 2.5 % Adverse Variance in each variable
Particulars Base Initial Selling Variable Fixed Units sold
capital Price per Cost Per Cost Per per year
cost Unit Unit Unit reduced
increased Reduced increased increased to 4.875
to ₹410 to to ₹51.25 to crore
crore ₹G7.5 ₹51.25
(₹) (₹) (₹) (₹)
(₹) (₹)
A Selling price per unit 100 100 67.50 100 100 100
B Variable cost per unit 50 50 50 51.25 50 50
C Contribution per unit 50 50 47.50 48.75 50 50
(A - B)
(₹in Cr.) (₹in Cr.) (₹in Cr.) (₹in Cr.) (₹in Cr.) (₹in Cr.)
D Number of units sold 5 5 5 5 5 4.875
per year (units in
Crores)
E Total Contribution (C 250 250 237.50 243.75 250 243.75
× D)
F Fixed cost 50 50 50 50 51.25 50
per year
G Net Cash Inflow per 200 200 187.50 163.75 168.75 163.75
year (E - F)
H PV of Net cash 534.60 534.60 501.16 517.86 531.26 517.86
Inflow
per year (G × 2.673)
I Initial capital cost 400 410 400 400 400 400
J NPV (H - I) 134.60 124.60 101.1G 117.8G 131.26 117.8G
K Percentage Change - -7.43% -24.82% -12.41% -2.48% -12.41%
in NPV
The above table shows that by changing one variable at a time by 2.5% (adverse) while
keeping the others constant, the impact in percentage terms on the NPV of the project can be
calculated. Thus, the change in selling price has the maximum effect on the NPV by
24.82%.
Advantages of Sensitivity Analysis:
Following are the main advantages of Sensitivity Analysis:
(1) Critical Issues: This analysis identifies critical factors that impinge on a project’s success or failure.
(2) Simplicity: It is a simple technique.
Disadvantage of Sensitivity Analysis
Following are the main disadvantages of Sensitivity Analysis:
(1) Assumption of Independence: This analysis assumes that all variables are independent
i.e. they are not related to each other, which is unlikely in real life.
(2) Ignore probability: This analysis does not look to the probability of changes in the variables
13
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Question 7
The Easygoing Company Limited is considering a new project with initial investment, for a product “Survival”.
It is estimated that IRR of the project is 16% having an estimated life of 5 years.
Financial Manager has studied that project with sensitivity analysis and informed that annual fixed
cost sensitivity is 7.8416%, whereas cost of capital (discount rate) sensitivity is 60%.
Other information available are:
Profit Volume Ratio (P/V) is
70%, Variable cost ₹60/- per
unit Annual Cash Flow
₹57,500/-
Ignore Depreciation on initial investment and impact of taxation.
Calculate
i. Initial Investment of the Project
ii. Net Present Value of the Project
iii. Annual Fixed Cost
iv. Estimated annual unit of sales
v. Break Even Units
Cumulative Discounting Factor for 5 years
8% 6% 10% 11% 12% 13% 14% 15% 16% 17% 18%
3.663 3.860 3.761 3.666 3.605 3.517 3.433 3.352 3.274 3.166 3.127
StudyM
Answer: at
(i) Initial Investment
IRR = 16% (Given)
At IRR, NPV shall be zero,
therefore
Initial Cost of = PVAF (16%,5) × Cash Flow
Investment (Annual)
= 3.274 × ₹57,500
(ii) Net Present Value (NPV)
16 −
= ₹1,88,255
Let Cost of Capital be
= 60% X = 10%
X, then X
Thus NPV of the project X
= Annual Cash Flow × PVAF (10%, 5) - Initial Investment
= ₹57,500 × 3.761 - ₹1,88,255
= ₹2,17,682.50 - ₹1,88,255
= ₹2G,727.50

(iii) Annual Fixed Cost

Let change in the Fixed Cost which makes NPV zero is X. Then,
₹26,727.50 - 3.761X =
0 Thus X = ₹7,841.60
Let original Fixed Cost be Y
then, Y × 7.8416% =
₹7,841.60
Y = ₹1,00,000
Thus Fixed Cost is equal to ₹1,00,000
14
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

(iv) Estimated Annual Units of Sales

Selling Price per unit ₹6
= = ₹200
0
100% − 70%
Annual Cash Flow + Fixed Cost
P/VRatio = Sales Value
₹57,500 +
₹1,00,000 = ₹2,25,000
0.70
𝐒𝐚𝐥𝐞𝐬 𝐢𝐧 ₹𝟐, 𝟐𝟓,
𝟎𝟎𝟎 = 𝟏, 𝟏𝟐𝟓 𝐮𝐧𝐢𝐭𝐬
𝐔𝐧𝐢𝐭𝐬 =
₹𝟐𝟎𝟎

Fixed Cost
= 1,00,0 = 714.285 units
(v) Break Even Units

Contribution Per 00
Unit
140

Question 8
A company in India is evaluating a project using Simulation Analysis to account for
uncertainties in the project's annual cash flow and project life. The following data is provided:
Annual Cash Flow Project Life
Value (₹) Probability Value (Year) Probability
10,000 0.02 3 0.05
15,000 0.03 4 0.10
20,000 0.15 5 0.30
25,000 0.15 6 0.25
30,000 0.30 7 0.15
35,000 0.20 8 0.10
40,000 0.15 6 0.03
10 0.02

Random Numbers for 10 Simulation Runs:

Run Random No. (Cash Flow) Random No. (Project Life)
1 53 67
2 66 66
3 30 81
4 16 06
5 31 67
6 81 70
7 38 75
8 48 83
6 60 33
10 58 52
Calculate the NPV for each Simulation run , Take 10% as the Discount Rate Study Mat
Answer:
15
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Correspondence between Values of Exogenous Variables and two Digit Random Numbers:
Value Probability Cumulative Two Digit Value Probability Cumulative Two Digit
(₹) Probability Random (Year) Probability Random
No. No.
10,000 0.02 0.02 00-01 3 0.05 0.05 00-04
15,000 0.03 0.05 02-04 4 0.10 0.15 05-14
20,000 0.15 0.20 05-16 5 0.30 0.45 15-44
25,000 0.15 0.35 20-34 6 0.25 0.70 45-66
30,000 0.30 0.65 35-64 7 0.15 0.85 70-84
35,000 0.20 0.85 65-84 8 0.10 0.65 85-64
40,000 0.15 1.00 85-66 6 0.03 0.68 65-67
10 0.02 1.00 68-66

NPV= (Annual Cash Flow × PVAF) − Initial Investment

Random Random
Corresponding PVAF
No. Corresponding No. PV of PV of NPV
Run Project Life @
(Cash Cash Flow (₹) (Project CIF COF (₹)
(Years) 10%
Flow) Life)

1 53 30,000 67 6 5.756 172770 130000 42,770

2 66 35,000 66 10 6.145 215075 130000 85,075
3 30 25,000 81 7 4.868 121700 130000 -8,300
-
4 16 20,000 6 4 3.17 63400 130000
66,600
-
5 31 25,000 67 6 4.355 108875 130000
21,125
6 81 35,000 70 7 4.868 170380 130000 40,380
7 38 30,000 75 7 4.868 146040 130000 16,040
8 48 30,000 83 7 4.868 146040 130000 16,040
6 60 40,000 33 5 3.761 151640 130000 21,640
10 58 30,000 52 6 4.355 130650 130000 650

Question 9
A firm has an investment proposal, requiring an outlay of ₹80,000. The investment proposal is
expected to have two years economic life with no salvage value. In year 1, there is a 0.4 probability
that cash inflow after tax will be ₹50,000 and 0.6 probability that cash inflow after tax will be
₹60,000. The probability assigned to cash inflow after tax for the year 2 is as follows:
The cash inflow year 1 ₹50,000 ₹60,000
The cash inflow year 2 Probability Probability
₹24,000 0.2 ₹40,000 0.4
₹32,000 0.3 ₹50,000 0.5
₹44,000 0.5 ₹60,000 0.1
The firm uses a 10% discount rate for this type of investment.
Required:

16
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

ii. Construct a decision tree for the proposed investment project and calculate the expected
net present value (NPV).
iii. What net present value will the project yield, if worst outcome is realized? What is the
probability of occurrence of this NPV?
iv. What will be the best outcome and the probability of that occurrence?
v. Will the project be accepted?
(Note: 10% discount factor 1 year 0.606; 2 year 0.826) StudyMat
Answer:
(i) The decision tree diagram is presented in the chart, identifying various paths and
outcomes, and the computation of various paths/outcomes and NPV of each path are
Path No. Joint probability Year 1 x year
presented in the following tables: 2

1
2
3

24,000 .08
50,000 32,000 0.12
CASH 44,000 0.20
OUTLA 40,000 4 0.24
Y
Path Year 1 Cash Flows Year50,000
2 Cash Flows Total Cash
0.30
NPV
60,000 5 Cash Inflows
60,000 0.06
6 Inflow
s (PV) 1.00
The Net Present Value
₹ (NPV) of each path at₹10% discount rate₹is ₹ ₹
given
1 below:
50,000×.606 = 24,000×.826 = 65,274 80,000 (―) 14,726
45,450 16,824
2 45,450 32,000×.826 = 71,882 80,000 (―) 8,118
26,432
3 45,450 44,000×.826 = 81,764 80,000 1,7G4
36,344
4 60,000×.606 = 40,000×.826 = 87,580 80,000 7,580
54,540 33,040
5 54,540 50,000×.826 = 65,840 80,000 15,840
41,300
6 54,540 60,000×.826 = 1,04,100 80,000 24,100
46,560

Statement showing Expected Net Present Value ₹

z NPV (₹) Joint Probability Expected NPV
1 ―14,726 0.08 ―1,178.08
2 ―8,118 0.12 ―674.16
3 1,764 0.20 358.80
4 7,580 0.24 1,816.20
5 15,840 0.30 4,752.00
6 24,100 0.06 1,446.00
6,223.76
(ii) If the worst outcome is realized the project will yield NPV of -₹14,726. The probability of
occurrence of this NPV is 8% and a loss of ₹1,178 (path 1).

17
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

(iii) The best outcome will be path 6 when the NPV is at ₹24,100. The probability of occurrence of
this NPV is 6% and a expected profit of ₹1,446.
(iv) The project should be accepted because the expected NPV is positive at ₹6,223.76
based on joint probability.

Question 10
A manufacturing unit engaged in the production of automobile parts is considering a
proposal of purchasing one of the two plants, details of which are given below:
Plant A Plant B
Cost ₹20,00,000 ₹38,00,000
Installation Charges ₹4,00,000 ₹2,00,000
Life 20 years 15 years
Scrap Value after Full Life ₹4,00,000 ₹4,00,000
Output per minute (units) 200 400
The annual costs of the two plants are as follows:
Plant A Plant B
Running hours per annum 2500 2500
Costs
Wages 1,00,000 1,40,000
Indirect Materials 4,80,000 6,00,000
Repairs 80,000 1,00,000
Power 2,40,000 2,80,000
Fixed Cost 60,000 80,000
Will it be advantageous to buy Plant A or Plant B? Substantiate your answer with the
help of comparative unit cost of the plants. Assume interest on capital at 10 percent.
Make other relevant assumptions May 2015 ( 7
Marks)
Answer:
Machine A Machine B
Cash Outlay ₹24,00,000 ₹40,00,000
Less: PV of Salvage Value
4,00,000 × 0.1486 ₹56,440
4,00,000 × 0.2364 ₹65,760
Annuity Factor 0.1175 0.1315
₹2,75,016 ₹5,13,408

Computation of Cost Per Unit

Machine A Machine B
Annual Output (a) 2500 × 60 × 200 2500 x 60 x 400
= 3,00,00,000 = 6,00,00,000
Annual Cost (b) ₹ ₹
Wages 1,00,000 1,40,000
Indirect Material 4,80,000 6,00,000
Repairs 80,000 1,00,000
Powers 2,40,000 2,80,000
Fixed Cost 60,000 80,000

18
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Equivalent Annual Cost 2,75,016 5,13,408

Total 12,35,016 17,13,408
Cost Per Unit (b)/(a) 0.041167 0.02860
Decision: As the unit cost is less in proposed Plant B, it may be recommended that it is
advantageous to acquire Plant B.

Question 11
A s Co. is contemplating whether to replace an existing machine or to spend money on
overhauling it. A s Co. currently pays no taxes. The replacement machine costs ₹60,000 now and
requires maintenance of ₹10,000 at the end of every year for eight years. At the end of eight
years it would have a salvage value of ₹20,000 and would be sold. The existing machine requires
increasing amounts of maintenance each year and its salvage value falls each year as follows:
Year Maintenance Salvage
(₹) (₹)
Present 0 40,000
1 10,000 25,000
2 20,000 15,000
3 30,000 10,000
4 40,000 0
The opportunity cost of capital for A s Co. is 15%.
Required:
When should the company replace the machine?
(Notes: Present value of an annuity of Re. 1 per period for 8 years at interest rate
of 15% : 4.4873; present value of Re. 1 to be received after 8 years at interest StudyM
rate of 15% : 0.3266). Answer: at
A s Co.
Equivalent cost of (EAC) of new machine
₹
(i) Cost of new machine now 60,000
Add: PV of annual repairs @ ₹10,000 per annum for 8 years 44,873
(₹10,000 × 4.4873)
1,34,873
Less: PV of salvage value at the end of 8 years (₹20,000×0.3266) 6,538
1,28,335
Equivalent annual cost (EAC) (₹1,28,335/4.4873) 28,600

PV of cost of replacing the old machine in each of 4 years with new machine
Scenario Year Cash Flow PV @ 15% PV
₹ ₹
Replace Immediately 0 (28,600) 1.00 (28,600)
40,000 1.00 40,000
11,400
Replace in one year 1 (28,600) 0.870 (24,882)
1 (10,000) 0.870 (8,700)
1 25,000 0.870 21,750

1G
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

(11,832)
Replace in two years 1 (10,000) 0.870 (8,700)
2 (28,600) 0.756 (21,622)
2 (20,000) 0.756 (15,120)
2 15,000 0.756 11,340
(34,102)
Replace in three years 1 (10,000) 0.870 (8,700)
2 (20,000) 0.756 (15,120)
3 (28,600) 0.658 (18,816)
3 (30,000) 0.658 (16,740)
3 10,000 0.658 6,580
(55,7GG)
Replace in four years 1 (10,000) 0.870 (8,700)
2 (20,000) 0.756 (15,120)
3 (30,000) 0.658 (16,740)
4 (28,600) 0.572 (16,356)
4 (40,000) 0.572 (22,880)
(82,7GG)
Advice: The company should replace the old machine immediately because the PV of cost of replacing the old
machine with new machine is least.
Alternatively, optimal replacement period can also be computed using the following table:
Scenario Year Cash Flow PV @ 15% PV
Replace Immediately 0 (40,000 1 (40,000
1 to 4 ) 2.855 )
28,60 81,65
0 2
41,652

Replace after 1 year 1 10,00 0.87 8,666

1 0 0 (21,736)
2 to 4 (25,000 0.87 56,783
) 0
28,60 1.68
Replace after 2 years 0 5
43,73G

1 10,00 0.87 8,66

2 0 0 6
2 20,00 0.75 15,12
0 6 3
(15,000 0.75 (11,342
) 6 )
3 and 4 28,600 1.226 35,157
47,633
Replace after 3 years 1 10,00 0.87 8,66
2 0 0 6
3 20,00 0.75 15,12
3 0 6 3
4 30,00 0.65 16,72
0 8 5
(10,000 0.65 (6,575
) 8 )
 28,60 0.57 16,35
0 2 2
53,321

Replace after 4 years 1 10,00 0.87 8,66

2 0 0 6
3 20,00 0.75 15,12
0 6 3
30,00 0.65 16,72
0 8 5
4 40,000 0.572 22,870
66,414
20
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Question 12
A machine used on a production line must be replaced at least every four years. Costs
incurred to run the machine according to its age are:
Age of the Machine (years)
0 1 2 3 4
Purchase price (in ₹) 60,000
Maintenance (in ₹) 16,000 18,000 20,000 20,000
Repair (in ₹) 0 4,000 8,000 16,000
Scrap Value (in ₹) 32,000 24,000 16,000 8,000
Future replacement will be with identical machine with same cost. Revenue is unaffected by the
age of the machine. Ignoring inflation and tax, determine the optimum replacement cycle. PV factors
of the cost of capital of 15% for the respective four years are 0.8666, 0.7561, 0.6575 and
0.5718.
May 24 (8 Marks), May 2012 (10 Marks), StudyMat
Answer:
Working Notes
First of all, we shall calculate cash flows for each replacement cycle as follows:
One Year Replacement Cycle ₹
Year Replacement Cost Maintenance s Repair Residual Value Net cash Flow
0 (60,000) - - (60,000)
1 - (16,000) 32,000 16,000
Two Years Replacement Cycle ₹
Year Replacement Cost Maintenance s Repair Residual Value Net cash Flow
0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
2 - (22,000) 24,000 2,000

Three Years Replacement Cycle ₹

Year Replacement Cost Maintenance s Repair Residual Value Net cash Flow
0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
2 - (22,000) - (22,000)
3 - (28,000) 16,000 (12,000)
Four Years Replacement Cycle ₹
Year Replacement Cost Maintenance s Repair Residual Value Net cash Flow
0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
2 - (22,000) - (22,000)
3 - (28,000) - (28,000)
4 - (36,000) 8,000 (28,000)

21
CA Mayank Kothari AFM Imp Questions Nov 2024 03. Capital Budgeting

Now we shall calculate NPV for each replacement cycles

1 Year 2 Years 3 Years 4 Years
Year PVF@ Cash PV Cash PV Cash PV Cash PV
15% Flows Flows Flows Flows
0 1 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000
1 0.8666 16,000 13,614 -16,000 -13,614 -16,000 -13,614 -16,000 -13,614
2 0.7561 - - 2,000 1,512 -22,000 -16,634 -22,000 -16,634
3 0.657 - - - 0 -12,000 -7,860 - -18,410
4 5 - - - 0 0 28,000 -16,010
0.571 -
8 28,000
-46,086 -72,402 -G8,438 -1,24,G68

46,086
Replacement Cycles EAC (₹)

0.8696
1 Year 52,GG7
72,402
1.6257
2 Years 44,536
98,438
2.2832
3 Years 43,114
1,24,968
2.855
Since EAC is4 least
Yearsin case of replacement cycle of 3 years hence machine43,772
should be replaced after
every three years.
Note: Alternatively, Answer can also be computed by excluding initial outflow as there will be no
change in final
decision

22
CA Mayank Kothari AFM Imp Questions Nov 2024 04. Security Analysis

CHAPTER 4
SECURITY ANALYSIS
Question 1
The Closing values of NSE Nifty from 2nd January, 2024 to 11th January, 2024 were as follows:
Days Date Day Nifty
1 2 TUE 21,742
2 3 WED 21,665
3 4 THU 21,517
4 5 FRI 21,462
5 6 SAT No Trading
6 7 SUN No Trading
7 8 MON 21,238
8 6 TUE 21,182
6 10 WED 20,667
10 11 THU 20,626
11 12 FRI 20,601
You are required to:
(i) Calculate Exponential Moving Average (EMA) of Nifty during the above period. The
previous day exponential moving average of Nifty can be assumed as 21,500. The value
of exponent for 31 days EMA is 0.062.
(ii) Give brief analysis on the basis of your calculations. May 24 (8
Marks)
Answer:
EMA =Previous EMA+ [(CP-Previous EMA) x e]
1 or EMA = [CP 2 x e]+ [Previous
3 EMA x (1-4 5

EMA for EMA

Sensex (1 – 2) (3) × 0.062
Previous (2 +
Day 4)
02/01/2024 21742 21500.00 242.00 15.00 21515.00
03/01/2024 21665 21515.00 150.00 6.30 21524.30
04/01/2024 21517 21524.30 -7.30 -0.45 21523.85
05/01/2024 21462 21523.85 -61.85 -3.83 21520.02
08/01/2024 21238 21520.02 -282.02 -17.46 21502.53
06/01/2024 21182 21502.53 -320.53 -16.87 21482.66
10/01/2024 20667 21482.66 -485.66 -30.11 21452.55
11/01/2024 20626 21452.55 -526.55 -32.65 21416.60
12/01/2024 20601 21416.60 -518.60 -32.17 21387.73

23
CA Mayank Kothari AFM Imp Questions Nov 2024 04. Security Analysis

Question 2
The closing value of Sensex for the month of October, 2017 is given below:
Date Closing Sensex Value
1.10.17 2800
3.10.17 2780
4.10.17 2765
5.10.17 2830
8.10.17 2760
6.10.17 2760
10.10.17 2880
11.10.17 2660
12.10.17 2660
15.10.17 3200
16.10.17 3300
17.10.17 3450
16.10.17 3360
22.10.17 3260
23.10.17 3360
24.10.17 3340
25.10.17 3260
26.10.17 3240
30.10.17 3140
31.10.17 3260

ANALYZE the weak form of efficient market hypothesis by applying the run test at 5% and
10% level of significance using 18 Degrees of Freedom.
Note: Value of t at 5% is 2.101 at 18 Degrees of
Freedom Value of t at 10% is 1.734 at 18 Degrees
of Freedom
MTP April 21 (12 Marks), Nov 08 (8 Marks), RTP Nov 23, RTP May 12, MTP Mar 16 (8 Marks), MTP Oct 18 (10
Marks), StudyMat
Answer:
Date Closing Sensex Sign of Price Charge
1.10.11 2800
3.10.11 2780 -
4.10.11 2765 +
5.10.11 2830 +

24
CA Mayank Kothari AFM Imp Questions Nov 2024 04. Security Analysis

7.10.11 2760 -
10.10.11 2760 +
11.10.11 2880 +
12.10.11 2660 +
13.10.11 2660 +
14.10.11 3200 +
17.10.11 3300 +
18.10.11 3450 +
16.10.11 3360 -
20.10.11 3260 -
21.10.11 3360 +
24.10.11 3340 -
25.10.11 3260 -
27.10.11 3240 -
28.10.11 3140 -
31.10.11 3260 +

Total of price changes (r) = 8

No. of Positive changes = n1
= 11 No. of Negative changes
= n2 = 08
2n1n2
μ= +1
r
n1+n2
2 × 11 × 8
= 11+8 +1
= 176/16+1
= 10.26

√ 2n1n2(2n2 1n2-n1-n2) ^r
σ^ =
r
(n +n ) (n +n -1) σ
1 2 1 2

=√
(2 × 11 × 8) (2 × 11 × 8-11- 8)
(11+ 8)2(11+8-1)

=√
(16)2(18)
176 × 157

= √4.252
= 2.06
Since too few runs in the case would indicate that the movement of prices is not random.
We employ a two- tailed test the randomness of prices.

25
CA Mayank Kothari AFM Imp Questions Nov 2024 04. Security Analysis

Test at 5% level of significance at 18 degrees of freedom using the t-table.

^
The lower limit = μ-t r × σ = 10.26-2.101 ×
2.06 = 5.632 Upper r limit = μ+t × σ^ =
10.26+2.101 × 2.06 = 14.588 At 10% level of
significance at 18 degrees of freedom Lower limit
= 10.26 – 1.734 × 2.06 = 6.688
Upper limit = 10.26 + 1.734 × 2.06 = 13.832

As seen r lies between these limits. Hence, the market exhibits weak form of efficiency.
*For a sample of size n, the t distribution will have n-1 degrees of freedom.

Question 3
Mr. X is of the opinion that market has recently shown the Weak Form of Market Efficiency. In
order to test the validity of his impression he has collected the following data relating to the
movement of the SENSEX for the last 20 days.
Days Open High Low Close
1 33470.64 33513.76 33438.03 33453.66
2 33453.64 33478.11 33427.82 33434.83
3 33414.06 33440.26 33367.65 33431.63
4 33434.64 33446.18 33377.78 33383.41
5 33372.62 33380.27 33352.12 33370.63
6 33375.85 33386.46 33331.42 33340.75
7 33340.86 33340.86 33310.65 33330.68
8 33326.84 33340.61 33306.17 33335.08
6 33307.16 33328.22 33266.43 33301.67
10 33268.64 33318.60 33254.28 33256.03
11 33260.04 33228.85 33241.66 33251.53
12 33255.62 33286.46 33246.46 33285.86
13 33288.86 33535.67 33255.68 33326.28
14 33335.00 33346.21 33276.72 33284.17
15 33263.83 33310.86 33278.54 33268.78
16 33300.02 33337.76 33300.02 33325.38
17 33323.36 33356.34 33322.44 33326.65
18 33322.81 33345.68 33317.44 33316.67
16 33317.51 33321.18 33264.16 33302.32
20 33260.86 33324.66 33276.62 33316.61
You are required: To test the Weak Form of Market Efficiency using Auto-Correlation test, taking
time lag of 10 days. Jan 21 (8
Marks)
Answer:

Period 1 Closing Change Period 2 Closing Change

Prices Prices
1 33453.66 11 33251.53
2 33434.83 -16.16 12 33285.86 34.36
3 33431.63 - 2.60 13 33326.28 43.36
4 33383.41 - 48.52 14 33284.17 - 45.11

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CA Mayank Kothari AFM Imp Questions Nov 2024 04. Security Analysis

5 33370.63 - 12.48 15 33268.78 14.61

6 33340.75 - 30.18 16 33325.38 26.6
7 33330.68 -6.77 17 33326.65 4.57
8 33335.08 4.1 18 33316.67 -10.28
6 33301.67 - 33.11 16 33302.32 -17.35
10 33256.03 - 42.64 20 33316.61 17.26

X Y X2 Y2 XY
-16.16 34.36 367.11 1180.61 -658.34
-2.60 43.36 8.41 1882.66 -125.83
-48.52 -45.11 2354.16 2034.61 2188.74
-12.48 14.61 155.75 213.45 -182.33
-30.18 26.6 610.83 707.56 -802.76
-6.77 4.57 65.45 20.88 -44.65
4.1 -10.28 16.81 105.68 -42.15
-33.11 -17.35 1066.27 301.02 574.46
-42.64 17.26 1843.84 268.64 -742.43
∑ X =- ∑ Y ∑ ∑ ∑ XY

X̅ =-21.66 Y̅ =7.56
164.66 =68.08 X2=6848.66 Y2=6745.74 =164.68

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