Solution:

The correct answer is **(b) divide the dividend amount by the rate of return**. Preferred stock typically pays a fixed dividend in perpetuity. Its price is therefore calculated as the present value of a perpetuity, which is the annual dividend divided by the required rate of return. This is similar to the formula for the value of a perpetual bond.

Solution:

The correct answer is **(c) the return on existing common stock**. The cost of retained earnings represents the opportunity cost to shareholders for forgoing dividends. If the earnings were paid out as dividends, shareholders could have invested that money in another asset with a similar risk profile, such as the company's existing common stock.

Solution:

The correct answer is **(a) equality of impact on EPS between two financing plans**. The indifference point, in the context of capital structure, is the level of EBIT (Earnings Before Interest and Taxes) at which the earnings per share (EPS) of two different financing alternatives (e.g., debt vs. equity) are exactly the same.

Solution:

The correct answer is **(d) the yield to maturity**. The yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures. It is the internal rate of return (IRR) of a bond's cash flows and is the market's required rate of return for that specific bond. The coupon rate is the interest paid, not the rate used for discounting.

Solution:

The correct answer is **(e) the previous share price**. An Initial Public Offering (IPO) is when a company's stock is sold to the public for the first time. Since the company was previously private, there is no "previous share price" to consider. All other options are factors that would be carefully analyzed by investment banks and underwriters to determine the offering price.

Solution:

We can use the Capital Asset Pricing Model (CAPM) formula to solve for beta ($\beta$).

Given: $k_e = 15\%$, $R_f = 5\%$, $R_M = 10\%$.

$0.15 = 0.05 + \beta \times (0.10 - 0.05)$

$0.15 - 0.05 = \beta \times 0.05$

$0.10 = \beta \times 0.05 \implies \beta = \frac{0.10}{0.05} = 2.0$

The value of beta is **(c) 2.0**.

Solution:

The correct answer is **(d) inflows are discounted back to determine if they exceed outflows**. The net present value (NPV) method calculates the difference between the present value of all cash inflows and the present value of all cash outflows. It is a fundamental capital budgeting technique that correctly incorporates the time value of money by using a discount rate to bring future cash flows to their present value.

Solution:

The correct answer is **(a) should be discounted at a rate higher than the cost of capital**. The cost of capital (WACC) is the appropriate discount rate for projects with an average risk level for the firm. A project that increases the firm's overall risk should be discounted at a higher rate to compensate investors for the additional risk. Using the firm's average cost of capital for a high-risk project would be incorrect and could lead to accepting a value-destroying project.

Solution:

The correct answer is **(b) trend analysis**. Trend analysis involves examining a firm's financial data and ratios over multiple periods to identify patterns and changes in performance. This helps in understanding the company's financial health over time, unlike a static analysis of a single period.

Solution:

The correct answer is **(e) government policies, balance of payments, inflation**. These are the key macroeconomic factors that influence the supply and demand for a country's currency. Inflation and interest rate differentials are major drivers (Purchasing Power Parity and Interest Rate Parity), and government policies and the balance of payments (which includes the balance of trade) directly affect the demand for a currency.

Solution:

True. The intrinsic value of any security is the present value of its expected future cash flows, discounted at a rate that reflects the risk of those cash flows. Knowing the future cash flows and the appropriate discount rate are the two fundamental inputs for any valuation model.

Solution:

True. The Treasurer is a key financial executive whose responsibilities typically include managing cash flows, obtaining financing, and making capital expenditure decisions, which fall under the scope of capital budgeting.

Solution:

False. The cost of raising an additional taka of capital is the **marginal cost of capital (MCC)**. The simple average cost of capital is the average cost of all the firm's capital sources, weighted by their proportion in the firm's capital structure.

Solution:

False. Working capital management is concerned with the management of a firm's **current assets and current liabilities**. The management of a firm's capital assets (long-term assets) is addressed by capital budgeting.

Solution:

False. A series of consecutive cash flows of equal amounts is known as an **annuity**. A compound sum refers to the future value of a single amount or a series of cash flows, which includes both the initial principal and the accumulated interest.

Solution:

The correct matches are as follows:

• **(1) Financial risk** matches with **(a) the inability to meet debt obligations**. Financial risk is the risk to a firm's equity holders that the firm will not be able to pay its debt obligations.
• **(2) Beta coefficient** matches with **(d) the historical volatility relative to the market's volatility**. Beta measures a security's systematic risk by comparing its historical returns to the market's historical returns.
• **(3) Cost of equity** matches with **(b) dividend yield plus growth rate**. This is the formula for the cost of equity under the constant growth (Gordon Growth) model.
• **(4) Short-term credit** matches with **(g) suppliers**. Trade credit from suppliers is a common and often spontaneous source of short-term financing for a firm.
• **(5) Net worth** matches with **(c) total assets minus total liabilities**. Net worth is another term for a company's total equity, which is found by subtracting total liabilities from total assets.

Solution:

i. Profit Maximization vs. Wealth Maximization:

Profit maximization is the objective of maximizing a firm's net income or earnings per share in the short term. It often focuses on quarterly or annual earnings and can lead to decisions that may not be in the firm's long-term best interest.

Wealth maximization is the long-term objective of maximizing the value of a firm's stock. It considers the timing of cash flows, the risk associated with those cash flows, and the impact of decisions on the firm's overall value. Wealth maximization is the preferred goal of modern financial management.

Example: Suppose a company has two projects. Project A has a higher expected profit in year one but is very risky. Project B has a lower profit in year one but is less risky and has a strong growth trajectory. A management focused on profit maximization might choose Project A, but a management focused on wealth maximization would likely choose Project B, as its lower risk and strong long-term growth would be more valuable to shareholders in the long run.

ii. Disadvantages of Profit and Advantages of Wealth Maximization:

• **Disadvantages of Profit as a Performance Measure:**
  1. **Ignores risk:** Profit maximization does not account for the riskiness of the cash flows. A project with a high expected profit but also a high risk of failure might be chosen over a less profitable but more certain project.
  2. **Ignores timing of cash flows:** It does not consider the time value of money. A profit of Tk. 100,000 today is more valuable than a profit of Tk. 100,000 five years from now, but profit maximization treats them as equal.
  3. **Ambiguous definition of profit:** There are many different ways to measure profit (e.g., net income, EBIT), which can lead to ambiguity and manipulation.
• **Advantages of Wealth Maximization as a Performance Measure:**
  1. **Considers risk:** Wealth maximization, as measured by stock price, inherently accounts for risk. Risky projects will be discounted at a higher rate, reducing their value to shareholders.
  2. **Considers the time value of money:** It uses discounting techniques to bring all future cash flows to their present value, making all decisions comparable in today's terms.
  3. **Focuses on long-term value:** By focusing on the stock price, it encourages management to make decisions that build sustainable, long-term value for the firm, which is aligned with shareholders' interests.

Solution:

i. Identification of cash flow patterns:

Strategy 1 is a combination of a lump-sum payment today and an **ordinary annuity** (a series of equal payments at the end of each period). The payments are quarterly.

Strategy 2 is an **annuity due** (a series of equal payments at the beginning of each period). The payments are monthly.

ii. Present value and advice:

We need to find the present value of each strategy. The required rate of return is 25% per annum.

• **Strategy 1 (Quarterly):**

  Quarterly rate = $\frac{25\%}{4} = 6.25\% = 0.0625$

  Number of quarters = $5 \text{ years} \times 4 \text{ quarters/year} = 20 \text{ quarters}$

  PV of annuity = $PMT \times \left[ \frac{1 - (1+i)^{-n}}{i} \right] = 50,000 \times \left[ \frac{1 - (1.0625)^{-20}}{0.0625} \right]$

  $= 50,000 \times 11.258 \approx \text{Tk. } 562,900$

  Total PV = Immediate Payment + PV of Annuity = $1,200,000 + 562,900 = \text{Tk. } 1,762,900$

• **Strategy 2 (Monthly):**

  Monthly rate = $\frac{25\%}{12} \approx 2.0833\% = 0.020833$

  Number of months = $5 \text{ years} \times 12 \text{ months/year} = 60 \text{ months}$

  The formula for an annuity due is the ordinary annuity formula multiplied by $(1+i)$.

  PV of annuity due = $PMT \times \left[ \frac{1 - (1+i)^{-n}}{i} \right] \times (1+i)$

  $= 55,000 \times \left[ \frac{1 - (1.020833)^{-60}}{0.020833} \right] \times (1.020833)$

  $= 55,000 \times [34.787] \times 1.020833 \approx \text{Tk. } 1,950,568$

Advice: ITC should choose **Strategy 2**. Its present value of approximately **Tk. 1,950,568** is significantly higher than the present value of Strategy 1 (**Tk. 1,762,900**), representing a greater value for the company today.

Solution:

i. Holding company's beta:

The beta of a portfolio (or holding company) is the weighted average of the betas of its individual components.

$\beta_{ECRI} = (0.60 \times 0.70) + (0.25 \times 0.90) + (0.10 \times 1.30) + (0.05 \times 1.50)$

$= 0.42 + 0.225 + 0.13 + 0.075 = 0.85$

The holding company's beta is **0.85**.

ii. Holding company's required rate of return:

Using the CAPM formula:

$k_e = 6\% + 0.85 \times 5\% = 6\% + 4.25\% = 10.25\%$

The holding company's required rate of return is **10.25%**.

iii. Required rate of return after strategic change:

We need to recalculate the portfolio beta with the new weights. The weights for the cable company and real estate development subsidiaries remain the same.

New weight for Electric utility = 50% = 0.50

New weight for International/special projects = 15% = 0.15

Weights for Cable company and Real estate = $1 - 0.50 - 0.15 = 0.35$.

We are not given a new breakdown for the remaining 35%. We can assume the proportions remain the same for the other two.

Original combined weight = $0.25+0.10 = 0.35$. So the proportions remain the same.

New weight of Cable = $0.25 \times \frac{0.35}{0.35} = 0.25$. New weight of Real estate = $0.10 \times \frac{0.35}{0.35} = 0.10$.

New portfolio beta = $(0.50 \times 0.70) + (0.25 \times 0.90) + (0.10 \times 1.30) + (0.15 \times 1.50)$

$= 0.35 + 0.225 + 0.13 + 0.225 = 0.93$

New required rate of return = $6\% + 0.93 \times 5\% = 6\% + 4.65\% = 10.65\%$

The company's new required rate of return will be **10.65%**.

Solution:

i. Explanation of capital rationing:

Capital rationing is the practice of restricting the amount of new investments or projects a firm undertakes to a certain budget, even if there are more projects with a positive Net Present Value (NPV) that could be accepted. This is typically done when a firm has a limited amount of capital to invest.

ii. Soft vs. Hard capital rationing:

• **Soft Capital Rationing:** This occurs when a firm's management voluntarily sets a limit on the amount of capital to be invested. This might be due to a desire to maintain a stable debt-to-equity ratio or to avoid taking on too many new projects at once to prevent overstretching management capacity.

  **Example:** A company's CEO decides to limit the capital budget for new projects to Tk. 10 million for the year, even though the company has access to more funds at a reasonable cost.

• **Hard Capital Rationing:** This occurs when a firm is unable to raise additional capital, regardless of how many profitable projects it has. This can happen due to external factors, such as a credit crisis, economic recession, or if the firm has a poor credit rating.

  **Example:** A small, unprofitable startup is unable to secure a bank loan or attract new investors to fund a promising new project because of its poor financial history.

iii. Uses and limitations:

• **Uses:** Capital rationing is used to enforce financial discipline, manage risk, and prevent over-expansion. It forces management to prioritize projects and choose only the most profitable ones, which can lead to a more efficient use of capital.
• **Limitations:** The primary limitation is that it may lead to the rejection of profitable projects (those with a positive NPV), which can reduce the firm's long-term value and growth potential. It can also lead to suboptimal decisions, as managers may choose a portfolio of smaller projects that fit within the budget, rather than a single, larger, and more valuable project.

Solution:

i. Accounting Rate of Return (ARR) for each project:

The formula for ARR on an average investment basis is: $ARR = \frac{\text{Average Annual Net Profit}}{\text{Average Investment}}$. To find the net profit, we must subtract the annual depreciation from the net cash flows.

• **Project A:**

  Total Net Cash Flows = $600,000+500,000+400,000+300,000 = \text{Tk. } 1,800,000$

  Average Annual Cash Flow = $\frac{1,800,000}{4} = \text{Tk. } 450,000$

  Depreciation = $\frac{\text{Initial Investment}}{\text{Life}} = \frac{1,000,000}{4} = \text{Tk. } 250,000$

  Average Annual Net Profit = $450,000 - 250,000 = \text{Tk. } 200,000$

  Average Investment = $\frac{\text{Initial Investment}}{2} = \frac{1,000,000}{2} = \text{Tk. } 500,000$

  $ARR_A = \frac{200,000}{500,000} = 0.40$ or $40\%$

• **Project B:**

  Total Net Cash Flows = $700,000+600,000+500,000+500,000+400,000 = \text{Tk. } 2,700,000$

  Average Annual Cash Flow = $\frac{2,700,000}{5} = \text{Tk. } 540,000$

  Depreciation = $\frac{1,600,000}{5} = \text{Tk. } 320,000$

  Average Annual Net Profit = $540,000 - 320,000 = \text{Tk. } 220,000$

  Average Investment = $\frac{1,600,000}{2} = \text{Tk. } 800,000$

  $ARR_B = \frac{220,000}{800,000} = 0.275$ or $27.5\%$

• **Project C:**

  Total Net Cash Flows = $800,000+600,000+500,000+400,000 = \text{Tk. } 2,300,000$

  Average Annual Cash Flow = $\frac{2,300,000}{4} = \text{Tk. } 575,000$

  Depreciation = $\frac{2,000,000}{4} = \text{Tk. } 500,000$

  Average Annual Net Profit = $575,000 - 500,000 = \text{Tk. } 75,000$

  Average Investment = $\frac{2,000,000}{2} = \text{Tk. } 1,000,000$

  $ARR_C = \frac{75,000}{1,000,000} = 0.075$ or $7.5\%$

ii. Advice to Sakura Limited:

Sakura Limited's target ARR is 25%. We should accept all projects whose ARR is equal to or greater than this hurdle rate.

• Project A's ARR (40%) is > 25% -> **Accept**
• Project B's ARR (27.5%) is > 25% -> **Accept**
• Project C's ARR (7.5%) is < 25% -> **Reject**

Sakura Limited should undertake **Projects A and B**.

Solution:

i. Capital structure of the company:

We first calculate the market value of each component of the capital structure.

Market Value of Equity = $10,000,000 \times 50 = \text{Tk. } 500,000,000$

Market Value of Preference Shares = $3,000,000 \times 25 = \text{Tk. } 75,000,000$

Market Value of Bonds = $5,000 \times 600 = \text{Tk. } 3,000,000$

Total Market Value of Capital = $500,000,000 + 75,000,000 + 3,000,000 = \text{Tk. } 578,000,000$

The capital structure, in terms of market value weights, is as follows:

• Weight of Equity: $\frac{500,000,000}{578,000,000} \approx 0.865$ or $86.5\%$
• Weight of Preference Shares: $\frac{75,000,000}{578,000,000} \approx 0.130$ or $13.0\%$
• Weight of Debt: $\frac{3,000,000}{578,000,000} \approx 0.005$ or $0.5\%$

The capital structure is approximately **86.5% equity, 13.0% preference shares, and 0.5% debt**.

ii. Annual earnings required:

We are asked to find the annual earnings required to achieve a **25% return on capital employed for equity holders**. This is different from a WACC calculation. We need to work backwards from the required return to find the required EBIT (Earnings Before Interest and Taxes).

Total Return on Equity = $0.25 \times 500,000,000 = \text{Tk. } 125,000,000$

After-tax earnings available to common shareholders (Net Income) must be Tk. 125,000,000.

First, we find the dividend payments on the preference shares and the interest payments on the bonds.

Preference dividend = $3,000,000 \times 25 \times 0.20 = \text{Tk. } 15,000,000$

Interest on bonds = $3,000,000 \times 0.18 = \text{Tk. } 540,000$

Total earnings after tax must cover the preference dividends and the required return for equity holders.

Earnings After Tax (EAT) = Return on Equity + Preference Dividend

$EAT = 125,000,000 + 15,000,000 = \text{Tk. } 140,000,000$

Since EAT = $(EBIT - \text{Interest}) \times (1-T)$, we can rearrange this to solve for EBIT.

$EBIT - \text{Interest} = \frac{EAT}{1-T} = \frac{140,000,000}{1-0.25} = \frac{140,000,000}{0.75} \approx \text{Tk. } 186,666,667$

$EBIT = 186,666,667 + \text{Interest} = 186,666,667 + 540,000 = \text{Tk. } 187,206,667$

The company should earn approximately **Tk. 187.21 million** annually.

Solution:

Listing on a stock exchange like the DSE, also known as an Initial Public Offering (IPO), can provide several significant benefits to a company like RANGSgroup.

• **Access to Capital:** An IPO provides the company with access to a much larger and more diverse pool of investors, allowing it to raise a significant amount of capital to fund expansion, research and development, or to pay off existing debt. This can be more cost-effective and flexible than relying on traditional bank loans.
• **Enhanced Reputation and Credibility:** Being a publicly listed company on a major stock exchange like the DSE can significantly enhance a company's public image, reputation, and credibility. This can help attract new customers, partners, and talent, as well as facilitate future financing.
• **Liquidity for Shareholders:** An IPO provides a liquid market for the shares of the company. This means that existing shareholders (such as the founders and early investors) can easily sell their shares and realize the value of their investment. This can be a key exit strategy and a powerful incentive for investors.
• **Improved Employee Incentives:** Publicly listed companies can use stock-based compensation (e.g., stock options, employee stock purchase plans) to attract and retain top talent. These incentives can align the interests of employees with those of the shareholders, motivating them to work towards increasing the company's value.

Solution:

We will compare the two options (Lease vs. Buy) by calculating the Net Present Value (NPV) of each. The discount rate for both options is the after-tax cost of debt.

Cost of Debt = 10%. Tax Rate = 34%.

After-tax cost of debt = $10\% \times (1 - 0.34) = 6.6\%$

Option 1: Lease the IPM machine

The cash flows for the lease option are the after-tax lease payments and the after-tax savings from the machine's operation.

After-tax lease payment (annuity due) = $80,000 \times (1-0.34) = \text{Tk. } 52,800$

After-tax savings = $29,000 \times (1-0.34) = \text{Tk. } 19,140$

NPV = PV of Savings - PV of Payments

The lease payments are an annuity due over 5 years.

PV of Payments = $52,800 + 52,800 \times \left[ \frac{1 - (1.066)^{-4}}{0.066} \right] = 52,800 + 52,800 \times 3.424 \approx \text{Tk. } 233,639$

The savings are an ordinary annuity over 5 years.

PV of Savings = $19,140 \times \left[ \frac{1 - (1.066)^{-5}}{0.066} \right] = 19,140 \times 4.198 \approx \text{Tk. } 80,359$

$NPV_{Lease} = 80,359 - 233,639 = \text{Tk. } -153,280$

The NPV of the lease option is approximately **Tk. (153,280)**.

Option 2: Purchase the BMC machine

Initial cost = Tk. (365,000)

Depreciation (straight-line) = $\frac{365,000}{5} = \text{Tk. } 73,000$ per year.

Depreciation tax shield = $73,000 \times 0.34 = \text{Tk. } 24,820$ per year.

After-tax savings = $32,000 \times (1 - 0.34) = \text{Tk. } 21,120$ per year.

NPV of Buying = $-365,000 + \sum_{t=1}^5 \frac{(\text{Savings} + \text{Dep. Tax Shield})}{(1.066)^t}$

$NPV_{Buy} = -365,000 + (21,120 + 24,820) \times \left[ \frac{1 - (1.066)^{-5}}{0.066} \right]$

$= -365,000 + 45,940 \times 4.198 \approx -365,000 + 192,866 = \text{Tk. } -172,134$

The NPV of the purchase option is approximately **Tk. (172,134)**.

Conclusion:

Both options result in a negative NPV, which means neither should be undertaken. However, if Farmer Corporation must replace the machine, the **lease option is marginally better** as it has a lower negative NPV ($-153,280$ vs. $-172,134$).

Solution:

We will calculate the value of 100% of Zeal Limited and then take 70% of that value to advise on the purchase price.

i. P/E Ratio Valuation:

Value = EPS $\times$ P/E Ratio $\times$ Number of Shares

Value = $15 \times 10 \times 20,000,000 = \text{Tk. } 3,000,000,000$

Purchase price for 70% = $3,000,000,000 \times 0.70 = \text{Tk. } 2,100,000,000$

Using the P/E ratio, the price to pay for 70% of the shares is **Tk. 2.1 billion**.

ii. Balance Sheet Valuation Basis:

First, we find the total net assets before any adjustments.

Book Value of Equity = Net assets per share $\times$ Number of shares = $8 \times 20,000,000 = \text{Tk. } 160,000,000$

Now, we apply the due diligence adjustments.

Value of Net Assets = Book Value of Equity - Overstated Fixed Assets - Irrecoverable Debt - Tax Provision

= $160,000,000 - 6,000,000 - 4,000,000 - 10,000,000 = \text{Tk. } 140,000,000$

Purchase price for 70% = $140,000,000 \times 0.70 = \text{Tk. } 98,000,000$

Using the balance sheet valuation, the price to pay for 70% of the shares is **Tk. 98 million**.

iii. Cash Flow Valuation:

We find the present value of the projected cash inflows. The discount rate is the company's cost of capital plus the additional risk premium.

Discount Rate = $16\% + 4\% = 20\%$

PV = $\frac{125}{(1.20)^1} + \frac{60}{(1.20)^2} + \frac{150}{(1.20)^3} + \frac{200}{(1.20)^4} + \frac{110}{(1.20)^5}$

$= 104.17 + 41.67 + 86.81 + 96.45 + 44.29 = \text{Tk. } 373.39 \text{ million}$

Purchase price for 70% = $373,390,000 \times 0.70 = \text{Tk. } 261,373,000$

Using the cash flow valuation, the price to pay for 70% of the shares is approximately **Tk. 261.37 million**.

Advice to Shareholders:

The three methods provide a wide range of values: Tk. 2.1 billion (P/E), Tk. 98 million (Balance Sheet), and Tk. 261.37 million (Cash Flow). The P/E and Cash Flow methods are typically more forward-looking and thus more relevant for an acquisition decision. The balance sheet method is more of a liquidation value. The P/E ratio of 10 times with an EPS of Tk. 15 may be too simplistic and not fully reflect the risks. The cash flow valuation, which accounts for the cost of capital and risk, provides the most robust valuation. Therefore, the shareholders should consider paying a price that is closer to the cash flow valuation, likely around **Tk. 261.37 million** for 70% of the shares.

Solution:

As a financial manager, I would recommend a policy of **stable dividend payment per share**. This policy aims to maintain a constant or steadily increasing dividend over time, even if the firm's earnings fluctuate.

The primary reason for this recommendation is that a stable dividend payment provides a clear and positive signal to the market. Investors often view a stable dividend as an indication of a firm's financial health, management's confidence in future earnings, and a commitment to returning value to shareholders. This predictability can reduce investor uncertainty, attract a stable base of investors, and potentially lead to a higher and more stable stock price. While a stable payout ratio may sound logical, it can result in volatile dividend payments that confuse investors and can be a sign of financial instability. A stable dividend policy, on the other hand, prioritizes investor relations and market stability over a rigid link between dividends and short-term earnings.

Solution:

We need to compare the incremental costs and benefits of the proposed credit policy change to determine if it is worthwhile.

Current Policy:

Sales = Tk. 80 million

Contribution Margin = $80,000,000 \times 0.30 = \text{Tk. } 24,000,000$

Bad Debt = $80,000,000 \times 0.02 = \text{Tk. } 1,600,000$

Collection Cost = Tk. 50,000

Receivables Investment = $\frac{80,000,000 \times (1-0.30)}{365} \times 15 = \text{Tk. } 2,301,370$

Cost of Investment = $2,301,370 \times 0.24 = \text{Tk. } 552,329$

Proposed Policy:

New Sales = $80,000,000 \times 1.20 = \text{Tk. } 96,000,000$

New Bad Debt = $96,000,000 \times 0.02 = \text{Tk. } 1,920,000$

New Collection Cost = Tk. 65,000

New Receivables Investment = $\frac{96,000,000 \times (1-0.30)}{365} \times 24 = \text{Tk. } 4,402,192$

New Cost of Investment = $4,402,192 \times 0.24 = \text{Tk. } 1,056,526$

Cash Discounts = $96,000,000 \times 0.30 \times 0.02 = \text{Tk. } 576,000$

Incremental Analysis:

Incremental Sales = $96,000,000 - 80,000,000 = \text{Tk. } 16,000,000$

Incremental Contribution Margin = $16,000,000 \times 0.30 = \text{Tk. } 4,800,000$

Incremental Bad Debt = $1,920,000 - 1,600,000 = \text{Tk. } 320,000$

Incremental Collection Cost = $65,000 - 50,000 = \text{Tk. } 15,000$

Incremental Cost of Receivables Investment = $1,056,526 - 552,329 = \text{Tk. } 504,197$

Incremental Cash Discounts = Tk. 576,000

Net Incremental Profit = Incremental CM - Incremental Bad Debt - Incremental Collection Cost - Incremental Cost of Receivables - Incremental Cash Discounts

= $4,800,000 - 320,000 - 15,000 - 504,197 - 576,000 = \text{Tk. } 3,384,803$

Recommendation: Since the net incremental profit is positive, the proposed change should be **implemented**.

Solution:

While both currency forwards and futures are used for hedging foreign exchange risk, a currency forward contract offers distinct advantages over a currency futures contract, particularly for a company like Home Decor Limited.

• **Customization:** A forward contract is a private agreement between two parties. This allows the contract to be customized to the exact amount and maturity date needed by the company, matching the value of the import invoice. Futures contracts, in contrast, are standardized in terms of size and maturity, which may result in a company being over- or under-hedged.
• **Flexibility in Delivery:** A forward contract can be settled by physical delivery of the currency or through cash settlement. Futures contracts, being standardized, usually involve a cash settlement. This flexibility is beneficial if the company needs to physically receive the foreign currency to pay for its imports.
• **No Margin Requirements:** Futures contracts are traded on exchanges and require a daily margin to be maintained. This means a company might have to post additional collateral if the market moves against it, creating a cash flow strain. Forward contracts, being over-the-counter, do not have a daily margin requirement.