THK JAIN COLLEGE

B. COM (Hons and Gen)

SEMESTER - VI
FINANCIAL MANAGEMENT
MODEL TEST PAPER WITH SOLUTION
FULL MARKS: 80 TIME: 3HRS
Group-A
Answer the following questions: 5x4=20
1) Write about the role of a finance manager.
Or, “Wealth maximization is dependent on profit maximization”- Discuss
2) From the following cash flow streams, which cash flow would you recommend and why?

End of year Stream A (₹ ) Stream B (₹ ) Stream C (₹ )

1 200 500 350
2 300 400 350
3 400 300 350
4 500 200 350
The rate to be used is 10%
Or, Explain the concept of time value of money with example.
3) What are the sources of long term capital?
4) The current market price of an equity share of a company is ₹.140. The expected dividend
per share is ₹. 28. In case the dividends are expected to grow at a rate of 10%, calculate
the cost of equity capital?

Group-B
Answer the following questions: 6x10=60
5) (a) Given the following information:
Sales (10000 units) = ₹10, 00,000; Variable cost per unit = ₹60; Interest = ₹1, 00,000;
EBT= ₹2, 00,000; DCL= 2.5
Calculate Operating Leverage and Financial Leverage.

(b) From the following information compute sales: DOL=2; DFL=3;

Interest= ₹300000 and contribution is 40% of sales.
Or, Write the differences between NI Approach and NOI Approach.
(10)
6) For a new business Mr. Bose supplied the following information:

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 i) The projected annual sales ₹. 1,20,00,000
ii) He has estimated fixed expenses ₹. 20,000 per month and variable expenses equal
to 2% of turnover.
iii) Percentage of gross profit on cost of purchase will be 25%.
iv) Average expected credit period allowed to debtors is 1 month.
v) Average expected credit period from suppliers is 15 days.
vi) He expects to turnover his stocks 5 times in a year.
vii) Average cash holding is 1 month’s expenses.
You are required to forecast his working capital requirement.
Or, What is meant by working capital cycle? State the factors on which the duration of the
Working capital cycle period depends?
(10)
7) A manufacturing company has two options for investing in a project. You are requested
to advise the management as to the profitability of the investment on the basis of Pay-
Back Profitability:
Project A (₹) Project B (₹)
Initial Investment 55,000 70,000
Estimated annual cash inflows after tax
Year:
1 16,000 15,000
2 18,000 19,000
3 21,000 20,000
4 22,000 16,000
5 20,000 25,000
6 - 28,000

Or, What is Capital Budgeting? What are the main methods of Capital Budgeting?
(10)
8) (a) L Ltd. Provides you the following information:
i) Purchase price of machine ₹. 1,73,500
ii) Useful Life of machine 3 years
iii) Salvage value at the end of useful life NIL
iv) Cost of capital 10%
v) Cash flow after tax (CFAT)
Year 1 ₹. 1,00,000
Year 2 ₹. 1,00,000
Year 3 ₹. 80,000
Note: Present Value Factors @ 10% are as follows:
Year : 1 2 3
PV Factor: 0.909 0.826 0.751
Calculate the Discounted Payback Period.

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 (b) S. Ltd. is planning its capital investment programme for next year. It has 4 proposals
all of which given a positive NPV at the company cut off rate of 12%. The required initial
capital outlay and present values are as follows:
Proposals Initial Capital NPV (@12%) Profitability Index
Outlays (₹)
X1 2,25,000 67,500 1.30
X2 1,00,000 45,000 1.45
X3 1,50,000 60,000 1.40
X4 1,75,000 64,750 1.37
The company is limited to a capital spending of ₹. 3,00,000.
(5+5)
Which of the proposals should be accepted by the company? Assume that the proposals
are divisible and there is no alternative use of the money allocated for capital budgeting.
(5+5)
9) (a) What are the different types of dividend?
(b) From the following information, calculate the market value of equity shares of a
company’s per Walter’s model.
EAT = ₹ 15, 00, 000;
Number of equity share outstanding = 3, 00,000
Dividend paid = ₹ 6, 00,000
P/E Ratio = 10
ROI= 20%
What will be the optimum dividend pay-out ratio in this case?
(4+6)
10) Orient Bros dealing in computers and other accessories has annual sales of ₹. 40 lakhs
and is currently extending 30 days credit to the dealers. It is felt that sales can be
increased considerably if the dealers are willing to carry increased stock, but the dealers
have difficulty in financing their inventory. The company is therefore, considering
shifting in credit policy. The following information is available.
Present average collection period = 30days
Variable Cost = 80% on Sales
Fixed Cost = ₹. 10,00,000 p.a.
Required Rate of Return (Before tax) = 16%
Credit Policy Average Collection Period Annual Sales
I 40 days 50 lakhs
II 60 days 60 lakhs
III 75 days 75 lakhs
IV 90 days 90 lakhs
Determine which policy, the company should adopt?

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Solution:
Answer 1:
Financial managers perform data analysis and advise senior managers on profit-maximizing
ideas. Financial managers are responsible for the financial health of an organization. They
produce financial reports, direct investment activities, and develop strategies and plans for the
long-term financial goals of their organization.
The roles or functions of a finance manager can be stated as below:
1. Estimation of financial requirements
2. Capital structure
3. Investment decision
4. Portfolio management
Answer 1(Or):
The terms Profit Maximization and Wealth Maximization are related to Financial
Management.

Financial management refers to the management of funds in an effective and efficient

manner so as to attain the objectives of the organization.

When we talk about Profit Maximization, it means that the business's primary focus is on
generating profits. It is a short term objective of the organization whereas Wealth
Maximization is a objective where the focus is on Maximization of wealth or the worth of
the business. In other words we can say it means increasing the shareholders’ wealth (i.e.
increase in share value). It is a long term objective of the firm.

Value of the business= Earnings per share (EPS) / Capitalization rate

Profit Maximization v/s Wealth Maximization.

 Profit Maximization is the short term goal whereas Wealth Maximization is long
term goal.
 Profit Maximization is a traditional approach. Financial management has shifted its
focus to modern approach i.e. Wealth Maximization.
 Profit Maximization is a more relative term as compared to wealth maximization
 Profit Maximization doesn't consider risks and uncertainties whereas Wealth
Maximization takes risks and uncertainties into consideration.
 Profit Maximization avoids time value of money but, wealth maximization
recognizes it.
 Profit Maximization is important for the growth and survival. Wealth Maximization
on the other hand accelerates the growth rate and aims at market share
Maximization.

Conclusion
Both the objectives of financial management have significance for the business. It will not be
appropriate to point out which one is important.

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Profit being the basic requirement of any organization, cannot be ignored because it is
necessary for the organization's survival.

Also shareholders are investing in the organization expecting higher rates of return. If
organization ignores this aspect shareholders will lose trust in the company and will back out
which will affect the company's reputation.

Therefore it can be concluded that both the decisions are significant in different ways. For
day to day decision making profit maximization can be considered but when it comes to
decisions regarding shareholders wealth maximization should be taken into consideration.

Answer 2: Statement showing calculation of Present Value under different options:

Year PVF @10% A*PV B *PV C *PV
1 0.91 182 455 318.50
2 0.83 249 332 290.50
3 0.75 300 225 262.50
4 0.68 340 136 238.00
Total 3.17 1071 1,148 1,109.50
Option C is recommended as the present value is maximum.

Answer 2(Or):
The time value of money draws from the idea that rational investors prefer to receive money
today rather than the same amount of money in the future because of money's potential to
grow in value over a given period of time. For example, money deposited into a savings
account earns a certain interest rate and is therefore said to be compounding in value.
Time Value of Money Formula
Depending on the exact situation in question, the time value of money formula may change
slightly. For example, in the case of annuity or perpetuity payments, the generalized formula
has additional or less factors. But in general, the most fundamental TVM formula takes into
account the following variables:

 FV = Future value of money

 PV = Present value of money
 i = interest rate
 n = number of compounding periods per year
 t = number of years

Based on these variables, the formula for TVM is:

FV = PV x [ 1 + (i / n) ] (n x t)

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Answer 3:
The funds which are not paid back within a period of less than a year are referred to as long
term finance. Certain long term finance options directly form a part of the permanent capital
of the firm. In such cases, the repayment obligation does not even arise. A 20 year mortgage
or 10 year treasury bills are examples of long term finance. The primary purpose of obtaining
long-term funds is to finance capital projects and carrying out operations on an expansionary
scale. Such funds are normally invested into avenues from which greater economic benefits
are expected to arise in future. Some of the sources of long term capital are:
1) Equity share capital: Equity is the foremost requirement at the time of floatation of any
company. They represent the ownership funds of the company and are permanent to
the capital structure of the firm. The equity can be private or public.
2) Preference Share capital: Preference share capital means the shares with preference over
the other equity capital of the shareholders' capital. Such share capital is
having preference over the dividend and repayment at the time of liquidation.
3) Debentures: Debenture is a long-term bond issued by a company, or an unsecured loan
that a company issues without a pledge of assets. An interest-bearing bond issued by a power
company is an example of a debenture.
4) Long term loans: A form of loan that is paid off over an extended period of time greater
than 3 years is termed as a long-term loan. This time period can be anywhere between 3-30
years. These loans generally offer a hefty loan amount and are thus spread over a
considerable period of repayment tenure.

Answer 4:

Cost of Equity Capital = +

Where, D1 = Expected Dividend at the end of the year = 28

P = Market Price per share = 140
G = Growth rate = 10% = 0.10
∴ Cost of Equity Capital = 28/140 + 0.10
= 0.30 = 30%

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Answer 5(a):
Contribution = Sales –VC = ₹ (1000000-600000) = ₹ 400000
EBIT = EBT + Interest = ₹ (200000 + 100000) = ₹ 300000
Therefore, DOL = Contribution/EBIT = 400000/300000= 1.33
∴ DFL = EBIT/EBT= 300000/200000 =1.5

(b) DFL =

Or, 3=

Or, 3=

Or, EBIT= ₹ 450000

DOL=

Or, 2=

Therefore, Contribution = 2* ₹ 450000 = ₹ 900000

Since, contribution is 40% sales,

Therefore sales = = ₹ 2250000

%

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Answer 5 (Or):

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Answer 6:
Statement of Working Capital Requirement Forecast
Particulars Amount(₹) Amount(₹)
A. Current Assets:
Stock 19,20,000
Debtors 10,00,000
Cash Balance 40,000
Total Current Assets 29,60,000

B. Current Liabilities
Creditors for Material 4,80,000

C. Working Capital Requirement (A-B) 24,80,000

Working Notes:
a) Projected Annual Sales = ₹. 1,20,00,000
b) % of GP = 25% of Cost of Purchase i.e. 20% on sales
c) Cost of Goods sold = Sales – GP
= ₹. (1,20,00,000 – 20% on 1,20,00,000) = ₹. 1,20,00,000 - ₹. 24,00,000
= ₹. 96,00,000
d) Stock:
Stock turnover = 5 times in a year
We know that,
Stock Turnover = 96,00,000
Average Stock

Or, 5 = 96,00,000
Average Stock
Average Stock = ₹. 19,20,000
Since, this is a new concern, there would be no opening stock.
So, average stock = Closing Stock = ₹. 19,20,000
e) Debtors:
Credit period allowed to debtors = 1 months
We know that,
Debtors Turnover =

Or, 1 =
, , ,
Debtors = ₹. 1,20,00,000 x 1/12 = ₹. 10,00,000

f) Expected Cash Balance:

Average cash holding = 1 month’s expenses (assumed both fixed and variable)

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 Amount (₹)
Fixed expenses per month 20,000
Variable expenses per month 20,000
@ 2% on ₹. 1,20,00,000 x 1/12
40,000

g) Creditors:
Credit period allowed by suppliers = 0.5 months,
We know that,
Creditors Turnover =

Or, 0.5 =
, , ,

∴ Creditors = ₹. 1,15,20,000 x 0.5/12 = ₹. 4,80,000

[N.B. Purchase = Cost of goods sold + Closing stock – Opening Stock
= ₹. (96,00,000 + 19,20,000 – NIL)]

Answer 6 (Or):
The working capital cycle (WCC) is the amount of time it takes to turn the net current assets
and current liabilities into cash. The longer the cycle is, the longer a business is tying up
capital in its working capital without earning a return on it. Therefore, companies strive to
reduce its working capital cycle by collecting receivables quicker or sometimes stretching
accounts payable.
A positive working capital cycle balances incoming and outgoing payments to minimize net
working capital and maximize free cash flow. For example, a company that pays its suppliers
in 30 days but takes 60 days to collect its receivables has a working capital cycle of 30 days.
This 30-day cycle usually needs to be funded through a bank operating line, and the interest
on this financing is a carrying cost that reduces the company's profitability.
Factors Affecting the Working Capital Cycle:
 Time Lag: The Volume of Working Capital requirement however depends on several
stages of working capital cycle such as, duration of raw material, storage period,
processing period, finished goods storage period, period of credit allowed to customer
and so on. If these time periods in different stages are changed then the duration of
working capital cycle is also changed.
 Production Efficiency: the duration of working capital cycle also depends on the
efficiency of the production process.
 Availability of Raw Materials: The duration of Working capital cycle depends on
the availability of raw materials in the market.
 Relationship between Production and Sales Departments: The Production
Department can able to assess the pattern of sales during an accounting period, only
when there is a cordial relationship between the production and sales department.
 Credit Collection Policy: The duration of working capital cycle depends on how fast
cash is collected from the customers

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  Debt Payment Policy: The duration of working capital cycle depends on the debt
repayment policy of the firm.
 Other factors: The duration of working capital cycle however depends on certain
other factors such as the nature of the business, type of market, discount allowed to
customers, discount received from creditors and so on.

Answer 7:
Statement showing computation of Net Cash Inflows of Different Projects:
Year Project A Project B
NCFAT Cumulative NCFAT Cumulative
NCFAT NCFAT
1 16,000 16,000 15,000 15,000
2 18,000 34,000 19,000 34,000
3 21,000 55,000 20,000 54,000
4 22,000 77,000 16,000 70,000
5 20,000 97,000 25,000 95,000
6 - - 28,000 1,23,000
[N. B. NCFAT = Net Cash Flow After Tax]
It is evident from the above table that the initial investment of ₹. 55,000 will be recovered
within 3 years in case of Project A whereas the initial investment of project B is recovered
within 4 years.
Statement showing Ranking of the Projects under Payback Period Method
Projects Payback Period Ranking
Project A 3 years I
Project B 4 years II

Statement Showing computation of Post Payback Profitability

Particulars Project A Project B
Total Expected annual cash inflows after tax (a) 97,000 1,23,000
Initial Investment (b) 55,000 70,000
Post Payback Profitability (a-b) 42,000 53,000
Rank II I

Recommendation: According to the criterion of Payback Period method, Project A should

be accepted as it has shorter Payback period than the project B. But if we follow Payback
Profitability Method for evaluation of investment proposals then Project B should be
accepted as it contributes more after recovering its initial investment. Therefore, it is
advisable to invest in Project B.

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 Answer 7(Or):
Capital budgeting is the process a business undertakes to evaluate potential major projects
or investments. Construction of a new plant or a big investment in an outside venture are
examples of projects that would require capital budgeting before they are approved or
rejected. As part of capital budgeting, a company might assess a prospective project's lifetime
cash inflows and outflows to determine whether the potential returns that would be generated
meet a sufficient target benchmark. The process is also known as investment appraisal.
Ideally, businesses would pursue any and all projects and opportunities that enhance
shareholder value. However, because the amount of capital any business has available for
new projects is limited, management uses capital budgeting techniques to determine which
projects will yield the best return over an applicable period.

Capital budgeting is set of techniques used to decide which investments to make in

projects. There are a number of capital budgeting techniques available, which include the
following:

 Discounted cash flows: Estimate the amount of all cash inflows and outflows associated
with a project through its estimated useful life, and then apply a discount rate to these
cash flows to determine their present value. If the present value is positive, accept the
funding proposal.
 Internal rate of return: Determine the discount rate at which the cash flows from a
project net to zero. The project with the highest internal rate of return is selected.
 Constraint analysis: Examine the impact of a proposed project on the bottleneck
operation of the business. If the proposal either increases the capacity of the bottleneck
or routes work around the bottleneck, thereby increasing throughput, then accept the
funding proposal.
 Breakeven analysis: Determine the required sales level at which a proposal will result in
positive cash flow. If the sales level is low enough to be reasonably attainable, then
accept the funding proposal.
 Discounted payback: Determine the amount of time it will take for the discounted cash
flows from a proposal to earn back the initial investment. If the period is sufficiently
short, then accept the proposal.
 Accounting rate of return: This is the ratio of an investment’s average annual profits to
the amount invested in it. If the outcome exceeds a threshold value, then an investment is
approved.

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Answer 8(a):
Computation of Discounted Payback Period:
Year CFAT PV Factor @ Discounted Cumulative
10% Cash Flow Discounted
Cash Flows
1 1,00,000 0.909 90,900 90,900
2 1,00,000 0.826 82,600 1,73,500
3 80,000 0.751 60,080 2,33,580
Discounted Payback Period = 2years, because the initial investment of ₹. 1,73,500 is fully
recover in year 2.
8(b) Statement showing of optional combination:
Rank Proposals Initial Cumulative NPV(₹)
Investment (₹) Initial
Investment(₹)
I X2 1,00,000 1,00,000 45,000
II X3 1,50,000 2,50,000 60,000
III X4 50,000 3,00,000 18,500
(Balancing
figure)
Total 1,23,500
Comment: Since the proposals are divisible, so the firm can accept proposals X2 and X3 in
full and X4 in part (28.57%) and thereby it can result the maximum NPV of ₹. 1,23,500.

Answer 9 (a):
Different types of dividend are:-
Based on form of payments
a) Cash Dividend
b) Bonus Dividend

Based on timing of payment

a) Final Dividend
b) Interim Dividend

Based on variability
a) Fixed Dividend
b) Fluctuation Dividend

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Answer 9 (b):

EPS= =5

DPS = =2

K= = = = 0.10
( / )

R= 20% or 0.20

Walter Model gives;

+( − )∗
=

0.20
2 + (5 − 2) ∗ 0.10
=
0.10

= ₹ 80
As per Walter’s model when r<K, it is preferred not to pay dividend, therefore dividend pay-
out ratio should be 0 (zero)

Answer 10:
Statement showing Evaluation of Credit Policy:
Particulars Policy I (₹) Policy II(₹) Policy III(₹) Policy IV(₹)
A. Sales 50,00,000 60,00,000 75,00,000 90,00,000
B. Cost of Sales:
Variable Cost (80% on
sales) 40,00,000 48,00,000 60,00,000 72,00,000
Fixed Cost 10,00,000 10,00,000 10,00,000
10,00,000
50,00,000 58,00,000 70,00,000 82,00,000
C. New level of Profit (A-B) NIL 2,00,000 5,00,000 8,00,000
D. Present Level of Loss 2,00,000 2,00,000 2,00,000 2,00,000
(Note 1)
Increase in Profit (C+D) 2,00,000 4,00,000 7,00,000 10,00,000
E. Cost of Additional
Capital (Note 3) 32,889 98,667 1,77,333 2,72,000
F. Incremental Profit (D-E) 1,67,111 3,01,333 5,22,667 7,28,000

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Comment: Incremental profit being highest in Policy No. IV. Therefore, the company should
follow this policy.
Note 1: Statement showing calculation of Present level of loss:
Particulars Amount(₹)
Sales 40,00,000
Less: Variable Cost @ 80% 32,00,000
Contribution 8,00,000
Less: Fixed Cost 10,00,000
Present level of loss 2,00,000

Note 2: Statement showing calculation of Present level of Cost of Sales:

Particulars Amount(₹)
Variable Cost (40,00,000 × 80%) 32,00,000
Fixed Cost 10,00,000
Old Cost of Sales (COSo) 42,00,000

Note 3: Statement showing calculation of cost of additional capital:

Particulars Policy I (₹) Policy II(₹) Policy Policy IV(₹)
III(₹)
Sales 50,00,000 60,00,000 75,00,000 90,00,000
Variable Cost @ 80% of sales 40,00,000 48,00,000 60,00,000 72,00,000
Fixed Cost 10,00,000 10,00,000 10,00,000 10,00,000
New Cost of Sales (COSn) 50,00,000 58,00,000 70,00,000 82,00,000
New Average Collection Period 40 60 75 90
(ACPn)
New Level of Receivable at
Cost 5,55,556 9,66,667 14,58,333 20,50,000
×

Less: Old Level of Receivable

at Cost
× , , × 3,50,000 3,50,000 3,50,000 3,50,000
=

Incremental Investment in
Receivable 2,05,556 6,16,667 11,08,333 17,00,000
Cost of Additional Capital 32,889 98,667 1,77,333 2,72,000
[16% of incremental investment
in receivable]

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