UNIT 4:

Question 1:

Foods Limited is presently operating at 60% level producing 36,000 packets

of snack food and proposes to increase capacity utilization in the coming
year by 33.3% over the existing level of production. The following data has
been supplied:

a) Unit cost structure of the product at current level

Rs. Raw material 4
Wages (Variable) 2
Overheads (variable) 2
Fixed overheads 1
Profit 1
Selling price 12
Raw materials will remain in stores for 1 month before being issued for
production. Material will remain in process for further 1 month.
Suppliers grant 3 months credit to the company.

b) Finished goods remain in godown for 2 months.

c) Debtors are allowed credit for 2 months
d) Lag in wages and overhead payment is 1 month and these expenses
accrue evenly throughout the production cycle.
e) No increase either in cost of inputs or selling price is envisaged.

Prepare a projected profitability statement and the working capital requirement

at the new level, assuming that a minimum cash balance of Rs. 19,500 has to
be maintained.

Solution:
Units at 80% capacity = 36,000 x 80/60 =48,000 units
Projected Profitability Statement at 80% capacity (48,000 units)
Particulars Per annum
Sales (@12) (a) 5,76,000
Cost
Raw materials (@ Rs. 4) 1,92,000
Wages (@ Rs. 2) 96,000
Overheads (variable) (@ Rs.2) 96,000
Overheads (fixed) (36,000x Re.1) 36,000
(b) 4,20,000
Profit (a-b) 1,56,000
Computation of Working Capital requirement (at 80% capacity)
(A) Current asset Rs. Rs.
Raw material stock Rs. 1,92,000 x 16,000
1/12
WIP Stock
Raw material Rs. 1,92,000 x 16,000
1/12
Wages Rs. 96,000 x 4,000
0.5/12
Variable overheads Rs. 96,000 x 4,000
0.5/12
Fixed overheads Rs. 36,000 x 1,500 25,500
0.5/12
Finished goods stock 35,000
Sundry Debtors 96,000
Cash balance 19,500
Total (A) 1,92,000
(B)Current
Liabilities
Creditors for goods Rs. 1,92,000 x 48,000
3/12
Creditors for wages Rs. 96,000 x 1/12 8,000
Creditors for
expenses
Variable overhead Rs. 96,000 x 1/12 8,000
Fixed overhead Rs. 36,000 x 1/12 3,000 11,000
Total (B) 67,000
Working capital requirement (A-B) 1,25,000

Question 2: You are required to construct a statement showing the working

capital required to finance the level of activity of 18,000 units per year from the
following information:-
Particulars Rs.
Raw material Per 12
Unit
Direct labor Per 3
Unit
Overheads per 9
Unit
Total cost Per Unit 24
Profit per Unit 6
Selling price Per 30
Unit
Additional Information:
1. Raw material is in stock on an average for 2 months.
2. Materials are in process on an average for half-a- month.
3. Finished goods are in stock on an average for two months.
4. Credit allowed by creditors is two months in respect of raw materials supplied.
5. Credit allowed to debtors is three months.
6. Lag in payment of wages is half month.
7. Cash on hand and at bank is expected to be Rs. 7,000.
8. You are informed that all activities are evenly spread out during the year.

Solution:
Particulars Amount Amount
A: Current Assets
1. Stock in Trade
a) Raw Materials 18,000 x 12 x 2/12 36,000
b) Work in Progress 18,000 x 18 x ½/12 13,500
c) Finished Goods 18,000 x 24 x 2/12 72,000
2. Sundry Debtors 18,000 x 30 x 3/12 1,35,000
3. Cash in Hand and at Bank 7,000
Total Current Assets 2,63,500
B: Current Liabilities
1. Sundry Creditors 18,000 x 12x 3/12 36,000
2. Wages 18,000 x 3 x ½/12 2,250
Total Current Liabilities 38,250
Estimated Net Working Capital Requirement (A-B) 2,25,250
Question 3: The management of Royal industries has called for a statement
showing the working capital needs to finance a level of activity of 1,80,000 units of
output for the year. The cost structure for the company’s product for the above-
mentioned activity level is detailed below.
Particulars Cost per unit (Rs.)
Raw Materials 20
Direct labour 5
Overheads (including depreciation of Rs. 5 per 15
unit)
40
Profit 10
Selling Price 50
Additional information:-
a. Minimum desired cash balance is Rs. 20,000.
b. Raw materials are held in stock, on an average, for 2 months.
c. Finished goods remain in warehouse, on an average, for a month.
d. Suppliers of materials extend a month’s credit and debtors are provided two
months credit; cash sales are 25% of total sales.
e. There is a time lag in payment of wages of a month and half-a-month in case of
overheads. From the above data, you are required to prepare a statement showing
working capital needs. Answer:
Production and sale per month = 1,80,000 / 12 = 15000 units
Statement of Working Capital
Particulars Rs. Rs.
Current Assets
Raw material stock (15000 x 2 x Rs. 20) 6,00,000
Finished goods (15000 x 1 x Rs. 40) 6,00,000
Debtors (75% credit sale) (15000 x 75% x 2 x Rs. 50) 11,25,000
Cash 20,000
23,45,000
Less Current Liabilities
Creditors for raw material (15000 x 1 x Rs. 20) 3,00,000
Creditors for wages (15000 x 1 x Rs. 5) 75,000
Creditors for overhead (excluding depreciation) (15000 x 75,000 4,50,000
½ x 10)
Working Capital 18,95,000
Note: Depreciation is excluded while calculating overhead payable because you
don’t have to pay depreciation like other expenses.
Question 4: On 1st January, the Managing Director of Golden Pvt. Ltd. wishes to
know the amount of working capital that will be required during the year. From the
following information PREPARE the working capital requirements forecast.
Production during the previous year was 60,000 units. It is planned that this level
of activity would be maintained during the present year.
The expected ratios of the cost to selling prices are Raw materials 60%, Direct
wages 10% and Overheads 20%.
Raw materials are expected to remain in store for an average of 2 months
before issue to production.
Each unit is expected to be in process for one month, the raw
materials being fed into the pipeline immediately and the labour and
overhead costs accruing evenly during the month.
Finished goods will stay in the warehouse awaiting dispatch to
customers for approximately 3 months.
Credit allowed by creditors is 2 months from the date of delivery of
raw material. Credit allowed to debtors is 3 months from the date
of dispatch.
Selling price is Rs. 5 per unit. There is a regular production and sales cycle. Wages
and overheads are paid on the 1st of each month for the previous month. The
company normally keeps cash in hand to the extent of Rs. 20,000.
Answer:
Statement of Working Capital Required:
Particulars Worki (Rs.) (Rs.)
ng
Current Assets:
Raw materials 60,000 units × Rs. 5 × 60% =Rs. 30,000
inventory
1,80,000 (Per month ) :
1,80,000/12 = Rs. 15,000
(Two months) : Rs. 15,000 X
2 = Rs. 30,000
Working–in-process :
Raw materials 60,000 units × Rs. 5 × 60% =Rs. 15,000
1,80,000
 (Per month ): 1,80,000/12 = Rs.
15,000
Labour costs 60,000 × Rs. 5 X 0.5/12 x 10% 1,250
 Overheads 60,000 × Rs. 5 x 0.5/12 X 20% 2,500
Total work-in-process 18,750
Finished goods
inventory
:
Raw materials 60,000 × Rs. 5 × 3/12 X 60% 45,000
Labour 60,000 × Rs. 5 × 3/12 X 10% 7,500
Overheads 60,000 × Rs. 5 × 3/12 X 20% 15,000
67,500
Debtors Rs. 2,70,000 × 3/12 67,500
Cash 20,000
Total Current Assets 2,03,750
Current Liabilities:
Creditors 60,000 × Rs. 5 × 2/12 X 60% 30,000
Direct wages payable 60,000 × Rs. 5 × 1/12 X 10% 2,500
Overheads payable 60,000 × Rs. 5 × 1/12 X 20% 5,000
Total Current Liabilities 37,500
Estimated Total Current Assets - Total 1,66,250
working capital Current Liabilities
requirements
Working Notes:
Total Cost of Sales = RM + Wages + Overheads + Opening Finished goods
inventory – Closing finished goods inventory.
= Rs. 1,80,000 + Rs. 30,000 + Rs. 60,000 + Rs. 67,500 – Rs. 67,500
= Rs. 2,70,000.
Here it has been assumed that inventory level is uniform throughout the year,
therefore opening inventory equals closing inventory.
Question 5: A proforma cost sheet of a company provides the following particulars:

Particula Amount per

rs unit
Elements of cost:
Raw materials 80
Direct labour 30
Overhead 60
Total cost 170
Profit 30
Selling price 200
The following further particulars are available:
Raw materials in stock, on average, one month; Materials in process
(completion stage, 50 per cent), on average, half a month; Finished goods in
stock, on average, one month.
Credit allowed by suppliers is one month; Credit allowed to debtors is two
months; Average time-lag in payment of wages is 1.5 weeks and one month in
overhead expenses; one-fourth of the output is sold against cash; cash in hand
and at bank is desired to be maintained at Rs 3,65,000.
You are required to prepare a statement showing the working capital needed
to finance a level of activity of 1,04,000 units of production. You may assume
that production is carried on evenly throughout the year, and wages and
overheads accrue similarly. For calculation purposes, 4 weeks may be taken as
equivalent to a month.
Answer:
Statement showing determination of net working capital
(A) Current assets:
(i) Stock of materials for 1 month: (1,04,000 x Rs 80 x Rs 6,40,000
4/52)
(ii) Work-in-progressfor 0.5 month:
(a) Material (1,04,000 x Rs 80 x2/52) x 0.50 1,60,000
(b) Labour (1,04,000 x Rs 30 x 2/52) x 0.50 60,000
(c) Overheads (1,04,000 x Rs 60 x 1,20,000
2/52) x0.50
 (iii) Finished goods for 1 month: (1,04,000 x Rs 170 13,60,000
x4/52)
(iv) Debtors for 2 months (78,000 x Rs 170 x8/52) 20,40,000
(v) Cash in hand and at bank 3,65,000
Total investments in current assets 47,45,000
(B) Current liabilities:
(i) Creditors, 1 month’s purchase of raw 6,40,000
materials, (i.e. 1,04,000 x Rs.80 x 4/52)
(ii) Average time-lag in payment of expenses
(a) Overheads (1,04,000 x Rs 60 x 4/52) 4,80,000
(b) Labour (1,04,000 x Rs 30 x 3/104) 90,000
Total estimate of current liabilities 12,10,000
(C) Net working capital = Current assets – Current 35,35,000
liabilities (A – B)
Working Notes and Assumptions
26,000 units have been sold for cash. Therefore, credit sales pertain to 78,000 units only.

Unit 5
Question 1:
b) The Cement Industry has been through a very trying period in the last five years
and the constraints on operations have been removed in the early part of the
year. The company hopes to improve the position in the years to come and has
plans to put up an additional plant in the neighbourhood of the present factory.
Increased profits due to expansion in capacity are expected to be 25% of the
additional capital investment after meeting interest charges but before
depreciation on the additional plant installed. Shares of this cement company
are widely distributed and there is large majority of holdings in the hands of
middle-class investors whose average holding do not exceed 500 shares. The
following data is made available to you.
Last five years:
Particulars 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20
EPS (Rs.) 6.00 5.00 4.50 4.50 4.00 17.50
Cash availability per 7.50 6.00 5.00 4.00 4.00 20.00
share (Rs.)
Dividend per share (Rs.) 3.00 3.00 3.00 2.00 NIL ?
Payout ratio % 50.00 60.00 67.00 45.00 NIL ?
Average market price 80.00 70.00 70.00 70.00 60.00 140
(face value Rs. 100)
P/E ratio 13.33:1 14:1 15.6:1 15.6:1 15
Cement Company requires you to advise them w.r.t the dividend policy they have
to follow for the current year 2019-20. What recommendations would you make?
Give reasons for your answer.
Solution
The company has a consistent track record of earnings and having a stable dividend
policy. The additional investments would fetch an expected return of 25%. The
current year’s EPS is Rs.
17.50 and cash EPS is Rs. 20. The average current market price is Rs.140. The
dividend pay-out of 2017-18 is 45% and in 2018-19 is Nil. This would be due to
use of retained earnings for additional capital investment without use of external
financing. This has reflected in the increase of EPS to Rs. 17.50. The growth in
earnings is likely to continue, since the company is also planning for setting up of
an additional plant in the neighbor hood of the present factory. The savings in costs
will further improve the future earning of the company. In view of the above, the
company is suggested to have a dividend pay-out ratio of 60% which requires the
cash outgo of Rs. 10.50. The cash EPS will also enable the pay-out of 60%.
Since the market price of share is increased to Rs. 140, the dividend yield works
out to only 7.5% (10.50/140 x100). The company has widely distributed
shareholding with a dividend clientele of middle-class investors whose
shareholding does not exceed 500 shares in the company. The dividend payable to
them many no to be tax deductible. The small investors prefer to receive dividends
periodically. The price earnings ratio of the current year is 8 (140/17.50). It is
expected that the market price of share would further increase due to its current
low PE ratio. The setting up of additional plant would require raising funds from
external sources by issue of new shares. To attract the potential investors for
company’s shares, it is required to have a dividend pay-out of 60%. But a higher
dividend pay-out is not suggested, since retained earnings can be used in further
expansion and growth schemes.
b) The following information is available in respect of
XYZ Ltd. Earnings per share – Rs.10
Cost of capital Ke – 0.10
Rate of return of company - 10%
Find out the market price of share as per Gordon’s model for pay-out ratios of
10%, 40%, 80% and 100%. Comment on the results of your calculations.
Answer: As per
P = [E(1-b)]/[Ke-br]
P=[10(1-0.90)]/[0.10-0.09] = 100
P=[10(1-0.60)]/[0.10-0.06] = 100
P=[10(1-0.20)]/[0.10-0.02] = 100
P=[10(1-0)]/[0.10-0.00] = 100
Comment: If r=Ke, the dividend is irrelevant.
Question 2: Rose Ltd. has a capital of Rs. 10,00,000 in equity shares of Rs. 100
each. The shares are currently quoted at par. The company proposes to declare a
dividend of Rs. 10 per share at the end of the current financial year. The
capitalization rate for the risk class of which the company belongs is 12%.
Compute market price of the share at the end of the year, if:
1. Dividend is not declared?

2. Dividend is declared?

3. Assuming that the company pays a dividend and has net profits of
Rs. 5,00,000 and makes new investments of Rs.10,00,000 during the
period, how many new shares must be issued? Use the MM model.
4. Show that the total market value of the shares at the end of the accounting year
will remain the same whether dividends are either distributed or not distributed.
Also find out the current market value of the firm under both situations.
Answer:
Given:
Cost of Equity (Ke) 12%
Number of shares in the beginning (n) 10,000
Current Market Price (P0) Rs. 100
Net Profit (E) Rs. 5,00,000
Expected Dividend Rs. 10 per share
Investment (I) Rs. 10,00,000
Computation of market price per share, when:
1. No dividend is

declared: P₀ = P1
+D1
1+Ke
100 = P1 +0
1+ 0.12
P1=112 – 0
= Rs. 112
2. Dividend is declared:
 100 = P1 + 10
1+ 0.12
P1=112 – 10
= Rs. 102
3. Calculation of funds required for investment:

Earning 5,00,000
Dividend distributed 1,00,000
Fund available for investment 4,00,000
Total Investment 10,00,000
Balance Funds required 10,00,000 - 4,00,000
= Rs. 6,00,000

No. of shares = Funds required / Price of the share

= 6,00,000 / 102
= 5882.35 or 5883 Shares
Value of the firm in both cases = V = [(N+n)P1+E-I]/(1+Ke) = Rs. 1000000

Question 3: Bajaj Ltd. has 1,20,000 shares outstanding and selling at Rs. 20 each
in the market. The company hopes to make a net income of Rs. 3,50,000 during the
year ended 31st March, 2009. The company is considering to pay a dividend of Rs.
2 per share at the end of the current year. The capitalization rate for class of this
company has been estimated to be 15% using MM Dividend Valuation Model.
a) What will be the price of a share at the end of the year: (i) if dividend is paid
and (ii) if dividend is not paid?
b) How many new shares must the company issue if the dividend is paid and the
company needs Rs. 7,40,000 for an approved investment expenditure during
the year?
c) Show that the total market value of the shares at the end of the accounting
year will remain the same whether dividends are either distributed or not
distributed. Also find out the current market value of the firm under both
situations.
Answer:
a) Calculation of market price per share under MM Dividend Valuation Model:

P1 = P0 (1 + Ke) –D1
i. If dividend is declared:
P1 = P0 (1 + Ke) – D1
= 20 (1 + 0.15) – 2
= 20 (1.15) – 2
= Rs. 21
ii. If dividend is not declared:
P1 = P0 (1 + Ke) – D1
= 20 (1 + 0.15) – 0
= 20 (1.15)
= Rs. 23
b) Calculation of number of shares of new shares to be issued:

Particulars Divide Dividend

nd Not
Declar Declared
ed
Net income (Rs.) 3,50,000 3,50,000
Less: Dividend paid 2,40,000 –
Retained earnings 1,10,000 3,50,000
New investments 7,40,000 7,40,000
Amount to be raised by issue of new 6,30,000 3,90,000
shares
Market price per shares 21 23
Number of new shares to be issued 30,000 16,957

c) Calculation of value of firm:

Value of the firm in both cases = V = [(N+n)P1+E-I]/(1+Ke) = Rs. 2400000

Question 4: A company belongs to a risk-class for which the appropriate

capitalization rate is 10%. It currently has outstanding 25,000 shares selling at Rs.
100 each. The firm is contemplating the declaration of dividend of Rs. 5 per share
at the end of the current financial
year. The company expects to have a net income of Rs.2.5 lakhs and a proposal for
making new investments of Rs. 5 Lakhs. Show that under the MM assumptions,
the payment of dividend does not affect the value of the firm.
Answer:
Existing Market Price per share (P0) =
Rs.100 Contemplated DPS (D1) = Rs. 5
Rate of Capitalization (Ke) = 10% or
0.10 Market price as per MM approach is,
D1 + P1
𝑃0 = 1 + k
e

i. If contemplated dividends are declared, then

5 + P1
100 =
1+
0.10
or, P1 = 105
ii. If dividends are not declared, then
0 + P1
100 =
1+
0.10
or, P1 = 110
Calculation of number of shares to be issued
Dividen Dividend
ds s not
Distribut Distribut
ed ed
Net Income Rs. 2,50,000 Rs. 2,50,000
Less: Total 1,25,000 --
Dividends 1,25,000 2,50,000
Retained Earnings
(A)
Investment Budget (B) 5,00,000 5,00,000
Amount to be raised by new issues 3,75,000 2,50,000
(B-A)
Relevant Market Price per share 105 110
No. of new shares to be issued 3,571.4 2,272.7
 Calculation of Value of the Firm
Dividen Dividend
ds s not
Distribut Distribut
ed ed
Existing No. of Shares 25,000.0 25,000.0
Add: New shares issued 3,571.4 2,272.7
Total No. of shares at the end of the 28,571.4 27,272.7
year
Market Price Per Share (Rs.) 105 110
Value of the Firm (Total No. of Rs. Rs.
shares X MPS) 30,00,000 30,00,000
Thus, the total market value of shares remains unaffected whether
dividends are distributed or not distributed at all.