Introduction to financial management

Questions for reinforcement of learning

1. With the help of details given under Indian Financial System, draw the map of Indian
Financial system, starting from Government of India – Ministry of Finance. Also visit
website – www.nic.in to know more about the functioning of Government of India –
Ministry of Finance, its different departments and their functions etc.
2. What is the difference between a share broker and a depository participant?
3. Is there a statute controlling the money markets in India? Who provides the secondary
market in the money markets segment?
4. What are the instruments in the money market and capital market?
5. What do you understand by the term “underwriting” in the capital market?
6. Can you name some NBFCs operating in India?
7. Try to bifurcate the banking sector in India into different segments like private sector,
public, co-operative and commercial banks. Further bifurcate the private sector banks
into banks of Indian origin and foreign banks.
8. Does ICICI still exist as a Financial Institution? If not, why?

Chapter No. 2 - Time Value of Money

Questions for reinforcement of learning and numerical exercises for practice

1. Why should return from a project be the highest in the 4-tier interest rate structure?
2. Future value interest factor x Present value interest factor = -----------------------
3. Can you find out the present value of a stream of annuity without using PVIFA? Explain the
process.
4. Find out the present value of a sum of Rs. 10 lacs at the end of five years in case the expected
rate of return is 12% and the compounding is done on half-yearly basis.
5. Suppose you open a recurring deposit account with annual interest of 6%. You open it for a
period of 12 months. The annuity is Rs.500/-. What will be the value at the end of one year?
6. Mr. George is about to retire. The employer places before him two alternatives. Mr. George
has to choose between them. Lump sum Rs. 12 lacs or half-yearly pension of Rs. 79,000/-.
Which one should he choose in case the annual expected return is 10%?
7. What is the present value of an income stream that provides Rs. 2,000/- at the end of year
one, Rs. 5000/- at the end of year two and Rs.10,000/- for the next 5 years? Assume the rate
of interest to be 8% p.a.
8. What is the present value of Rs. 5,000/- receivable annually for 30 years if the first receipt
occurs after 5 years and the rate of interest is 10% p.a?

Chapter 3 – Risk and Return

Questions for reinforcement of learning and numerical exercises for practice

1. How do you measure the risk associated with an investment in capital market?
2. What are the components of return in the case of investment in a debt instrument like
debenture or bond? Try to find out from general reading and answer this question.
3. What are the components of return in the case of investment in equity shares? Suppose the
market price of a given stock is very high then what will be practically the return on investment
in such stocks?
4. Explain the difference between standard deviation and co-efficient of variation with an
example and which is more reliable?
5. Can you name the various market portfolios besides the ones mentioned in the chapter?
6. What are the sources of information on Beta, risk free rate and market premium? Find them
out yourself.
7. Beta measures the relationship between the return from a given stock with the return from
market portfolio – Do you agree with the statement and if not explain the reasons with an
example.
8. Discuss the limitations of CAPM with an example.
9. Find out the Betas for the following stocks along with market premium and risk-free rates
and determine your expected rates of return from these stocks. Please explore the “Financial
Dailies” and the “Financial Magazines” for getting the data for this.
ACC

Bombay Dyeing

Indian Hotels

Lupin Laboratories

TISCO

Ashok Leyland

Infosys

Wipro
 Chapter No. 4 – Financial Resources: Short-term and Long-term

Questions for reinforcement of learning

1. Name the recent public issues of equity shares, at least five, made by private sector
companies in India.
2. What are the features of the public issue made by Canara Bank made recently?
3. Study the latest guidelines for issue of commercial paper and certificates of deposit.
4. Study the working of Discount and Finance House of India (DFHI)
5. Compare term loan with other forms of finance available for fixed assets
6. What are the differences between operating and finance leases?
7. Draw a table for medium and long-term resources, bifurcating them into categories like:
Available both for working capital and fixed assets

Available only for fixed assets

Available only for specific fixed assets

8. Study the new financial instruments introduced in India.

Chapter No. 5 – Operating and Financial Leverages in Business

Numerical exercises in operating, financial and total leverages

1. Is there any difference between operating leverage and degree of operating leverage? Explain
with an example.
2. Is there any difference between financial leverage and degree of financial leverage? Explain
with an example.
3. Classify the following short-run manufacturing costs as either typically fixed or typically
variable. Are any of these costs fixed in the long run?
 Insurance
 Direct labour
 Research and development
 Advertising
 Raw materials
 Depreciation
 Repairs and maintenance
4. What is the difference between fixed costs in break-even sales analysis and fixed operating
costs in the context of operating leverage?
5. How does continuous increase in debt affect the firm in the long run? Discuss with an
example.
6. A firm is an all-equity firm. It earns monthly after taxes Rs. 24 lacs on sales of Rs.880 lacs.
The tax rate of the company is 40%. The company’s product sells for Rs. 20,000/-. (Only
product). Rs. 15,000/- is the variable cost of the product. Answer the following questions:
 What is the monthly fixed operating cost?
 What is the monthly operating break-even point in units? What are the break-even
sales?
 What is its DOL?
 What is its DFL?

Chapter No. 6 – Long-term financing

Questions for practice and reinforcement of learning:

1. Learn the depreciation rates in the Companies” Act – Schedule XIV and compare them with the rates
of depreciation in the Income Tax Act.
2. Take an asset worth Rs. 1lac (plant and machinery) and work out the depreciation schedule as per
The Companies’ Act Schedule XIV under both the methods. Compare the two and verify as to which
is more beneficial to the company for showing higher residual value of fixed assets.
3. Practise creating a programme in Excel spreadsheet for working out projections for an existing
business enterprise. For this, the last year’s performance would be the basis. Estimate the %
increase in sales during the current year and prepare the estimated costs by employing suitably the
two methods, namely BEM and PSM.
4. Visit websites of leading commercial banks and financial institutions in India and learn how they
finance fixed assets by various methods.
5. Fixed deposits accepted from the public are one of the very important sources of medium-term
finance for limited companies. These deposits are accepted as per the Provisions of the Companies’
Act as well as Acceptance of Deposit Rules. Learn these rules and read advertisements connected
with acceptance of fixed deposits by limited companies.

Chapter No. 7 – Working Capital Management

Questions for practice and reinforcement of learning along with numerical exercises
1. Discuss at least 4 important factors that determine the quantum of working capital required
for any business with examples.
2. From the following, determine the operating cycle in number of days and value, investment
per cycle from our side, total current assets, total current liabilities and eligible bank finance
at current ratio of 2:1. (Rupees in lacs)
  Raw materials - imported - annual consumption 1800 - holding 45 days
 Raw materials - indigenous - annual consumption 2400 - holding 20 days
 Packing materials - annual consumption 420 - holding 30 days
 Consumable stores and spares - annual consumption 360 - holding 60 days
 Work-in-progress - annual cost of production 6300 - holding 21 days
 Finished goods - annual cost of goods sold 7200 - holding 15 days
 Inland short-term receivables - gross sales 12720 - outstanding 2 months
 Other current assets - 10% of total current assets
 Other current liabilities - 10% of total current liabilities
3. At present you are selling Rs. 200 lacs per month.
 The credit period on sales is 30 days.
 The % of bad debts is 0.5%.
 The bank finance is 70% of outstanding receivables and rate of interest is 15% p.a.
 Your investment should earn 25% (pre-tax).
 Your profit margin on sales is 15% (before tax)
 You want to double the sales per month. The marketing department recommends an
increase of 20 days in the credit period, as the demand for your products is quite
good. The bank is willing to give you incremental credit on the same terms as at
present. However the percentage of bad debts could go up to 1.5%. Your management
also wants to earn 25% (pre-tax) on its additional investment. EBIT to sales is 22%.
 Find out the feasibility of the proposal received from the marketing department. Show
all the steps. Do not skip any step.

4. Your company is at present doing Rs.1200 lacs sales a year. The credit period is 30 days for
all customers. You draw bank finance to the extent of 70% and the balance is the margin.
Rate of interest is 16% p.a. and the management is expecting a return of 24% on its
investment. The % of EBIT to sales is 20%. You want to expand your market and the
marketing department advises you to increase the credit period by another 30 days. The
promised increase in sales is 20%. There is no incidence of bad debts on new sales as well as
old sales. Examine the issue and advise the management suitably as to whether they should
accept the recommendation and go ahead with increasing the credit period
5. From the following determine the operating cycle in days, value of operating cycle,
investment in current assets and eligible bank borrowing.
Raw materials: 30 days – 100 lacs

Packing materials: 30 days – 30 lacs

Consumable stores and spares: 60 days – 20 lacs

 Work-in-progress: 15 days – 75 lacs

Finished goods: 30 days - 200 lacs

Receivables: 45 days – Annual sales being Rs.3120 lacs

Creditors at 20 days of purchases

Profit margin – 15% on sales

Current ratio – 2:1

There are no other current liabilities

6. From the following find out the EOQ

Annual demand – 12000 units

Cost per order – Rs.1500/-

Carrying cost of inventory per unit 12% of the value of Rs.150/- per unit.

The supplier is willing to give quantity discount of 10% (reduction in Rs.150/- per unit)
provided you increase the quantum per order by 25%. If the carrying cost remains the same
in value (not in %) and the annual demand is not changed what is the revised EOQ?

Compare the total costs in both the cases (excluding the cost of material) and advise as to
whether we should go in for quantity discount?

7. From the following construct a cash flow statement in the proper format and offer your
comments if any (all figures in lacs of rupees)
Sales receipts – 100

Disposal of investment – 25

Purchase of fixed assets – 95

Sale of goods on credit – 80

Long-term loans received – 80

Repayment of loans – 50

Fresh preference share capital – 50

Creditors payment – 45

Operating expenses for the period – 38

 Cash purchases of components, spares etc. – 30

Other income for the period – 15

Opening balance for the period – 15

Purchase of materials on credit – 40

Chapter No. 8 – Financial statements analysis

Questions and numerical exercises for practice and reinforcement of learning

1. What is the difference between cash flow statement and funds flow statement?
2. What are the components of annual report of limited companies?
3. Practise analysing the financial statements of Profit and Loss Account and Balance Sheet of
limited companies in different sectors in groups and interpret the financial ratios – intra-firm
analysis should be possible.
4. What are the limitations of analysis of performance of a business enterprise based on
published annual accounts?
5. What is the usual characteristic feature of funds flow statement? If this feature is not
observed in funds flow statement what is the risk to a business?
6. Give the formulae for the following ratios:
Earning per share

Return on net worth

Return on capital employed

Return on total capital employed

Debt service coverage ratio

Asset coverage ratio

7. Find out the debt to equity ratio from the following – both all external debts and only
medium and long-term debts. Find out both the ways, one by treating PSC as debt and
another treating it as part of equity:
Net worth Rs. 5000 lacs

Preference share capital Rs. 500 lacs

Medium and long-term liabilities Rs. Rs. 7500 lacs

Current liabilities Rs. 5000 lacs

8. Give your responses to the question at the end of the following:
Parameter 2000-2001 2001-2002

Sales 5000 lacs 6200 lacs

Other income 250 lacs 500 lacs

Operating expenses 4900 lacs 6300 lacs

Are the company’s operations profitable?

What do the above figures indicate on the performance of the company?

9. Determine the required financial parameter or ratio as given at the end from the following:
(Rupees in lacs)
EBIDT 2500

Interest 500 (on M&T liabilities - 340 and the rest working capital)

Book depreciation 240

Income tax depreciation 360

Misc. expense written off during the year 120

Income tax 40%

Dividend on preference share capital 30 (rate 10%)

Dividend on equity share capital 200 (rate 20% - FV Rs. 25/-)

Reserves 500 (excluding profit retained in business during the year)

Medium and long term liability to be met during the period 500

WDV of fixed assets -3500

Outstanding medium and long-term liabilities 2400

Outstanding current liabilities - 2000 including dividend payable for the year and
provision for tax for the year as under
Misc. expenses outstanding (yet to be written off) – Rs. 240 lacs

Find out -

Profit before tax

 Profit subject to tax as per Income tax calculation

Amount of income tax payable

Profit after tax

Profit retained in business

Gross cash accruals

Net cash accruals

Debt/equity ratio (both)

Asset coverage ratio

Interest coverage ratio

Debt service coverage ratio

Earnings ratio

Also indicate the desirable minimum or maximum within brackets against each parameter,
wherever applicable

10. From the following construct the funds flow statement in the proper format including
summary and offer your comments (all figures in lacs of rupees)
Increase in share capital – 250

Sale of fixed assets – 50

Increase in inventory – 100

Decrease in cash and bank – 20

Repayment of loans for fixed assets – 80

Profits after tax for the period – 120

Dividend declared along with tax – 36

Increase in bank borrowing – 80

Decrease in other current liabilities – 35

Disposal of existing investment – 25 and new investment – 35

New debentures – 150

Redemption of other medium and long-term liabilities – 100

Increase in inventory – 80

Depreciation for the period – 70

Amount amortised during the period – 25

Increase in other current assets – 28

Increase in fixed assets – 226

Balance increase in receivables

 Chapter No. 9 – Capital structure and cost of capital

Questions for practice and reinforcement of learning along with numerical exercises
1. Find out the post tax cost of the following components of capital structure:
Assume wherever necessary 40% tax rate

Equity – FV Rs. 35/- Dividend rate – 17% Floatation cost = 8% Growth rate = 5%

Debenture – FV Rs.1000/- Rate 12.5% Redemption premium 7% Maturity period 3 years and
floatation cost 2.5%

Acceptances – Rate of interest 14%, acceptance commission – 1.5% and processing charges
= 1.5% Maturity period = 5 years

2. From the following choose the best capital structure, i.e., the most economical capital
structure (Figures in lacs of rupees)
The respective costs are indicated in the brackets

Component Structure 1 Structure 2 Structure 3

ESC 1000 (15%) 1500 (16%) 1300 (18%)

PSC 200 (8%) 300 (10%) 300 (9%)

Debentures 800 (13%) 900 (12%) 500 (12.5%)

Term loans 1000 (14%) 1200 (13.5%) 1300 (13%)

Fixed deposits 200 (12.5%) 300 (11%) 400 (12%)

Effective rate of tax = 38.50%

3. How do you overcome the limitations in Miller/Modigliani position on capital structure?

4. Given the various factors influencing capital structure, find out from website or other
sources, the relevance of these factors in Indian firms.
5. From the following find out the weighted average cost of capital, both in pre-tax and post-tax
terms (All figures are rupees in lacs)
Tax rate 35%

Equity share capital 1000 – 18%

 Term Loan – 1000 – 15%

Preference share capital – 200 – 12%

Unsecured loans – 200 – 20%

Debenture – 600 – 13%

Fixed deposits – 250 – 14%

Acceptances – 150 – 16%

Deferred Payment Credit – 100 – 14%

6. From the following find out the WACC of the capital structure both in post-tax and pre-tax
terms.

The corporate tax rate is 30%

Component Amount (in lacs) Rate

Equity share capital 500 18%

Preference share capital 200 12%

Debentures 500 14%

Term loans 500 16%

Unsecured loans 200 22%

Fixed deposits 100 15%

Acceptances 100 16%

7. Discuss the difference between net income approach and net operating income approach with
a suitable example.
8. What are the difficulties in fixing an optimal debt to equity relationship in a capital structure?

Chapter No. 10 – Dividend policy

Numerical exercises on equity valuation based on dividend amount and growth rate
1. Examine the dividend policies of Indian companies in different sectors and map the DPO
over a period of time. Can you link the dividend policy with the following?
 Growth in fixed assets of the company and opportunity to save tax through depreciation
 Effective tax rate as opposed to corporate tax rate
  High profitability
2. Given the following information about ABC corporation, show the effect of dividend policy
on the market price of its shares, using the Walter’s model:
 Cost of equity or “equity capitalisation rate” = 12%
 Earnings per share = Rs. 8
 Assumed return on equity under three different scenarios:
 r = 15%
 r = 10%
 r = 12%
 Assume DPO ratio to be 50%.
3. As per Gordon’s model calculate the stock value of Cranes Limited as per following
information:
 Cost of equity = 11% and Earnings per share = Rs. 15 Three different scenarios: r = 12%,
r = 11% and r = 10%. Assume DPO ratio to be 40%.
4. Study the “buy back” option being exercised by Indian companies and understand the market
compulsions that make them prefer “buy back” option to paying “high dividends”.
5. Are there any companies in India similar to the Microsoft in its approach to dividend pay
out?

Chapter No. 11 – Capital Budgeting

Questions for reinforcement of learning and numerical exercises for practice:

1. Discuss the sources if you want to build a canteen for your workers – is it external loan or
internal accrual? Give the reasons for your answer.
2. Enumerate the steps involved in estimating the cash flow projections for a project starting
from financial planning till financial ratios.
3. Explain with examples how conflicts could arise in ranking of different projects based on
different parameters like NPV and IRR.
4. How does one overcome the shortcoming in the case of conventional “payback” method?
Explain with an example.
5. From the following find out the best project in terms of Net Present Value and profitability
index
Original investment = Rs.500 lacs

The projected cash flows in lacs of rupees are as under:

Year of operation Project 1 Project 2 Project 3

 1 180 250 200

2 250 250 250

3 300 250 250

4 320 400 400

Expected rate of return = 20% p.a.

6. From the following find out the best project in terms of Net Present Value and profitability
index
Original investment = Rs.1000 lacs and expected rate of return = 17% p.a.

The projected cash flows in lacs of rupees are as under:

Year of operation Project 1 Project 2 Project 3

1 360 250 200

2 250 250 250

3 300 250 250

4 320 400 400

7. From the following stream, find out the implied rate of return by the method of
interpolation.
Original investment – Rs.170 lacs
Cash inflows
Year 1 – 80 lacs
Year 2 – 40 lacs
Year 3 – 60 lacs
Year 4 – 80 lacs