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 Introduction

PREFACE TO THIS EDITION

CA INTER - FM REGULAR COURSE PRACTICAL BOOK

Through the medium of this book, we present to you the Financial Management concepts in a refined and
simplified manner. Each chapter has been covered through detailed questions to help in learning by practising.
Effort has been done to write this book in a way which makes it easy to understand and
remember.
I am thankful to God, my family, my friends and most importantly my students for always loving me and
having faith in my hard work.
Also, the sincere effort, persistence and determination of our associated teachers, staff members, well
Wishers and students are highly appreciated.
Every effort has been taken to avoid any errors / omissions, but errors are inevitable. Any mistake may kindly
be brought to our notice and it shall be dealt with suitably.
We welcome your valuable suggestions and feedback in developing this book further.

As per ICAI
Under the Revised Scheme of Education and Training, at the Intermediate Level, students are expected not
only to acquire professional knowledge but also to develop the ability to apply the knowledge in real-life
business situations. The process of learning should also help the students in imbibing professional skills, i.e.,
the intellectual skills and communication skills, necessary for achieving the desired professional competence.

In our book
Every effort has been taken to present this subject in a manner that students are able to acquire the skill set as
prescribed by ICAI.

The entire syllabus has been covered in two books.

Book 1 - Presents practical questions.
The concepts shall be covered in class and students will be able to acquire knowledge to solve questions.
We shall be doing about 55% of all the questions in class and the rest shall be given as homework.
The solution set for homework questions will be provided in soft copy in your batch.

Book 2 - Presents theory questions.

We will discuss these questions in separate theory classes.
You must read theory well to be able to write theoretical answers and solve MCQs

Multiple Choice Questions (MCQs) will be presented on our WWW.CANITINGURU.COM

Thank You !!
CA. Nitin Guru

www.canitinguru.com l @canitinguru
 Introduction

ABOUT THE AUTHOR

CA Nitin Guru is a Post Graduate in Commerce & a Member of The Institute of Chartered Accountants of India.
●​ He is the lead trainer for various courses for Costing and Financial management at CA NITIN GURU
CLASSES.
●​ He is a First Class Graduate from Delhi College of Arts and Commerce.
●​ He is a College Topper & a Gold Medallist.
●​ His areas of specialisation are Cost & Management Accounting, Financial Management, Economics for
Finance and Strategic Financial Management.
●​ At a young age, he has amassed vast experience of teaching over 60,000 students.
●​ His style of teaching, techniques and guidelines for preparing for examination are well accepted &
acknowledged by all the students. His friendly and interactive approach makes him popular amongst
the students.
●​ He has maintained a very high passing rate. He has been a Visiting Faculty to various Professional
Institutes & MBA Colleges in the past.

CLASS ATTRACTIONS
●​ Start the topic from the base.
●​ Explains reasons and logic inbuilt behind concepts and has a unique method of making students
understand them.
●​ Real life examples make classes interesting & lively.

CLASSES AVAILABLE ON WWW.CANITINGURU.COM

● CA Inter - Cost & Management Accounting (Regular & Fast Track)
● CA Inter - Financial Management (Regular & Fast Track)
● CA Final - Advanced Financial Management (Regular & Fast Track)

Thank You !!
CA Nitin Guru

www.canitinguru.com l @canitinguru
 Introduction

INDEX
CA INTER - FM REGULAR COURSE PRACTICAL BOOK

Chapter No. Name of the Chapter Page No.

1 Financial Analysis ( Ratio Analysis ) 1.1-1.20

2 Cost of Capital 2.1-2.13

3 Capital Structure 3.1-3.9

4 Leverages 4.1-4.9

5 Investment Decisions 5.1-5.22

6 Dividend Decisions 6.1-6.6

7 Introduction to Working Capital Management 7.1-7.13

8 Management of Receivables 8.1-8.6

9 Treasury and Cash Management 9.1-9.13

10 Inventory Management 10.1-10.2

11 Management of Payables 11.1-11.1

12 Financing of Working Capital 12.1-12.3

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 Chapter 1 - Ratio Analysis

Chapter 1
Financial Analysis & Planning - Ratio Analysis
TYPES OF RATIO
I. PROFITABILITY RATIOS BASED ON SALES:
These ratios measure how efficiently a company has generated profit on sales and investment.
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
i. Gross Profit Ratio= 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 (In %)

●​ Gross Profit = Gross Profit as per Trading Account.

●​ Sales = Sales net of returns.
Significance = Indicator of Basic Profitability.

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡
ii. Operating Profit Ratio= 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
(In %)

●​ Operating Profit = Sales Less Cost of Sales

[OR]
= Net Profit as per P & L Account
(+) Non-Operating Expenses (e.g. Loss on sale of assets, preliminary Expenses written off, etc.)
(-) Non-Operating Income (e.g. Rent, Interest & Dividends received)

●​ Sales = Sales net of returns.

Significance = Indicator of Operating Performance of business.

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
iii. Net Profit Ratio= 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
(In %)

●​ Net Profit = Net profit as per P & L A/c (either before tax or after tax, depending upon data).
●​ Sales = Sales net of returns.
Significance= Indicator of Overall Profitability.

iv. Contribution Sales Ratio [or] Profit Volume Ratio = Contribution/ Sales

●​ Contribution = Sales Less Variable Costs.

●​ Sales = Sales net of returns.
Significance = Indicator of Profitability in Marginal Costing.

II. COVERAGE RATIOS:

The soundness of a firm, from the view point of long term creditors & Preference shares, lays its ability to
service their client.
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑓𝑜𝑟 𝐷𝑒𝑏𝑡 𝑆𝑒𝑟𝑣𝑖𝑐𝑒
I. Debt Service Coverage Ratio= (𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝐼𝑛𝑠𝑡𝑎𝑙𝑚𝑒𝑛𝑡) (In Times)

●​ Earnings for Debt Service = Net Profit after Taxation

(+) Interest on Debt Funds
(+) Non-Cash Operating Expenses(e.g. depreciation & amortizations)
(+) Non-Operating Items/Adjustments (e.g. Loss on sale of Fixed Assets,etc.)
●​ Interest + Instalment = Interest + Principal, i.e.
Interest on Debt
(+)Instalment of Loan Principal
Significance =Indicates extent of current earnings available for meeting commitments of interest and
instalment. Ideal Ratio must be between 2 to 3 times.

𝐸𝐵𝐼𝑇
ii. Interest Coverage Ratio= 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
(In Times)

●​ EBIT = Earnings before Interest and Tax.

●​ Interest = Interest on Debt
Significance = Indicates ability to meet interest obligations of the current year. Should be greater than 1.

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 Chapter 1 - Ratio Analysis

𝐸𝐴𝑇
Iii. Preference Dividend Coverage Ratio= 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 (In Times)

●​ EAT = Earnings after Tax.

●​ Preference Dividend = Dividend on Preference Capital.
Significance = Indicates ability to pay dividend on Preference Capital. Should be greater than 1.

III. TURNOVER/ACTIVITY/PERFORMANCE RATIOS

These ratios show how efficiently a company is using its assets to generate sales, e.g. Fixed Assets Turnover
ratio, Debtor Turnover ratio etc.
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑
i. Raw Material Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 (In Times)

●​ Cost of Raw Material Consumed = Opening Stock of Raw Materials

(+) Purchases of Raw Materials
(-) Closing Stock of Raw Materials

(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑅𝑀 𝑆𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑅𝑀 𝑆𝑡𝑜𝑐𝑘)

●​ Average Stock of Raw Material = 2

Significance= Indicates how fast/regularly Raw Materials are used in production.

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑐𝑜𝑠𝑡
ii. WIP Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝐼𝑃 (In Times)

●​ Factory Cost = Materials Consumed + Wages + POH

(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑊𝐼𝑃 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑊𝐼𝑃)
●​ Average Stock of WIP = 2
​
Significance = Indicates the WIP movement/production cycle.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑

iii. Finished Goods or Stock Turnover Ratio = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝐺𝑜𝑜𝑑𝑠
(In Times)

●​ Cost of Goods Sold =

(a) For Manufacturers: OpeningStock of FG (+)Cost of Production (-) Closing Stock of FG. ​
(b) For Traders: Opening Stock of FG + Cost of Goods Purchased (-) Closing Stock of FG.
(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐹𝐺 𝑆𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐹𝐺 𝑆𝑡𝑜𝑐𝑘)
●​ Average Stock of Finished Goods = 2
Significance =Indicates how fast inventory is used/sold. High Turnover shows fast moving FG. Low Turnover
may mean dead or excessive stock.

𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
iv. Debtors Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 (In Times)

●​ Credit Sales = Credit Sales net of returns

●​ Average Accounts Receivable = Average Accounts Receivable (i.e. Debtors + B/R)
(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐷𝑟𝑠 & 𝐵/𝑅 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐷𝑟𝑠 & 𝐵/𝑅 )
​ 2
Significance = Indicates the speed of collection of Credit Sales/Debtors.

𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
v. Creditors Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
(In Times)

●​ Credit Purchases = Credit Purchases net of returns

●​ Average Accounts Payable = Average Accounts Payable (i.e. Creditors + B/P)
(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐶𝑟𝑠 & 𝐵/𝑃 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐶𝑟𝑠 & 𝐵/𝑃)
2
​ ​
𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 (𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠)
vi. Working Capital Turnover Ratio= 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 (In Times)

[Also called Operating Turnover (or) Cash Turnover Ratio]

●​ Turnover = Sales net of returns

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 Chapter 1 - Ratio Analysis

●​ Net Working Capital = Current Assets Less: Current Liabilities

(Average of Opening and Closing balances may be taken)
Significance = Ability to generate sales per rupee of Working Capital.

𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
vii. Fixed Assets Turnover Ratio= 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 (In Times)

●​ Turnover = Sales net of returns

●​ Net Fixed Assets = Net Fixed Assets (Average of Opening and Closing balances may be taken)
Significance = Ability to generate sales per rupee of Fixed Assets.

𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
viii. Capital Turnover Ratio = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
(In Times)

●​ Turnover = Sales net of returns ​

●​ Capital Employed = (Average of Opening and Closing balances may be taken)
Significance = Ability to generate sales per rupee of long-term Investment.

ALSO STUDY CONCEPT OF DEBTOR, CREDITORS & STOCK VELOCITY

IV. CAPITAL STRUCTURE RATIOS

These ratios measure the extent to which a company which has been financed by long term debt obligations
like Debt equity ratio. It measures the ability of an enterprise to survive over a long period of time.
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
i. Debt to Total Assets Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

●​ Debt = Borrowed Funds (or) Loan Funds

​ = Debentures + Long-Term Loans from Banks, Financial Institutions, etc.

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
ii. Debt Ratio = 𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

●​ Total debt includes both long term and short term debt.

𝐸𝑞𝑢𝑖𝑡𝑦
iii. Equity to Total Funds Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐹𝑢𝑛𝑑𝑠

●​ Equity = Net Worth (or) Shareholders’ Funds (or) Proprietors’ Funds (or) Owners’ Funds (or) Own Funds
= Equity Share Capital + Preference Share Capital + Reserves & Surplus Less: Miscellaneous Expenditure (as
per Balance Sheet) and Accumulated Losses.

●​ Total Funds = Long Term Funds (or) Capital Employed (or) Investment
= Debt + Equity......Liability Route
= Fixed Assets + Net Working Capital ..........Assets Route

Significance = Indicates Long Term Solvency, mode of financing and extent of own funds used in operations.
Ideal Ratio is 33%.

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
iv. Equity Ratio = 𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

v. Debt – Equity Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦
OR 𝐸𝑞𝑢𝑖𝑡𝑦

●​ Long term Debt = Borrowed Funds (or) Loan Funds = Debentures + Long-Term Loans from Banks, Financial
Institutions, etc.

●​ Equity = Net Worth (or) Shareholders’ Funds (or) Proprietors’ Funds (or) Owners’ Funds (or) Own Funds
= Equity Share Capital + Preference Share Capital + Reserves & Surplus Less: Miscellaneous Expenditure (as
per Balance Sheet) and Accumulated Losses.

Significance= Indicates the relationship between Debt & Equity. Ideal Ratio is 2:1.

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 Chapter 1 - Ratio Analysis

𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝐷𝑒𝑏𝑒𝑛𝑡𝑢𝑟𝑒𝑠 + 𝑜𝑡ℎ𝑒𝑟 𝑏𝑜𝑟𝑟𝑜𝑤𝑒𝑑 𝑓𝑢𝑛𝑑𝑠

vi. Capital Gearing Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠

●​ Preference Capital + Debentures + Other borrowed funds = Preference Share Capital and Debt i.e.
Debentures + Long-Term Loans from Banks, Financial Institutions, etc.

●​ Equity Shareholders Funds = Equity Share Capital Less Preference Share Capital i.e.
= Equity Share Capital + Reserves & Surplus Less: Miscellaneous Expenditure (as per Balance Sheet) and
Accumulated Losses.

Significance = Show proportion of Fixed Charge (Dividend or Interest) Bearing Capital to Equity Funds, and the
extent of advantage or leverage enjoyed by Equity Shareholders.

𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑎𝑟𝑦 𝐹𝑢𝑛𝑑𝑠
vii. Proprietary Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

●​ Proprietary Funds = Net Worth (or) Shareholders’ Funds (or) Proprietors’ Funds (or) Owners’ Funds (or)
Own Funds
= Equity Share Capital + Preference Share Capital + Reserves & Surplus Less: Miscellaneous Expenditure (as
per Balance Sheet) and Accumulated Losses.

●​ Total Assets = Net Tangible Fixed Assets (+) Total Current Assets

Significance = Shows extent of Owner’s Funds, i.e. Shareholders’ Funds utilised in financing the assets of the
business.

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
viii. Fixed Asset to Long Term Fund Ratio = 𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐹𝑢𝑛𝑑𝑠

●​ Fixed Assets = Net Fixed Assets, i.e. Gross Block (-) Depreciation

●​ Long Term Funds = Debt + Equity......Liability Route

= Fixed Assets + Net Working Capital ..........Assets Route

Significance = Shows proportion of Fixed Assets (Long-Term Assets) financed by long-term funds.
Indicates the financing approach followed by the Firm, i.e. Conservative, Matching or Aggressive. Ideal Ratio is
less than one.

V. LIQUIDITY RATIO
These ratios show a company's ability to meet its short term financial obligation like current ratio and quick
ratio.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
i. Current Ratio= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

●​ Current Assets = Inventories/Stocks

(+) Debtors & B/R
(+) Cash & Bank
(+) Receivables
(+) Accruals
(+) Shot Term Loans
(+) Marketable Investments/Short Term Securities
●​ Current Liabilities = Sundry Creditors
(+) Outstanding Expenses
(+) Short Term Loans & Advances (Cr.)
(+) Bank Overdraft/Cash Credit
(+) Provision for Taxation
(+) Proposed Dividend
​ (+) Unclaimed Dividend

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 Chapter 1 - Ratio Analysis

Significance = Ability to repay short-term liabilities promptly. Ideal Ratio is 2:1. Very high Ratio indicates
existence of idle Current Assets.

ii. Quick Ratio= Quick Assets / Current Liabilities

(Also called Liquid Ratio [or] Acid Test Ratio)

●​ Quick Assets = Current Assets

(-) Inventories
(-) Prepaid Expense

Significance = Ability to meet immediate liabilities. Ideal Ratio is 1:1

𝐶𝑎𝑠ℎ + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠

iii. Absolute Cash Ratio [or] Cash Ratio [or] Absolute Liquidity Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

●​ Cash + Marketable Securities = Cash in Hand

(+) Cash at Bank (Dr)
(+) Marketable Investments/Short Term Securities(current investments)

Significance = Availability of cash to meet short-term commitments. No ideal ratio as such. If Ratio > 1, it
indicates very liquid resources, which are low in profitability.

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
iv. Basic Defence Interval Measure= 𝐶𝑎𝑠ℎ 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
(In days)

●​ Quick Assets = Current Assets

​ (-) Inventories
​ (-) Prepaid Expenses
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
●​ Cash Expenses per Day = 365
●​ Cash Operating Expenses = COGS + Selling admin other expenses ( excluding depreciation and non cash
exp)
●​ Cash Expenses = Total Expenses (-) Depreciation& write-offs.

Significance= Ability to meet regular Cash Expenses.

VI. OVERALL RETURN RATIOS - OWNER VIEW POINT

i. Return on Investment (ROI) [or] Return on Capital Employed (ROCE) =

𝐸𝐵𝐼𝑇
●​ Pre-tax ROCE: = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝐸𝐵𝐼𝑇(1−𝑡) 𝐸𝑎𝑡 +𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
●​ Post-tax ROCE: = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
Either pre-tax or post-tax ROCE may be computed.
Pre-tax ROCE is generally preferred for analysis purposes.
Capital Employed = Investment = Equity + Debt

Significance = Overall profitability of the business on the Total Funds Employed.

ii. Return on Net Worth (RONW) =

●​ Pre-tax RONW: =
●​ Post – tax RONW: =
Either pre-tax or post-tax ROE may be computed.
Post-tax ROE is generally preferred for analysis purposes.
Equity (or) Net Worth (or) Shareholders’ Funds (or) Proprietors’ Funds (or) Owners’ Funds (or)Own Funds

Significance = Indicates profitability of Equity Funds/Owner’s Funds invested in the business.

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 Chapter 1 - Ratio Analysis

iii. Return on Assets (ROA) =

𝐸𝐵𝑇
●​ Pre-tax ROA: = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝐴𝑇 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝐵𝑇(1−𝑇)
●​ Post-tax ROA: = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 or 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Either pre-tax or post-tax ROA may be computed.
Pre-tax ROA is generally preferred for analysis purposes.
Average, i.e. ½ of Opening & Closing Balances of any of the following items –
(a) Total Assets, (or)
(b) Tangible Assets, (or)
(c) Fixed Assets.

Significance = Indicates Net Income per rupee of Average Total Assets or Tangible or Fixed Assets.

𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
iv. Earnings per Share (EPS) = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠
​
●​ Residual Earnings, i.e. EAT (-) Preference Dividend
𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
●​ Number of Equity Shares outstanding = 𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

Significance = Income per share, whether or not distributed as dividends.

𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

v. Dividend per share(DPS) = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠

Profits distributed to Equity Shareholders.

Significance= Profits distributed per Equity Share.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

vi. Price Earnings Ratio (PE Ratio) = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Average Market price (or closing Market price) as per Stock Exchange quotations. (Market price per share =
MPS)

Significance = Indicates relationship between MPS and EPS, and Shareholders’ perception of the Company.

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
vii. Dividend Yield (%) = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Average MPS (or Closing MPS) as per stock Exchange quotations.

Significance = True return on Investment, based on Market Value on Market Value of Shares.

𝐸𝑆𝐻𝐹
viii. Book Value per Share = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠

𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
●​ Number of Equity Shares outstanding = 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

Significance= Basis of Valuation of Shares based on Book Values.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

ix. Market Value to Book Value= 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

Average MPS (or Closing MPS) as per stock Exchange quotations.

Significance= Higher ratio indicates better position for Shareholders in terms of return & capital gains.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑎𝑛𝑑 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑜𝑚𝑝𝑎𝑛𝑦

X. Q Ratio = 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑟𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠
or 𝐴𝑠𝑠𝑒𝑡 𝑅𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝐶𝑜𝑠𝑡

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 Chapter 1 - Ratio Analysis

PRACTICAL PROBLEMS

Calculate values from Ratios

Question 1 - Rtp
FM Ltd. is in a competitive market where every company offers credit. To maintain the competition, FM Ltd.
sold all its goods on credit and simultaneously received the goods on credit.
The company provides the following information relating to current financial year:
Debtors Velocity 3 months
Creditors Velocity 2 months
Stock Turnover Ratio (on Cost of Goods Sold) 1.5
Fixed Assets turnover Ratio (on Cost of Goods Sold) 4
Gross Profit Ratio 25%
Bills Receivables ₹ 75,000
Bills Payables ₹ 30,000
Gross Profit ₹ 12,00,000
FM Ltd. has the tendency of maintaining extra stock of ₹ 30,000 at the end of the period than that at the
beginning. DETERMINE:
(i) Sales and cost of goods sold (ii) Sundry Debtors (iii) Closing Stock (iv) Sundry Creditors (v) Fixed Assets

Question 2 - Pyq
From the information given below calculate the amount of Fixed assets and Proprietor’s Funds:
Ratio of fixed assets to Proprietors Funds : 0.75
Net working capital : ₹ 6,00,000

Question 3 - Rtp
You are required to calculate the Total Current Assets of Ananya Limited from the given information:
Stock Turnover : 5 times Current liabilities : ₹ 2,40,000
Sales (All credit) : ₹ 7,20,000 Liquidity Ratio : 1.25
Gross Profit Ratio : 25% Stock at the end is ₹ 30,000 more than stock in the beginning

Question 4 -
Compute Average collection Period from the following details by adopting a 360 days year (a) Average
Inventory – ₹ 3,60,000, (b) Debtors – ₹ 2,40,000 (c) Inventory Turnover – 6 Times (d) GP Ratio – 10%
(e) Credit Sales to Total Sales – 80%.

Question 5 -
Following are the ratios to the trading activities of Put Ltd:
Gross Profit -20%,
Debtors Velocity – 3 months. Gross Profit for the year just ended was ₹ 5 lakhs.
Stock at the end of the year was ₹ 2,00,000 more than it was at the
Stock Velocity – 6 month beginning
Creditors Velocity – 2
months. Bills Payable & Receivable were ₹ 36,667 & ₹ 60,000 respectively.
From the above, compute the figures of – (a)Sales , (b) Sundry Debtors, (c) Sundry Creditors, & (d) Stock.

Question 6 - Pyq
Following information relates to a firm:
Current ratio ​ ​ : 1.5 : 1
Inventory Turnover Ratio (Based on COGS) : 8
Sales ​ ​ : ₹ 40,00,000
Working capital ​ ​ : ₹ 2,85,000
Gross Profit Ratio​ ​ : 20%
You are required to find out:
(i)The value of the opening stock presuming that the closing stock is ₹ 40,000 more than the opening stock.
(ii)The value of Bank overdraft, presuming that the Bank overdraft and other current liabilities are in a ratio of
2:1

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 Chapter 1 - Ratio Analysis

Calculate Ratios
Question 7 - Pyq
MN Limited gives you the following information related for the year ending 31st March, 2009:
1. Current Ratio ​ : 2.5 : 1
2. Debt – Equity Ratio ​ : 1: 1.5
3. Return on Total Assets ​ : 15%
4. Total Assets Turnover Ratio ​ :2
5. Gross Profit Ratio : 20%
6. Stock Turnover Ratio ​ :7
7. Current Market Price per Equity Share ​ : ₹ 16
8. Net Working Capital ​ : ₹ 4,50,000
9. Fixed Assets ​ : ₹ 10,00,000
10. 60,000 Equity Shares of ​ : ₹ 10 each
11. 20,000, 9% Preference shares of : ₹ 10 each
12. Opening Stock ​ : ₹ 3,80,000
You are required to calculate:
(a) Quick Ratio (b) Fixed assets Turnover Ratio (c) Proprietary Ratio (d) Earnings per share
(e) Price Earnings Ratio.

Question 8 - Study Material

The total sales (all credit) of a firm are ₹ 6,40,000. It has a gross profit margin of 15 per cent and a current ratio
of 2.5. The firm’s current liabilities are ₹ 96,000; inventories ₹ 48,000; cash ₹ 16,000.
a) Determine the average inventory to be carried by the firm, if an inventory of 5 times is expected?
(Assume a 360 day year).
(b) Determine the average collection period if the opening balance of debtors is intended to be of ₹ 80,000?
(Assume a 360 day year).

Question 9 - Study Material

Additional information: Equity shares 80,000 @ 10 each ₹ 8,00,000 & 9% Preference shares of ₹ 3,00,000, Profit
(after tax at 35 per cent), ₹ 2,70,000; Depreciation, ₹ 60,000; Equity dividend paid, 20 percent; Market price of
equity shares, ₹ 40.
You are required to compute the following, showing the necessary workings:
(a) Dividend Yield on the Equity Shares (b) Cover for the Preference and Equity Dividends
(c) Earnings per Share (d) Price-earnings Ratio.

Question 10 - Pyq
The equity share capital of Sky pack Ltd. as on 31st march , 2024 was ₹2,00,000.
The relevant ratios of the company are as follows:
Current debt to Total Debt 0.35
Total debt to Owner’s equity 0.65
Fixed assets to Owner’s equity 0.55
Total assets turnover 2.5 times
Inventory turnover 10 times
You are required to prepare the Balance Sheet of Sky Pack Ltd. as on 31st March, 2024.

Question 11 -
Excellence Ltd. has the following data for projections for the next five years.
It has an existing Term Loan of ₹ 360 lakhs repayable over next five years and has got sanctions for a new
term loan for ₹ 500 lakhs which is also repayable in five years.
As a Finance Manager you are required to calculate:
(i) Interest Service coverage ratio and (ii) Debt Service Coverage Ratio
Particulars Amount(₹ in Lakhs)
Profit after tax 480
Depreciation 155
Taxation 125
Interest on Term Loans 162
Repayment of Term Loans 178

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 Chapter 1 - Ratio Analysis

Question 12 - Pyq
Theme Ltd provides you the following information:
12.5% Debt : ₹45,00,000
Debt to Equity Ratio : 1.5 : 1
Return on shareholder’s fund : 54%
Operating Ratio : 85%
Ratio of operating expenses to Cost of Goods sold :2:6
Tax Rate : 25%
Fixed Assets : ₹ 39,00,000
Current Ratio : 1.8 : 1
You are required to calculate: (i) Interest Coverage Ratio (ii) Gross Profit Ratio (iii) Current Assets

Prepare Balance sheet

Question 13 - Pyq
Following are the data in respect of ABC Industries for the year ended 31st March, 2021:
Debt to Total assets ratio : 0.40
Long-term debts to equity ratio : 30%
Gross profit margin on sales : 20%
Accounts receivable period : 36 days
Quick ratio ​ : 0.9
Inventory holding period : 55 days
Cost of goods sold : ₹ 64,00,000
Liabilities ₹ Assets ₹
Equity Share Capital 20,00,000 Fixed assets
Reserves & Surplus Inventories
Long-term debts Accounts receivables
Accounts payable Cash
Total 50,00,000 Total
Complete the Balance Sheet of ABC Industries as on 31st March, 2021. All calculations should be in the
nearest Rupee. Assume 360 days in a year.

Question 14 - Mtp
The following figures and ratios are related to a company:
(i)Sales of the year (all credit) : ₹ 30,00,000
(ii)Gross Profit ratio : 25 percent
(iii)Fixed assets turnover (based on cost of goods sold) : 1.5
(iv)Stock turnover (based on cost of goods sold) :6
(v)Liquid ratio : 1:1
(vi)Current ratio : 1.5:1
(vii)Receivable (Debtors) collection period : 2 months
(viii)Reserves and surplus to Share capital : 0.6:1
(ix)Capital gearing ratio : 0.5
(x)Fixed assets to net worth : 1.20:1
You are required to prepare:
(a)Balance Sheet of the company on the basis of above details.
(b)The statement showing working capital requirement, if the company wants to make a provision for
contingencies @ 10 percent of net working capital including such provision.

Question 15 - Pyq
From the following information, prepare a summarised Balance sheet as at 31st March 2002:
Working Capital ₹ 2,40,000
Bank overdraft ₹ 40,000
Fixed Assets to Proprietary Ratio 0.75
Reserves and Surplus ₹ 1,60,000
Current ratio 2.5
Liquid Ratio 1.5

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 Chapter 1 - Ratio Analysis

Question 16 -
Using the following Data, complete the balance sheet given below:
Gross Profit ₹ 54,000
Shareholders’ Funds ₹ 6,00,000
Gross Profit Margin 20%
Credit sales to total sales 80%
Total assets turnover 0.3 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.8
Long term debt of Equity 40%

Balance Sheet
Liabilities ₹ Assets ₹
Creditors ………. Cash ……….
Long term Debt ………. Debtors ……….
Shareholders’ funds ………. Inventory ……….
Fixed Assets ……….

Question 17 - Pyq
With the help of the following information complete the Balance Sheet of MNOP LTD:
Equity share capital ​ : ₹ 1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt : 0.40
Total debt to owner’s equity : 0.60
Fixed assets to owner’s equity : 0.60
Total assets turnover : 2 Times
Inventory turnover : 8 Times

Question 18 - Study Material

Using the following information, complete this balance sheet:
Long-term debt to net worth 0.5 to 1
Total asset turnover 2.5 times
Average collection period* 18 days
Inventory turnover 9 times
Gross profit margin 10%
Acid-test ratio 1 to 1

*Assume a 360-day year and all sales on credit.

Liabilities ₹ Assets ₹
Notes and payables 1,00,000 Cash -
Long-term debt - Accounts receivable -
Common stock 1,00,000 Inventory -
Retained earnings 1,00,000 Plant and equipment -
Total liabilities and equity - Total assets -

Question 19 -
From the following particulars prepare the Balance Sheet of Krishna Ltd.
Current Ratio 2
Working Capital ₹ 2,00,000
Capital Block to Current Assets 3:2
Fixed Assets to Turnover 1:3
Sales Cash/Credit 1:2
Creditors Velocity 2 months
Stock Velocity 2 months
Debtors Velocity 3 months

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 Chapter 1 - Ratio Analysis

Capital Block:
Net profit – 10% of turnover
Reserve – 2 1/2% of turnover
Debenture/Share Capital – 1:2
Gross Profit Ratio – 25% (of sales)

Question 20 - Study Material

From the following information, you are required to PREPARE a summarised Balance Sheet for Rudra Ltd. for
the year ended 31st March, 2023:
Debt Equity Ratio 1:1
Current Ratio 3:1
Acid Test Ratio 8:3
Fixed Asset Turnover (on the basis of sales) 4
Stock Turnover (on the basis of sales) 6
Cash in hand ₹ 5,00,000
Stock to Debtor 1:1
Sales to Net Worth 4
Capital to Reserve 1:2
Gross Profit 20% of Cost
COGS to Creditor 10:1
Interest for the entire year is yet to be paid on a Long Term loan @ 10%.

Question 21 -
Below is given the balance Sheet of A Ltd. as on 31st March,2001:
Liabilities ₹ Assets ₹
Share Capital: Fixed Assets:
14% Preference Shares 1,00,000 At Cost ​ 5,00,000
Equity Shares 2,00,000 Less: Depreciation - 1,60,000 3,40,000
General Reserves 40,000 Stock in trade 60,000
12% Debentures 60,000 Sundry Debtors 80,000
Current Liabilities 1,00,000 Cash 20,000
Total 5,00,000 Total 5,00,000
The following information is available.
1. Fixed assets costing ₹ 1,00,000 to be installed on 1st April 2001 & would become operative on that date,
payment is required to be made on 31st March2002.
2. The Fixed Assets-Turnover Ratio would be 1.5 (on the basis of cost of Fixed Assets).
3. The Stock-Turnover Ratio would be 14.4 (on the basis of the opening & closing stock).
4. The break-up of cost and Profit would be as follows: Materials – 40%, Labour – 25%, Manufacturing
Expenses – 10%, Office and Selling Expenses – 10% , Depreciation – 5%, Profit – 10% and Sales – 100% .The
Profit is subject to interest & taxation at 50%.
5. Debtors would be 1/9th of Sales which Creditors would be 1/5th of Materials Cost.
6. A Dividend at 10% would be paid on Equity Shares in March 2002.
7. ₹ 50,000, 12% Debentures were issued on 1st April 2001.
Prepare the forecast Balance Sheet as on 31st March 2002.

Question 22 - Study Material

Following is the abridged Balance Sheet of Alpha Ltd.:-
Liabilities ₹ Assets ₹
Share Capital 1,00,000 Land and Buildings 80,000
Profit and Loss Account 17,000 Plant and Machineries 50,000
Current Liabilities 40,000 Less: Depreciation -​ 15,000 35,000
1,15,000
Stock 21,000
Debtors 20,000
Bank 1,000 42,000
Total 1,57,000 Total 1,57,000

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 Chapter 1 - Ratio Analysis

With the help of the additional information furnished below, you are required to prepare Trading and Profit &
Loss Account and a Balance Sheet as at 31st March, 2010:
(i) The company went in for reorganization of capital structure, with share capital remaining the same as
follows:
Share capital : 50%
Other Shareholders’ funds : 15%
5% Debentures : 10%
Trade Creditors : 25%
Debentures were issued on 1 April, interest being paid annually on 31st March.
st

(ii) Land and Buildings remained unchanged. Additional plant and machinery has been bought and a further ₹
5,000 depreciation written off.(The total fixed assets then constituted 60% of total fixed and current assets.)
(iii) Working capital ratio was 8:5.
(iv) Quick assets ratio was 1:1.
(v) The debtors (four-fifth of the quick assets) to sales ratio revealed a credit period of 2 months. There were
no cash sales.
(vi) Return on net worth was 10%.
(vii) Gross profit was at the rate of 15% of selling price.
(viii) Stock turnover was eight times for the year. Ignore Taxation.

Question 23 - Pyq
Balance sheet of ABC Ltd. is as follows :
Balance sheet as on 31-03-2020
Liabilities Amount (₨) Assets Amount (₨)
Share capital 2,00,000 Land & buildings 40,000
Reserves & surplus​ 30,000 Plant & machinery​ 1,00,000
current liabilities 20,000 Less : Depreciation​ - 30,000 70,000
Stock 55,000
Debtors 45,000
Cash & bank 40,000
2,50,000 2,50,000
Following additional information is also provided for the year 2020-21 :
(i) The company has decided for re – organization of its total liabilities, (with the amount of share capital
remaining the same) as follows :
As % of total liabilities
Share capital : 40%
Reserves : 20%
10% debentures : 15%
Trade creditors : 25% ​
Debentures will be issued on 1st April ; interest will be paid annually on 31st March.
(ii) Land & Buildings remained unchanged. Additional plant and machinery has been introduced and further ₨
10,000 depreciation is to be written off on additions . ( Total fixed assets then constituted 30% of total assets)
(iii) Quick ratio is 1:1.
(iv) The debtor (One fourth of the quick assets ) to sales ratio represents a credit period of 1.5 months .
There are no cash sales .
(v) Return of net worth is 15%.
(vi) Gross Profit is at the rate of 40% of selling price.
You are required to prepare:
(i) Projected profit & loss account for the year ended March, 2021 and
(ii) Balance sheet as on 31st March, 2021. (Ignore Corporate Tax)

Question 24 - Pyq
Using the following, complete the balance sheet given below:
1. Total debt to net worth :1:2
2. Total assets turnover :2
3. Gross profit on sales : 30%
4. Average collection period (assume 360 days in a year) : 40 days
5. Inventory turnover ratio based on cost of goods sold and year-end inventory :3
6. Acid test ratio : 0.75

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 Chapter 1 - Ratio Analysis

Balance Sheet as on March 31, 2007

Liabilities ₹ Assets ₹
Plant and Machinery and other fixed
Equity Shares capital 4,00,000 assets …..
Reserves and Surplus 6,00,000 Current assets:
Total Debt: Inventory …..
Current liabilities ….. Debtors …..
Cash …..

Question 25 - Rtp
From the following information, find out missing figures and REWRITE the balance sheet of Mukesh
Enterprise.
Current Ratio : 2:1
Acid Test ratio : 3:2
Reserves and surplus : 20% of equity share capital
Long term debt : 45% of net worth
Stock turnover velocity : 1.5 months
Receivables turnover velocity : 2 months
You may assume closing Receivables as average Receivables.
Gross profit ratio : 20%
Sales is ₹ 21,00,000 (25% sales are on cash basis and balance on credit basis)
Closing stock is ₹ 40,000 more than opening stock.
Accumulated depreciation is 1/6 of the original cost of fixed assets.
Balance sheet of the company is as follows:
Liabilities (₹) Assets (₹)
Equity Share Capital ? Fixed Assets (Cost) ?
Reserves & Surplus ? Less: Accumulated. Depreciation ?
Long Term Loans 6,75,000 Fixed Assets (WDV) ?
Bank Overdraft 60,000 Stock ?
Creditors ? Debtors ?
Cash ?
Total ? Total ?

Prepare P&L account and Balance Sheet

Question 26 - Study Material
VRA Limited has provided the following information for the year ending 31st March 2015​
Debt Equity Ratio : 2:1​
14% long term debt : ₹ 5,00,000​
Gross Profit Ratio : 30%​
Return on equity : 50%​
Income Tax Rate : 35%​
Capital Turnover Ratio : 1.2 times​
Opening Stock : ₹ 4,50,000​
Closing stock : 8% of sales​
You are required to prepare a Trading and Profit and Loss Account for the year ending 31st March, 2015.

Question 27 - Mtp
From the following information and ratios, PREPARE the Balance sheet as at 31st March 2022 and income
statement for the year ended on that date for M/s Ganguly & Co :
Average Stock ₹10 lakh
Current Ratio 3:1
Acid Test Ratio 1:1
PBIT to PBT 2.2:1
Average Collection period (Assume 360 days in a year) 30 days
Stock Turnover Ratio (Use sales as turnover) 5 times
Fixed assets turnover ratio 0.8 times

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 Chapter 1 - Ratio Analysis

Working Capital ₹10 lakh

Net profit Ratio 10%
Gross profit Ratio 40%
Operating expenses (excluding interest) ₹ 9 lakh
Long term loan interest 12%
Tax Nil

Question 28 -
From the following information and ratios, prepare the Profit and Loss Account and Balance Sheet of M/s
Check & Co. an export company. [Take 1 year = 360 days] (Ignore taxation).
Book value per share ₹ 40.00 Stock Turnover Ratio 5.00
Variable cost 60% Total liabilities to Net worth 2.75
Average collection Period 30 Days Long term Loan interest 12%
Financial Leverage (i.e. EBIT/EBT) 2.20 Net profit to sales 10%
Earnings per share (each of ₹ 10) ₹ 10.00 Current Ratio 3.00
Current Assets to stock 3:2 Net working capital ₹ 10 Lakhs
Acid test ratio 1.00 Fixed assets Turnover Ratio 1.20

Question 29 - Study Material

Ganpati Limited has furnished the following ratios and information relating to the year ended 31st March, 2010.
Sales ₹ 60,00,000
Return on Net Worth 25%
Rate of Income Tax 50%
Share Capital to Reserves 7:3
Current Ratio 2
Net Profit to Sales 6.25%
Inventory Turnover (based on Cost of goods sold) 12
Cost of goods sold ₹ 18,00,000
Interest on Debentures ₹ 60,000
Sundry Debtors ₹ 2,00,000
Sundry Creditors ₹ 2,00,000
You are required to:
(a) Calculate the operating expenses for the year ended 31st March, 2010.
(b) Prepare a balance sheet as on 31st March in the following format:
Balance Sheet as on 31st March, 2010
Liabilities ₹ Assets ₹
Share Capital - Fixed Assets -
Reserve and Surplus - Current Assets
15% Debentures - Stock -
Sundry Creditors - Debtors -
Cash -

Question 30 -
Masco Ltd. has furnished the following ratios and information relating to the year ended 31st March 2021 :
Sales ₨ 75,00,000
Return on net worth 25%
Rate of income tax 50%
Share capital to reserves 6:4
Current ratio 2.5
Net profit to sales ( After Income tax) 6.50%
Inventory turnover ( based on cost of goods sold) 12
Cost of goods sold ₨ 22,50,000
Interest on debentures ₨ 75,000
Receivables (includes debtors ₨ 1,25,000) ₨ 2,00,000
Payables ₨ 2,50,000
Bank overdraft ₨ 1,50,000

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 Chapter 1 - Ratio Analysis

You are required to :

(a) Calculate the operating expenses for the year ended 31st March, 2021.
(b) Prepare a balance sheet as on 31st March in the following format :
Liabilities ₨ Assets ₨
Share capital Fixed Assets
Reserves & Surplus Current Assets
15% Debentures Stock
Payables Receivables
Bank Term Loan Cash

Question 31 - Study Material

The following accounting information and financial ratios of PQR Ltd. relate to the year ended 31st March, 2020
I Accounting Information :
Gross profit 15% of Sales
Net profit 8% of Sales
Raw materials consumed 20% of works cost
Direct wages 10% of work cost
Stock of Raw materials 3 months usage
Stock of finished goods 6% of works cost
Debt collection period 60 days
All sales are on credit
II Financial Ratios :
Fixed assets to Sales 1:3
Fixed assets to Current assets 13 : 11
Current Ratio 2:1
Long – term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4
If the value of Fixed Assets as on 31st March , 2019 amounted to ₹ 26 lakhs , Prepare a summarised Profit and
Loss Account of the company for the year ended 31st March , 2020 and also the Balance Sheet as on 31st
March, 2020.

Question 32 - Rtp
The following information of ASD Ltd. relate to the year ended 31st March, 2022:
Net profit ​ : 8% of sales
Raw materials consumed : 20% of Cost of Goods Sold
Direct wages : 10% of Cost of Goods Sold
Stock of raw materials : 3 months’ usage
Stock of finished goods : 6% of Cost of Goods Sold
Gross Profit ​ : 15% of Sales
Debt collection period ​ : 2 Months (All sales are on credit)
Current ratio ​ :2:1
Fixed assets to Current assets : 13 : 11
Fixed assets to sales ​ :1:3
Long-term loans to Current liabilities : 2 : 1
Capital to Reserves and Surplus :1:4
You are required to PREPARE-
Profit & Loss Statement of ASD Limited for the year ended 31st March, 2022 in the following format.
Particulars (₹) Particulars (₹)
To Direct Materials consumed ? By Sales ?
To Direct Wages ?
To Works (Overhead) ?
To Gross Profit c/d ?
? ?
To Selling and Distribution Expenses ? By Gross Profit b/d ?
To Net Profit ?
? ?

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 Chapter 1 - Ratio Analysis

Balance Sheet as on 31st March, 2022 in the following format.

Liabilities (₹) Assets (₹)
Share Capital ? Fixed Assets 1,30,00,000
Reserves and Surplus ? Current Assets:
Long term loans ? Stock of Raw Material ?
Current liabilities ? Stock of Finished Goods ?
Debtors ?
Cash ?
? ?

Question 33 - Rtp
From the following table of financial ratios of Prabhu Chemicals Limited, comment on various ratios given at
the end:
Ratios 2021 2022 Average of Chemical Industry
Liquidity Ratios
Current ratio 2.1 2.3 2.4
Quick ratio 1.4 1.8 1.4
Receivable turnover ratio 8 9 8
Inventory turnover 8 9 5
Receivables collection period 46 days 41 days 46 days
Operating profitability
Operating income –ROI 24% 21% 18%
Operating profit margin 18% 18% 12%
Financing decisions
Debt ratio 45% 44% 60%
Return
Return on equity 26% 28% 18%
COMMENT on the following aspect of Prabhu Chemicals Limited
(1)​ Liquidity
(2)​ Operating profits
(3)​ Financing
(4)​ Return to the shareholders.

Taking averages in denominator

Question 34 - Pyq
JKL Limited has the following Balance Sheets as on March 31, 2006 and March 31, 2005:
Balance Sheet(₹ in Lakhs)
Particulars March 31,2006 March 31, 2005
Sources of Funds
Shareholders’ funds 2,377 1,472
Loan Funds 3,570 3,083
5,947 4,555
Application of Funds
Fixed Assets 3,466 2,900
Cash and Bank 489 470
Debtors 1,495 1,168
Stock 2,867 2,407
Other Current Assets 1,567 1,404
Less: Current Liabilities (3,937) (3,794)
5,947 4,555

The Income Statement of the JKL Ltd. for the year ended is as follows: ​ (₹ in lakhs)
Particulars March 31, 2006 March 31, 2005
Sales 22,165 13,882
Less: Cost of Goods sold 20,860 12,544
Gross Profit 1,305 1,338
Less: Selling, General and Administrative expenses 1,135 752

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 Chapter 1 - Ratio Analysis

Earnings before Interest and Tax (EBIT) 170 586

Interest Expense 113 105
Profit before tax 57 481
Tax 23 192
Profit after tax (PAT) 34 289
You are required to:
(i) Calculate for the year 2005-06:
(a) Inventory Turnover Ratio (b) Financial Leverage (c) Return on Investment (ROI) (d) Return on Equity (ROE)
(e) Average Collection Period.
(ii) Give a brief comment on the financial position of JKL Limited.

Question 35 - Study Material

In a meeting held at Solan towards the end of 2009, the Directors of M/s HPCL Ltd. has taken a decision to
diversify. At present HPCL Ltd. sells all finished goods from its own warehouse.
The company issued debentures on 01.01.2010 and purchased fixed assets on the same day.
The purchase prices have remained stable during the concerned period.
Following information is provided to you:
INCOME STATEMENTS
Particulars 2009 (₹) 2010 (₹)
Cash Sales 30,000 32,000
Credit Sales 2,70,000 3,00,000 3,42,000 3,74,000
Less: Cost of goods sold 2,36,000 2,98,000
Gross profit 64,000 76,000
Less: Expenses
Warehousing 13,000 14,000
Transport 6,000 10,000
Administrative 19,000 19,000
Selling 11,000 14,000
Interest on Debentures 49,000 57,000
Net Profit 15,000 19,000

BALANCE SHEET
Particulars 2009 (₹) 2010 (₹)
Fixed Assets (Net Block) - 30,000 - 40,000
Debtors 50,000 82,000
Cash at Bank 10,000 7,000
Stock 60,000 94,000
Total Current Assets (CA) 1,20,000 1,83,000
Creditors 50,000 76,000
Total Current Liabilities (CL) 50,000 76,000
Working Capital (CA – CL) 70,000 1,07,000
Total Assets 1,00,000 1,47,000
Represented by:
Share Capital 75,000 75,000
Reserve and Surplus 25,000 42,000
Debentures - 30,000
1,00,000 1,47,000
You are required to calculate the following ratios for the years 2009 and 2010.
(i) Gross Profit Ratio (ii) Operating Expenses to Sales Ratio (iii) Operating Profit Ratio
(iv) Capital Turnover Ratio (v) Stock Turnover Ratio (vi) Net Profit to Net Worth Ratio, and
(vii) Debtors Collection Period.
Ratio relating to capital employed should be based on the capital at the end of the year.
Give the reasons for change in the ratios for 2 years. Assume opening stock of ₹ 40,000 for the year 2009.
Ignore Taxation.

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 Chapter 1 - Ratio Analysis

DUPONT ANALYSIS
Question 36 - Study Material
XYZ Company’s details are as under:
Revenue: ₹ 29,261; Net Income: ₹ 4,212; Assets: ₹ 27,987: Shareholders’ Equity: ₹ 13,572.
Calculate return on equity.

Question 37 -
Particulars Amount (₹)
Return 80,000
Sales 3,00,000
Capital Employed 2,25,000
Compute (a) Capital Turnover Ratio, (b) Net Operating Profit ratio and
(c) Applying Du Pont analysis, state the relationship between the two.

Question 38 -
Compute the Return on Capital Employed from the following data relating to company A and B applying Du
Pont analysis:-
Particulars Ram Ltd Shyam Ltd
Gross Profit Margin 30% ₹ 1,80,000 (15%)
Capital Employed Nil ₹ 2,00,000
Turnover on Capital Employed 4 Times Nil
Net Sales for the year ₹ 10,00,000 Nil
Operating Profit on Sales 5% 6%

Question 39 -
The profit margin of a company is 10% and the capital turnover is 3 times.
What is the return on investment (ROI) of the company? Applying du Pont analysis, state by what percentage
the company’s return on investment increase will or decrease if –
(i) The profit margin decreases by 2%? (ii) The profit margin increases by 2%?
(iii) The capital turnover decreases by 1? (iv) The capital turnover increases by 1?

Margin of safety topic

Question 40 - Study Material
ABC Company sells plumbing fixtures on the terms of 2/10 , net 30. Its financial statements over the last 3
years are as follows :
Particulars 2018 2019 2020
₹ ₹ ₹
Cash 30,000 20,000 5,000
Accounts Receivable 2,00,000 2,60,000 2,90,000
Inventory 4,00,000 4,80,000 6,00,000
Net fixed assets 8,00,000 8,00,000 8,00,000
14,30,000 15,60,000 16,95,000
₹ ₹ ₹
Accounts payable 2,30,000 3,00,000 3,80,000
Accruals 2,00,000 2,10,000 2,25,000
Bank loan , short - term 1,00,000 1,00,000 1,40,000
Long - term debts 3,00,000 3,00,000 3,00,000
Common stock 1,00,000 1,00,000 1,00,000
Retained earnings 5,00,000 5,50,000 5,50,000
14,30,000 15,60,000 16,95,000
₹ ₹ ₹
Sales 40,00,000 43,00,000 38,00,000
Cost of goods sold 32,00,000 36,00,000 33,00,000
Net profit 3,00,000 2,00,000 1,00,000
Analyse the company’s financial condition and performance over the last 3 years. Are there any problems ?

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 Chapter 1 - Ratio Analysis

Question 41 - Study Material

Following information is available for Navya Ltd. along with various ratios relevant to the particular industry it
belongs to. Appraise your comments on strength and weakness of Navya Ltd. comparing its ratios with the
given industry norms .
Balance sheet as at 31.3.2020
Liabilities Amount (₹) Assets Amount (₹)
Equity share capital 48,00,000 Fixed Assets 24,20,000
10% Debentures 9,20,000 Cash 8,80,000
Sundry Creditors 6,60,000 Sundry Debtors 11,00,000
Bills payable 8,80,000 Stock 33,00,000
Other current 4,40,000 -
liabilities
Total 77,00,000 Total 77,00,000

Statement of Profitability For the year ending 31.03.2020

Particulars Amount (₹) Amount (₹)
Sales 1,10,00,000
Less : Cost of goods sold : - -
Material 41,80,000 -
Wages 26,40,000 -
Factory Overhead 12,98,000 81,18,000
Gross profit - 28,82,000
Less : Selling and Distribution Cost 11,00,000 -
Administrative Cost 12,28,000 23,28,000
Earnings before Interest & Taxes - 5,54,000
Less : Interest Charges - 92,000
Earnings before tax - 4,62,000
Less : Taxes & 50% - 2,31,000
Net Profit (PAT) 2,31,000

Industry Norms
Ratios Norm
Current Ratio 2.5
Receivable Turnover Ratio 8.0
Inventory Turnover Ratio (based on Sales) 9.0
Total assets Turnover Ratio 2.0
Net Profit Ratio 3.5%
Return on Total assets 7.0%
Return on Net Worth (Based on Net profit ) 10.5%
Total Debt / Total Assets 60.0%

Question 42 - Mtp
Jensen and Spencer pharmaceutical is in the business of manufacturing pharmaceutical drugs including the
newly invented Covid vaccine.
Due to the increase in demand of Covid vaccines, the production has increased to an all time high level and the
company urgently needs a loan to meet the cash and investment requirements.
It had already submitted a detailed loan proposal and project report to Expo-Impo bank, along with the
financial statements of previous three years as follows:
Statement of Profit and Loss (in ‘000)
Particulars 2018-19 2019-20 2020-21
Sales
Cash 400 960 1,600
Credit 3,600 8,640 14,400
Total Sales 4,000 9,600 16,000
Cost of goods sold 2,480 5,664 9,600
Gross profit 1,520 3,936 6,400

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 Chapter 1 - Ratio Analysis

Operating Expenses
General, administration, and selling expenses 160 900 2,000
Depreciation 200 800 1,320
Interest expenses (on borrowings) 120 316 680
Profit before tax (PBT) 1,040 1,920 2,400
Tax@ 30% 312 576 720
Profit after tax (PAT) 728 1,344 1,680
Balance Sheet (In ‘000)
2018-19 2019-20 2020-21
Assets
Non-Current Assets
Fixed Assets (net of depreciation) 3,800 5,000 9,400
Current Assets
Cash and Cash equivalents 80 200 212
Accounts receivable 600 3,000 4,200
Inventories 640 3,000 4,500
Total 5,120 11,200 18,312
Equity & Liabilities
Equity Share capital (shares of ₹ 10 each) 2,400 3,200 4,000
Other Equity 728 2,072 3,752
Non-Current borrowings 1,472 2,472 5,000
Current Liabilities 520 3,456 5,560
Total 5,120 11,200 18,312

Industry Average of Key ratios

Ratio Sector Average
Current ratio 2.30:1
Acid test ratio (quick ratio) 1.20:1
Receivable Turnover ratio 7 times
Inventory turnover ratio 4.85 times
Long-term debt to total debt 24%
Debt-to-equity ratio 35%
Net profit ratio 18%
Return on total assets 10%
Interest coverage ratio (times interest earned) 10
As a loan officer of Expo-Impo Bank, you are required to appraise the loan proposal on the basis of
comparison with industry average of key ratios considering balance for accounts receivable of ₹ 6,00,000 and
inventories of ₹ 6,40,000 respectively as on 31st March, 2018. ​

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 Chapter 2 - Cost of Capital

Chapter 2
Cost of Capital
Cost of Debt
Question 1 - Study Material
Five years ago, Sona Limited issued 12 per cent irredeemable debentures at ₹ 103, at ₹ 3 premium to their par
value of ₹ 100. The current market price of these debentures is ₹ 94. If the company pays corporate tax at a
rate of 35 per cent CALCULATE its current cost of debenture capital?

Question 2 - Study Material

A company issued 10,000, 10% debentures of ₹ 100 each at a premium of 10% on 1.4.2017 to be matured on
1.4.2022. The debentures will be redeemed on maturity.
COMPUTE the cost of debentures assuming 35% as tax rate.

Question 3 - Study Material

A company issued 10,000, 10% debentures of ₹ 100 each at par on 1.4.2012 to be matured on 1.4.2022. The
company wants to know the cost of its existing debt on 1.4.2017 when the market price of the debentures is
₹ 80. COMPUTE the cost of existing debentures assuming 35% tax rate.

Question 4 - Study Material , Pyq

(a) A company issues ₹ 10,00,000 16% debentures of ₹ 100 each. The company is in the 35% tax bracket.
You are required to calculate the cost of debt after tax, if debentures are issued at:
(i) par, ​ ​ ​ (ii) 10% discount and ​​ ​ (iii) 10% premium.
(b) If brokerage is paid at 2% what will be the cost of debentures if the issue is at par?

Question 5 - Pyq
A Company issues ₹ 10,00,000 12% debentures of ₹ 100 each. The debentures are redeemable after the expiry
of a fixed period of 7 years. The Company is in the 35% tax bracket. You are required to:
(i)​ Calculate the cost of debt after tax, if debentures are issued at
(a)​ Par; ​ (b) 10% Discount; ​ ​ ​ (c) 10% Premium.
(ii)​ If brokerage is paid at 2%, what will be the cost of debentures, if the issue is at par?

Question 6 -
A Company is considering raising funds of about ₹ 100 lakhs by one of two alternative methods, viz. 14%
Institutional Term Loan and 13% Non-Convertible Debentures. The Term Loan option would attract no major
incidental cost. The Debentures would be issued at a discount of 2.5% and would involve a cost of issue ₹ 1
lakh. Advice the company as to the better option based on effective cost of capital. Assume Tax Rate of 50%.
[Debentures Kd = 6.74% Rank I, Term Loan Kd = 7.00% Rank II]

Zero coupon / Deep discount bonds

Question 7 - Study Material/MTP
A.​ Institutional Development Bank(IDB) issued Zero interest deep discount bonds of face value of ₹1,00,000
each issued at ₹2500 & repayable after 25 years. COMPUTE the cost of debt if there is no corporate tax.
B.​ Development Finance Corporation issued zero interest deep discount bonds of face value of ₹1,50,000
each issued at ₹ 3,750 & repayable after 25 years.
C.​ COMPUTE the cost of debt if there is no corporate tax.

Convertible bonds & YTM

Question 8 - Pyq
TT Ltd. issued 20,000, 10% convertible debenture of ₹ 100 each with a maturity period of 5 years.
At maturity the debenture holders will have the option to convert debentures into equity shares of the company
in a ratio of 1:5 (5 shares for each debenture).
The current market price of the equity share is ₹ 20 each and historically the growth rate of the share is 4% per
annum. Assuming tax rate is 25%.
Compute the cost of 10% convertible debenture using Approximation Method and Internal Rate of Return
Method.

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 Chapter 2 - Cost of Capital

PV Factor are as under:

Year 1 2 3 4 5
PV Factor @ 10% 0.909 0.826 0.751 0.683 0.621
PV Factor @ 15% 0.870 0.756 0.658 0.572 0.497

Question 9 -
A company issues:
A.​15% convertible debentures of ₹ 100 each at par with a maturity period of 6 years. On maturity, each
debenture will be converted into 2 equity shares of the company. The risk - free rate of return is 10%, market
risk premium is 18% and beta of the company is 1.25. The company has paid a dividend of ₹ 12.76 per
share. Five years ago, it paid a dividend of ₹ 10 per share. Flotation cost is 5% of issue amount.
B.​8.3333% Debentures of ₹ 100 each at premium of 10%. These Debentures are redeemable after 10 years at
par. Flotation cost is 6% of issue amount. Assuming corporate tax rate is 40%.
1.​ Calculate the cost of convertible debentures using the approximation method.
2.​ Use the YTM method to Calculate cost of Debentures.

Year 1 2 3 4 5 6 7 8 9 10
PVIF 0.03, t 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744
PVIF 0.05, t 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614
PVIFA 0.03, t 0.971 1.913 2.829 3.717 4.580 5.417 6.230 7.020 7.786 8.530
PVIFA 0.05, t 0.952 1.859 2.723 3.546 4.329 5.076 5.786 6.463 7.108 7.722

Interest rate 1% 2% 3% 4% 5% 6% 7% 8% 9%
FVIF i, 5 1.051 1.104 1.159 1.217 1.276 1.338 1.403 1.469 1.539
FVIF i, 6 1.062 1.126 1.194 1.265 1.340 1.419 1.501 1.587 1.677
FVIF i, 7 1.072 1.149 1.230 1.316 1.407 1.504 1.606 1.714 1.828

Value of Amortized bonds

Question 10 -
A Company sells a 4 year Bond of ₹ 20,000 at 12.5% Interest per annum. The bond will be amortised equally
over its life. What will be the Present value of the Bond for an investor who expects a minimum rate of return
of 12%?

Question 11 - Study Material

Reserve Bank of India is proposing to sell a 5-year bond of ₹ 5,000 at 8 per cent rate of interest per annum. The
bond amount will be amortised over its life. What is the bond’s present value of an inventor if he expects a
minimum rate of return of 6 per cent?

Cost of Preference Share

Question 12 - Study Material
If Reliance Energy is issuing preferred stock at ₹ 100 per share, with a stated dividend of ₹ 12, and a floatation
cost of 3% then, what is the cost of preference share?

Question 13 - Study Material

XYZ & Co. issues 2,000 10% preference shares of ₹ 100 each at ₹ 95 each. Calculate the Cost of Preference
Shares.

Question 14 - Study Material

Referring to the earlier question but taking into consideration that if the company proposes to redeem the
preference shares at the end of 10th year from the date of issue. Calculate the Cost of Preference Share?
[KP = 0.107]

Question 15 - Pyq
A company issued 40,000, 12% Redeemable Preference Shares of ₹100 each at a premium of ₹ 5 each,
redeemable after 10 years at a premium of ₹ 10 each. The floatation cost of each share is ₹ 2.
You are required to calculate the cost of preference share capital ignoring dividend tax.

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 Chapter 2 - Cost of Capital

Question 16 -
Correct Ltd. issued 30,000 15% Preference shares of ₹ 100 each, redeemable at 10% premium after 20 years.
Issue Management Expenses were ₹ 30,000.
Find out the Cost of Preference Capital, if shares are issued:
(a) at par, (b) at a premium of 10%, and (c) at a discount of 10%.

Cost of Equity Share

Dividend Price Approach
Question 17 -
Bee Ltd. has a stable income and stable dividend policy. The average annual dividend payout is ₹ 27 per share
(Face value = ₹ 100).
You are required to find out:
(1)​ Cost of Equity Capital, if market price in Year 1 is ₹ 150.
(2)​ Expected Market price in Year 2, if cost of Equity is expected to rise to 20%.
(3)​ Dividend payout required in year 2, if the company were to have an expected Market Price of ₹ 160 per
share, at the existing Cost of Equity.

Earnings Price Approach

Question 18 -
Renowned Ltd. has a uniform income that accrues in a four year business cycle. It has an average EPS of ₹ 25
(per share of ₹ 100) over its business cycle.
You are required to find out:
(1)​ Cost of Capital, if Market Price in Year 1 is ₹ 150.
(2)​ Expected Market Price in Year 2, if Cost of Equity is expected to rise to 18%
(3)​ EPS in Year 2, if the Company were to have an expected Market Price of ₹ 160 per share, at the existing
Cost of Equity.

Dividend Growth Model Approach

Question 19 - Study Material
A company has paid a dividend of Re. 1 per share (of face value of ₹ 10 each) last year and it is expected to
grow @ 10% next year. Calculate the Cost of Equity if the Market Price of Share is ₹ 55.

Question 20 -
A company’s current price of share is ₹ 60 and dividend per share is ₹ 4. If its capitalisation rate is 12%, what is
the Dividend growth rate?

Question 21 - Study Material

A company’s share is quoted in the market at ₹ 40 currently. A company pays a dividend of ₹ 2 per share and
investors expect a growth rate of 10% per year, compute:
(a) The company’s cost of equity capital.
(b) If anticipated growth rate is 11% p.a. calculate the indicated market price per share.
(c) If the company’s cost of capital is 16% and anticipated growth rate is 10% p.a., calculate the market price if
a dividend of ₹ 2 per share is to be maintained.

Question 22 -
During the past four years following dividend has been paid by Bharat Ltd. which are as follows:
Year Ended Dividend per Share (₹)
2002 26
2005 30
The company has issued 10,000 ordinary shares of ₹ 100 each. The current market value of each ordinary
share of Bharat Ltd. is ₹ 235 cum-dividend. The 2005 dividend of ₹ 30 per share has just been paid.
You are required to estimate the cost of capital for Bharat Ltd. ordinary share capital.

Question 23 -
A company’s policy is to pay dividends at the rate of 5% on the market price of the share at the beginning of
year. Find the growth rate if Ke = 12%.

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 Chapter 2 - Cost of Capital

Capital Asset Pricing Model (CAPM)

Question 24 - Study Material
Calculate the Cost of Equity of H Ltd., whose risk free rate of return equals 10%. The firm’s beta equals 1.75
and the return on the market portfolio equals to 15%.

Question 25 -
Compute Cost of Equity if Interest on Government Bonds is 6%, Market Return is 18%, Beta Factor for
Company K is 1.10.

Question 26 -
The Risk-free return is 9% and the Market return is 15%. Ram intends to invest 80% of his money in an
investment having a beta of 0.8 and 20% of this investment having a Beta of 1.4.
(i)​ What will be the return from each investment?
(ii)​ What will be his overall return?
(iii)​What will be the Beta Factor for his total investment?

Question 27 -
A Company has estimated that overall return for the Market will be 15%, Interest rate on Treasury securities
will average 10%.
Management has attached the following Probabilities to possible outcome:
Probability 0.2 0.3 0.2 0.2 0.1
Beta 1.00 1.10 1.20 1.30 1.40
(a) What is the required rate of return for the project using the mode – average beta of 1.10?
(b) What is the range of required rates of return?
(c) What is the expected value of the required rate of return?

Cost of Equity using CAPM and Product Wise Beta

Question 28 - Pyq
You are analysing the beta for XYZ Computers Ltd. and have divided the Company into four broad business
groups, with market values and betas for each group.
Business Group Market Value of Equity Beta
Main Frames ₹ 100 Billion 1.10
Personal Computers ₹ 100 Billion 1.50
Software ₹ 50 Billion 2.00
Printers ₹ 150 Billion 1.00
XYZ Computers Ltd. has ₹ 50 billion in debt outstanding.
You are required to:
(i)​ Estimate the beta for XYZ Computers Ltd. as a Company.
(ii)​ If the Treasury bond rate is 7.5%, estimate the Cost of Equity for XYZ Computers Ltd. Estimate the Cost of
Equity for each division. Which Cost of Equity would you use to value the printer division? The average
market risk premium is 8.5%.

Realised Yield Approach

Question 29 -
An individual wishes to purchase the share of a Company for ₹ 500. At present, the Company is expected to
pay a dividend of ₹ 40 on this share at the end of the year and its Market Price after the payment of the
dividend is expected to be ₹ 520. What is the Cost of Equity in this case, using the Realised Yield Approach?

Question 30 - Rtp
Jet Ltd is a Large Company with several thousand shareholders. An investor buys 100 shares of the company
at the beginning of the year at a Market price of ₹ 225. The Par value of each share is ₹ 10.
During the year, the company pays a dividend at 25%. The Price of the share at the end of the Year is ₹ 267.50.
Calculate the total return on the Investment. Suppose the investor sells the shares at the end of the year, what
would be the cash Inflows at the end of the year?

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 Chapter 2 - Cost of Capital

Valuation of Equity Share Capital – Present Value of Future Dividend Flows

Question 31 - Study Material
Calculate the cost of equity from the following data using realized yield approach:
Year 1 2 3 4 5
Dividend per share 1.00 1.00 1.20 1.25 1.15
Price per share(at the beginning) 9.00 9.75 11.50 11.00 10.60

Question 32 - Study Material

Mr. Mehra had purchased a share of Alpha Limited for ₹1,000. He received a dividend for a period of five years
at the rate of 10 percent. At the end of the fifth year, he sold the share of Alpha Limited for ₹1,128.
You are required to compute the cost of equity as per realised yield approach.

Cost of Retained Earnings

Question 33 -
Calculate the cost of retained earnings from the following information:
Current market price of a share ₹ 140
Cost of Flotation/brokerage per share 3% on market price
Growth in expected dividend 5%
Expected dividend per share on new shares ₹ 14
Shareholders marginal/personal income tax 22%

Question 34 - Pyq
Y Ltd. retains ₹ 7,50,000 out of its current earnings. The expected rate of return to the shareholders, if they had
invested the funds elsewhere is 10%. The brokerage is 3% and the shareholders come in a 30% tax bracket.
Calculate the cost of retained earnings.

Weighted Average Cost of Capital

Question 35 - Study Material
The following details are provided by the GPS Limited:
Particulars (₹)
Equity Share Capital 65,00,000
12% Preference Share Capital 12,00,000
15% Redeemable Debentures 20,00,000
10% Convertible Debentures 8,00,000
The cost of equity capital for the company is 16.30% and income tax rate for the company is 30%.
You are required to CALCULATE the Weighted Average Cost of Capital (WACC) of the company.

Question 36 - Pyq
PQR Ltd. has the following Capital Structure on 31st October:
Equity Share Capital (2,00,000 Shares of ₹ 10 each) ₹ 20,00,000
Reserves and Surplus ₹ 20,00,000
12% Preference Shares ₹ 10,00,000
9% Debentures ₹ 30,00,000
Total ₹ 80,00,000
The Market Price of Equity Share is ₹ 30. It is expected that the Company will pay next year a dividend of
₹ 3 per share, which will grow at 7% forever. Assume 40% Income tax rate. You are required to compute the
Weighted Average Cost of Capital of the Company using Market Value Weights.

Question 37 - Pyq
The following is the extract of the Balance Sheet of M/s KD Ltd.:
Particulars Amount (₹)
Ordinary shares (Face Value ₹ 10/- per share) 5,00,000
Share Premium 1,00,000
Retained Profits 6,00,000
8% Preference Shares (Face Value ₹ 25/- per share) 4,00,000
12% Debentures (Face value ₹ 100/- each) 6,00,000
22,00,000

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 Chapter 2 - Cost of Capital

The ordinary shares are currently priced at ₹ 39 ex-dividend and preference share is priced at ₹ 18
cum-dividend. The debentures are selling at 120 percent ex-interest. The applicable tax rate to KD Ltd. is 30
percent. KD Ltd.'s cost of equity has been estimated at 19 percent. Calculate the WACC (weighted average
cost of capital) of KD Ltd. on the basis of market value.

Question 38 - Pyq
The Capital Structure of a Company as on 31st March is as follows:
Equity Share Capital (6,00,000 Shares of ₹ 100 each) ₹ 6.00 Crores
Reserves and Surplus ₹ 1.20 Crores
12% Debentures of ₹ 100 each ₹ 1.80 Crores
For the year ended 31st March, the company has paid Equity Dividend at 24%. The dividend is likely to grow by
5% every year. Market Price of Equity Share is ₹ 600 per Share. Income Tax Rate applicable to the Company is
30%. You are required to:
(1) Compute the Current Weighted Average Cost of Capital.
(2) The Company has a plan to raise a further ₹ 3 crores by way of Long Term Loan at 18% Interest. If the Loan
is raised, the Market Price of Equity Share is expected to fall to ₹ 500 per share. What will be the new Weighted
Average Cost of Capital of the Company?

Question 39 - Rtp, Pyq

JKL Ltd. has the following book-value capital structure:
Particulars Amount (₹)
Equity Share Capital (2,00,000 shares) 40,00,000
11.5% Preference Shares 10,00,000
10% Debentures 30,00,000
80,00,000
The equity share of the company sells for ₹ 20. It is expected that the company will pay next year a dividend of
₹ 2 per equity share, which is expected to grow at 5% p.a. forever. Assume a 35% corporate tax rate.
(i)​ Compute weighted average cost of capital (WACC) of the company based on the existing capital structure.
(ii)​ Compute the new WACC, if the company raises an additional ₹ 20 lakhs debt by issuing 12% debentures.
This would result in increasing the expected equity dividend to ₹ 2.40 and leave the growth rate
unchanged, but the price of equity share will fall to ₹ 16 per share.
Comment on the use of weights in the computation of weighted average cost of capital.

Question 40 - Pyq
The Capital structure of PQR Ltd. is as follows:
Particulars ₹
10% Debenture 3,00,000
12% Preference Shares 2,50,000
Equity Share (face value ₹ 10 per share) 5,00,000
10,50,000
Additional Information:
(i ) ₹ 100 per debenture redeemable at par has 2% floatation cost & 10 years of maturity. The market price per
debenture is ₹ 110.
(ii) ₹ 100 per preference share redeemable at par has 3% floatation cost & 10 years of maturity. The market
price per preference share is ₹ 108.
(iii)Equity share has ₹ 4 floatation cost and market price per share of ₹ 25. The next year expected dividend is
₹ 2 per share with annual growth of 5%. The firm has a practice of paying all earnings in the form of
dividends.
(iv) Corporate Income Tax rate is 30%.
Calculate Weighted Average Cost of Capital (WACC) using market value weights.

Question 41 - Pyq
The capital structure of Shine Ltd. as on 31.03.2024 is as under:
Particulars Amount (₹)
Equity share capital of ₹10 each 45,00,000
15% Preference share capital of ₹100 each 36,00,000
Retained earnings 32,00,000

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 Chapter 2 - Cost of Capital

13% convertible debenture of ₹100 each 67,00,000

11% Term Loan 20,00,000
Total 2,00,00,000
Additional information:
(A)​The company issued 13% Convertible Debentures of ₹100 each on 01.04.2023 with a maturity period of 6
years. At maturity , the debenture holders will have an option to convert the debentures into equity shares
of the company in the ratio of 1:4 ( 4 shares for each debenture). The market price of the equity share is
₹25 each as on 31.03.2024 and the growth rate of the share is 6% per annum.
(B)​Preference stock, redeemable after eight years, is currently selling at ₹150 per share.
(C)​The prevailing default-risk free interest rate on 10-year GOI treasury bonds is 6%. The average market risk
premium is 8% and the Beta (β) of the company is 1.54.
Corporate tax rate is 25% and rate of personal income tax is 20%.
You are required to calculate the cost of:
(i) Equity Share Capital
(ii) Preference Share Capital
(iii) Convertible Debenture
(iv) Retained Earnings
(v) Term Loan

Question 42 - Study Material

Gamma Limited has in issue 5,00,000 ₹ 1 ordinary shares whose current ex-dividend market price is ₹ 1.50 per
share. The company has just paid a dividend of 27 paise per share, and dividends are expected to continue at
this level for some time. If the Company has no debt, what is the Weighted Average Cost of Capital?

Question 43 - Study Material

CALCULATE the WACC using the following data by using:
(a) Book value weights
(b) Market value weights
The capital structure of the company is as under:
Particulars (₹)
Debentures (₹ 100 per debenture) 5,00,000
Preference shares (₹ 100 per share) 5,00,000
Equity shares ( ₹ 10 per share) 10,00,000
20,00,000
The market prices of these securities are:
Debentures : ₹ 105 per debenture
Preference shares : ₹ 110 per preference share
Equity shares : ₹ 24 each.
Additional information:
(1) ₹ 100 per debenture redeemable at par, 10% coupon rate, 4% floatation costs, 10-year maturity.
(2) ₹ 100 per preference share redeemable at par, 5% coupon rate, 2% floatation cost and 10-year maturity.
(3) Equity shares have ₹ 4 floatation cost and market price ₹ 24 per share.
The next year expected dividend is ₹ 1 with annual growth of 5%. The firm has a practice of paying all earnings
in the form of dividend.
Corporate tax rate is 30%. Use the YTM method to calculate cost of debentures and preference shares.

Question 44 - Study Material

(i)​ DETERMINE the cost of capital of Best Luck Limited using the book value (BV) and market value (MV)
weights from the following information:
Sources Book Value Market Value
(₹) (₹)
Equity Shares 1,20,00,000 2,00,00,000
Retained Earnings 30,00,000 ---
Preference Shares 36,00,000 33,75,000
Debentures 9,00,000 10,40,000

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 Chapter 2 - Cost of Capital

(ii)​ Additional information:

I.​ Equity: Equity shares are quoted at ₹ 130 per share and a new issue priced at ₹ 125 per share will be fully
subscribed; flotation costs will be ₹ 5 per share.
II.​ Dividend: During the previous 5 years, dividends have steadily increased from ₹ 10.60 to ₹ 14.19 per share.
Dividend at the end of the current year is expected to be ₹ 15 per share.
III.​ Preference shares: 15% Preference shares with face value of ₹ 100 would realise ₹ 105 per share.
IV.​ Debentures : The company proposes to issue 11-year 15% debentures but the yield on debentures of
similar maturity and risk class is 16% ; flotation cost is 2%.
V.​ Tax : Corporate tax rate is 35%. Ignore dividend tax. Floatation cost would be calculated on face value.

Question 45 - Pyq
ABC Ltd. wishes to raise additional finance of ₹ 20 lakhs for meeting its Investment Plans.
The company has ₹ 4,00,000 in the form of retained earnings available for investment purposes.
The following are the further details:
●​ Debt equity ratio 25: 75.
●​ Cost of debt at the rate of 10 percent (before tax) upto ₹ 2,00,000 and 13% (before tax) beyond that.
●​ Earnings per share, ₹ 12.
●​ Dividend payout 50% of earnings.
●​ Expected growth rate in dividend 10%.
●​ Current market price per share, ₹ 60.
●​ Company’s tax rate is 30% and shareholder’s personal tax rate is 20%.
You are required to:
(i) Calculate the post-tax average cost of additional debt.
(ii) Calculate the cost of retained earnings and cost of equity.
(iii) Calculate the overall weighted average (after tax) cost of additional finance.

Question 46 - Rtp
Jason Limited is planning to raise additional finance of ₹ 20 lakhs for meeting its new project plans.
It has ₹ 4,20,000 in the form of retained earnings available for investment purposes.
Further details are as following:
Debt / Equity Mix 30 / 70
Cost of Debt
Upto ₹ 3,60,000 8 % (before tax)
Beyond ₹ 3,60,000 12 % (before tax)
Earnings per share ₹4
Dividend pay-out 50% of earnings
Current Market Price per share ₹ 44
Expected Growth rate in Dividend 10 %
Tax 40%
You are required:
(a) To determine the cost of retained earnings and cost of equity.
(b) To determine the post-tax average cost of additional debt.
(c) To determine the pattern for raising the additional finance, and
(d) Compute the overall weighted average after tax cost of additional finance.

Debt – Equity Ratio using WACC

Question 47 -
Aries Ltd has a WACC of 18.00%. Its Capital Structure consists of Equity and Debt only. If the PE Ratio is 4,
Interest Rate on Debt Is 15%, Tax Rate is 35%, find out the Company’s Debt-Equity Ratio.

Question 48 -
Step Ltd. has a WACC of 20.00%. Preference Capital (Dividend Rate 18%) constitutes 30% of the Total Capital
Employed. If the PE Ratio is 4, Interest Rate on Debt is 15%, Tax Rate is 35%, find out the ratio between Debt
and Equity Capital in the Company.

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Effect of Debt Funding on Value of Equity Shares – WACC not affected by Gearing
Question 49 - Rtp
Zeta Ltd is presently financed entirely by Equity Shares. The current Market Value is ₹ 6,00,000. A Dividend of ₹
1,20,000 has just been paid. This level of dividend is expected to be paid indefinitely. The Company is thinking
of investing in a new project involving an outlay of ₹ 5,00,000 now and is expected to generate Net Cash
Receipts of ₹ 1,05,000 per annum indefinitely. The project would be financed by issuing ₹ 5,00,000 Debentures
at 18% Interest Rate. Ignoring tax consideration:
(1)​ Calculate the Value of Equity Shares & the gain made by Shareholders, if the Cost of Equity rises to 21.6%.
(2)​ Prove that the Weighted Average Cost of Capital is not affected by gearing.

Marginal WACC
Question 50 - Rtp Pyq
Amrit Corporation has the following book value capital structure:
Equity Capital (50 lakh shares of ₹ 10 each). ₹ 5,00,00000
15% Preference share (50,000 shares ₹ 100 each) ₹ 50,00,000
Retained earnings ₹ 4,00,00,000
Debentures 14% (2,50,000 debentures ₹ 100 each) ₹ 2,50,00,000
Term loan 13% ₹ 4,00,00000
The company's last year earnings per share was ₹ 5, and it maintains a dividend pay-out ratio of 60% and
returns on equity is 10%. The market price per share is ₹ 20.8. Preference share redeemable after 10 years is
currently selling for ₹ 90 per share. Debentures redeemable after 6 years are currently selling for ₹ 75 per
debenture. The income tax rate is 40%.
(1)​ Calculate the Weighted Average Cost of Capital (WACC) using market value proportions.
(2)​ Determine the Marginal Cost of Capital (MACC) if it needs ₹ 5,00,00000 next year assuming the amount
will be raised by 60% equity, 20% debt and 20% retained earnings. Equity issues will fetch a net price of ₹
14 and cost of debt will be 13% before tax up to ₹ 40,00,000 and beyond ₹ 40,00,000 it will be 15% before
tax.

Question 51 -
On January 1, 2005 the total market value of the Octane Company was ₹ 60 million.
During the year, the company plans to raise and invest ₹ 30 million in new projects.
The firm’s present market value capital structure, shown below, is considered to be optimal.Assume that there
is no short term debt.
Debt ₹ 3,00,00,000
Common Equity ₹ 3,00,00,000
Total Capital ₹ 6,00,00,000
New bonds will have an 8% coupon rate, and they will be sold at par. Common stock, currently selling at ₹ 30 a
share, can be sold to net the company ₹ 27 a share. Stockholders' required rate of return is estimated to be
12% consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected
dividend is ₹ 1.20, so ₹ 1.20/30 = 4%). Retained Earnings for the year are estimated to be ₹ 3 million. The
marginal corporate tax is 40%. You are required to:
(a)​ To maintain the present capital structure, how much of the new investment must be financed by common
equity?
(b)​ How much of the needed new common equity funds must be generated internally?
(c)​ Calculate the cost of each common equity component?
(d)​ At what level of capital expenditures will the firm’s WACC increase?
(e)​ Calculate the firm’s WACC using (1) the cost of retained earnings (First breaking point) and (2) the cost of
new equity (second breaking point) (3) WACC of additional funds ₹ 30 million.

Question 52 - Pyq
The R & G Co. has following capital structure at 31st March 2010, which is considered to be optimum
Particulars Amount (₹)
13% Debentures 3,60,000
11% Preference 1,20,000
Equity Share Capital (2,00,000 Shares) 19,20,000
The Company’s Share has a current market price of ₹ 27.75 per share.
The expected Dividend per share in the next year is 50% of the 2010 EPS of the last 10 years is as follows.

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The past trends are expected to continue:

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
EPS (₹) 1 1.12 1.254 1.405 1.574 1.762 1.974 2.211 2.476 2.773
The company can issue 14% New Debenture the company’s debenture is currently selling at Rs 98.
The New Preference Issue can be sold at a net price of ₹ 9.80, paying a dividend of ₹ 1.20 per share.
The Company’s Marginal Tax Rate is 50%. You are required to:
(1)​ Calculate the After Tax Cost – (a) of new Debt and new preference Share Capital, (b) of ordinary Equity,
assuming new Equity comes from Retained Earnings.
(2)​ Calculate the marginal cost of capital.
(3)​ How much can be spent for Capital Investment before new ordinary shares must be sold? Assuming that
retained earnings available for next year’s investment are 50% of 2010 earnings.
(4)​ What will be Marginal Cost of Capital (Cost of fund raised in excess of the amount calculated in Part (3) , if
the company can sell new Ordinary shares to net ₹ 20 per share? Cost of Debt and of Preference Capital is
constant.

Question 53 - Study Material

ABC Ltd. has the following capital structure which is considered to be optimum as on 31st March, 2010.
Particulars Amount (₹)
14% debentures 30,000
11% preference shares 10,000
Equity (10,000 shares) 1,60,000
2,00,000
The company share has a market price of ₹ 23.60. Next year's dividend per share is 50% of 2010 EPS.
The following is the trend of EPS for the preceding 10 years which is expected to continue in future.
Year EPS (₹) Year EPS (₹)
2001 1.00 2006 1.61
2002 1.10 2007 1.77
2003 1.21 2008 1.95
2004 1.33 2009 2.15
2005 1.46 2010 2.36
The company issued new debentures carrying 16% rate of interest and the current market price of debenture is
₹ 96. Preference share ₹ 9.20 (with annual dividend of ₹ 1.1 per share) was also issued. The company is in the
50% tax bracket. You are required to:
(A) Calculate after tax:
(i) Cost of new debt (ii) Cost of new preference shares (iii) New equity share (consuming new equity from
retained earnings)
(B) Calculate marginal cost of capital when no new shares are issued.
(C) How much can be spent for capital investment before new ordinary shares must be sold. Assuming that
retained earnings for next year’s investment are 50 percent of 2010.
(D) What will be the marginal cost of capital when the funds exceed the amount calculated in (C), assuming
new equity is issued at ₹ 20 per share?

Question 54 - Pyq
MR Ltd. has the following capital structure, which is considered to be optimum as on 31.03.2022.
Equity share capital (50,000 shares) ​ ₹ 8,00,000
12% Pref. share capital ₹ 50,000
15% Debentures ​ ₹ 1,50,000
₹ 10,00,000
The earnings per share (EPS) of the company were ₹ 2.50 in 2021 and the expected growth in equity dividend
is 10% per year. The next year's dividend per share (DPS) is 50% of EPS of the year 202I. The current market
price per share (MPS) is ₹ 25.00. The 15% new debentures can be issued by the company. The company's
debentures are currently selling at ₹ 96 per debenture. The new 12% Pref. shares can be sold at a net price of
₹ 91.50 (face value ₹ 100 each). The applicable tax rate is 30%.You are required to Calculate:
(a) After tax cost of
(1)​ New debt, (2) New pref. share capital and
(3)Equity shares assuming that new equity shares come from retained earnings.
(b) Marginal cost of capital,

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How much can be spent for capital investment before sale of new equity shares assuming that retained
earnings for next year investment is 50% of 2021?

Question 55 - Mtp
Ram Ltd evaluates all its capital projects using a discounting rate of 16%.
Its capital structure consists of equity share capital, retained earnings, bank term loan and debentures
redeemable at par. Rate of interest on bank term loan is 1.4 times that of debenture. Remaining tenure of
debenture and bank loan is 4 years and 6 years respectively.
Book value of equity share capital, retained earnings and bank loan is ₹ 20,00,000, ₹ 30,00,000 and ₹ 20,00,000
respectively. Debentures which are having book value of ₹ 30,00,000 are currently trading at ₹ 98 per
debenture. The ongoing PE multiple for the shares of the company stands at 4.
You are required to:
(i) CALCULATE the rate of interest on bank loan and
(ii) CALCULATE the rate of interest on debentures
The tax rate applicable is 30%.

Question 56 - Pyq
The following information pertain to CMC Limited:
Number of Equity Shares 20,00,000
Book Value of 10% Convertible Debentures ₹1,00,00,000
Book Value of 12% Bank Term Loan ₹25,00,000
Market Price of Equity Share ₹55
Market Value of 10% Convertible debenture ₹108
Face Value of Equity Share ₹10
Face Value of 10% Convertible Debenture ₹100
Beta coefficient of Equity shares of CMC Ltd. 1.5
Risk free rate of return 4.5%
Equity risk premium 9%
Rate of taxation 30%
The company expects that the share prices will rise in future at an average rate of 6% per annum.
The 10% convertible debentures of ₹100 each will be converted in six years time into equity shares of the
company in the ratio of 1:4 (4 equity shares for each debenture).
The market value of a 12% bank term loan is at par.
You are required to calculate:
(i) Cost of Equity Share Capital by applying Capital Asset Pricing Model (CAPM) Approach
(ii) Cost of Convertible Debenture by using approximation method,
(iii) Cost of Bank Term Loan
(iv) Weighted Average Cost of Capital using Market Value weights

Equilibrium Price
Question 57 -
A firm has the next expected dividend of ₹ 3 with a growth rate at 8%. The risk free rate, RF is 10% and market
rate of return, Rm is 14%. Presently, the firm has a β, beta factor of 1.50.
However, due to a decision of the finance manager, β is likely to increase to 1.75.
Find out the present as well as the likely value of the share after the decision.
[Present value = ₹ 37.5; Likely value = ₹ 33.33]
Present Situation Likely value
1. Ke = Rf + β(ERm - Rf) 1. Ke = Rf + β(ERm - Rf)
= Ke = 10% + 1.5 (14% - 10%) = Ke = 10% + 1.75 (14% - 10%)
= 10% + 6% = 16% = 10% + 7% = 17%
2. Ke = (D1 / P0) + g 2. Ke = (D1 / P0) + g
16% = (3/P0 x 100) + 8% 17% = (3/P0 x 100) + 8%
8% = 300/P0 = P0 = 37.5 9% = 300/P0 = P0 = 33.33

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 Chapter 2 - Cost of Capital

Question 58 - Rtp
M/s Robert Cement Corporation has a financial structure of 30% debt and 70% equity. The company is
considering various investment proposals costing less than ₹ 30 lakhs. The corporation does not want to
disturb its present capital structure.
The cost of raising the debt and equity are as follows:
Project Cost Cost of Debt Cost of Equity
Upto ₹ 5 lakhs 9% 13%
Above ₹ 5 lakhs & upto ₹ 20 lakhs 10% 14%
Above ₹ 20 lakhs & upto ₹ 40 lakhs 11% 15%
Above ₹ 40 lakhs & upto ₹ 1 crore 12% 15.5%
Assuming the tax rate of 50%, you are required to calculate:
(1)​ Cost of capital of two projects A & B whose funds requirements are ₹ 8 Lakhs and ₹ 21 lakhs respectively;
and
(2)​ If a project is expected to give an after tax return of 11% determine under what conditions it would be
acceptable.

Optimal Debt Equity Mix by Computing Composite Cost of Capital

Question 59 -
For varying levels of Debt-Equity mix, the estimates of the cost of debt (after tax) and equity capital are given
below:
Debt as % of Total Capital Employed Cost of Debt Cost of Equity
0 Nil 15.0
10 7.0 15.0
20 7.0 15.5
30 7.5 16.0
40 8.0 17.0
50 8.5 19.0
60 9.5 20.0
You are required to decide on the optimal debt equity mix for the company by calculating the composite cost
of capital. [Optimum Debt Equity Mix = 40 : 60]

Ke Using WACC – Reverse Working

Question 60 -
Display Ltd has a Debt Equity Ratio of 2 : 1 and a WACC of 12%. Its Debentures bear interest of 15%.
Find out the cost of Equity Capital. (Assume Tax = 35%)

Question 61 - Rtp
Bounce Ltd. evaluates all its capital projects using a discounting rate of 15%. Its capital structure consists of
equity share capital, retained earnings, bank term loan and debentures redeemable at par.
Rate of interest on bank term loan is 1.5 times that of debenture. Remaining tenure of debenture and bank
loan is 3 years and 5 years respectively. Book value of equity share capital, retained earnings and bank loan is
₹ 10,00,000, ₹ 15,00,000 and ₹ 10,00,000 respectively. Debentures which are having book value of ₹ 15,00,000
are currently trading at ₹ 97 per debenture.
The ongoing P/E multiple for the shares of the company stands at 5.
You are required to calculate the rate of interest on bank loans and debentures if tax applicable is 25%.

Question 62 - Study Material

ABC Company’s equity share is quoted in the market at ₹ 25 per share currently. The company pays a dividend
of ₹ 2 per share and the investor’s market expects a growth rate of 6% per year.
You are required to:
(i) CALCULATE the company’s cost of equity capital.
(ii) If the company issues 10% debentures of face value of ₹ 100 each and realises ₹ 96 per debenture while
the debentures are redeemable after 12 years at a premium of 12%, CALCULATE cost of debenture Using
YTM?
Assume Tax Rate to be 50%.

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Question 63 - Rtp
Indel Ltd. has the following capital structure, which is considered to be optimum as on 31st March, 2021:
Particulars (₨)
14% Debentures 60,000
11% Preference shares 20,000
Equity Shares (10,000 shares) 3,20,000
4,00,000

The company share has a market price of ₨ 47.20. Next year's dividend per share is 50% of 2020 EPS.
The following is the uniform trend of EPS for the preceding 10 years which is expected to continue in future.
Year EPS (₨) Year EPS (₨)
2011 2.00 2016 3.22
2012 2.20 2017 3.54
2013 2.42 2018 3.90
2014 2.66 2019 4.29
2015 2.93 2020 4.72
The company issued new debentures carrying 16% rate of interest and the current market price of debenture is
₨ 96.
Preference shares of ₨ 18.50 (with annual dividend of ₨ 2.22 per share) were also issued.
The company is in the 30% tax bracket.
(A) CALCULATE after tax:
(i) Cost of new debt
(ii)Cost of new preference shares
(iii)New equity share (assuming new equity from retained earnings)
(B) CALCULATE marginal cost of capital when no new shares are issued.
(C) DETERMINE the amount that can be spent for capital investment before new ordinary shares must be sold,
assuming that the retained earnings for next year’s investment is 50 percent of earnings of 2020.
(D) COMPUTE marginal cost of capital when the fund exceeds the amount calculated in (C), assuming new
equity is issued at ₨ 40 per share?

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 Chapter 3 - Capital Structure

Chapter 3
Financing Decisions - Capital Structure
Effects of Different Modes of Financing – Maximizing EPS & MPS
Question 1 - Pyq
Earnings before interest and tax of a company are ₹ 4,50,000. Currently the company has 80,000 Equity shares
of ₹ 10 each, retained earnings of ₹ 12,00,000. It pays annual interest of ₹ 1,20,000 on 12% debentures.
The company proposes to take up an expansion scheme for which it needs additional funds of ₹ 6,00,000.
It is anticipated that after that after expansion, the company will be able to achieve the same return on
investment as at present. It can raise funds either through debts at a rate of 12%p.a. or by issuing Equity
shares at par. The tax rate is 40%. You are required to:
Compute the earning per share if:
(i)The additional funds were raised through debts.
(ii)The additional funds were raised by issue of Equity Shares.
Advise whether the company should go for expansion plan and which sources of finance should be preferred.

Question 2 - Study Material, Rtp

Goodluck Charm Ltd., a profit making company, has a paid-up capital of ₹ 100 lakhs consisting of 10 lakhs
ordinary shares of ₹ 10 each. Currently, it is earning an annual pre-tax profit of ₹ 60 lakhs. The company’s
shares are listed and are quoted in the range of ₹ 50 to ₹ 80. The management wants to diversify production
and has approved a project which will cost ₹ 50 lakhs and which is expected to yield a pre-tax income of ₹ 40
lakhs per annum.
To raise this additional capital, the following options are under consideration of the management:
(a)​ To issue equity capital for the entire additional amount. It is expected that the new shares (face value of ₹
10) can be sold at a premium of ₹ 15.
(b)​To issue 16% non-convertible debentures of ₹ 100 each for the entire amount.
(c)​ To issue equity capital for ₹ 25 lakhs (face value of ₹ 10) and 16% non-convertible debentures for the
balance amount. In this case, the company can issue shares at a premium of ₹ 40 each.
You are required to advise the management as to how the additional capital can be raised, keeping in mind
that the management wants to maximise the earnings per share to maintain its goodwill.
The company is paying income tax at 50%.

Question 3 - Pyq
A Company earns a profit of ₹ 3,00,000 per annum after meeting its interest liability of ₹ 1,20,000 on 12%
debentures. The tax rate is 50%. The number of Equity Shares of ₹ 10 each are 80,000 and the retained
earnings amount to ₹ 12,00,000. The company proposes to take up an expansion scheme for which a sum of ₹
4,00,000 is required. It is anticipated that after expansion, the company will be able to achieve the same return
on investment as at present. The funds required for expansion can be raised either through debt at the rate of
12% or by issuing Equity Shares at par.
You are required to:
(i) Compute the Earnings Per Share (EPS), if:
(1)​ The additional funds were raised as debt.
(2)​ The additional funds were raised by issue of equity shares.
(ii) Advise the company as to which source of finance is preferable.

Question 4 - Study Material, Pyq

The Modern Chemicals Ltd. requires ₹ 25,00,000 for a new plant. This plant is expected to yield earnings
before interest and taxes of ₹ 5,00,000. While deciding about the financial plan, the company considers the
objective of maximising earnings per share. It has three alternatives to finance the project-by raising debt of
₹ 2,50,000 or ₹ 10,00,000 or ₹ 15,00,000 and the balance, in each case, by issuing equity shares.
The company’s share is currently selling at ₹ 150, but is expected to decline to ₹ 125 in case the funds are
borrowed in excess of ₹ 10,00,000. The funds can be borrowed at the rate of 10% up to ₹ 2,50,000, at 15% over
₹ 2,50,000 and up to ₹ 10,00,000 and at 20% over ₹ 10,00,000. The tax rate applicable to the company is 50%.
Which form of financing should the company choose?

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Question 5 - Pyq
Delta Ltd. Currently has an Equity Share Capital of ₹ 10,00,000 consisting of 1,00,000 Equity Shares of ₹ 10
each. The company is going through a major expansion plan requiring to raise funds to the tune of ₹ 6,00,000.
To finance the expansion, the management has following plans:
Plan I Issue of 60,000 Equity shares of ₹ 10 each.
Plan II Issue of 40,000 Equity shares of ₹ 10, and the balance through long term borrowing at 12% interest p.a.
Plan III Issue of 30,000 Equity shares of ₹ 10 each and 3,000 ₹ 100 9% Debentures.
Plan IV Issue of 30,000 Equity shares of ₹ 10 each and balance through 6% preference shares.
The Company’s EBIT is expected to be ₹ 4,00,000 p.a. Assume Corporate tax rate of 40%.
You are required to:
(1) Calculate EPS in each of the above plans.
(2) Ascertain the degree of financial leverage in each plan.

Question 6 - Rtp
Prakash Limited provides you the following information:
(₹)
Profit (EBIT) 3,00,000
Less: Interest on Debenture @ 10% (50,000)
EBT 2,50,000
Less Income Tax @ 50% (1,25,000)
1,25,000
No. of Equity Shares (₹ 10 each) 25,000
Earnings per share (EPS) 5
Price /EPS (PE) Ratio 10
The company has reserves and surplus of ₹ 7,50,000 and required ₹ 5,00,000 further for modernisation.
Return on Capital Employed (ROCE) is constant. Debt (Debt/ Debt + Equity) Ratio higher than 40% will bring the
P/E Ratio down to 8 and increase the interest rate on additional debts to 12%.
You are required to ASCERTAIN the probable price of the share.
(i) If the additional capital is raised as debt; and
(ii) If the amount is raised by issuing equity shares at ruling market price

Question 7 - Study Material

The following figures are made available to you:
Net profits for the year 18,00,000
Less: Interest on secured debentures at 15% p.a.
(Debentures were issued 3 months after the commencement of the year) (1,12,500 )
Profit before tax 16,87,500
Less: Income-tax at 35% and dividend distribution tax (8,43,750)
Profit after tax 8,43,750
Number of equity shares (₹ 10 each) 1,00,000
Market quotation of equity share ₹ 109.70
The company has accumulated revenue reserves of ₹ 12 lakhs.
The company is examining a project calling for an investment obligation of ₹ 10 lakhs.
This investment is expected to earn the same rate as funds already employed.
You are informed that a debt equity ratio (Debt divided by debt plus equity) higher than 40% will cause the
price earnings ratio to come down by 25% and the interest rate on additional borrowings will cost the company
300 basis points more than on their current borrowings in secured debentures.
You are required to advise the company on the probable price of the equity share, if
(a)​ The additional investment were to be raised by way of loans; or
(b)​ The additional investments were to be raised by way of equity shares issued at ₹ 100 per share.

Question 8 - Study Material, Rtp

A company provides the following figures:
Particulars Amount (₹)
Profit before interest and tax 52,00,000
Less: Interest on debentures @ 12% (12,00,000)
Profit before tax 40,00,000

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 Chapter 3 - Capital Structure

Less: Income-tax @ 50% (20,00,000)

Profit after tax 20,00,000
Number of equity shares (of ₹ 10 each) 8,00,000
Earning per share (EPS) 2.50
Market price per share 25
P/E (Price/Earning) Ratio 10
The company is planning to start a new project requiring a total capital outlay of ₹40,00,000.
You are informed that a debt equity ratio (D/D+E) higher than 35% pushing the Ke upto 12.5% means reducing
PE ratio to 8 and raising the interest rate on additional amounts borrowed at 14%.
FIND OUT the probable price of share if:
(i)​ The additional funds are raised as a loan.
(ii)​ The amount is raised by issuing equity shares.
(Note : Retained earnings of the company is ₹1.2 crore)

Question 9 - Pyq
The particulars relating to Raj Ltd. for the year ended 31 st March, 2022 are given as follows:
Output (units at normal capacity) 1,00,000
Selling price per unit ₹ 40
Variable cost per unit ₹ 20
Fixed cost ₹ 10,00,000
The capital structure of the company as on 31st March, 2022 is as follows:
Particulars Amount in ₹
Equity share capital (1,00,000 shares of ₹ 10 each) 10,00,000
Reserves and surplus 5,00,000
Current liabilities 5,00,000
Total 20,00,000
Raj Ltd. has decided to undertake an expansion project to use the market potential that will involve ₹ 20 lakhs.
The company expects an increase in output by 50%. Fixed cost will be increased by ₹ 5,00,000 and variable
cost per unit will be decreased by 15%.
The additional output can be sold at the existing selling price without any adverse impact on the market.
The following alternative schemes for financing the proposed expansion program are planned:
(Amount in ₹)
Alternative Debt Equity Shares
1 5,00,000 Balance
2 10,00,000 Balance
3 14,00,000 Balance
Current market price per share is ₹ 200.
Slab wise interest rate for fund borrowed is as follows:
Fund limit Applicable interest rate
Up-to ₹ 5,00,000 10%
Over₹ 5,00,000 and up-to ₹ 10,00,000 15%
Over ₹ 10,00,000 20%
Find out which of the above-mentioned alternatives would you recommend for Raj Ltd. with reference to the
EPS, assuming a corporate tax rate is 40%?

Financial Break-even point & Indifference Point

Question 10 - Mtp
HN Limited is considering a total investment of ₹ 20 lakhs. You are required to CALCULATE the level of
earnings before interest and tax (EBIT) at which the EPS indifference point between the following financing
alternatives will occur:
(i) Equity share capital of ₹ 12,00,000 and 14% debentures of ₹ 8,00,000.
Or
(ii) Equity share capital of ₹ 8,00,000, 16% preference share capital of ₹ 4,00,000 and 14% debentures of ₹
8,00,000.
Assume the corporate tax rate is 30% and par value of equity share is ₹10 in each case.

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 Chapter 3 - Capital Structure

Question 11 - Pyq
Calculate the level of EBIT at which EPS Indifference Point between the following financing alternatives will
occur:
●​ Equity Share capital of ₹ 6,00,000 and 12% Debentures of ₹ 4,00,000 [or]
●​ Equity Share capital of ₹ 4,00,000, 14% Preference Share Capital of ₹ 2,00,000 and 12% Debentures of ₹
4,00,000.
Assume that corporate Tax Rate is 35% and par value of Equity Share is ₹ 10 in each case.

Question 12 - Rtp, Study Material

Ganesha Limited is setting up a project with a capital outlay of ₹ 60,00,000.
It has two alternatives in financing the project cost.
Alternative (a): 100% equity finance in ₹ 200 shares; Alternative (b): Debt-equity ratio 2:1
The rate of interest payable on the debts is 18% p.a. The corporate tax rate is 40%.
Calculate the indifference point between the two alternative methods of financing.

Question 13 - Study Material, Pyq

Alpha Limited requires funds amounting to ₹ 80 lakhs for its new project.
To raise the funds, the company has following two alternatives:
(i) To issue Equity shares (at par) amounting to ₹60 lakhs and borrow the balance amount at the interest of
12% p.a., or
(ii) To issue Equity shares (at par) and 12% Debentures in equal proportion.
The income tax rate is 30%. Find out the point of indifference between the available two modes of financing
and state which option will be beneficial in different situations.

Question 14 - Pyq
A new project is under consideration in ZIP Ltd, which requires a Capital Investment of ₹ 4.50 crores. Interest
on Term Loan is 12% and Corporate Tax Rate is 50%. If the Debt Equity Ratio insisted by the financing agencies
is 2:1 OR if it's all equity financed. Calculate the point of indifference for the project.

Question 15 - Study Material, Pyq, Mtp, Rtp

The management of Z Ltd wants to raise its funds from the market to meet out the financial demands of its
long term projects. The Company has various combinations of proposals to raise its funds.
You are given the following proposals of the company:
Proposals % of Equity % of Debt % of Preference Shares
P 100 - -
Q 50 50 -
R 50 - 50
●​ Cost of Debt – 10%, Cost of Preference shares – 10%.
●​ Tax Rate – 50%.
●​ Equity Shares of the face value of ₹ 10 each will be issued at a premium of ₹ 10 per share.
●​ Total Investment to be raised ₹ 40,00,000.
●​ Expected Earnings Before Interest and Tax ₹ 18,00,000.
From the above proposals the management wants to take advice from you for appropriate plans after
computing the following – (1) Earnings Per Share, (2) Financial Break Even Point, and (3) Compute the EBIT
Range among the plans for indifference. Also indicate if any of the plans dominate.

Question 16 - Pyq, Mtp

A company needs ₹ 31,25,000 for the construction of a new plant. The following three plans are feasible:
Plan I: The company May issue 3,12,500 Equity Shares at ₹ 10 per share
Plan II: The company May issue 1,56,250 ordinary Equity shares at ₹ 10 per share and 15,625 Debentures of ₹
100 denomination bearing a 8% rate of interest.
Plan III: The company May issue 1,56,250 Equity shares at ₹ 10 per share and 15,625 Preference shares at ₹
100 per share bearing a 8% rate of dividend.
(1)​ If the company’s EBIT are ₹ 62,500, ₹ 1,25,000, ₹ 2,50,000, ₹ 3,75,000 and ₹ 6,25,000, what are the Earnings
Per share under each of three financial plans? Assume a corporate Income-tax rate of 40%.
(2)​ Which alternative would you recommend and why?
(3)​ Determine the EBIT – EPS Indifference Points by formulae between Financing Plan I & Plan II and Plan I &
Plan III.

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 Chapter 3 - Capital Structure

Question 17 -
A Company has the choice of raising an additional sum of ₹ 25,00,000 either (i) by issue of 8% debentures, or
(ii) issue of additional equity shares @ ₹ 10 per share. Presently, the capital structure of the firm does not
consist of any debt and the company has issued 5,00,000 equity shares only.
(1)​ At what level of EBIT, after the new capital funds are acquired, would the EPS be the same under different
alternative financing plans.
(2)​ Also determine the level of EBIT at which uncommitted earnings per share (UEPS) would be the same, if
the sinking fund obligations amounting to ₹ 2,50,000 in respect of debenture issue is to be made every
year. Tax rate may be assumed at 50% and also verify the result.

Question 18 - Study Material

Toyo Limited presently has ₹ 36,00,000 in debt outstanding bearing an interest rate of 10 per cent.
It wishes to finance a ₹ 40,00,000 expansion programme and is considering three alternatives: additional debt
at 12 percent interest, preferred stock with an 11 per cent dividend, and the sale of common stock at ₹ 16 per
share. The company presently has 8,00,000 shares of common stock outstanding and is in a 40 percent tax
bracket.
(a)​ If earnings before interest and taxes are presently ₹ 15,00,000, what would be earnings per share for the
three alternatives, assuming no immediate increase in profitability?
(b)​ Develop an indifference chart for these alternatives. What are the approximate indifference points? To
check one of these points, what is the indifference point mathematically between debt and common
stock?
(c)​ Which alternative do you prefer? How much would EBIT need to increase before the next alternative would
be best?

Net Income Approach

Question 19 - Study Material
Rupa Company’s EBIT is ₹ 5,00,000. The company has 10%, 20 lakhs debentures. The equity capitalization rate
i.e. Ke is 16%.
You are required to calculate:
(i) Market value of equity and value of firm;
(ii) Overall cost of capital.

Question 20 -
Bajaj Ltd. has earnings before interest and taxes (EBIT) of ₹ 20 million.
The company currently has outstanding debt of ₹ 40 million at a cost of 8%.
(a) Using the net income (NI) approach and a cost of equity of 17.5%;
(1) Compute the total value of the firm and firm’s overall weighted average cost of capital (Ko) and
(2) Determine the firm’s market debt/equity ratio.
(b) Assume that the firm issues an additional ₹ 20 million in debt and uses the proceeds to retire stock; the
interest rate and the cost of equity remain the same.
(1) Compute the new total value of firm and the firm’s overall cost of capital and
(2) Determine the firm’s market debt/equity ratio.

Question 21 -
AD Ltd. pays 100% of its earnings to its shareholders as dividends. Its funds requirement is met entirely by
1,00,000 shares of common stock selling at ₹ 50 per share. Its EBIT would be ₹ 4,00,000.
(1) Compute value of Firm, cost of equity and overall cost of capital using NI approach.
(2) The Company has decided to redeem ₹ 1 million of common stock, replacing it with 6% long term debt.
Compute overall cost of capital and value of the firm after refinancing.

Net Operating Income Approach

Question 22 - Study Material
Amita Ltd’s operating income is ₹ 5,00,000. The firm's debt is 10% and currently the firm employs ₹ 15,00,000
of debt. The overall cost of capital of the firm is 15%.
You are required to determine:
(i) Total value of the firm;
(ii) Cost of equity.

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 Chapter 3 - Capital Structure

Question 23 - Pyq
Z Ltd’s Operating Income (before Interest and Tax) is ₹ 9,00,000. The Firm’s Cost of Debt is 10% and currently
the Firm employs ₹ 30,00,000 of Debt. The Overall Cost of Capital of the Firm is 12%.
Calculate the Cost of Equity.

Question 24 -
Financial Ltd. has EBIT ₹ 20 million. The company currently has outstanding debt of ₹ 40 million at cost of 8%
(a) Using the net operating income approach and an overall cost of capital of 12%;
(1) compute the value of stock market value of firm, and the cost of equity and
(2) determine the firm’s market debt/equity ratio.
(b) Determine the answer to (a) if the company were to sell the additional ₹ 20 million in debt.

Traditional Approach of Capital Structure

Question 25 - Pyq
Equity shares are issued by Nature Ltd. with an equity capitalization rate of 16% to fulfill its whole fund
requirement of ₹ 20,00,000.
The company is planning to redeem a part of capital by raising debt.
It has two alternatives to do so:
Alternative 1 : Raise debt to the limit of 30% of total funds. The rate of interest will be 10% and Ke will rise to
17%.
Alternative 2 : Raise debt to the limit of 50% of total funds. The rate of interest will be 12% and Ke will be 20%.
The operating profit (EBIT) would be ₹ 3,00,000.
Using Traditional approach, Compute:
(1) Value of company; (2) Overall cost of capital.

MM Approach & Arbitrage Process

Question 26 - Mtp
Kee Ltd. and Lee Ltd. are identical in every respect except for capital structure. Kee Ltd. does not employ debt
in its capital structure, whereas Lee Ltd. employs 12% debentures amounting to ₹ 20 lakhs.
Assuming that:
(i)All assumptions of MM model are met;
(ii)The income tax rate is 30%;
(iii)EBIT is ₹ 5,00,000 and
(iv)The equity capitalization rate of Kee Ltd. is 25%. CALCULATE the average value of both the Companies.

Question 27 - Study Material

Alpha Limited and Beta Limited are identical except for capital structures.
Alpha Ltd. has 50 per cent debt and 50 per cent equity, whereas Beta Ltd. has 20 per cent debt and 80 per cent
equity. (All percentages are in market-value terms).
The borrowing rate for both companies is 8 percent in a no-tax world, and capital markets are assumed to be
perfect.
(a) (i) If you own 2 percent of the shares of Alpha Ltd., DETERMINE your return if the company has net
operating income of ₹3,60,000 and the overall capitalisation rate of the company, K0 is 18 per cent?
(ii) Calculate the implied required rate of return on equity?
(b) Beta Ltd. has the same net operating income as Alpha Ltd.
(i) DETERMINE the implied required equity return of Beta Ltd.?
(ii) ANALYSIS: Why does it differ from that of Alpha Ltd.?

Question 28 - Mtp
Capital structure (in market-value terms) of AN Ltd is given below:
Company Debt Equity
AN Ltd. 50% 50%
The borrowing rate for the company is 10% in a no-tax world and capital markets are assumed to be perfect.
(i) If Mr. R, owns 8% of the equity shares of AN Ltd., DETERMINE his return if the Company has net operating
income of ₹ 10,00,000 and the overall capitalization rate of the company (Ko) is 20%.
(ii) CALCULATE the implied required rate of return on equity of AN Ltd.

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 Chapter 3 - Capital Structure

Question 29 - Pyq
The following are the costs and values for the firms A and B according to the traditional approach.
Firm A Firm B
Total value of firm, V (in ₹) 50,000 60,000
Market value of debt, D (in ₹) 0 30,000
Market value of equity, E (in ₹) 50,000 30,000
Expected net operating income (in ₹) 5,000 5,000
Cost of debt (in ₹) 0 1,800
Net Income (in ₹) 5,000 3,200
Cost of equity, Ke = NI/V 10.00% 10.70%
(1)​ Compute the Equilibrium value for Firm A and B in accordance with the M-M approach.
Assume that (a) taxes do not exist and (b) the equilibrium value of Ko is 9.09%.
(2)​ Compute Value of Equity and Cost of Equity for both the firms.

Question 30 - Study Material

One-third of the total market value of Sanghmani Limited consists of loan stock, which has a cost of 10 per
cent. Another company, Samsui Limited, is identical in every respect to Sanghmani Limited, except that its
capital structure is all-equity, and its cost of equity is 16 per cent. According to Modigliani and Miller, if we
ignore taxation and tax relief on debt capital, COMPUTE the cost of equity of Sanghmani Limited?

Question 31 - Rtp
The following data relates to two companies belonging to the same risk class:
Particulars Bee Ltd. Cee Ltd.
12% Debt ₹ 27,00,000 - 18
Equity Capitalization Rate -
Expected Net Operating Income ₹ 9,00,000 ₹ 9,00,000
(1)​ Determine the total market value, Equity capitalization rate and weighted average cost of capital for each
company assuming no taxes as per M.M. Approach.
(2)​ Determine the total market value, Equity capitalization rate and weighted average cost of capital for each
company assuming 40% taxes as per M.M. Approach.

Question 32 - Pyq
The details about two companies R Ltd. and S Ltd. having same operating risk are given below :
Particulars R Ltd S Ltd
Profit before interest & tax ₹ 10 lakhs ₹ 10 lakhs
Equity share capital @ 10 each ₹ 17 lakhs ₹ 50 lakhs
Long term borrowings @10 % ₹ 33 lakhs -
Cost of Equity (Ke) 18% 15%
(1) Calculate the value of equity of both the companies on the basis of M.M. Approach without tax.
(2) Calculate the Total value of both the companies on the basis of M.M. Approach without tax.

Question 33 - Rtp ,Pyq

Companies Uma and Lata are identical in every respect except that the former does not use Debt in its capital
structure, while the latter employs ₹ 6 lakhs of 15% Debt. Assume that:
(a) All the M & M assumption are met,
(b) the corporate tax rate is 35%,
(c) the EBIT is ₹ 2,00,000 and
(d) the equity capitalization of the Unlevered Company is 20%.
(1)​ What will be the value of the Firms – Uma and Lata?
(2)​ Determine the weighted Average Cost of Capital for both the firms.

Question 34 - Rtp , Pyq

RES Ltd. is an all equity financed company with a market value of 25,00,000 and cost of equity Ke = 21%. The
company wants to buy back equity shares worth 5,00,000 by issuing and raising 15% perpetual debt of the
same amount. Rate of tax May be taken as 30%. After the capital restructuring and applying MM Model (with
taxed), you are required to calculate:
(i)​ Market value of RES Ltd. (ii) Cost of Equity Ke (iii)Weighted average cost of capital and comment on it.

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Question 35 - Study Material

Zion Company has earnings before interest and taxes of ₹ 30,00,000 and a 40 per cent tax rate.
Its required rate of return on equity in the absence of borrowing is 18 per cent.
(a) In the absence of personal taxes, what is the value of the company in an MM world
(i) With no leverage? (ii) With ₹ 40,00,000 in debt? (iii) With ₹ 70,00,000 in debt?
(b) Personal as well as corporate taxes now exist. The marginal personal tax rate on common stock income is
25 percent, and the marginal personal tax rate on debt income is 30 percent. Determine the value of the
company for each of the three debt alternatives in part (a). Why do your answers differ?

Question 36 - Study Material

Following data is available in respect of two companies having same business risk:
Capital employed = ₹2,00,000 ,EBIT = ₹30,000 Ke = 12.5%
Sources Levered company (₹) Unlevered company (₹)
Debt (@ 10%) 1,00,000 Nil
Equity 1,00,000 2,00,000
The investor is holding 15% shares in the levered company. CALCULATE increase in annual earnings of
investors if he switches his holding from Levered to Unlevered company.

Question 37 - Study Material

Following data is available in respect of two companies having same business risk:
Capital employed = ₹2,00,000 ,EBIT = ₹30,000
Sources Levered company (₹) Unlevered company (₹)
Debt (@ 10%) 1,00,000 Nil
Equity 1,00,000 2,00,000
Ke 20% 12.5%
The investor holds 15% shares in Unlevered company. CALCULATE increase in annual earnings of investors if
he switches his holding from Unlevered to Levered Company.

Question 38 - Pyq
Following data is available in respect of Levered and Unlevered companies having same business risk:
Capital employed = ₹2,00,000, EBIT = ₹25,000 and Ke = 12.5%
Sources Levered Company (₹) Unlevered Company (₹)
Debt (@ 8%) 75,000 Nil
Equity 1,25,000 2,00,000
An investor is holding 12% shares in levered company.Calculate the increase in annual earnings of investor if
he switches over his holding from Levered to Unlevered Company.

Question 39 - Rtp
Following data is available in respect of two companies having same business risk:
Capital employed = ₹ 3,00,000, EBIT = ₹ 45,000 and Ke = 12.5%
Sources A Ltd B Ltd
Levered Company (₹) Unlevered Company (₹)
Debt (@10%) 1,50,000 Nil
Equity 1,50,000
An investor is holding 20% shares in a levered company. CALCULATE the increase in annual earnings of the
investor if he switches his holding from Levered to Unlevered company.

Miscellaneous Practical Problems

Question 40 - Rtp
ABC Ltd adopts Constant-WACC Approach, and believes that its cost of debt and overall cost of capital is at
9% and 12% respectively. If the ratio of the market value Debt to market value of Equity is 0.8, what Rate of
Return do equity shareholders earn? Assume that there are no taxes.

Question 41 - Rtp
Zordon Ltd. has net operating income of ₨ 5,00,000 and total capitalization of ₨ 50,00,000 during the current
year. The company is contemplating to introduce debt financing in capital structure and has various options
for the same.

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 Chapter 3 - Capital Structure

The following information is available at different levels of debt value:

Debt value (₨) Interest rate (%) Equity capitalization rate (%)
0 - 10.00
5,00,000 6.0 10.50
10,00,000 6.0 11.00
15,00,000 6.2 11.30
20,00,000 7.0 12.40
25,00,000 7.5 13.50
30,00,000 8.0 16.00
Assuming no tax and that the firm always maintains books at book values, you are REQUIRED to calculate:
(a) Amount of debt to be employed by a firm as per traditional approach.
(b) Equity capitalization rate, if MM approach is followed.

Margin of safety
Question 42 - Mtp
The financial advisor of Sun Ltd is confronted with following two alternative financing plans for raising
₹ 10 lakhs that is needed for plant expansion and modernization
Alternative I: Issue 80% of funds with 14% Debenture [Face value (FV) ₹ 100] at par and redeem at a
premium of 10% after 10 years and balance by issuing equity shares at 33.33 % premium.
Alternative II: Raise 10% of funds required by issuing 8% Irredeemable Debentures [Face value (FV)
₹ 100] at par and the remaining by issuing equity shares at current market price of ₹125.
Currently, the firm has an Earnings per share (EPS) of ₹ 21
The modernization and expansion programme is expected to increase the firm’s Earnings before Interest and
Taxation (EBIT) by ₹ 200,000 annually.
The firm’s condensed Balance Sheet for the current year is given below:
Balance Sheet as on 31.3.2022
Liabilities Amount (₹) Assets Amount (₹)
Current Liabilities 5,00,000 Current Assets 16,00,000
10% Long Term Loan 15,00,000 Plant & Equipment (Net) 34,00,000
Reserves & Surplus 10,00,000
Equity Share Capital (FV: ₹ 100 each) 20,00,000
TOTAL 50,00,000 TOTAL 50,00,000
●​ However, the finance advisor is concerned about the effect that issuing of debt might have on the firm. The
average debt ratio for firms in industry is 35%.He believes if this ratio is exceeded, the P/E ratio of the
company will be 7 because of the potentially greater risk.
●​ If the firm increases its equity capital by more than 10 %, he expects the P/E ratio of the company will
increase to 8.5 irrespective of the debt ratio.
●​ Assume Tax Rate of 25%. Assume target dividend pay-out under each alternative to be 60% for the next
year and growth rate to be 10% for the purpose of calculating Cost of Equity
SUGGEST with reason which alternative is better on the basis of each of the below given criteria:
(1)​ Earnings per share (EPS) & Market Price per share (MPS)
(2)​ Financial Leverage
(3)​ Weighted Average Cost of Capital & Marginal Cost of Capital (using Book Value weights)

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 Chapter 4 - Leverages

Chapter 4
Financing Decision - Leverages
Question 1 - Pyq
Calculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage
for the following firms:
Particulars N S D
Production (in units) 17,500 6,700 31,800
Fixed cost (₹) 4,00,000 3,50,000 2,50,000
Interest on loan (₹) 1,25,000 75,000 Nil
Selling price per unit (₹) 85 130 37
Variable cost per unit (₹) 38.00 42.50 12.00

Question 2 - Mtp
The following information is related to Navya Company Ltd. for the year ended 31st March 2022:
Equity share capital (₹ 10 each) ₹ 65,50,000
12% Bonds of ₹ 1,00 each ₹ 60,91,400
Sales ₹ 111 lakhs
Fixed cost (excluding interest) ₹ 7,15,000
Financial leverage 1.55
Profit-volume Ratio 25%
Income Tax Applicable 30%
You are required to Calculate and show calculations upto two decimal points.
(1)​ Operating Leverage.
(2)​ Combined leverage; and
(3)​ Earnings per share.

Question 3 - Pyq
The following information is available for SS Ltd.
Profit volume (PV) ratio 30%
Operating leverage 2.00
Financial leverage 1.50
Loan ₹ 1,25,000
Post-tax interest rate 5.6%
Tax rate 30%
Market Price per share (MPS) ₹ 140
Price Earnings Ratio (PER) 10
You are required to:
(1)​ Prepare the Profit-Loss statement of SS Ltd. and
(2)​ Find out the number of equity shares.

Question 4 - Pyq
Find Ltd. has estimated that for a new product, its operating break-even point is 2,000 units, if the item is sold
for ₹ 14 per unit. The cost accounting department has currently identified a variable cost of ₹ 9 per unit.
Calculate the operating leverage for sales volume of 2,500 units and 3,000 units and their difference, if any?

Question 5 - Pyq
Following is the Balance Sheet of EXIM Ltd. as on 31st March, 2024:
Liablities ₹ Assets ₹
Equity Share Capital of ₹100 each 20,00,000 Fixed Assets 50,00,000
Retained Earnings 4,00,000 Current Assets 30,00,000
12.5 % Debenture 40,00,000
Current Liabilities 16,00,000
80,00,000 80,00,000

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 Chapter 4 - Leverages

The additional information is given as under:

Fixed costs per annum (exclusive interest) : ₹16,00,000
Variable operating cost ratio : 70%
Total Assets turnover ratio : 2.5
Income tax rate : 30%
You are required to calculate:
(i) Earnings per Share (ii) Operating Leverage (iii) Financial Leverage (iv) Combined Leverage

Question 6 - Study Material, Pyq

The following information is available in respect of two firms, P Ltd. and Q Ltd.: (In ₹ Lacs)
Particulars P Ltd. Q Ltd.
Sales 500 1,000
Less: Variable Cost 200 300
Contribution 300 700
Less: Fixed Cost 150 400
EBIT 150 300
Less: Interest 50 100
Profit before tax 100 200
You are required to calculate different leverages for both the firms and also comment on their relative risk
position.

Question 7 - Study Material, Pyq

The capital structure of ABC Ltd. consists of an ordinary share capital of ₹ 5,00,000 (equity shares of ₹ 100
each at par value) and ₹ 5,00,000 (10% debenture of ₹ 100 each). Sales increased from 50,000 units to 60,000
units, the selling price is ₹ 12 per unit, variable cost amounts to ₹ 8 per unit and fixed expenses amount to ₹
1,00,000. The income tax rate is assumed to be 50%.
You are required to calculate the following:
(a) The percentage increase in earnings per share;
(b) The degree of financial leverage at 50,000 units and 60,000 units;
(c) The degree of operating leverage at 50,000 units and 60,000 units;
(d) Comment on the behaviour E.P.S., operating and financial leverage in relation to increases in sales from
50,000 units to 60,000 units.

Question 8 - Study Material, Pyq

From the following, prepare the Income statement of Company A, B and C.
Company A B C
Financial Leverage 3:1 4:1 2:1
Interest ₹ 200 ₹ 300 ₹ 1,000
Operating Leverage 4:1 5:1 3:1
Variable cost as a percentage to 2
sales 66 3 % 75% 50%
Income tax rate 45% 45% 45%

Question 9 - Pyq
From the following data of Company A and Company B, Prepare their Income Statement
Particulars Company A Company B
Variable cost ₹ 56,000 60% of sales
Fixed Cost ₹ 20,000 -
Interest Expense ₹ 12,000 ₹ 9,000
Financial Leverage 05:01 -
Operating Leverage - 04:01
Income tax rate 30% 30%
Sales - ₹ 1,05,000

Question 10 - Pyq
Z Limited is considering the installation of a new project costing ₹ 80,00,000. Expected annual sales revenue
from the project is ₹ 90,00,000 and its variable costs are 60 percent of sales. Expected annual fixed cost other

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 Chapter 4 - Leverages

than interest is ₹ 10,00,000. Corporate tax rate is 30 percent. The company wants to arrange the funds through
issuing 4,00,000 equity shares of ₹ 10 each and 12 percent debentures of ₹ 40,00,000.
You are required to:
(i) Calculate the operating, financial and combined leverages and Earnings per Share (EPS).
(ii) Determine the likely level of EBIT, if EPS is (1) ₹ 4, (2) ₹ 2, (3) ₹ 0.

Question 11 -
Ram Ltd. produces Mobile phones with a selling price per unit of ₹ 100. Fixed cost amounted to ₹ 2,00,000.
5,000 units are produced and sold each year. Annual profits amount to ₹ 50,000. The company’s all
equity-financed assets are ₹ 5,00,000.
The company proposes to change its production process, adding ₹ 4,00,000 to investment and ₹ 50,000 to
fixed operational costs. The consequences of such a proposal are:
(i)​ Reduction in variable cost per unit by ₹ 10
(ii)​ Increase in output by 2,000 units
(iii)​ Reduction in selling price per unit to ₹ 95
Assuming a rate of interest on debt is 10%, examine the above proposal and advise whether or not the
company should make the change. Ignore taxation. Also measure the degree of operating leverage and overall
break-even-point.

Question 12 - Pyq
A company had the following Balance Sheet as on March 31, 2006:
Liabilities and Equity ₹ (In Crores) Assets ₹ (In Crores)
Equity Share Capital (1 10 Fixed Assets (Net) 25
crore shares of ₹ 10 each)
Reserves and Surplus 2 Current Assets 15
15% Debentures 20
Current Liabilities 8
40 40
The additional information given is as under:
Fixed Costs per annum (excluding interest) ₹ 8 crores
Variable operating costs ratio 65%
Total Assets turNover ratio 2.5
Income-tax rate 40%
Calculate the following and comment:
(i) Earnings per share (iii) Financial Leverage (v) Current Ratio
(ii) Operating Leverage (iv) Combined Leverage

Question 13 - Study Material, Rtp

(i)​ You are required to calculate the Operating leverage from the following data:
Sales ₹ 50,000
Variable Costs 60%
Fixed Costs ₹ 12,000
(ii)​ You are required to calculate the Financial Leverage from the following data:
Net Worth ₹ 25,00,000
Debt /Equity 3:1
Interest rate 12%
Operating Profit ₹ 20,00,000

Question 14 - Study Material, Pyq

A firm has sales of ₹ 75,00,000, variable cost of ₹ 42,00,000 and fixed cost of ₹ 6,00,000.
It has a debt of ₹ 45,00,000 at 9% and equity of ₹ 55,00,000.
(i) What is the firm’s ROI?
(ii) Does it have favourable financial leverage?
(iii) If the firm belongs to an industry whose asset turnover is 3, does it have a high or low assets leverage?
(iv) What are the operating, financial and combined leverages of the firm?
(v) If the sales drop to ₹ 50,00,000 what will be the new EBIT?
(vi) At what level the EBT of the firm will be equal to zero?

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 Chapter 4 - Leverages

Question 15 - Study Material, Pyq

You are given two financial plans of a company which has two financial situations.
The detailed information is as under:
Installed Capacity 10,000 units
Actual Production and Sales 60% of installed capacity
Selling Price per unit ₹ 30
Variable cost per unit ₹ 20
Fixed cost Situation A = ₹ 20,000 Situation B = ₹ 25,000

Capital Structure of the company is as follows:

Financial Plans
XY (₹) XM (₹)
Equity 12,000 35,000
Debt (Cost of Debt 12%) 40,000 10,000
52,000 45,000
You are required to calculate operating Leverage and Financial Leverage of both the plans.

Question 16 -
ABC Ltd. has its assets turnover ratio equal to 2. Its variable cost ratio is 60% of sales.
Consider the following three different capital structures and calculate the operating and financial leverages for
the three different fixed costs:-
(a) ₹ 4,000.
(b) ₹ 6,000.
(c) ₹ 8,000.
Capital Structure (In ₹)
Particulars A B C
Equity 60,000 40,000 20,000
10% Debt 20,000 40,000 60,000
Which combination has the highest & lowest DCL?

Percentage change concept with Leverages

Question 17 - Study Material
A Company produces and sells 10,000 shirts.
The selling price per shirt is ₹ 500.
Variable cost is ₹ 200 per shirt and
Fixed operating cost is ₹ 25,00,000.
(a)​ Calculate operating leverage.
(b)​ If sales are up by 10%, then what is the impact on EBIT?

Question 18 - Pyq
Consider the following information for Omega Ltd.:
Particulars ₹ (In lakhs)
EBIT (Earnings before Interest and Tax) 15,750
Earnings before Tax (EBT) 7,000
Fixed Operating costs 1,575
Calculate percentage change in earnings per share, if sales increases by 5%.

Question 19 - Study Material

XYZ Ltd. sells 2,000 units @ ₹ 10 per unit. The variable cost of production is ₹ 7 and fixed cost is ₹ 1,000.
The company raised the required funds by issue of 100, 10% debentures @ ₹ 100 each and 2,000 equity shares
@ ₹ 10 per share.
The sales of XYZ Ltd. are expected to increase by 20%.
Assume the tax rate of the company is 50%.
You are required to calculate the impact of increase in sales on earnings per share.

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 Chapter 4 - Leverages

Question 20 - Study Material

The following information is available for a concern for the year ended 31.3.2011.
Total Sales (Quantity) 100,000 units
Fixed Cost ₹ 12,60,000
Variable Cost 55% of sales
Debt (@ 10%) ₹ 54,00,000
Equity (Face value of each share of ₹ 10) ₹ 50,00,000
Income tax rate 35%
Selling price per unit ₹ 80
You are required to find out –
(1)​ Income Statement for the year ended 31.3.2011.
(2)​ Operating and Financial Leverage
(3)​ Company’s Return on Investment
(4)​ How much of the Company’s sales have to come down so that earning of the company before tax comes
down to zero?

Question 21 - Study Material

PL Forgings Ltd. has the following balance sheet and income statement information:
Balance Sheet as on March 31st
Liabilities ₹ Assets ₹
Equity Capital (₹ 10 per share) 8,00,000 Net Fixed Assets 10,00,000
10% Debt 6,00,000 Current Assets 9,00,000
Retained Earnings 3,50,000
Current Liabilities 1,50,000
19,00,000 19,00,000

Income Statement for the year ending March 31

Particulars ₹
Sales 3,40,000
Operating expenses (including ₹ 60,000 depreciation) (1,20,000)
EBIT 2,20,000
Less: Interest (60,000)
Earnings before tax 1,60,000
Less: Taxes (56,000)
Net Earnings (EAT) 1,04,000
(a)​ Determine the degree of operating, financial and combined leverages at the current sales level, if all
operating expenses, other than depreciation, are variable costs.
(b)​ If total assets remain at the same level, but sales
(i) increase by 20 percent and (ii) decrease by 20 per cent, what will be the earnings per share at the new
sales level?

Question 22 - Pyq
Alpha Limited has provided following information:
Equity Share Capital 25,000 Shares @ ₹100 per share
15% Debentures 10,000 Debentures @ ₹750/- per Debenture
Sales 50 Lakhs units @ ₹20 per unit
Variable Cost ₹12.50 per unit
Fixed Costs ₹175.00 Lakhs
Due to recent policy changes and entry of foreign competitors in the sector, Alpha Limited expects the sales
may decline by 15-20%.
However, selling price and other costs will remain the same. Corporate Taxes will continue @ 20%.
You are required to calculate the decrease in Earnings per share, Degree of Operating Leverage and Financial
Leverage separately if sales are declined by (i) 15% ; and (ii) 20%.

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 Chapter 4 - Leverages

Question 23 - Pyq
Details of a company for the year ended 31st March, 2022 are given below:
Sales ₹ 86 lakhs
Profit Volume (P/V) Ratio 35%
Fixed Cost excluding interest expenses ₹ 10 lakhs
10% Debt ₹ 55 lakhs
Equity Share Capital of ₹ 10 each ₹ 75 lakhs
Income Tax Rate 40%
You are required to:
(1)​ Determine company's Return on Capital Employed (Pre-tax) and EPS.
(2)​ Does the company have a favourable financial leverage?
(3)​ Calculate operating and combined leverages of the company.
(4)​ Calculate percentage change in EBIT, if sales increases by 10%.
(5)​ At what level of sales, the Earning before Tax (EBT) of the company will be equal to zero?

Question 24 -
Show the effect of Trading on equity on ROE of an entity from the following information:-
Particulars (₹ in 000's)
Total Assets 2000
Debt Equity Ratio
Case I 0:1
Case II 1:4
Case III 2:3
Tax rate – 35%, Rate of Interest – 15%, Return on Investment – 30%.

Question 25 - Rtp
Following information has been extracted from the accounts of newly incorporated Textyl Pvt. Ltd. for the
Financial Year 2020-21:
Sales : ₨ 15,00,000
P/V ratio : 70%
Operating Leverage : 1.4 times
Financial Leverage : 1.25 times
Using the concept of leverage, find out and verify in each case:
(i) The percentage change in taxable income if sales increase by 15%.
(ii)The percentage change in EBIT if sales decrease by 10%.
(iii)The percentage change in taxable income if EBIT increases by 15%.

Question 26 - Study Material

The Sale revenue of TM excellence Ltd. @ ₹20 Per unit of output is ₹20 lakhs and Contribution is ₹10 lakhs. At
the present level of output the DOL of the company is 2.5. The company does not have any Preference Shares.
The number of Equity Shares is 1 lakh. Applicable corporate Income Tax rate is 50% and the rate of interest on
Debt Capital is 16% p.a. What is the EPS (At sales revenue of ₹ 20 lakhs) and amount of Debt Capital of the
company if a 25% decline in Sales will wipe out EPS.

Computation of Operating Leverage and Beta Analysis

Question 27 - Pyq
The following summarises the percentage changes in operating income, percentage changes in revenues, and
betas for four pharmaceutical firms.
Firm Change in Revenue Change in Operating Income Beta
PQR Ltd. 27% 25% 1.00
RST Ltd. 25% 32% 1.15
TUV Ltd. 23% 36% 1.30
WXY Ltd. 21% 40% 1.40
You are required to:
(i)​ Calculate the degree of operating leverage for each of these firms. Comment also.
(ii)​ Use the operating leverage to explain why these firms have different beta.

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 Chapter 4 - Leverages

Question 28 -
The following summarises the percentage change in E.P.S. percentage change in revenues & betas for four
companies in mobile business
Name of Companies Change in Revenues Change in EPS Beta
Nokia 10% 50% 1.40
Motorola 20% 80% 1.27
Samsung 25% 75% 1.18
Blackberry 30% 75% 1.10
(a)​ Calculate the Degree of Combined Leverage for each of these companies.
(b)​ If the Degree of operating leverage of these four companies is 2.5, 2, 2.25 & 1.2 respectively for Nokia,
Motorola, Samsung and Blackberry. Compute Degree of Financial Leverage.
(c)​ Explain why these companies have different betas.

Question 29 - Pyq
You are given the following information of 5 firms of the same industry:
Name of the firm Change in revenue Change in operating income Change in Earning per share
M 28% 26% 32%
N 27% 34% 26%
P 25% 38% 23%
Q 23% 43% 27%
R 25% 40% 28%
You are required to calculate:
(i)​ Degree of operating leverage and
(ii)​ Degree of combined leverage for all firms.

Reverse Working with All Leverages

Question 30 - Pyq
The following details of RST Limited for the year ended 31st March, 2006 are given below:
Operating leverage 1.4 times
Combined leverage 2.8 times
Fixed cost (Excluding interest) ₹ 2.04 lakhs
Sales ₹ 30.00 lakhs
12% Debentures of ₹ 100 each ₹ 21.25 lakhs
Equity Share Capital of ₹ 10 each ₹ 17.00 lakhs
Income tax rate 30 per cent
You are required to:
(i)​ Calculate Financial leverage.
(ii)​ Calculate P/V ratio and Earning per Share (EPS).
(iii)​If the company belongs to an industry, whose assets turnover is 1.5, does it have a high or low assets
leverage?
(iv)​At what level of sales the Earning before Tax (EBT) of the company will be equal to zero?

Question 31 - Pyq
A company operates at a production level of 1,000 units. The contribution is ₹ 60 per unit, operating leverage is
6, and combined leverage is 24. If the tax rate is 30%, what would be its earnings after tax?

Question 32 - Mtp
Axar Ltd. has a Sales of ₹ 68,00,000 with a Variable cost Ratio of 60%.
The company has a fixed cost of ₹16,32,000.
The capital of the company comprises 12% long term debt, ₹1,00,000 Preference Shares of ₹ 10 each carrying
dividend rate of 10% and 1,50,000 equity shares.
The tax rate applicable for the company is 30%.
At current sales level, Determine the Interest, EPS and amount of debt for the firm if a 25% decline in Sales will
wipe out all the EPS.

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 Chapter 4 - Leverages

Concept of MOS & Leverages

Question 33 - Rtp
Company P and Q are having the same earnings before tax. However, the margin of safety of Company P is
0.20 and, for Company Q, is 1.25 times that of Company P. The interest expense of Company P is ₹ 1,50,000
and, for Company Q, is 1/3rd less than that of Company P. Further, the financial leverage of Company P is 4
and, for Company Q, is 75% of Company P.
Other information is given as below:
Particulars Company P Company Q
Profit volume ratio 25% 33.33%
Tax rate 45% 45%
You are required to PREPARE Income Statement for both the companies.

Question 34 - Rtp
From the following financial data of Company A and Company B, PREPARE their Income Statements.
Particulars Company A (₹) Company B (₹)
Variable Cost 88,000 50% of sales
Fixed Cost 26,500 -
Interest Expenses 14,000 11,000
Financial Leverage 5:1 -
Margin of Safety - 0.25
Income Tax Rate 30% 30%
EBIT - 14,000

Question 35 - Pyq
Financial information for the year 2023-24 of two companies, N Limited and C Limited are as under:
Details N Limited C Limited
Equity share capital (₹ 100 each) ₹ 10,00,000 ₹ 8,00,000
Debt ₹ 5,00,000@10% ₹ 7,00,000@8%
Fixed Cost 3,00,000 3,36,000
Combined Leverage 8 4.5
Financial Leverage 2 1.5
You are required to calculate:
(i) Contribution for N Ltd. and C Ltd.
(ii) Margin of safety in % for N Ltd. and C. Ltd.
(iii) Sales of C Ltd.

Missing Interest (additional interest)

Question 36 - Pyq
The following information is related to YZ Company Ltd. for the year ended 31st March, 2020:
Equity share capital (of ₹ 10 each) ₹ 50 lakhs
12% Bonds of ₹ 1,000 each ₹ 37 lakhs
Sales ₹ 84 lakhs
Fixed cost (excluding interest) ₹ 6.96 lakhs
Financial leverage 1.49
Profit-volume Ratio 27.55%
Income Tax Applicable 40%
You are required to CALCULATE:
(i) Operating Leverage; (ii) Combined leverage; and (iii) Earnings per share.
Show calculations up-to two decimal points.

Question 37 - Pyq
The information related to XYZ Company Ltd. for the year ended 31st March, 2020 are as follows:
Equity Share Capital of ₹ 100 each ₹ 50 Lakhs
12% Bonds of ₹ 1000 each ₹ 30 Lakhs
Sales ₹ 84 Lakhs
Fixed Cost (Excluding Interest) ₹ 7.5 Lakhs

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 Chapter 4 - Leverages

Financial Leverage 1.39

Profit-Volume Ratio 25%
Market Price per Equity Share ₹ 200
Income Tax Rate Applicable 30%
You are required to compute the following:
(i) Operating Leverage (ii) Combined Leverage (iii) Earnings per share (iv) Earning Yield

Question 38 - Pyq
The data of SM Limited for the year ended 31st March 2020 is given below:
Fixed Cost (Excluding Interest) : ₹ 2.25 Lakhs
Sales : ₹ 45 Lakhs ​
Equity Share Capital of ₹ 10 each : ₹ 38.50 Lakhs
12% Debentures of ₹ 500 each : ₹ 20 Lakhs
Operating Leverage : 1.2
Combined Leverage : 4.8
Income tax rate : 30%
You are required to:
(i) Calculate P/V ratio, Earning per share Financial leverage and Assets turnover.
(ii) If asset turnover of an industry is 1.1, then comment on adequacy of assets turnover of SM Limited.
(iii) At what level of sales the Earnings before tax (EBT) of SM Limited will be equal to zero?

Miscellaneous questions
Question 39 - Pyq
Information of A Ltd. is given below:
Earnings after tax : 5% on sales
Income tax rate : 50%
Degree of Operating Leverage : 4 times
10% debentures in capital structure : ₹ 3 lakhs
Variable costs: : ₹ 6 lakhs
(i) From the given data complete the following statement:
Sales XXXX
Less: Variable Costs ₹ 6,00,000
Contribution XXXX
Less: Fixed Cost XXXX
EBIT XXXX
Less: Interest Expenses XXXX
EBT XXXX
Less: Income tax XXXX
EAT XXXX
(ii) Calculate the Financial Leverage and Combined Leverage.
(iii) Calculate the percentage change in earning per share, if sales increased by 5%.

Segments of ROE
Question 40 - Pyq
ABC Limited has an average cost of debt at 10 percent and tax rate is 40 percent. The financial leverage ratio
for the company is 0.60. Calculate Return on Equity (ROE) if its Return on Investment (ROI) is 20%.

Question 41 - Study Material

The net sales of Carlton Limited is ₹ 30 crores. Earnings before interest and tax of the company as a
percentage of net sales are 12%. The capital employed comprises ₹ 10 crores of equity, ₹ 2 crores of 13%
Cumulative Preference Share Capital and 15% Debentures of ₹ 6 crores. Income-tax rate is 40%.
(i) Calculate the Return-on-equity for the company and indicate its segments due to the presence of
Preference Share Capital and Borrowing (Debentures).
(ii) Calculate the Operating Leverage of the Company given that combined leverage is 3.

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 Chapter 5 - Investment Decision

Chapter 5
Investment Decisions
Payback Period
Question 1 - Study Material
Suppose a project costs ₹ 20,00,000 and yields annually a profit of ₹ 3,00,000 after depreciation @ 12.5%
(Straight Line Method) but before tax 50%.What would be the payback period?

Question 2 - Study Material

Consider the following cash flows from two projects.(In ₹)
No. of years Project A Project B
1 Nil 40,000
2 Nil 50,000
3 5,000 1,20,000
4 20,000 10,000
5 50,000 10,000
6 1,50,000 Nil
7 50,000 Nil
8 40,000 Nil
Total 3,15,000 2,30,000
Both projects cost ₹ 1,50,000 each. You are required to compute the payback period for both projects.
Which project will you prefer?

Payback Reciprocal
Question 3 - Study Material
Suppose a project requires an initial investment of ₹ 20,000 and it would give annual cash inflow of ₹ 4,000.
The useful life of the project is estimated to be 5 years. What will be the Payback Reciprocal?

Accounting or Average Rate of Return (ARR)

Question 4 - Study Material
Suppose a project requiring an investment of ₹ 10,00,000 yields profit after tax and depreciation as follows:
Years Profit after tax and depreciation (₹)
1 50,000
2 75,000
3 1,25,000
4 1,30,000
5 80,000
Total 4,60,000
Suppose further that at the end of 5 years, the plant and machinery of the project can be sold for ₹ 80,000.
Calculate Average Rate of Return?

Question 5 - Study Material

Times Ltd. is going to invest in a project a sum of ₹ 3,00,000 having a life span of 3 years.
The salvage value of the machine is ₹ 90,000. The profit before depreciation for each year is ₹1,50,000.
The Profit after Tax and value of Investment in the Beginning and at the End of each year shall be as follows:
Year Profit before Depreciation Profit after Value of investment
depreciation depreciation Beginning End
1 1,50,000 70,000 80,000 3,00,000 2,30,000
2 1,50,000 70,000 80,000 2,30,000 1,60,000
3 1,50,000 70,000 80,000 1,60,000 90,000
Compute ARR.

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 Chapter 5 - Investment Decision

Net Present Value (NPV)

Question 6 - Study Material
Compute the net present value for a project with a net investment of ₹ 1,00,000 and the following cash flows if
the company’s cost of capital is 10%? Net cash flows for year one is ₹ 55,000; for year two is ₹ 80,000 and for
year three is ₹ 15,000. [PVIF @ 10% for three years are 0.909, 0.826 and 0.751].

Question 7 - Study Material

Cello Limited is considering buying a new machine which would have a useful economic life of 5 years, a cost
of ₹ 1,25,000 and a scrap value of ₹ 30,000, with 80 per cent of the cost being payable at the start of the
project and 20 per cent at the end of the first year. The machine would produce 50,000 units per annum of a
new project with an estimated selling price of ₹ 3 per unit. Direct costs would be ₹ 1.75 per unit and annual
fixed costs, including depreciation calculated on a straight-line basis, would be ₹ 40,000 per annum. In the first
year and the second year, special sales promotion expenditure, not included in the above costs, would be
incurred, amounting to ₹ 10,000 and ₹ 15,000 respectively.
Evaluate the project using the NPV method of investment appraisal, assuming the company’s cost of capital to
be 10 percent.
A.​ When tax rate is 50%
B.​ When tax rate is not mentioned (ignoring tax).

Question 8 - Rtp
PQR Limited is considering buying a new machine which would have a useful economic life of five years, at a
cost of ₹ 40,00,000 and a scrap value of ₹ 5,00,000, with 80 per cent of the cost being payable at the start of
the project and 20 per cent at the end of the first year. The machine would produce 80,000 units per annum of
a new product with an estimated selling price of ₹ 400 per unit. Direct costs would be ₹ 375 per unit and
annual fixed costs, including depreciation calculated on a straight- line basis, would be₹ 10,40,000 per annum.
In the first year and the second year, special sales promotion expenditure, not included in the above costs,
would be incurred, amounting to ₹ 1,25,000 and ₹ 1,75,000 respectively.
EVALUATE the project using the NPV method of investment appraisal, assuming the company’s cost of capital
to be 12 percent.

Desirability / Profitability Index

Question 9 - Study Material
There are three projects involving discounted cash outflow of ₹ 5,50,000, ₹ 75,000 and ₹ 1,00,20,000
respectively. Suppose that the sum of discounted cash inflows for these projects are ₹ 6,50,000, ₹ 95,000 and
₹ 1,00,30,000 respectively. Calculate the desirability factors for the three projects.

Question 10 - Rtp
K. K. M. M Hospital is considering purchasing an MRI machine.
Presently, the hospital is outsourcing the work received relating to MRI machines and is earning commission
of ₹ 6,60,000 per annum (net of tax).
The following details are given regarding the machine:
Particulars (₹)
Cost of MRI machine 90,00,000
Operating cost per annum (excluding Depreciation) 14,00,000
Expected revenue per annum 45,00,000
Salvage value of the machine (after 5 years) 10,00,000
Expected life of the machine 5 years

Assuming tax rate @ 40%, whether it would be profitable for the hospital to purchase the machine?
Give your RECOMMENDATION under:
1.​ Net Present Value Method, and
2.​ Profitability Index Method.
PV factors at 10% are given below:
Year 1 2 3 4 5
PV factor 0.909 0.826 0.751 0.683 0.620

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Internal Rate Of Return

Question 11 - Study Material
Calculate the Internal Rate of Return of an Investment of ₹ 1,36,000 which yields the following cash inflows:
YEAR CASH INFLOWS(RS)
1 30000
2 40000
3 60000
4 30000
5 20000

Question 12 - Study Material

A company proposes to install a machine involving a capital cost of ₹ 3,60,000.The life of the machine is 5
years and its salvage value at the end of the life is nil. The machine will produce the net operating income after
depreciation of ₹ 68,000 per annum. The company’s tax rate is 45%
The Net present value factor for 5 years are as under:
Discounting Rate 14 15 16 17 18
Cumulative Factor 3.43 3.35 3.27 3.20 3.13
You are required to calculate the internal rate of return of the proposal.

Modified Internal Rate Of Return

Question 13 - Study Material
An investment of ₹ 1,36,000 yields the following cash inflows.
Year 1 2 3 4 5
CFAT(RS) 30,000 40,000 60,000 30,000 20000
Determine the MIRR if the Cost of Capital = 8%.

Discounted Payback Period

Question 14 - Study Material
Suppose a project costs ₹ 20,00,000 and yields annually a profit of ₹ 3,00,000 after depreciation @ 12.5%
(Straight Line Method) but before tax 50%.
What would be the Discounted payback period? Using a discount rate of 10%.

Question 15 - Study Material

Consider the following cash flows from two projects.(In ₹)
No. of years Project A Project B
1 Nil 40,000
2 Nil 50,000
3 5,000 1,20,000
4 20,000 10,000
5 50,000 10,000
6 1,50,000 Nil
7 50,000 Nil
8 40,000 Nil
Total 3,15,000 2,30,000
Both projects cost ₹ 1,50,000 each. You are required to compute the Discounted payback period for both
projects. Which project will you prefer? Using a discount rate as 10%.

Using More than One Technique of Capital Budgeting

Question 16 - Rtp
A Ltd is considering a new 5-year project. Its investment costs and annual profits are projected as follows:
Investment Profits
Year 0 1 2 3 4 5
Amount(₹) (2,50,000) 40,000 30,000 20,000 10,000 10,000
Residual Value at the end of the project is expected to be ₹ 40,000 and Depreciation of the Original Investment
is on a straight line basis. Using Average profits and Average Capital Employed, calculate ARR for the project
and also the payback period.

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Question 17 - Study Material

The Alpha Co. Ltd, is considering the purchase of a new machine.
Two alternative machines (A & B) have been suggested, each costing ₹ 4,00,000.
Earnings after taxation but before depreciation are expected to be as follows:
YEAR CASH FLOWS
Machine A Machine B
1 40,000 1,20,000
2 1,20,000 1,60,000
3 1,60,000 2,00,000
4 2,40,000 1,20,000
5 1,60,000 80,000
Total 7,20,000 6,80,000
The company has a target rate return on capital @ 10 percent and on this basis, you are required:
(a) Compare profitability of the machines and state which alternative you consider financially preferable;
(b) Compute the payback period for each project; and (c) Compute annual rate of return for each project.
[Present value of machine B is higher than that of machine A; Payback period machine A – 3 years 4 months,
machine B 2 years 7.2 months; Annual return machine A – 16%, machine B – 14%]

NPV, IRR, Payback Period, ARR

Question 18 - Study Material
Hind lever Company is considering a new product line to supplement its range line. It is anticipated that the
new product line will involve cash investment of ₹ 7,00,000 at time 0 and ₹ 10,00,000 in year 1. After-tax cash
inflows of ₹ 2,50,000 are expected in year 2, ₹ 3,00,000 in year 3, ₹ 3,50,000 in year 4 and ₹ 4,00,000 each year
thereafter through year 10. Although the product line might be viable after year 10, the company prefers to be
conservative and end all calculations at that time.
(a) If the required rate of return is 15 percent, what is the net present value of the project? Is it acceptable?
(b) What would be the case if the required rate of return were 10 per cent?
(c) What is its internal rate of return?
(d) What is the project’s payback period?
(e) Discounted PBP at 10%.

Question 19 - Study Material

Alpha company is considering the following investment projects:
PROJECTS CASH FLOWS
C0 C1 C2 C3
A -10,000 10,000
B -10,000 7500 7500
C -10,000 2000 4000 12000
D -10,000 10000 3000 3000
(a)​ Rank the projects according to each of the following methods: (i) Payback, (ii) ARR, (iii) IRR and (iv) NPV,
assuming discount rates of 10 and 30 per cent.
(b)​ Assuming the projects are independent, which one should be accepted? If the projects are mutually
exclusive, which project is the best?

NPV and PI with Differential Cash flows

Question 20 - Pyq
New Thought Company is evaluating an Investment proposal of ₹ 3,06,000 with expected cash flows as:
YEAR 1 2 3 4
CFAT(Rs) 100000 130000 150000 100000
The Company’s Cost of Capital is 10%. Compute the NPV and PI for this project.

NPV and PI with Uniform Cash Flows

Question 21 - Rtp
Bhilwara Co.’s cost of capital is 10% and it is subject to 50% tax rate.
The Company is considering buying a new finishing machine.
The machine will cost ₹ 2 Lakhs and will reduce materials waste by an estimated amount of ₹ 50,000 a year.
The machine will last for 10 years and will have a zero salvage value.

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Assume a straight line method of depreciation on assets.

1. Compute the Annual Cash Inflows, Present Value, Net Present Value, and Profitability Index.
2. Should the company purchase the new finishing machine?

Payback, ARR, NPV, IRR and PI

Question 22 - Pyq
C Ltd. is considering investing in a project.
The expected original investment in the project will be ₹ 2,00,000, the life of the project will be 5 years with no
salvage value.
The expected net cash inflows after depreciation but before tax during the life of the project will be as
following:
YEAR 1 2 3 4 5
(Rs) 85000 100000 80000 80000 40000
The project will be depreciated at the rate of 20% on original cost. The company is subjected to a 30% tax rate.
(i) Calculate payback period and average rate of return (ARR).
(ii) Calculate net present value and net present value index, if cost of capital is 10%.
(iii) Calculate internal rate of return.
Note: The P.V. factors are
YEAR P.V. at 10% P.V. at 37% P.V. at 38% P.V. at 40%
1 0.909 0.730 0.725 0.714
2 0.826 0.533 0.525 0.510
3 0.751 0.389 0.381 0.364
4 0.683 0.284 0.276 0.260
5 0.621 0.207 0.200 0.186

Simple & Discounted Payback Period, NPV and PI

Question 23 - Pyq
Consider the following mutually exclusive projects:
Cash Flows (₹)
Projects C0 C1 C2 C3 C4
A -10,000 6,000 2,000 2,000 12,000
B -10,000 2,500 2,500 5,000 7,500
C -3,500 1,500 2,500 500 5,000
D -3,000 0 0 3,000 6,000
You are required to:
(i) Calculate the payback period for each project.
(ii) If the standard payback period is 2 years, which project will you select? Will your answer differ, if the
standard payback period is 3 years?
(iii) If the cost of capital is 10%, compute the discounted payback period for each project. Which projects will
you recommend, if the standard discounted payback period is (i) 2 years; (ii) 3 years?
(iv) Compute NPV of each project. Which project will you recommend on the NPV criterion? The cost of capital
is 10%. What will be the appropriate choice criteria in this case?
The PV factors at 10% are:
YEAR 1 2 3 4
PV factor at 10% (PV/F 0.10,t) 09091 08264 0.7513 0.6830

NPV and IRR

Question 24 - Study Material
A sole trader installs plant and machinery in rented premises for the production of luxury articles, the demand
for which is expected to last only 5 years.
The total capital put in by the sole trader is as under:
Plant and machinery : ₹ 2,70,500
Working capital : ₹ 40,000
₹ 3,10,500
The working capital will be fully realized at the end of 5th year.
The scrap value of the plant expected to be realized at the end of the 5th year is only ₹ 5,500.

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The trader’s earning are expected to be as under:

Year Cash profit (before depreciation & tax) (₹) Tax payable (₹)
1 90,000 20,000
2 1,30,000 30,000
3 1,70,000 40,000
4 1,16,000 26,000
5 19,500 5,000

Present value factors of various rates of interest are given below:

Years 11% 12% 13% 14% 15%
1 0.9009 0.8929 0.8850 0.8770 0.8696
2 0.8116 0.7972 0.7831 0.7695 0.7561
3 0.7312 0.7118 0.6931 0.6750 0.6675
4 0.6587 0.6355 0.6133 0.5921 0.5718
5 0.5935 0.5674 0.5428 0.5194 0.4972
You are required to compute the present value of cash flows discounted at the various rates of interests given
above and state the return from the project.

Question 25 - Pyq
A company is considering the proposal of taking up a new project which requires an investment of ₹ 400 lakhs
on machinery and other assets.
The project is expected to yield the following earnings (before depreciation and taxes) over the next five years:
Year Earnings (₹ in lakhs)
1 160
2 160
3 180
4 180
5 150
The cost of raising the additional capital is 12% and assets have to be depreciated at 20% on ‘Written Down
Value’ basis. The scrap value at the end of the five years’ period may be taken as zero. Income-tax applicable
to the company is 50%.
You are required to calculate the net present value of the project and advise the management to take
appropriate decisions. Also calculate the Internal Rate of Return of the Project.
Note: Present values of Re. 1 at different rates of interest are as follows:
Year 10% 12% 14% 16%
1 0.91 0.89 0.88 0.86
2 0.83 0.80 0.77 0.74
3 0.75 0.71 0.67 0.64
4 0.68 0.64 0.59 0.55
5 0.62 0.57 0.52 0.48

Computing Missing Figure with IRR, PI, NPV

Question 26 - Pyq
Following are the data on a Capital project being evaluated by the management of X Ltd.
Particulars Project M
Annual cost saving ₹ 40,000
Useful life 4 years
I.R.R 15%
Profitability Index (P.I) 1.064
NPV ?
Cost of capital ?
Cost of project ?
Payback ?
Salvage value 0

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Find the missing values considering the following table discount factor only:
Discount factor 15% 14% 13% 12%
1 year 0.869 0.877 0.885 0.893
2 year 0.756 0.769 0.783 0.797
3 year 0.658 0.675 0.693 0.712
4 year 0.572 0.592 0.613 0.636
2.855 2.913 2.974 3.038

Question 27 - Pyq
A Doctor is planning to buy an X-Ray machine for his hospital.
He has two options – he can either purchase it by making a cash payment of ₹ 5 lakhs or ₹ 6,15,000 are to be
paid in six equal annual instalments.
Which option do you suggest to the Doctor assuming the Rate of Return is 12%? The present Value of ₹ 1 at
12% rate of discount for 6 years is 4.111.

Replacement Decision based on NPV, Discounted Payback and PI

Question 28 - Study Material
Lockwood Limited wants to replace its old machine with a new automatic machine.
Two models A and B are available at the same cost of ₹ 5 lakhs each.
The salvage value of the old machine is ₹ 1 lakh.
The utilities of the existing machine can be used if the company purchases A.
Additional cost of utilities to be purchased in that case are ₹ 1 lakh.
If the company purchases B then all the existing utilities will have to be replaced with new utilities costing ₹ 2
lakhs. The salvage value of the old utilities will be ₹ 0.20 lakhs.
The earnings after taxation are expected to be:
(Cash Inflows of)
Year A (₹) B(₹) P.V. Factor @15%
1 1,00,000 2,00,000 0.87
2 1,50,000 2,10,000 0.76
3 1,80,000 1,80,000 0.66
4 2,00,000 1,70,000 0.57
5 1,70,000 40,000 0.50
Salvage value at the end of year 5 50,000 60,000
The targeted return on capital is 15%. You are required to:
(i) Compute, for the two machines separately, Net present value, Discounted payback period and Desirability
factor and (ii) Advice which of the machines is to be selected?

Decision of Acceptance – Rejection based on Payback, NPV and IRR

Question 29 - Pyq
A company is considering a proposal of installing drying equipment.
The equipment would involve a cash outlay of ₹ 6,00,000 and net working capital of ₹ 80,000. The expected life
of the project is 5 years without any salvage value.
Assume that the company is allowed to charge depreciation on a straight-line basis for income-tax purposes.
The estimated before-tax cash inflows are given below:
Before-Tax Cash Inflows (₹ ‘000)
Year 1 2 3 4 5
240 275 210 180 160
The applicable Income-tax rate to the company is 35%.
If the company’s opportunity cost of capital is 12%, calculate the equipment’s discounted payback period,
payback period, net present value and internal rate of return.
The PV factors at 12%, 14% and 15% are:
Year 1 2 3 4 5
PV factor at 12% 0.8929 0.7972 0.7118 0.6355 0.5674
PV factor at 14% 0.8772 0.7695 0.6750 0.5921 0.5194
PV factor at 15% 0.8696 0.7561 0.6575 0.5718 0.4972

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Commission Income foregone

Question 30 - Pyq
A Hospital is considering purchasing a Diagnostic Machine costing ₹ 80,000. The projected life of the machine
is 8 years, and it has an expected Salvage Value of ₹ 6,000 at the end of 8 years. The annual operating cost of
the machine is ₹ 7,500. It is expected to generate revenues of ₹ 40,000 per year for 8 years. Presently, the
Hospital is outsourcing the diagnostic work and is earning Commission Income of ₹ 12,000 per annum, net of
taxes. Advise: Whether it would be profitable for the Hospital to purchase the machine? Give your
recommendation under Net Present Value and Profitability Index Methods. PV Factors at 10% are given below:
Year 1 2 3 4 5 6 7 8
PV Factor 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467
[Additional Cash Flow p.a. by Purchasing new Diagnostic Machine: ₹ 11,200; Net Present Value: (17,457);
Profitability Index: 0.78]

Question 31 - Pyq
A hospital is considering purchasing a diagnostic machine costing ₹ 80,000. The projected life of the machine
is 8 years and has an expected salvage value of ₹ 6,000 at the end of 8 years. The annual operating cost of the
machine is ₹ 7,500. It is expected to generate revenues of ₹ 40,000 per year for eight years. Presently, the
hospital is outsourcing the diagnostic work and is earning commission income of ₹ 12,000 per annum.
Consider the tax rate of 30% and the Discounting Rate as 10%. Advise: Whether it would be profitable for the
hospital to purchase the machine? Give your recommendation as per Net Present Value method and Present
Value Index method under below mentioned two situations:
1.​ If Commission income of ₹ 12,000 p.a. is before taxes.
2.​ If Commission income of ₹ 12,000 p.a. is net of taxes.
t 1 2 3 4 5 6 7 8
PVIF (t, 10%) 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

Mutually Exclusive Decisions – NPV and Simple Payback

Question 32 - Pyq
PR Engineering Ltd. is considering the purchase of a new machine which will carry out some operations which
are at present performed by manual labour.
The following related to the alternative models – ‘MX’ and ‘MY’ are available:
Particulars Machine ‘MX’ Machine ‘MY’
Cost of Machine ₹ 8,00,000 ₹ 10,20,000
Expected Life 6 year 6 year
Scrap value ₹ 20,000 ₹ 30,000
Estimated Net Income before Depreciation and Tax are as under:
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Machine MX 2,50,000 2,30,000 1,80,000 2,00,000 1,80,000 1,60,000
Machine MY 2,70,000 3,60,000 3,80,000 2,80,000 2,60,000 1,85,000
Depreciation will be charged on a Straight Line basis. Tax rate is 30%.
1.​ Calculate the payback period of each proposal.
2.​ Calculate the Net Present Value of each proposal, if the PV Factor at 10% is 0.909, 0.826, 0.751, 0.683,
0.621 and 0.564.
3.​ Which proposal would you recommend and why?

Mutually Exclusive Projects/ Independent Project Evaluation using NPV & IRR
Question 33 - Rtp
The Director of Damon Electronics Co. has asked you to analyse two proposed investment projects X and Y.
Each project has an initial investment of ₹ 10,000 at a cost of 12%.
The Cash Flows are expected as under:
Year 1 2 3 4
Cash Flows of X ₹ 6,500 ₹ 3,000 ₹ 3,000 ₹ 1,000
Cash Flows of Y ₹ 3,500 ₹ 3,500 ₹ 3,500 ₹ 3,500
1.​ Calculate for each project – (a) Simple payback period, (b) NPV, and (c) IRR.
2.​ Which project(s) should be accepted if the projects were independent?
3.​ Which project should be accepted if they were mutually exclusive?

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Mutually Exclusive Projects unequal life

Question 34 - Pyq
The Management of P Limited is considering selecting a machine out of the mutually exclusive machines.
The company’s Cost of Capital is 12% and Corporate Tax Rate for the Company is 30%.
Details of the machines are as follows:
Particulars Machine – I Machine – II
Cost of Machine ₹ 10,00,000 ₹ 15,00,000
Expected life 5 years 6 years
Annual Income before Tax Depreciation ₹ 3,45,000 ₹ 4,55,000
Depreciation is to be charged on a straight line basis. You are required to:
1.​ Calculate the Discounted Payback Period, Net Present Value and Internal Rate of Return for each machine.
2.​ Advise the Management of P Limited as to which Machine they should take up.

Question 35 - Pyq
A Ltd. is considering the purchase of a machine which will perform some operations which are at present
performed by workers. Machines X and Y are alternative models.The following details are available:
Particulars Machine X (₹) Machine Y (₹)
Cost of machine 1,50,000 2,40,000
Estimated life of machine 5 years 6 years
Estimated cost of maintenance p.a. 7,000 11,000
Estimated cost of indirect material p.c. 6,000 8,000
Estimated savings in scrap p.a. 10,000 15,000
Estimated cost of supervision p.a. 12,000 16,000
Estimated savings in wages p.a. 90,000 1,20,000
Depreciation will be charged on a straight line basis. The tax rate is 30%.
Evaluate the alternatives according to:
(i)​ Average rate of return method, and
(ii)​ Present value index method assuming cost of capital being 10%.

Question 36 - Study Material

Ae Bee Cee Ltd. is planning to invest in machinery, for which it has to make a choice between the two identical
machines, in terms of Capacity, ‘X’ and ‘Y’. Despite being designed differently, both machines do the same job.
Further, details regarding both the machines are given below:
Particulars Machine ‘X’ Machine ‘Y’
Purchase Cost of the Machine (₹) 15,00,000 10,00,000
Life (years) 3 2
Running cost per year (₹) 4,00,000 6,00,000
The opportunity cost of capital is 9%. You are required to:
IDENTIFY the machine the company should buy? The present value (PV) factors at 9% are:
Year t1 t2 t3
PVIF0.09.t 0.917 0.842 0.772

NPV – IRR Conflict

Question 37 - Pyq
The Cash flows of projects C and D are reproduced below:
Project C0 C1 C2 C3 NPV at 10% IRR
C -₹ 10,000 + 2,000 + 4,000 + 12,000 + ₹ 4,139 26.5%
D -₹ 10,000 + 10,000 + 3,000 + 3,000 + ₹ 3,823 37.6%
(i) Why is there a conflict of ranking?
(ii) Why should you recommend project C in spite of lower internal rate of return?
Discount Rate 1 2 3
10% 0.9090 0.8264 0.7513
14% 0.8772 0.7695 0.6750
15% 0.8696 0.7561 0.6575
30% 0.7692 0.5917 0.4552
40% 0.7143 0.5102 0.3644

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Question 38 - Pyq
A Firm can make investment in either of the following two projects.
The firm anticipates its cost of capital to be 10% and the net (after taxes).
Cash flows of the five years are as follows: (in ₹ ‘000)
Year 0 1 2 3 4 5
Project A (500) 85 200 240 220 70
Project B (500) 480 100 70 30 20
The discount factors are as under:
Year 0 1 2 3 4 5
PVF (10%) 1 0.91 0.83 0.75 0.68 0.62
PVF (20%) 1 0.83 0.69 0.58 0.48 0.41
1.​ Calculate the NPV and IRR of each project.
2.​ State with reasons which project you would recommend.
3.​ Explain the inconsistency in ranking of two projects.

NPV & PI Calculation

Question 39 - Pyq
SRT Limited manufactures steel rods and is now considering purchasing a new aluminium smelting and
moulding plant. This plant will have the cost of ₹20,00,000 to purchase and install the plant. It has a useful life
of 5 years with a residual value of ₹1,00,000. Production and sales from the new plant are expected to be
1,00,000 units per year.
Other estimates are as follows:
Selling price ₹150 per unit
Direct Cost ₹100 per unit
Fixed cost (including depreciation) is ₹8,00,000 per annum. Marketing and promotion costs not included in the
above will be ₹1,00,000 and ₹1,60,000 for years 1 and 2, respectively.
Additionally , investment in debtors and stocks will increase in year 1 by ₹1,50,000and ₹2,00,000 respectively.
Creditors will also increase by ₹1,00,000 in year 1. Thus , Debtors, stocks and creditors will be recouped at the
end of the fifth year.
The cost of capital is 18%. Corporate tax is 30% and is paid in the year in which profits are made.
Depreciation is tax deductible. The company follows a straight line method of depreciation.
(i) Calculate the Net Present Value and Profitability Index of the project.
(ii) Advise SRT Limited whether the plant should be purchased.
The PV factors at 18% are:
Year 1 2 3 4 5
PV factor 0.847 0.718 0.609 0.516 0.437

Selling Processed waste

Question 40 - Study Material
A large profit making company is considering the installation of a machine to process the waste produced by
one of its existing manufacturing processes to be converted into a Marketable product.
At present, the waste is removed by a contractor for disposal on payment by the company of ₹ 150 lakh per
annum for the next four years. The contract can be terminated upon installation of the aforesaid machine on
payment of a compensation of ₹ 90 lakh before the processing operation starts. This compensation is not
allowed as deduction for tax purposes.
The machine required for carrying out the processing will cost ₹ 600 lakh to be financed by a loan repayable in
4 equal instalments commencing from end of the year- 1. The interest rate is 14% per annum. At the end of the
4th year, the machine can be sold for ₹ 60 lakh and the cost of dismantling and removal will be ₹ 45 lakh.
Sales and direct costs of the product emerging from waste processing for 4 years are estimated as under:
(₹ In lakh)
Year 1 2 3 4
Sales 966 966 1,254 1,254
Material consumption 90 120 255 255
Wages 225 225 255 300
Other Expenses 120 135 162 210
Factory overheads 165 180 330 435
Depreciation (as per income tax rules) 150 114 84 63

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Initial stock of materials required before commencement of the processing operations is ₹ 60 lakh at the start
of year 1. The stock levels of materials to be maintained at the end of year 1, 2 and 3 will be ₹ 165 lakh and the
stocks at the end of year 4 will be nil. The storage of materials will utilise space which would otherwise have
been rented out for ₹ 30 lakh per annum.
Labour costs include wages of 40 workers, whose transfer to this process will reduce idle time payments of ₹
45 lakh in the year- 1 and ₹ 30 lakh in the year- 2.
Factory overheads include apportionment of general factory overheads except to the extent of insurance
charges of ₹ 90 lakh per annum payable on this venture. The company’s tax rate is 30%.
Present value factors for four years are as under:
Year 1 2 3 4
PV factors @14% 0.877 0.769 0.674 0.592
ADVISE the management on the desirability of installing the machine for processing the waste. All
calculations should form part of the answer.

Service or replace parts

Question 41 - Study Material
Alley Pvt. Ltd. is planning to invest in machinery that would cost ₹ 1,00,000 at the beginning of year 1.
Net cash inflows from operations have been estimated at ₹ 36,000 per annum for 3 years.
The company has two options for smooth functioning of the machinery- one is service, and another is
replacement of parts.
If the company opts to service a part of the machinery at the end of year 1 at ₹ 20,000, in such a case, the
scrap value at the end of year 3 will be ₹ 25,000.
However, if the company decides not to service the part, then it will have to be replaced at the end of year 2 at
₹ 30,800. And in this case, the machinery will work for the 4th year also and get an operational cash inflow of
₹ 36,000 for the 4th year. It will have to be scrapped at the end of year 4 at ₹ 18,000.
Assuming cost of capital at 10% and ignoring taxes, DETERMINE the purchase of this machinery based on the
net present value of its cash flows? If the supplier gives a discount of ₹ 10,000 for purchase, what would be
your decision?
Note: The PV factors at 10% are:
Year 0 1 2 3 4 5 6
PV Factor 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645

Finding NPV with different Capital gain/loss situations

Question 42 - Rtp
Fair Ltd. is a manufacturer of high quality running shoes. Hari, President, is considering computerizing the
company’s ordering, inventory and billing procedures. He estimates that the annual savings from
computerization include a reduction of 10 clerical employees with annual salaries of ₹ 15,000 each, ₹ 8,000
from, reduced production delays caused by raw materials inventory problems, ₹ 12,000 from lost sales due to
inventory stock out and ₹ 3,000 associated with timely billing procedures.
The purchase price of the system is ₹ 2,00,000 and installation costs are ₹ 50,000.
These outlays will be capitalized (depreciated) on a straight-line basis to a zero book salvage value, which is
also its Market value at the end of 5 years.
Operation of the new system requires two computer specialists with annual salaries of ₹ 40,000 per person.
Also annual maintenance and operating (cash) expenses of ₹ 12,000 are estimated to be required.
The company’s tax rate is 40% and its required rate of return (cost of capital) for this project is 12%.
You are required to:
(i)​ Find the project’s initial net cash outlay;
(ii)​ Find the project’s operating and terminal value cash flows over its 5-year life;
(iii)​ Evaluate the project using NPV method;
(iv)​ Evaluate the project using PI method;
(v)​ Calculate the project’s payback period;
(vi)​ Find the project’s cash flows and NPV *parts (i) through (iii)+ assuming that the system can be sold for ₹
25,000 at the end of five years even though the book salvage value will be zero; and
(vii) Find the project’s cash flows and NPV *parts (i) through (iii)+ assuming that the book salvage value for
depreciation purposes is ₹ 20,000 even though the machine is worthless in terms of its resale value.
Note: Present value of annuity of Re. 1 at 12% rate of discount for 5 years is 3.605.
Present value of Re. 1 at 12% rate of discount, received at the end of 5 years is 0.567.

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Treatment of subsidy
Question 43 - Pyq
XYZ Ltd. is planning to introduce a new product with a project life of 8 years. The project is to be set up in
Special Economic Zone (SEZ), Qualifies for one time (at starting)tax free subsidy from the State Government
of ₹ 25,00,000 on Capital investment. Initial equipment cost will be ₹ 1.75 crores. Additional equipment cost
₹12,50,000 will be purchased at the end of the third year from the cash inflow of this year. At the end of 8
years, the original equipment will have no resale value, but additional equipment can be sold for ₹ 1,25,000. A
Working Capital of ₹20,00,000 will be needed and it will be released at the end of the eight year. The project
will be financed with a sufficient amount of Equity Capital.
The sales volumes over eight years have been estimated as follows:
Year 1 2 3 4-5 6-8
Units 72,000 1,08,000 2,60,000 2,70,000 1,80,000
A sales price of ₹120 per unit is expected and variable expenses will amount to 60% of sales revenue. Fixed
Cash operating costs will amount ₹ 18,00,000 per year. The loss of any year will be set off from the profits of
subsequent two years. The company is subject to a 30 percent tax rate and considers 12 percent to be an
appropriate after tax cost of capital for this project. The company follows a straight line method of
depreciation.
Calculate the net present value of the project and advise the management to take appropriate decisions.
Note: The PV factors at 12% are:
Year 1 2 3 4 5 6 7 8
Pv factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404

Question 44 - Pyq
ABC Ltd., a profit-making company, is engaged in the business of car manufacturing.
In order to be independent in terms of its electricity needs, the company's management has proposed to put
up a Solar Power Plant to generate the electricity.
The details of the proposal are as follows:
Cost of the power plant : ₹ 280 lakhs
Cost of land : ₹ 30 lakhs
Subsidy of ₹ 25 lakhs from state government to be received at the end of first year of installation.
Sale of electricity to State Electricity Board will be at ₹ 2.25 per unit in year 1. This will increase by ₹ 0.25 per
unit every year till year 7. After that it will increase by ₹ 0.50 per unit every year.
(1)Maintenance cost will be ₹ 4 lakhs in year 1 and the same will increase by ₹ 2 lakhs every year.
(2)Estimated life is 10 years.
(3)Cost of capital 15%.
(4)The residual value of power plant is nil. However, land value will go up to ₹ 90 lakhs at the end of year 10.
(5)Depreciation will be 100% of the cost of the power plant in year 1 (entire ₹ 280 lakhs is to be depreciated in
year 1 without considering subsidy) and the same will be allowed for tax purposes.
(6)Gross electricity generated will be 25 lakhs units per annum. 4% of this electricity generated will be
committed free to the State Electricity Board as per the agreement.
(7)Tax rate is 50%.
You are required to suggest the viability of the proposal by calculating the 'Net Present Value' while ignoring
the tax on capital profit. Assume that the tax savings, if any, are utilized in the year of their occurrence.
Present value (PV) factors @ 15% for the year 1 to year 10 are as given below and should be used for
calculating present value of various cash flows. ​
Year 1 2 3 4 5 6 7 8 9 10
PV Factor 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247

Question 45 - Pyq
HCP Ltd. is a leading manufacturer of railway parts for passenger coaches and freight wagons.
Due to high wastage of material and quality issues in production, the General Manager of the company is
considering the replacement of machine A with a new CNC machine B.
Machine A has a book value of ₹4,80,000 and remaining economic life is 6 years. It could be sold now at
₹1,80,000 and zero salvage value at the end of sixth year. The purchase price of Machine B is ₹24,00,000 with
an economic life of 6 years. It will require ₹1,40,000 for installation and ₹60,000 for testing.
Subsidy of 15% on the purchase price of machine B will be received from the Government at the end of 1st
year. Salvage value at the end of sixth year will be ₹3,20,000.

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The General manager estimates that the annual savings due to installation of Machine B include a reduction of
three skilled workers with annual salaries of ₹1,68,000 each, ₹4,80,000 from reduced wastage of materials and
defectives and ₹3,50,000 from loss in sales due to delay in execution of purchase orders. Operation of
Machine B will require the services of a trained technician with an annual salary of ₹3,90,000 and annual
operation and maintenance cost will increase by ₹1,54,000. The company’s tax rate is 30% and its required rate
of return is 14%. The company follows a straight line method of depreciation. Ignore tax savings on loss due to
sale of existing machine.The present value factors at 14% are:
Years 0 1 2 3 4 5 6
PV Factor 1 0.877 0.769 0.675 0.592 0.519 0.456
(i) Calculate the Net Present Value and profitability Index and advise the company for a replacement decision.
(ii) Also calculate the discounted pay-back period.

100% Depreciation in year one

Question 46 - Study Material, Pyq
Modern Enterprises Ltd. is considering the purchase of a new computer system for its Research and
Development Division, which would cost ₹ 35 lakhs. The operation and maintenance costs (excluding
depreciation) are expected to be ₹ 7 lakhs per annum. It is estimated that the useful life of the system would
be 6 years, at the end of which the disposal value is expected to be ₹ 1 lakh.
The tangible benefits expected from the system in the form of reduction in designing costs would be ₹ 12
lakhs per annum. Besides, the disposal of used drawing, office equipment and furniture, initially, is anticipated
to net ₹ 9 lakhs. Capital expenditure in research and development would attract 100% write-off for tax purpose.
The gains arising from disposal of used assets May be considered tax-free. The company’s effective tax rate is
50%.
The average cost of capital to the company is 12%. The present value factors at 12% discount rate are:
Year PVF
1 0.892
2 0.797
3 0.711
4 0.635
5 0.567
6 0.506
After appropriate analysis of cash flows, please advise the company of the financial viability of the proposal.

Asset Replacement
Question 47 - Rtp, Study Material
Beta Electronics is considering a proposal to replace one of its machines.
The following information is available to you.
The existing machine was bought 3 years ago for ₹ 10 Lakhs. It was depreciated at 25% p.a. on a reducing
balance basis. It has a remaining useful life of 5 years, but its annual maintenance cost is expected to increase
by ₹ 50,000 from the sixth year of its installation. Its present realisable value is ₹ 6 Lakhs.
The company has several machines, having 25% depreciation.
The new Machine costs ₹ 15 Lakhs and is subject to the same rate of depreciation. On sale after 5 years, it is
expected to net ₹ 9 Lakhs. With the new machine, the annual operating costs (excluding depreciation) are
expected to decrease by ₹ 1 Lakh. In addition, the new machine would increase productivity on account of
which Net Revenues would increase by ₹ 1.5 Lakhs annually.
The tax-rate application to the company is 35% and cost of Capital is 10%.
Advise the company, on the basis of NPV of the proposal, whether the proposal is financially viable. .

Question 48 - Rtp
The General Manager of Merry Ltd. is considering the replacement of five -year-old equipment.
The company has to incur excessive maintenance cost of the equipment. The equipment has zero written
down value. It can be modernized at a cost of ₹ 1,40,000 enhancing its economic life to 5 years.
The equipment could be sold for ₹ 30,000 after 5 years. The modernization would help in material handling
and in reducing labour , maintenance & repairs costs.
The company has another alternative to buy a new machine at a cost of ₹ 3,50,000 with an economic life of 5
years and salvage value of ₹ 60,000. The new machine is expected to be more efficient in reducing costs of
material handling, labour , maintenance & repairs, etc.

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 Chapter 5 - Investment Decision

The annual cost are as follows:

Existing Equipment (₹) Modernization (₹) New Machine (₹)
Wages & Salaries 45,000 35,500 15,000
Supervision 20,000 10,000 7,000
Maintenance 25,000 5,000 2,500
Power 30,000 20,000 15,000
1,20,000 70,500 39,500
Assuming a tax rate of 50% and required rate of return of 10%, should the company modernize the equipment
or buy a new machine? PV factor at 10% are as follows:
7B Year 1 2 3 4 5
PV factor 0.909 0.826 0.751 0.683 0.621

Concept of additional and allocated overheads

Question 49 -
ABC Ltd. manufactures toys and other gift items. The R & D Division has come up with a product that would
make a good promotional gift for office equipment dealers.
As a result of efforts by the sales personnel, the Firm has commitments for this product.
To produce the quantity demanded, the company will need to buy additional machinery and rent additional
space. It appears that about 25,000 square feet will be needed. 12,500 square feet of presently unused space,
but leased at the rate of ₹ 3 per square foot per year, is available. There is another 12,500 square feet available
at an annual rent of ₹ 4 per square foot.
The Machinery will be purchased for ₹ 9,00,000. It will require ₹ 30,000 for modifications, ₹ 60,000 for
installation and ₹ 90,000 for testing. The machinery will have a salvage value of about ₹ 1,80,000 at the end of
the third. No additional General Overheads Costs are expected to be incurred.
The estimated revenues and costs for this product for the three years have been developed as follows:(₹)
Particulars Year I Year II Year III
Sales 10,00,000 20,00,000 8,00,000
Less: Material and 4,00,000 7,50,000 3,50,000
Labour 40,000 75,000 35,000
Overheads allocated 50,000 50,000 50,000
Rent 3,00,000 3,00,000 3,00,000
Depreciation
Earnings Before 2,10,000 8,25,000 65,000
Taxes 1,05,000 4,12,500 32,500
Less: Taxes
Earnings After Taxes 1,05,000 4,12,500 32,500
If the Company sets a required rate of return of 20% after taxes, should this product be manufactured?

Question 50 - Pyq
Swastik Ltd. manufactures special purpose machine tools, have two divisions, which are periodically assisted
by visiting terms of consultants.
The management is worried about the steady increase of expenses in this regard over the years.
An analysis of last year’s expenses reveals the following:
Particulars ₹
Consultant's Remuneration 2,50,000
Travel and Conveyance 1,50,000
Accommodation Expenses 6,00,000
Boarding charges 2,00,000
Special Allowances 50,000
12,50,000
The management estimates accommodation expenses to increase by ₹ 2,00,000 annually.
As part of a cost reduction drive, Swastik Ltd. is proposing to construct a consultancy centre to take care of
the accommodation requirements of the consultants.
This centre will additionally save the company ₹ 50,000 in boarding charges and ₹ 2,00,000 in the cost of
Executive Training Programmes hitherto conducted outside the company’s premises, every year.
The following details are available regarding the construction and maintenance of the new centre:
a)​ Land: At a cost of ₹ 8,00,000 already owned by the company will be used.

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b)​ Construction cost: ₹ 15,00,000 including special furnishings.

c)​ Cost of annual maintenance: ₹ 1,50,000.
d)​ Construction cost will be written off over 5 years being the useful life.
Assuming that the write-off of construction cost as aforesaid will be accepted for tax purposes, that the rate
of tax will be 50% and that desired rate of return is 15%, you are required to analyse the feasibility of the
proposal and make recommendations. The relevant Present Value Factors are:
Year 1 2 3 4 5
PV Factor 0.87 0.76 0.66 0.57 0.50

Question 51 - Pyq
Alpha Limited is a manufacturer of computers. It wants to introduce artificial intelligence while making
computers. The estimated annual saving from introduction of the artificial intelligence (AI) is as follows:
●​ Reduction of five employees with annual salaries of ₹ 3,00,000 each
●​ Reduction of ₹ 3,00,000 in production delays caused by inventory problem
●​ Reduction in lost sales ₹ 2,50,000 and
●​ Gain due to timely billing ₹ 2,00,000
The purchase price of the system for installation of artificial intelligence is ₹ 20,00,000 and installation cost is
₹ 1,00,000. 80% of the purchase price will be paid in the year of purchase and remaining will be paid in next
year.The estimated life of the system is 5 years and it will be depreciated on a straight -line basis.
However, the operation of the new system requires two computer specialists with annual salaries of ₹ 5,00,000
per person.
In addition to above, annual maintenance and operating cost for five years are as below:
Year 1 2 3 4 5
Maintenance & Operating Cost 2,00,000 1,80,000 1,60,000 1,40,000 1,20,000
Maintenance and operating costs are payable in advance.
The company's tax rate is 30% and its required rate of return is 15%.
Year 1 2 3 4 5
PVIF 0.10, t 0.909 0.826 0.751 0.683 0.621
PVIF 0.12, t 0.893 0.797 0.712 0.636 0.567
PVIF 0.15, t 0.870 0.756 0.658 0.572 0.497
Evaluate the project by using Net Present Value and Profitability Index.

Replacement + Incremental
Question 52 - Pyq
Excel Ltd. Manufacture a special chemical for sale at ₹ 30 per Kg. The variable cost of manufacture is ₹ 15 per
kg. Fixed cost excluding depreciation is ₹ 2,50,000. Excel Ltd. is currently operating at 50% capacity.
It can produce a maximum of 1,00,000 kgs. at full capacity.
The production manager suggests that if the existing machines are fully replaced, the company can achieve
maximum capacity in the next five years, gradually increasing the production by 10% per year.
The finance Manager estimates that for each 10% increase in capacity, the additional increase in fixed cost will
be ₹ 50,000. The existing machines with a current book value of ₹ 10,00,000 can be disposed of for ₹ 5,00,000.
The Vice President (finance) is willing to replace the existing machines provided the NPV on replacement is
about ₹ 4,53,000 at 15% cost of capital after tax.
(i) You are required to compute the total value of machines necessary for replacement.
For your exercise you may assume the following:
a)​ The company follows the block of assets concept and all the assets are in the same block. Depreciation
will be in a straight line basis and the same basis is allowed for tax purposes.
b)​ There will be no salvage value for the machines newly purchased. The entire cost of the assets will be
depreciated over a five years period.
c)​ Tax rate is at 40%
d)​ Cash inflows will arise at the end of the year.
e)​ Replacement outflow will be at beginning of the year (Year 0)
Year 0 1 2 3 4 5
Discount Factor at 15% 1 0.87 0.76 0.66 0.57 0.49
(ii) On the basis of data given above, the managing director feels that the replacement, if carried out, would
yield post tax return of 15% in the three years provided the capacity build up is 60%, 80% and 100%
respectively. Do you agree?

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Repair – Replace – Conflict

Question 53 - Pyq
S Engineering Company is considering replacing or repairing a particular machine, which has just broken
down. Last year this machine cost ₹ 20,000 to run and maintain. These costs have been increasing in real
terms in recent years with the age of the machine. A further useful life of 5 years is expected, if immediate
repairs of ₹ 19,000 are carried out. If the machine is not repaired it can be sold immediately to realise about ₹
5,000 (Ignore loss/gain on such disposal).
Alternatively, the company can buy a new machine for ₹ 49,000 with an expected life of 10 years with no
salvage value after providing depreciation on a straight line basis. In this case, running and maintenance costs
will reduce to ₹ 14,000 each year and are not expected to increase much in real terms for a few years at least.
S Engineering Company regards a normal return of 10% p.a. after tax as a minimum requirement on any new
investment. Considering capital budgeting techniques, which alternative will you choose? Take the corporate
tax rate of 50% and assume that depreciation on a straight line basis will be accepted for tax purposes also.
Given cumulative present value of Re. 1 p.a. at 10% for 5 years ₹ 3.791, 10 years ₹ 6.145.

Question 54 - Rtp
ABC & Co. is considering whether to replace an existing machine or to spend money on revamping it. ABC &
Co. currently pays no taxes. The replacement machine costs ₹ 18,00,000 now and requires maintenance of ₹
2,00,000 at the end of every year for eight years.
At the end of eight years, it would have a salvage value of ₹ 4,00,000 and would be sold.
The existing machine requires increasing amounts of maintenance each year and its salvage value fall each
year as follows:
Year Maintenance (₹) Salvage (₹)
Present 0 8,00,000
1 2,00,000 5,00,000
2 4,00,000 3,00,000
3 6,00,000 2,00,000
4 8,00,000 0
The opportunity cost of capital for ABC & Co. is 15%. You are required to advise:
When should the company replace the machine? The following present value table is given for you:
Year Present value of ₹ 1 at 15% discount rate
1 0.8696
2 0.7561
3 0.6575
4 0.5718
5 0.4972
6 0.4323
7 0.3759
8 0.3269

Retain or Replace – Incremental NPV

Question 55 - Pyq
An existing company has a machine which has been in operation for two years , its estimated remaining useful
life is 4 years with no residual value in the end. Its current Market value is ₨ 3 lakhs. The management is
considering a proposal to purchase an improved model of a machine which gives increased output.
The details are as under :
Particulars Existing Machine New Machine
Purchase price ₨ 6,00,000 ₨ 10,00,000
Estimated life 6 years 4 years
Residual value 0 0
Annual operating days 300 300
Operating hours per day 6 6
Selling price per unit ₨ 10 ₨ 10
Material cost per unit ₨2 ₨2
Output per hours in unit 20 40
Labour cost per hour ₨ 20 ₨ 30
Fixed overhead per annum excluding depreciation ₨ 1,00,000 ₨ 60,000

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 Chapter 5 - Investment Decision

Working capital ₨ 1,00,000 ₨ 2,00,000

Income tax rate 30% 30%
Assuming that the – cost capital is 10% and the company uses a written down value of depreciation @ 20%
and it has several machines in 20% block.
Advise the management on the Replacement of Machine as per the NPV method.
The discounting factors table given below :
Discounting factors Year 1 Year 2 Year 3 Year 4
10% 0.909 0.826 0.751 0.683

Question 56 - Mtp
WX Ltd. is considering a proposal to replace an existing machine.
The details of existing machine and new machine are as under:
Particulars Existing Machine New Machine
Cost of Machine ₹ 3,75,000 ₹ 5,25,000
Estimated life (in years) 10 5
Present Book value ₹ 1,87,500 -
(i)Out of the life of 10 years of the present machine, five years have already lapsed. The management can
continue with this machine for the remaining lifetime.
(ii)The activity level of both the machines is the same.
(iii)Residual value of the new machine at the end of the life - ₹. 60,000.
(iv)There will be a saving of ₹. 2,40,000 in the variable cost each year by new machine.
(v)If the old machine is sold, then it will fetch ₹. 90,000.
(vi)WX Ltd. expects a minimum return of 11 % on the investment.
(vii)Corporate tax - 30%
(viii)No depreciation is to be charged in the year of sale.
(ix)Present value of ₹. 1 @ 11% is as under:
Year 1 2 3 4 5
P/V Factor 0.901 0.812 0.731 0.659 0.593
You are required to comment on the suitability of replacement of the old machine.

Only outflow & unequal life

Question 57 - Pyq
Company X is forced to choose between two machines A and B. The two machines are designed differently,
but have identical capacity and do exactly the same job. Machine A costs ₹ 1,50,000 and will last for 3 years. It
costs ₹ 40,000 per year to run. Machine B is an ‘economy’ model costing only ₹ 1,00,000, but will last only for 2
years, and costs ₹ 60,000 per year to run. These are real cash flows. The costs are forecasted in rupees of
constant purchasing power. Ignore tax. Opportunity cost of capital is 10 percent.
Which machine company X should buy?

Question 58 - Pyq
A Company is required to choose between two machines A and B. The two machines are designed differently,
but have identical capacity to do exactly the same job.
Machine A costs ₹ 6,00,000 and will last for 3 years. It costs ₹ 1,20,000 per year to run.
Machine B is an Economy Model costing ₹ 4,00,000 but will last only for two years, and cost ₹ 1,80,000 per
year to run. These are real cash flows. The costs are forecasted in rupees of constant purchasing power.
Opportunity Cost of Capital is 10%. Which Machine should the Company buy? Ignore tax.
Given: PVIF0.10,1= 0.9091, PVIF0.10,2 = 0.8264, PVIF0.10,3= 0.7513.

Question 59 - Pyq
A firm is in need of a small vehicle to make deliveries. It is intended to choose between two options.
One option is to buy a new three wheeler that would cost ₹ 1,50,000 and will remain in service for 10 years.
The other alternative is to buy a second hand vehicle for ₹ 80,000 that could remain in service for 5 years.
Thereafter the firm can buy another second hand vehicle for ₹ 60,000 that will last for another 5 years.
The scrap value of the discarded vehicle will be equal to its written down value (WDV). The firm pays 30% tax
and is allowed to claim depreciation on vehicles @ 25% on WDV basis.
The cost of capital of the firm is 12%. You are required to advise the best option. Given:

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t 1 2 3 4 5 6 7 8 9 10
PVIF (t,12%) 0.892 0.797 0.711 0.635 0.567 0.506 0.452 0.403 0.360 0.322

Replacing Part or Servicing

Question 60 - Pyq
(a) A company wants to invest in machinery that would cost ₹ 50,000 at the beginning of year 1. It is estimated
that the net cash inflows from operations will be ₹ 18,000 per annum for 3 years, if the company opts to
service a part of the machine at the end of year 1 at ₹ 10,000. In such a case, the scrap value at the end of year
3 will be ₹ 12,500. However, if the company decides not to service the part, then it will have to be replaced at
the end of year 2 at ₹ 15,400. But in this case, the machine will work for the 4th year also and get an
operational cash inflow of ₹ 18,000 for the 4th year. It will have to be scrapped at the end of year 4 at ₹ 9,000.
Assuming cost of capital at 10% and ignoring taxes, will you recommend the purchase of this machine based
on the net present value of its cash flows?
(b) If the supplier gives a discount of ₹ 5,000 for purchase, what would be your decision?
(The present value factors at the end of years 0,1,2,3,4,5 and 6 are respectively 1, 0.9091, 0.8264, 0.7513,
0.6830, 0.6209 and 0.5644).

Question 61 - Mtp
Rambow Ltd. is contemplating purchasing machinery that would cost ₹ 10,00,000 plus GST @ 18% at the
beginning of year 1. Cash inflows after tax from operations have been estimated at ₹ 2,56,000 per annum for 5
years.
The company has two options for the smooth functioning of the machinery - one is service, and another is
replacement of parts. The company has the option to service a part of the machinery at the end of each of the
years 2 and 4 at ₹ 1,00,000 plus GST @ 18% for each year. In such a case, the scrap value at the end of year 5
will be ₹ 76,000. However, if the company decides not to service the part, then it will have to be replaced at the
end of year 3 at ₹ 3,00,000 plus GST@ 18% and in this case, the machinery will work for the 6th year also and
get operational cash inflow of ₹ 1,86,000 for the 6th year. It will have to be scrapped at the end of year 6 at ₹
1,36,000.Assume cost of capital at 12% and GST paid on all inputs including capital goods are eligible for input
tax credit in the same month as and when incurred.
(i) DECIDE whether the machinery should be purchased under option 1 or under option 2 or it
shouldn’t be purchased at all.
(ii) If the supplier gives a discount of ₹ 90,000 for purchase, WHAT would be your decision?
Note: The PV factors at 12% are:
Year 0 1 2 3 4 5 6
PV Factor 1 0.8928 0.7972 0.7118 0.6355 0.5674 0.5066

Labour Savings by Utilisation of Machine

Question 62 - Study Material
An investment in new machinery is being considered. The machine will cost ₹ 80,000 and will last for seven
years. It is expected to yield savings in raw material cost of ₹ 8,000 p.a. (due to lower wastage) and it is hoped
also to achieve labour savings of ₹ 14,000 p.a., however the arrangement has not yet been discussed with the
trade union. The company’s cost of capital is 12%. What percentage change in the estimated labour savings
will render the project not viable? Given that the present value of an annuity for 7 years at 12% = ₹ 4.564.

Waste processed and sold

Question 63 - Pyq
A chemical company is presently paying an outside firm ₹ 1 per gallon to dispose off the waste resulting from
its manufacturing operations. At normal operating capacity, the waste is about 50,000 gallons per year.
After spending ₹ 60,000 on research, the company discovered that the waste could be sold for ₹ 10 per gallon
if it was processed further. Additional processing would, however, require an investment of ₹ 6,00,000 in new
equipment, which would have an estimated life of 10 years with no salvage value. Depreciation would be
calculated by a straight line method.
Except for the costs incurred in advertising ₹ 20,000 per year, no change in the present selling and
administrative expenses is expected, if the new product is sold.
The details of additional processing costs are as follows:
Variable : ₹ 5 per gallon of waste put into process.
Fixed : (Excluding Depreciation) ₹ 30,000 per year.

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 Chapter 5 - Investment Decision

There will be no losses in processing, and it is assumed that the total waste processed in a given year will be
sold in the same year. Estimates indicate that 50,000 gallons of the product could be sold each year.
The management, when confronted with the choice of disposing off the waste or processing it further and
selling it, seeks your advice. Which alternative would you recommend? Assume that the firm's cost of capital is
15% and it pays on an average 50% Tax on its income.
You should consider the Present value of Annuity of ₹ 1 per year @ 15% p.a. for 10 years as 5.019.

New product introduced

Question 64 - Pyq
PD Ltd. an existing company, is planning to introduce a new product with a projected life of 8 years.
Project cost will be ₹ 2,40,00,000. At the end of 8 years no residual value will be realized. Working capital of
₹ 30,00,000 will be needed.
The 100% capacity of the project is 2,00,000 units p.a. but the Production and Sales Volume is expected are as
under :
Year Number of Units
1 60,000 units
2 80,000 units
3-5 1,40,000 units
6-8 1,20,000 units
Other Information:
(i)​ Selling price per unit ₹ 200
(ii)​ Variable cost is 40% of sales.
(iii)​Fixed cost p.a. ₹ 30,00,000.
(iv)​In addition to these advertisement expenditure will have to be incurred as under:
Year 1 2 3-5 6-8
Expenditure 50,00,000 25,00,000 10,00,000 5,00,000
(v) Income Tax is 25%.
(vi) A straight line method of depreciation is permissible for tax purposes.
(vii) Cost of capital is 10%.
(viii) Assume that loss cannot be carried forward.
Present Value Table
Year 1 2 3 4 5 6 7 8
PVF @ 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467
Advise about the project acceptability.

Investment at Different Point of time – NPV Based Evaluation

Question 65 - Pyq
X Ltd. an existing profit-making company, is planning to introduce a new product with a projected life of 8
years. Initial equipment cost will be ₹ 120 lakhs and additional equipment costing ₹ 10 lakhs will be needed at
the beginning of third year. At the end of the 8 years, the original equipment will have resale value equivalent to
the cost of removal, but the additional equivalent would be sold for ₹ 1 lakh. Working Capital of ₹ 15 lakhs will
be needed.
The 100% capacity of the plant is of 4,00,000 units per annum, but the production and sales-volume expected
are as under:
Year Capacity in percentage
1 20
2 30
3-5 75
6-8 50
A sale price of ₹ 100 per unit with a profit-volume ratio of 60% is likely to be obtained. Fixed Operating Cash
Cost are likely to be ₹ 16 lakhs per annum.
In addition to this the advertisement expenditure will have to be incurred as under
Year 1 2 3-5 6–8
Expenditure in ₹ lakhs each year 30 15 10 4
The company is subject to 50% tax, straight-line method of depreciation, (permissible for tax purposes also)
and taking 12% as appropriate after tax cost of capital, should the project be accepted?

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 Chapter 5 - Investment Decision

Question 66 - Study Material

XYZ Ltd. is planning to introduce a new product with a project life of 8 years. Initial equipment cost will be
₹ 3.5 crores. Additional equipment costing ₹ 25,00,000 will be purchased at the end of the third year from the
cash inflow of this year. At the end of 8 years, the original equipment will have no resale value, but additional
equipment can be sold for ₹ 2,50,000. A working capital of ₹ 40,00,000 will be needed and it will be released at
the end of eighth year. The project will be financed with a sufficient amount of equity capital.
The sales volumes over eight years have been estimated as follows:
Year 1 2 3 4-5 6-8
Units 72,000 1,08,000 2,60,000 2,70,000 1,80,000
A sales price of ₹ 240 per unit is expected and variable expenses will amount to 60% of sales revenue. Fixed
cash operating costs will amount ₹ 36,00,000 per year. The loss of any year will be set off from the profits of
subsequent two years. The company is subject to a 30 per cent tax rate and considers 12 per cent to be an
appropriate after tax cost of capital for this project. The company follows a straight line method of
depreciation.
CALCULATE the net present value of the project and advise the management to take appropriate decisions.
Note:The PV factors at 12% are
Year 1 2 3 4 5 6 7 8
PV Factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404

Selection based on NPV

Question 67 - Study Material
Elite Cooker Company is evaluating three investment situations:
(1) Produce a new line of aluminium skillets, (2) expand its existing cooker line to include several new sizes,
(3) develop a new, higher-quality line of cookers.
If only the project in question is undertaken, the expected present value and the amounts of investment
required are:
Project Investment required (₹) Present value of Future Cash-Flows (₹)
1 2,00,000 2,90,000
2 1,15,000 1,85,000
3 2,70,000 4,00,000
If projects 1 and 2 are jointly undertaken, there will be no economies; the investment required and preset value
will simply be the sum of the parts. With projects 1 and 3, economies are possible in investment because one
of the machines acquired can be used in both production processes. The total investment required for
projects 1 and 3 combined is ₹ 4,40,000.If projects 2 and 3 are undertaken, there are economies to be
achieved in Marketing and producing the products but not in investment. The expected present value of future
cash flows for projects 2 and 3 is ₹ 6,20,000. If all three projects are undertaken simultaneously, the
economies noted will still hold. However, a ₹ 1,25,000 extension on the plant will be necessary, as space is not
available for all three projects. Which project or projects should be chosen?

Question 68 - Pyq
CK Ltd. is planning to buy a new machine.
Details of which are as follows:
Cost of the Machine at the commencement : ₹ 2,50,000
Economic Life of the Machine : 8 year
Residual Value : Nil
Annual Production Capacity of the Machine : 1,00,000 units
Estimated Selling Price per unit :₹6
Estimated Variable Cost per unit :₹3
Estimated Annual Fixed Cost (Excluding depreciation) : ₹ 1,00,000
Advertisement Expenses in 1st year in addition of annual fixed cost : ₹ 20,000
Maintenance Expenses in 5th year in addition of annual fixed cost : ₹ 30,000
Cost of Capital : 12%
Ignore Tax.
Analyse the above mentioned proposal using the Net Present Value Method and advice.
P.V. factor @ 12% are as under:
Year 1 2 3 4 5 6 7 8
PV Factor 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404

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 Chapter 5 - Investment Decision

Capital Rationing
Question 69 - Pyq
A company has ₹ 1,00,000 available for investment and has identified the following four investments in which
to invest:
Project Investment (₹) NPV (₹)
C 40,000 20,000
D 1,00,000 35,000
E 50,000 24,000
F 60,000 18,000
You are required to optimize the returns from a package of projects within the capital spending limit if:
(i)​ The projects are independent of each other and are divisible.
(ii)​ The projects are not divisible

Question 70 - Pyq
S. Ltd. has ₹ 10,00,000 allocated for capital budgeting purposes.
The following proposals and associated profitability indexes have been determined.
Project Amount (₹) Profitability Index (₹)
1 3,00,000 1.22
2 1,50,000 0.95
3 3,50,000 1.20
4 4,50,000 1.18
5 2,00,000 1.20
6 4,00,000 1.05
Which of the above investments should be undertaken? Assume that projects are indivisible and there is no
alternative use of the money allocated for capital budgeting.

Question 71 - Pyq
Venture Ltd. has ₹ 30 lakhs available for investment in capital projects. It has the option of making investment
in projects 1, 2, 3 and 4. Each project is entirely independent and has a useful life of 5 years.
The expected present values of cash flows from the projects are as follows:
Projects Initial outlay (₹) Present value of Cash Inflows (₹)
1 8,00,000 10,00,000
2 15,00,000 19,00,000
3 7,00,000 11,40,000
4 13,00,000 20,00,000
Which of the above investments should be undertaken? Assume that the cost of capital is 12% and risk free
interest rate is 10% per annum. Given compounded sum of Re. 1 at 10% in 5 years is ₹ 1.611 and discount
factor of Re. 1 at 12% rate for 5th year is 0.567.

Question 72 - Study Material

Shiva Limited is planning its capital investment programme for next year.
It has five projects all of which give a positive NPV at the company cut-off rate of 15 percent, the investment
outflows and present values being as follows:
Project Investment (₹ '000) NPV @ 15% (₹ '000)
A (50) 15.4
B (40) 18.7
C (25) 10.1
D (30) 11.2
E (35) 19.3
The company is limited to a capital spending of ₹ 1,20,000.You are required to optimize the returns from a
package of projects within the capital spending limit.
The projects are independent of each other and are divisible (i.e., part-project is possible).

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 Chapter 5 - Investment Decision

Traditional approach
Question 73 - Mtp
Superb Ltd. constructs customized parts for satellites to be launched by the USA and Canada. The parts are
constructed in eight locations (including the central headquarters) around the world.
The Finance Director, Ms. Kuthrapali, chooses to implement video conferencing to speed up the budget
process and save travel costs. She finds that, in earlier years, the company sent two officers from each
location to the central headquarters to discuss the budget twice a year. The average travel cost per person,
including airfare, hotels and meals, is ₹ 27,000 per trip. The cost of using video conferencing is ₹ 8,25,000 to
set up a system at each location plus ₹ 300 per hour average cost of telephone time to transmit signals. A
total 48 hours of transmission time will be needed to complete the budget each year. The company
depreciates this type of equipment over five years by using a straight line method. An alternative approach is
to travel to local rented video conferencing facilities, which can be rented for ₹ 1,500 per hour plus ₹ 400 per
hour average cost for telephone charges. You are a Senior Officer of the Finance Department.
You have been asked by Ms. Kuthrapali to EVALUATE the proposal and SUGGEST if it would be worthwhile for
the company to implement video conferencing.

Margin Of SafetyTopics
Choice of machine to be purchased
Question 74 - Mtp
GG Pathology Lab Ltd. is using a 2D sonography machine which has reached the end of its useful life.
The lab is intending to upgrade along with the technology by investing in a 3D sonography machine as per the
choices preferred by the patients.
Following new 3D sonography machine of two different brands with same features is available in the Market:
Brand Cost of machine Life of machine Maintenance Cost (₹.) SLM
Depreciation rate
(₹.) (₹.) Year 1-5 Year 6-10 Year 11-15 (%)
X 15,00,000 15 50,000 70,000 98,000 6
Y 10,00,000 10 70,000 1,15,000 - 6
Residual Value of machines shall be dropped by 10% and 40% of Purchase price for Brand X and Y respectively
in the first year and thereafter shall be depreciated at the rate mentioned above on the original cost.
Alternatively, the machine of Brand Y can also be taken on rent to be returned back to the owner after use on
the following terms and conditions:
●​ Annual Rent shall be paid at the beginning of each year and for the first year it shall be ₹. 2,24,000. Annual
Rent for the subsequent 4 years shall be ₹. 2,25,000.
●​ Annual Rent for the final 5 years shall be ₹. 2,70,000.
●​ The Rent/Agreement can be terminated by GG Labs by making a payment of ₹. 2,20,000 as penalty.
●​ This penalty would be reduced by ₹. 22,000 each year of the period of rental agreement.
You are required to:
(i) ADVISE which brand of 3D sonography machine should be acquired assuming that the use of the machine
shall be continued for a period of 20 years.
(ii) STATE which of the options is most economical if the machine is likely to be used for a period of 5 years?
The cost of capital of GG Labs is 12%.
The present value factor of ₹. 1 @ 12% for different years is given as under:
Year PVF Year PVF
1 0.893 9 0.361
2 0.797 10 0.322
3 0.712 11 0.287
4 0.636 12 0.257
5 0.567 13 0.229
6 0.507 14 0.205
7 0.452 15 0.183
8 0.404 16 0.163

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 Chapter 6 - Dividend Decision

Chapter 6
Dividend Decisions
Walter Model
Question 1 - Study Material
The following figures are collected from the annual report of XYZ Ltd.:
Net Profit ₹ 30 lakhs
Outstanding 12% preference shares ₹ 100 lakhs
No. of equity shares 3 lakhs
Return on Investment 20%
Cost of capital i.e. (Ke) 16%
COMPUTE the approximate dividend pay-out ratio so as to keep the share price at ₹ 42 by using Walter’s
model?

Question 2 - Study Material

The following information pertains to M/s XY Ltd.
Earnings of the Company 5,00,000
Dividend Payout ratio 60%
No. of shares outstanding 1,00,000
Equity capitalization rate 12%
Rate of return on investment 15
CALCULATE:
(i)​ What would be the market value per share as per Walter’s model?
(ii)​ What is the optimum dividend payout ratio according to Walter’s model and the market value of Company’s
share at that payout ratio?

Question 3 - Study Material

The following information is supplied to you:
Total Earnings 2,00,000
No. of equity shares (of ₹ 100 each) 20,000
Dividend paid 1,50,000
Price/ Earnings ratio 12.5
Applying Walter’s Model
(i)​ ANALYSE whether the company is following an optimal dividend policy.
(ii)​ COMPUTE P/E ratio at which the dividend policy will have no effect on the value of the share.
(iii)​Will your decision change, if the P/E ratio is 8 instead of 12.5? ANALYSE

Question 4 - Rtp
The earnings per share of a company is ₹ 10 and the rate of capitalisation applicable to it is 10 percent.
The company has three options of paying dividend i.e. (i) 50%, (ii) 75% and (iii) 100%.
CALCULATE the market price of the share as per Walter’s model if it can earn a return of (a) 15, (b) 10 and (c)
5 per cent on its retained earnings.

Question 5 - Rtp
The following figures have been collected from the annual report of ABC Ltd. for the current financial year:
Net Profit ₹ 75 lakhs
Outstanding 12% preference shares ₹ 250 lakhs
No. of equity shares 7.50 lakhs
Return on Investment 20%
Cost of capital i.e. (Ke) 16%
(a) COMPUTE the approximate dividend pay-out ratio so as to keep the share price at ₹ 42 by using Walter’s
model?
(b) DETERMINE the optimum dividend pay-out ratio and the price of the share at such pay-out.
(c) PROVE that the dividend pay-out ratio as determined above in (b) is optimum by using random pay-out
ratio.

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 Chapter 6 - Dividend Decision

Question 6 - Pyq
Following figures and information were extracted from the company A Ltd:
Earnings of the company ₹ 10,00,000
Dividend paid ₹ 6,00,000
No. of shares outstanding 2,00,000
Price Earnings Ratio 10
Rate of return on investment 20%
You are required to calculate:
(i) Current Market price of the share
(ii)Capitalisation rate of its risk class
(iii)What should be the optimum pay-out ratio?
(iv)What should be the market price per share at an optimal pay-out ratio? (use Walter’s Model)

Gordon Model
Question 7 - Study Material, Mtp
The following figures are collected from the annual report of XYZ Ltd.:
Net Profit ₹ 30 lakhs
Outstanding 12% preference shares ₹ 100 lakhs
No. of equity shares 3 lakhs
Return on Investment 20%
Cost of capital i.e. (Ke) 16%
CALCULATE price per share using Gordon’s Model when dividend pay-out is:
(i) 25%;
(ii) 50% and
(iii) 100%.

Question 8 - Study Material

A firm had been paid a dividend at ₹ 2 per share last year.
The estimated growth of the dividends from the company is estimated to be 5% p.a.
DETERMINE the estimated market price of the equity share if the estimated growth rate of dividends
(i) rises to 8%, and (ii) falls to 3%.
Also FIND OUT the present market price of the share, given that the required rate of return of the equity
investors is 15%.

Question 9 - Study Material

Again taking an example of three different firms i.e. growth, normal and declining firm.
CALCULATE the Gordon’s model with the help of a following example:
Factors Growth Firm Normal Firm Declining Firm
r > Ke r = Ke r < Ke
r (rate of return on retained earnings) 15% 10% 8%
Ke (Cost of Capital) 10% 10% 10%
E (Earning Per Share) ₹ 10 ₹ 10 ₹ 10
b (Retained Earnings) 0.6 0.6 0.6
1- b 0.4 0.4 0.4

Question 10 - Mtp
The annual report of XYZ Ltd. provides the following information for the Financial Year 2019-20:
Particulars Amount (₹)
Net Profit 78 lakhs
Outstanding 15% preference shares 120 lakhs
No. of equity shares 6 lakhs
Return on Investment 20%
Cost of capital i.e. (Ke) 16%
Calculate price per share using Gordon’s Model when dividend pay-out is-
1. 30%; 2. 50%; 3. 100%.

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 Chapter 6 - Dividend Decision

Multi Method
Question 11 - Study Material
With the help of following figures CALCULATE the market price of a share of a company by using:
(i) Walter’s formula
(ii) Dividend growth model (Gordon’s formula)
Earnings per share (EPS) ₹ 10
Dividend per share (DPS) ₹6
Cost of capital (Ke) 20%
Internal rate of return on investment 25%
Retention Ratio 40

Question 12 - Mtp
Following information is given for WN Ltd.:
Earnings ​ : ₹ 30 per share
Dividend ​ : ₹ 9 per share
Cost of capital ​ : 15%
Internal Rate of Return on investment : 20%
You are required to Calculate the market price per share using-
1.​ Gordon’s formula
2.​ Walter’s formula

Question 13 - Pyq
The following information is supplied to you:
Total Earning ₹ 40 lakhs
No. of Equity Shares (of ₹ 100 each) 4,00,000
Dividend Per Share ₹4
Cost of Capital 16%
Internal rate of return on investment 20%
Retention ratio 60%
Calculate the market price of a share of a company by using :
(i) WaIter’s Formula (ii) Gordon's Formula

Gordon Multiple Growth Rate

Question 14 -
MNP Ltd. Has declared and paid an annual dividend of ₹ 4 per share. It is expected to grow @ 20% for the next
two years and 10% thereafter. The required rate of return of equity investors is 15%.
Compute the current price at which equity shares should sell.
Note: present value interest factor (PVIF) @ 15% for
Year 1: 0.8696
Year 2: 0.7561

Question 15 -
A company is currently paying a dividend of ₹ 2.00 per share. The dividend is expected to grow at a 15%
annual rate for three years, then at 10% rate for the next three years, after which it is expected to grow at a 5%
rate forever. What is the present value of the share if the capitalization rate is 9%?

Question 16 -
D Ltd. Is foreseeing a growth rate of 12% per annum in the next two years.
The growth rate is likely to be 10% for the third and fourth year.
After that, the growth rate is expected to stabilise at 8% per annum.
If the last dividend was ₹ 1.50 per share and the investor’s required rate of return is 16%, determine the current
value of equity share of the company.
The P.V. factors at 16% are:
Year 1 2 3 4
PVF 0.862 0.743 0.641 0.552

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 Chapter 6 - Dividend Decision

Question 17 - Pyq
X Ltd. is a multinational company. Current market price per share is ₹ 2,185.
During the F.Y. 2020-21, the company paid ₹ 140 as dividend per share.
The company is expected to grow @ 12% p.a. for the next four years, then 5% p.a. for an indefinite period.
Expected rate of return of shareholders is 18% p.a.
(i) Find out intrinsic value per share.
(ii) State whether shares are overpriced or underpriced.
Year 1 2 3 4 5
Discounting Factor @ 18% 0.847 0.718 0.608 0.515 0.436

Question 18 - Pyq
Vista Limited’s retained earnings per share for the year ending 31.03.2023 being 40% is ₹3.60 per share. The
company is foreseeing a growth rate of 10% per annum in the next two years. After that the growth rate is
expected to stabilize at 8% per annum. The company will maintain its existing pay-out ratio. If the investor’s
required rate of return is 15%, Calculate the intrinsic value per share as of date using Dividend Discount model.

MM Approach (Dividend Irrelevance)

Question 19 - Study Material
AB Engineering Ltd. belongs to a risk class for which the capitalization rate is 10%. It currently has outstanding
10,000 shares selling at ₹ 100 each. The firm is contemplating the declaration of a dividend of ₹ 5/ share at
the end of the current financial year. It expects to have a net income of ₹ 1,00,000 and has a proposal for
making new investments of ₹ 2,00,000. CALCULATE the value of the firms when dividends:
(i) are not paid (ii) are paid.

Question 20 - Study Material

RST Ltd. has a capital of ₹ 10,00,000 in equity shares of ₹ 100 each. The shares are currently quoted at par.
The company proposes to declare a dividend of ₹ 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
(i)​ Dividend is not declared ?
(ii)​ Dividend is declared ?
(iii)​Assuming that the company pays the dividend and has net profits of ₹ 5,00,000 and makes new
investments of ₹ 10,00,000 during the period, how many new shares must be issued? Use the MM model.

Question 21 -
A chemical company belongs to a risk – class for which the appropriate P/E Ratio is 10. It currently has 50,000
equity shares (outstanding) selling at ₹ 100 each. The firm is contemplating declaring a dividend of ₹ 8 per
share at the current fiscal year, which has just started.
Given the assumption of MM, answer the following questions:
(i) What will be the price of the share at the end of the year
a) If dividend is not declared, and
b) If it is declared?
(ii) Assuming that the company pays the dividend, has a net income (Y) of ₹ 5,00,000 and makes new
investments of ₹ 10,00,000 during the period, how many new shares must be issued?

Question 22 - Rtp
Ordinary shares of a listed company are currently trading at ₹ 10 per share with two lakh shares outstanding.
The company anticipates that its earnings for next year will be
₹ 5,00,000. The existing cost of capital for equity shares is 15%. The company has certain investment
proposals under discussion which will cause an additional 26,089 ordinary shares to be issued if no dividend
is paid or an additional 47,619 ordinary shares to be issued if dividend is paid.
Applying the MM hypothesis on dividend decisions, Calculate the amount of investment and dividend that is
under consideration by the company.

Question 23 - Rtp
Aakash Ltd. has 10 lakh equity shares outstanding at the start of the accounting year 2021. The existing
market price per share is ₹ 150. Expected dividend is ₹ 8 per share . The rate of capitalization appropriate to
the risk class to which the company belongs is 10%.

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 Chapter 6 - Dividend Decision

(i) Calculate the market price per share when expected dividends are : (a) declared , and (b) not declared ,
based on the Miller – Modigliani approach.
(ii) Calculate number of shares to be issued by the company at the end of the accounting year on the
assumption that the net income for the year is ₹ 3 crore , investment budget is ₹ 6 crores, when (a) Dividends
are declared, and (b) Dividends are not declared.
(iii) Proof that the market value of the shares at the end of the accounting year will remain unchanged
irrespective of whether (a) Dividends are declared , or (ii) Dividends are not declared.

Question 24 - Mtp
M Ltd. belongs to a risk class for which the capitalization rate is 12%. It has 40,000 outstanding shares and the
current market price is ₹ 200. It expects a net profit of ₹ 5,00,000 for the year and the Board is considering a
dividend of ₹ 10 per share.
M Ltd. requires to raise ₹ 10,00,000 for an approved investment expenditure.
ILLUSTRATE, how the MM approach affects the value of M Ltd. if dividends are paid or not paid.

Miscellaneous Questions
Question 25 - Study Material
Mr H is currently holding 1,00,000 shares of HM ltd, and currently the share of HM ltd is trading on Bombay
Stock Exchange at ₹ 50 per share. Mr A has a policy to re-invest the amount of any dividend received into the
shared back again of HM ltd. If HM ltd has declared a dividend of ₹ 10 per share, please determine the number
of shares that Mr A would hold after he re-invests dividend in shares of HM ltd.

Question 26 - Study Material

Following information is given pertaining to DG ltd,
No of Shares outstanding : 1 lakh shares
Earnings Per share : ₹ 25 per share
P/E Ratio : 20
Book Value per share : ₹ 400 per share
If a company decides to repurchase 5,000 shares, at the prevailing market price, what is the resulting book
value per share after repurchasing.

Question 27 - Rtp
HM Ltd. is listed on Bombay Stock Exchange which is currently being evaluated by Mr. A on certain
parameters.
Mr. A collated following information:
(a)​ The company generally gives a quarterly interim dividend. ₹ 2.5 per share is the last dividend declared.
(b) The company’s sales are growing by 20% on a 5-year Compounded Annual Growth Rate (CAGR) basis,
however the company expects following retention amounts against probabilities mentioned as contention is
dependent upon cash requirements for the company. Rate of return is 10% generated by the company.
Situation Prob. Retention Ratio
A 30% 50%
B 40% 60%
C 30% 50%
(c) The current risk-free rate is 3.75% and with a beta of 1.2. The company is having a risk premium of 4.25%.
You are required to help Mr. A in calculating the current market price using Gordon’s formula.

Question 28 - Rtp
Mr. A had gathered the following information for his analysis:
(A)​A Company pays regular dividend on quarterly basis and the last interim dividend declared for the quarter
was ₹ 3 per share
(B)​Owing to a wide market reach and presence, the company's turnover has seen an annual compounded
growth of 25% (CAGR) in the last 5 years and the turnover is expected to grow at the same rate in the
future as well. The company expects the following Rate of Return (ROI) against the probabilities of likely
achievement mentioned along with in different situations.
Scenario ROI Probability
I 20% 0.30
II 15% 0.60
III 12% 0.50

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 Chapter 6 - Dividend Decision

(C) The retention ratio over the last 5 years has been 40%, 65%, 50%, 45%, 30% respectively and the company
plans to retain based on the past average.
(D) The current interest rate on GOI Treasury bond is at 4.5% and the beta of the company is 1.3 and a market
return of 12.5%
You are required to CALCULATE the theoretical market price of the company’s share for Mr. A’s
decision-making using Gordon’s model and Walter’s model.

Margin of safety Topics

Graham Dodd
Question 29 - Study Material
The earnings per share of a company is ₹ 30 and dividend payout ratio is 60%. Multiplier is 2.
DETERMINE the price per share as per Graham & Dodd model.

Question 30 - Study Material

The following information regarding the equity shares of M Ltd. is given below:
Market price ₹ 58.33
Dividend per share ₹5
Multiplier 7
According to the Graham & Dodd approach to the dividend policy, COMPUTE the EPS.

Question 31 - Study Material

The dividend payout ratio of H Ltd. is 40%. If the company follows a traditional approach to dividend policy
with a multiplier of 9, COMPUTE P/E ratio.

Linter Model
Question 32 - Study Material
Given the last year’s dividend is ₹ 9.80, speed of adjustment = 45%, target payout ratio 60% and EPS for current
year ₹ 20. COMPUTE current year’s dividend using Linter’s model.

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 Chapter 7 (7A) - Introduction to Working Capital

Chapter 7 (7A)
Introduction to Working Capital
Operating Cycle
Question 1 - Pyq
Following information is forecasted by CS Limited for the year ending 31st March:
Particulars Opening Balance (₹ ) Closing Balance (₹ )
Raw Materials 45,000 65,356
Work-in-Progress 35,000 51,300
Finished Goods 60,181 70,175
Debtors 1,12,123 1,35,000
Creditors 50,079 70,469

Other Particulars Amount (₹ )

Annual Purchases of Raw Material (all credit) 4,00,000
Annual Cost of Production 7,50,000
Annual Operating Cost 9,50,000
Annual Sales (all credit) 11,00,000
Annual Cost of Goods Sold 9,15,000
Take 1 year = 365 days. Calculate the following:
(1) Net Operating Cycle Period,
(2) Number of Operating Cycles in a year, and
(3) Amount of Working Capital required.

Question 2 - Pyq
The following information is available for SK Limited for the year ended on 31st March,2024:
Particulars ₹
Cost of production 15,48,000
Cost of goods sold 14,61,000
Average stock of work-in-progress 94,600
Average stock of finished goods 2,43,500
Administration and Selling expenses 4,14,000
Receivables collection period 36 days
Raw Material Storage period 65 days
Creditors payment period 63 days
You are required to calculate the working capital requirement by operating cycle method.
Assume a 360 days year.

Question 3 - Study Material

From the following information of XYZ Ltd., you are required to calculate:
(a) Net Operating cycle period
(b) Number of Operating cycles in years.
Raw material inventory consumed during the year ₹ 6,00,000
Average stock of raw material ₹ 50,000
Work-in-Progress Inventory ₹ 5,00,000
Average Work-in-Progress Inventory ₹ 30,000
Finished Goods Inventory ₹ 8,00,000
Average Finished Goods stock held ₹ 40,000
Average Collection Period from Debtors 45 Days
Average Credit Period Availed 30 Days
No. of days in a year 360 Days

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 Chapter 7 (7A) - Introduction to Working Capital

Question 4 -
The following data are available for Gama Limited.
Particulars 1995 (₹ In Lakhs)
Opening Balance of
a) Raw materials, stores etc. 80
b) Work-in-Progress 20
c) Finished goods 90
d) Book debts 140
e) Trade Creditors 80
Closing Balance of
a) Raw materials, stores etc. 85
b) Work-in-Progress 24
c) Finished goods 100
d) Book debts 150
e) Trade Creditors 105
Purchase of Raw materials, Stores etc. 300
Consumption of Raw materials, Stores etc. 295
Manufacturing expenses 145
Depreciation 20
Quality control cost 60
Administration & Financial and Selling costs 80
Sales 800
Calculate the duration of:
(i) Raw materials and stores storage period (ii) Work-in-Progress period (iii) Finished goods storage period
(iv) Debtors collection period. (v) Creditors payment period (vi) Operating cycle.

Question 5 -
The following data relating to a consumer goods manufacturing Firm is available for the year ended 31st
March.
Debtors Collection Period 30 days
Advance payment to Creditors 5 days
Total Cash Operating Expenses per annum
(60% of the Total Cash Operating Expenses are due to Raw Material) ₹ 600 lakhs
Number of days Raw Materials in storage 30 days
Average Credit period from Suppliers 50 days
Conversion Process Period 12 days
Finished Goods Storage Period 45 days
Determine the Average Cash Working Capital needed by the Firm at any point of time during the year,
assuming that the Firm wants to carry a Cash Balance of ₹ 10 Lakhs at all the time.

Question 6 - Rtp
Trading and Profit and Loss Account of Beat Ltd. for the year ended 31st March, 2022 is given below:
Particulars Amount Amount Particulars Amount Amount
To Opening Stock: By Sales (Credit) 1,60,00,000
- Raw Materials 14,40,000 By Closing Stock:
- Work-in- progress 4,80,000 - Raw Materials 16,00,000
- Finished Goods 20,80,000 40,00,000 - Work-in-progress 8,00,000
To Purchases (credit) 88,00,000 - Finished Goods 24,00,000 48,00,000
To Wages 24,00,000
To Production Exp. 16,00,000
To Gross Profit c/d 40,00,000
2,08,00,000 2,08,00,000
To Administration Exp. 14,00,000 By Gross Profit b/d 40,00,000
To Selling Exp. 6,00,000
To Net Profit 20,00,000
40,00,000 40,00,000

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 Chapter 7 (7A) - Introduction to Working Capital

The opening and closing payables for raw materials were ₹ 16,00,000 and ₹ 19,20,000 respectively whereas
the opening and closing balances of receivables were ₹ 12,00,000 and ₹ 16,00,000 respectively.
You are required to ASCERTAIN the working capital requirement by operating cycle method.

Question 7 - Pyq
The following information is provided by MNP Ltd. for the year ending 31st March, 2020:
Raw Material Storage period 45 days
Work-in-Progress conversion period 20 days
Finished Goods storage period 25 days
Debt Collection period 30 days
Creditors payment period 60 days
Annual Operating Cost ₹ 25,00,000
(Including Depreciation of ₹ 2,50,000)
Assume 360 days in a year. You are required to calculate:
(i)Operating Cycle period (ii)Number of Operating Cycle in a year.
(iii)Amount of working capital required for the company on a cost basis.
(iv)The company is a market leader in its product, and it has no competitor in the market. Based on a market
survey it is planning to discontinue sales on credit and deliver products based on pre-payments in order to
reduce its working capital requirement substantially.
You are required to compute the reduction in working capital requirement in such a scenario.

Question 8 - Study Material

Following information is forecasted by R Limited for the year ending 31st March, 2020 :
Particulars Balance as at 31st March , 2020 Balance as at 31st March , 2019
(₹ in Lakh) (₹ in lakh)
Raw material 65 45
Work in progress 51 35
Finished goods 70 60
Receivables 135 112
Payables 71 68
Annual purchases of raw 400
material(all credit)
Annual cost of production 450
Annual cost of goods sold 525
Annual operating cost 325
Annual sales (all credit) 585
You may take one year as equal to 365 days. You are required to CALCULATE :
(i) Net operating cycle period.
(ii)Number of operating cycles in the year.
(iii)Amount of working capital requirement .

Working Capital Forecast – Total Approach & Cash Cost Approach.

Question 9 - Study Material
On 1st January, the Managing Director of Naureen 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 are 50% complete. 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 materials. Credit allowed to debtors is 3 months from
the date of dispatch. Selling price is ₹ 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 ₹ 20,000. Solve by A. Total approach and B. Cash cost approach.

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 Chapter 7 (7A) - Introduction to Working Capital

Question 10 - Pyq
The following information has been extracted from the records of a company:
Product Cost Sheet ₹ Per Unit
Raw Materials 45
Direct Labour 20
Overheads 40
Total 105
Profit 15
Selling Price 120
●​ Raw materials are in stock for an average of two months.
●​ The materials are in process on an average for 4 weeks. The degree of completion is 50%.
●​ Finished goods stock on an average is for one month.
●​ Time lag in payment of wages and overheads is 1 ½ weeks.
●​ Time lag in receipt of proceeds from debtors is 2 months.
●​ Credit allowed by suppliers is one month.
●​ 20% of the output is sold against cash.
●​ The company expects to keep a cash balance of ₹ 1,00,000.
●​ Take 52 weeks per annum.
The company is poised for a manufacture of 1,44,000 units in the year.
You are required to prepare a statement showing the Working Capital Requirements of the Company.

Question 11 - Rtp
Kalyan limited has provided you the following information for the year 2021-22:
By working at 60% of its capacity the company was able to generate sales of ₹ 72,00,000.
Direct labour cost per unit amounted to ₹ 20 per unit.
Direct material cost per unit was 40% of the selling price per unit. Selling price was 3 times the direct labour
cost per unit. Profit margin was 25% on the total cost.
For the year 2022-23, the company makes the following estimates:
Production and sales will increase to 90% of its capacity. Raw material per unit price will remain unchanged.
Direct expense per unit will increase by 50%. Direct labour per unit will increase by 10%.
Despite the fluctuations in the cost structure, the company wants to maintain the same profit margin on sales.
Raw materials will be in stock for one month whereas finished goods will remain in stock for two months.
Production cycle is for 2 months. The credit period allowed by suppliers is 2 months.
Sales are made to three zones:
Zone Percentage of sale Mode of Credit
A 50% Credit period of 2 months
B 30% Credit period of 3 months
C 20% Cash Sales
There are no cash purchases and cash balance will be ₹ 1,11,000
The company plans to apply for a working capital financing from the bank for the year 2022 -23.
ESTIMATE Net Working Capital of the Company receivables to be taken on sales and also COMPUTE the
maximum permissible bank finance for the company using 3 criteria of Tandon Committee Norms.
(Assume stock of finished goods to be a core current asset)

Question 12 - Pyq
PK Ltd., a manufacturing company, provides the following information:
Particulars (₹)
Sales 1,08,00,000
Raw Material Consumed 27,00,000
Labour Paid 21,60,000
Manufacturing Overhead (Including Depreciation for the 32,40,000
year ₹ 3,60,000)
Administrative & Selling Overhead 10,80,000
Additional Information:
(a)Receivables are allowed 3 months' credit.
(b)Raw Material Supplier extends 3 months' credit.
(c)Lag in payment of Labour is 1 month.

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 Chapter 7 (7A) - Introduction to Working Capital

(d)Manufacturing overhead is paid one month in arrear.

(e)Administrative & Selling Overhead is paid 1 month advance.
(f)Inventory holding period of Raw Material & Finished Goods are of 3 months.
(g)Work-in-Progress is Nil.
(h)PK Ltd. sells goods at Cost plus 33⅓%.
(i)Cash Balance ₹ 3,00,000.
(j)Safety Margin 10%.
You are required to compute the Working Capital Requirements of PK Ltd. on Cash Cost basis.

Question 13 - Mtp
Kady Ltd. sells goods at a uniform rate of gross profit of 20% on sales including depreciation as part of cost of
production.
Its annual figures for the year ending 31st March 2021 are as under:
Particulars (₹)
Sales (at 2 months’ credit) 12,00,000
Materials consumed (Supplier's credit 2 months) 3,00,000
Wages paid (Monthly at the beginning of the subsequent month) 2,40,000
Manufacturing expenses (Cash expenses are paid – one month in arrear) 3,00,000
Administration expenses (General) (Cash expenses are paid – one month in arrear) 75,000
Selling expenses (Paid quarterly in advance) 37,500
The company keeps one month's stock of raw materials and finished goods. A minimum cash balance of
₹ 40,000 is always kept. The company wants to adopt a 15% safety margin in the maintenance of working
capital.Ignore work in progress.Find out the requirements of working capital of Kady Ltd. on cash cost basis.

Question 14 - Pyq
XYZ Co. Ltd. is a pipe manufacturing company. Its production cycle indicates that materials are introduced in
the beginning of the production cycle; wages and overhead accrue evenly throughout the period of the cycle.
Wages are paid in the next month following the month of accrual.
Work-in-progress includes full units of raw materials used in the beginning of the production process and 50%
of wages and overheads are supposed to be conversion costs.
Details of production process and the components of working capital are as follows:
Production of pipes 12,00,000 units
Duration of the production cycle One month
Raw materials inventory held One month consumption
Finished goods inventory held for Two months
Credit allowed by creditors One month
Credit given to debtors Two months
Cost price of raw materials ₹ 60 per unit
Direct wages ₹ 10 per unit
Overheads ₹ 20 per unit
Selling price of finished pipes ₹ 100 per unit
You are required to calculate the amount of working capital required for the company.

Question 15 - Pyq
A Performa Cost Sheet of a Company provides the following data:
Particulars Cost Per Unit (₹)
Raw Material 117
Direct Labour 49
Factory Overheads (Includes Depreciation of ₹ 18 per unit at budgeted level of
activity) 98
Total Cost 264
Profit 36
Selling Price 300
Following additional information is available:
Average raw material in stock : 4 weeks
Average work-in-progress stock : 2 weeks
(% completion with respect to Materials is 80% and Labour and Overheads is 60%)
Finished goods in stock : 3 weeks

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 Chapter 7 (7A) - Introduction to Working Capital

Credit period allowed to debtors : 6 weeks

Credit period availed from suppliers : 8 weeks
Time lag in payment of wages : 1 week
Time lag in payment of overheads : 2 weeks
The company sells one-fifth of the output against cash and maintains cash balance of ₹ 2,50,000.
Prepare a statement showing an estimate of working capital needed to finance a budgeted activity level of
78,000 units of production. You may assume that production is carried on evenly throughout the year and
wages and overheads accrue similarly.

Question 16 - Pyq
MNO Ltd. has furnished the following cost data relating to the year ending of 31st March, 2008:
Particulars Amount (₹ In Lakhs)
Sales 450
Material Consumed 150
Direct Wages 30
Factory Overheads (100% variable) 60
Office and Administrative Overheads (100% variable) 60
Selling Overheads 50
The company wants to make a forecast of working capital needed for the next year and anticipates that:
●​ Sales will go up by 100%.
●​ Selling expenses will be ₹ 150 Lakhs.
●​ Stock holdings for the next year will be – Raw material for two and half months, work-in-progress for one
month, Finished goods for half month and Book debts for one and half month.
●​ Lag in payment will be 3 months for creditors, 1 month for wages and half month for Factory, Office and
Administrative and Selling Overheads.
You are required to prepare statement showing Working Capital Requirements for next year, and

Question 17 - Rtp
TMT Limited is commencing a new project for manufacture of electric toys.
The following cost information has been ascertained for annual production of 60,000 units at full capacity:
Particulars Amount per unit (₹)
Raw materials 20
Direct labour 15
Manufacturing overheads:
₹
Variable 15
Fixed 10 25
Selling and Distribution overheads:
₹
Variable 3
Fixed 1 4
Total cost 64
Profit 16
Selling price 80
In the first year of operations expected production and sales are 40,000 units and 35,000 units respectively.
To assess the need of working capital, the following additional information is available:
(i) Stock of Raw materials 3 months consumption.
(ii) Credit allowable for debtors 1½ months.
(iii) Credit allowable by creditors for 4 months.
(iv) Lag in payment of wages 1 month.
(v) Lag in payment of overheads ½ month.
(vi) Cash in hand and Bank is expected to be ₹ 60,000.
(vii) Provision for contingencies is required @ 10% of working capital requirement including that provision.
You are required to PREPARE a projected statement of working capital requirement for the first year of
operations. Debtors are taken at cost.

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Question 18 - Study Material

The following annual figures relate to XYZ Company: ​
Particulars Amount (₹ )
Sales (at two months credit) 18,00,000
Materials Consumed (suppliers extend two months credit) 4,50,000
Wages paid (monthly in arrear) 3,60,000
Manufacturing expenses outstanding at the end of the year (Cash expenses
are paid one month in arrear) 40,000
Total administrative expenses, paid as above 1,20,000
Sales promotion expenses, paid quarterly in advance 60,000
The company sells its products on gross profit of 25% counting depreciation as part of the cost of production.
It keeps one month’s stock each of raw materials and finished goods, and a cash balance of ₹ 1,00,000.
Assuming a 15% safety margin, ascertain the requirements of working capital requirement of the company on
a cash cost basis. Ignore work-in-progress.

Working Capital Forecast of New Company

Question 19 - Pyq
A newly formed company has applied to the Commercial Bank for the first time for financing its working
capital requirements.
The following information is available about the projections for the current year:
Particulars Per unit (₹ )
Raw Material 40
Direct Labour 15
Overhead 30
Total Cost 85
Profit 15
Sales 100
Other information:
Raw material in stock: Average 4 weeks consumption, Work-in-Progress (completion stage, 50 percent), on
an average half a month. Finished goods in stock: on an 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 ½ weeks and 4 weeks in overhead expenses.
Cash in hand and at bank is desired to be maintained at ₹ 50,000. All sales are on credit basis only.
Prepare a statement showing an estimate of working capital needed to finance an activity level of 96,000 units
of production. Assume that production is carried on evenly throughout the year, and wages and overhead
accrue similarly. For the calculation purpose 4 weeks may be taken as equivalent to a month and 52 weeks in
a year.

Question 20 - Study Material, Rtp, Pyq

A newly formed company has applied to the commercial bank for the first time for financing its working
capital requirements. The following information is available about the projections for the current year:
Estimated level of activity: 1,04,000 completed units of production plus 4,000 units of work-in-progress.
Based on the above activity, estimated cost per unit is:
Raw Material ₹ 80 per unit
Direct Wages ₹ 30 per unit
Overheads (Exclusive of Depreciation) ₹ 60 per unit
Total Cost ₹ 170 per unit
Selling Price ₹ 200 per unit
Raw materials in stock: Average 4 weeks consumption, work-in-progress (Assume 50% completion stage in
respect of conversion cost) (Materials issued at the start of the processing).
Finished goods in stock 8,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors/receivables Average 8 weeks
Lag in payment of wages Average 1 ½ weeks
Cash at banks is expected to be ₹ 25,000
Assume that production is carried on evenly throughout the year (52 weeks) and wages and overheads accrue
similarly. All sales are on credit basis only. Find out: The Net Working Capital Required.

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 Chapter 7 (7A) - Introduction to Working Capital

Question 21 - Rtp
PQR Ltd., a company newly commencing business in the year 2021-22, provides the following projected Profit
and Loss Account:
Particulars (₹) (₹)
Sales 5,04,000
Cost of goods sold 3,67,200
Gross Profit 1,36,800
Administrative Expenses 33,600
Selling Expenses 31,200 64,800
Profit before tax 72,000
Provision for taxation 24,000
Profit after tax 48,000
The cost of goods sold has been arrived at as
under:
Materials used 2,01,600
Wages and manufacturing Expenses 1,50,000
Depreciation 56,400
4,08,000
Less: Stock of Finished goods
(10% of goods produced not yet sold) 40,800
3,67,200
The figure given above relates only to finished goods and not to work-in-progress.
Goods equal to 15% of the year’s production (in terms of physical units) will be in process on the average
requiring full materials but only 40% of the other expenses. The company believes in keeping materials equal
to two months’ consumption in stock.
All expenses will be paid one month in advance. Suppliers of materials will extend 1 -1/2 months credit. Sales
will be 20% for cash and the rest at two months’ credit. 70% of the Income tax will be paid in advance in
quarterly installments. The company wishes to keep ₹ 19,200 in cash. 10% must be added to the estimated
figure for unforeseen contingencies. PREPARE an estimate of working capital.

Question 22 - Study Material

PQ Ltd., a company newly commencing business in 2019 has the following projected Profit and Loss Account:
Particulars (₹ ) (₹ )
Sales 2,10,000
Cost of goods sold 1,53,000
Gross Profit 57,000
Administrative Expenses 14,000
Selling Expenses 13,000 27,000
Profit before tax 30,000
Provision for taxation 10,000
Profit after tax 20,000
The cost of goods sold has been arrived at as under:
Materials used 84,000
Wages and manufacturing Expenses 62,500
Depreciation 23,500
1,70,000
Less: Stock of Finished goods 17,000
(10% of goods produced not yet sold)
1,53,000
The figure given above relates only to finished goods and not to work-in-progress.
Goods equal to 15% of the year’s production (in terms of physical units) will be in process on the average
requiring full materials but only 40%.of the other expenses. The company believes in keeping materials equal
to two months’ consumption in stock.
All expenses will be paid one month in advance. Suppliers of materials will extend 1-1/2 months credit. Sales
will be 20% for cash and the rest at two months’ credit. 70% of the Income tax will be paid in advance in
quarterly installments. The company wishes to keep ₹ 8,000 in cash. 10% has to be added to the estimated

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 Chapter 7 (7A) - Introduction to Working Capital

figure for unforeseen contingencies. PREPARE an estimate of working capital. Note: All workings should form
part of the answer.

Two year question

Question 23 - Study Material
M.A. Limited is commencing a new project for manufacture of a plastic component.
The following cost information has been ascertained for annual production of 12,000 units which is the full
capacity:
Particulars Costs per unit (₹ )
Materials 40.00
Direct labour and variable expenses 20.00
Fixed manufacturing expenses 6.00
Depreciation 10.00
Fixed administration expenses 4.00
80.00
The selling price per unit is expected to be ₹ 96 and the selling expenses ₹ 5 per unit, 80% of which is
variable.
In the first two years of operations, production and sales are expected to be as follows:
Year Production (No. of units) Sales (No. of units)
1 6,000 5,000
2 9,000 8,500

To assess the working capital requirements, the following additional information is available:
(a) Stock of materials – 2.25 months’ average consumption
(b) Work in progress – Nil
(c) Debtors – 1 months’ average sales
(d) Cash balance - ₹ 10,000
(e) Creditors for supply of materials – 1 month’s average purchase during the year.
(f) Creditors for expenses – 1 month’s average of all expenses during the year.
Prepare, for the two years:
(i) A projected statement of Profit/Loss (ignoring taxation); and
(ii) A projected statement of working capital requirements.

Domestic sale + Exports

Question 24 - Pyq
The Management of MNP Company Ltd is planning to expand its business and consult you to prepare an
estimated Working Capital Statement.
The records of the Company reveal the following annual information:
Particulars Amount (₹)
Sales – Domestic at one Month’s Credit 24,00,000
Export at three Month’s Credit (Sales Price 10% below Domestic Price) 10,80,000
Materials used (Suppliers extend two months credit) 9,00,000
Lag in Payment of Wages – ½ Month 7,20,000
Lag in Payment of Manufacturing Expenses (Cash) – 1 month 10,80,000
Lag in Payment of Administration Expenses – 1 month 2,40,000
Sales Promotion Expenses payable quarterly in advance 1,50,000
Income Tax payable in four instalments of which one falls in the next Financial Year 2,25,000
Rate of Gross Profit is 20%. Ignore Work-in-Progress and Depreciation.
The Company keeps one Month’s Stock of Raw Materials and Finished Goods (each) and believes in keeping
₹ 2,50,000 available to it including the Overdraft Limit of ₹ 75,000 not yet utilized by the Company.
The Management is also of the opinion to make 12% Margin for Contingencies on the computed figures.
You are required to prepare the estimated Working Capital Statement for the next year.

Question 25 - Rtp
The management of Trux Company Ltd. is planning to expand its business and consults you to prepare an
estimated working capital statement.

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 Chapter 7 (7A) - Introduction to Working Capital

The records of the company reveals the following annual information:

Particulars (₹)
Sales – Domestic at one month’s credit 18,00,000
Export at three month’s credit (sales price 10% below domestic price) 8,10,000
Materials used (suppliers extend two months credit) 6,75,000
Lag in payment of wages – ½ month 5,40,000
Lag in payment of manufacturing expenses (cash) – 1 month 7,65,000
Lag in payment of Administration Expenses – 1 month 1,80,000
Selling expenses payable quarterly in advance 1,12,500
Income tax payable in four installments, of which one falls in the next financial year 1,68,000
Rate of gross profit is 20%. Ignore work-in-progress and depreciation.
The company keeps one month’s stock of raw materials and finished goods (each) and believes in keeping
₹ 2,50,000 available to it including the overdraft limit of ₹ 75,000 not yet utilized by the company.
The management is also of the opinion to make 10% margin for contingencies on computed figures.
You are required to PREPARE the estimated working capital statement for the next year.

Double Shift Working

Question 26 - Study Material
Samreen Enterprises has been operating its manufacturing facilities till 31.3.2010 on single shift working with
the following cost structure:
Particulars Per Unit (₹ )
Cost of Materials 6
Wages (out of which 40% fixed) 5
Overheads (out of which 80% fixed) 5
Profit 2
Selling Price 18
Sales during 2009-10 is ₹ 4,32,000.
As at 31.3.2010 the company held:
Stock of raw materials (at cost) ₹ 36,000
Work-in-progress (valued at prime cost) ₹ 22,000
Finished goods (Valued at total cost) ₹ 72,000
Sundry debtors ₹ 1,08,000
In view of increased market demand, it is proposed to double production by working an extra shift.
It is expected that a 10% discount will be available from suppliers of raw materials in view of increased volume
of business. The selling price will remain the same. The credit period allowed to customers will remain
unaltered. Credit availed of from suppliers will continue to remain at the present level i.e., 2 months Lag in
payment wages and expenses will continue to remain half a month.
You are required to assess the additional working capital requirements, if the policy to increase output is
implemented.

Question 27 - Rtp
MT Ltd. has been operating its manufacturing facilities till 31.3.2021 on a single shift working with the
following cost structure:
Particulars Per unit (₹ )
Cost of Materials 24
Wages (out of which 60% variable) 20
Overheads (out of which 20% variable) 20
64
Profit 8
Selling Price 72

As at 31.3.2021 with the sales of ₨ 17,28,000, the company held:

Particulars (₹ )
Stock of raw materials (at cost) 1,44,000
Work-in-progress (valued at prime cost) 88,000
Finished goods (valued at total cost) 2,88,000
Sundry debtors 4,32,000

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 Chapter 7 (7A) - Introduction to Working Capital

In view of increased market demand, it is proposed to double production by working an extra shift.
It is expected that a 10% discount will be available from suppliers of raw materials in view of increased volume
of business. The selling price will remain the same. The credit period allowed to customers will remain
unaltered. Credit availed from suppliers will continue to remain at the present level i.e. 2 months.
Lag in payment of wages and overheads will continue to remain for one month.
You are required to CALCULATE the additional working capital requirements, if the policy to increase output is
implemented, to assess the impact of double shift for long term as a matter of production policy.

Margin of safety
Maximum Permissible Bank Finance.
Question 28.
Total Current Assets required : ₹ 40,000
Current liabilities other than bank borrowings : ₹ 10,000
Core current assets : ₹ 5,000
Compute MPBF under all the three methods of lending norms as suggested by the Tandon Committee.

Question 29 - Rtp (May 2025)

The management of Parshvam Limited is planning to expand its business at international level and consults
you for preparing and estimation of working capital needs so that they can avail the finance from the bank.
The estimated data of Parshvam Limited reveal the following information:
Particulars Amount(₹)
Materials Used 9,00,000
Domestic on 2 months credit Imports on 3 months credit ** 6,00,000
Lag in Payment of wages - 1 month 6,00,000
Lag in Payment of Manufacturing Overheads – ½ Month 26,40,000
Sales
Domestic on 1.5 months credit 30,00,000
Export on 3 months credit (sale price 10% below domestic price) 24,80,000
Administrative expenses payable in advance for 2 months 3,60,000
Lag in payment of Selling & Distribution expenses – 1 month 3,00,000
Advance Income tax for ₹25,000 for the quarter falling in the next financial year is paid by the company.
Manufacturing overheads is inclusive of depreciation on the new machine purchased for tailor-made export
products. The purchase price for the new machine is ₹24,00,000 with a depreciation rate of 10%. Cash Gross
profit is at 20% on domestic sales.
However, to promote exports, the Export Promotion Council (EPC Board) provides a revenue subsidy of 2.5%
for the new machine purchased. Furthermore, Parshvam Limited submits the letter of credit (LOC) to its bank
and avails the all-Export Sales value within 1 month. Financial institutions charge a fee of 5% for the same.
The company keeps one month's stock of raw materials and finished goods each. Goods remain in process for
half a month with 90% raw materials introduced in the process. The company believes in keeping cash and
bank balance of ₹1,50,000. The management is of the opinion that the safety margin is to be kept at 15%.
**Raw materials imported will attract a custom duty at 20% to be paid up front with a duty drawback of 5%
credited upfront. You are required to :
(A) PREPARE the estimated working capital statement for the next year.
(B) ADVISE whether Parshvam Limited should continue with the export business or not.
(Requisite assumptions and notes should form part of the solution).

Solution 29.
(A)​ Statement for estimation of Working Capital using Cash Cost Basis
Parshvam Limited
Particulars Amount (₹) Amount (₹)
(A) Current Assets
1. Raw materials 15,90,000 x 1/12 1,32,500
2. WIP
~ RM 15,90,000 x 0.5 /12 x 90% 59,625
~ Wages 6,00,000 x 0.5 /12 x 50% 12,500
~ Manufacturing OH 23,40,000 x 0.5 /12 x 50% 48,750
~ Other OH 74,472 x 0.5 /12 x 50% 1,552

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 Chapter 7 (7A) - Introduction to Working Capital

3. FG (on COGS) 46,04,472 x 1/12 3,83,706

4. Debtors
~ Domestic 27,61,314 x 1.5/12 3,45,164
~ Export 26,27,158 X 1/12 WN - 5 2,18,930
5. Cash/bank balance (given) 1,50,000
6. Prepaid admin exp 3,60,000 x 2/12 60,000
7. Income tax paid in advance (given) 25,000
Gross working capital 14,37,727
(B) Current Liabilities
1. Creditors
~ Domestic ​ 9,00,000 x 2/12 1,50,000
~ Import ​ 6,00,000 x 3/12 1,50,000
2. Lag in wages payment 6,00,000 x 1/12 50,000
3. Lag in manufacturing OH 23,40,000 x 0.5/12 97,500
Lag in other OH 74,472 x 0.5/12 3,103
4. Lag in S&D exp 3,00,000 x 1/12 25,000
Excess of CA over CL 9,62,124
Add: 15% safety margin (9,87,124 x 15%) 1,44,319
Net working capital 11,06,443
Notes –
(a) Working Capital is estimated on Cash Cost Basis
(b) Other overheads are assumed to be part of production.
(c) In absence of information on % completion for wages, manufacturing and other overheads, it is assumed
to be 50% complete for the purpose of calculating WIP.
(d) Other Overheads are also assumed to be outstanding for a period of ½ month. In absence of specific
information, it can also be assumed that nothing is outstanding or prepaid.

(B)
If just the monetary aspects and factors are considered then, Parshvam limited should discontinue its
operations at international level as the Cash Cost of sales for export at ₹ 26,27,158 is higher than the Export
sales value which is just ₹ 24,80,000. In reality, non-monetary factors are also considered in decision making;
exports will add a new customer base for the company. Furthermore, existence at international level brings on
a high credibility and image to the company, etc.

WN 1 - Calculation of gross profit on Export Sales:

Let the domestic selling price be ₹100.
Therefore, Gross profit = ₹20, and cost per unit = ₹ 80
Now as given, the export price is 10% less than the domestic price = 100 – 10% = ₹ 90. However, the cost per
unit to produce exported goods will remain at ₹ 80 only.
So gross profit on exports will be ₹ 90 - 80 = ₹ 10.
Therefore, Gross profit in % for Export Sales = 10 / 90 = 11.11%
Particulars Domestic Export Total
Sales 30,00,000 24,80,000 54,80,000
Less: Gross Profit (6,00,000) (2,75,528) (8,75,528)
20% for Domestic
11.11% for Export
COGS 24,00,000 22,04,472 46,04,472
Add: Admin Exp 1,97,080 1,62,920 3,60,000
(To be Apportioned in the ratio of Sales)
Add: S&D Expense 1,64,234 1,35,766 3,00,000
(To be Apportioned in the ratio of Sales)
Add: Bank Fees and charges for providing LOC services - 1,24,000 1,24,000
Cash Cost of Sales 27,61,314 26,27,158 53,88,472

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 Chapter 7 (7A) - Introduction to Working Capital

WN 2 - Preparation of Cost/Income Statement

Particulars Amount (₹)
Raw Materials
Domestic 9,00,000
Import​ WN - 3 6,90,000
Wages 6,00,000
Manufacturing Overheads (Cash) WN - 4 23,40,000
Other Overheads (Bal. Fig) 74,472
Cost of Production/Cost of Goods Sold 46,04,472
Add: Admin Exp 3,60,000
Add: S&D Exp 3,00,000
Add: Bank charges & Fees for L.O.C services 1,24,000
Cost of Sales 53,88,472

WN 3 – Calculation of Raw Materials Purchased - Imports

Purchase Price ​ = ₹ 6,00,000
+ Custom Duty @ 20% ​ = ₹ 1,20,000
(-) Upfront Duty Drawback @ 5% ​ = ₹ (30,000)
Total Value of Raw materials ​ = ₹ 6,90,000

WN 4 – Calculation of Cash Manufacturing Overheads

Manufacturing Overheads ​ = ₹ 26,40,000
Less: Depreciation on Machinery
(24,00,000 x 10%) ​ = ₹ (2,40,000)
Less: Revenue Subsidy from EPC Board ***
(24,00,000 x 2.5%) ​ = ₹ (60,000)
Cash Manufacturing Overheads ​ = ₹ 23,40,000
***Revenue subsidy shall not be capitalized but instead it will result in bringing down your manufacturing
expenses which is revenue in nature. Had it been the capital subsidy, then it would have reduced the purchase
price of the machine and thereby changing the amount of depreciation.

WN 5 - Credit Period for Export customers

Since the company is availing the benefit of Letter of Credit (L.O.C), the funds blocked in export customers
would only be for 1 month and not 3 months; as the company would receive the entire Export Sales value in 1
month’s time from the financial institution after paying the bank charges and fees.

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 Chapter 8 (7B) - Management of Receivables

Chapter 8 (7B)
Management of Receivables
Evaluating Different Grades of Customer and Credit Policies
Question 1 - Pyq , Study Material
The credit manager of XYZ Ltd. is reappraising the Company’s policy. The company sells its products in terms
of net 30. Cost of goods sold is 85% of sales and fixed costs are further 5% of sales. XYZ classifies its
customers on a scale of 1 to 4.
During the past five years, the experience was as under:
Classification Default as a percentage of sales Average collection period in days
for non-defaulting
1 0 45
2 2 42
3 10 40
4 20 80
The average rate of interest is 15%. What conclusions do you draw about the Company’s Credit Policy?
What other factors should be taken into account before changing the present policy? Discuss.

Question 2 - Study Material

Star Limited is considering the liberalization of existing credit terms to three of their large customers A, B and
C.
The credit period and likely quantity of TV Sets that will be lifted by the customers are as follows:
Quantity lifted (No. of units)
Credit Period (Days) A B C
0 1,000 1,000 -
30 1,000 1,500 -
60 1,000 2,000 1,000
90 1,000 2,500 1,500
The Selling Price per unit is ₹. 750. The expected contribution is 1/3rd of the Selling Price.
The cost of carrying Debtors averages 20% per annum.You are required:
(a) To determine the credit period to be allowed to each customer. (Assume 360 days in a year for calculation
purposes).
(b) To list what other problems the Company might face in allowing the credit period as determined in (a)
above?

Credit Period Relaxation – Effect of Given After Tax Return Amount

Question 3 - Pyq
The Sales Manager of AB Limited suggests that if credit period is given for 1.5 months then sales may likely to
increase by ₹. 1,20,000 per annum. Cost of sales amounted to 90% of sales. The risk of non-payment is 5%.
Income tax rate is 30%. The expected return on investment is ₹. 3375 (after tax.)
Should the company accept the suggestion of the Sales Manager?

Question 4 - Pyq
A new customer has approached a firm to establish a new business connection. The customer requires 1.5
months of credit. If the proposal is accepted, the sales of the firm will go up by ₹.2,40,000 per annum.
The new customer is being considered as a member of 10% risk of non-payment group.
The cost of sales amounts to 80% of sales. The tax rate is 30% and the desired rate of return is 40% (after tax).
Should the firm accept the offer? Give your opinion on the basis of calculations.

Question 5 - Pyq
JKL Ltd. is selling 90,000 units of its product @₨ 150 per unit.
At current level of production , the cost per unit is ₨ 132 per unit.
Variable cost ratio is 80% of sales. Currently all its sales are on credit basis.
The company’s existing credit terms are 2/20, net 60 days .Generally 30% of its customers avail the cash
discount facility. The current bad debt loss is 2 %. The opportunity cost of investment in receivables is 12%.
The company is considering a proposal to change the credit terms to 3/20, net 60 days .

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 Chapter 8 (7B) - Management of Receivables

As a result following is expected :

Increase in Sales : 30%
Increase in average stock ​ : ₨ 4,00,000
Increase in average creditors : ₨ 2,40,000
Increase in present fixed cost : 10%
Increase in % of customer availing the cash discount : 100%
Expected bad debt loss : ​1.5 %
Evaluate the proposal and give your recommendations whether the company should accept the proposal.
(Assume 360 days in a year and investment in debtors to be taken on total cost)

Question 6 - Study Material

A trader whose current sales are in the region of ₹ 6 lakhs per annum and an average collection period of 30
days wants to pursue a more liberal policy to improve sales.
A study made by a management consultant reveals the following information:-
Credit Policy Increase in Collection Increase in Sales Present Default
Period anticipated
A 10 days ₹. 30,000 1.5%
B 20 days ₹. 48,000 2%
C 30 days ₹. 75,000 3%
D 45 days ₹. 90,000 4%
The selling price per unit is ₹ 3. Average cost per unit is ₹ 2.25 and variable costs per unit are ₹ 2.
The current bad debt loss is 1%. Required return on additional investment is 20%.
Assume a 360 days year. ANALYSE which of the above policies would you recommend for adoption?

Question 7 - Pyq
A Company currently has an annual turnover of ₹. 50 Lakhs and an average collection period of 30 days.
The Company wants to experiment with a more liberal credit policy on the ground that an increase in collection
period will generate additional sales.
From the following information, kindly indicate which policy the company should adopt:
Credit Policy Average Collection Period Annual Sales (₹. in Lakhs)
A 45 days 56
B 60 days 60
C 75 days 62
D 90 days 63
Variable Cost is 80% of Sales;
Required (pre-tax) Return on Investment is 20%.;
Fixed Cost is ₹. 6 Lakhs per annum.
A year may take up to 360 days.

Degree of risk of non-payment

Question 8 - Pyq
As a part of the strategy to increase sales and profits, the sales manager of a company proposes to sell goods
to a group of new customers with 10% risk of non-payment.
This group would require one and a half months credit and is likely to increase sales by ₹ 1,00,000 p.a.
Production and Selling expenses amount to 80% of sales and the income-tax rate is 50%.
The company’s minimum required rate of return (after tax) is 25%.
Should the sales manager’s proposal be accepted?
ANALYSE and COMPUTE the degree of risk of non-payment that the company should be willing to assume if
the required rate of return (after tax) were
(i) 30%,
(ii) 40% and
(iii) 60%.

Unique way of calculating ACP

Question 9 - Pyq
Slow Payers are regular customers of Goods Dealers Ltd. and have approached the sellers for extension of
credit facility for enabling them to purchase goods.

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 Chapter 8 (7B) - Management of Receivables

On an analysis of past performance and on the basis of information supplied, the following pattern of payment
schedule emerges in regard to Slow Payers:
Pattern of Payment Schedule
At the end of 30 days 15% of the bill
At the end of 60 days 34% of the bill
At the end of 90 days 30% of the bill
At the end of 100 days 20% of the bill
Non-Recovery 1% of the bill
Slow Payers want to enter into a firm commitment for purchase of goods of ₹ 15 lakhs in 2007, deliveries to be
made in equal quantities on the first day of each quarter in the calendar year. The price per unit of commodity
is ₹ 150 on which a profit of ₹ 5 per unit is expected to be made. It is anticipated by Goods Dealers Ltd., that
taking up this contract would mean an extra recurring expenditure of ₹ 5,000 per annum. If the opportunity
cost of funds in the hands of Goods Dealers is 24% per annum, would you as the finance manager of the seller
recommend the grant of credit to Slow Payers? ANALYSE. Workings should form part of your answer. Assume
a year of 365 days.

Question 10 - Rtp
A regular customer of your company has approached you for extension of credit facility for purchasing of
goods.
On analysis of past performance and on the basis of information supplied, the following pattern of payment
schedule emerges:
Pattern of Payment Schedule
At the end of 30 days 20% of the bill
At the end of 60 days 30% of the bill.
At the end of 90 days 30% of the bill
At the end of 100 days 18% of the bill
Non-recovery 2% of the bill
The customer wants to enter into a firm commitment for purchase of goods of ₹ 40 lakhs in 2022, deliveries to
be made in equal quantities on the first day of each quarter in the calendar year. The price per unit of
commodity is ₹ 400 on which a profit of ₹ 20 per unit is expected to be made. It is anticipated that taking up
this contract would mean an extra recurring expenditure of ₹ 20,000 per annum. If the opportunity cost is 18%
per annum, would you as the finance manager of the company RECOMMEND the grant of credit to the
customer? Assume 1 year = 360 days.

Question 11 - Study Material

Mosaic Limited has current sales of ₹. 1.5 lakh per year. Cost of sales is 75 per cent of sales and bad debts
are one per cent of sales. Cost of sales comprises 80 per cent variable cost and 20 per cent fixed costs, while
the company’s required rate of return is 12 per cent. Mosaic Limited currently allows customers 30 days’
credit, but is considering increasing this to 60 days’ credit in order to increase sales.
It has been estimated that this change in policy will increase sales by 15 per cent, while bad debts will increase
from one per cent to four per cent. It is not expected the policy change will result in an increase in fixed costs
and creditors and stock will be unchanged.
Should Mosaic Limited introduce the proposed policy?

Question 12 - Study Material

XYZ Corporation is considering relaxing its present credit policy and is in the process of evaluating two
proposed policies.
Currently, the firm has annual credit sales of ₹. 50 lakhs and accounts receivable of ₹. 12,50,000. The current
level of loss due to bad debts is ₹. 1,50,000. The firm is required to give a return of 20% on the investment in
new accounts receivables.
The company’s variable costs are 70% of the selling price. Given the following, which is the better option?
Particulars Present Policy Policy Option I Policy Option II
Annual credit sales 50,00,000 60,00,000 67,50,000
Accounts receivable 12,50,000 20,00,000 28,12,500
Bad debt losses 1,50,000 3,00,000 4,50,000

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 Chapter 8 (7B) - Management of Receivables

Question 13 - Pyq
PTX Limited is considering a change in its present credit policy. Currently, it is evaluating two policies.
The company is required to give a return of 20% on the investment in new accounts receivables.
The company’s variable costs are 70% of the selling price.
Information regarding present and proposed policies are as follows:
Particulars Present policy Policy option 1 Policy option 2
Annual credit sales (₹.) 30,00,000 42,00,000 45,00,000
Debtors turnover ratio 4 times 3 times 2.4 times
Loss due to bad debts 3% of sales 5% of sales 6% of sales
Note: Return on investments in new accounts receivable is based on cost of investment in debtors.
Which option would you recommend?

Question 14 - Rtp
ABC Ltd is now extending 1 month credit to its selected customers. It sells its products at ₹. 100 each, and has
an annual sales volume of 60,000 units. At current level of production, which matches with sales, the product
has a Total Cost of ₹. 90 per unit and a Variable Cost of ₹. 80 per unit. The Company is considering a plan to
grant more liberal terms by extending the duration of credit from 1 month to 2 months and expects the sales
to the customer group to go up by 25%. In the background of a normal expectation of a 20% return on
investment, will this relaxation in credit standard justify itself?

Question 15 - Study Material

Easy Limited specializes in the manufacture of a computer component. The component is currently sold for ₹.
1,000 and its variable cost is ₹. 800. For the year ended 31-3-2010 the company sold on an average 400
components per month. At present the company grants one month credit to its customers.
The company is thinking of extending the same to two months on account which the following is expected:
Increase in Sales 25%
Increase in Stock ₹2,00,000
Increase in Creditors ₹1,00,000
You are required to advise the company on whether or not to extend the credit terms if:
(a) All customers avail the extended credit period of two months; and
(b) Existing customers do not avail the credit terms but only the new customers avail the same. Assume in
this case the entire increase in sales is attributable to the new customers. The company expects a minimum
return of 40% on investment

Question 16 - Study Material

PQR Ltd. having an annual sales of ₹ 30 lakhs, is re-considering its present collection policy. At present, the
average collection period is 50 days and the bad debt losses are 5% of sales. The company is incurring an
expenditure of ₹ 30,000 on account of collection of receivables. Cost of funds is 10 percent.
The alternative policies are as under:
Particulars Alternative I Alternative II
Average Collection Period 40 days 30 days
Bad Debt Losses 4% of sales 3% of sales
Collection Expenses ₹. 60,000 ₹. 95,000
DETERMINE the alternatives on the basis of incremental approach and state which alternative is more
beneficial.

Question 17 - Pyq
Current annual sale of SKD Ltd. is ₨ 360 lakhs . Its directors are of the opinion that the company's current
expenditure on receivables management is too high and with a view to reduce the expenditure they are
considering following two new alternative credit policies.
Policy ‘X’ Policy ‘Y’
Average collection period 1.5 months 1 month
% of default 2% 1%
Annual collection expenditure ₨ 12 lakh ₨ 20 lakh
Selling price per unit of product is ₨ 150.Total cost per unit is ₨ 120. Current credit terms are 2 months and
the percentage of default is 3 %. Current annual collection expenditure is ₨ 8 lakh. The required rate of return
on investment of SKD Ltd. is 20%. Determine which credit policy SKD Ltd. should follow.

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 Chapter 8 (7B) - Management of Receivables

Credit Period Relaxation Decision – Effect of Tax Rate and Given After Tax Return
Question 18 - Pyq
The firm has a current sales of ₹2,56,48,750. The firm has unutilized capacity. In order to boost its sales, it is
considering the relaxation in its credit policy. The proposed terms of credit will be 60 days credit against the
present policy of 45 days. As a result, the bad debts will increase from 1.5% to 2% of sales. The firm’s sales are
expected to increase by 10%. The variable costs are 72% of the sales. The firm’s corporate tax rate is 35%, and
it requires an after tax return of 15% on its investment. Should the firm change its credit period?

Credit Relaxation Decision – Effect of Discount Offer – Weighted Average Collection Period
Question 19 -
New Ltd sells on credit terms “2/15 net 45”. Its present Sales are ₹. 100 Lakhs per annum, Fixed Costs are ₹.12
Lakhs per annum and Variable Costs are 70% of Sales. The Company’s cost of funds is 24% and it is observed
that 40% of the customers avail the discount, while the rest pay on the due date.
The Company is considering relaxing its credit terms to “3/18 net 45’. This relaxation is expected to increase
Sales by 25% and Fixed Costs by ₹. 3 Lakhs per annum. Due to the economy of operations, Variable Costs will
be reduced to 68% on all Sales. It is expected that 80% of the customers will avail the discount, the rest paying
on the due date. Advise whether the relaxation in credit terms is worthwhile.

Question 20 - Pyq
A company is presently having credit sales of ₹ 12 lakh. The existing credit terms are 1/10, net 45 days and
average collection period is 30 days. The current bad debts loss is 1.5%. In order to accelerate the collection
process further as also to increase sales, the company is contemplating liberalization of its existing credit
terms to 2/10, net 45 days. It is expected that sales are likely to increase by 1/3 of existing sales, bad debts
increase to 2% of sales and average collection period to decline to 20 days. The contribution to sales ratio of
the company is 22% and opportunity cost of investment in receivables is 15 percent (pre-tax). 50 per cent and
80 percent of customers in terms of sales revenue are expected to avail cash discount under existing and
liberalization schemes respectively. The tax rate is 30%.
Should the company change its credit terms? (Assume 360 days in a year.)

Relaxation of Discount Policy

Question 21 - Pyq , Study Material
The present credit terms of P Company are 1/10 net 30. Its annual sales are ₹. 80 lakhs, its average collection
period is 20 days. Its variable costs and average total costs to sales are 0.85 and 0.95 respectively and its cost
of capital is 10 per cent. The proportion of sales on which customers currently take a discount is 0.5. P
Company is considering relaxing its discount terms to 2/10 net 30. Such relaxation is expected to increase the
sales by ₹. 5,00,000 , reduce the average collection period to 14 days and increase the proportion of discount
to sales to 0.8. What will be the effect of relaxing the discount policy on a company's profit? Take a year as
360 days.

Pledging on Receivable – Decision of Bank

Question 22 - Study Material
A Bank is analysing the receivables of Jackson Company in order to identify acceptable collateral for a
short-term loan. The company’s credit policy is 2/10 net 30. The bank lends 80 per cent on accounts where
customers are not currently overdue and where the average payment period does not exceed. 10 days past the
net period. A schedule of Jackson’s receivables has been prepared. How much will the bank lend on a pledge
of receivables, if the bank uses a 10 per cent allowance for cash discount and returns?
Account Amount (₹.) Days Outstanding In days Average Payment Period historically
74 25,000 15 20
91 9,000 45 60
107 11,500 22 24
108 2,300 9 10
114 18,000 50 45
116 29,000 16 10
123 14,000 27 48

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 Chapter 8 (7B) - Management of Receivables

Disadvantage of not Availing Discount

Question 23 - Study Material
The Dolce Company purchased raw materials on terms of 2/10, net 30. A review of the company’s records by
the owner Mr. Gupta, revealed that payments are usually made 15 days after purchase are received. When
asked why the firm did not take advantage of its discounts, the accountant, Mr. Ram, replied that it cost only 2
per cent for these funds, whereas a bank loan would cost the company 12 per cent.
(a) What mistake is Ram making?
(b) What is the cost of not taking advantage of the discount?
(c) If the firm could not borrow from the bank and was forced to resort to the use of trade credit funds, what
suggestion might be made to Ram that would reduce the annual interest cost?

Decision Tree Analysis

Question 24 -
Interest Ltd. is considering offering credit to a customer. The probability that the customer would pay is 0.5
and the probability that the customer would default is 0.5. The revenues from the sale would be ₹. 5,000 and
the cost of sale would be ₹. 2,400. Should credit be granted to the customer? Draw a decision tree.

Computation of Discount Rate to be Offered

Question 25 - Pyq
A firm is considering offering 30-day credit to its customers. The firm likes to charge them an annualized rate
of 24%. The firm wants to structure the credit in terms of a cash discount for immediate payment. How much
would the discount rate have to be?

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 Chapter 9 (7C) - Treasury and Cash Management

Chapter 9 (7C)
Treasury and Cash Management
Cash Budget
Question 1 - Study Material
Prepare monthly cash budget for six months beginning from April 2010 on the basis of the following
information:
(i) Estimated monthly sales are as follows: ​
Particulars Amount(₹) Particulars Amount(₹)
January 1,00,000 June 80,000
February 1,20,000 July 1,00,000
March 1,40,000 August 80,000
April 80,000 September 60,000
May 60,000 October 1,00,000

(ii) Wages and salaries are estimated to be payable as follows:

Particulars Amount (₹) Particulars Amount (₹)
April 9,000 July 10,000
May 8,000 August 9,000
June 10,000 September 9,000
(iii) Of the sales, 80% is on credit and 20% for cash. 75% of the credit sales are collected within one month and
the balance in two months. There are no bad debt losses.
(iv) Purchases amount to 80% of sales and are made and paid for in the month preceding the sales.
(v) The firm has 10% debentures of ₹ 1,20,000. Interest on these has to be paid quarterly in January, April and
so on.
(vi) The firm is to make an advance payment of tax of ₹ 5,000 in July, 2010.
(vii) The firm had a cash balance of ₹ 20,000 on April 1, 2010, which is the minimum desired level of cash
balance. Any cash surplus/deficit above or below this level is made up by temporary investments /liquidation
of temporary investment or temporary borrowings at the end of each month (interest on these to be ignored).

Question 2 - Mtp
Prepare monthly cash budget for the first six months of 2021 on the basis of the following information:
(i) Actual and estimated monthly sales are as follows:
Actual (₹.) Estimated (₹.)
October 2020 2,00,000 January 2021 60,000
November 2020 2,20,000 February 2021 80,000
December 2020 2,40,000 March 2021 1,00,000
April 2021 1,20,000
May 2021 80,000
June 2021 60,000
July 2021 1,20,000
(ii) Operating Expenses (including salary & wages) are estimated to be payable as follows:
Month (₹.) Month (₹.)
January 2021 22,000 April 2021 30,000
February 2021 25,000 May 2021 25,000
March 2021 30,000 June 2021 24,000
(iii)Of the sales, 75% is on credit and 25% for cash. 60% of the credit sales are collected after one month, 30%
after two months and 10% after three months.
(iv)Purchases amount to 80% of sales and are made on credit and paid for in the month preceding the sales.
(v) The firm has 12% debentures of ₹.1,00,000. Interest on these has to be paid quarterly in January, April and
so on.
(vi)The firm is to make an advance payment of tax of ₹. 5,000 in April.
(vii)The firm had a cash balance of ₹. 40,000 at 31st Dec. 2020, which is the minimum desired level of cash
balance. Any cash surplus/deficit above/below this level is made up by temporary investments/liquidation of
temporary investments or temporary borrowings at the end of each month (interest on these to be ignored).

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 Chapter 9 (7C) - Treasury and Cash Management

Question 3 - Study Material

From the following information relating to a departmental store, you are required to prepare for the three
months ending 31st March, 2010:
(a) Month wise cash budget on receipts and payments basis; and
It is anticipated that the working capital at 1st January, 2010 will be as follows:
Particulars ₹ '000's
Cash in hand and at bank 545
Short term investments 300
Debtors 2,570
Stock 1,300
Trade Creditors 2,110
Other creditors 200
Dividends payable 485
Tax due 320

Budgeted Profit Statement​ (₹ In '000's)

Particulars January February March
Sales 2,100 1,800 1,700
Cost of sales 1,635 1,405 1,330
Gross Profit 465 395 370
Administrative Selling and Distribution
Expenses 315 270 255
Net Profit before tax 150 125 115

Budgeted balances at the end of each months (₹ In '000's)

Particulars 31st Jan. 29th Feb. 31st March
Short term investments 700 - 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade Creditors 2,000 1,950 1,900
Other creditors 200 200 200
Dividend Payable 485 - -
Tax due 320 320 320
Plant (depreciation ignored) 800 1,600 1,550
Depreciation amount to ₹ 60,000 is included in the budgeted expenditure for each month.
Capital Expenditure amounting to ₹ 8,00,000 is expected to be incurred during February 2010 and proceeds
from sale of Plant and Equipment of ₹ 50,000 is expected in March 2010.

Solution 3:
Cash Budget
(a) 3 month ending 31st March, 2010 (₹ In 000's)
Particulars January 2010 February 2010 March 2010
Opening cash balances 545 315 65
Add: Receipts
​ From Debtors 2,070 1,900 1,850
​ Sale of Investments - 700 -
​ Sale of plant - - 50
Total (A) 2615 2,915 1,965
Payments:
Creditors 1,645 1,355 1,280
​ Expenses 255 210 195
​ Capital Expenditure - 800 -
​ Payment of dividend - 485 -
​ Purchase of investments 400 - 200
Total Payments (B) 2,300 2,850 1,675
Closing Cash Balance (A) – (B) 315 65 290

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 Chapter 9 (7C) - Treasury and Cash Management

Working Notes:
(1) ​ Payment to Creditors (₹ In 000’s)
Particulars January 2010 February 2010 March 2010
​ Cost of Sales 1,635 1,405 1,330
Add: Closing Stock 1,200 1,100 1,000
2,835 2,505 2,330
Less: Opening Stock (1,300) (1,200) (1,100)
​ Purchases 1,535 1,305 1,230
Add: Opening Creditors 2,110 2,000 1,950
3,645 3,305 3,180
Less: Closing Creditors (2,000) (1,950) (1,900)
​ Payment 1,645 1,355 1,280

(2) ​ Receipts from Debtors (₹ In 000’s)

Particulars January 2010 February 2010 March 2010
​ Opening Debtors 2,570 2,600 2,500
Add: Sales 2,100 1,800 1,700
4,670 4,400 4,200
Less: Closing Debtors (2,600) (2,500) (2,350)
​ Receipt 2,070 1,900 1,850

Cash Budget for Long Period

Question 4 - Study Material
You are given below the profit & Loss Accounts for two years for a company:
Profit and Loss Account
Particulars Year 1 (₹) Year 2 (₹) Particulars Year 1 (₹) Year 2 (₹)
To Opening stock 80,00,000 1,00,00,000 By Sales 8,00,00,000 10,00,00,000
To Raw materials 3,00,00,000 4,00,00,000 By Closing stock 1,00,00,000 1,50,00,000
By Miscellaneous
To Stores 1,00,00,000 1,20,00,000 Income 10,00,000 10,00,000
To Manufacturing
Expenses 1,00,00,000 1,60,00,000
To Other Expenses 1,00,00,000 1,00,00,000
To Depreciation 1,00,00,000 1,00,00,000
To Net Profit 1,30,00,000 1,80,00,000
9,10,00,000 11,60,00,000 9,10,00,000 11,60,00,000
Sales are expected to be ₹ 12,00,00,000 in year 3.
As a result, other expenses will increase by ₹ 50,00,000 besides other charges. Only raw materials are in stock.
Assume sales and purchase are in cash terms and the closing stock is expected to go up by the same amount
as between year 1 and 2. You may assume that no dividend is being paid.
The company can use 75% of the cash generated to service a loan.
How much cash from operations will be available in year 3 for the purpose? Ignore income tax.

Question 5 - Study Material

The selling price of a book is ₹ 15, and sales are made on credit through a book club and invoiced on the last
day of the month. Variable costs of production per book are materials (₹ 5), labour (₹ 4), and overhead (₹ 2).
The sales manager has forecasted the following volumes:
Nov Dec Jan Feb March April May June July Aug
No. of Books 1,000 1,000 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300
Customers are expected to pay as follows:
One month after the sale 40%
Two months after the sale 60%
The company produces the books two months before they are sold and the creditors for materials are paid
two months after production.
Variable overheads are paid in the month following production and are expected to increase by 25% in April;
75% of wages are paid in the month of production and 25% in the following month. A wage increase of 12.5%
will take place on 1st March.

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 Chapter 9 (7C) - Treasury and Cash Management

The company is going through a restructuring and will sell one of its freehold properties in May for ₹ 25,000,
but it is also planning to buy a new printing press in May for ₹ 10,000.
Depreciation is currently ₹ 1,000 per month, and will rise to ₹ 1500 after the purchase of the new machine.
The company’s corporation tax (of ₹ 10,000) is due for payment in March.
The company presently has a cash balance at bank on 31 December 2010, of ₹ 1500.
You are required to prepare a cash budget for the six months from January to June.

Question 6 - Study Material

From the information and the assumption that the cash balance in hand on 1st January 2010 is ₹ 72,500,
prepare a cash budget. Assume that 50 per cent of total sales are cash sales. Assets are to be acquired in the
months of February and April. Therefore, provisions should be made for the payment of ₹ 8,000 and ₹ 25,000
for the same. An application has been made to the bank for the grant of a loan of ₹ 30,000 and it is hoped that
loan amount will be received in the month of May.
It is anticipated that a dividend of ₹ 35,000 will be paid in June. Debtors are allowed one month’s credit.
Creditors for materials purchased and overheads grant one month’s credit. Sales commission at 3 per cent on
sales is paid to the salesman each month.
Material Salaries & Production Office & Selling
Months Sales (₹) Purchases (₹) Wages (₹) Overheads (₹) Overheads (₹)
January 72,000 25,000 10,000 6,000 5,500
February 97,000 31,000 12,100 6,300 6,700
March 86,000 25,500 10,600 6,000 7,500
April 88,600 30,600 25,000 6,500 8,900
May 1,02,500 37,000 22,000 8,000 11,000
June 1,08,700 38,800 23,000 8,200 11,500

Question 7 - Study Material

Consider the balance sheet of Maya Limited as on 31 December,2008.
The company has received a large order and anticipates the need to go to its bank to increase its borrowings.
As a result, it has to forecast its cash requirements for January, February and March, 2009.
Typically, the company collects 20 per cent of its sales in the month of sale, 70 per cent in the subsequent
month, and 10 per cent in the second month after the sale. All sales are credit sales.
Equity & liabilities Amount (₹ in ‘000) Assets Amount (₹ in ‘000)
Equity shares capital 100 Net fixed assets 1,836
Retained earnings 1,439 Inventories 545
Long-term borrowings 450 Accounts 530
receivables
Accounts payables 360 Cash at bank 50
Loan from banks 400
Other liabilities 212
2,961 2,961
Purchases of raw materials are made in the month prior to the sale and amounts to 60 per cent of sales.
It is paid in the subsequent month. Payments for these purchases occur in the month after the purchase.
Labour costs, including overtime, are expected to be ₹ 1,50,000 in January, ₹ 2,00,000 in February, and
₹ 1,60,000 in March. Selling, administrative, taxes, and other cash expenses are expected to be ₹ 1,00,000 per
month for January through March.
Actual sales in November and December and projected sales for January through April are as follows:
(in thousands)
Month ₹ Month ₹ Month ₹
November 500 January 600 March 650
December 600 February 1,000 April 750
On the basis of this information:
(a) PREPARE a cash budget for the months of January, February, and March.
(b) DETERMINE the amount of additional bank borrowings necessary to maintain a cash balance of ₹ 50,000
at all times.
(c) PREPARE a pro forma balance sheet for March 31.

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 Chapter 9 (7C) - Treasury and Cash Management

Solution 7:
(a) Cash budget (in thousands)
Nov Dec Jan Feb March April
₹ ₹ ₹ ₹ ₹ ₹
Sales 500 600 600 1,000 650 750
Collections, current month’s sales 120 200 130
Collections, previous month’s sales 420 420 700
Collections, previous 2 month’s sales 50 60 60
Total cash receipts 590 680 890
Purchases 360 600 390 450
Payment for purchases 360 600 390
Labour costs 150 200 160
Other expenses 100 100 100
Total cash disbursements 610 900 650
Receipts less disbursements (20) (220) 240

(b) Collections, previous 2 month’s sales

Equity & liabilities Amount (₹ in ‘000) Assets Amount (₹ in ‘000)
Equity shares capital 100 Net fixed assets 1,836
Retained earnings 1,529 Inventories 635
Long-term borrowings 450 Accounts receivables 620
Accounts payables 450 Cash at bank 50
Loan from banks 400
Other liabilities 212
3,141 3,141
Accounts receivable = Sales in March × 0.8 + Sales in February × 0.1
Inventories = ₹545 + Total purchases from January to March
− Total sales from January to March × 0.6
Accounts payable = Purchases in March
Retained earnings = ₹ 1,439 + Sales
– Payment for purchases
– Labour costs and
– Other expenses, all for January to March

Question 8 - Rtp
Optimum Ltd. is a Trading Company, in respect of which you are required to prepare a cash forecast
statement, together with supporting schedules, for each of the 3 months of January to March on the basis of
the following information:
Sales Department advises that sales for the current year estimated on the basis of actual sales for the
previous year of ₹ 180 Lakhs, which were as follows:
Particulars Amount (₹)
January 9.00 Lakhs
February 12.60 Lakhs
March 18.00 Lakhs
April 16.20 Lakhs
May 14.40 Lakhs
June 12.00 Lakhs
July 10.50 Lakhs
August 16.50 Lakhs
September 15.00 Lakhs
October 12.00 Lakhs
November 18.00 Lakhs
December 25.80 Lakhs
st
●​ Sundry Debtors, as at 1 January would be at ₹ 11.40 Lakhs. The pattern of sales collection is: 50% in the
month of sale, 40% in the first subsequent month, 9% in the second subsequent month and 1% bad debt.
●​ The Company expects that it would realize by sale of machinery ₹ 1,00,000 in February, and capital
expenditure during the month would amount to ₹ 2,00,000.

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 Chapter 9 (7C) - Treasury and Cash Management

●​ The normal expenditure, for the replacement of equipment, is estimated at ₹ 9,000 per month. The items of
equipment have an average estimated life of five yea₹
●​ Ex-gratia payment to staff will be made in January ₹ 30,000 and March ₹ 45,000.
●​ It is anticipated that Cash Dividends of ₹ 1,20,000 will be paid in March.
●​ Payment in respect of fixed and variable expenses for the first three months of January ₹ 4,81,860,
February ₹ 3,56,400 and March ₹ 4,75,200.
●​ The purchase cost of goods averages to 50% of Selling Price. The cost of the stock on hand as 31st
December is ₹ 25,20,000 of which ₹ 90,000 is obsolete. It is anticipated that this latter stock will be sold in
March, at 75% of the normal Selling Price. The Company wishes to maintain stock for each month at a
level of 3 subsequent months’ sales as determined by the sales forecast. All purchases are paid in the
immediately subsequent month. The liability on this account, as at 31st December would be ₹ 6,95,000.
●​ Income Tax and Provident Fund payments-January ₹ 50,000, February ₹ 50,000, March ₹ 1,00,000.
●​ As on 1st January, the Company has a bank Loan of ₹ 8,40,000 which, together with simple interest at the
rate of 15% p.a. is payable on 31st March. The interest is due for the period January to March.
●​ The Cash Balance on 31st December was ₹ 3,00,000.

Cash Budget for Manufacturing Concern

Question 9 - Pyq
The following details are forecasted by a Company for the purpose of effective utilization and management of
Cash:
· Estimated Sales and Manufacturing Costs:
Year 2010 Month Sales (₹) Materials (₹) Wages (₹) Overheads (₹)
April 4,20,000 2,00,000 1,60,000 45,000
May 4,50,000 2,10,000 1,60,000 40,000
June 5,00,000 2,60,000 1,65,000 38,000
July 4,90,000 2,82,000 1,65,000 37,500
August 5,40,000 2,80,000 1,65,000 60,800
September 6,10,000 3,10,000 1,70,000 52,000
●​ Credit-Terms:
(a) 20% Sales are on Cash. 50% of the Credit Sales are collected next month and the balance in the
following month.
(b) Credit allowed by Suppliers is 2 months.
(c) Delay in payment of Wages is ½ (one-half) month and of Overheads is 1 (one) month.
●​ Interest on 12% Debentures of ₹ 5,00,000 is to be paid half-yearly in June and December.
●​ Dividends on Investments amounting to ₹ 25,000 are expected to be received in June.
●​ A New Machinery will be installed in June at a cost of ₹ 4,00,000 payable in 20 monthly instalments from
July onwards.
●​ Advance Income-Tax to be paid in August is ₹ 15,000.
●​ Cash balance on 1st June is expected to be ₹ 45,000 and the Company wants to keep it at the end of every
month around this figure, the excess cash (in multiple of thousands rupees) being put in Fixed Deposit.
You are required to prepare a monthly Cash Budget on the basis of above information for four months
beginning from June.

Solution 9:
Cash Budget for the months of June, July, August and September
Particulars June (₹) July (₹) August (₹) September (₹)
Opening Balance 45,000 45,500 45,500 45,000
Add: Receipts
Cash Sales (20% of respective month's Sales) 1,00,000 98,000 1,08,000 1,22,000
Collection from Debtors 3,48,000 3,80,000 3,96,000 4,12,000
Interest on Investments 25,000 - - -
Total Receipts (A) 5,18,000 5,23,500 5,49,500 5,79,000
Payments:
Creditors (2 months) April paid in June, and so on. 2,00,000 2,10,000 2,60,000 2,82,000
Wages (½ of previous month + ½ of Current month) 1,62,500 1,65,000 1,65,000 1,67,500
Overheads (1 month), previous month expenses
paid now 40,000 38,000 37,500 60,800

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 Chapter 9 (7C) - Treasury and Cash Management

Interest on Debentures (6% on ₹ 5,00,000) 30,000 - - -

Instalment on Machinery (₹ 4,00,000 ÷ 20 months) - 20,000 20,000 20,000
Advance Tax - - 15,000 -
Total Payments (B) 4,32,500 4,33,000 4,97,500 5,30,300
Closing Balance before investment in FD (A) – (B) 85,500 90,500 52,000 48,700
Investment in Fixed Deposit (multiples of 1,000)
(Balancing Figure) 40,000 45,000 7,000 3,000
Closing Balance (required around ₹ 45,000) 45,500 45,500 45,000 45,700

Working Notes:
Computation of Collection from Debtors
Particulars April (₹) May (₹) June (₹) July (₹) August (₹) September (₹)
Total Sales 4,20,000 4,50,000 5,00,000 4,90,000 5,40,000 6,10,000
Cash Sales 84,000 90,000 1,00,000 98,000 1,08,000 1,22,000
Credit Sales 3,36,000 3,60,000 4,00,000 3,92,000 4,32,000 4,88,000
Receipt:
50% 1,68,000 1,80,000 2,00,000 1,96,000 2,16,000
50% 1,68,000 1,80,000 2,00,000 1,96,000
Total Receipts 3,48,000 3,80,000 3,96,000 4,12,000

Question 10 - Rtp
Current Limited is into retail business. The following information is given for your consideration:
●​ Purchases are 75% of Sales and Purchases are sold at Cost plus 33 1/3rd %.
●​ Budgeted Sales, Labour Cost and expenses incurred are:
Budgeted Sales (₹) Labour Cost (₹) Expenses incurred (₹)
January 40,000 3,000 4,000
February 60,000 3,000 6,000
March 1,60,000 5,000 7,000
April 1,20,000 4,000 7,000
●​ 75% Sales are for Cash. 25% of Sales are one month’s interest-free credit.
●​ The policy of the Management is to have sufficient stock in hand at the end of each month to meet sales
demand in the next half month.
●​ Creditors for Materials and Expenses are paid in the month after the Purchases are made or the expenses
incurred. Labour is paid in full by the end of each month.
●​ Expenses include a monthly depreciation charge of ₹ 2,000.
●​ The Company will buy Equipment costing ₹ 18,000 cash in February and will pay a Dividend of ₹ 20,000 in
the month of March. The opening Cash Balance in February is ₹ 1,000.
Prepare for the months of February and March: (a) Profit and Loss Account, and (b) Cash Budget.

Question 11 - Pyq
Slide Ltd. is preparing a cash flow forecast for the three months period from January to the end of March.
The following sales volume have been forecasted:
December January February March April
Sales (units) 1800 1875 1950 2100 2250
Selling price per unit is ₹ 600. Sales are all on one month credit. Production of goods for sale takes place one
month before sales. Each unit produced requires two units of raw materials costing ₹ 150 per unit.
No raw material inventory is held. Raw material purchases are on one month credit.
Variable overheads and wages equal to ₹ 100 per unit are incurred during production and paid in the month of
production.
The opening cash balance on 1st January is expected to be ₹ 35,000.
A long term loan of ₹ 2,00,000 is expected to be received in the month of March.
A machine costing ₹ 3,00,000 will be purchased in March.
(a) Prepare a cash budget for the months of January, February and March and calculate the cash balance at
the end of each month in the three month period.
(b) Calculate the forecast current ratio at the end of the three months period.

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 Chapter 9 (7C) - Treasury and Cash Management

Question 12- Rtp

A company was incorporated w.e.f. 1st April, 2021. Its authorised capital was ₹ 1,00,00,000 divided into
10 lakh equity shares of ₹ 10 each. It intends to raise capital by issuing equity shares of ₹ 50,00,000 (fully paid)
on 1st April. Besides this, a loan of ₹ 6,50,000 @ 12% per annum will be obtained from a financial institution on
1st April and further borrowings will be made at the same rate of interest on the first day of the month in which
borrowing is required. All borrowings will be repaid along with interest on the expiry of one year.
The company will make payment for the following assets in April.
Particulars (₹)
Plant and Machinery 10,00,000
Land and Building 20,00,000
Furniture 5,00,000
Motor Vehicles 5,00,000
Stock of Raw Materials 5,00,000

The following further details are available:

(1)​ Projected Sales (April-September):

(₹)
April 15,00,000
May 17,50,000
June 17,50,000
July 20,00,000
August 20,00,000
September 22,50,000
(2)​ Gross profit margin will be 25% on sales. The company will make credit sales only and these will be
collected in the second month following sales.
●​ Creditors will be paid in the first month following credit purchases. There will be credit purchases only.
●​ The company will keep a minimum stock of raw materials of ₹ 5,00,000.
●​ Depreciation will be charged @ 10% per annum on cost on all fixed assets.
●​ Payment of miscellaneous expenses of ₹ 50,000 will be made in April.
●​ Wages and salaries will be ₹ 1,00,000 each month and will be paid on the first day of the next month.
●​ Administrative expenses of ₹ 50,000 per month will be paid in the month of their incurrence.
●​ No minimum cash balance is required.
You are required to PREPARE the monthly cash budget (April-September), the projected Income Statement for
the 6 months period and the projected Balance Sheet as on 30th September, 2021.

Cash Management Models

Question 13 -
Briefly explain William J. Baumal’s EOQ model for optimum cash balance?

Solution 13 -
The Baumol model is as follows:
1. Assumptions:
The Optimum Cash Balance model is based on the following assumptions:
(a) Uniform Cash Flows: Cash payments arise uniformly during a year.
(b) Fixed Transaction Costs: Surplus cash can be invested in short-term marketable securities. However, for
every purchase of securities (i.e. investments) and for every sale (i.e. disposal of investments), fixed
transaction costs are incurred, e.g. Brokerage, registration costs, etc.
(c) Fixed Holding Costs: Surplus cash, if held by the Firm, entails loss of interest at a fixed rate. This
constitutes the carrying costs of cash, i.e. the interest foregone on marketable securities.
(d) Free Marketability: Short-term instruments can be freely traded. The Firm can invest them at any time, and
sell off/dispose investments at any time.

2. Principle:
According to the Baumol Model, Optimum Investment Size is that level of investment where the total of
Transaction Costs per annum and Carrying Costs per annum are the minimum.

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 Chapter 9 (7C) - Treasury and Cash Management

3. Formula: Optimum Transfer Size of Cash =

Where
A = Annual (Monthly) Cash Requirement.
T = Fixed Cost per transaction
C = Opportunity cost of one rupee per annum (or Per Month)

4. (a)Average Cash Balance = ½ of Optimum Transfer Size

(b)Associated Costs of Optimum Investment Size = Transaction Costs p.a. + Interest Costs p.a. = [(No. of
Transaction X Cost per
Transaction) + (Average Cash balance × Interest Rate p.a.)]
(c) At the Optimum Investment Size level, Transaction Costs p.a. = Interest Costs p.a. = ½ of Associated Costs
per annum

Question 14 -
Explain Miller – Orr Cash Management Model?

Solution 14 -
1. Stochastic Cash Flow Assumption:
(a) Under this model, cash payments are presumed at different amounts on different days, i.e. variable or
stochastic, e.g. Wage and Salary payment arises in the first week etc.
(b) With this assumption, this model is designed to determine the time and size of transfers between an
Investment Account and Cash Account.

2. Theory: This model Operates as under:

(a) Upper and lower limits can be fixed for cash balances, as outflows do not exceed a certain limit on any day.
These limits are determined based on fixed transaction costs, interest foregone on marketable securities and
the degree of likely fluctuations in cash balances.
(b)During the period when Cash Balance stays between high and low limits, there are no transactions between
cash and marketable securities.
(c) When cash balance reaches the upper limit, surplus cash is invested in marketable securities, to bring
down the cash balance to the average limit or return point.
(d) Cash Outflows/Payments are not uniform during the year.
(e) When cash balance touches the lower limit, investments (marketable securities) are disposed off so that
cash balances go up to the average limit or return point.

Optimal Investment Size – Baumol Model

Question 15 - Rtp, Pyq
Decision Ltd. estimates its Total Cash Requirement at ₹ 4 Lakhs next year. Its Opportunity Cost of Funds is
15% per annum. The Company will incur ₹ 300 per transaction to convert its short-term securities to cash and
vice-versa. Determine the Optimum Cash Balance according to the Baumol Model.

Solution 15 -
2𝐴𝑇
Optimum Transfer Size = 𝐶
2×4,00,000×300
= 0.15
= ₹ 40,000

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 Chapter 9 (7C) - Treasury and Cash Management

Question 16 - Study Material, Pyq

A firm maintains a separate account for cash disbursement. Total disbursements are ₹ 1,05,000 per month or
₹ 12,60,000 per year. Administrative and transaction cost of transferring cash to disbursement account is ₹ 20
per transfer. Marketable securities yield is 8% per annum. ​ ​
Determine the optimum cash balance according to William J. Baumol model.

Solution 16 -
2×₹.12,60,000×₹.20
The optimum cash balance C = 0.08
​ = ₹ 25,100

Question 17 - Study Material, Pyq

JPL has two dates when it receives its cash inflows, i.e., Feb. 15. On each of these dates, it expects to receive
₹ 15 crore. Cash expenditure is expected to be steady throughout the subsequent 6 months period. Presently,
the ROI in marketable securities is 8% per annum, and the cost of transfer from securities to cash is ₹ 125
each time a transfer occurs.
(i) What is the optimal transfer size using the EOQ model? What is the average cash balance?
(ii) What would be your answer to part (i), if the ROI were 12% per annum and the transfer costs were ₹ 75?
Why do they differ from those in part (i)?

Solution 17 -
2𝐴𝑇
(i) Optimum Transfer Size of Cash = 𝐶
2×30,00,00,000×125
= 0.08
= ₹ 9,68,245
Average Cash Balance ​ = ½ × Optimum Transfer Size of Cash
​ ​ = ½ × ₹ 9,68,245 ​= ₹ 4,84,123

2𝐴𝑇
(ii) Optimum Transfer Size of Cash = 𝐶
2×30,00,00,000×75
= 0.12
= ₹ 6,12,372
Average Cash Balance ​ = ½ × Optimum Transfer Size of Cash
= ½ × ₹ 6,12,372 ​ = ₹ 3,06,186

Reasons for difference between Present and Revised: (a) Increase in Opportunity Cost of holding cash, i.e. 8%
to 12%, (b) Decrease in transaction/ transfer costs.

Baumol Model and Tabular Analysis for Optimum Investment Size

Question 18 - Study Material
The annual cash requirement of A Ltd. is ₹ 10 lakhs. The company has marketable securities in lot sizes of ₹
50,000, ₹ 1,00,000, ₹ 2,00,000, ₹ 2,50,000 and ₹ 5,00,000. Cost of conversion of marketable securities per lot is
₹ 1,000. The company can earn 5% annual yield on its securities.
You are required to prepare a table indicating which lot size will have to be sold by the company. Also show
that the economic lot size can be obtained by the Baumol Model.

Lock Box System

Question 19 - Rtp
ABC Limited currently has a centralized billing system. It takes around 4 days for customers mailed payments
to reach the central billing location. Subsequently, it takes another 1 ½ days for processing these payments,
only after which deposits are made. ABC Limited has a daily average collection of ₹ 5,00,000. The company
plans to initiate a lock box system in which customers mailed payments would reach the receipt location 2 ½
days earlier. Further the process time would be reduced by another 1 day, since each lock box bank would
collect mailed deposits twice daily.
You are required to:
(i) Determine the reduction in cash balances that can be achieved through the use of a lock box system.
(ii) Determine the reduction in opportunity cost of the present system by introduction of the Lock box system
assuming a 5% return on short-term investments.
(iii)If the annual cost of the lock box system is ₹ 80,000, should the system be initiated?

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 Chapter 9 (7C) - Treasury and Cash Management

Solution 19:
(i) Total time saving = 3 & ½ days
Time savings × Daily average collection = Reduction in cash balances achieved
3 & ½ days × ₹ 5,00,000 = ₹ 17,50,000
(ii) 5% × ₹ 17,50,000 = ₹ 87,500
(iii) Since the opportunity cost of the present system (₹ 87,500) exceeds the cost of the lock box system
(₹ 80,000), the system should be initiated.

Float Management – Effects of Production in Bill Float – Hiring of Agency

Question 20 - Study Material
Star Limited is a manufacturer of various electronic gadgets. The annual turnover for the year 2010 was ₹ 730
lakhs. The company has a wide network of sales outlets all over the country. The turnover is spread evenly for
each of the 50 weeks of the working year. All sales are for credit and sales within the week are also spread
evenly over each of the five working days.
All invoicing of credit sales is carried out at the Head Office in Bombay. Sales documentation is sent by post
daily from each location to the Head Office for the past two years. Delays in preparing and dispatching
invoices were noticed. As a result, only some of the invoices were dispatched in the same week and the
remainder in the following week.
An analysis of the delay in invoicing (being the interval between the date of sale and the date of dispatch of
the invoice indicated the following pattern:
No. of days of delay in invoicing 3 4 5 6
% of weeks sales 20 10 40 30
A further analysis indicated that the debtors take on an average 36 days of credit before paying.
This period is measured from the day of dispatch of the invoice rather than the date of sale.
It is proposed to hire an agency for undertaking the invoicing work at various locations.
The agency has assured that the maximum delay would be reduced to three days under the following pattern:
No. of days of delay in invoicing 0 1 3
% of weeks sales 40 40 20
The agency has also offered additionally to monitor the collections which will reduce the credit period to 30
days.
Star Limited expects to save ₹ 4,000 per month in postage costs.
All working funds are borrowed from a local bank at a simple interest rate of 20% p.a.
The agency has quoted a fee of ₹ 2,00,000 p.a. for the invoicing work and ₹ 2,50,000 p.a. for monitoring
collections and is willing to offer a discount of ₹ 50,000 provided both the works are given.
You are required to advise Star Limited about the acceptance of the agency's proposal.
Working should form part of the answer.

Lock Box System Vs Concentration Banking Vs Compensating Balances

Question 21 - Study Material
Prachi Ltd is a manufacturing company producing and selling a range of cleaning products to wholesale
customers. It has three suppliers and two customers.
Prachi Ltd relies on its cleared funds forecast to manage its cash.
You are an accounting technician for the company and have been asked to prepare a cleared funds forecast to
manage its cash.
You are an accounting technician for the company and have been asked to prepare a cleared funds forecast
for the period Friday 7 August to Tuesday 11 August 2020 inclusive.
You have been provided with the following information:

(1) Receipts from customers

Credit terms Payment method 7 Aug 2020 Sales 7Jul 2020 Sales
W Ltd 1 calendar month BACS ₹ 1,50,000 ₹ 1,30,000
X Ltd None Cheque ₹ 1,80,000 ₹ 1,60,000
(a) Receipt of money by BACS (Bankers’ Automated Clearing Services) is instantaneous.
(b) X Ltd’s cheque will be paid into Prachi Ltd’s bank account on the same day as the sale is made and will
clear on the third day following this (excluding day of payment).

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 Chapter 9 (7C) - Treasury and Cash Management

(2)Payment to suppliers
Suppliers Credit Payment 7 Aug 2020 7 July 2020 7 Jun 2020
name terms method Purchases Purchases Purchases
A Ltd 1 Calendar Standing ₹ 65,000 ₹ 55,000 ₹ 45,000
month order
B Ltd 2 Calendar Cheque ₹ 85,000 ₹ 80,000 ₹ 75,000
month
C Ltd None Cheque ₹ 95,000 ₹ 90,000 ₹ 85,000
(a) Prachi Ltd has set up a standing order for ₹ 45,000 a month to pay for supplies from A Ltd.
This will leave Prachi’s bank account on 7 August. Every few months , an adjustment is made to reflect the
actual cost of supplies purchased (you do NOT need to make this adjustment).
(b) Prachi Ltd will send out , by post , cheques to B Ltd and C Ltd on 7 August.
The amounts will leave its bank account on the second day following this (excluding the day of posting).

(3) Wages and Salaries

July 2020 August 2020
Weekly Wages ​ ₹ 12,000 ₹ 13,000
Monthly Salaries ​ ₹ 56,000 ₹ 59,000
(a) Factory workers are paid cash wages (weekly). They will be paid one week’s wages, on 11 August, for the
last week’s work done in July (i.e. they work a week in hand).
(b) All the office workers are paid salaries (monthly) by BACS. Salaries for July will be paid on 7 August.

(4) Other Miscellaneous payments

(a) Every Friday morning , the pretty cashier withdraws ₹ 200 from the company bank account for the pretty
cash . The money leaves Prachi’s bank account straight away.
(b) The room cleaner is Paid ₹ 30 from pretty cash every Sunday morning.
(c) Office stationery will be ordered by telephone on Saturday 8 August to the value of ₹ 300. This is paid for by
company debit cards . Such payments are generally seen to leave the company account on the next working
day.
(d) Five new softwares will be ordered over the Internet on 10 August at a total cost of ₹ 6,500. A cheque will
be sent out on the same day . The amount will leave Prachi Ltd’s bank account on the second day following
this (excluding the day of posting).

(5) Other Information

The balance on Prachi’s bank account will be ₹ 2,00,000 on 7 August 2020. This represents both the book
balance and the cleared funds.
Prepare a cleared funds forecast for the period Friday 7th August to Tuesday 11th August 2020 inclusive using
the information provided. Show clearly the uncleared funds float each day.

Question 22 - Study Material

The following Information is available in respect of Sai Trading Company:
On an average, debtors are collected after 45 days; inventories have an average holding period of 75 days and
creditor’s payment period on an average is 30 days.The firm spends a total of ₹ 120 lakhs annually at a
constant rate. It can earn 10 per cent on investments.
From the above information, you are required to calculate:
(a) The cash cycle and cash turnover.
(b) Minimum amounts of cash to be maintained to meet payments as they become due.
(c) Savings by reducing the average inventory holding period by 30 days.

Solution 22:
(a) Cash cycle = 45 days + 75 days – 30 days = 90 days (3 months)
Cash turnover = 12 months (360 days)/3 months (90 days) = 4.
(b) Minimum operating cash = Total operating annual outlay/cash turnover, that is, ₹ 120 lakhs/4 = ₹ 30 lakhs.
(c) Cash cycle = 45 days + 45 days – 30 days = 60 days (2 months)
Cash Turnover = 12 Months (360 days) / 2 Months (60 Days) = 6
Minimum Operating Cash = ₹ 120 lakhs/6 = ₹ 20 lakhs
Reduction in investments = ₹ 30 lakhs – ₹ 20 lakhs = ₹ 10 lakhs
Saving = 0.10 x ₹ 10 lakhs = ₹ 1 lakh.

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 Chapter 9 (7C) - Treasury and Cash Management

Question 23 - Pyq
K Ltd. has a Quarterly cash outflow of ₹ 9,00,000 arising uniformly during the Quarter. The company has an
Investment portfolio of Marketable Securities. It plans to meet the demands for cash by periodically selling
marketable securities. The marketable securities are generating a return of 12% p.a. Transaction cost of
converting investments to cash is ₹ 60. The company uses the Baumol model to find out the optimal
transaction size for converting marketable securities into cash. Consider 360 days in a year.
You are required to Calculate
1.​ Company's average cash balance,
2.​ Number of conversions each year and
3.​ Time interval between two conversions.

Evaluation of Alternative Working Capital Policies

Question 24 - Study Material, Pyq
A company is considering its working capital investment and financial policies for the next year. Estimated
fixed assets and current liabilities for the next year are ₹ 2.60 crores and ₹ 2.34 crores respectively. Estimated
Sales and EBIT depend on current assets investment, particularly inventories and book-debts.
The financial controller of the company is examining the following alternative Working Capital Policies:
(₹ In Crores)
Working Capital Policy Investment in Current Assets Estimated Sales EBIT
Conservative 4.50 12.30 1.23
Moderate 3.90 11.50 1.15
Aggressive 2.60 10.00 1.00
After evaluating the working capital policy, the Financial Controller has advised the adoption of the moderate
working capital policy. The company is now examining the use of long-term and short-term borrowings for
financing its assets. The company will use ₹ 2.50 crores of the equity funds. The corporate tax rate is 35%.
The company is considering the following debt alternatives:
Financing Policy Short-term Debt Long-term Debt
Conservative 0.54 1.12
Moderate 1.00 0.66
Aggressive 1.50 0.16
Interest Rate – Average 12% 16%
You are required to calculate the following:
(1) Working Capital Investment for each policy:
(a) Net Working Capital position; (b) Rate of Return; (c) Current ratio.
(2) Financing for each policy;
(a) Net Working Capital; (b) Rate of Return of Shareholders equity; (c) Current ratio.

Question 25 - Study Material

A firm has the following data for the year ending 31st March, 2017:
Particulars (₹)
Sales (1,00,000 @ ₹ 20) 20,00,000
Earnings before Interest and Taxes 2,00,000
Fixed Assets 5,00,000
The three possible current assets holdings of the firm are ₹ 5,00,000, ₹ 4,00,000 and ₹ 3,00,000. It is
assumed that fixed assets level is constant and profits do not vary with current assets levels.
ANALYSE the effect of the three alternative current assets policies.

Question 26 - Rtp
The Management of Fibroplast Limited is trying to establish a Current Assets policy. Fixed Assets are ₹
6,00,000, and the Company plans to maintain a 50% Debt-to-Assets ratio. It has no operating Current
Liabilities. The Interest Rate is 10% on all Debts. The Company is considering three alternative Current Asset
Policies – 40%, 50% and 60% of Projected Sales. The Company expects to earn 15% before Interest and Taxes
on Sales of ₹ 30,00,000. The effective tax rate is 40%.
You are required to calculate the expected Return on Equity under each alternative.

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 Chapter 10 (7D) - Inventory Management

Chapter 10 (7D)
Inventory Management
Computation of EOQ
Question 1 - Pyq
The following details are available in respect of a firm:
●​ Annual requirement of inventory ​ : 40,000 units
●​ Cost per unit (other than carrying and ordering cost) : ₹ 16
●​ Carrying costs are likely to be ​ ​ ​ : 15% per year
●​ Cost of placing order ​ ​ ​ ​ : ₹ 480 per order
Determine the economic ordering quantity.

Solution 1 -
Carrying cost per annum = Cost per unit × Carrying cost % p.a.
= ₹ 16 × 0.15 = ₹ 2.40
2 × 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑝.𝑎. × 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
EOQ ​ ​ ​ = 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
2 × 40,000 × 480
​ ​ ​ = 2.40
= 4,000 units

Question 2 - Pyq
The demand for a certain product is random. It has been estimated that the monthly demand of the product
has a normal distribution with a mean of 390 units. The unit price of the product is ₹ 25. Ordering cost is ₹ 40
per order and inventory carrying cost is estimated to be 35 per cent per year.
Calculate Economic Order Quantity (EOQ).

Solution 2 -
A = 390 units × 12 = 4,680 units
O = ₹ 40
C = 35% × ₹ 25 = ₹ 8.75
2×𝐴×𝑂
EOQ ​ = 𝐶
2 × 4,680 × 40
​ = 8.75
​ = 206.85 units

EOQ and Discount

Question 3 - Pyq
A publishing house purchases 72,000 rims of a special type paper per annum at cost ₹ 90 per rim. Ordering
cost per order is ₹ 500 and the carrying cost is 5 per cent per year of the inventory cost. Normal lead time is 20
days and safety stock is Nil. Assume 300 working days in a year:
You are required to:
(i)​ Calculate the Economic Order Quantity (E.O.Q).
(ii)​ Calculate the Reorder Inventory Level.
(iii)​If a 1 per cent quantity discount is offered by the supplier for purchases in lots of 18,000 rims or more,
should the publishing house accept the proposals?

Solution 3 -
2𝐴𝑂
(i)​ EOQ = 𝐶
Where,
A = Annual consumption
O = Ordering cost per order
C = Stock carrying cost per unit annum
2 × 72,000 × 500
EOQ = 5% 𝑜𝑓 𝑅𝑠. 90
= 1, 60, 00, 000 = 4,000 Rims.

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 Chapter 10 (7D) - Inventory Management

(ii)​ Re-order Level = Normal Lead Time × Normal Usage

= 20 × 240 = 4,800 Rims.
Working Notes:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑈𝑠𝑎𝑔𝑒
Normal Usage = 𝑁𝑜𝑟𝑚𝑎𝑙 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
72,000
​ = 300
= 240 Rims.

(iii)​Evaluation of quantity Discount Offer

Particulars EOQ Discount Offer
Size of order 4,000 Rims 18,000 Rims
No. of orders in year 18 4
Average Inventory (Order size/2) 2,000 Rims 9,000 Rims
Cost: ₹ ₹
Ordering Cost @ ₹ 500 per order 9,000 2,000
Inventory carrying cost
At EOQ: (4,000/2) × ₹ 4.5 9,000 -
At Discount offer: (18,000/2) × ₹ 4.455 - 40,095
Purchase Cost
At EOQ: 72,000 × ₹ 90 64,80,000 -
At discount offer: 72,000 × ₹ 89.10 - 64,15,200
Total Cost 64,98,000 64,57,295
The total cost is less in case of quantity discount offer. Hence, a quantity discount offer should be accepted.

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 Chapter 11 (7E) - Management of Payables

Chapter 11 (7E)
Management of Payables
Cost and Benefits of Trade Credit
Question 1.
Bring out the costs and benefits of Trade Credit?

Solution 1:
(a)​ Cost of Availing Trade Credit
(i)​ Price
(ii)​ Loss of goodwill
(iii)​Cost of managing
(iv)​Conditions
(b)​ Cost of Not taking Trade Credit
(i)​ Impact of inflation
(ii)​ Interest
(iii)​Inconvenience

Question 2.
How is the cost of Payables Computed?

Solution 2:
The following equation can be used to calculate nominal cost, on an annual basis of not taking the discount:
𝑑 365 𝑑𝑎𝑦𝑠
100 − 𝑑
× 𝑡
The cost of lost cash discount can be estimated by the formula:
365
100 𝑡

100−𝑑
–1
Where,
d = Size of discount i.e. for 6% discount, d = 6
t = The reduction in the payment period in days, necessary to obtain the early discount or Days Credit
Outstanding – Discount Period.

Practical Problems
Question 3 - Study Material
Suppose ABC Ltd. has been offered credit terms from its major supplier of 2/10, net 45. Hence the company
has the choice of paying ₹ 98 per ₹ 100 or to invest the ₹ 98 for an additional 35 days and eventually pay the
supplier ₹ 100 per ₹ 100. The decision as to whether the discount should be accepted depends on the
opportunity cost of investing ₹ 98 for 35 days. What should the company do? ​

Question 4 -
XYZ Limited normally pays its Suppliers in the third month after invoicing. It is now offered a 2% discount for
payment within one month on invoicing. Payments are at ₹ 3,00,000 per month, and the Company operates on
Bank Overdraft on which interest is charged at 14.5%. Advise whether the offer should be accepted.
Would your answer differ if the Company were given 3% discount, all other conditions remaining the same as
above?

Question 5 - Study Material

The Dolce Company purchases raw materials on terms of 2/10, net 30 . A review of the company’s record by
the owner , Mr. Gautam , revealed that payments are usually made 15 days after purchases are made. When
asked why the firm did not take advantage of its discounts , the accountant , Mr. Rohit , replied that it cost only
2 per cent for these funds , whereas a bank loan would cost the company 12 per cent .
(a) Analyse what mistake is Rohit making ?
(b) If the firm could not borrow from the bank and was forced to resort to the use of trade credit funds , what
suggestions might be made to Rohit that would reduce the annual interest cost ? IDENTIFY.

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 Chapter 12 (7F) - Financing of Working Capital

Chapter 12 (7F)
Financing of Working Capital
Question 1 - Pyq
A factoring firm has offered a company to buy its accounts receivables.
The relevant information is given below.
(i)The current average collection period for the company’s debt is 80 days and ½% of debtors default.
The factor has agreed to pay over money due to the company after 60 days and it will suffer all the losses of
bad debts also.
(ii)Factors will charge commission @ 2%.
(iii)The company spends ₹ 1,00,000 p.a. on administration of debtors. These are avoidable costs.
(iv)Annual credit sales are ₹ 90 lakhs. Total variable costs are 80% of sales. The company’s costs of borrowing
is 15% per annum. Assume 365 days in a year.
Should the company enter into an agreement with a factoring firm?

Question 2 - Study Material

A Factoring firm has credit sales of ₹ 360 lakhs and its average collection period is 30 days. The financial
controller estimates, bad debt losses are around 2% of credit sales. The firm spends ₹ 1,40,000 annually on
debtors' administration. This cost comprises telephonic and fax bills along with salaries of staff members.
These are the avoidable costs. A Factoring firm has offered to buy the firm’s receivables. The factor will
charge 1% commission and will pay an advance against receivables on an interest @15% p.a. after withholding
10% as reserve. ANALYSE what should the firm do? Assume 360 days in a year.

Effective Cost of Factoring

Question 3 - Pyq
A Ltd has a total sales of ₹ 3.2 Crores and its Average Collection Period is 90 days. The past experience
indicates that Bad Debt losses are 1.5% on Sales. The expenditure incurred by the Firm in administering its
receivable collection efforts are ₹ 5,00,000. A Factor is prepared to buy the Firm’s receivables by charging 2%
Commission. The Factor will pay advance on receivables to the Firm at an Interest Rate of 18% p.a. after
withholding 10% as Reserve. Calculate the Effective Cost of Factoring to the Firm.

Factoring Vs Own Collection System

Question 4 - Rtp
Jaidev Ltd has total credit sales of ₹ 40 lakhs p.a. and its average collection period is 90 days. The past
experience indicates that the Bad Debt losses are around 3% of credit sales. Jaidev spends about ₹ 1,00,000
per annum on administrating its credit sales. It is considering availing the services of a Factoring Firm. It has
received an offer from Uday Ltd, which agrees to buy the receivables of Company. Uday will charge
Commission of 3% and also agrees to pay advance against receivables at an Interest Rate of 18% p.a. after
withholding 10% as Reserve. Should Jaidev accept Uday’s offer if the former’s ROI is 15%? Assume 360 days
in a year.

Own Financing Vs Non-Recourse Factoring

Question 5 - Rtp
Laxman Ltd sells on credit terms 2/10 net 30. It has an annual credit sales of ₹ 900 lakhs, with a Variable Cost
of 80% and Bad Debts of 0.75%. Past experience shows that 50% of the customers avail cash discount and the
remaining customers pay 50 days after the date of sale. Presently the Company’s investment in receivables
are financed in the ratio of 2 : 1 by a mix of Bank Borrowings and Own Funds, which cost 24% and 27% p.a.
respectively. The Company also incurs ₹ 16 Lakhs on Credit Collection Costs.
The Company is considering a “Non-Recourse Factoring” arrangement with T-Factors Ltd on the following
terms – (a) 15% Factor Reserve, (b) Guaranteed Payment date = 24 days after the date of purchase, (c) 22%
Interest/ Discount, (d) 4% Factoring Commission. Evaluate whether the factoring proposal is worthwhile, with
suitable assumptions, wherever applicable.

Question 6 - Pyq
A firm has a total sales of ₹ 200 lakhs of which 80% is on credit. It is offering credit terms of 2/40, net 120. Of
the total, 50% of customers avail of discount & the balance pay in 120 days. Past experience indicates that bad
debt losses are around 1% of credit sales. The firm spends about ₹2,40,000 per annum to administer its credit

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 Chapter 12 (7F) - Financing of Working Capital

sales. These are avoidable as a factor is prepared to buy the firm’s receivables. He will charge 2% commission.
He will pay advance against receivables to the firm at an interest rate of 18% after withholding 10% as reserve.
(i)​ What is the effective cost of factoring? Consider the year as 360 days.
(ii)​ If bank finance for working capital is available at 14% interest, should the firm avail of factoring service?

Question 7 - Pyq
XYZ Limited normally pays its Suppliers in the third month after invoicing. It is now offered a 2% discount for
payment within one month on invoicing. Payments are at ₹ 3,00,000 per month, and the Company operates on
Bank Overdraft on which interest is charged at 14.5%. Advise whether the offer should be accepted.
Would your answer differ if the Company were given 3% discount, all other conditions remaining the same as
above?

Question 8 - Pyq
Following is the sales information in respect of Bright Ltd:
Annual Sales (90% on credit) : ₹7,50,00,000
Credit period : 45 days
Average Collection period : 70 days
Bad debts : 0.75%
Credit administration cost
(Out of which 2/5th is avoidable) : ₹18,60,000
A factor firm has offered to manage the company’s debtors on a non-recourse basis at a service charge of 2%.
Factor agrees to grant advance against debtors at an interest rate of 14% after withholding 20% as reserve.
Payment period guaranteed by factor is 45 days. The cost of capital of the company is 12.5%. One time
redundancy payment of ₹50,000 is required to be made to factor.
Calculate the effective cost of factoring to the company. (Assume 360 days in a year)

Question 9 - Mtp
Sundaram limited, a plastic manufacturing company, had invested enormous amounts of money in a new
expansion project. Due to such a great amount of capital investment, the Company needs an additional ₹
2,00,00,000 in working capital immediately.
The CFO has determined the following three feasible sources of working capital funds:
Bank Loan: The company's bank will lend ₹2,30,00,000 at 12% per annum. However, the bank will require 15%
of the loan granted to be kept in a current account as the minimum average balance which otherwise would
have been just ₹ 50,000.
Trade Credit: A major supplier with 2/20 net 80 credit terms has approached for supply of raw material worth
₹1,90,00,000 p.m.
Factoring: factoring firm will buy the companies receivables of ₹ 2,50,00,000 per month, which have a
collection period of 60 days. factor will advance up to 75% of the face value of the receivables at 14 percent
per annum. Factor Commission will amount to 2% on all receivables purchased. Factoring will save credit
department expense and bad debts of ₹ 1,75,000 p.m. and ₹ 2,25,000 p.m. Based on annual percentage cost,
ADVISE which alternative should the company select. Assume 360 days a year

Question 10 - Study Material

The Megatherm Corporation has just acquired a large account.
As a result, it needs an additional ₹. 75,000 in working capital immediately.
It has been determined that there are three feasible sources of funds:
(a) Trade credit: The company buys about ₹. 50,000 of materials per month on terms of 3/30, net 90.
Discounts are taken.
(b) Bank loan: The firm’s bank will lend ₹. 1,00,000 at 13 per cent. A 10 per cent compensating balance will be
required, which otherwise would not be maintained by the company.
(c) A factor will buy the company’s receivables (₹. 1,00,000 per month), which have a collection period of 60
days. The factor will advance up to 75 percent of the face value of the receivables at 12 per cent on an annual
basis. The factors will also charge a 2 per cent fee on all receivables purchased. It has been estimated that the
factor’s services will save the company a credit department expense and bad-debt expenses of ₹. 1500 per
month. On the basis of annual percentage costs, which alternative should the company select?

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 Chapter 12 (7F) - Financing of Working Capital

Miscellaneous
Question 11 - Rtp
Nirmoh Limited wants to avail short-term loans from the bank. However, banks grant short term loans by
keeping the collateral in the form of accounts receivable. A bank is analyzing the receivables of Nirmoh
Limited to identify acceptable collateral for a short-term loan.
The current policy of the company is 3/10 net 40. The bank will lend only to the extent of 90% of acceptable
receivables at an interest rate of 12% only if both the conditions mentioned below are fulfilled.
The bank will keep a reserve of 5% for cash discount & returns.
(a)​ Customers are not currently overdue for more than 5 days to the net period
(b)​Average aging (payment period) of the customer should not exceed 15 days past the net period.
If any of the above conditions are not fulfilled, the bank will lend 65% of the receivables subject to a reserve of
15% and the interest rate will be charged at 15% on such accounts. The corporate tax rate applicable is 25%.
On the scrutiny of all the receivables, following are the acceptable receivables considered for lending:
Accounts Amount Outstanding in Average Aging (payment period) in
(₹) Days since invoiced Days
DR 01 50,000 37 40
DR 02 25,000 25 48
DR 03 1,20,000 47 49
DR 04 72,000 10 56
DR 05 45,000 30 30
DR 06 1,75,000 39 50
DR 07 19,000 55 25
DR 08 54,000 44 54
DR 09 1,05,000 15 25
DR 10 37,000 22 75
You are required to CALCULATE:
(a) Total amount lent by the bank
(b) Effective Interest cost (%) to the company

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