Answer to PTP_Intermediate_Syllabus 2012_Jun2014_Set 3

Paper – 8: Cost Accounting & Financial Management

Time Allowed: 3 Hours Full Marks: 100

Section A-Cost Accounting

(Answer Question No. 1 which is compulsory and any three from the rest in this section)
Working Notes should form part of the answer.

Question.1
(a) The repairs and maintenance of machinery in factory is found to be a semi variable cost
having some relationship with the no. of machine hours run. It was ` 17,500 during
October, 2013 for 7500 machine hours worked and ` 15,400 for November, 2013 when
only 5,400 machine hours were worked. What will be the budgeted cost of repairs and
maintenance for December 2013 when 6,200 machine hours are expected to be
worked? [2]
Answer:
Budgeted Cost of repairs and maintenance for December 2013:

Variable cost per hour= ` (17500 -15400)/ ` (7500 - 5400) = ` 1/hour

Fixed cost= [` 17,500 - ( ` 7,500x1)= ` 10,000
Cost of repairs & maintenance for December 2013= (6,200x1) +10,000= `16,200

(b) If the ordering cost per order is ` 40, carrying cost is 10% of average inventory value,
purchase cost is ` 10 per unit and Economic Order Quantity (EOQ) for the product is 800
units; What is the expected annual demand for the product? [2]
Answer:
2AO
EOQ
C
A=Annual demand of the product
O=Ordering cost
C=Carrying cost

2 A 40
=>800=
1
=>A=8,000 Units

(c) The standard time required per unit of a product is 20 minutes. In a day of 8 working hours
a worker gives an output of 30 units. If he gets a time rate of ` 20, then what will be the
total earning under Halsey Scheme? [2]
Answer:
Under Halsey scheme
50
Earnings = Hours Worked Rate per Hour TimeSaved Rate per Hour
100
Total earning under Halsey Scheme
Time allowed for 30 units [30 × 20 minutes] =10 hrs
Time taken=8 hrs
Time saved=2 hrs
Normal wage for 8 hrs= ` 160
Bonus= (50% of 2hrs x ` 20)= ` 20
Total= ` 180

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(d) Define profit centre. [2]

Answer:
A profit centre is any sub-unit of an organization to which both revenues and costs are
assigned so that the profitability of the sub-unit (or division) may be measured. Thus, in
profit centre the performance measurement relates to both costs and profits of the
division. Profit centre is a part of responsibility accounting.

(e) Differentiate between Job Evaluation and Merit Rating. [2]

Answer:

Job Evaluation Merit Rating

1. It is a method of ranking job. 1. It is method of ranking employees.
2. It ascertains the relative worth of 2. It ascertains the relative worth of
jobs. employees.
3. Useful in bringing uniformity in wage 3. Useful in determination of fair wages
rate. on the basis of performance of the
workers.

(f) What is the basis for cost classification as per CAS-1? [2]
Answer:
As per Cost Accounting Standard 1 (CAS 1), the basis for cost classification is as follows:
(i) Nature of expense
(ii) Relation to objective-Traceability
(iii) Functions/Activities
(iv) Behavior -Fixed, Semi-Variable or Variable
(v) Management decision making
(vi) Production process
(vii)Time period

Question.2
(a) The following are the costing records for the year 2012 of a manufacturing Company.
Production 1,00,000 units; Cost of raw materials ` 20,00,000; Labour cost ` 12,00,000;
Factory overheads ` 8,00,000; Office overheads ` 4,00,000; Selling Expenses ` 1,00,000,
Rate of Profit 25% on the selling price.
The manufacturing Company decided to produce 1,50,000 units in 2013. It is estimated
that the cost of materials will increase by 15%, the labour cost will increase by 10%, 50%
of the overhead charges are fixed and the other 50% are variable. The selling expenses
per unit will be reduced by 20%. The rate of profit will remain the same.
Prepare a cost statement for the year 2012 and 2013 showing the total profit and selling
price per unit. [4+6]

Answer:
Statement of Cost & Profit (Cost Sheet)
(Output 1,00,000 units)
Particulars Cost per unit(in ` ) Total Cost
Raw Materials 20 20,00,000
Labour 12 12,00,000
Prime Cost 32 32,00,000
Add: Factory overhead 8 8,00,000
Work Cost 40 40,00,000
Add: Office Overhead 4 4,00,000

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Cost of production 44 44,00,000

Add: Selling Expenses 1 1,00,000
Cost of sales 45 45,00,000
Add: Profit (25% on selling price or 33.33% on cost of 15 15,00,000
sales)
Selling Price 60 60,00,000

Statement of Cost & Profit (Cost Sheet)

(Output 1,50,000 units)
Particulars Cost per unit (in ` ) Total cost (in ` )
Raw Materials (`20X115%X1,50,000) 23 34,50,000
Labour (`12X110%X1,50,000) 13.20 19,80,000
Prime Cost 36.20 54,30,000
Add: Factory Overhead 6.67 10,00,000
(`8,00,000X50%+`4X1,50,000)
Work Cost 42.87 64,30,000
Add: Office Overhead (`4,00,000X50%+`2X1,50,000) 3.33 5,00,000
Cost of Production 46.20 69,30,000
Add; Selling Expenses (`1X80%X1,50,000) 0.80 1,20,000
Cost of Sales 47.00 70,50,000
Add: Profit (25% on selling price or 33.33% on cost of 15.66 23,49,765
sales)
Selling Price 62.66 93,99,765

(b) State the Treatment of the following Special Items:

(i) Insurance Charges
(ii) Spoiled Work [2+2]
Answer:
(i) Insurance Charges:
The insurance premium paid may cover several kinds of insurances.
(a) The amount of premium paid on insurance of fixed assets is allocated to particular
departments or cost centres where the assets are located, as items of overhead
costs.
(b) Premium for insurance of material and processed goods are treated as factory or
manufacturing overhead and charged to production costs.
(c) Premium for insurance of finished goods in stock or in transit is absorbed as distribution
overhead.
(d) Premium for other types of insurance such as relating to fire, burglaries etc. are
related to general administration overhead.

(ii) Spoiled Work:

The loss by spoilage may be inherent to the nature of the product or it may be
caused by normal circumstances. If it is of an inherent nature and cannot be
avoided, it should be charged either to the specific job in which it has accrued or
should be recovered as overhead charge from the entire production, where there is
no specific work or job order. In case it has been caused by abnormal
circumstances, it should be charged to costing Profit and Loss account. While
accounting for loss by spoilage, any proceeds of the scrap should be accounted for
either as deduction from spoilage or by crediting it to the account which has been
debited with the spoilage.

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(c) 50 items are required everyday for a machine. Fixed cost of ` 50 per order is incurred for
placing an order. The inventory carrying cost per item amounts to ` 0.02 per day. The
lead period is 32 days. Compute: Economic Ordering Quantity. [2]

Answer:
2AO
EOQ
C
A=Annual demand of the product
O=Ordering cost
C=Carrying cost

In this case,
Annual consumption = 50 items × 365 days = 18,250 items
Buying cost per order = ` 50
Inventory carrying cost per item per annum = ` 0.02 × 365 = ` 7.30
2 18,250 50
EOQ 500 items
7.30

Question.3
(a) A company makes components for television sets using two service departments and
two production departments. The inter-departmental relationships and overhead costs
are given below.
Percentage of Service provided to
From: Maintenance Scheduling Moulding Assembly
Maintenance - 10 % 40 % 50 %
Scheduling 20 % - 50 % 30 %
Total Overhead Cost (`) 7,50,000 4,00,000 3,78,000 2,76,000
You are required to show the amount of Scheduling Department cost and Maintenance
Department cost to be allocated to the Production Department, using Simultaneous
Equation Method. [6]
Answer:
Let M be the overheads of Maintenance Department
Let S be the overheads of Scheduling Department
M= 7,50,000 + 0.2S……………….(i)
S = 4,00,000 + 0.1M……………...(ii)
By solving equation we get,
S = 4,84,694 and
M = 8,46,939

Allocation of Overheads:
Service Production
Departments
Maintenance Scheduling Moulding Assembly
Total Overheads ( `) 7,50,000 4,00,000 3,78,000 2,76,000
Maintenance (`) 8,46,939 84,694 3,38,775 4,23,470
Scheduling (`) 96,939 4,84,694 2,42,347 1,45,408
9,59,122 8,44,878

(b) The Standard labour time required for the production of a certain component has been
fixed as 4 hours. An incentive scheme was introduced recently to raise labour
productivity. The relevant details of the scheme are as follows:

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Efficiency Incentive as a percentage of Basic Wage

Below 100% No incentive
100 % (ie 4 hours / unit) 10%
Above 100% 1% additional incentive for every 1% increase in
efficiency above 100%, fractions excluded
Four Workers A, B, C and D produced 16, 12, 14 and 10 units respectively in a particular
week of 48 hours. The basic wages of all workers is ` 15 per hour.
Calculate the efficiency, incentive bonus, total earnings and labour cost per unit in
respect of each of the four workers. [2+2+2+2]
Answer:
Calculation of Efficiency and Incentive Bonus
Worker No of Units Standard Time (ST) Actual Time (AT) Efficiency* Incentive in %
A 16 64 48 133 % (10+33) = 43
B 12 48 48 100 % 10
C 14 56 48 116 % (10+16) = 26
D 10 40 48 83 % -
ST
*Efficiency = 100
AT

Computation of Total earnings per worker and Labour cost per unit of component
Incentives Labour
Basic Wages* Total No. of units
Worker Cost per
(`) % Amount Earnings Produced
unit (`)
A 720.00 43 309.60 1029.60 16 64.35
B 720.00 10 72.00 792.00 12 66.00
C 720.00 26 187.20 907.20 14 64.80
D 720.00 - - 720.00 10 72
*Basic Wages: 48 Hours × ` 15 = ` 720

(c) List out the duties of Store Keeper. [2]

Answer:
The duties of store keeper are as follows:-
(a) To exercise general control over all activities in store department.
(b) To ensure safe storage of the materials.
(c) To maintain proper records.
(d) To issue materials only in required quantities against authorized requisition
documents.

Question.4
(a) A manufacturing unit has pre-determined overhead recovery rates as 400% on direct
wages, 20% on works cost and 25% on cost of production for works expenses,
management expenses and commercial expenses respectively.
At the end of the year, it has been found that the works overhead stands unabsorbed to
the extent of 30% of the total productive wages, management overhead shows under
recovery of one-eighth of the absorbed amount, and the recovery of commercial
expenses result in an over absorption of the total amount absorbed.
If the prime cost of the three jobs is as under, find the profit / loss on the respective selling
prices (both on the basis of standard cost and on the basis of full absorption overheads)
Costs Job A (`) Job B (`) Job C (`)
Direct Material 45.50 32.60 26.80
Direct Wages 15.20 8.60 7.20

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60.70 41.20 34.00

Selling Price 200.00 130.00 90.00
[5+5]
Answer:
Statement for ascertaining Cost of Sales ( at standard recovery and on full absorption of
overheads)
Job A (`) Job B (`) Job C (`)
Direct Material 45.50 32.60 26.80
Direct Wages 15.20 8.60 7.20
Works Overhead ( 400% on Direct Wages) 60.80 34.40 28.80
Works Cost 121.50 75.60 62.80
Management Expenses (20% on works Cost) 24.30 15.12 12.56
Cost of Production 145.80 90.72 75.36
Commercial Expenses ( 25 % on Cost of 36.45 22.68 18.84
Production)
Cost of Sales ( At Standard Recovery) 182.25 113.40 94.20
Add: Under recovery of Works Overhead (30%
4.56 2.58 2.16
of productive wages)
Add: Under Recovery of management
3.04 1.89 1.57
expenses (1/8 of the absorbed amount)
Total 189.85 117.87 97.93
Less: Over absorption of commercial expenses
12.15 7.56 6.28
(1/3 of the absorbed)
Cost of Sales (On full absorption of overhead) 177.70 110.31 91.65

Statement of Profit / Loss

Job A (`) Job B (`) Job C (`)
Selling Price 200.00 130.00 90.00
Cost of Sales at Standard Absorption 182.25 113.40 94.20
Profit / Loss at Standard Cost 17.75 16.60 (4.20)
Cost of Sales on full absorption of Overhead 177.70 110.31 91.65
Profit / Loss on full absorption of Overhead 22.30 19.69 (1.65)

(b) The Budgeted annual production of a company is 1,20,000 units, each unit requiring 2½
hours at an hourly wage rate of ` 15. Currently the average efficiency of the production
workers is only 60%. The management has a scheme to raise this to 75 %. The scheme
involves realigning the machinery and intensive training of the production workers, at a
onetime cost of ` 10 lakhs. The scheme also proposes to raise the wage rate to ` 16 to
ensure the full co-operation of workers. Calculate the scheme and state whether it can
be accepted. [3+1]
Answer:
Budgeted annual Production = 1,20,000 units
Standard Hours required for production @ 2½ hours per unit = 3,00,000 hours
Statement of Comparative labour cost before and after the implementation of the
scheme
Before After
Standard Time required for production 3,00,000 hrs 3,00,000 hrs
Labour efficiency 60 % 75 %
Estimated labour hours likely to be taken 5,00,000 hrs 4,00,000 hrs

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(3,00,000 / 60%) (3,00,000 / 75%)

Wage Rate / hour ` 15 ` 16
Total estimated wages per year ` 75,00,000 ` 64,00,000
So, net savings for change of scheme is (75-64) = 11 lakhs
Since the net savings i.e. ` 11 lakhs exceeds the total cost of implementing the project
i.e. ` 10 lakhs the scheme should be accepted by the management.

(c) XYZ Co. Ltd. is having 400 workers at the beginning of the year and 500 workers at the
end of the year. During the year 20 workers were discharged and 15 workers left the
company. Calculate the Labour Turnover rate under ‘separation method’. [2]

Answer:
Average No. of workers (400 + 500) / 2 = 450 Labour Turnover rate (Separation Method)
The Labour Turnover rate under separation method
Number of separations during the year 20 15
= 100 100 7.78%
Average number of worker s 450

Question.5
(a) For the manufacture of certain product two components X and Y are used. The following
particulars about these components are available:
X Y
Normal usage (Per Week) 60 nos. 60 nos.
Maximum usage (Per week) 80 nos. 80 nos.
Minimum usage (Per week) 30 nos. 30 nos.
Reorder quantity 400 nos. 600 nos.
Reorder period 4 to 6 weeks 2 to 4 weeks
You are required to calculate for each component:
(i) Reorder level
(ii) Minimum level
(iii) Maximum level
(iv) Average stock level. [2x4=8]

Answer:
Components (Units)
X Y
(i) Reorder level:
(Maximum usage x Maximum Reorder 480 320
period)
X=80 x 6 =480
Y=80 x 4 =320
(ii) Minimum level:
Reorder level - (Normal usage x Normal re- 180 140
order period)
X=480-(60 x 5) =180
Y=320-(60 x 3) =140
(iii) Maximum level:
(Re-order level + Reorder quantity)- 760 860
(Minimum usage x minimum reorder
period)
X=480 + 400 - 30 x 4 =760
Y=320 + 600 – 30 x 2 =860

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(iv) Average stock level:

(Minimum level + Maximum Level)/2 470 500
X=(180 + 760) /2 =470
Y=(140 + 860) /2 =500
Alternative:
Average stock level
Minimum level + (Re-order quantity)/2 380 440
X=180 + (400/2) =380 units
Y=140 + (600/2) =440 units

(b) A company manufactures a standard component. The detail of current operation of the
company is as follows.
Number of workers employed 100
Weekly working hours 48
Average number of hours lost due to idle time per employee per week 8
Standard time required per unit 2 Hours
Hourly wage Rate ` 15
Current Level of Efficiency 80%
For every unit sold the company is getting a cash profit of ` 120 before charging labour
cost.
In view of the increased demand for the product, the company has come to an
agreement with the labour union to raise the wage rate by ` 3 per hour in return for the
workers reducing idle time by 4 hours and raising operational efficiency to 90%
You are required to calculate:
(i) Net profit at current operation
(ii) Net profit after the agreement [2.5x2=5]

Answer:
(i) Calculation of Net profit at current operation:
Total Hours of work= [(48-8) x 80%] x 100=3200 hours
3200
Number of units produced = 1600
2
`
Total Cash Profit = 120 × 1600 1,92,000
Less: Labour cost ( 4800 × 15) (72,000)
Net profit 1,20,000

(ii) Calculation of Net profit after the agreement:

Total Hours of Work = 48 4 90% 100 3,960 Hours

3960
Number of Units produced = = 1980 units
2
`
Total Cash Profit = 120 × 1980 2,37,600
Less: Labour cost ( 4800 × 18) (86,400)
Net profit 1,51,200

(c) A manufacturing organization has imported four types of materials. The invoice reveals
the following data:
Quantity kgs. Rate US $ per kg.

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Material
P 1,000 1.50
Q 2,000 1.25
R 1,500 2.00
S 3,000 1.00
Import duty 23% of invoice value
Insurance 2% of invoice value
Freight and cleaning ` 30,000
Exchange Rate US $ 1= ` 16.00
50% of the materials imported are issued to production centers. While determining the
value of closing stock 10% allowance is provided to cover up storage loss. Determine the
value of closing stock of each type of materials. [3]
Answer:
Statement showing computation of total cost of material purchase and value of closing
stock:
Particulars P Q R S
(a) Basic cost of 1,500 2,500 3,000 3,000
material in $
(b) Insurance & import 375 625 750 750
duty @ 25%
Cost in $ 1,875 3,125 3,750 3,750
Cost in Rupees 30,000 50,000 60,000 60,000
(c) (+) Freight & 4,000 8,000 6,000 12,000
clearing (on weight
basis) (1:2:1.5:3)
34,000 58,000 66,000 72,000
(d) (-) Issued to 17,000 29,000 33,000 36,000
production (50%)
17,000 29,000 33,000 36,000
(e) (-) Storage loss @ 1,700 2,900 3,300 3,600
10%
Closing Stock 15,300 26,100 29,700 32,400

Section B–Financial Management

(Answer Question no.6 which is compulsory and any two from the rest in this section.)

Question.6.Choose the most appropriate one from the stated options.

(a) A bond costing @ ` 800 is redeemable after 5 years @ ` 1,000. No interest is to be

received and the discounting rate is 10%. What would be the NPV of bond? [2]
(a) ` 720
(b) ` (720)
(c) ` (179)
(d) ` 179
Answer:
(c) ` (179)
Outflow in purchasing a bond of ` 800
Inflow on Redemption of bond at the end of 5th year= `1,000
Present value of inflow=1000 x PVIF (10%, 5th year)

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=1000 x 0.62092 = ` 620.92 i.e. 621

NPV= Present value of inflow - Present value of outflow
NPV= `621 - `800
NPV= ` (179)

(b) The following data relate to SSCO Ltd:

`
Earnings before interest and tax (EBIT) 10,00,000
Fixed Cost 20,00,000
Earnings before tax (EBT) 8,00,000
Required combined leverage will be….. [2]
(a) 2.75
(b) 3.75
(c) 4.75
(d) 0.75

Answer:
(b) 3.75
Contribution:
C=S-V and
EBIT=C-F
Where,
C=Contribution;
S= Sales;
V= Variable Cost
F= Fixed Cost
10,00,000=C-20,00,000
C=30,00,000
Operating leverage (OL)= C/EBIT
=30,00,000/ 10,00,000 =3 times
Financial leverage (FL) =EBIT/EBT
=10,00,000/ 8,00,000
=1.25 times
Combined leverage=OL x FL=3 x 1.25 =3.75 times

(c) The current market price of an equity share of a company is ` 90. The current dividend
per share is ` 4.50. In case the dividends are expected to grow at the rate of 7%, then the
cost of equity capital will be…. [2]
(a) 10%
(b) 11%
(c) 12%
(d) 13%

Answer:
(c)12%
Ke=Cost of equity capital
D1=Expected dividend per share
NP=Net proceeds of per share (Issue price- Flotation Cost)
g=growth in expected dividend
Ke=D1/NP +g
Ke=4.50/90 +0.07
Ke=0.05+0.07=0.12=12%
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Note: Here market price is taken as net proceed (NP). Here there is no under writing
expenses so full amount that is ` 90 will be taken.

(d) A company’s expected annual net operating income (EBIT) is ` 50,000. The company has
` 2,00,000, 10% debentures. The equity capitalization rate (Ke) of the company is 12.5%.
Find the value of the firm under Net Income approach. [2]
(a) ` 4,80,000
(b) ` 4,60,000
(c) ` 4,45,000
(d) ` 4,40,000
Answer:
(d) ` 4,40,000

Calculation of value of firm under Net Income approach

Value of firm=MV of Equity + MV of Debt
EBIT 50,000
Less: Interest (2,00,000 x 10%) 20,000
EBT 30,000
Equity Capitalisation Rate (K e) 12.5%

Therefore
Value of Equity=30,000/12.5% ` 2,40,000
Value of Debt (given) ` 2,00,000
Value of firm ` 4,40,000

Question.7
(a) How does financial leverage increase the potential reward to the shareholders? [6]
Answer:
Financial leverage is based on the assumption that firm is to earn more on the assets that
acquired by the use of Funds on which a Fixed Rate of interest/dividend is to be paid.
Financial leverage can be calculated as follows:
Financial leverage=EBIT/EBT
The Financial leverage increase the reward to the shareholders, as by increasing the
debt, the organization enjoys the tax benefit as the interest on the debt capital is
chargeable to the profit, thus reducing the tax burden. Again the Profit Before Tax (PBT)
will be higher with lower or nil interest on debt, leading to high incidence of Corporation
tax. The Balance representing Profit After Tax (PAT) become proportionately lower when
such PAT is related to the higher equity capital and lower or nil debt capital. As the
shareholder’s reward is the PAT earned against the volume of capital invested, the
financial leverage increase the potential reward to the shareholders. Further, Increase in
Equity to finance low risk activities will lead to lower return for shareholders. Companies
having lower risk cash flow can therefore enhance the shareholders return by increasing
the debt instead of Equity. The net operating surplus represents PAT when related to the
lower level of paid up share capital shows a higher reward to the shareholder.

(b) ABC Limited has made plans for the year 2013-2014. It is estimated that the Company will
employ total assets of ` 25,00,000; 30% of assets being financed by debt at an interest
cost of 9%p.a. The direct cost for the year are estimated at ` 15,00,000 and all other
operating expenses are estimated at ` 2,40,000. The sales revenue is estimated at `
22,50,000. Tax rate is assumed to be 50%. Required to calculate:
(i) Net profit margin
(ii) Return on assets
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(iii) Assets turnover and

(iv) Return on equity. [1.5 x 4 = 6]

Answer:
The net profit is calculated as follows:
Sales revenue 22,50,000
Less: Direct Costs 15,00,000
Gross profits 7,50,000
Less: Operating Expenses 2,40,000
EBIT 5,10,000
Less: Interest (9% x 7,50,000) 67,500
EBT 4,42,500
Less: Taxes @ 50% 2,21,250
PAT 2,21,250

Debt= 25,00,000 × 30% = ` 7,50,000

Equity= 25,00,000 × 70% = ` 17,50,000

(i) Net Profit Margin= EBIT (1 - t) x 100/Sales

=5,10,000 (1 - 0.5) x 100/ 22,50,000
=11.33%

(ii) Return on Assets (ROA)

ROA=EBIT (1 - t)/ Total Assets
=5,10,000 (1 - 0.5)/ 25,00,000
=3,06,000/ 25,00,000
=0.102
=10.2%

(iii) Assets Turnover=Sales/Assets

=22,50,000/ 25,00,000
=0.9

(iv) Return on Equity (ROE)

ROE=PAT/ Equity
=2,21,250/ 17,50,000
=12.64%
(c) Discuss about the evolution of Zero Based Budgeting and state its advantages. [1+3]

Answer:
Zero Based Budgeting (ZBB):
Evolution: ZBB was first introduced by Peter A. Pyhrr, a staff control manager at Texas Instruments
Corporation, U.S.A. He developed this technique and implemented it for the first time during the
year 1969-70 in Texas in the private sector and popularized its wider use. He wrote an article on
ZBB in Harvard Business Review and later wrote a book on the same. The ZBB concept was first
applied in the State of Georgia, U.S.A. when Mr. Jimmy Carter was the Governor of the State.
Later after becoming the President of U.S.A. Mr. Carter introduced and implemented the ZBB in
the country in the year 1987, ZBB has a wide application not only in the Government
Departments but also in the private sector in a variety of business. In India, the ZBB was applied
in the State of Maharashtra in 80s and early 90s.

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Benefits from ZBB can be summarized in the following manner.

1. ZBB facilitates review of various activities right from the scratch and a detailed cost
benefit study is conducted for each activity. Thus an activity is continued only if the cost
benefit study is favorable. This ensures that an activity will not be continued merely
because it was conducted in the previous year.
2. A detailed cost benefit analysis results in efficient allocation of resources and
consequently wastages and obsolescence is eliminated.
3. A lot of brainstorming is required for evaluating cost and benefits arising from an activity
and this results into generation of new ideas and also a sense of involvement of the
staff.
4. ZBB facilitates improvement in communication and co-ordination amongst the staff.
5. Awareness amongst the managers about the input costs is created which helps the
organization to become cost conscious.
6. An exhaustive documentation is necessary for the implementation of this system and it
automatically leads to record building.

Question.8
(a) The Beta co-efficient of Target Ltd. is 1.4. The Company has been maintaining 7% rate of
growth in dividends. The last dividend paid was ` 4 per share. Return on Government
securities is 10%. Return on market portfolio is 15%. The current market price of one share
of Target Ltd. is ` 36.
What will be the equilibrium price per share of Target Ltd.? [3]
Answer:
CAPM formula= E(R) =Rf + b [Rm - Rf]
Where,
E(R) =Expected rate of return on the security
Rf =risk free returns
(Rm) =market rate of return
β =Beta co-efficient (given 1.4)

Substituting the values

E (R) =10+1.4 (15% - 10%)
E (R) =17% or Ke = 17%
Dividend growth model =(D1/P0) +G
Where,
D1, is dividend per share in year 1, [dividend (1+G)]
G is growth rate of dividends,
P0=Market price/ share in year 0.
E (R) or Ke being 17, we can make the equation as
P0=D1/ Ke - G
P0=4 (1.07)/ 0.17- 0.07
= ` 42.80

(b) A chemical company is considering replacing an existing machine with one costing `
65,000. The existing machine was originally purchased two years ago for ` 28,000 and is
being depreciated by the straight line method over its seven-year life period. It can
currently be sold for ` 30,000 with no removal costs. The new machine would cost `
10,000 to install and would be depreciate over five years. The management believes that
the new machine would have a salvage value of ` 5,000 at the end of year 5. The
management also estimates an increase in net working capital requirement of `10,000 as

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 Answer to PTP_Intermediate_Syllabus 2012_Jun2014_Set 3

a result of expanded operations with the new machine. The firm is taxed at a rate of 55%
on normal income and 30% on capital gains. The company’s expected after-tax profits
for next 5 years with existing machine and with new machine are given as follows:
`
Expected after-tax profits

Year With existing machine With new machine

1 2,00,000 2,16,000
2 1,50,000 1,50,000
3 1,80,000 2,00,000
4 2,10,000 2,40,000
5 2,20,000 2,30,000
(a) Calculate the net investment required by the new machine.
(b) If the company’s cost of capital is 12%, determine whether the new machine should
be purchased. [3+6]
Answer:
(a) Net Investment required by the New Machine:

Calculation of present value of net investment required: `

Cost of new asset 65,000
Add: Installation cost 10,000
75,000
Add: Additional WC 10,000
85,000
Less: Sale proceeds of old machine 30,000
Less: Tax 5,000
[8,000 x 55/100 + 2000 x 30/100] 25,000
Net Investment required 60,000

(b) Appraisal of Replacement decision under NPV Method:

Calculation of Present Value of Incremental Operating cash inflows for 5 years.

Year CIAT (PAT + Dep) Incremental PV factor at Present Value
12%
Old New
1 2,04,000 2,30,000 26,000 0.8928 23,213
2 1,54,000 1,64,000 10,000 0.7971 7,971
3 1,84,000 2,14,000 30,000 0.7117 21,351
4 2,14,000 2,54,000 40,000 0.6355 25,420
5 2,24,000 2,44,000 20,000 0.5674 11,348
PV of cash inflows for 5 years 89,303

Calculation of PV of terminal cash inflow `

Salvage value of asset 5,000
[No taxes because book value and salvage value are equal]
Working capital recovered [100% recovered] 10,000
Terminal cash inflows 15,000
Its PV at the end of 5th year = 15,000 x 0.5674 = 8,511

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 Answer to PTP_Intermediate_Syllabus 2012_Jun2014_Set 3

Calculation of NPV `
PV of total cash inflows = 97814
[89,303 + 8,511]
(–) Outflow (Net Investment Required) = 60,000
NPV = 37,814

Comment:
As NPV is positive, it is advised to replace.
Note 1:
Depreciation for old Machine = 28,000 / 7 = ` 4,000
Depreciation for new Machine = [(`65,000 + `10,000 - `5,000) ÷ 5] = ` 14,000

(c) List out the importance of Cash Management. [4]

Answer:
Some of the importance of Cash Management is:
(i) Cash Management ensures that the firm has sufficient cash during peak times for
purchase and for other purposes.
(ii) Cash Management help to meet obligatory cash out flows that are all due.
(iii) Cash Management assists in planning capital expenditure projects.
(iv) Cash Management helps to arrange for outside financing at favorable terms and
conditions, if necessary.
(v) Cash Management helps to allow the firm to take advantage of discount, special
purchases and business opportunities.
(vi) Cash Management helps to invest surplus cash for short or long term periods to keep
the idle funds fully employed.

Question.9
(a) From the following figures, prepare a statement showing the changes in the working
capital and fund flow statement during the year 2013:-
Assets Dec.31,2012 Dec.31,2013
Fixed Assets (net) ` 5,10,000 6,20,000
Investment 30,000 80,000
Current Assets 2,40,000 3,75,000
Discount on debentures 10,000 5,000
7,90,000 10,80,000
Liabilities
Equity share capital 3,00,000 3,50,000
Preference share capital 2,00,000 1,00,000
Debentures 1,00,000 2,00,000
Reserves 1,10,000 2,70,000
Provision for doubtful debts 10,000 15,000
Current liabilities 70,000 1,45,000
7,90,000 10,80,000
You are informed that during the year:
(a) A machine costing ` 70,000 book value ` 40,000 was disposed of for ` 25,000.
(b) Preference share redemption was carried out at a premium of 5% and
(c) Dividend at 10% was paid on equity share for the year 2012.
Further:
(i) The provision for depreciation stood at ` 1,50,000 on 31.12.12 and at ` 1,90,000 on
31.12.13; and

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 Answer to PTP_Intermediate_Syllabus 2012_Jun2014_Set 3

(ii) Stock which was valued at ` 90,000 as on 31.12.12; was written up to its cost, `
1,00,000 for preparing Profit and Loss account for the year 2013. [3+5]

Answer:
Change in working capital
2012 2013
Current Assets 2,40,000 3,75,000
(+) Stock under valued 10,000
Current liabilities 70,000 1,45,000
Net working capital 1,80,000 2,30,000
Increase in working capital 50,000

Fund flow statement

Sources Amount (`) Applications Amount (`)
Sale of fixed assets 25,000 Increase in working capital 50,000
Fund from operation 2,80,000 Purchase of fixed assets 2,20,000
Issue of shares 50,000 Purchase of investment 50,000
Debentures 1,00,000 Redemption of preference 1,05,000
shares
Dividend paid 30,000
4,55,000 4,55,000
Working note
1. Depreciation
(`)
Opening provision 1,50,000
(-) Provided on sale of asset 30,000
1,20,000
(+) Provided during the year (b /f) 70,000
Closing provision 1,90,000

2. Purchase & Sale of Fixed Assets

(`)
Opening (2013) 5,10,000
(-) Provided on sale of asset 40,000
Sold 4,70,000
(-) Depreciation provided 70,000
4,00,000
(+) Purchases (b /f) 2,20,000
Closing 2013 6,20,000

3. P & L Adjustment A/c

Particulars Amount (`) Particulars Amount (`)
To depreciation 70,000 By balance b/d 1,20,000
(1,10,000+10,000)
To loss on sale of fixed assets 15,000 By fund from operations 2,80,000
(Bal. figure)
To loss on redemption of 5,000
shares
To discount written off 5,000
To provision for doubtful 5,000
debt
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 Answer to PTP_Intermediate_Syllabus 2012_Jun2014_Set 3

To dividend 30,000
To balance c/d 2,70,000
4,00,000 4,00,000

(b) A Company provide the following data:

Cost per unit (`)
Raw materials 52.00
Direct labour 19.50
Overheads 39.00
Total cost 110.50
Profit 19.50
Selling price 130.00

The following additional information is available:-

(a) Average raw materials in stock: one month.
(b) Average materials in process: half-a-month
(c) Average finished goods in stock: one month
(d) Credit allowed by suppliers: one month
(e) Credit allowed to debtors: two month
(f) Time lag in payment of wages: one and a half weeks.
(g) Overheads: one month
(h) One-fourth of sales are on cash basis.
(i) Cash balance is expected to be ` 1,30,000
You are required to prepare a statement showing the working capital needed to finance
a level of activity of 70,000 units of annual output. The production is carried evenly
throughout the year and wages and overheads accrue similarly. (Calculation is made on
the basis of 30 days a month and 52 weeks a year.) [8]
Answer:
Statement showing estimate of Working Capital
Particulars Amount (`) Amount (`)
Current Assets:
Stock of Raw material (70,000 units x 52 x 30/ 360) 3,03,333
Work in progress:
Raw materials (70,000 units x 52 x 15/ 360) 1,51,667
Direct labour (70,000 units x 19.50 x 30/ 360 x1/2 × 28,437
50%)
Overheads (70,000 units x 39 x 30/ 360 x ½ × 50% ) 56,875 2,36,979
Stock of finished goods (70,000 units x 110.50 x 30/ 6,44,583
360)
Debtors (70,000 units x 130 x 60/ 360) 15,16,667
Cash balance 1,30,000
(a) 28,31,562
Current Liabilities:
Creditors for raw material (70,000 units x 52 x 30/ 360) 3,03,333
Creditor for wages (70,000 units x 19.50 x 1.5/ 52) 39,375
Creditors for overheads (70,000 units x 39 x 30/ 360) 2,27,500
(b) 5,70,208
Net working Capital (a) – (b) 22,61,354

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