FinancialManagement

DSE - 6.2A
- Honours
2020 Examination Paper's Solution
Group - A
Answer any two questions.
You are working in afirm having ROI 18% and Cost of Capital
1. 12%. For a proposed project
with effective life of 3 years, the
inflows are estimated as 67,500, 76,500 and ? 56,700.
Calculate the present value of benefits from the project. (15marks)
Ans.
Years CFAT PVFactor @12% DCFAT
1 67500 0.893 60278
2 76500 0.797 60970
3 56700 0.712 40370
Net Present Value 161618

2- Discuss Matching and aggressive approaches in the context of Working Capital Financing
strategies. (15 marks)
Ans.
Working capital Approaches:
A) Matching or hedging approach: This approach matches assets
and liabilities to
and
Basically, a company uses long term sources to finance fixed assets
maturities.
current assets.
permanent current assets and short term financing to finance temporary
flow for 5 years should be
Example: A fixed asset which is expected to provide cash
the company needs to have
financed by approx 5 years long-term debts. Assuming
seek short term 2 months bank credit to
additional inventories for 2 months, it will then
match it.
more
Conservative approach: it is conservative because the company prefers to have
B) long-term or
hand. That is why, fixed and part of current assets are financed by
cash on sources are more expensive, this leads
to
long-term
permanent funds. As permanent or
"lower risk lower return"
Company wants to take high risk where short tem funds are
C) Aggressive approach: The assets. An aggressive
current and even fixed
degree to finance
used to a very high
capital financing strategies. It doesn't assume to
working means that only some
approach is most risky among
spontaneous needs in working capital. It
noid any reserves to
cOver
financed by long-term financing The rest and the
capital is by short-tem
portion of permanent working including seasonal fluctuations, are met
temporary working capital, possible to reduce interest expense and
approach makes it
borrowing. Adopting this but it also carries the
greatest risk.
business,
increase profitability of a
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3.
Management
YLtd. started a project with the initial investment of ? 5,00,000. The life of the project is 5
years. It is expected that cash inflows starting from first year to fifth year will be ? 1,10,000. ?
1,40,000, 1,80,000, 2,50,000 and 3,80,000 respectively. What will be the Pay back
period
of the project? (15 marks)
Ans.
Years CFAT Cumulative CFAT
1 110000 110000
2 140000 250000
3 180000 430000
4 250000 680000
5 380000 1060000
Payback Period =3 years + (70000/250000) years = 3.28 years
4. From the following information,determine the theoretical market price of each equity share of
acompany as per Walter's Model:
Earnings of the Company 710,00,000
Dividend paid 75,00,000
No. of equity shares outstanding ? 2,00,000
Cost of Equity capital 12%
Rate of return on investment 15%
(15 marks)
Ans.
EPS (E) = 1000000 / 200000 = 5
DPS (D) = 500000 / 200000=2.5
Cost of Capital (K) =12% =0.12
Rate of Return (r) = 15%=0.15
As per Walter, P = [D+ r/k(E -D)] /k=[5 +0.15/0.12(5 - 2.5)] /0.12 = 67.708
Group - B
Answer any two questions.
5. Calculate weighted average cost of capital (WACC) considering market values for AD Ltd.
from the following details :
Sources of Capital
Equity share capital (? 10 each) 12,00,000
Retained Earnings 28,00,000
14% Preference shares (issued at a premium of 8%) 90,000
15% Debentures 3.60,000
 Examination Paper 2020
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otherintormation
Applicable corporate tax rate 30%
Market price per share R50, Dividend per share is expected to be ?6. AD Ltd. maintains a
growth of 5% in this regards.
hanhures of face value 1O00 each were issued at 3% discount (with an additional
danwriters' commission of 1.5% on face value). Tenure of Debenture 10 years.(25 marks)
= 17%
Ans. Ke = (6/50) + 5%
17%
K= K =
Ko = 14%
(1000 - 955)/10/(1000 +955)/2 = 11.2%.
Kg =[150 (1-0.3) + WACC
Capital Structure Market Value Weight (w) Cost of Capital (k) (Wx k)
17% 11.03%
Equity Capital 6000000 0.6486
0.30268 17% 5.15%
Retained Earning 2800000
14% 0.14%
90000 0.009729
Pref. Capital 0.44%
360000 0.038916 11.2%
Debt Capital 16.76%
9250000 1

Hence, VWACC = 16.76% as shown below :

Construction Ltd. is considering the five possible projects to invest in,
6 PP PVof Cash Inflows ()
Cash Outflow ()
Project 7,50,000
5,00,000
A 2,10,000
2,00,000
B 8,00,000
5,00,000
80,000
1,00,000
D 3,30,000
3,00,000
E
decision concept and select the projects.
Available fund is 12,00,000.Apply Capital rationing (25 marks)
nature.
All the projects are divisible in
Profitability Index Rank
Ans.
Cash Outflow PVof Cash Inflows
Project (bla)
(b)
(a) 7,50,000
1.50 =2- >=IV
A 5,00,000 1.05
2,10,000
B 2,00,000 1.60
8,00,000 V
C 5,00,000 80,000
0.80
D 1,00,000 1.10
330,000
3,00,000 -C; 500000
E
should employ ? 500000in project
the company
Hence as per capital rationing
200000 in project-E.
balance
H project - Aand
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4

given below
Managerment
7. Relevant information about two companies are
X

Annual production capacity (Units) 1,00,000 1,50,000

Capacity utilisation and sales
75% 75%
40 50
Unit selling price () 15 15
Unit variable cost (?)
2,00,000 3,00,000
Fixed cost for the year (?)
Equity capital(? 10 per share)
5,00,000 7,00,000
10% Preference share capital (?) 50,000
15% Debentures (?) 1,00,000 2,00,000
Determine the degree of Operating Leverage, degree of Financial Leverage, degree of
Financial Leverage and Earning per Share of two companies. (Tax rate 40%). (25 marks)
Ans.
Details X Y

Unit selling price (a) 40 50

Unit variable cost (b) 15 15
Unit Contribution (a- b) 25 35
Production &Sales (75% of Annual Capacity) (in units) 75000 112500
Total contribution (c) 1875000 3937500
Fixed Cost (d) 200000 300000
EBIT (C - d) 1675000 3637500
Interest 15000 30000
EBT (EBIT - Interest) 1660000 3607500
Tax (40% of EBT) 664000 1443000
PAT (EBT - Tax) 996000 2164500
Preference Dividend
5000
Profit after tax & Pref. Dividend (e) 2159500
996000
No. Of Equity Shares (f) 50000 70000
EPS (elf) 30.85
19.92
DOL (Contribution /EBIT)
1.12 1.08
DFL (EBIT /EBT)
1.01 1.01
DCL (DOL x DFL)
1.13 1.09
8 The capacity of your company is tO produce
40,000 units of valve per annum. The compay
expects to operate at 60% of the capacity level.
capital requirement at the current level of You are required to ascertain he
operation.
Honours
Examination Paper 2020 5

Thefollowinginformation on the cost-price structure of valves at the current level of production

is available
Elements of costs Per unit (?)
Raw-material
Direct labour
4
Overhead
13
Total cost
3
Profit
16
Selling price
The duration of the production
Raw-materials are in stock, on an average, for 2months.
stock, on an average for 1 month. Credit
process is half a month. Finished goods are in
customers is 3 months and that obtained from suppliers is 1.5 months, lag in
allowed to marks)
wages is half a month. There is usually no lag in payment of overhead. (25
payment of
Ans.
(40000x60%) / 12 = 2000 units
Monthly Production & Sales =
Monthly Cost Statement: Amount
Particulars 12000
RawMaterials (2000x6) 6000

Labour (2000 x 3) 8000

26000
Overheads (2000 x 4)
6000
Total Cost
32000
Profit (2000 x 3)
Sales (2000 x16)
Capital Required
Statement Showing Working Debtors Creditor
Time WIP Fin Stock
Total RM
Particulars Lag
(Months)
A. RawMaterials 24000 24000
- in Store 2 6000
6000 12000
0.5
- in WIP 12000 36000
- in Fin Stock 36000 (18000)
3
- to Debtors (18000)
from 1.5
Less: 6000 12000 36000 (18000)
Creditor 60000 24000
Total (A) 1500
B. Direct Labour 1500 6000
- in WIP
0.25 18000
6000
1
- in Fin Stock 18000 (3000)
3
- to Debtors (3000)
0.5
Less:
 6 Lawpoint's B.Com Solutions - inancial
Management
Outstanding
Total (B) 22500 1500 6000 18000
C. Overheads
(3000)
in WIP 0.25 2000 2000
in Fin Stock 1 8000 8000
to Debtors 3 24000 24000
Less:
Outstanding
Total (C) 34000 2000 8000 24000
D. Profit
- to Debtors 3 18000 18000
Total (D) 18000 18000
Working Capital
Required 134500 24000 9500 26000 96000 (21000)
(A+B+C+D)
9. X Ltd. wants to purchase one machine out of two mutually exclusive machines under
consideration.
Other information related to these machines are as below :
Particulars Machine 1 Machine 2
Purchase price (?) 3,00,000 2,80,000
Estimated life (years) 5 5
Net cash flows():
Year 1 80,000 60,000
Year 2 1,20,000 80,000
Year 3 90,000 1,20,000
Year 4 85,000 1,50,000
Year 5 92.000
1,58,000
Compute the NPVof each machine assuming a cost of capital of 10%. Which machine should
the company buy?
The present value of 1to be received at the end of each
year at 10% is given below
Year 1 2 3 4 5
P.V. () 0.909 0.826 0.751 0.621
0.683
(25 marks)
Ans.
PV Factor Machine -1
Years Machine -2
@10% CFAT DCFAT
1 0.909
DCFAT CFAT
80000 72720 60000 54540
2 0.826 120000 99120 80000 66080
3 0.751 90000 67590 120000 90120
 Examination Paper 2020
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0.683
85000 58055
5 0.621 150000 102450
158000 98118 92000
Total DCFAT 57132
395603 370322
Cash Outflow
300000 280000
NPV
95603 90322
as per higher NPV, Machine -1 should buy.
ia) Mention any five important factors that afirm should consider in
formulating dividend policy.
(13 marks)
Ans. The factorS Which determine the dividend policy of any business firm are stated beloW
1. Desires of Shareholders: Generally the equity shareholders expect a regular return
on their investment in form of current dividends and increase in the market value of
the equity shares held by them.
2. Dividend Payout (D/P) Ratio: High D/P Ratio depicts lesser amount of funds for
future growth of fim. An optimum dividend policy maintains a balance between
current dividends and future growth of firm by evokingan ideal D/P Ratio.
take decisions on their
3. Financial Requirement of Company: A company generally the firm need fund for
requirement. If
dividend policies, on the basis of its financial
profitable investments, then they will not declare any dividend to their
Some
shareholders.
for
liquidity position of firm is good then itmay take favourable decision
4. Liquidity: If
dividend payments and vice-versa. stable flow of dividend income.
shareholder of a firm always want a
to
5. Stability: The
taking into consideration that whether the firm is able
Hence it is very necessary to
dividend policy or not. consideration while preparing its
give stability to its taken into
trend of earning is also
6. Trend: The past
surplus, can
dividend policy.
firm haVing suffiCient reserves and
established
7. Age of Fim:
An old and
difficult in case of newly established firm.
which is quite of fund to finance its
afford higher D/P ratio, enough provisions
Prospect: If the firm has sufficient or decision regarding its dividend
8. Growth difficult to take
expansion plans, it is not sO difficult to even think about this
very
future
But inthe opposite case, it will be payments of dividend by
anv
payments. upon the
constraints: Several legal restrictions company.
9. Legal shape the dividend policy of the (12 marks)
company also reference to the formulae. due to
financial leverage with additional risk placed on equity shareholders
(D) Discuss the
Leverage: It is measured using ratios like leverage multiplier, debt to
Financial
Ans.
debt funds. It
can be
funds. Afirm which is
entirely financed by equity (i.e.
the use of linked to use of
debt
financial risk.
assets, etc and almost no
firm)will have
an unlevered is measured as under
(DFL)
degree of financial leverage
The
 Lawpoint's B.Com Solutions Financial
Management
DFL= %Change in EPS
% Changein EBIT
EBIT
FL=
EPS
DFP?nge in EPS
Mathe matically, % Changein EBIT