NAVIN CLASSES CA NAVNEET MUNDHRA

FM chakra
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COST OF CAPITAL
Q 1. 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%.

Q 2. Masco Limited wishes to raise additional finance of ₹ 10 lakhs for meeting its
investment plans. It has ₹ 2,10,000 in the form of retained earnings available for investment
purposes. Further details are as following:
(1) Debt/ Equity mix 3:7
(2) Cost of debt:
Upto ₹ 1,80,000 10% (before tax)
Beyond ₹ 1,80,000 16% (before tax)

(3) Earnings per share ₹ 4

(4) Dividend payout 50% of earnings
(5) Expected growth rate of dividend 10%
(6) Current market price per share ₹ 44
(7) Tax rate 50%

You are required to:

(a) DETERMINE the pattern for raising the additional finance.
(b) DETERMINE the post-tax average cost of additional debt.
(c) DETERMINE the cost of retained earnings and cost of equity.
(d) COMPUTE the overall weighted average after tax cost of additional finance.

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Q 3. Mr. Mehra had purchased a share of Alpha Limited for ₹ 1,000. He received 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.

Q 4. 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:

₹
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 per equity share

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 has ₹ 4 floatation cost and market price of ₹ 24 per share.
The next year expected dividend is ₹ 1 with annual growth of 5%. The firm has practice of
paying all earnings in the form of dividend. Corporate tax rate is 30%. Use YTM method to
calculate cost of debentures and preference shares.

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Q 5. ABC Ltd. has the following capital structure, which is considered to be optimum as on
31st March, 2022.

₹
14% Debentures 30,000
11% Preference shares 10,000
Equity shares (10,000 shares) 1,60,000
2,00,000
The company share has a market price of ₹ 23.60. Next year dividend per share is 50% of
year 2021 EPS. Following is the uniform trend of EPS for the preceding 10 years which is
expected to continue in future:

Year EPS (₹) Year EPS (₹)

2012 1.00 2017 1.67
2013 1.10 2018 1.77
2014 1.21 2019 1.95
2015 1.33 2020 2.15
2016 1.46 2021 2.36
The company issued new debentures carrying 16% rate of interest and the current market
price of debenture is ₹ 96.

Preference shares of ₹ 9.20 (with annual dividend of ₹ 1.1 per share) were also issued. The
company is in 50% tax bracket.

(A) CALCULATE after tax:

(i) Cost of new debt
(ii) Cost of new preference shares
(iii) Cost of 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 2021.

(D) COMPUTE marginal cost of capital when the fund exceeds the amount calculated in (C),
assuming new equity is issued at ₹ 20 per share?

Q 6. A company issued 10,000, 15% Convertible debentures of ₹ 100 each with a maturity
period of 5 years. At maturity, the debenture holders will have an option to convert the
debentures into equity shares of the company in the ratio of 1:10 (10 shares for each
debenture). The current market price of the equity shares is ₹ 12 each and historically the
growth rate of the shares is 5% per annum.
Compute the cost of debentures assuming 35% tax rate

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CAPITAL STRUCTURE
Q 7. Alpha Ltd. and Beta Ltd. are identical except for capital structure. 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 the
companies is 8 per cent in a no-tax world, and capital markets are assumed to be perfect.
(a) (i) If you own 2 per cent 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 (Ko) is 18 per cent.
(ii) CALCULATE the implied required rate of return on equity of Alpha Ltd.
(b) Beta Ltd. has the same net operating income as Alpha Ltd.
(i) CALCULATE the implied required rate of return on equity of Beta Ltd.

(ii) ANALYSE why does it differ from that of Alpha Ltd.

Q 8. Following data is available in respect of two companies having same business risk:
Capital employed = ₹ 2,00,000, EBIT = ₹ 30,000 and Ke = 12.5%

Sources Levered Company (₹) Unlevered Company (₹)

Debt (@ 10%) 1,00,000 Nil
Equity 1,00,000 2,00,000
An investor is holding 15% shares in levered company.

CALCULATE the increase in annual earnings of investor if he switches his holding from
Levered to Unlevered company.

Q 9. 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%
An investor is holding 15% shares in Unlevered company.

CALCULATE the increase in annual earnings of investor if he switches his holding from
Unlevered to Levered Company.

Q 10. Best of Luck 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

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raise this additional capital, the following options are under consideration of the
management:
(a) To issue equity share 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% nonconvertible
debentures for the balance amount. In this case, the company can issue shares at a premium
of ₹40 each.
ADVISE which option is the most suitable to raise the additional capital, keeping in mind that
the management wants to maximize the earnings per share to maintain its goodwill. The
company is paying income tax at 50%.

Q 11. The following data are presented in respect of Quality Automation Ltd.:

Amount (₹)
Profit before interest and tax 52,00,000
Less: Interest on debentures @ 12% 12,00,000
Profit before tax 40,00,000
Less: Income tax @ 50% 20,00,000
Profit After tax 20,00,000
No. of equity shares (of ₹10 each) 8,00,000
EPS 2.5
PE Ratio 10
Market price per share 25
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%, pushes the Ke
up to 12.5%, means reducing the PE ratio to 8 and rises the interest rate on additional
amount borrowed to 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)

Q 12. Xylo Ltd. is considering two alternative financing plans as follows:

Particulars Plan A (₹) Plan B (₹)

Equity shares of ₹10 each 8,00,000 8,00,000
Preference Shares of ₹100 each - 4,00,000
12% Debentures 4,00,000 -
12,00,000 12,00,000

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The indifference point between the plans is ₹ 4,80,000. Corporate tax rate is 30%.
CALCULATE the rate of dividend on preference shares.

Q 13. The following data relates to two companies belonging to the same risk class

Particulars A Ltd. B Ltd.

Expected Net Operating Income ₹ 18,00,000 ₹ 18,00,000
12% Debt ₹ 54,00,000 -
Equity Capitalization Rate - 18

REQUIRED:

(a) 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.

(b) 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.

Q 14. 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. The following
information is available at different levels of debt value:

Debt Value (₹ in Lakhs) Interest rate (%) Equity capitalization rate (%)
0 0 10.00
5 6.00 10.50
10 6.00 11.00
15 6.20 11.30
20 7.00 12.40
25 7.50 13.50
30 8.00 16.00

Assuming no tax and that the firm always maintains books at book values, you are
REQUIRED to calculate:
(i) Amount of debt to be employed by firm as per traditional approach.
(ii) Equity capitalization rate, if MM approach is followed.

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DIVIDEND POLICY
Q 15. 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.

Q 16. 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%

Q 17. A&R Ltd. is a large-cap multinational company listed in BSE in India with a face value of
₹ 100 per share. The company is expected to grow @ 15% p.a. for next four years then 5%
for an indefinite period. The shareholders expect 20% return on their share investments.
Company paid ₹ 120 as dividend per share for the FY 2020-21. The shares of the company
traded at an average price of ₹ 3,122 on last day.
FIND out the intrinsic value of per share and state whether shares are overpriced or
underpriced.

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Q 18. 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%.
(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.
Q 19. 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 have 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 no of shares that Mr A would
hold after he re-invests dividend in shares of HM ltd.

Q 20. Following information is given pertaining to DG ltd,

No of shares outstanding shares 1 lakh shares
Earnings Per share 25 per share

P/E Ratio 20
Book Value per share 400 per share
If company decides to repurchase 25,000 shares, at the prevailing market price, what is the
resulting book value per share after repurchasing.

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LEVERAGE
Q 21. The following information is related to Yizi Company Ltd. for the year ended
31stMarch, 2021:

Financial leverage 1.49:1

P.V. Ratio 27.55%
Fixed Cost excluding interest ₹ 6.96 lakhs
Sales ₹ 84 lakhs
12% Bonds of ₹ 1000 each ₹ 37 lakhs
Equity Share Capital of ₹ 10 each ₹ 50 lakhs
Income Tax Rate 40%

You are required to CALCULATE:

(i) Operating Leverage;

(ii) Combined leverage; and

(iii) Earnings per share. Show calculations up-to two decimal points.

Q 22. From the following information, prepare Income Statement of Company A & B:
Particulars Company A Company B
Margin of safety 0.20 0.25
Interest ₹ 3,000 ₹ 2,000
Profit volume ratio 25% 33.33%
Financial Leverage 4 5
Tax rate 45% 45%

Q 23. The following particulars relating to Navya Ltd. for the year ended 31st March 2021 is
given:
Output 1,00,000 units at normal capacity
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, 2021 is as follows:

Particulars ₹
Equity share capital (1,00,000 shares of ₹10 each) 10,00,000
Reserves and surplus 5,00,000

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7% debentures 10,00,000
Current liabilities 5,00,000
Total 30,00,000
Navya Ltd. has decided to undertake an expansion project to use the market potential, that
will involve ₹ 10 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 10%. 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 programme are
planned:
(i) Entirely by equity shares of ₹ 10 each at par.

(ii) ₹ 5 lakh by issue of equity shares of ₹ 10 each and the balance by issue of 6% debentures
of ₹ 100 each at par.

(iii) Entirely by 6% debentures of ₹ 100 each at par.

FIND out which of the above-mentioned alternatives would you recommend for Navya Ltd.
with reference to the risk and return involved, assuming a corporate tax of 40%.

Q 24. The following details of a company for the year ended 31st March, 2021 are given
below:

Operating leverage 2:1

Combined leverage 2.5:1
Fixed Cost excluding interest ₹ 3.4 lakhs
Sales ₹ 50 lakhs
8% Debentures of ₹ 100 each ₹ 30.25 lakhs
Equity Share Capital of ₹ 10 each 34 lakhs
Income Tax Rate 30%

CALCULATE:
(i) Financial Leverage
(ii) 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 turnover?

(iv) At what level of sales, the Earning before Tax (EBT) of the company will be equal to zero?

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RATIO ANALYSIS
Q 25. In a meeting held at Solan towards the end of 2019-20, the Directors of HPCL Ltd. have
taken a decision to diversify. At present HPCL Ltd. sells all finished goods from its own
warehouse. The company issued debentures on 01.04.2020 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 STATEMENT
Particulars 2019-20 (₹) 2020-21 (₹)
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: Operating Expenses:
Warehousing 13,000 14,000
Transport 6,000 10,000
Administrative 19,000 19,000
Selling 11,000 49,000 14,000 57,000
Net Profit 15,000 19,000

BALANCE SHEET
Particulars 2019-20 (₹) 2020-21 (₹)
Fixed Assets (Net Block) - 30,000 -
Receivables 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
Payables 50,000 76,000
Total Current Liabilities (CL) 50,000 76,000
Working Capital (CA - CL) 70,000 1,07,000
Net 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 2019-20 and 2020-21:
(i) Gross Profit Ratio
(ii) Operating Expenses to Sales Ratio
(iii) Operating Profit Ratio

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(iv) Capital Turnover Ratio
(v) Stock Turnover Ratio
(vi) Net Profit to Net Worth Ratio

(vii) Receivables 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
2019- 20. Ignore Taxation.
Q 26. ArMore LLP is a newly established startup dealing in manufacture of a revolutionary
product HDHMR which is a substitute to conventional wood and plywood. It is an
economical substitute for manufacture of furniture and home furnishing. It has been
asked by a venture capitalist for an estimated amount of funds required for setting up
plant and also the amount of circulating capital required. A consultant hired by the entity
has advised that the cost of setting up the plant would be ` 5 Crores and it will require 1
year to make the plant operational.
The anticipated revenue and associated cost numbers are as follows:
Units to be sold = 3 lakh sq metres p.a.
Sale Price of each sq mtr = Rs.1000
Raw Material cost = Rs. 200 per sq mtr
Labour cost = Rs.50 per hour
Labour hours per sq mtr = 3 hours
Cash Manufacturing Overheads = ` 75 per machine hour
Machine hours per sq mtr = 2 hours
Selling and credit administration Overheads = ` 250 per sq mtr
Being a new product in the industry, the firm will have to give a longer credit
period of 3 months to its customers. It will maintain a stock of raw material equal
to 15% of annual consumption. Based on negotiation with the creditors, the
payment period has been agreed to be 1 month from the date of purchase. The
entity will hold finished goods equal to 2 months of units to be sold. All other
expenses are to be paid one month in arrears. Cash and Bank balance to the tune
of ` 25,00,000 is required to be maintained.

The entity is also considering reducing the working capital requirement by either of the
two options: a) reducing the credit period to customers by a month which will lead
to reduction in sales by 5%. b) Engaging with a factor for managing the receivables,
who will charge a commission of 2% of invoice value and will also advance 65% of
receivables @ 12% p.a. This will lead to savings in administration and bad debts cost
to the extent of ` 20 lakhs and 16 lakhs respectively.

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The entity is also considering funding a part of working capital by bank loan. For
this purpose, bank has stipulated that it will grant 75% of net current assets as
advance against working capital. The bank has quoted 16.5% rate of interest
with a condition of opening a current account with it, which will require 10% of
loan amount to be minimum average balance.
You being an finance manager, has been asked the following questions:
i) The anticipated profit before tax per annum after the plant is operational
ii) The estimated current assets requirement in the first year of operation (debtors
calculated at cost) is
iii) The net working capital requirement for the first year of operation is
iv) The annualised % cost of two options for reducing the working capital is
v) What will be the Maximum Permissible Bank Finance by the bank and annualised
% cost of the same?

Q 27. The following accounting information and financial ratios of PQR Ltd. relates to the
year ended 31st March, 2021:

I. Accounting Information:
Gross Profit 15% of Sales
Net profit 8% of sales
Raw materials consumed 20% of works cost
Direct wages 10% of works 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
Share Capital to Reserves and Surplus 1:4
If value of Fixed Assets as on 31st March, 2020 amounted to ₹ 26 lakhs,

PREPARE a summarised Profit and Loss Account of the company for the year ended 31st
March, 2021 and also the Balance Sheet as on 31st March, 2021.

Q 28. Manan Pvt. Ltd. gives you the following information relating to the year ending 31
March, 2021:

(1) Current Ratio 2.5:1

(2) Debt-Equity Ratio 1:1.5
(3) Return on Total Assets (After Tax) 15%

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(4) Total Assets Turnover Ratio 2
(5) Gross Profit Ratio 20%
(6) Stock Turnover Ratio 7

(7) Net Working Capital ₹ 13,50,000

(8) Fixed Assets ₹ 30,00,000
(9) 1,80,000 Equity Shares of ₹ 10 each
(10) 60,000, 9% Preference Shares of ₹ 10 each
(11) Opening Stock ₹ 11,40,000

You are required to CALCULATE:

(a) Quick Ratio
(b) Fixed Assets Turnover Ratio
(c) Proprietary Ratio
(d) Earnings per Share

Q 29. You are available with following information of Brave Ltd:

Debtor’s velocity 3 months
Stock velocity 6 months
Creditor’s velocity 2 months
Gross profit ratio 20%

The gross profit for the year ended 31st March,2023 was ` 10,00,000. Stock for the
same period was Rs.40,000 more than what it was at the beginning of the year.
Bills receivable were Rs. 1,20,000.

Form the above information you are required to calculate:

(i) Sales
(ii) Sundry debtors
(iii) Closing stock

WORKING CAPITAL
Q 30. The following annual figures relate to XYZ Co.:

₹
Sales (at two months’ credit) 36,00,000
Materials consumed (suppliers extend two months’ credit) 9,00,000

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Wages paid (1 month lag in payment) 7,20,000
Cash manufacturing expenses (expenses are paid one month in arrear) 9,60,000
Administrative expenses (1 month lag in payment) 2,40,000
Sales promotion expenses (paid quarterly in advance) 1,20,000
The company sells its products on gross profit of 25%. Depreciation is considered as a 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 20% safety margin, COMPUTE the working capital requirements of the company
on cash cost basis. Ignore work-in-process.

Q 31. From the following data, calculate the maximum permissible bank finance under the
three methods suggested by the Tandon Committee:

Liabilities ₹ in Lakhs
Creditors 120
Other current liabilities 40
Bank borrowing 250
Total 410
Current Assets ₹ in Lakhs
Raw material 180
Work-in-progress 60
Finished goods 100
Receivables 150
Other current assets 20
Total current assets 510
The total Core Current Assets (CCA) are ₹ 200 lakhs

Q 32. Following information is forecasted by R Limited for the year ending 31st March, 2021:

Balance as at 31st Balance as at

March, 2021 31st March, 2020
₹ in Lakhs ₹ in Lakhs
Raw Material 65 45
Work-in-progress 51 35
Finished goods 70 60
Receivables 135 112
Payables 71 68
Annual purchases of raw material (all credit) 400
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.

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You are required to CALCULATE:
(i) Net operating cycle period.
(i) Number of operating cycles in the year.

(iii) Amount of working capital requirement.

Q 33. PQ Ltd., a company newly commencing business in 2020-21 has the following
projected Profit and Loss Account:

(₹) (₹)
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
(10% of goods produced not yet sold) 17,000
1,53,000
The figure given above relate 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 instalments. The company wishes to keep ₹
8,000 in cash. 10% has to be added to the estimated figure for unforeseen contingencies.
PREPARE an estimate of working capital.
Note: All workings should form part of the answer.

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Q 34. PQ Ltd. has commenced new business segment in 2023-24. The following information
has been ascertained for annual production of 25,000 units which is the full capacity.

Cost per unit (`)

Material 100
Labour and variable overhead expenses 50
Fixed manufacturing expenses 35
Depreciation 15
Selling expenses (80% variable) 10

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 12,000 10,000
2 18,000 19,000

To assess the working capital requirements, the following additional information is available:
(a) Stock of materials 2 months’ average consumption

(b) Work-in-process Nil

(c) Debtors 1.5 month’s average sales.
(d) Cash balance 50,000
(e) Creditors for supply of materials 1 month’s average purchase during the year.
(f) Expenses All expenses will be paid 1 month in advance during theyear.

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 management is also of the opinion to make 10% margin for contingencies on computed
figure and value the closing stock at cost of production
PREPARE, for the two years:
(i) A projected statement of Profit/Loss (Ignoring taxation); and
(ii) A projected statement of working capital requirements on a cash cost basis.

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MANAGEMENT OF RECEIVABLES
Q 35. 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 scheme respectively. The tax rate is 30%.

ADVISE, should the company change its credit terms? (Assume 360 days in a year).

Q 36. 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 of
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.

Q 37. The Dolce Company purchases raw materials on terms of 2/10, net 30. A review of the
company’s records 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 suggestion might be made to Rohit that would reduce the annual interest
cost? IDENTIFY.
Q 38. The Alliance Ltd., a Petrochemical sector company had just invested huge amount in
its new expansion project. Due to huge capital investment, the company is in need of an
additional ₹ 1,50,000 in working capital immediately. The Finance Manger has determined
the following three feasible sources of working capital funds:
(i) Bank loan: The Company’s bank will lend ₹ 2,00,000 at 15%. A 10% compensating balance
will be required, which otherwise would not be maintained by the company.

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(ii) Trade credit: The company has been offered credit terms from its major supplier of 3/30,
net 90 for purchasing raw materials worth ₹ 1,00,000 per month.
(iii) Factoring: A factoring firm will buy the company’s receivables of ₹ 2,00,000 per month,
which have a collection period of 60 days. The factor will advance up to 75% of the face
value of the receivables at 12% on an annual basis. The factor will also charge commission of
2% on all receivables purchased. It has been estimated that the factor’s services will save the
company a credit department expense and bad debt expense of ₹ 1,250 and & ₹ 1,750 per
month respectively.

On the basis of annual percentage cost, ADVISE which alternative should the company
select? Assume 360 days year.

MANAGEMENT OF CASH
Q 39. Alpha Ltd. has an annual turnover of ₹ 84 crores and the same is spread over evenly
each of the 50 weeks of the working year. However, the pattern within each week is that the
daily rate of receipts on Monday and Tuesdays is twice that experienced on the other three
days of the week. The cost of banking per day is ₹ 2500. It is suggested that the banking
should be done daily or twice a week Tuesdays and Fridays as compared to current practice
of banking only on Fridays. Alpha Ltd. always operates on bank overdraft and current rate of
interest is 15% per annum. The interest charge is applied by the bank on simple daily basis.
Ignoring taxation, advise Alpha Ltd. the best course of banking. Use 360 days a year.

Q 40. The annual turnover of Star Ltd. is Rs. 730 lakhs & is spread evenly for each of 50
weeks of the year. All sales are on credit & is also spread evenly 5 days of the week.
Sales invoices are prepared at head office & sent to each location by post. An analysis of
delay in invoicing (being the interval between the date of sale & the date of dispatch of the
invoice) indicated the following pattern.

No. of days of delay invoicing 3 4 5 6

% age of week sales 20 10 40 30
A further analysis indicated that the debtors take on an average 36 days of credit before
paying. The period is measured from the day of dispatch of invoice rather than the date of
sale.
It is proposed to hire an agency to undertake the invoicing work at various locations. The agency has
given the following delay pattern.

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No. of days of delay invoicing 0 1 3
% age of week sales 40 40 20
The agency has also offered to monitor the collections, which will reduce the collection
period to 30 days.
Star Ltd. expects to save Rs. 4,000 per month in postage costs. All working funds are
borrowed at a rate of 20% p.a.
The agency has quoted a fee of Rs. 2, 00,000 p.a. for the invoicing work & Rs. 2, 50,000 p.a.
for monitoring collections & is willing to offer discount of Rs. 50,000 provided both the
works are given.
You are required to advise about the acceptance of agency’s proposal individually or
together.

CAPITAL BUDGETING
Q 41. HMR Ltd. is considering replacing a manually operated old machine with a fully
automatic new machine. The old machine had been fully depreciated for tax purpose but
has a book value of Rs.2,50,000 on 31st March. The machine has begun causing problems
with breakdowns and it cannot fetch more than ` 40,000 if sold in the market at present. It
will have no realizable value after 10 years. The company has been offered Rs.1,50,000 for
the old machine as a trade in on the new machine which has a price (before allowance for
trade in) of Rs. 6,00,000. The expected life of new machine is 10 years with salvage value
of Rs. 35,000.
Further, the company follows written down value method depreciation @ 10% but for
tax purpose, straight line method depreciation is used considering that this is the only
machine in the block of assets. A working capital of ` 50,000 will be needed and it will be
released at the end of tenth year.

Given below are the expected sales and costs from both old and new machine:

Old machine New machine

Annual output 60,000 units 80,000 units
Selling price per unit ` 18 ` 18
Annual operating hours 2,800 2,800
Material cost per unit `5 `5
Labour cost per hour ` 50 ` 75
Indirect cash cost per annum ` 1,00,000 ` 1,75,000

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(a) ANALYSE whether old machine should be replaced or not if the opportunity cost of
capital of Company is 10%?

The Income tax rate is 30%. Further assume that book profit is treated as ordinary income
for tax purpose.
Also ESTIMATE the internal rate of return of the replacement decision.

All calculations to be calculated to 3 decimal places.

Q 42. HMR Ltd. is considering replacing a manually operated old machine with a fully
automatic new machine. The old machine had been fully depreciated for tax purpose but
has a book value of ₹ 2,40,000 on 31st March 2021. The machine has begun causing
problems with breakdowns and it cannot fetch more than ₹ 30,000 if sold in the market at
present. It will have no realizable value after 10 years. The company has been offered ₹
1,00,000 for the old machine as a trade in on the new machine which has a price (before
allowance for trade in) of ₹ 4,50,000. The expected life of new machine is 10 years with
salvage value of ₹ 35,000.
Further, the company follows straight line depreciation method but for tax purpose, written
down value method depreciation @ 7.5% is allowed taking that this is the only machine in
the block of assets.
Given below are the expected sales and costs from both old and new machine:

Old Machine (₹) New Machine (₹)

Sales 8,10,000 8,10,000
Material cost 1,80,000 1,26,250
Labour cost 1,35,000 1,10,000
Variable overhead 56,250 47,500
Fixed overhead 90,000 97,500
Depreciation 24,000 41,500
PBT 3,24,750 3,87,250
Tax @ 30% 97,425 1,16,175
PAT 2,27,325 2,71,075

From the above information, ANALYSE whether the old machine should be replaced or not if
required rate of return is 10%? Ignore capital gain tax.
PV factors @ 10%:

Year 1 2 3 4 5 6 7 8 9 10
PVF 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386

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Q 43. Cello Limited is considering buying a new machine which would have a useful
economic life of five 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 product with an
estimated selling price of ` 3 per unit. Direct costs would be Rs.1.75 per unit and annual
fixed costs, including depreciation calculated on a straight- line basis, would be Rs. 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 Rs. 10,000 and Rs. 15,000 respectively.
(iii)Calculate NPV of the project for investment appraisal, assuming that the cost of capital is
10 percent.

Q 44. Following data has been available for a capital project:

Annual cash inflows ₹ 1,00,000
Useful life 4 years,
Salvage value 0
Internal rate of return 12%
Profitability index 1.064
You are required to CALCULATE the following for this project:
(i) Cost of project
(i) Cost of capital
(iii) Net present value
(iv) Payback period
PV factors at different rates are given below:

Discount factor 12% 11% 10% 9%

1 year 0.893 0.901 0.909 0.917
2 year 0.797 0.812 0.826 0.842
3 year 0.712 0.731 0.751 0.772
4 year 0.636 0.659 0.683 0.708
Q 45. A & Co. is contemplating whether to replace an existing machine or to spend
money on overhauling it. A & Co. currently pays no taxes. The replacement machine costs
Rs. 90,000 now and requires maintenance of ` 10,000 at the end of every year for eight
years. At the end of eight years it would have a salvage value of ` 20,000 and would be
sold. The existing machine requires increasing amounts of maintenance each year and its
salvage value falls each year as follows:

Year Maintenance (`) Salvage (`)

Present 0 40,000

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1 10,000 25,000
2 20,000 15,000
3 30,000 10,000
4 40,000 0

The opportunity cost of capital for A & Co. is 15%.

REQUIRED:
When should the company replace the machine?
(Note: Present value of an annuity of Re. 1 per period for 8 years at interest rate of 15% :
4.4873; present value of Re. 1 to be received after 8 years at interest rate of 15% :
0.3269).
Q 46. A large profit-making company is considering the installation of a machine to process
the waste produced by one of its existing manufacturing process 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. At the end of the
4th year. the machine can be sold for ₹ 60 lakh and the cost of dismantling and removal
would be ₹ 45 lakh. Sales and direct costs of the product emerging from waste processing
for 4 years are estimated as under:

Year (₹ in lakh)
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
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%.
Consider cost of capital @ 14%, the present value factors of which is given below for four
years:
Year 1 2 3 4

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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.

Q 47. A firm ‘s cost of capital is 10%. It has ₹ 4300 available for outlay on five investments

YEARS A B C D E
0 -2400 -2000 -1800 -1200 -500
1 1500 0 500 350 150
2 1500 0 500 350 150
3 0 1000 500 350 150
4 0 1000 500 350 150
5 0 1000 500 350 150
No investment may be repeated but a fractional share may be taken.
(i) Which investment should be selected to maximize NPV?
(ii) What would NPV have been if all investment were repeatable?
(iii) Calculate the overall IRR on the total sum invested.

Q 48. 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:

Project Investment Required (₹) Present value of Future Cash Flows (₹)
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 investment should be undertaken? Assume that the cost of capital is
12% and risk-free interest rate is 10% per annum. Given compounded sum of 1 at 10% in 5
years is 1.611 and discount factor of 1 at 12% rate for 5th year is 0.567

Q 49. Manoranjan Ltd is a News broadcasting channel having its broadcasting Centre
in Mumbai. There are total 200 employees in the organisation including top
management. As a part of employee benefit expenses, the company serves tea or coffee
to its employees, which is outsourced from a third-party. The company offers tea or
coffee three times a day to each of its employees. 120 employees prefer tea all three
times, 40 employees prefer coffee all three times and remaining prefer tea only once in a
day. The third-party charges ` 10 for each cup of tea and ` 15 for each cup of coffee. The
company works for 200 days in a year.
Looking at the substantial amount of expenditure on tea and coffee, the finance
department has proposed to the management an installation of a master tea and coffee

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vending machine which will cost ` 10,00,000 with a useful life of five years. Upon
purchasing the machine, the company will have to enter into an annual maintenance
contract with the vendor, which will require a payment of` 75,000 every year. The
machine would require electricity consumption of 500 units p.m. and current
incremental cost of electricity for the company is ` 12 per unit. Apart from these running
costs, the company will have to incur the following consumables expenditure also:

(1) Packets of Coffee beans at a cost of ` 90 per packet.

(2) Packet of tea powder at a cost of ` 70 per packet.
(3) Sugar at a cost of ` 50 per Kg.
(4) Milk at a cost of ` 50 per litre.
(5) Paper cup at a cost of 20 paise per cup

Each packet of coffee beans would produce 200 cups of coffee and same goes for tea
powder packet. Each cup of tea or coffee would consist of 10g of sugar on an average and
100 ml of milk.

The company anticipate that due to ready availability of tea and coffee through vending
machines its employees would end up consuming more tea and coffee.

It estimates that the consumption will increase by on an average 20% for all class of
employees. Also, the paper cups consumption will be 10% more than the actual cups
served due to leakages in them.

The company is in the 25% tax bracket and has a current cost of capital at 12% per
annum. Straight line method of depreciation is allowed for the purpose of taxation. You
as a financial consultant is required to ADVISE on the feasibility of acquiring the vending
machine.

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