CA INTER -FM DATE – 06.08.

24 Marks: 50 Duration: 2 HRS

Case study 1
Adroit Manufacturers Pvt. Ltd. is a newly established startup dealing in manufacture of a revolutionary product HDXMR
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 Rs. 5 crores and it will require 1 yearto make the plant operational.
The anticipated revenue and associated cost numbers are as follows:Units to be sold = 3 lakh
sq meters p.a.
Sale Price of each sq meter = Rs. 1,000 Raw Material cost =
Rs. 180 per sq meterLabour cost = Rs. 40 per hour
Labour hours per sq meter = 3 hours
Manufacturing Overheads = Rs. 60 per machine hourMachine hours per sq
meter = 2 hours
Selling and Administration Overheads = Rs. 250 per sq meter

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 tuneof Rs. 25 lakhs is required to be
maintained.

The entity is considering two options to reduce working capital requirement:

a) Reducing credit period to customers by 1 month leading to 5% fall in sales
b) Engaging a factor to manage receivables, charging 2% commission and advancing 65% receivables at 12% p.a. This will
lead to savings of Rs. 20 lakhs in administration costs and Rs. 16 lakhs in bad debts.
The bank has offered 75% of net current assets as working capital advance at 16.5% interestprovided 10% of the loan is
maintained as minimum balance.
As a finance manager, you have been asked the following questions:
1. The anticipated profit before tax per annum after the plant is operational is ……….
a) 990 Lakhs b) 780 Lakhs c) 370 Lakhs d) 525 Lakhs

The estimated current assets requirement in the first year of operation (debtors calculated at cost) is ……….
a) 9,42,50,000 b) 8,32,00,000 c) 7,25,41,667 d) 67,08,333

The net working capital requirement for the first year of operation is ……….
a) 6,39,12,500 b) 2,17,08,333 c) 7,25,41,667 d) 67,08,333

The annualised % cost of two options for reducing the working capital is ……….
a) 18.33% and 16.92% b) 26.86% and 16.92%
c) 26.33% and 18.33% d) 16.92% and 19.05%

What will be the Maximum Permissible Bank Finance by the bank and annualised % costof the same?
a) 4,55,03,630 and 18.33% b) 4,79,34,375and 18.33%
c) 4,45,86,025 and 18.59% d) 3,45,89,020 and 19.85%

(2×5 = 10 MARKS)
Q2. DEF Ltd. is exploring various financing options for its upcoming expansion. The management team is considering
different types of preference shares and their characteristics. Considering the scenario, what is a characteristic of non-
participating preference shares?
A) Non-participating preference shares have a fixed dividend rate.
B) Non-participating preference shares can accumulate arrear dividends.
C) Non-participating preference shares provide voting rights to shareholders.
D) Non-participating preference shares cannot share in the surplus profits after payment offixed dividends.
Q3. Rahul, the financial analyst of LMN Ltd., is explaining the concept of Marginal Cost of Capital to his team. He mentions
that the marginal cost of capital is the cost incurred in raising new funds and is derived based on the intended financing
proportion. He also points out that the marginal weights are used in this calculation, which represent the proportion of
funds the firm intends to employ. What is a key characteristic of the marginal cost of capital in relation to the average cost
of capital?
A) The marginal cost of capital is always lower than the average cost of capital.
B) The marginal cost of capital is equal to the average cost of capital.
C) The marginal cost of capital may be lower or higher than the average cost of capital,depending on the funds
raised.
D) The marginal cost of capital is inversely proportional to the average cost of capital.

Q4. Company A and B are homogeneous in all respects except that Company A is levered while Company B is unlevered.
Company A has Rs. 5,00,000 assumptions are met and the tax rate is 50%. (3). EBIT is Rs. 50,000 and that equity-
capitalisation rate for Company B is 12%. What would be the value for unlevered Firm according to M— M’s approach?
(a) Rs. Rs. 2,08,333 (b) Rs. 11,50,000
(c) Rs. 30,00,000 (d) Rs. 20,30,000

Q5. Rajesh is considering two investment projects, Project X and Project Y, for his business. Project X requires an initial
investment of ₹1,000,000 and is expected to generate an average annual net income of ₹200,000 over its useful life.
Project Y, on the other hand, requires an initial investment of ₹2,000,000 and is expected to generate an average annual
net income of ₹400,000. If Rajesh calculates the ARR for both projects, which of the following statements is true?
A) Project X has a higher ARR than Project Y.
B) Project Y has a higher ARR than Project X.
C) Both Project X and Project Y have the same ARR.
D) ARR cannot be determined without knowing the payback period.

Q6. Following information is provided by the DPS Ltd. for the year ending 31st March 2019. Raw material storage period
— 55 days
WW conversion period — 18 days Finished goods storage period — 22 daysDebt collection period — 45 days
Creditor’s payment period — 60 days
Annual operating cost including depreciation of ₹ 2,10,000 was ₹ 21,00,000. *1 Year =360days]
You are required to calculate working capital on cash cost basis.
(A) ₹ 4,20,000 (B) ₹ 4,66,667
(C) ₹ 7,35,000 (D) ₹ 8,16,667

(1×5 = 5 MARKS)

Question 1 is compulsory; Attempt any 4 questions from the remaining questionsDescriptive Questions
Q1. MNP Limited is thinking of replacing its existing machine by a new machine which would cost Rs. 60 lakhs. The
company’s current production is Rs. 80,000 units, and is expected to increase to 1,00,000 units, if the new machine is
bought. The selling price of the product would remain unchanged at Rs. 200 per unit. The following is the cost of
producing one unit of product using both the existing and new machine:
Unit Cost (Rs.)
Existing Machine New Machine Difference
(80,000 units) (1,00,000 units)
Materials 75.0 63.75 (11.25)
Wages & Salaries 51.25 37.50 (13.75)
Supervision 20.0 25.0 5.0
Repairs and Maintenance 11.25 7.50 (3.75)
Power and Fuel 15.50 14.25 (1.25)
Depreciation 0.25 5.0 4.75
Allocated Corporate Overheads 10.0 12.50 2.50
183.25 165.50 (17.75)
The existing machine has an accounting book value of Rs. 1,00,000, and it has been fully depreciated for tax purpose. It is
estimated that machine will be useful for 5 years. The supplier of the new machine has offered to accept the old machine
for Rs. 2,50,000. However, the market price of old machine today is Rs. 1,50,000 and it is expected to be Rs. 35,000 after 5
years. The new machine has a life of 5 years and a salvage value of Rs. 2,50,000 at the end of its economic life. Assume
corporate Income tax rate at 40%, and depreciation is charged on straight line basis for Income-tax purposes. Further
assume that book profit is treated as ordinary income for tax purpose. The opportunity cost of capital of the Company is
15%.
Required:
(i) Estimate net present value of the replacement decision.
(ii) Should Company go ahead with the replacement decision? Suggest

Year (t) 1 2 3 4 5
PVIF0.15,t 0.8696 0.7561 0.6575 0.5718 0.4972
PVIF0.20,t 0.8333 0.6944 0.5787 0.4823 0.4019
PVIF0.25,t 0.80 0.64 0.512 0.4096 0.3277
PVIF0.30,t 0.7692 0.5917 0.4552 0.3501 0.2693
PVIF0.35,t 0.7407 0.5487 0.4064 0.3011 0.2230

(7 MARKS)
Q2. The accountant of Moon Ltd. has reported the following data:
Gross profit Rs.60,000
Gross Profit Margin 20 Per cent
Total Assets Turnover 0.30:1
New Worth to Total Assets 0.90:1
Current Ratio 1.5:1
Liquid Assets To Current Liability 1:1
Credit Sales to Total Sales 0.80:1
Average Collection Period 60 Days
Assume 360 Days in a year
You are required to complete the following:

Balance Sheet of Moon Ltd.

Liabilities Rs. Assets Rs.
New Worth - Fixed Assets -
Current Liabilities - Stock -
Debtors -
Cash -
Total Liabilities - Total Assets -

(7 MARKS)
Q3. The Sneha Ltd. has following capital structure at 31st December 2015, which is considered to be optimum:
Particulars Amount (Rs.)
13% Debenture 3,60,000
11% Preference share capital 1,20,000
Equity share capital (2,00,000 shares) 19,20,000
The company’s share has a current market price of Rs.27.75 per share. The expected dividend per share in next year is 50
percent of the 2015 EPS. The EPS of last 10 years is as follows. The past trends are expected to continue.
Year 2006 2007 2008 2009 2010 2011 2012
EPS (Rs) 1.00 1.120 1.254 1.405 1.574 1.762 1.974
The company can issue 14 percent new debenture. The company’s debenture is currently selling at Rs.98. The new
preference issue can be sold at a net price of Rs.9.80, paying a dividend of Rs.1.20 per share. The company’s marginal tax
rate is 50%.
i) Calculate the after tax cost
ii)(a) of new debts & new preference share capital,
(b) Of ordinary equity, assuming new equity comes from retained earnings.
iii)Calculate the marginal cost of capital.
iv) How much can be spent for capital investment before new ordinary share must be sold? (Assuming that retained
earnings available for next year’s investment is 50% of 2015 earnings.)
v) What will be marginal cost of capital (cost of fund raised in excess of amount calculatedin part (iii) if the company can
sell new ordinary shares to net Rs.20 per share ? Cost of debt and of preference capital is constant
(7 MARKS)

Q4(a). A firm has total sales of Rs.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 and the balance pay in 120 days. Past experience indicates that bad debts losses
are around 1% of credit sales. The firm spends about Rs.2,40,000 per annum to administer its credit 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.
1) What is the effective cost of factoring? Consider year as 360 days.
2) If bank finance for working capital is available at 14% interest, should the firm avail of factoring service.
(3 MARKS)
Q4(b). Explain packing credit? State the different types of Packing Credit.
(4 MARKS)

Q5. 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 Rs.40
Variable cost per unit Rs.20
Fixed cost Rs.10,00,000
The capital structure of the company as on 31st March, 2021 is as follows:
Particulars Rs.
Equity Share Capital (1,00,000 shares of Rs.10 each) 10,00,000
Reserves and surplus 5,00,000
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 Rs.10 lakhs. The
company expects an increase in output by 50%. Fixed cost will be increased by Rs.5,00,000 and variable cost per unit will
be decreased by 10%. Theadditional output can be sold at the existing 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 Rs.10 each at par.
(ii) Rs.5 lakh by issue of equity shares of Rs.10 each and the balance by issue of 6%debentures of Rs.100 each at par.
(iii) Entirely by 6% debentures of Rs.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%. (7 MARKS)

Q6(a). A Company earns a profit of Rs.3,00,000 per annum after meeting its interest liability of Rs. 1,20,000 on 12%
debentures. The Tax rate is 50%. The number of Equity Shares of Rs.10 each are 80,000 and the retained earnings amount
to Rs.12,00,000. The company proposes to take up an expansion scheme for which a sum of Rs.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.
Required:
1) Compute the Earnings per Shares (EPS), if:
a) The additional funds were raised as debt
b) The additional funds were raised by issue of equity shares
2) Advise the company as to which source of finance is preferable.
(4 MARKS)
Q6(b). State Agency Cost. Discuss the ways to reduce the effect of it.

(3 MARKS)