MODULE –I Ignoring tax consideration:

i) Calculate the value of equity shares and the gain made

COST OF CAPITAL and WACC by the shareholders if the cost of equity rises to 21.6%.

Q. 1) The following information is available from the ii) Prove that the weighted average cost of capital is not
Balance Sheet of a Company : affected by gearing.

Equity Share Capital Q. 4) International Foods Limited has the following

(20,000 shares of Rs. 10 each) Rs. 2,00,000 capital structure :
Reserves and Surplus Rs. 1,30,000
8% Debentures Rs. 1,70,000 Book Value Market Value
Rs. Rs.
The rate of tax for the company is 50%. Current
level of Equity Dividend is 12%. Equity Capital
Calculate the weighted average cost of capital (25,000 shares of Rs. 10 each) 2,50,000 4,50,000
using the above figures. 13% Preference Capital
(500 shares of Rs. 100 each) 50,000 45,000
Q. 2) PQR & Co. has the following capital structure as Reserves and Surplus 1,50,000 -
on Dec. 31, 2000. 14% Debentures
(1500 debentures of Rs. 100 each) 1,50,000 1,45,000
Equity Share Capital (5000 shares of 100 each)Rs. 5,00,000 6,00,000 6,40,000
9% Preference Shares Rs. 2,00,000
10% Debentures Rs. 3,00,000 The expected dividend per share is Rs. 1.40 and
the dividend per share is expected to grow at a rate of 8
The equity shares of the company are quoted at per cent forever. Preferences share are redeemable after
Rs. 102 and the company is expected to declare a 5 years at par whereas debentures are redeemable after 6
dividend of Rs. 9 per share for the next year. The years at par. The tax rate for the company is 50 per cent.
company has registered a dividend growth rate of 5%
which is expected to be maintained. You are required to compute the weighted
average of capital for the existing capital structure using
i) Assuming the tax rate applicable to the company at market value as weights.
50%, calculate the weighted average cost of capital, and
ii) Assuming that the company can raise additional term Q. 5) The capital structure of XYZ & Co. is comprising
loan at 12% for Rs. 5,00,000 to finance its expansion, of 12% debenture, 9% preference share and some equity
calculate the revised WACC. The company’s expectation share of Rs. 100 each in the ratio of 3:2:5. The company
is that the business risk associated with new financing is considering to introduce additional capital to meet the
may bring down the market price from Rs. 102 to Rs. 96 needs of expansion plans by raising 14% loan from
per share. financial institutions. As a result of this of proposal, the
proportions of different above sources would go down by
Q. 3) a) Three companies A, B and C are in the 1/10, 1/15 and 1/16 respectively.
same type of business and hence have similar operating In the light of the above proposal, find out the
risks. However, the capital structure of each of them is impact on the WACC of the firm given that (i) tax rate is
different and the following are the details : 50%, (ii) expected dividend of Rs. 9 at the end of the year
A B C and (iii) the growth rate, g, may be taken at 5%. No
Equity Share CapitalRs. 4,00,000Rs. 2,50,000 Rs. 5,00,000 change is expected in dividends, growth rate, market price
[Face value Rs. 10 per share] of the share etc. after availing the proposed loan.
Market value per share 15 20 12
Dividend per share 2.70 4 2.88 Q. 6) An electric equipment manufacturing company
Debentures - 1,00,000 2,50,000 wishes to determine the weighted average cost of capital
[Face value per debenture Rs. 100] for evaluating capital budgeting projects. You have been
Market value per debenture - 125 80 supplied with the following information :
Interest Rate - 10% 8%
BALANCE SHEET
Assume that the current levels o dividends are
generally expected to continue indefinitely and the Liabilities Rs. Assets Rs.
income-tax rate at 50%. Equity share capital12,00,000 Fixed Assets 25,00,000
You are required to compute the weighted Pref. share capital 4,50,000 Current Assets 15,00,000
average cost of each company. Retained Earnings 4,50,000
Debentures 9,00,000
b) ZED Limited is presently financed entirely by Current Liabilities 10,00,000
equity shares. The current market value is Rs. 6,00,000. A
dividend of Rs. 1,20,000 has just been paid. This level of 40,00,000 40,00,000
dividend is expected to be paid indefinitely. The company Additional Information :
is thinking of investing in a new project involving an outlay i) 20 years 14% debentures of Rs. 2,500 face value,
of Rs. 5,00,000 now and is expected to generate net cash redeemable at 5% premium can be sold at par. 2%
receipts of Rs. 1,05,000 per annum indefinitely. The floatation costs.
project would be financed by issuing Rs. 5,00,000
debentures at the market interest rate of 18%. ii) 15% preference shares : Sale price Rs. 100 per share,
2% flotation costs.
iii) Equity shares : Sale price Rs. 115 per share, flotation c) Determine the effect of Income Tax on the cost of
costs, Rs. 5 per share. capital under both premises. (Tax rate 40%).

The corporate tax rate is 55% and the expected Q. 3) In considering the most desirable capital structure
growth in equity dividend is 8% per year. The expected for a company, the following estimates of the cost of debt
dividend at the end of the current financial year is Rs. 11 capital (after tax) have been made at various levels of
per share. Assume that the company is satisfied with its debt-equity mix:
present capital structure and intends to maintain it.
Debt as percentage of Cost of debt Cost of equity
Q. 7) The following is the capital structure of Simons total capital employed % %
Company Ltd. as on 31.12.1998 :
0 7.0 15.0
Equity shares : 10,000 (of Rs. 100 each) Rs. 10 7.0 15.0
10,00,000 20 7.0 15.5
10% Preference Shares (of Rs. 100 each) 4,00,000 30 7.5 16.0
12% Debentures 6,00,000 40 8.0 17.0
20,00,000 50 8.5 19.0
The market price of the company’s share is Rs. 60 9.5 20.0
110 and it is expected that a dividend of Rs. 10 per share You are required to find out the weighted average
would be declared after 1 year. The dividend growth rate cost of capital o the firm for different proportions of debt.
is 6% :
(i) If the company is in the 50% tax bracket, compute Q. 4) A Limited has the following capital structure :
the weighted average cost of capital. Equity share capital (2,00,000 shares) Rs. 40,00,000
(ii) Assuming that in order to finance an expansion 6% Preference shares 10,00,000
plan, the company intends to borrow a fund of Rs. 10 lac 8% Debentures 30,00,000
bearing 14% rate of interest, what will be the company’s 80,00,000
revised weighted average cost of capital ? This financing The market price of the company’s equity share is Rs. 20.
decision is expected to increase dividend from Rs. 10 to It is expected that company will pay a dividend of Rs. 2
Rs. 12 per share. However, the market price of equity per share at the end of current year, which will grow at 7
share is expected to decline from Rs. 110 to Rs. 105 per per cent for ever. The tax rate may be presumed at 50 per
share. cent. You are required to compute the following :

Extra Questions: a) A weighted average cost of capital based on existing

Q. 1) The following figures are taken from the current capital structure.
balance sheet of Delaware & Co. b) The new weighted average cost of capital if the
Capital Rs. 8,00,000 company raises an additional Rs. 20,00,000 debt by
Share Premium 2,00,000 issuing 10 per cent debentures. This would result in
Reserves 6,00,000 increasing the expected dividend to Rs. 3 and leave the
Shareholder’s funds 16,00,000 growth rate unchanged but the price of share will fall to
12% Irredeemable debentures 4,00,000 Rs. 15 per share.

An annual ordinary dividend of Rs. 2 per share c) The cost of capital if in (b) above, growth rate increases
has just been paid. In the past, ordinary dividends have to 10 per cent.
grown at a rate of 10 per cent per annum and this rate of
growth is expected to continue. Annual interest has Q. 5) Aries Limited wishes to realize additional finance
recently been paid on the debentures. The ordinary of Rs. 10 lac for meeting its investment plans. It has Rs.
shares are currently quoted at Rs. 27.5 and the 2,10,000 in the form of retained earnings available for
debentures at 80 per cent. Ignore taxation. investment purposes. The following are the further details
:
You are required to estimate the weighted
average cost of capital (based on market values) for 1. Debt/equity mix 30% / 70%
Delaware & Co. 2. Cost of debt up to Rs. 1,80,000 10% (before tax)
beyond Rs. 1,80,000 16% (before tax)
Q. 2) The following information has been extracted from 3. Earnings per share Rs. 4
the balance sheet of Fashions Ltd. as on 31.12.2000 : 4. Dividend payout 50% of earnings
5. Expected growth rate in dividend 10%
Rs. in Lac 6. Current market price per share Rs. 44
Equity Share Capital 400 7. Tax rate 50%
12% Debentures 400
18% Term loan 1,200 You are required to :
2,000 a) To determine the pattern for raising the additional
a) Determine the weighted average cost of capital of the finance.
company. It had been paying dividends at a consistent b) To determine the post-tax average cost of additional
rate of 20% per annum. debt.
b) What difference will it make if the current price of the c) To determine the cost of retained earnings and cost of
Rs. 100 share is Rs. 160 ? equity, and
d) Compute the overall weighted average after tax cost Q. 10) Calculate the cost of capital in each of the
of additional finance. following cases :
i) A 7-years Rs. 100 bond of a firm can be sold for a net
Q. 6) The latest Balance Sheet of D Ltd. is given below price of Rs. 97.75 and is redeemable at a premium of 5%.
: The coupon rate of interest is 15% and the tax rate is
(Rs. ‘000) 55%.
Ordinary shares (50000 shares) 500 ii) A company issues 10% Irredeemable Preference
Share Premium 100 Shares at Rs. 105 each (FV = 100).
Retained Profits 600 iii) The current market price of share is Rs. 90 & the
1,200 expected dividend at the end of current year is 4.50 with a
8% preference shares 400 growth rate of 8%.
13% Perpetual debt (Face value Rs. 100 each) 600 iv) The current market price of share is Rs. 100. The firm
2,200 needs Rs. 1,00,000 for expansion and the new shares can
be sold only at Rs. 95. The expected dividend at the end
The ordinary shares are currently priced at Rs. 39 of current year is Rs. 4.75 with a growth rate of 6%. Also
ex-dividend each and Rs. 25 preference share is priced at calculate the cost of capital of new equity.
Rs. 18 cum-dividend. The debentures are selling at 110 v) A company is about to pay a dividend of Rs. 1.40 per
per cent ex-interest and tax is paid by D Ltd. at 40 per share having a market price of Rs. 19.50. The expected
cent. Cost of equity of D Ltd has been estimated at 19 per future growth in dividends is estimated at 12%.
cent.
Calculated the weighted average cost of capital, Q. 11) Calculate the cost of capital in the following cases
(based on market value) WACC of D Ltd. :
(i) X Ltd. issues 12% Debentures of face value Rs. 100
Q. 7) The following information is available relating to each and realizes Rs. 95 per Debenture. The Debentures
risk free interest rate, If and market rate, Rm, of a security are redeemable after 10 years at a premium of 10%.
during last 6 years. (ii) Y Ltd. issues 14% Preference shares of face value Rs.
100 each Rs. 92 per share. The shares are repayable
Year If Rm after 12 years at par.
1 .06 .14 Note : Both companies are paying income-tax at 50%.
2 .05 .03
3 .07 .21
4 .08 .26
5 .09 .03
6 .07 .11
On the basis of above information find out the cost
of equity capital on the basis of the CAPM given that the
beta factor is .863.

Q. 8) The following information is provided in respect of

the specific cost of capital of different sources along with
the book value (BV) and market value (MV) weights.
Source C/C BV MV
Equity share capital 18% .50 .58
Preference share 15% .20 .17
Long term debts 7% .30 .25
i) Calculate the weighted average cost of capital,
WACC, using both the BV and the MV weights.
ii) Calculate the WMCC using marginal weights given
that the company intends to raise additional funds using
50% long term debts, 35% preference share & 15% by
retaining profits.

Q. 9) KLM Turnkey Ltd., has an operating profit of Rs.

40,00,000 and has employed Debt (Total Interest Charge
of Rs. 10,00,000). The existing Cost of equity and Cost of
Debt to the firm are 18% and 12% respectively. The firm
has a proposal before it requiring funds of Rs. 100 lacs (to
be raised by issue of additional debt.) which is expected to
bring additional profit of Rs. 20,00,000.
Find out the existing WACC & the new WACC. Assume no
Tax.
 MODULE –II Sales for the first three years of operations are
estimated at Rs. 100 lac, Rs. 125 lac and Rs. 150 lac and
EBIT- EPS Analysis and a 10% profit before interest and taxes is forecast to be
achieved, Corporate taxation to be taken at 50%.
LEVERAGES Compute earnings per share in each of the alternative
plans of financing for the three years and evaluate the
Q. 1) Bhaskar Manufacturer Ltd. has Equity share proposals.
capital of Rs. 5,00,000 (face value Rs. 100). To meet the
expenditure of an expansion program, the company Q. 5) AB Ltd. provides you the following figures :
wishes to raise Rs. 3,00,000 and is having following four Profit Rs. 3,00,000
alternative sources to raise the funds : -Interest on debenture @ 12% 60,000
Plan A : To have full money from the issue of Equity 2,40,000
shares. Income tax @ 50% 1,20,000
Plan B : To have Rs, 1,00,000 from Equity and Rs. 1,20,000
2,00,000 from Number of Equity Shares (Rs. 10 each) 40,000
Plan C : Full money from borrowings @ 10% per annum. EPS (Rs.) 3
Plan D : Rs. 1,00,000 in Equity and Rs. 2,00,000 from Ruling price in market (Rs.) 30
8% Preference shares. PE Ratio (Price/EPS) 10
The company is having present earnings of Rs. The company has undistributed reserves of Rs.
1,50,000. The corporate tax is 50%. Select a suitable plan 6,00,000. The company needs Rs. 2,00,000 for
out of the above four plans to raise the required funds. expansion. This amount will earn at the same rate as
funds already employed. You are informed that a debt
Q. 2) A Ltd. has a share capital of Rs. 1,00,000 equity ratio i.e., Debt/(Debt+Equity) higher than 35% will
dividend into share of Rs. 10 each. It has a major push the PE ratio down to 8 and raise the interest rate on
expansion program requiring an investment of another Rs. additional amount borrowed to 14%. You are required to
50,000. The management is considering the following ascertain the probable price of the share :
alternatives for raising this amount : i) If the additional funds are raised as debt; and
i) Issue of 5,000 equity shares of Rs. 10 each. ii) If the amount is raised by issuing equity
ii) Issue of 5,000, 12% preference shares of Rs. shares.
10 each.
iii) Issue of 10% debentures of Rs. 50,000. Q. 6) A Ltd. has agreed to buy the net assets of B Ltd.
The company’s present earnings before interest (having EBIT of Rs. 2,30,000) for Rs. 18,00,000. In order
and tax (EBIT) are Rs. 40,000 per annum subject to tax @ to finance the acquisition, the following three proposals
50%. You are required to calculate the effect of each of are submitted :
the above financial plan on the earnings per share 1. To issue 5% debentures of Rs. 18,00,000 redeemable
presuming : in 20 years.
a) EBIT continues to be the same even after 2. To issue 51/2% Cumulative Preference shares of Rs.
expansion. 18,00,000.
b) EBIT increases by Rs. 10,000. 3. To issue 60,000 equity shares at a premium of Rs. 10
per share.
Q. 3) A company needs Rs. 12,00,000 for the The following are the balance sheet and income
installation of a new factory which is expected to earn an statement of A Ltd.
EBIT of Rs. 2,00,000 per annum. The company has the Balance Sheet of A Ltd.
objective of maximizing the earnings per share. It is
considering the possibility of issuing equity shares plus Liabilities Rs. Assets Rs.
raising a debt of Rs. 2,00,000 or Rs. 6,00,000 or Rs. Share capital (equity Fixed Assets 20,00,000
10,00,000. The current market price of the share is Rs. 40 shares of Rs. 20 Current assets 30,00,000
and will drop to Rs. 25 if the borrowings exceed Rs. each) 5,00,000
7,50,000. The cost of borrowing are indicated as under : Revenue Reserves19,00,000
Up to Rs. 2,50,000 10% 5% Debentures 10,00,000
Rs. 2,50,000-6,25,000 14% Trade Creditors 16,00,000
Rs. 6,25,000-10,00,000 16% 50,00,000 50,00,000
Assuming the tax rate to be 50%, find out the EPS
under different options. Income Statement of A Ltd.
EBIT Rs. 12,50,000
Q. 4) X Co. Ltd. is considering three different plans to -Interest 50,000
finance its total project costs of Rs. 100 lac. These are: -Tax 6,00,000
(Rs. in Lac) Profit after Tax 6,00,000
Plan A Plan B Plan C -Dividend paid 1,25,000
Equity (Rs. 100 per share) 50 34 25 Retained Earnings 4,75,000
8% Debentures 50 66 75 You are required to (a) calculate the consolidated
100 100 100 EPS of the new firm assuming that the EBIT and tax rate
remains same, and (b) calculate the additional net cash i) Advise the company on the financial plan to be
outlay during next year under each of the above three selected.
proposals assuming that the rate of dividend will be same ii) If it is assumed that there will be no change in the PE
as in current year. Ratio if either of the two alternatives are adopted, would
your advice still hold good ?
Q. 7) A firm is considering alternative proposals to
finance its expansion plan of Rs. 4,00,000. Q. 11) From the following information available for 4
Two such proposals are : firms, calculate the EBIT, the EPS, the Operating leverage
i) Issue of 15% loans of Rs. 2,00,000 and issue of 2,000 and the Financial leverage :
equity shares of 100 each, and Firm P Firm Q Firm R Firm S
ii) Issue of 4,000 equity shares of 100 each. Sales (in Units) 20,000 25,000 30,000 40,000
Given the tax rate at 50%, and assuming EBIT of Selling price per unit (Rs.) 15 20 25 30
Rs. 70,000 and Rs. 80,000, which alternative is better ? Variable cost per unit (Rs.) 10 15 20 25
Also compute the indifference level of EBIT of the two Fixed costs (Rs.) 30,000 40,000 50,000 60,000
financial plans. Interest (Rs.) 15,000 25,000 35,000 40,000
Tax % 40 40 40 40
Q. 8) The Evergreen Company has the choice of raising Number of equity shares 5,000 9,000 10,000 12,000
an additional sum of Rs. 50,00,000 either (i) by issue of
10% debentures, or (ii) issue of additional issue shares @ Q. 12) MC Ltd. is planning an expansion program which
Rs. 50 per share. Presently, the capital structure of the will require Rs. 30 crore and can be funded through one of
firm does not consist of any debt and the company has the three following options :
issued 10,00,000 equity shares only. At what level of 1. Issue further equity shares of Rs. 100 each at par.
EBIT, after the new capital funds are acquired, would the 2. Raise a 15% loan, and
EPS be the same under different alternative financing 3. Issue 12% preference shares.
plans? Also determine the level of EBIT at which
uncommitted earnings per share (UPES) would be the The present paid up capital is 60 crore and the annual
same, if the sinking fund obligations amounting to Rs. EBIT is Rs. 12 crore. The tax rate may be taken at 50%.
5,00,000 in respect of debenture issue is to be made After the expansion plan is adopted, the EBIT is expected
every year. Tax rate may be assumed at 50% and also to be Rs. 15 crore
verify the result. .
Calculate the EPS under all the three financing options
Q. 9) A new project under consideration requires a indicating the alternative giving the highest return to the
capital outlay of Rs. 300 lac for which the funds can either equity shareholders. Also determine the indifference point
be raised by the issue of equity shares of Rs. 100 each or between the equity share capital and the debt financing
by the issue of equity shares of the value of Rs. 200 lac (i.e. option 1 and option 2 above).
and by the issue of 15% loan of Rs. 100 lac. Find out the
indifference level of EBIT given the tax rate at 50%.
LEVERAGE ANALYSIS
Q. 10) The following figures of Krish Ltd. are presented
to you: Income Statement
Earnings before Interest and Tax Rs. 23,00,000 Particular Amount
-Debenture interest @ 8% 80,000
Sales xxxx
-Long term loan interest @ 11% 2,20,000 3,00,000
- Variable Costs xxxx
Profit before Tax 20,00,000
Contribution xxxx
-Income tax 10,00,000
- Fixed Costs xxxx
Earnings after tax 10,00,000
EBIT (Operating Profit) xxxx
No. of equity shares of Rs. 10 each 5,00,000
- Interest xxxx
EPS (Rs.) 2
EBT (Earning Before Tax) xxxx
Market price of share (Rs.) 20
- Tax xxxx
PE Ratio 10
EAT (Earning After Tax) xxxx
The company has undistributed reserves and - Preference Dividend xxxx
surplus of Rs. 20 lac. It is in need of Rs, 30 lac to pay off Profit for Equity Shareholder xxxx
debentures and modernize its plants. It seeks advice on EPS (Earning per share) Profit for equity shares xxxx
the following alternative modes of raising finance: No. of equity shares
Alternative 1 - Raising entire amount as term loan from
banks @ 12% Formulae :
Alternative 2 - Raising part of the funds by issue of DOL - Degree of Operating Leverage :
1,00,000 shares of Rs. 20 each and the rest by
DOL = Contribution
term loan at 12%.
EBIT
The company expects to improve its rate of return DFL - Degree of Financial Leverage:
by 2% as a result of modernization, but PE ratio is likely to
DOL = EBIT
go down to 8 if the entire amount is raised as term loan.
EBT
DFL = EBIT PROBLEM NO. 5
EBT - (Preference Dividend / 1 - tax rate) The following information is available in respect of
two firms, P Ltd. and Q Ltd. :
DCL - Degree of Combined Leverage: (Figures in Rs. Lac)
DCL = Contribution P Ltd. Q Ltd.
EBT - (Preference Dividend / 1 - tax rate) Sales 500 1000
OR -Variable cost 200 300
DCL = DOL x DFL Contribution 300 700
-Fixed cost 150 400
% Change in Sales x DOL = % Change in EBIT EBIT 150 300
% Change in EBIT x DFL = % Change in EBT/EAT/EPS -Interest 50 100
% Change in Sales x DCL = % Change in EBT/EAT/EPS Profit before Tax 100 200
You are required to calculate different leverages
for both the firms and also comment on their relative risk
position.
PROBLEM NO. 1
Calculate the degree of operating leverage (DOL), PROBLEM NO. 6
degree of financial leverage (DEL) and the degree of The capital structure of the Progressive
combined leverage (DCL) for the following firms and Corporation consists of Ordinary share capital of Rs.
interpret the results. 10,00,000 (shares of Rs. 100 each) and Rs. 10,00,000 of
Firm A Firm B Firm C 10% debentures. The selling price is Rs. 10 per unit;
variable costs amount to Rs. 6 per unit and fixed
1. Output (Units) 60,000 15,000 1,00,000 expenses amount to Rs. 2,00,000. The income tax rate is
2. Fixed costs (Rs.) 7,000 14,000 1,500 assumed to be 50%. The sales level is expected to
3. Variable on borrowed funds (Rs.)4,000 8,000 - increase form 1,00,000 units to 1,20,000 units.
5. Selling price per unit (Rs.) 0.60 5.00 0.10
a) You are required to calculate :
PROBLEM NO. 2 i) The percentage increase in earnings per share;
A firm has sales of Rs. 10,00,000, variable cost of ii) The degree of Financial leverage at 1,00,000 units and
Rs. 7,00,000 and fixed costs of Rs. 2,00,000 and debt of 1,20,000 units.
Rs. 5,00,000 at 10% rate of interest. What are the iii) The degree of Operating leverage at 1,00,000 units and
operating, financial and combined leverages ? If the firm 1,20,000 units.
wants to double its Earnings before interest and tax b) Comment on the behavior of Operating and Financial
(EBIT), how much of a rise in sales would be needed on a leverages in relation to increase in production from
percentage basis ? 1,00,000 units to 1,20,000 units.

PROBLEM NO. 7
PROBLEM NO. 3 The following information is available for ABC & Co.
X corporation has estimated that for a new EBIT Rs. 11,20,000
product its break-even point is 2,000 units if the item is Profit before Tax 3,20,000
sold for Rs. 14 per unit; the cost accounting department Fixed costs 7,00,000
has currently identified variable cost of Rs. 9 per unit.
Calculate the degree of operating leverage for sales Calculate % change in EPS if the sales are
volume of 2,500 units and 3,000 units. What do you infer expected to increase by 5%.
from the degree of operating leverage at the sales
volumes of 2,500 units and 3,000 units and their PROBLEM NO. 8
difference if any ? XYZ and Co. has three financial plans before it,
Plan I, Plan II and Plan III. Calculate operating and
PROBLEM NO. 4 financial leverage for the firm on the basis of the following
The balance sheet of Well Established Company information and also find out the highest and lowest value
is as follows : of combined leverage:
Liabilities Rs. Assets Rs. Production 800 units
Selling Price per unit Rs. 15
Equity share capital 60,000 Fixed assets 1,50,000 Variable cost per unit Rs. 10
Retained Earnings 20,000 Current Assets 50,000 Fixed cost : Situation A Rs. 1,000
10% Long term debt 80,000 Situation B Rs. 2,000
Current Liabilities 40,000 Situation C Rs. 3,000
2,00,000 2,00,000 Capital Structure Plan I Plan II Plan III
The company’s Total Assets turnover ratio is 3, its Equity Capital Rs. 5,000 Rs. 7,500 Rs. 2,500
Fixed operating costs are Rs. 1,00,000 and its Variable 12% Debt 5,000 2,500 7,500
operating cost ratio is 40%. The income-tax rate is 50%.
Calculate for the Company the different types of leverages
given that the face value of the share is Rs. 10.
PROBLEM NO. 9 PROBLEM NO. 13
The following data relate to two companies A Ltd & B Ltd. From the following, prepare Income Statements of
A Ltd. B Ltd. A, B and C. Briefly comment an each firm’s performance :
Capital Employed : Firm A Firm B Firm C
Equity share capital (in Rs. 10 shares)5,00,000 2,50,000
9% Debentures - 2,50,000 Financial Leverage 3:1 4:1 2:1
Earnings before interest and tax 1,00,000 1,00,000 Interest Rs. 200 Rs. 300 Rs. 1,000
Return on capital employed 20% 20% Operating Leverage 4:1 5:1 3:1
Variable cost as a % of sales 66.67% 75% 50%
The equity shareholders of A Ltd. find to their Income - tax Rate 45% 45% 45%
dismay that in spite of same return earned by their
company on the total capital employed, their earning per PROBLEM NO. 14
share is much less as compared to B Ltd. The Combined Leverage and Operating Leverage
You are required to state for the satisfaction of the of a company are 2.5 and 1.25 respectively. Find out the
shareholders of A Ltd., the reasons for such lower Financial Leverage and PV Ratio given that
earnings per share on their capital. Assume the tax at
50%. (i) Equity Dividend is Rs. 2 per share
(ii) Interest payable is Rs. 1,00,000
PROBLEM NO. 10 (iii) Sales Rs. 10,00,000 and
The selected financial data for A, B and C (iv) Fixed cost Rs. 50,000.
Companies for the year ended Dec., 1998 are as follows :
PROBLEM NO. 15
A B C A firm has sales of Rs. 75,00,000, Variable cost of
Variable expenses as a% Sales 66.67 75 50 Rs. 42,00,000 and Fixed cost of Rs. 6,00,000. It has a
Interest Rs. 200 Rs. 300 Rs. 1,000 debt of Rs. 45,00,000 at 9% and equity of Rs. 55,00,000.
Degree of Operating leverage 5-1 6-1 2-1
Degree of Financial leverage 3-1 4-1 2-1 (i) What is the firm’s ROI ?
Income tax rate 50% 50% 50% (ii) Does it have favorable financial leverage ?
(iii) If the firm belongs, to an industry whose asset turnover
Prepare Income Statements for A, B and C Companies. is 3, does it have a high or low asset leverage ?
(iv) What are the Operating, Financial and Combined
PROBLEM NO. 11 leverages of the firm ?
The following data is available for XYZ Ltd. : (v) If the sales drop to Rs. 50,00,000, what will be the new
Sales Rs. 2,00,000 EBIT?
-Variable cost @ 30% 60,000 (vi) At what level, the EBT of the firm will be equal to zero
Contribution 1,40,000
Fixed cost 1,00,000
EBIT 40,000
-Interest 5,000
Profit before tax 35,000
Find out :
i) Using the concept of financial leverage, by what
percentage will the taxable income increase if EBIT
increases by 6%.
ii) Using the concept of operating leverage, by what
percentage will EBIT increase if there is 10% increase in
sales, and
iii) Using the concept of leverage, by what percentage will
t taxable income increase if the sales increase by 6%.
Also verify the results in view of the above figures.

PROBLEM NO. 12
i) Find out Operating leverage from the following data :
Sales Rs. 50,000
Variable Costs 60%
Fixed Costs Rs. 12,000
ii) Find out Financial leverage from the following data :
Net Worth Rs. 25,00,000
Debt/Equity 3:1
Interest rate 12%
Operating Profit Rs. 20,00,000
 MODULE – III 3
4
30,000
45,000
20,000
10,000
CAPITAL BUDGETING 5 60,000 10,000
Compute the Net Present Value at 10%, Profitability
Q.1) Albion Broadcasting Instruments Ltd. is Index, and Internal Rate of Return for the two projects.
considering the purchase of a machine to replace an
existing machine that has a book value of Rs. 48,000, and Q.6) Jingle Bell company has an investment
can be sold for Rs. 16,000. The salvage value of the old opportunity costing Rs. 1,00,000 with the following
machine in four years is zero, and it is depreciated on a expected cash inflow (i.e., after tax and before
straight-line basis. The proposed machine will perform the depreciation) :
same function the old machine is performing; however
improvements in technology will enable the firm to reap Year InflowsPVF(10%,n)Year InflowsPVF(10%,n)
cash benefits (before depreciation and taxes) of Rs.
72,000 per year in materials, labour, and overhead. The 1 Rs. 15,000 0.909 6 Rs. 18,000 0.564
new machine has a four year life, cost Rs. 1,50,000 and 2 16,000 0.826 7 15,000 0.513
can be sold for an expected Rs. 6,000 at the end of the 3 17,000 0.751 8 14,000 0.467
fourth year. Assuming straight-line depreciation and a 4 17,500 0.683 9 10,000 0.424
35% tax rate, compute cash flows associated with this 5 17,500 0.621 10 10,000 0.386
replacement.
Using 10% the costs of capital (rate of discount) determine
Q.2) A company is considering introducing a new the (i) Net Present Value; and (ii) Profitability Index and
product. The manufacturing equipment will cost Rs. (iii) Internal Rate of Return
4,50,000. The expected life of the equipment is 9 years.
The company is thinking of selling the product in Rs. 15 Q.7) There are two projects X and Y. Each project
per unit. It is estimated that variable cost per unit would be requires a investment of Rs. 2,00,000. You are required to
Rs. 7.5 and annual fixed cost Rs. 4,00,000. Fixed cost rank these projects according to the pay back method
includes (straight line) depreciation of Rs. 50,000 and from the following information:
allocated overheads of Rs. 25,000. The company expects (Net profit before depreciation and after Tax)
to sell 1,00,000 units of the product each year. Assume Years Project X Project Y
that tax is 40% and straight line depreciation is allowed for 1st 20,000 20,000
tax purpose. Calculate the cash flows. 2nd 60,000 40,000
3rd 60,000 60,000
Q.3) Hindalco Co. is considering a proposal to replace one 4th 50,000 70,000
of its equipment costing Rs. 6,00,000 and having a written 5th 50,000 50,000
down value of Rs. 40,000. The remaining economic life of
the plant is 4 years after which it will have no salvage Q.8) ABC Ltd. is evaluating the following independent
value. However, if sold today, if has a salvage value of Rs. projects:
50,000. The new machine costing Rs. 12,00,000 is also Project X Project Y
expected to have a life of 4 years with a scrap value of Rs. Initial cost Rs. 10,00,000 Rs. 5,00,000
30,000. The new equipment, due to its technological Cash flows: Year 1 4,00,000 2,00,000
superiority, is expected to contribute additional annual 2 3,00,000 2,50,000
benefit (before depreciation and tax) of Rs. 2,25,000. Find 3 4,00,000 1,50,000
out the cash flows associated with this decision given that 4 2,00,000 1,00,000
the tax rate applicable to the firm is 40%. (The capital gain 5 2,00,000 75,000
or loss may be taken as not subject to tax.) Find out the Discounted Payback period of both Projects
given the discount rate at 12%.
Q.4) A company is faced with the problem of choosing
between two mutually exclusive projects. Project A Q.9) XYZ Co. is considering the purchase of one of the
requires a cash outlay of Rs. 1,50,000 and cash running following machines, whose relevant data are as given
expenses of Rs. 25,000 per year. On the other hand, below:
Project B will cost Rs. 2,00,000 and requires cash running Machine A Machine B
expenses of Rs. 20,000 per year. Both the machines have Estimated life 3 years 3 years
eight-year life. Project A has a Rs. 5,000 salvage value Capital cost Rs. 90,000 Rs. 90,000
and Project B has Rs. 10,000 salvage value. The Earnings (after tax) : Year 1 40,000 20,000
company’s tax rate is 50% and has a 10% required rate of Year 2 50,000 70,000
return. Assume depreciation on straight line basis and no Year 3 40,000 50,000
tax on salvage values of assets. Find out the Initial, The company follows the straight-line method of
Annual and Terminal cash flows on incremental basis. depreciation; the estimated salvage value of both the
types of machines is zero. Show the most profitable
Q.5) A firm whose cost of capital is 10% is considering investment based on (i) Payback period, (ii) Accounting
two mutually exclusive projects X and Y, the details of rate of return, and (iii) Net present value assuming a 10%
which are: cost of capital.
Year Project X Project Y
Cost 0 Rs. 70,000 Rs. 70,000 Q.10) Bright Metals Ltd. is considering two different
Cash inflows 1 10,000 50,000 investment proposals, A and B. The details are as under:
2 20,000 40,000 Proposal A Proposal B
Investment Cost Rs. 9,500 Rs. 20,000
Estimated Income : Year 1 4,000 8,000
Year 2 4,000 8,000
Year 3 4,500 12,000

Suggest the most attractive proposal on the basis

of the NPV method considering that the future incomes
are discounted at 12%. Also find out the IRR of the two
proposals.

Q.11) A company proposes to undertake one of two

mutually exclusive projects namely, AAA and BBB. The
initial capital outlay and annual cash inflows are as under:

AAA BBB
(Rs) (Rs)
Initial Capital outlay 22,50,000 30,00,000
Salvage value at the end of the life 0 0
Economic life (years) 4 7
After tax annual cash inflowsYears 1Rs. 6,00,000Rs. 5,00,000
2 12,50,000 7,50,000
3 10,00,000 7,50,000
4 7,50,000 12,00,000
5 - 12,50,000
6 - 10,00,000
7 - 8,00,000
The Company’s cost of capital is 15%
Calculate for each project. (a) Net Present Value of cash
flows. (b) Internal Rate of Return.
 Additional information:
WORKING CAPITAL a) Minimum desired cash balance is Rs. 20,000.
b) Raw materials are held in stock, on an average, for two
PROBLEM NO. 1
months.
The cost sheet of POR Ltd. provides the following data:
c) Work-in-progress (assume 50% completion stage) will
Cost per unit
approximate to half-a-month’s production.
Raw material Rs. 50
d) Finished goods remain in warehouse, on an average,
Direct Labor 20
for a month.
Overheads (including depreciation of Rs. 10) 40
e) Suppliers of materials extend a month’s credit and
Total cost 110
debtors and provided two month’s credit; cash sales are
Profits 20
25% of total sales.
Selling price 130
f) There is a time-lag in payment of wages of a month; and
Average raw material in stock is for one month. half-a-month in the case of overheads.
Average material in work-in-progress is for half month.
From the above facts, you are required to prepare
Credit allowed by suppliers : one month; credit allowed to
a statement showing working capital requirements.
debtors : one month. Average time lag in payment of
wages: 10 days; average time lag in payment of
PROBLEM NO. 4
overheads 30 days. 25% of the sales are on cash basis.
XYZ Ltd. sells its products on a gross profit of 20% of
Cash balance expected to be Rs. 1,00,000. Finished
sales. The following information is extracted from its
goods lie in the warehouse for one month.
annual accounts for the year ending 31st Dec., 1999.
You are required to prepare a statement of the
working capital needed to finance a level of the activity of Sales (at 3 months credit) Rs. 40,00,000
54,000 units of output. Production in carried on evenly Raw material 12,00,000
throughout the year and wages and overheads accrue Wages (15 days in arrears) 9,60,000
similarly. State your assumptions, if any, clearly. Manufacturing and General expenses (one month in
arrears) 12,00,000
PROBLEM NO. 2 Administration expenses (one month in arrears) 4,80,000
Grow More Ltd. is presently operating at 60% level, Sales promotion expenses (payable half yearly in
producing 36,000 units per annum. In view of favorable advance) 2,00,000
market conditions, it has been decided that from 1st The company enjoys one month’s credit from the suppliers
January 2000, the Company would operate at 90% of raw materials and maintains 2 months stock of raw
capacity. The following information are available: materials and 11/2 months finished goods. Cash balance is
i) Existing cost - price structure per unit is given below: maintained at Rs. 1,00,000 as a precautionary balance.
Raw material Rs. 4.00 Assuming a 10% margin, find out the working capital
Wages 2.00 requirement of XYZ Ltd.
Overheads (Variable) 2.00
Overheads (Fixed) 1.00 PROBLEM NO. 5
Profits 1.00 Hi-tech Ltd. plans to sell 30,000 units next year. The
ii) It is expected that the cost of raw material, wages rate, expected cost of goods sold is as follows :
expenses and sales per unit will remain unchanged in Rs. (Per Unit)
2000. Raw material 100
iii) Raw materials remain in stores for 2 months before Manufacturing expenses 30
these are issued to production. These units remain in Selling, administration and financial expenses 20
production process for 1 month. Selling price 200
iv) Finished goods remain in warehouse for 2 months. The duration at various stages of the operating cycle is
v) Credit allowed to debtors is 2 months. Credit allowed by expected to be as follows:
creditors is 3 months.
vi) Lag in wages and overhead payments is 1 month. It Raw material stage 2 months
may be assumed that wages and overhead accrue evenly Work-in-progress stage 1 months
throughout the production cycle. Finished stage 1
/2 month
Debtors stage 1 month
PROBLEM NO. 3 Assuming the monthly sales level of 2,500 units, estimate
The management of Royal Industries has called for a the gross working capital requirement desired cash
statement showing the working capital to finance a level of balance is 5% of he gross working capital requirement,
activity of 1,80,000 units of output for the year. The cost and work-in-progress is 25% complete with respect to
structure for the company’s product for the above manufacturing expenses.
mentioned activity level is detailed below :
Cost per unit PROBLEM NO. 6
Raw material Rs. 20 Calculate the amount of working capital requirement for
Direct labor 5 SRCC Ltd. from the following information:
Overheads (including depreciation of Rs. 5 per unit) 15 Rs. (Per Unit)
40 Raw material 160
Profit 10 Direct labor 60
Selling price 50 Overheads 120
Total cost 340 Wages and Manufacturing expenses 6,25,000
Profit 60 Depreciation 2,35,000 17,00,000
Selling price 400 -Stock of finished goods (10% of total production)
Raw materials are held in stock on an average for one 15,30,000
month. Materials are in process on an average for half-a- The figures given above relate only to the goods that have
month. Finished goods are in stock on an average for one been finished and not to W.I.P. goods which is equal to
month. 15% of the year’s production (in terms of physical units)
Credit allowed by suppliers is one month and credit on an average, requiring full materials but only 40% on the
allowed to debtors is two months. Time lag in payment of other expenses. The company believes in keeping 2
wages is 11/2 weeks. Time lag in payment of overhead months consumption of material in stock.
expenses is one month. One fourth of the sales are made All expenses are paid one month in arrears. Suppliers of
on cash basis. material extend 11/2 months credit. Sales are 20% cash,
Cash in hand and at the bank is expected to be Rs. rest are at 2 months credit. You can make such other
50,000 : and expected level of production amounts to assumptions as you deem necessary for estimating
1,04,000 units for a year of 52 weeks. working capital requirement.
You may assume that production is carried on evenly
throughout the year and a time period of four weeks is PROBLEM NO. 9
equivalent to a month. JBC Ltd. sells goods on a gross profit of 25%.
Depreciation is considered as a part of cost of production.
PROBLEM NO. 7 The following are the annual figures given to you :
X Ltd. sells goods at a gross profit of 20%. It includes Sales (2 months credit) Rs. 18,00,000
depreciation as part of cost of production. The following Materials consumed (1 month credit) 4,50,000
figures for the 12 months ending 31st Dec, 1999 are given Wages paid (1 month lag in payment) 3,60,000
to enable you to ascertain the working capital of the Cash manufacturing expenses
company on a cash cost basis. (1 month lag in payment) 4,80,000
In your working, you are required to assume that : Administrative expenses (1 month lag in payment) 1,20,000
i) a safety margin of 15% will be maintained; Sales promotion expenses (paid quarterly in advance)60,000
ii) cash is to be held to the extent of 50% of current The company keeps one month’s stock each of raw
liabilities; materials and finished goods. It also keeps Rs. 1,00,000 in
iii) there will be no work-in-progress; cash. You are required to estimate the working capital
iv) tax is to be ignored. requirements of the company on cash cost basis,
Stock of raw materials and finished goods are kept at one assuming 15% safety margin.
month’s requirements. All working notes are to form part
of your answer. PROBLEM NO. 10
Prepare a working capital forecast from the following
Sales at 2 months credit Rs. 27,00,000 information :
Materials consumed Production during the previous year was 10,00,000 units.
(suppliers credit is for 2 months) 6,75,000 The same level of activity is intended to be maintained
Total wages during the current year.
(paid at the beginning of the next month) 5,40,000 The expected ratios of cost to selling price are :
Manufacturing expenses outstanding at the end of the
year 60,000 Raw materials 40%
(These expenses are paid one month in arrears) Direct Wages 20%
Total administrative expenses (paid as above) 1,80,000 Overheads 20%
Sales promotion expenses paid quarterly in advance90,000 The raw materials ordinarily remain in stores for 3 months
before production. Every unit of production remains in the
PROBLEM NO. 8 process for 2 months and is assumed to be consisting of
A company has applied a short-term loan to a commercial 100% raw material, wages and overheads. Finished
bank for financing its working capital requirement. You are goods remain in the warehouse for 3 months. Credit
asked by the bank to prepare an estimate of the allowed by creditors is 4 months from the date of the
requirement of the working capital for that company. Add delivery of raw material and credit given to debtors is 3
10% to your estimated figure to cover unforeseen months from the date of dispatch.
contingencies. The information about the projected Profit The estimated balance of cash to be held Rs. 2,00,000
and Loss A/c of the company is as under : Lag in payment of wage 1/2 month
Rs. Rs. lag in payment of expenses 1/2 month
Sales 21,00,000 Selling price is Rs. 8 per unit. Both production and sales
Cost of goods sold 15,30,000 are in a regular cycle. You are required to make a
Gross Profit 5,70,000 provision so 10% for contingency (except cash). Relevant
Administrative expenses 1,40,000 assumptions may be made.
Selling expenses 1,30,000 2,70,000
Profit before Tax 3,00,000 PROBLEM NO. 11
Provision for Tax 1,00,000 On 1st January, 2000, the Board of Directors of Dowell
Cost of goods sold has been derived as follows: Co. Ltd. wishes to know the amount of working capital that
Materials used 8,40,000 will be required to meet the program of activity they have
planned for the year. The following information are Average finished goods stock 180
available: Average creditors 90
i) Issued and paid-up capital Rs. 2,00,000. Average debtors 350
ii) 5% Debentures (secured on assets) Rs. 50,000.
iii) Fixed assets valued at Rs. 1,25,000 on 31.12.2000. PROBLEM NO. 14
iv) Production during the previous year was 60,000 A firm has applied to the commercial bank for financing its
units. It is planned that the level of activity should be working capital requirement. The following information is
maintained during the present year. available about the projections for the current year :
v) The ratios of cost to selling price are - raw materials 1. Estimated level of activity: 1,04,000 completed units of
60%., direct wages 10%, and overheads 20%. production plus 4,000 units of work-in-progress. Based on
vi) Raw materials are expected to remain in stores for this level, the estimated cost per unit is :
an average of two months before these are issued for Raw materials Rs. 80 per unit
production. Direct wages Rs. 30 per unit
vii) Each unit of production is expected to be in process Overheads (excluding depreciation) Rs. 60 per unit
for one month. Total cost Rs. 170 per unit
viii) Finished goods will stay in warehouse for Selling price Rs. 200 per unit
approximately three months.
ix) Creditors allow credit for 2 months form the date of 2. Raw materials is stock: Average one week
delivery of raw materials. consumption, work-in-progress (assume 50% completion
x) Credit allowed to debtors is 3 months from the date of stage in respect of conversion cost & that material are
dispatch. issued at the start of processing).
xi) Selling price per unit is Rs. 5. 3. Finished goods in stock is 8,000 units.
xii) There is a regular production and sales cycle. 4. Credit allowed by suppliers and to debtors is 4 weeks
and 8 weeks respectively.
Prepare-a) working capital requirement forecast; and 5. Lag in payment is wages is 11/2 week.
b) an estimated Profit and Loss Account and Balance
Sheet at the end of the year. 6. Cash at bank required for smooth operations is Rs.
25,000.
PROBLEM NO. 12 Assume that the production is carried on evenly
Prepare an estimate of net working capital requirement for throughout the year (52 weeks) and that wages and
the WCM Ltd. adding 10% for contingencies from the overheads accrue similarly. All sales are made on credit
information given below: basis. Find out (i) the net working capital required, and (ii)
Estimated cost per unit of production Rs. 170 includes raw the maximum permissible bank finance as per the Tandon
materials Rs. 80, direct labour Rs. 30 and overheads Committee norms
(exclusive of depreciation) Rs. 60. Selling price is Rs. 200
per unit. Level of activity per annum 1,04,000 units. Raw
material is stock: average 4 weeks; work-in-progress
(assume 50% completion stage) : average 2 weeks;
finished goods in stock: average 4 weeks; credit allowed
by suppliers : average 4 weeks; credit allowed to debtors:
average 8 weeks; lag in payment of wages : average 1.5
weeks, and cash at bank is expected to be Rs. 25,000.
You may be assuming that production is carried on evenly
throughout the year (52 weeks) and wages and overheads
accrue similarly. All sales are on credit basis only. You
may state your assumptions, if any.

PROBLEM NO. 13
XYZ Ltd. has obtained the following data
concerning the average working capital cycle for the
companies in the same industry :
Raw material stock turnover 20 Days
Credit received -40 Days
Work-in-progress turnover 15 Days
Finished goods stock turnover 40 Days
Debtors’ collection period 65 Days
95 Days
Using the following data, calculate the current working
capital cycle for XYZ Ltd. and briefly comment on it.
(Rs. in ‘000)
Sales 3,000
Cost of Production 2,100
Purchases 600
Average raw material stock 80
Average work-in-progress 85
 MODULE – V Total Earnings Rs. 2,00,000
Number of equity shares (of Rs. 100 each) 20,000
DIVIDEND DECISION Dividend paid 1,50,000
Price/Earning ratio 12.5
Q. 1) Following are the details regarding three The firm is expected to maintain its rate of return
companies A Ltd., B Ltd. and C Ltd. : on fresh investment. Also find out what should be the P/E
A Ltd. B Ltd. C Ltd. ratio at which the dividend policy will have no effect on the
value of the share ? Will your decision change if the P/E
r = 15% r = 5% r = 10%
ratio is 8 instead of 12.5 ?
ke = 10% ke = 10% ke = 10%
E = Rs. 8 E = Rs. 8 E = Rs. 8 Q. 7) RST Ltd. has a capital of Rs. 10,00,000 in equity
Calculate the value of an equity share of each of shares of Rs. 100 each. The shares are currently quoted
these companies applying Walter’s formula when dividend at par. The company proposes to declare a dividend of
payment ratio (D/P ratio) is : (a) 25%, (b) 50%, (c) 75%. Rs. 10 per share at the end of the current financial year.
The capitalization rate for the risk class to which the
What conclusions do you draw ?
company belongs is 12%.
Q. 2) The earnings per share of a share of the face of What will be the market price of the share at the
Rs. 100 of PQR Ltd. is Rs. 20. It has a rate of return of end of the year, if
25%. Capitalization rate of its risk class 12.5%. If Walter’s i) A dividend is not declared ?
model is used :
ii) A dividend is declared ?
a) What should be the optimum payout ratio?
iii) Assuming that the company pays the dividend and
b) What should be the market price per share if the has net profits of Rs. 5,00,000 and makes new
payout ratio is zero? investments of Rs. 10,00,000 during the period, how many
c) Suppose, the company has a payout of 25% of EPS, new shares must be issued ? Use the MM model.
what would be the price per share?
Q. 8) Textrol Ltd. has 80,000 shares outstanding. The
Q. 3) The earnings per share of ABC Ltd. is Rs. 10 and current market price of these shares is Rs. 15 each. The
rate of capitalization applicable to it is 10%. The company Company expect a net profit of Rs. 2,40,000 during the
has before it the options of adopting a pay-out of 20% or year and it belongs to a risk class for which the
40% or 80%. Using Walter’s formula, compute the market appropriate capitalization rate has been estimated to be
value of the company’s share if the productivity of retained 20%. The Company is considering dividend of Rs. 2 per
earnings is (i) 20%, (ii) 10%, or (iii) 8%. share for the current year.
a) What will be the price of the share at the end of the
Q. 4) Determine the market value of equity shares of year (i) if the dividend is paid and (ii) if the dividend is not
the company form the following information: paid ?
Earnings of the company Rs. 5,00,000 b) How many new shares must the Co. issue if the
Dividend paid 3,00,000 dividend is paid and the Co. needs Rs. 5,60,000 for an
Number of shares outstanding 1,00,000 approved investment expenditure during the year ? Use
Price-earning ratio 8 MM model for the calculation.
Rate of return of investment 15%
Are you satisfied with the current dividend policy Q. 9) Diamond Engineering Company has 10,00,000
of the firm ? If not, what should be the optimal dividend equity shares outstanding at the start of the accounting
payout ? Use Walter’s Model. year 1997. The ruling market price per share is Rs. 150.
The Board of Directors of the Company contemplates
Q. 5) ABC and Co. has been following a dividend policy declaring Rs. 8 share as dividend at the end of the current
which can maximize the market value of the firm as per year. The rate of Capitalization appropriate to the risk-
Walter’s model. Accordingly, each year, at dividend time class to which the company belongs is 12%.
the capital budget is reviewed in conjunction with the a) Based on Modigliani-Miller Approach, calculate the
earnings for the periods and alternative investment market price per share of the company when the
opportunities for the shareholders. contemplated dividend is (i) declared and (ii) not declared.
In the current year, the firm expects earnings of b) How many new shares are to be issued by the
Rs. 5,00,000. It is estimated that the firm can earn Rs. company at the end of the accounting year on the
1,00,000 if the profits are retained. The investors have assumption that the Net Income for the year is Rs. 2
alternative investment opportunities that will yield them crore? Investment budget is Rs. 4 crore and (i) the above
10% return. The firm has 50,000 shares outstanding. dividends are distributed and (ii) they are not distributed.
What should be the dividend payout ratio in order to
maximize the wealth of the shareholders ? Also find out c) Show that the total market value of the shares at the
the current market price of the share. end of the accounting year will remain the same whether
dividends are either distributed or not distributed. Also find
Q. 6) From the following information supplied to you, out the current market value of the firm under both
ascertain whether the firm is following an optimal dividend situations.
policy as per Walter’s model?
Q. 10) A company belongs to a risk-class for which the iii) What would be the current value of the firm : (a) if a
appropriate capitalization rate is 10%. It currently has dividend is declared, (b) if a dividend is not declared ?
outstanding 25,000 shares selling at Rs. 100 each. The
firm is contemplating the declaration of dividend of Rs. 5
per share at the end of the current financial year. The
company expects to have a net income Rs. 2.5 lac and a
proposal for making new investments of Rs. 5 lac.
Show the under the MM assumptions, the payment of
dividend does not affect the value of the firm.

Q. 11) Calculate the market price of a share of ABC Ltd.

under (i) Walter’s formula; and
(ii) Dividend growth model from the following data :
Earnings per share Rs. 5
Dividend per share Rs. 3
Cost of capital 16%
Internal rate of return on investment 20%
Retention ratio 40%

Q. 12) A company has a total investment of Rs. 5,00,000

in assets, and 50,000 outstanding common shares at Rs.
10 per shares (per value). It earns a rate of 15% on its
investment, and has a policy of retaining 50% of the
earnings. If the appropriate discount rate of the firm is 10
per cent, determine the price of its share using Gordon’s
model. What shall happen to the price of the share if the
company has payout of 80 per cent or 20 per cent ?

Q. 13) The following information is available in respect of

ABC Ltd.
EPS Rs. 10
Rate of return 20%
Required rate of return of equity investment, k e 16%
Find out the market price of the share under
Gordon model if the firm follows a payout of 50% or 25%.

Q. 14) The present share capital A Ltd. consist of 1,000

shares selling at Rs. 100 each. The company is
contemplating a dividend of Rs. 10 per share at the end of
the current financial year. The company belongs to a risk
class for which appropriate capitalization rate is 20%. The
company expects to have a net income of Rs. 25,000.
What will be the price of the share at the end of the year if
(i) dividend is not declared, and (ii) a dividend declared.
Presuming that the company pays the dividend and has to
make new investment of Rs. 48,000 in the coming period,
how many new shares be issued to finance the investment
program ? You are required to use the MM model for this
purpose.

Q. 15) A textile company belongs to a risk-class for

which the appropriate PE ratio is 10. currently has 50,000
outstanding shares selling at Rs. 100 each. The firm is
contemplating the declaration of Rs. 8 dividend at the end
of the current fiscal year which has just started. Given the
assumption of MM, answer the following questions.
i) What will be the price of the share at the end of the year
: (a) if a dividend is not declared, (b) if its is declared ?
ii) Assuming that the firm pays the dividend and has a net
income of Rs. 5,00,000 and makes new investments of
Rs. 10,00,000 during the period, how many new shares
must be issued ?