Q1. Explain the steps involved in Financial Planning.

Ans.

Financial Planning

The Finance Manager has to estimate the financial requirements of the company. He should determine the sources from which capital can be raised and determine how effectively and judiciously these funds are put into use so that repayments can be done in time. Financial planning is deciding in advance the course of action for future. Financial planning includes Estimation of the amount of funds to be raised, finding out the various sources of capital and the securities offered against the money so received and laying down policies to administer the usage of funds in the most appropriate way.

Estimate capital requirements:

This is the first step in financial planning. The following factors may be used to determine the capital

Requirement of fixed assets.Investment intangible assets like patents, copyrights, etc.Amount required for current assets like stocks, cash, bank balances, etc.Cost of set-up and likely expenses to be incurred on the new issue of shares and debentures.Determine the type of sources to be acquired and their proportion:

The Finance Manager has to decide on the form in which the money is to be sourced, that is, debt, equity, preference shares, loans from banks and the proportion in which these are to be procured.

Steps in Financial Planning:

 The financial planning process involves the following steps: Projection of financial statements, Financial statements are the company's profit and loss account and the balance sheet. These two statements can be prepared for a certain period of future time and they help the manager to determine the amount of fund requirements

Determination of funds needed, Once the projections are drawn in terms of sales of products, the cost of production, marketing.

Activities, etc., the Finance Manager can draw up a plan as to the fund requirement based on the time factor. He can know whether the funds are to be procured on a short term basis or on a long term basis.

Forecast the availability of funds:A company will have a steady flow of funds. If the manager is able to forecast these amounts properly, then the moneys to be borrowed can be reduced, thus saving on the interest payments.

Establish and maintain control system:Control system is ineffective without adequate planning and the adequacy of planning can be gauged only through proper control measures. Both these activities are essential for effective utilization of funds.

Develop procedures:Procedures should be developed for basic plans how they should be achieved.

Summary of Steps in Financial Planning:

 The financial planning process involves the following steps:Assess the business environmentConfirm the business vision and objectivesIdentify the types of resources needed to achieve these objectivesQuantify the amount of resource (labor, equipment, materials)Calculate the total cost of each type of resourceSummarize the costs to create a budgetIdentify any risks and issues with the budget set

Q2. A company is considering a capital project with the following information:

The cost of the project is Rs.200 million, which consists of Rs.150 million in plant machinery and Rs.50 million on net working capital. The entire outlay will be incurred in the

beginning. The life of the project is expected to be 5 years. At the end of 5 years, the fixed assets will fetch a net salvage value of Rs. 48 million and the net working capital will be liquidated at par. The project will increase revenues of the firm by Rs. 250 million per year. The increase in costs will be Rs.100 million per year. The depreciation rate applicable will be 25% as per written down value method. The tax rate is 30%. If the cost of capital is 10% what is the net present value of the project.

Ans.

Cost of Project PV Factor PV of Cash Inflow200 Million 0.909 181.8150 Million 0.826 123.950 Million 0.751 37.55

Q3. Discuss the relevance and factors that influence the determination of stock level.

Ans.

Most of the industries are subject to seasonal fluctuations and sales during different months of the year are usually different. If, however, production during every month is geared to sales demand of the month, facilities have to install to cater to for the production required to meet the maximum demand. During the slack season, a large portion of the installed facilities will remain idle with consequent uneconomic production cost. To remove this disadvantage, attempt has to be made to obtain a stabilized production program throughout the year. During the slack season, there will be accumulation of finished products which will be gradually cleared as sales progressively increase. Depending upon various factors of production, storing and cost, a normal capacity will be determined. To meet the pressure of sales during the peak season, however, higher capacity may have to be sued for temporary periods. Similarly, during the slack season, to avoid loss due to excessive accumulation, capacity usage may have to be scaled down. Accordingly, there will be a maximum capacity and minimum capacity, only consumption of raw material will accordingly vary depending upon the capacity usage. Again, the delivery period or lead time for procuring the materials may fluctuate. Accordingly, there will be maximum and minimum delivery period and the average of these two is taken as the normal delivery period.

Maximum Level:

Maximum level is that level above which stock of inventory should never rise.

Maximum level is fixed after taking in to account the following factors

1. Requirement and availability of capital2. Availability of storage space and cost of storing.3. Keeping the quality of inventory intact.4. Price fluctuations5. Risk of obsolescence.6. Restrictions, if any, imposed by the government. Maximum Level = Ordering level – (MRC x MDP) + Standard ordering quantity. Where, MRC = minimum rate of consumption MDP= minimum lead time.

Minimum Level:

Minimum level is that level below which stock of inventory should not normally fall. Minimum level = OL – (NRC x NLT) Where, OL = ordering level NRC = Normal rate of consumption NLT = Normal Lead Time.

Ordering Level:

Ordering level is that level at which action for replenishment of inventory is initiated. OL `= MRC X MLT

 Where, MRC = Maximum rate of consumption MLT = Maximum lead time.

3. Average stock levelAverage stock level can be computed in two ways1. Minimum level + maximum

level / 2.

Minimum level + 1 /2 of reorder quantity. Average stock level indicates the average investment in that item of inventory. It in of quite relevant from the point of view of

working capital management.

Managerial significance of fixation of Inventory level:1. It ensures the smooth productions of the finished goods by making available the raw

material of right quality in right quantity at the right time.2. It optimizes the investment in inventories. In this process, management can avoid both overstocking and shortage of each and every essential and vital item of inventory.3. It can help the management in

identifying the dormant and slow moving items of inventory. This brings about better coordination between materials management and production management on the one

hand and between stores manager and marketing manager on the other. – 

Order Point:“When to order” is another aspect of inventory management. This is answered by re – Order point. The re order point is that inventory level at which an order should be place

to replenish the inventory.

To arrive at the re order point under certainty the two key required details are:1. Lead time2. Average usage lead time refers to the average time required to replenish

the inventory after placing orders for inventory. – 

Order point = lead time x Average usage under certainty, re order point refers to that inventory level which will meet the consumption needs during the lead time.

Safety Stock

Since it is difficult to predict in advance usage and lead time accurately, provision is made for handling the uncertainty in consumption due to changes in usage rate and lead

time. The firm maintains a safety stock to manage the stock  – 

Out arising out of this uncertainty. When safety stock is maintained, (When Variation is only in usage rate) Re

 – Order point = lead time x Average usage + Safety stock

 Safety stock = [(maximum usage rate)– (Average usage rate)] x lead time.

 OrSafety stock when the variation in both lead time and usage rate are to be incorporated. Safety stock = (Maximum possible usage) – (Normal usage)Maximum possible usage = Maximum daily usage x Maximum lead time Normal usage = Average daily usage x Average lead time Example: A manufacturing company has an expected usage of 50,000 units of certain product during the next year. Re cost of processing an order is Rs 20 and the carrying cost per unit per annum is Rs 0.50. Lead time for an order is five days and the company will keep a reserve of two days usage. Calculate 1. EOQ 2. Re – Order point. Assume 250 days in a year Solution: EOQ =√

2DK / √Kc=√2 x 50000 x 20 / 0.50= 2000 units

Re order pointDaily usage = 50000 / 250= 200 units Safety stock = 2 x 200 400 units.

Reorder point (lead time x Average usage) + safety stock (5 x 200) + 400 = 1,400 units

Ques 4 There was a replacement of its existing machine by a new machine. The new machine will cost Rs 2, 00, 000 and have a life of five years. The new machine will yield annual cash revenue of Rs 2, 50,000 and incur annual cash expenses of Rs 1, 30,000. The estimated salvage of the new machine at the end of its economic life is Rs 8,000. The existing machine has a book value of Rs 40,000 and can be sold for Rs 20,000. The existing machine, if used for the next five years is expected to generate annual cash revenue of Rs 2, 00,000 and to involve annual cash expenses of Rs 1, 40,000. If sold after five years, the salvage value of the existing machine will be negligible. The company pays tax at 40%. It writes off depreciation at 30% on the written down value. The company’s cost of capital is 20%

Compute the incremental cash flows of replacement decisionsAns.

Initial Investment  Gross Investment for new machine (200000.00)Less Cash Recvd from sale of existing machine 20000.00 Net Cash (180000.00)

Annual Cash Flow from Ops  Incremental cash flow from revenue 50000.00

incremental decrease in expenses 10000.00

YearDepreciation (New machine)

Depreciation (Old Machine)

Incremental Depreciation

1 66000 10000 350002 46200 7500 262503 32340 5625 196874 22638 4219 147655 15847 3164 11074

Initial Investment  Book Value 40000.00 Add Cost of new machine 200000.00   240000.00 Less Sale proceeds of old machine 20000.00   220000.00    Dep for 1 Year 30% 66000.00   154000.00 Dep for 2 Year 30% 46200.00   107800.00 Dep for 3 Year 30% 32340.00   75460.00 Dep for 4 Year 30% 22638.00   52822.00 Dep for 5 Year 30% 15847.00   36975.00

Q6. The following details have been extracted from the books of Ashraya Ltd Income Statement (Rs. In millions)

2009 2010 Sales less returns

1200 1000

Gross Profit 300 520 Selling Expenses 100 120 Administration 40 45 Deprecation 60 75 Operating Profit 100 280 Non operating income

20 40

EBIT (Earnings before interest & Tax

120 320

Interest 15 18 Profit before tax 105 302 Tax 30 100 Profit after tax 75 202 Dividend 38 100 Retained earnings

37 102

Ans.

Balance SheetLiabilities ‘09 ‘10 Assets ‘09 ‘10           S/H Funds     Fixes Assets 400 510      Less Depreciation 100 120Equity 120 120   300 390Pref 50 50      Reserves 122 224 Investment 50 50           Unsecured Loans 50 60 Current Assets, Loans& Advances    Secured Loans 100 120            Cash 10 12Current Liabilities     Receivables 80 128Trade Creditors 210 250 Inventories 200 300      Loans and Advances 50 80Provisions     Misc Expenditure 10 24           Tax 10 60      Proposed Dividend 38 100        700 984   700 984

Following is the, Income statement and balance sheet for the year 2008 based on the following assumptions: Sales for the year 2008 will increase by 30% over the sales value for 2007. 

Use percent of sales method to forecast the values for various items of income statement using the percentage for the year 2007. – Depreciation is charged at 25% of fixed assets.– Fixed assets will increase by Rs.100 million– Investments will increase by Rs.100 million– Current assets and current liabilities are to be decided based on their relationship

with the sales in the year 2007– Miscellaneous expenditure will increase by Rs.19 million– Secured loans in 2008 will be based on its relationship with the sales in the year2007– Additional funds required, if any, will be met by bank borrowings– Tax rates will be 30 %– Dividends will be 50 % of the profit after tax– Non- operating income will increase by 10%– There will be no change in the total amount of administration expenses to be spent in

the year 2008– There is no change in equity and preference capital in 2008 Interest for 2008 will maintain the same ratio as it has in 2007 with the sales of 200