Study Material of FM

8/6/2019 Study Material of FM

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Name ____________________________________

Study Material

for

Financial Management

MBA II Sem.

Compiled by

Dr. Sachin MittalAssociate Professor, PIMR, Indore

Prestige Institute of Management & Research

Indore


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Working Capital Management

Q1. From the following projections of XYZ & Company for the next year, you arerequired to work out the working capital required by the company.

Annual sales Rs. 14,40,000Cost of production (including depreciation Rs. 1,20,000) 12,00,000

Raw material purchases 7,05,000

Monthly expenses 25,000

Anticipated opening stock of raw material Rs. 1,40,000

Anticipated closing stock of raw material Rs. 1,25,000

Inventory norms:

Raw material 2 months

Work-in-process 15 days

Finished Goods 1 month

The firm enjoys a credit of 15 days on its purchases, and allows one month credit onits supplies. The company has received an advanced of Rs. 15,000 on sales order.

You may assume that production is carried on evenly throughout the year, and the

minimum cash balance desired to be maintained is Rs. 10,000.

Q2. XYZ Cements Limited sells its products on a gross profit of 20% on sales. The

following information is extracted from its annual accounts for the current year ended

31st December.Rs.

Sales at 3 months credit 40,00,000Raw material 12,00,000Wages paid average time lag 15 days 9,60,000

Manufacturing expenses paid one month in arrears 12,00,000

Administrative expenses paid - one month in arrears 4,80,000Sales promotion expenses payable half yearly in arrears 2,00,000

The company enjoy one months credit from the suppliers of raw materials and

maintains a 2 months stock of raw materials and one and half months stock offinished goods. The cash balance is maintained at Rs. 1,00,000 as a precautionary

measure. Assuming a 10% margin, find out the working capital requirements of XYZ

Cements Ltd.

Q3. The management of Gemini Ltd. has called for a statement showing the workingcapital needed to finance a level of activity of 3,00,000 units of output for the year.

The cost structure for the companys product, for the above mentioned activity level,

is detailed below:

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Amount Per unit (Rs.)

Raw material 80

Direct labour 30Overheads (Including depreciation Rs. 5) 65

Total Cost 175

Additional Information:

Selling price Rs. 200 per unitLevel of activity 1,04,000 units of production per annum

Raw material in stock average 4 weeks

Work in progress (assume full unit of raw

material required in the beginning ofmanufacturing; other conversion costs are 50%) average 2 weeks

Finished goods in stock average 4 weeks

Credit allowed by suppliers average 4 weeks

Credit allowed to debtors average 8 weeksLag in payment of wages average 1.5 weeks

Desire cash in bank Rs. 25,000

You may assume that the production is carried on evenly throughout the year (52

weeks) and wages / overheads accrue similarly. All sales are on a credit basis only.

Q6 XYZ co. plans to sell 48,000 units next year. The expected cost of Goods Sold is as

follows:

Unit Cost Monthly Cost

Raw Material Rs. 60/- Rs.2,40,000

Manufacturing Expenses Rs. 40/- Rs. 1,60,000

Selling & other Exp. Rs. 20/- Rs. 80,000

----------- ------------------

Rs. 120/- Rs.4,80,000

----------- ------------------

The selling price per unit is expected to be Rs. 160/-. The duration of various stages

of the operating cycle is expected to be as follows.

Raw material stage 1 month , Work in Progress stage 2 month, Finished Goodsstage -1month, Debtors stage 2 month

Calculate the investment in various current assets.

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Leverage

Q1.XYZ Ltd. has an average selling price of Rs. 10 per unit. Its variable unit costs areRs. 7, and fixed costs amount to Rs. 1,70,000. It finances all its assets by equity

funds. It pays 50% tax on its income. ABC Ltd. is identical to XYZ Ltd, except in

respect of the pattern of financing. ABC Ltd. finance its assets 50% by equity and50% by debt, the interest on which amounts to Rs. 20,000. Determine the degree of

operating, financial and combined leverages at Rs. 7,00,000 sales for both the firms,

and interpret the results.

Q2. From the following selected operating data. Determine the degree of operating

leverage. Which company has the greater amount of business risk? Why?

Company A (Rs.) Company B (Rs.)

Sales 25,00,000 30,00,000

Fixed Cost 7,50,000 15,00,000

Variable expenses as a percentage of sales are 50% for firm A and 25% for firm B.

Q3. Royal Industries, a well established firm in plastics, is considering the purchase of

one of the two manufacturing companies. The financial manager of the company has

developed the following information about the two companies. Both companies havetotal assets of Rs. 15,00,000.

Operating Statement

Company X (Rs.) Company Y (Rs.)Sales Revenue 30,00,000 30,00,000

Less: Cost of Goods Sold 22,50,000 22,50,000Less: Selling Expenses 2,40,000 2,40,000Less: Administrative Expenses 90,000 1,50,000

Less: Depreciation 1,20,000 90,000

EBIT 3,00,000 2,70,000

Cost break-ups

Variable Cost

Cost of Goods Sold 9,00,000 18,00,000

Selling Expenses 1,50,000 1,50,000

Total variable costs 10,50,000 19,50,000

i) Prepare operating statements for both the companies, assuming that sales increase

by 20%. The Total fixed cost are likely to remain unchanged and the variablecosts are linear function of sales.

ii) Calculate the degree of operating leverage.

iii) If Royal Industries wishes to buy a company which has a lower degree of businessrisk, which company would be purchased by it?

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Q4. From The following financial data of companies X and Y, prepare their income

statements.

Company X Company Y

Variable cost as % of sales 50 60Interest Expense Rs. 20,000 6,000

Degree of Operating Leverage 3-1 5-1

Degree of Financial Leverage 2-1 3-1Income Tax rate 55% 55%

Q5. The selected financial data for A, B and C companies for the current year ended

December 31 are as follows:

Company X Company Y Company C

Variable cost as % of sales 66.67 75 50

Interest Expense Rs. 200 Rs. 300 Rs. 1,000Degree of Operating Leverage 5-1 6-1 2-1

Degree of Financial Leverage 3-1 4-1 2-1

Income Tax rate 50% 50% 50%

a) Prepare income statements for A, B and C Companies.

b) Comment on the financial position and structure of these companies.

Q6. (a) Retained Earning of a firm are Rs. 1,26,000. Its payout ratio is 30%. It pays 40%tax on income. Its financial leverage and operating leverage are 4.3 and 1.5

respectively. The variable cost to sales revenue is 40%. Determine its salesrevenue.

(b) If sales increase by 50% while variable cost element, fixed cost, interestamount, tax rate, and pay-out ratio remain unchanged, what will be the new

degrees of operating and financial leverage and retained earnings?

Q7. The operating and cost data of ABC Ltd. are:

Sales Rs. 20,00,000

Variable Costs 14,00,000Fixed Cost 4,00,000 (including 15% interest on Rs. 10,00,000)

i) Calculate its operating, financial and combined leverage.ii) Determine the additional sales to double its EBIT.

Q8. The operating income of Avish Engineering Ltd. is Rs. 1,86,000. It pays 50% tax on

its income its capital structure consist of the following:14% Debentures Rs. 5,00,000

15% Preference shares 1,00,000

Equity shares (Rs. 100 each) 4,00,000

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(i) Determine the firms EPS

(ii) Determine the % change in EPS, if EBIT increase by 30%.

(iii) Determine the degree of financial leverage at the current level of EBIT.(iv)What additional data do you need to compute operating as well as combine leverage?

Capital Budgeting

Non Discounting Techniques

1. Payback period Method

Initial Investment / Annual CFAT

2. Average rate of return (ARR)

(Annual avg. PAT / Avg. Investment) x 100

Avg. Investment = (Initial investment + NWC ) x Annual avg. PAT = Expected PAT / no. of years

Discounting Techniques

3. Discounted Payback = Initial Investment / Present value of CFAT

4. NPV = PV of cash inflow cash outlayPV of cash inflow = PVIF x CFAT

Or

CF0 + CF1 + -------------CFnNPV = ------------------------------------

(1+K)0 + (1+K)1 --------- (1+K)n

5.

DFrL Initial Investment

IRR = r + ----------------------------

DFrL DFrH

PB = Payback period

DFr = Discounted Factor for interest rate rDFrL = Discounted factor for lower interest rate

DFrH = Discounted factor for Higher interest rate

r = either of the two interest rate used in the question

Note: Discounting factor @10% = 1/1.10

6. Present value of cash inflowPI = --------------------------------

Present value of cash outflow

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Q1. A chemical company is considering investing in a project that cost Rs. 5,00,000. the

estimated salvage value is zero. Tax rate is 55%,. The company uses straight linedepreciation and the proposed project Has cash flow before tax (CFBT) as follows:

Year CFBT1 1,00,000

2 1,00,000

3 1,50,0004 1,50,000

5 2,50,000

Determine the following: 1. Payback period 2. Average rate of return.Ans. PB = 4.33 years, ARR= 20%, 9%, 49%

Q2. A company is considering a new project for which investment data are as follows:

Capital Outlay Rs. 2,00,000Depreciation 20% per annum

Forecasted annual income before charging depreciation, but after all other charges asfollows:

Year amount

1 1,00,000

2 1,00,0003 80,000

4 80,000

5 40,000

On the basis of available data, set out calculations, illustrate and comparing the

following methods of evaluating the return of capital employed;a. Payback period

b. Rate of return on original investments

c. Discounted Cash flow

Ans. PB = 2 years, ARR= 40%

Q3. A new machine requires an investment of Rs. 4,00,000 and has a useful economiclife of 5 years. The components manufactured on this machine can be sold to give

annual end period cash flow after all costs, taxes etc. have been met of Rs. 1,00,000

for each of the year. The one old machine has disposable value of Rs. 50,000 and isnot likely to generate any further cash flows. The New machine will require an

infusion of Rs. 10,000 in the form of stores and maintenance at the end of the second

year. The new machine can be sold at an expected price or solvage value of Rs.75,000 at the end of the 5th year. The cost of capital is estimated to be 16% for similar

investments. (Ans = NPV = 5670)

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Q4. A firm whose cost of capital is 10% is considering two mutually exclusive projects

X and Y, the details of which are:

Project X Project YInvestment Rs. 70,000 Rs. 70,000

Cash inflow: year 1. 10,000 50,0002. 20,000 40,000

3. 30,000 20,000

4. 45,000 10,0005. 60,000 10,000

---------------- ---------------

1,65,000 1,30,000

Compute the net present value at 10%, profitability index, and internal rate of return

for the two projects.

Ans : NPV 46,130 & 36,550, PI 1.659 & 1.522, IRR 27% & 37%

Q5. A co. wants to replace the manual operations by new machines. There are twoalternative model of x and y of the new machine. Using payback period, suggest the

most important profitable investment. Ignore taxation.

Machine X Machine Y

Original Investment 9,000 18,000

Estimated Life of Machine 4 5Estimated saving in scrap 500 800

Estimated saving in wages 6000 8000

Additional cost of Maintenance 800 1000Additional cost of Supervision 1200 1800

Ans: X=2 year payback, Y=3 year payback

Q6. Royal manufacturing corporation is considering the purchase of new asphalt laying

machine for Rs. 6,00,000. It has a life of four years and estimated salvage value is Rs.

1,00,000. The machine will generate an extra of Rs. 20,00,000 for year in revenuesand have variable costs of Rs. 16,00,000 per year. The cost of capital is 20% and tax

rate is 50%. Should the machine be acquired?

(PVF @ 20% for year 1-.833, 2-..694, 3-.579, 4-.482, 5-.402)Ans. NPV -34,200, machine should not be acquired

Q7 (a) Incremental investment in a project is Rs. 3,00,000 while the present value of allincremental cash advantages arising out of it is Rs. 3,30,000. Would you consider the

project financially acceptable under (i) Present value method (ii) Net present value

method and (iii) Profitability index method ? Give the decision criterion used in each

case. (Ans: PV= 3,30,000, NPV= 30,000, PI = 1.1)

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Q7 (b) Incremental investment in a project would be Rs. 1,00,000 and its useful life will

be 5 years. Incremental cash advantages out of it are estimated as follows.Year Advantages. (Rs.)

1 25,000

2 35,0003 40,000

4 40,000

5 40,000

The required rate of return is 10%. Using the discounted payback method, advice

whether the project is acceptable or not. (Ans: Discounted payback period is .367

years, project is acceptable)

Q8 A project requires Rs. 1,00,000 as incremental investment. Annual incremental cash

benefits are estimated at Rs. 20,000. The required rate of return of the firm is 10%.

What should be the minimum useful life of the project to make it acceptable onquantitative considerations and why? Show calculations in justification of your

answer.(Ans: DPB = 7.28 years (minimum useful life should be 8 years), NPV in 8th years = 6700)

Q9 Estimated cost of capital of a project is Rs. 11,50,000 and working capital requiredfor it is Rs. 20,000. salvage value is estimated at Rs. 20,000 life time of the assets is

5 years and required rate of return is 10%. Annual incremental cash benefit is Rs.

3,00,000. is the proposal acceptable using (i) PV method (ii) NPV method (iii) PI

method.Ans: NPV= 11,61,500 11,70,000 = -8500, PI = .99 (Project should not be accepted)

Q10. Estimated incremental investment of a firm in a new project is Rs. 15 lakhs.Estimated incremental cash advantages on it is Rs. 3 lakhs, Rs. 3.5 lakhs and Rs. 4

lakhs for first, second and third year respectively and Rs. 4.5 lakhs there after.

If the required rate of return is 10% after tax what should be the minimum life ofthe project in completed years to qualify for acceptance.?

Ans: DPB= 5.20 years, NPV in 6 year = 17.01 15 = 2.01, PI in 6th year = 1.13

(Project minimum life should be 6 years.)

Q11. ABC Corporation is considering the purchase of new machine for Rs. 6,50,000. It

has a life of five years and an estimated salvage value of Rs. 75,000. The machine

will generate an extra of Rs. 20,00,000 for year in revenues and have variable costof Rs. 16,00,000 per year. The cost of capital is 20% and tax rate is 50%. Should

the machine be acquired (PV factor @ 20% FOR 1-0.833, 2-0.694, 3-0.579, 4-

0.482, 5-.402)

Q12. A company is planning to purchase a machine to meet increased demand for itsproduct in the market. The machine costs Rs. 50,000 and has no salvage value.

The expected life of the machine is 5 years, and the co. employs the straight line

method of the depreciation. The estimated earning after taxes Are Rs. 5000 each

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year for 5 years. The after tax required rate of return of the company is 12%.

Determine the IRR, Also find the payback period.

Q13. A Project costs Rs. 36000 and is expected to generate cash flows of Rs. 11,200

annually for 5 years. Calculate the IRR of the project. (Ex 5.5/205 of K&J mainbook)

Ans : IRR = 16.8%

Shares and Debentures

Q1. if co. X issue one share for every 5 shares at a price od Rs. 50 per share and existingprice of the stock is Rs. 70 per share. What should be the ex-rights price of the stock.

5 x 70 = 350 + 50 = 600/6 = Rs. 66.67

Q2. The co. issue one right share for every 4 shares held at a subscription price of Rs. 60

per share. The current market price of the share is Rs. 80. what will be the value ofthe right?

ex-rights price = 80 x 4 = 320 + 60 = 380/5 = Rs. 76

Q3. A co. offers to its shareholders the right to buy 2 shares at Rs. 130 each for every 5

shares of Rs. 100 each held in the company. The market value of the shares is Rs. 200

each. What will be the value of right?

Statement of change in Financial Position (Fund Flow Statement and

Cash Flow Statement)

Q. 1 The Profit and Loss Account balance in the Balance Sheet of 1997 is Rs. 16000. Ithas been Rs. 13000 in the Balance Sheet of 1996. During the year 1997 Rs. 2000

was transferred to General Reserve and Rs. 3,000 paid as Interim Dividend. Profit

and Loss A/c for the year 1997 was debited with inter alia the following items:

Depreciation Rs. 4000

Loss on Sale of Machine Rs. 2000

Goodwill written off Rs. 1000Find out profit from operations.

Q. 2 From the following Balance Sheets of Texal Ltd., you are required to prepare aSchedule of change in working capital and a statement of flow of fund:

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31st Dec., 1996 31st Dec., 1997

Rs. Rs.

Loan and Buildings 50,000 50,000

Plant and Machinery 24,000 34,000

Stock 9,000 7,000Debtors 16,500 19,500

Cash at Bank 4,000 9,000

1,03,500 1,19,500

Capital 80,000 85,000

Profit and Loss A/c 14,500 24,500Creditors 9,000 5,000

Mortgage ------ 5,000

1,03,500 1,19,500

Q. 3 From the following Balance Sheets as on 31st December, 1996 and 1997, you are

required to prepare a statement showing flow of funds:

1996 1997

Rs. Rs.

Assets:

Cash 35,000 50,000

Debtors 1, 25,000 1,20,000

Stock 70,000 80,000Land 40,000 60,000

2,70,000 3,10,000

Liabilities

Share Capital 2,00,000 2,50,000

Creditors 60,000 35,000Retained earnings 10,000 25,000

2,70,000 3,10,000

Q. 4 The Balance Sheets of I.T.R. Co., as at December 31, 1996 and 1997 are as under:31st December

Assets: 1996 1997

Buildings 40,000 60,000Plant and Machinery 2,50,000 4,00,000

Stocks 50,000 37,500

Debtors 75,000 80,000Cash 10,000 10,000

4,25,000 5,87,500

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Liabilities & Capital :

Share Capital 2,50,000 3,50,000

Profit & Loss A/c 50,000 80,000General Reserve 25,000 35,000

Sundry Creditors 76,500 95,000

Bills Payable 20,000 25,000Outstanding Expenses 3,500 2,500

4,25,000 5,87,500

Additional informations :i) Rs. 25,000 depreciation has been charged on plant & Machinery during

the year 1997.

ii) A machinery was sold for Rs. 4,000 during the year 1997. It had cost

Rs.6,000 and depreciation Rs. 3,500 had been provided on it. Preparefund statement.

Q. 5 The following are the summarized Balance Sheets of V Ltd., as on 31st December

for year 1 and 2:Liabilities Year 1

(Rs.)Year 2(Rs.)

Assets Year 1(Rs.)

Year 2(Rs.)

Share

Capital

2,00,000 2,60,000 Goodwill ---------- 20,000

P & L A/c 39,690 41,220 Machinery 1,12,950 1,16,200

Reserve 50,000 50,000 Buildings 1,48,500 1,44,250

TaxProvision

40,000 50,000 Stock 1,11,040 97,370

BankOverdraft

59,510 ---- Sundrydebtors

87,490 73,360

Bills

Payable

33,780 11,525 Cash 2,500 2,700

Sundry

Creditors

39,500 41,135 ---------

4,62,480 4,58,880 4,62,480 4,53,880

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Additional information

The following additional information is obtained form the general ledger

a) During year 2, an interim dividend of Rs 26,000 was paid.

b) The assets of another company were purchased for Rs.60,000 payable in fullypaid shares of V. Ltd. These assets included stock, Rs.22,000 and machinery,

Rs. 18,000. In addition, sundry purchases of machinery amounted to Rs.

5,600.

c) Income tax paid during the year amounted to Rs.25,000.d) The net profit for the year before tax was Rs.62,500.

Prepare a fund flow statement.

Q. 6 Prepare a funds flow statement (all resources basis) of Atlantic Business

Corporation from the following information:

Balance sheet as on 1st January and 31st December

January 1 December 31Rs. Rs.

Cash and Bank 40,000 44,400Account receivable 10,000 20,700

Inventories 15,000 15,000

Land 15,000 15,000Business premises 4,000 4,000

Plant and equipment 20,000 16,000

Accumulated depreciation 15,000 17,000Patents and trade marks (5,000) (2,800)

Total assets 1,000 900

1,00,000 1,15,200

Current Liabilities 30,000 32,000Bonds payable 22,000 22,000

Bonds payable discount (2,000) (1,800)

Capital stock 35,000 43,500Retained earnings 15,000 19,500

Total liabilities 1,00,000 1,15,200Additional information

(a) Income for the period, Rs. 10,000.

(b) A building that costed Rs.4,000, and had a book value of Rs 1,000, was sold for

Rs 1,400

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(c) The depreciation charge for the period, Rs 800.

(d) There was a Rs 5,000 issue of capital stock.

(e) Cash dividends of Rs 2,000 and a stock dividend for Rs.3,500 were declared.

Q7. Presented below are data taken from the record of XYZ co. Ltd_________________________________________________________________

Jan 01 Dec31

________________________________________________________________

Current Assets 1,60,000 3,20,000

Long Term Investment 2,40,000 40,000

Plant Assets 9,60,000 15,40,000----------- ------------

13,60,000 19,00,000

------------ ------------

Accumulated depreciation 1,60,000 1,20,000

Current Liabilities 1,20,000 1,40,000

14% Debentures - 4,00,000

Equity Capital 10,00,000 10,00,000

Donation - 1,00,000

Retained earnings 80,000 1,40,000

------------ ------------

13,60,000

19,00,000-------------------------------------------------------------------------------------------------

Additional Information

1. Securities carried at a cost of Rs. 2,00,000 on Jan 01, were sold during the

current year for Rs. 1,60,000. The loss was incorrectly charged directly to

retained earning.2. Plant assets which cast Rs. 2,00,000 and were 60% depreciation were sold

during the year for Rs. 40,000, The Loss was incorrectly charged directly to

retained earning.3. Net income for the current year as reported by the income statement was Rs.

2,00,0004. Dividend paid amounted to Rs. 60,0005. Depreciation charged for the year was Rs. 80,000

You are required to prepare a statement of changes in financial position.

COST OF CAPITAL

Base Formula :

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K = P X 100

C

K = Cost of CapitalP = Interest or Dividend

C = Capital Received

Major Source of Capital are following

(1) Debentures or Borrowed Capital (Debt. Capital)(2) Preference Share Capital

(3) Equity Share Capital

(4) Retained Earning

Cost of perpetual Debt. (Non Redeemable Debentures) (Kd)

Kd = P X 100 [ P = Interest Payable ]

C [ C = Capital Received ]

Debenture can be issued at par value or on Discount or on premium.

C = Par value Discount Floating charges + Premium

Floating charges = Commission, Brokerage. etc.

Q. 1 A company is willing to issue 1,000, 7% debentures (irredeemable) of Rs.100 each

and for which the company will have to incur the following expenses:Underwriting Commission 1.5 %; Brokerage 0.5%, Printing and other expenses

Rs.500. Find out the cost of capital.

Ans. 7.19%

Q. 2 X Ltd. Has 10% irredeemable debentures of Rs. 1,00,000. Par value of debentures isRs. 100. Find out the cost of capital, if debentures have been issued (i) at par, (ii) at

discount of 10%, and (iii) at premium of 10 %. (Ans. i. 10%, ii. 11.1%, iii. 9.09%)

Cost of Redeemable Debt.( Kd)

Kd = P X 100C

(i) If Redeemption at par = P = Contractual Rate+ Floatation Charges

Period of IssueC = Par Value Floatation Charges

2

(ii) P = Contractual Rate + Floating Charges + DiscountPeriod of Issue

C = Par value Floating Charges + Discount

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2

(iii) P = Contractual Rate + Floating Charges PremiumPeriod of Issue Period of Issue

C = Par value Floating Charges + Premium

2 2

Q.3 A company has issued 7% debenture of Rs.100 each at a discount of 6% repayable

after 12 years. Find out the Cost of Capital. Ans. 7.7%.

Q.4 A company has issued 7% debentures of Rs.100 each at a premium of 6% for a

period of 12 years. Find out the Cost of Capital. Ans. 6.31%.

Cost of Debt after Tax (Kdt)

Kdt = Kd (1-t)

t = Tax rateKd = Cost of Debt before tax

Q.5 A company is willing to issue 1,000, 7% irredeemable debentures of Rs.100 eachand for which the company will have to incur the following expenses: Underwriting

commission 1.5%, Brokerage 0.5%, Printingand other expenses Rs.500.Assuming

that companys tax rate is 50%, find out the Cost of Capital. Ans. 3.59%

Q.6 X Ltd. Is willing to issue 5,000, 6% debentures of 100 each at a discount of 10%, the

debentures are repayable after 10 year. The expenses on issue are expected to be

Rs.3 per debenture. Assuming the tax rate to be 50%, find out the Cost of Capital.

Ans. 3.9%

Cost of Preference Share Capital (Kpt) (After Tax)

Kpt = P X 100

CC = Redemption of preference Shares

C = Per Value + Premium - Discount Expenses of Issue

P = Dividend. AmountKpt = Cost of Premium Share Capital After Tax

Cost of Preference Share Capital (Before Tax) (Kp)

Kp = kpt

(1-t)

Kpt = Cost of Capital (After Tax)

Kp = Cost of Capital (Before Tax)

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Q.7 Z Ltd. Has issued, 10,000, 9% Preference Shares of Rs. 100 each and has incurred

the following expenses:Underwriting Commission 2%, Brokerage 1%, other expenses Rs.10,000.

Find out the cost of capital. If the present companys tax rate is 50%, what will be

the cost of capital before tax? Ans. 18.75%

Q.8 Y Ltd. Issued 10% irredeemable preference shares. The nominal value of each share

is Rs.100. You are required to calculate the cost of preference share capital in each

of the following cases.A) When issued at 5% discount?

B) When issued at 5% premium? Ans. A) 10.53% b) 9.52%

Cost of Equity Capital

It has three Method

1) Dividend per share method.2) Earning per share method or Earning yield method

3) Dividend yield plus growing dividend method.

1) Dividend per Share mehthod :-

Ke = D X 100P

D = Dividend per share.

P = Market price per share

Ke = Cost of Equity capital

Q.9 X Ltd. A dynamic growth Company, which pays no dividend, anticipates a long-run

level of future earnings of Rs.7 per share. The current price of shares is Rs.55.45per share, floatation costs for the sale of equity shares would average about 10% of

the price of shares. What is the cost of new efquity share capital?

Earning per share method/ Earning yield method

Ke = E X 100

P

Ke = Cost of Equity Capital

E = Earnings per share (EPS)P = Market Price per Share

Q.10 Bright Ltd. A, dynamic growth Company, which pays no dividend, anticipates a

long run level of future earnings of Rs.7 per share. The current price of shares isRs.55.45 per share, floatation costs for the sale of equity shares would average

about 10% of the price of shares. What is the cost of new equity share capital? Ans.14.03%

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Dividend Yield Plus Growing Dividend Method

Ke =D X 100 + G (Growth rate in dividend)

P

Q.11 The average rate of dividend paid by Y Ltd. For the last five years is 25%. The

earnings of the company have recorded a growth rate of 4% per annum every year.

The market value of the equity share is estimated to be Rs.110. Find out the Cost ofEquity Share Capital. Ans. 26.73%

Cost of Retained Earning:

Kr = KeKr = Cost of R.E.

Ke = Cost of Equity Capital

OrKr = AD X 100

PEAD = No. of Shares X EPS

RE = No. of Shares X (EPS DPS)

Cost of R.E. (After Tax)

Kr = Ke (1-t) (1-b)

t = Tax Rate, b = Brokerage Cost

Q.12 X holds 110 Shares of Rs.100 each in Y Ltd. Y Ltd. Has earned Rs.10 per share

and distributed Rs.6 per share as dividend among shareholders and the balance isretained. The market price of the shares in Y Ltd. Is Rs.110. If personal income

tax applicable to Mr. X is 40%, find out the Cost of retained Earnings.

Ans.5.45%

Q.13 A Company is earning a net profit of Rs.50,000 per annum. The shareholders

required rate of return is 10%. It is expected that retained earnings, if distributed

among the shareholders, can be invested by them in securities of similar typecarrying return of 10% per annum. It is further expected that the shareholders will

have to incur 2% of the net dividends received by them as brokerage cost for

making new investments. The shareholders of the company are in 30% tax bracket.You are required to calculate the cost of retained earnings. Ans. 6.76%

Weighted Average cost of capital

Ko = Kdwd + KpWp + KeWe + KrWr

Ko = Overall Cost of Capital

K = Cost of Debt / Pre. Share / Equity Capital / R.E.

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W = Contribution in total Capital

Q.14 X Ltd. has the following Capital structure:

Equity Capital (expected dividend 12%) 10,00,000

10% Preference Share 5,00,0008% Loan 15,00,000

You are required to calculate the weighted average cost of capital before tax and

after tax assuming tax rate of 50%. Ans. 7.66%

Ratio Analysis

Q1. You have been furnished with the financial information of Aditya Mills Limited as

under

Balance sheet as on 31st December

Liabilities Amount Assets Amount

Equity Share Capital of Rs. 100 Each 10,00,00

0

Plant and equipments 6,40,000

Retained earning 3,68,000 Land and Building 80,000

Sundry Creditors 1,04,000 Cash 1,60,000Bills Payable 2,00,000 Sundry Debtors 3,60,000

Less: allowances 40,000

3,20,000

Other current liabilities 20,000 Stock 4,80,000

Prepaid Insurance 12,000

16,92,00

0

16,92,000

Statement of profit for the year ended December 31

(Rs.)

Sales 40,00,000

Less: Cost of goods sales 30,80,000Gross profit on sales 9,20,000

Less: Operating Expenses 6,80,000

Net Profit 2,40,000

Less: taxes @ 50% 1,20,000

Net Profit after taxes 1,20,000

Sundry debtors and stock at the beginning of the year were Rs. 3,00,000 and

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4,00,000 respectively. (i) Determine the following ratios of Aditya Mills Ltd:

(a) Current ratio (b) Acid test ratio

(c) Stock turnover (d) Debtors turnover (e) Gross profit ratio (f) Net profit ratio

(g) Operating ratio (h) Earning per share (EPS)

(i) Rate of return on equity capital(j) Market value of the share, if price earning (P/E) ratio is 10 times.

(ii) Indicate for each of the following transactions whether the transaction wouldimprove weaken or have no effect on the current ratio of the

Aditya Mills Limited(Assume current ratio 2):

(a) Sell additional equity shares (b) Sell 15% debentures

(c) Pay bill payables (d) Collect 40% sundry debtors(e) Purchase additional plant (f) Issue bills payable to creditors

(g) Collect bills receivables from debtors (h) Purchase treasury bills

(i) Write off bad debts

Q2 From the following information, prepare a summarized balance sheet as on 31st march

1) Working Capital Rs. 1,20,000

2) Reserve and Surplus 80,000

3) Bank Overdraft 20,000

4) Asset (fixed) to proprietory ratio .755) Current ratio 2.5

6) Liquid ratio 1.5

Q3 Using the following data, complete the balance sheet given below.

Gross profit (20% of sales) Rs. 60,000

Shareholders equity 50,000Credit sales to total sales 80%

Total assets turnover 3 times

Inventory turnover (to cost of sales) 8 timesAverage collection period (a 360 day year) 18 days

Current ratio 1.6

Long term debt to equity 40%

Balance sheet as on ------

Q4 With the help of the following information complete the balance sheet of XYZ Ltd.

i) Owners equity Rs. 1,00,000

Liabilities Amount Assets Amount

Creditors CashLong Term Debt Debtors

Shareholders equity Inventory

Fixed Assets

Total Total

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ii) Current Debt to total debt .40

iii) Total Debt to owners equity .60

iv) Fixed cost to owners equity .60v) Total asset turnover 2 times

vi) Inventory turnover 8 times

If you need any other figure, assume with giving reasons.

Q5. From the following details regarding Indu Films, draw the balance sheet of company,

for the current year ended 31st March.

Current ratio 2.5

Liquid ratio 1.5

Net working capital Rs. 3,00,000Stock turnover ratio (cost of sales/cl. stock) 6 times

GP ratio 20%

Fixed assets turnover ratio (on cost of sales) 2 times

Debtors collection period 2 monthsFixed assets to share holders net worth .80

Reserve and Surplus to capital .50

Documents

Study Material of FM