ADL 13 Financial Management V2

Financial Management
Assignment - A
Question 1a: Should the titles of controller and treasurer be adopted under
Indian context? Would you like to modify their functions in view of the
company practice in India? Justify your opinion?
Answer to 1a:
Controller & Treasurer are independent & they have their own Perspectives & Drivers as detailed below:
Controller
Responsibilities
include,
Double
entry
accounting, financial reporting, Fraud measure,
detective controls, Financial restatement,
Compliance with statutory requirements like
Rules, Accounting standards, GAAP, IFRS etc.,
Controller works & forecasts the events for a
long term. Main focus income statement
Treasurer
Responsible for Liquidity management ( very
important function), Risk Management, More
focus on financial statements, follows leading
practices & responsible for the future
performance of company (projects cash flows)
Treasurer works/ forecasts the events regularly (
daily / weekly) focus Balance sheet & future
capital structure, capital expenditure etc.,
Treasurer concentrates more on cash availability
focus i.e. how to bring in the required cash etc,
Ex: Cash involved event

Controller looks from compliance angle (how to
record, what GAAP provides etc.,)
Therefore, from the above it is clear that, controller & treasurer have different roles to play. However,
majority of the Indian companies works with Financial Controller who himself takes care of the treasury
department / Portfolio.
Therefore, as far as from Indian context, it can be concluded that, controller is also responsible for treasury
jobs & there is no separate treasurer / treasury department exists
Question 1b: firm purchases a machinery for Rs. 8, 00,000 by making a down payment of Rs.1,50,000 and
remainder in equal installments of Rs. 1,50,000 for six years. What is the rate of interest to the firm?
Answer to Q1b:
Particulars
Ref
Cost of Machinery
(a)
Down Payment
made by firm
(b)
Financed through
c = (aborrowings
b)
Repayment in equal
instalments every
year
( maximum of six
years)
Total interest paid
over 6 year period
Year 0
Year 2
Year 3
Rs.
Year 4
Year 5
Year 6
150,000
150,000
150,000
150,000
150,000
150,000
800,000
150,000
650,000
d=6*15
0,000
900,000
e=dc
250,000
Rate of Interest
= total interest
/ total
f=e/c
borrowings
Year 1
38.46 %
Rate of interet g = f / 6
yrs
per annum
6.41 %
Break of interest
cost / principal
repayment:
1) interest cost (can
be apportioned in
6:5:4:3:
the ratio of no
2:1
of
years
repayment
i.e.
earlier the years
more
(ratio)
the interest cost &
vice versa)
h
2) Principal
Outstanding
adjustment
Yearwise
Interest rates: Principal
Outstanding at year
end
(prinicpal o/s at
year beginning Principal
repayment)
RATE OF
INTEREST
EVERY YEAR
21
(6+5+4+3+2
+1)
250000
71429
(250,000
*6/21)
59524
(250,000
*5/21)
47619
(250,00
0*4/21)
35714
(250,00
0*3/21)
23810
(250,000*
2/21)
11905
(250,00
0*1/21)
i=d-h
650000
78571
90476
102381
114286
126190
138095
650000
571429
480952
378571
264286
138095
(480952
- i)
(378571
- i)
(650000i)
h/
princip
al o/s
at year
beginni
ng)
11.0%
(h /
650000)
(571429i)
10.4%
(h /
571429)
9.9%
9.4%
(h /
480952)
(h /
378571)
(264286i)
9.0%
(h /
264286)
(138095
- i)
8.6
%
(h/
138095)
Question 2a: Explain the mechanism of calculating the present value of

cash flows. What is annuity due? How can you calculate the present and
future values of an annuity due? Illustrate
Answer 2a:
Calculating Present Value of Cash flows:
Money has time value. For ex: Rs.1000 received today is not the same worth after a year (actually it is
less)
Present value of cash flows: It indicates the value of expected worth at current value. (Discounts the expected
cash flows at appropriate discount rate (may be 10%, 20% etc.,)
Discount rate will generally be equal to = Inflation rate + Reqd. rate of return + risk free premium rate
Details required for calculating Present Value of cash flows: Cash flows year wise, discount rate. This
technique is very useful for decision-making.
Annuity due: Uniform/ Constant/ Equal cash flows every year
Present value of annuity
Worth of Lump sum consideration today which
is going to be received tomorrow
Computation:
Annuity * Present value annuity factor (PVAF)
Future value of annuity

Value of fixed investment every year worth
tomorrow. (i.e. corpus it grows)
PVAF is calculated as = 1-[1/(1+r) to the power

n].
Illustration:
FVAF is calculated as = [(1+r) to the power n] - 1
Mr. A would like to receive Rs.1000/- every

year for 10 years from now.
Mr.X would like to grow a corpus by investment

of Rs.10, 000 10 years from now.
It is assumed discount rate 10%, the present

value annuity factor for 10 years 10% is 6.144.
Rate of interest @10%, the future value annuity

factor for 10 years 10% is 1.594
Present value of annuity = 1000 * 6.144 =

Rs.6145/-
Future value of annuity = 10000 * 1.594=

Rs.15937/-
Annuity * Future value annuity factor (FVAF)
Question 2b: "The increase in the risk-premium of all stocks, irrespective of

their beta is the same when risk aversion increases" Comment with
practical examples
Answer 2b:
The security's beta is a function of the correlation of the security's returns with the market index returns and the
variability of the security's returns relative to the variability of the index returns.
In simple, beta measures the sensitivity of the stock with reference to broad based market index.
For instance: a beta of 1.2 for a stock would indicate that this stock is 20% riskier than the index &
similarly beta of 0.9 for a stock indicates 10% less riskier than the index. Finally, a beta of 1.0 means, stock
is as risky as the stock market index.
Therefore, the given statement is false. Expected risk-premium for stock is beta times the market risk
premium. For ex: let us assume beta = 1.2 times, market risk premium = 10%, then expected risk premium
= 10% * 1.2 times = 12%.
Question 3a: How leverage is linked with capital structure? Take example of
a MNC and analyze.
Answer to 3a:
Leverage: It is an advantage gained (it may be anything)
Leverage is linked with Capital Structure, since an organization having a optimum capital structure (where
WACC (weighted average cost of capital) is minimum) is a great leverage/ advantage both to the company
as well for the investors.
Organizations, generally have two types of risks; operating risks impact of fixed costs & variability of EBIT &
Financial risks impact of interest cost/financial charges & variability of EBT.
Example:
XYZ ltd has the following nos:
Contribution Rs.100 lacs, fixed cost Rs.25 lacs, Financial Charges/debt cost Rs.40 lacs.
Particulars
Value (Rs. In lacs)
Contribution
100
Fixed cost
25
EBIT
75
Interest cost
35
EBT
40
XYZ Ltd. has following:
Operating leverage
Financial leverage
Contribution / EBIT = 100 / 75 = 1.33

EBIT / EBT = 75 / 40 = 1.87
It is always preferable to have low operating risk & high financial risk (subject to Return on capital employed
(ROCE) > Interest cost on debt funds)
We can conclude that, XYZ ltd (MNC) is having a optimum capital structure & manageable risk.
Question 3b: The following figures relate to two companies (10)

P LTD. Q LTD.
( In Rs. Lakhs )
500
1,000
200
300
-----------300
700
150
400
-----------150
400
50
100
-----------100
200
Sales
Variable costs
Contribution Fixed costs
Fixed Cost
Interest
Profit before tax

You are required to:
(i)
Calculate the operating, financial and combined leverages for the two companies; and
Comment on the relative risk position of them
Answer 3b:
P ltd
Particulars
Q ltd
( in R s. Lacs )
Sales
Variable costs
Contibution
Fixed cost
PBIT / EBIT
Interest
Profit before Tax / EBT
500
200
300
150
150
50
100
1000
300
700
400
300
100
200
a) Opearting leverage:
= Contribution / EBIT
2.0
2.3
b) Financial leverage:
= EBIT / EBT
1.5
1.5
c) Combined leverage:
= Contirbution / EBT
3.0
3.5
Computation:
Comments:
Operating risk is higher

(i.e. fixed costs are high)
Operating risk is higher than 'P' ltd

( i.e. fixed costs are high )
Financial risk looks low
Financial risk looks low
Overall risk is low as compared

to 'Q' ltd.
Overall risk is high as compared

to 'P' ltd.
It is always preferable to have low Operating leverage & high Financial

leverage (provided, Return on capital employed > Interest on debt funds)
Question 4a: Define various concepts of cost of capital. Explain the procedure of
calculating weighted average cost of capital.
Answer 4a:
Concepts of Cost of Capital:
a) All source of finance have its own cost. Out of long source finance, equity mode of sourcing is costlier
than debt financing because of expectation of shareholders.
b) RISK VS. COST: Equity mode of finance will have low risk but costlier as against debt funds which will
have high risk but relatively cheaper & have tax advantage thus reducing the net cost of debt.
Organizations have to effectively trade off between risk, cost & control.
c) Optimum Capital Structure: When the firm / organization has a combination of debt and equity, such
that the wealth of the firm is maximum. At this point, cost of capital is minimum & market price of a
share is maximum.
Procedure of calculating Weighted Average Cost of Capital (WACC):
It is computed by reference to proportion of each component of capital (book value or market value as
specified) as weights.
WACC = Sum [proportion of each component of capital (weights) * individual cost of capital] Note:
Tax rates needs to be adjusted in respect of debt funds.
Question 4b: The following items have been extracted from the liabilities side of
the balance sheet of XYZ Company as on 31st December 2005.
Paid up capital:
4 , 00,000 equity shares of Rs each
40, 00,000
Loans:
16 % non-convertible debentures
% institutional loans
20, 00,000 12
60, 00,000
Other information about the company as relevant is given below:

st
31 dec
Per share
Dividend
per share
per share
Earning
average market price 2005
7.2
10.50
65
You are required to calculate the weighted average cost of capital, using book values as weights and
earnings/price ratio as the basis of cost of equity. Assume 9.2% tax rate
Answer 4b:
Computation of Weighted Average Cost of Capital (WACC):
Nature of Capital
Value
Cost of capital
Weights
( basis of
bookvalues
O/S.)
a) Equity Capital
b)
16%
debentures
non-convertible
c) 12% institutional loans
4,000,000
2,000,000
6,000,000
16.15 ( refer W.No.

33%
1)
14.53
17%
Interest (1-taxrate) =
16 % (100%-9.2% )
50%
Weights * Cost of
Capital
5.38
2.42
5.45
10.90
Interest (1-taxrate) =
12 % (100%-9.2% )
Total
Working Note: 1
12,000,000
Cost of equity:
Price earnings approach =
Earnings
per
share /
Market price
per share
10.50 / 65 =
16.15 %
100%
13.25
Question 5a: A company has issued debentures of Rs. 50 Lakhs to be repaid

after 7 years. How much should the company invest in a sinking fund
earning 12% in order to be able to repay debentures? Show the procedure of
loan amortization and capital recovery through an example.
Answer 5a:
Debentures to be redeemed after 7 years
5,000,000
Expected rate of return - on sinking fund investment to be created
12 %
Discount rate@12%, 7 yrs
0.452
Present value of expected repayment of debentures @12% 7 yrs
2,261,746
therefore, company has to invest Rs.22,61,746 @ 12% earning in Sinking fund to cover
the repayment expected 7 years from now.
Loan Amortization Capital Recovery
A loan amortization schedule is a repayment plan that The reciprocal of Present value annuity factor is
calculated before repayment of a loan begins. ( PVAF) is the capital recovery.
Amortization schedules are used for fixed interest long Below example will clarify better the meaning:
term loans such as mortgages, expenses like R& D
expenses,
Purchase
of
Goodwill,
Voluntary
Retirement
payment
expenses,
Amalgamation
expenses etc.
Procedure with Ex:
Procedure with Ex: Mr.X plan to lend Rs.1 lac today for a period of 5 years @ int.rate
of 12%, M/s.XYZ ltd has incurred a Rs.50, 00,000 as lump sum how much income Mr.X should receive each
year payment towards voluntary retirement separation to recover investment & principal back.
charges during the accounting year 2009-2010.
The result is known as capital recovery & which XYZ
ltd have planned to amortize the above expenses can be arrived by capital recovery factor.
for a period of 10 years commencing from FY.09-10
Calculation:
Therefore, the schedule of amortization for 10 year
period as follows:
Present value = Annuity * PVAF @12%,5years
Rs. 500,000/- per years for 10 years
/
Capital
Recovery
Annuity
PVAF@12%,5years
Therefore, capital recovery = 100,000 * 0.27739 =
Rs.27,740 each year for 5 years.
Question 5b: A bank has offered to you an annuity of Rs. 1,800 for 10 years
if you invest Rs. 12,000 today. What is the rate of return you would earn? .
Answer 5b:
Particulars
Rs.
Return expected per annum

Fixed return/annuity for no of years
Total return expected
1800
10
18000
Investment required today
12000
Nett return expected from investment
6000
Percentage of return for 10 years
50 %
Percentage of return per annum
5%
Assignment - C
Question 1: The proforma of cost-sheet of HLL provides the following data:

Cost (perunit):
Rs.
Raw materials
52.0
Direct labour
19.5
Overheads
39.0
Total cost (per unit):
110.5
Profit
19.5
Selling price
130.0
The following is the additional information available:

Average raw material in stock: one month; Average materials in process: half month; Credit allowed by
suppliers: one month; Credit allowed to debtors: two months; Time lag in payment of wages: one and half
weeks; Overheads: one month. One-fourth of sales are on cash basis. Cash balance expected to be Rs.
12,000.
You are required to prepare a statement showing the working capital needed o finance a level of activity of
70,000 units of output. You may assume that production is carried on evenly throughout the year and
wages and overheads accrue similarly.
Answer 1:
Particulars
Cost/unit
Production = 70,000 units

cost (Rs.) for 70000 units
Raw Material
52
3640000
Direct Labour
19.5
1365000
Prime cost
5005000
Overheads
39
2730000
Total cost
110.5
7735000
Profit
19.5
1365000
Sales
130
9100000
Statement of Working Capital for HLL - 70,000 units production per
year:
Particulars
No of
months
Computation
Rs.
Current Assets: (A)

Raw material stock
Process stock - Work in progress
(WIP)
Debtors - customers
Cash balance expected to
maintain
1
0.5
2
36,40,000/12*1month
50,05,000/12*0.5 months
91,00,000*3/4 (credit
sales)/12*2
303333
208542
1137500
12000
Total of CURRENT ASSETS (A)
1661375
Current Liabilities: (B)

Creditors - suppliers
Wages Outstanding
Overheads outstanding
1
1.5
36,40,000/12*1month
13,65,000/12*0.34
week
s or
0.34
month
1
27,30,000/12*1
Total of CURRENT LIABILITIES

- (B)
NETT WORKING CAPITAL
REQUIRED
303333
38675
227500
569508
1091867
Question 2a: Through quantitative analysis prove that PI is a better technique

than NPV in Capital Budgeting.
Answer 2a:
PI Profitability Index & NPV Net Present Value both are capital budgeting techniques.
Profitability Index (PI)
PI = Present value of inflows / Present value of
outflows
Ideal = should be > 1
Net Present Value (NPV)

NPV = Present value of inflows Present
value of outflows
Ideal = NPV should be positive, it shows
absolute present value of tomorrows wealth
Quantitative analysis:
Present value of inflows = Rs. 200,000
Present value of outflows = Rs. 100,000
Present value of inflows = Rs. 200,000

Present value of outflows = Rs. 100,000
PI = 2
NPV = Rs.100,000
NPV technique is better than PI technique for capital budgeting decisions. NPV shows wealth at the end in
absolute amount, which will be helpful to make decisions clearly, whereas the same advantage is not
available with PI technique.
However, PI shows return over investment in times, which will be very useful for immediate decision making.
Generally, over the years, organizations prefer NPV technique for capital budgeting decisions than PI technique.
Question 2b: A company is considering the following investment projects:
II.
Assuming the project is independent, which one should be accepted? If the projects are mutually
exclusive, which project is the best?
Answer 2b:
I)
Project A
Project B
Project C
Methods
(1) Payback
@10% discount
1 + years
1.13 years
2.14 years 3
rate
1 + years
1.25 years
+ years
@30% discount
rate
(2) Accounting rate of
100%
150%
180%
return (ARR)
(3) NPV
@10% discount
(909)
4140
3017
rate
(2308)
207
(633)
@30% discount
rate
(4) IRR
0%
32%
26%
Independent project: Project with higher NPV needs to be selected, which shows
the end of the project
Project D
1.7 years
2.8 years
160 %
3824
833
38 %
wealth in absolute value at
Therefore, Project C needs to be accepted.

II) In case projects are mutually exclusive:
First disparity between projects needs to be resolved. NPV selects Project C whereas IRR selects Project
D, therefore, disparity exists. Since cash outflows (Rs.10, 000/-) are same for both the projects, the
disparity arisen is called as Cash flow disparity.
It can be resolved by using Incremental cash flow technique. After resolving, the right project can be accepted.
Workings are as follows:
PROJECT A:
The following has been calculated assuming discount rates of 10%
& 30% separately:
1) Payback period: time period to recover initial investment
a) Disco unted @10 %
Years
Cash
flows
b) Disc ounted @ 30 %
Discount
rate *
Discounted
cash flows
Unrecover
ed
discounte
d cash
flows
Years
Cash
flows
Discou
nt rate
*
@
30 %
@ 10%
(4) =
(2) * (3)
(1)
(2)
Discounted
cashflows
Unrecove
red
discounte
d cash
flows
(3)
(5)
(1)
(2)
(3)
(4) =
(2) *
(3)
(5)
(10,000)
1.000
(10,000)
(10,000)
(10,000)
1.00 0
(10,000)
(10,000)
10,000
0.909
9,091
(909)
10,000
0.76 9
7,692
(2,308)
* disocunt rate computed using formule = 1 / (1+r) to the power

n; where r = disocunt rate & n = year
Payback period = Base year + [(unrecovered disocunted cash flow of base year /
disocunted cash flows of next year) *12]
Payback period exceed 1 year, since unrecovered cash flows turns

positive only from IInd yr onwards
where base year =
flows turns 0 or +ve
year in which unrecovered cash
Payback period @ 10% & 30%

discount rate = 1 + years =1+ years
where r = disocunt rate
& n = year
3) IRR (Internal rate of return): which is the rate of

return at which NPV = 0
In project A , IRR is '0'% at which NPV =0
( i.e. there is no return from
the project)
PROJECT B:
The following has been calculated assuming discount rates of 10% & 30
% separately :
*
disocunt rate computed using formule = 1 / (1+r) to the
power n; where r = disocunt rate & n = year
where base year =
Payback period @ 10% discount rate= 1 + Payback period @ 30% discount rate=
[(3182/3017)*12]
1 + [(4231/207)*12]
=1.13
=1.25 years
years
4) NPV (net present value ):

a) Discounted @10%
Years
Cash
flows
2) Accounting rate of return: rate of return on initial investment made:
Discoun
t rate *
@ 10%
(1)
(2)
(3)
Discounte
d
cashflows
given as: Average profit after depriciation & Tax / Initial

investment
Since no information on profits, depreciation & taxes, it is treated cash inflows
considered as profits after depreciation & taxes
(4) =
(2) * (3)
(10,000)
1.000
(10,000)
7,500
0.909
6,818
7,500
0.826
6,198
therefor
e=
(15,000 (inflow) / 10,000

(investment)) * 100
accounting rate of return = 150%;

effectively 50% return
b) Discounted @30%
Years
Cash
flows
Discoun
t rate *
Discounted
cashflows
@ 30%
NPV
3,017
(1)
(2)
(10,0
00)
1.000
(10,000)
7,500
0.769
5,769
7,500
0.592
4,438
*
disocunt rate computed using formule = 1 / (1+r) to the
power n; where r = disocunt rate
& n = year
where L1 = guess rate (depend on NPV, disocunted at

given required rate of return)
L2 = one more
guess rate
(4) = (2)
* (3)
NPV

For project B , IRR is calculated as below:
IRR = L1 + [NPVL1 / (NPVL1 - NPVL2)] *
( L2 - L 1)
(3)
207
Relationship between discount rate and NPV:

inverse relationship:
Discount rate
goes up
NPV falls
NPV goes
Discount rate comes down
up
Let us assume L1 = 30% (why, because as could be seen at 30%

@ discount rate NPV is +ve by applying the
relationship, increased
disocunt rate)
Let us calculate L2 = 32%
Discounted
@32%
assumed rate )
Years
Cash
flows
Discoun
t rate *
Discounte
d
cashflows
@ 32%
(1)
(2)
(4) =
(2) * (3)
(3)
(10,000)
1.000
(10,000)
7,500
0.758
5,682
7,500
0.574
4,304
(14)
NPV
therefore, IRR for Project B = 30%

207+14)]*32% - 30 %
+ [207 /(
30 % +
IRR 1.873 31.87 %
PROJECT C:
The following has been calculated assuming discount rates of 10%
& 30% separately:
a) Disco unted
@10%
Years
Cash
flows
b) Disc ounted
@30%
Discoun
t rate *
Discounte
d
cashflows
Unrecover
ed
discounte
d cash
flows
Years
Cash
flows
Discount
rate *
Disco
unted
cashf
lows
Unrecove
red
discounte
d cash
flows
@ 10%
(1)
(2)
@ 30%
(4) =
(2) * (3)
(3)
(5)
(1)
(2)
(3)
(4) =
(2) *
(3)
(5)
(10,000)
1.000
(10,000)
(10,000)
(10,000)
1.000
(10,0
00)
(10,000)
2,000
0.909
1,818
(8,182)
2,000
0.769
1,538
(8,462)
4,000
0.826
3,306
(4,876)
4,000
0.592
2,367
(6,095)
12,000
0.455
5,462
(633)
3
12,000
0.751 9,016
4,140
3
Payback period = Base year + [(unrecovered disocunted cash flow of base year / disocunted cash flows of next
year) *12]
where base year =
[(4876/4140)*12]
exceeds 3 years
=2.14
= 3 + years
years
2) Accounting rate of return: rate of retur n on initial inve stment made :

investment
Since no information on profits, depreciation & taxes, it is treated cash inflows
considered as profits after depreciation & taxes
therefor (18,000 ( inflow) / 10,000 e
=
( investment)) * 100
4) NPV (net prese nt value ):
a) Discounted @10%
Years
Cash
flows
b) Discounted @30%
Discoun
t rate *
Discounted
cash flows
Years
Cash
flows
Disco
unt
rate *
@
30 %
@ 10%
(4) =
(2) * (3)
(1)
(2)
(3)
Discoun
ted
cashflo
ws
(1)
(2)
(3)
(4) =
(2) *
(3)
(10,000)
1.000
(10,000)
(10,000)
1.000
(10,000)
2,000
0.909
1,818
2,000
0.769
1,538
4,000
0.826
3,306
4,000
0.592
2,367
12,000
0.751
9,016
12,000
0.455
5,462
NPV
4,140
NPV
* disocunt rate computed using formule = 1 / (1+r) to the power n;
& n = year
For project C , IRR is calculated as below:
( L2 - L 1)
L2 = one more
guess rate
Discount rate
goes up
NPV falls
NPV goes
up
Let us assume L1 = 30% (why, because as could be seen at 30% @

discount rate NPV is -ve by applying the relationship,
reduced disocunt rate) Let us calculate L2 = 26%
Discounted
@26%
assumed rate )
Years
Cash
flows
Discoun
t rate *
@ 26%
(1)
(2)
(3)
Discounte
d
cashflows
(4) =
(2) * (3)
(10,000)
1.000
(10,000)
2,000
0.794
1,587
4,000
0.630
2,520
12,000
0.500
5,999
NPV
106
therefore, IRR for Project B = 30% + [-633 /( -633106)]*26%
- 30 %
30% -
(633)
IRR 3.43
26.57
PROJECT D:
The following has been calculated assuming discount rates of 10% & 30
% separately :
a) Disco unted @10 %
Years
Cash
flows
b) Discounted @3 0 %
Discoun
t rate *
Discounte
d
cashflows
Unrecover
ed
discounte
d cash
flows
Years
Cash
flows
Discoun
t rate *
@ 10%
(1)
(2)
(3)
Discou
nted
cashflo
ws
Unrecove
red
discounte
d cash
flows
@ 30%
(4) =
(2) * (3)
(5)
(1)
(2)
(3)
(4)
= (2) *
(3)
(5)
(10,000)
1.000
(10,000)
(10,000)
(10,000)
1.000
(10,000)
(10,000)
10,000
0.909
9,091
(909)
10,000
0.769
7,692
(2,308)
3,000
0.826
2,479
1,570
3,000
0.592
1,775
(533)
3,000
0.455
1,365
833
3
3,000
0.751 2,254
3,824
3
where base year =
[(909/1570)*12]
2 + [(533/833)*12]
=1.7
= 2.8 years
years
2) Accounting rate of return: rate of retur n on initial inve stment made :

investment
Since no information on profits, depreciation & taxes, it is treated cash inflows considered as
profits after depreciation & taxes
therefor (16,000 ( inflow) / 10,000 e
=
( investment)) * 100
4) NPV (net prese nt value ):

a) Discounted @10%
Years
Cash
flows
b) Discounted @30%
Discoun
t rate *
Discounte
d cash
flows
Cash
flows
Years
@ 10%
(1)
(2)
(3)
(4) =
(2) * (3)
(1)
Disco
unt
rate *
@
30 %
(2)
(3)
Discounted
cashflows
(4) = (2)
* (3)
(10,000)
1.000
(10,000)
(10,000)
1.000
(10,000)
10,000
0.909
9,091
10,000
0.769
7,692
3,000
0.826
2,479
3,000
0.592
1,775
3,000
0.751
2,254
3,000
0.455
1,365
NPV
3,824
NPV

( L2 - L 1)
L2 = one more
guess rate
Discount rate
goes up
NPV falls
NPV goes
up

discount rate NPV is+ve by applying the
relationship,
increased
disocunt rate)
Discounted
@38%
(
assumed rate )
833
Years
Cash
flows
Discoun
t rate *
@ 38%
(1)
(2)
Discounte
d
cashflows
(4) =
(2) * (3)
(3)
(10,000
)
1.000
(10,000)
10,000
0.725
7,246
3,000
0.525
1,575
3,000
0.381
1,142
NPV
(37)
833+37)]*38% - 30 %
IRR 7.66
+ [833 /(
30 % +
37.66 %
1) NPV (net presen t value): f or increment s cash f lows

a) Discounted @10%
Years
Increme
ntal
Cash
flows
(project
C
project
D)
b) Discounted @30%
Discou
nt rate
*
Discounted
cashflows
Years
Cash
flows
@
10%
(1)
Discou
nt rate
*
Discounte
d
cashflows
@
30 %
(4) =
(2) * (3)
(2)
(3)
1.000
(8,000)
0.909
1,000
9,000
(1)
(4) =
(2) * (3)
(2)
(3)
1.000
(7,273)
(8,000)
0.769
(6,154)
0.826
826
1,000
0.592
592
0.751
6,762
9,000
0.455
4,096
NPV
316
NPV
* disocunt rate computed using formule = 1 / (1+r) to the power n;
& n = year
(1,466)

( L2 - L 1)
L2 = one more
guess rate
Discount rate
goes up
NPV falls
NPV goes
up

discount rate NPV is+ve by applying the
relationship,
increased
disocunt rate)
Discounted
@13%
assumed rate )
Years
Cash
flows
Discoun
t rate *
@ 13%
(1)
(2)
Discounte
d
cashflows
(4) =
(2) * (3)
(3)
1.000
(8,000)
0.885
(7,080)
1,000
0.783
783
9,000
0.693
6,237
NPV
(59)
316+59)]*13% - 10 %
IRR 2.5
+ [316 /(
10 % +
12.50 %
Target return =
10 %
IRR for incremental cash
flows = 12.5%
since IRR for incremental cash flows > Target return,
select / accept Project C
Question 3a: "Firm should follow a policy of very high dividend pay-out Taking
example of two organization comment on this statement"
Answer 3a:
The statement not necessarily be true. Let us take 2 companies;
High dividend pay out company 100% payout
Low dividend payout company 20% payout
a) Less retained earnings
a) More retained earnings
b) Slower / lower growth rate
b) Accelerated/higher growth rate
c) Lower market price
c) Higher market price
d) Cost of equity (Ke) > IRR (r = rate of return
d) Cost of equity (Ke) < IRR (r = rate of return
earned by company on its investment.
earned by company on its investment.
e) Indicates that company is declining.
e) Indicates that company is growing.
It must be noted that, dividend is a trade off between retaining money for capital expenditure and issuing new
shares.
Question 3b: An investor gains nothing from bonus share "Critically analyse
the statement through some real life situation of recent past.
Answer 3b:
The statement is false. An investor gains bonus shares at zero cost, However, the market price of the stock
will come down & over the long period, the investor definitely maximizes his wealth due to bonus shares.
From company angle, bonus issue is only an accounting entry & it doesnt change the wealth/value of the firm.
Recently, Bharti Airtel have issued bonus share 2:1, due to which, the investors have gained Bonus shares
at zero cost & the market have come down to the extent of bonus issue & immediately went up & investors
have cashed the bonus shares thus maximized their wealth. However, currently it is trading down due to
varied reasons.
CASE STUDY
Q 1 Give your recommendations about the proposed investment
Particulars
1) NPV
2) Profitability index
3) Pay Back period
4) Discounted pay back period
Machine A (Rs. In lacs)

12
1.48
2 years
3.18 years
Machine B (Rs. In lacs)

14
1.35
3 years
3.21 years
It is advised to go in for Machine B with enhanced capacity, which will add more value to the firm. NPV
is higher in respect of Machine B as compared to Machine A & therefore machine with higher NPV needs
to be invested.
Ques 1: You are required to make these calculations and in the light thereof,
advise the finance manager about the suitability, or otherwise, of machine A
or machine B.
Solution:
Advise to finance manager of Brown metals ltd, to select the appropriate machine:
Particulars
Machine A (Rs. In lacs)

Machine B (Rs. In lacs)
14
1) NPV
12
1.35
2) Profitability index
1.48
3 years
3) Pay Back period
2 years
3.21 years
4) Discounted pay back period
3.18 years
It is advised to go in for Machine B with enhanced capacity, which will add more value to the firm.
NPV is higher in respect of Machine B as compared to Machine A & therefore machine with higher
NPV needs to be invested.
Workings are as follows:
( a) to buy machine A which is similar to the existing machine :
Years
Cash
flows
(Rs. In
lacs)
Unrecovered
cash flows
Discount rate
*
Discounted
cashflows
Unrecovered
discounted
cash flows
@10%
(1)
(2)
0
1
(25)
(3)
(4) = (2) *
(3)
(5)
(25)
(25)
1.000
0.909
(25)
-
(25)
(25)
(20)
0.826
(21)
20
0.751
15
(6)
14
14
0.683
10
5
14
28
0.621
9
12
NPV
12
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = disocunt rate
& n = year
1) Net Present value = Present value of inflows - Present value of outflows = 12 (as computed above)
2) Profitability Index = Present value of inflows / present value of outflows which should be >1
37 / 25 1.48
3) Payback period = Base year + [(unrecovered cash flow of base year / cash flows of next year ) *12] where
base year = year in which unrecovered cash flows turns 0 or +ve
Payback period = 2 + [(20/0)*12]

= 2 years
4) Discounted Payback period = Base year + [(unrecovered disocunted cash flow of base year / disocunted
cash flows of next year) *12] where base year = year in which unrecovered cash flows turns 0 or +ve
=3.18 years
( b) to go in for machine B which is more expensive & has much greater capacity :
Years
Cash
flows
(Rs. In
lacs)
Unrecovered
cash flows
Discount rate
*
Discounted
cashflows
Unrecovered
discounted
cash flows
@10%
(1)
(2)
(3)
(4) = (2) *
(3)
(5)
(40)
(40)
1.000
(40)
(40)
10
(30)
0.909
(31)
14
(16)
0.826
12
(19)
16
0.751
12
(7)
17
17
0.683
12
5
15
32
0.621
9
14
NPV
14
* disocunt rate computed using formule = 1 / (1+r) to the power n; where r = disocunt rate
& n = year
1) Net Present value = Present value of inflows - Present value of outflows = 14 (as computed above)
2) Profitability Index = Present value of inflows / present value of outflows which should be
>1
54 / 40 1.35
3) Payback period = Base year + [(unrecovered cash flow of base year / cash flows of next year ) *12] where
base year = year in which unrecovered cash flows turns 0 or +ve
= 3 years
4) Discounted Payback period = Base year + [(unrecovered disocunted cash flow of base year / disocunted
cash flows of next year) *12] where base year = year in which unrecovered cash flows turns 0 or +ve
=3.21 years
Assignment - C
1.
(a)
(b)
(c)
(d)
The main function of a finance manager is

capital budgeting
capital structuring
management of working capital
(a),(b)and(c ) Answer (d)
2 . Earning per share

(a) refers to earning of equity and preference shareholders.
(b) refers to market value per share of the company.
(c) reflects the value of the firm.
(d) refers to earnings of equity shareholders after all other obligations of the company have been met.
Answer (d)
3.
a)
(b)
(c)
(d)
4.
If the cut off rate of a project is greater than IRR, we may (

accept the proposal.
reject the proposal.
be neutral about it.
wait for the IRR to increase and match the cut off rate. Answer (b)
Cost of equity share capital is
(a)
(b)
(c)
(d)
equal to last dividend paid to equity shareholders.

equal to rate of discount at which expected dividends are discounted to determine their PV.
less than the cost of debt capital.
equal to dividend expectations of equity shareholders for coming year. Answer (b)
5 . Degree of the total leverage (DTL) can be calculated by the following formula
[ Given degree of operating leverage (DOL) and degree of financial leverage (DFL )]
(a) DOL + DFL
(b) DOL /DFL
(c) DFL-DOL
(d) DOL x DFL
Answer (d)
6.
(a)
(b)
(c)
Risk- Return trade off implies

increasing the profits of the firm through increased production
not taking any loans which increase the risk of the firm
taking decisions in a way which optimizes the balance between risk and return ( d)
risky customers Answer (c)
7 . The goal of a firm should be (

a) maximization of profit
(b) maximization of earning per share
(c) maximization of value of the firm
(d) maximization of return on equity
Answer (c)
8 . Current Assets minus current liabilities is equal to

(a) Gross working capital
(b) Capital employed
(c) Net worth
(d) Net working capital.
Answer (d)
9 . The indifference level of EBIT is one at which
(a) EPS increases
(b) EPS remains the same
(c) EPS decreases
(d) EBIT=EPS.
Answer (d)
10 . Money has time value since
(a) The value of money gets compounded as time goes by
(b) The value of money gets discounted as time goes by
(c) Money in hand today is more certain than money in future
(d) (b) and (c )
Answer (b)
11 . Net working capital is
(a) excess of gross current assets over current liabilities
(b) same as net worth
(c) same as capital employed
(d) same as total assets employed
Answer (a)
12 .
(a)
(b)
(c)
(d)
The internal rate of return of a project is the discount rate at which NPV is
positive
negative
zero
negative minus positive Answer (c)
13 . Compounding technique is
(a) same as discounting technique
not granting credit to
(b) slightly different from discounting technique

(c) exactly opposite of discounting technique
(d) one where interest is compounded more than once in a year. Answer (c)
14 . For determining the value of a share on the basis of P/E ratio, information is required
regarding:
(a) earning per share
(b) normal rate of return
(c) capital employed in the business
(d) contingent liabilities
Answer (a)
15 . Tandon committee suggested inventory and receivable norms for
(a) 15 major industries
(b) 20 minor industries
(c) 25 major and minor industries
(d) 30 major and minor industries
Answer (c)
16 . Capital structure of ABC Ltd. consists of equity share capital of Rs. 1,00,000 (10,000 share of
Rs. 10 each) and 8% debentures of Rs. 50,000 & earning before interest and tax is Rs. 20,000. The
degree of financial leverage is
(a)
(b)
(c)
(d)
1.00
1.25
2.50
2.00
Answer (b)
17 . The following data is given for a company. Unit SP = Rs. 2, Variable cost/unit = Re. 0.70, Total fixed
cost- Rs. 1,00,000 Interest Charges Rs. 3,668, Output-1,00,000 units. The degree of operating leverage is
( a) 4.00
(b) 4.33
(c) 4.75
(d) 5.33
Answer (b)
18 . Market price of equity share of a company is Rs. 25 and the dividend expected a year hence is Rs. 10.
The expected rate of dividend growth is 5%. The cost of equal capital to company will be
(a) 40%
(b) 45%
(c) 35%
(d) 50%
Answer (b)
19 . The dilemma of "liquidity Vs profitability" arise in case of
(a) Potentially sick unit
(b) Any business organization
(c) Only public sector unites
(d) Purely trading companies
Answer (b)
20 . The present value of Rs. 15000 receivable in 7 years at a discount rate of 15% is (
a) 5640
(b) 5500
(c) 5900
(d) 5940
Answer (a)
21 . A bond of Rs. 1000 bearing coupon rate of 12% is redeemable at par in 10 yrs. If the required
rate of return is 10% the value of bond is
(a) 1000
(b) 1123
(c) 1140
(d) 1150
Answer (a)
22 . The EPS of ABC Ltd. is Rs. 10 & cost of capital is 10%.The market price of share at return rate
of 15% and dividend pay out ratio of 40% is
(a) 100
(b) 120
(c) 130
(d) 150
Answer (a)
23 . The credit term offered by a supplier is 3/10 net 60.The annualized interest cost of not availing
the cash discount is
(a) 22.58%
(b) 27.45%
(c) 37.75%
(d) 38.50%
Answer (a)
24 . The costliest of long term sources of finance is
(a) Preference share capital
(b) Retained earnings
(c) Equity share capital
(d) Debentures
Answer (c)
25 . Which of the following approaches advocates that the cost of equity capital & debit capital
remains the degree of leverages varies
(a) Net income approach
(b) Net operating income approach
(c) Traditional approach
(d) Modigliani-Miller approach Answer (b) & (d)
26 . Which of the following is not a feature of an optimal capital structure.
(a) Profitability
(b) Safety
(c) Flexibility
(d) Control
Answer (b)
27 . While calculating weighted average cost of capital (
a) Retained earnings are excluded
(b) Bank borrowings for working capital are included
(c) Cost of issues are included
(d) Weights are based on market value or on book value Answer (a)
28 .
(a)
(b)
(c)
(d)
Which of the following factors influence the capital structure of a business entity?
Bargaining power with suppliers
Demand for product of company
Expected income
Technology adopted Answer (c)
29 . According to the Walters model, a firm should have 100% dividend pay-out ratio when.
(a) r = ke
(b) r < ke
(c) r > ke
(d) g > ke
Answer (a)
30 . Operating cycle can be delayed by (
a) Increase in WIP period
(b) Decrease in raw material storage period
(c) Decrease in credit payment period
(d) Both a & c above

Answer (d)
31 . If net working capital is negative, it signifies that
(a) The liquidity position is not comfortable
(b) The current ratio is less then 1
(c) Long term uses are met out of short- term sources
(d) All of a, b and c above
Answer (d)
32 . Which of the following models on dividend policy stresses on investors preference for
the current dividend ( a) Traditional model
(b) Walters model
(c) Gordon model
(d) MM model
Answer (d)
33 . Which of the following is a technique for monitoring the status of receivables (
a) ageing schedule
(b) outstanding creditors
(c) selection matrix
(d) credit evaluation
Answer (a)
34 . Average collection period is equal to (
a) 360/ Receivables Turnover Ratio
(b) Average Creditors / Sales per day
(c) Sales / Debtors
(d) Purchases / Debtors
Answer (a)
35 . In IRR, the cash flows are assumed to be reinvested in the project at
(a) Internal rate of return
(b) cost of capital
(c) Marginal cost of capital
(d) risk free rate
Answer (d)
36 . In a capital budgeting decision, incremental cash flow mean (
a) cash flows which are increasing.
(b) cash flows occurring over a period of time
(c) cash flows directly related to the project
(d) difference between cash inflows and outflows for each and every expenditure. Answer (d)
37 . The simple EOQ model will not hold good under which of the following conditions
(a) Stochastic demand
(b) constant unit price
(c) Zero lead time
(d) Fixed ordering costs
Answer (a)
38 . The opportunity cost of capital refers to the (
a) net present value of the investment.
(b) return that is foregone by investing in a project.
(c) required investment in a project.
(d) future value of the investments cash flows.
Answer (b)
39 . Which of the following factors does not influence the composition of Working Capital
requirements
(a) Nature of the business
(b) seasonality of operations
(c) availability of raw materials
(d) amount of fixed assets
Answer (d)
40 . The capital structure ratio measure the
(a) Financial Risk
(b) Business Risk
(c) Market Risk
(d) operating risks
Answer (a)

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Financial Management

Ex: Cash involved event

Question 2a: Explain the mechanism of calculating the present value of

Future value of annuity

PVAF is calculated as = 1-[1/(1+r) to the power

FVAF is calculated as = [(1+r) to the power n] - 1

Mr. A would like to receive Rs.1000/- every

Mr.X would like to grow a corpus by investment

It is assumed discount rate 10%, the present

Rate of interest @10%, the future value annuity

Present value of annuity = 1000 * 6.144 =

Future value of annuity = 10000 * 1.594=

Annuity * Future value annuity factor (FVAF)

Question 2b: "The increase in the risk-premium of all stocks, irrespective of

Contribution / EBIT = 100 / 75 = 1.33

Question 3b: The following figures relate to two companies (10)

Profit before tax

Operating risk is higher

Operating risk is higher than 'P' ltd

Financial risk looks low

Financial risk looks low

Overall risk is low as compared

Overall risk is high as compared

It is always preferable to have low Operating leverage & high Financial

Other information about the company as relevant is given below:

average market price 2005

c) 12% institutional loans

16.15 ( refer W.No.

Question 5a: A company has issued debentures of Rs. 50 Lakhs to be repaid

Expected rate of return - on sinking fund investment to be created

Discount rate@12%, 7 yrs

Present value of expected repayment of debentures @12% 7 yrs

Return expected per annum

Investment required today

Nett return expected from investment

Percentage of return for 10 years

Percentage of return per annum

Question 1: The proforma of cost-sheet of HLL provides the following data:

Total cost (per unit):

The following is the additional information available:

Production = 70,000 units

Current Assets: (A)

Total of CURRENT ASSETS (A)

Current Liabilities: (B)

Total of CURRENT LIABILITIES

Question 2a: Through quantitative analysis prove that PI is a better technique

Net Present Value (NPV)

Present value of inflows = Rs. 200,000

Question 2b: A company is considering the following investment projects:

Therefore, Project C needs to be accepted.

* disocunt rate computed using formule = 1 / (1+r) to the power

Payback period exceed 1 year, since unrecovered cash flows turns

year in which unrecovered cash

Payback period @ 10% & 30%

3) IRR (Internal rate of return): which is the rate of

year in which unrecovered cash

4) NPV (net present value ):

2) Accounting rate of return: rate of return on initial investment made:

given as: Average profit after depriciation & Tax / Initial

(15,000 (inflow) / 10,000

accounting rate of return = 150%;

where L1 = guess rate (depend on NPV, disocunted at

3) IRR (Internal rate of return): which is the rate of

Relationship between discount rate and NPV: