Name ____________________________________

Study Material
for

Financial Management

MBA II Sem.

Compiled by

Dr. Sachin Mittal

Associate Professor, PIMR, Indore

Prestige Institute of Management & Research Indore

Working Capital Management

Q1. From the following projections of XYZ & Company for the next year, you are required to work out the working capital required by the company. Annual sales Cost of production (including depreciation Rs. 1,20,000) Raw material purchases Monthly expenses 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 on its 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 40,00,000 Raw material 12,00,000 Wages 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 4,80,000 Sales 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 of finished 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 working capital 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: Rs. 14,40,000 12,00,000 7,05,000 25,000

Raw materials Direct labour Overheads Total cost Profit Selling price

Cost per unit (Rs.) 20 5 15 40 10 50

Past trends indicate that the raw materials are held in stock, on an average, for two months. Work in process (50% complete) will approximate to half a months production. Finished goods remain in warehouse, on average, for a month. Suppliers of materials extend a months credit. Two months credit is normally allowed to debtors. A minimum cash balance of Rs. 25,000 is expected to be maintained. The production pattern is assumed to be even during the year. Prepared the statement of working capital determination. Q4 The board of directors of Krishna Engineering Co Ltd Request you to prepare a statement showing the working capital requirements for a level of activity at 1,56,000 units of production. The following information is available for your calculation. (A) Raw materials Direct Labour Overheads Total Profit Selling price per unit Per unit (Rs.) 90 40 75 205 60 265

(B) (i) Raw materials are in stock, on average, for one month. (ii) Materials are in process, (50% complete) on average, for 4 weeks. (iii) Finished goods are in stock, on average, for one month. (iv) Credit allowed by suppliers is one month. (v) Time lag in payment from debtors is 2 months. (vi) Average lag in payment of wages is 1.5 weeks. (vii) Average lag in payment of overheads is 1month. 20% of output is sold against cash. Cash in hand and bank is expected to be Rs. 60,000. It is to be assumed that production is carried on evenly throughout the year; wages and overheads accrue similarly. Time period of 4 weeks is equivalent to a month. Q5. While preparing a project report on behalf of a client you have collected the following facts. Estimate the net working capital required for the project. Add 10% to your computed figure to allow for contingencies.

Raw material Direct labour Overheads (Including depreciation Rs. 5) Total Cost Additional Information:

Amount Per unit (Rs.) 80 30 65 175

Selling price Rs. 200 per unit Level 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 of manufacturing; 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 weeks Lag 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 Raw Material Manufacturing Expenses Selling & other Exp. Rs. 60/Rs. 40/Rs. 20/----------Rs. 120/----------Monthly Cost Rs.2,40,000 Rs. 1,60,000 Rs. 80,000 -----------------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 Goods stage -1month, Debtors stage 2 month Calculate the investment in various current assets.

Leverage
Q1.XYZ Ltd. has an average selling price of Rs. 10 per unit. Its variable unit costs are Rs. 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 and 50% 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? Sales Fixed Cost Company A (Rs.) 25,00,000 7,50,000 Company B (Rs.) 30,00,000 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 have total assets of Rs. 15,00,000. Operating Statement Company X (Rs.) Sales Revenue 30,00,000 Less: Cost of Goods Sold 22,50,000 Less: Selling Expenses 2,40,000 Less: Administrative Expenses 90,000 Less: Depreciation 1,20,000 EBIT 3,00,000 Cost break-ups Variable Cost Cost of Goods Sold Selling Expenses Total variable costs 9,00,000 1,50,000 10,50,000 18,00,000 1,50,000 19,50,000 Company Y (Rs.) 30,00,000 22,50,000 2,40,000 1,50,000 90,000 2,70,000

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 variable costs 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 business risk, which company would be purchased by it?

Q4. From The following financial data of companies X and Y, prepare their income statements. Company X 50 Rs. 20,000 3-1 2-1 55% Company Y 60 6,000 5-1 3-1 55%

Variable cost as % of sales Interest Expense Degree of Operating Leverage Degree of Financial Leverage Income Tax rate

Q5. The selected financial data for A, B and C companies for the current year ended December 31 are as follows: Company X 66.67 Rs. 200 5-1 3-1 50% Company Y Company C 75 50 Rs. 300 Rs. 1,000 6-1 2-1 4-1 2-1 50% 50%

Variable cost as % of sales Interest Expense Degree of Operating Leverage Degree of Financial Leverage Income Tax rate

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 sales revenue. (b) If sales increase by 50% while variable cost element, fixed cost, interest amount, 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 14,00,000 Fixed 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 6

(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 outlay PV of cash inflow = PVIF x CFAT Or CF0 + CF1 + -------------CFn NPV = -----------------------------------(1+K)0 + (1+K)1 --------- (1+K)n 5. IRR = r + DFrL Initial Investment ---------------------------DFrL DFrH

PB = Payback period DFr = Discounted Factor for interest rate r DFrL = 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. PI = Present value of cash inflow -------------------------------Present value of cash outflow 7

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 line depreciation and the proposed project Has cash flow before tax (CFBT) as follows: Year 1 2 3 4 5 CFBT 1,00,000 1,00,000 1,50,000 1,50,000 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. 2,00,000 Depreciation 20% per annum Forecasted annual income before charging depreciation, but after all other charges as follows: Year amount 1 1,00,000 2 1,00,000 3 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 economic life 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 is not 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)

Q4. A firm whose cost of capital is 10% is considering two mutually exclusive projects X and Y, the details of which are: Investment Cash inflow: year 1. 2. 3. 4. 5. Project X Rs. 70,000 10,000 20,000 30,000 45,000 60,000 ---------------1,65,000 Project Y Rs. 70,000 50,000 40,000 20,000 10,000 10,000 --------------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 two alternative model of x and y of the new machine. Using payback period, suggest the most important profitable investment. Ignore taxation. Machine X Original Investment Estimated Life of Machine Estimated saving in scrap Estimated saving in wages Additional cost of Maintenance Additional cost of Supervision 9,000 4 500 6000 800 1200 Machine Y 18,000 5 800 8000 1000 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 revenues and 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 all incremental 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)

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 35,000 3 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 on quantitative 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 required for 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 of the 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 cost of 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, 40.482, 5-.402) Q12. A company is planning to purchase a machine to meet increased demand for its product 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 main book) 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 existing price 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 of the 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. It has 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 Loss on Sale of Machine Goodwill written off Find out profit from operations. Q. 2 Rs. 4000 Rs. 2000 Rs. 1000

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

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31st Dec., 1996 Rs. Loan and Buildings Plant and Machinery Stock Debtors Cash at Bank 50,000 24,000 9,000 16,500 4,000 1,03,500 Capital Profit and Loss A/c Creditors Mortgage Q. 3 80,000 14,500 9,000 -----1,03,500

31st Dec., 1997 Rs. 50,000 34,000 7,000 19,500 9,000 1,19,500 85,000 24,500 5,000 5,000 1,19,500

From the following Balance Sheets as on 31st December, 1996 and 1997, you are required to prepare a statement showing flow of funds: 1996 Rs. Assets: Cash Debtors Stock Land Liabilities Share Capital Creditors Retained earnings 35,000 1, 25,000 70,000 40,000 2,70,000 2,00,000 60,000 10,000 1997 Rs. 50,000 1,20,000 80,000 60,000 3,10,000 2,50,000 35,000 25,000

Q. 4

2,70,000 3,10,000 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 60,000 Plant and Machinery 2,50,000 4,00,000 Stocks 50,000 37,500 Debtors 75,000 80,000 Cash 10,000 10,000 4,25,000 5,87,500

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Liabilities & Capital : Share Capital Profit & Loss A/c General Reserve Sundry Creditors Bills Payable Outstanding Expenses

2,50,000 50,000 25,000 76,500 20,000 3,500 4,25,000

3,50,000 80,000 35,000 95,000 25,000 2,500 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. Prepare fund statement. Q. 5 The following are the summarized Balance Sheets of V Ltd., as on 31st December for year 1 and 2: Liabilities Share Capital P & L A/c Reserve Tax Provision Bank Overdraft Bills Payable Sundry Creditors Year 1 (Rs.) 2,00,000 39,690 50,000 40,000 59,510 33,780 39,500 4,62,480 Year 2 (Rs.) 2,60,000 41,220 50,000 50,000 ---11,525 41,135 4,58,880 Assets Goodwill Machinery Buildings Stock Sundry debtors Cash --------4,62,480 4,53,880 Year 1 (Rs.) ---------1,12,950 1,48,500 1,11,040 87,490 2,500 Year 2 (Rs.) 20,000 1,16,200 1,44,250 97,370 73,360 2,700

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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 fully paid 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 Corporation from the following information: Balance sheet as on 1st January and 31st December January 1 Rs. Cash and Bank Account receivable Inventories Land Business premises Plant and equipment Accumulated depreciation Patents and trade marks Total assets Current Liabilities Bonds payable Bonds payable discount Capital stock Retained earnings 40,000 10,000 15,000 15,000 4,000 20,000 15,000 (5,000) 1,000 1,00,000 30,000 22,000 (2,000) 35,000 15,000 December 31 Rs. 44,400 20,700 15,000 15,000 4,000 16,000 17,000 (2,800) 900 1,15,200 32,000 22,000 (1,800) 43,500 19,500 Business

Total liabilities 1,00,000 1,15,200 Additional 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 Long Term Investment Plant Assets 1,60,000 2,40,000 9,60,000 ----------13,60,000 -----------1,60,000 1,20,000 10,00,000 80,000 -----------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. 2,00,000 4. Dividend paid amounted to Rs. 60,000 5. 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 : 3,20,000 40,000 15,40,000 -----------19,00,000 -----------1,20,000 1,40,000 4,00,000 10,00,000 1,00,000 1,40,000 ------------

Accumulated depreciation Current Liabilities 14% Debentures Equity Capital Donation Retained earnings

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P X 100 C K = Cost of Capital P = Interest or Dividend C = Capital Received Major Source of Capital are following (1) (2) (3) (4) Debentures or Borrowed Capital (Debt. Capital) Preference Share Capital Equity Share Capital Retained Earning

K=

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 is Rs. 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) P X 100 C (i) If Redeemption at par = P = Contractual Rate+ C = Par Value (ii) P = Contractual Rate C = Par value + Kd =

Floatation Charges Period of Issue

Floatation Charges 2 Floating Charges + Discount Period of Issue

Floating Charges + Discount

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2 (iii) P = Contractual Rate + Floating Charges Period of Issue Floating Charges 2 + Premium Period of Issue Premium 2

C = Par value

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 rate Kd = Cost of Debt before tax Q.5 A company is willing to issue 1,000, 7% irredeemable debentures 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.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 C C = Redemption of preference Shares C = Per Value + Premium - Discount Expenses of Issue P = Dividend. Amount Kpt = 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) 17

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 100 P 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.55.45 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 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 is Rs.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 P + G (Growth rate in dividend)

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 of Equity Share Capital. Ans. 26.73% Cost of Retained Earning: Kr = Ke Kr = Cost of R.E. Ke = Cost of Equity Capital Or Kr = AD X 100 PE AD = 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 is retained. 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 type carrying 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 5,00,000 8% 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 Equity Share Capital of Rs. 100 Each Retained earning Sundry Creditors Bills Payable Other current liabilities Amount 10,00,00 0 3,68,000 1,04,000 2,00,000 20,000 16,92,00 0 Statement of profit for the year ended December 31 (Rs.) Sales 40,00,000 Less: Cost of goods sales 30,80,000 Gross 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 20 Assets Plant and equipments Land and Building Cash Sundry Debtors 3,60,000 Less: allowances 40,000 Stock Prepaid Insurance Amount 6,40,000 80,000 1,60,000 3,20,000 4,80,000 12,000 16,92,000

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 would improve 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 2) Reserve and Surplus 3) Bank Overdraft 4) Asset (fixed) to proprietory ratio 5) Current ratio 6) Liquid ratio Rs. 1,20,000 80,000 20,000 .75 2.5 1.5

Q3 Using the following data, complete the balance sheet given below. Gross profit (20% of sales) Rs. 60,000 Shareholders equity 50,000 Credit sales to total sales 80% Total assets turnover 3 times Inventory turnover (to cost of sales) 8 times Average collection period (a 360 day year) 18 days Current ratio 1.6 Long term debt to equity 40% Balance sheet as on -----Liabilities Creditors Long Term Debt Shareholders equity Total Amount Assets Cash Debtors Inventory Fixed Assets Total Amount

Q4 With the help of the following information complete the balance sheet of XYZ Ltd. i) Owners equity Rs. 1,00,000 21

ii) Current Debt to total debt iii) Total Debt to owners equity iv) Fixed cost to owners equity v) Total asset turnover vi) Inventory turnover If you need any other figure, assume with giving reasons.

.40 .60 .60 2 times 8 times

Q5. From the following details regarding Indu Films, draw the balance sheet of company, for the current year ended 31st March. Current ratio Liquid ratio Net working capital Stock turnover ratio (cost of sales/cl. stock) GP ratio Fixed assets turnover ratio (on cost of sales) Debtors collection period Fixed assets to share holders net worth Reserve and Surplus to capital 2.5 1.5 Rs. 3,00,000 6 times 20% 2 times 2 months .80 .50

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