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Financial Management Assignment - A

Question 1a: Should the titles of controller and treasurer be adopted under Indian context? Would ou li!e to modif their functions in "ie# of the compan practice in India? $ustif our opinion?
Ans#er to 1a: Controller & Treasurer are independent & they have their own Perspectives & Drivers as detailed below:

Responsibilities include, Double entry accounting, financial reporting, Fraud measure, detective controls, Financial restatement

Controller wor s & forecasts the events for a long term! "ain focus # income statement $%: Cash involved event Controller loo s from compliance angle &how to record, what '((P provides etc!,) Therefore, from the above it is clear that, controller & treasurer have different roles to play! *owever, ma+ority of the ,ndian companies wor s with Financial Controller who himself ta es care of the treasury department - Portfolio! Therefore, as far as from ,ndian conte%t, it can be concluded that, controller is also responsible for treasury +obs & there is no separate treasurer - treasury department e%ists Question 1b: firm purchases a machinery for Rs! ., //,/// by ma ing a down payment of Rs!0,1/,/// and remainder in e2ual installments of Rs! 0,1/,/// for si% years! 3hat is the rate of interest to the firm4 Ans#er to Q1b: %articulars Cost of "achinery Down Payment made by firm Financed through borrowings Repayment in e2ual instalments every year &ma%imum of si% years) Total interest paid over 7 year period &ef &a) &b) c 5 &a6 b) d57801 /,/// 'ear ( .//,/// 01/,/// 71/,/// 9//,/// 01/,/// 01/,/// 01/,/// 01/,/// 01/,/// 01/,/// 'ear 1 'ear ) 'ear * &s. 'ear + 'ear , 'ear -

e5d6 c

),(/(((

&ate of Interest 0 total interest 1 total borro#ings

f5e-c

*2.+-3

&ate of interet

g5f-7

per annum
cost - principal repayment: be apportioned in the ratio of no of years repayment 6 i!e! earlier the years more the interest cost & vice versa) 7:1:=:?:

&ratio)

:earwise ,nterest ;utstanding rates: ad+ustment 6 Principal ;utstanding at year end &prinicp al o-s at year beginnin g6 Principal repayme nt) h &71 /// /6 i) &1<0= >96 i) &=./9 1> 6 i)

i5d6h

&?<.1 <0 6 i)

&>7=> .76 i)

&0?./9 1 6 i)

&A45 6F I745&5S 4 585&' '5A&

p r i n c i p a l o s a t y e a r b e

g i n n i

n g &h 71////)

11.(3 ) 1(.+3 9.93 9.+3 9.(3 2.-3


& h 1 < & & hh ?> <7 & h 0 ?

Question )a: 5xplain the mechanism of calculating the present "alue of cash flo#s. What is annuit due? :o# can ou calculate the present and future "alues of an annuit due? Illustrate
A n s # e r ) a : ;alculating %resent 8alue of ;ash flo#s: "oney has time value! For e%: Rs!0/// received today is not the same worth after a year &actually it is less) %resent "alue of cash flo#s: ,t indicates the value of e%pected worth at current value! &Discounts the e%pected cash flows at appropriate discount rate &may be 0/@, >/@ etc!,) <iscount rate will generally be e2ual to 5 ,nflation rate A Re2d! rate of return A ris free premium rate <etails re=uired for calculating %resent 8alue of cash flo#s: Cash flows year wise, discount rate! This techni2ue is very useful for decision6ma ing!

Annuit due: Bniform- Constant- $2ual cash flows every year %resent "alue of annuit 3orth of Cump sum consideration today which is going to be received tomorrow Computation: (nnuity 8 Present value annuity factor &PD(F) PD(F is calculated as 5 06E0-&0Ar) to the power nF! ,llustration: "r! ( would li e to receive Rs!0///-6 every year for 0/ years from now! ,t is assumed discount rate 0/@, the present value annuity factor for 0/ years 0/@ is 7!0==! Present value of annuity 5 0/// 8 7!0== 5 Rs!70=1-6

Question )b: >4he increase in the ris!-premium of all stoc!s/ irrespecti"e of their beta is the same #hen ris! a"ersion increases> ;omment #ith practical examples
Ans#er )b: The securityGs beta is a function of the correlation of the securityGs returns with the mar et inde% returns and the variability of the securityGs returns relative to the variability of the inde% returns! ,n simple, beta measures the sensitivity of the stoc with reference to broad based mar et inde%! For instance: a beta of 0!> for a stoc would indicate that this stoc is >/@ ris ier than the inde% & similarly beta of /!9 for a stoc indicates 0/@ less ris ier than the inde%! Finally, a beta of 0!/ means, stoc is as ris y as the stoc mar et inde%! Therefore, the given statement is false! $%pected ris 6premium for stoc is beta times the mar et ris premium! For e%: let us assume beta 5 0!> times, mar et ris premium 5 0/@, then e%pected ris premium 5 0/@ 8 0!> times 5 0>@!

Question *a: :o# le"erage is lin!ed #ith capital structure? 4a!e example of a M7; and anal ?e.
Ans#er to *a: @e"erage: ,t is an advantage gained &it may be anything) Ceverage is lin ed with Capital Htructure, since an organiIation having a optimum capital structure &where 3(CC &weighted average cost of capital) is minimum) is a great leverage- advantage both to the company as well for the investors! ;rganiIations, generally have two types of ris sJ operating ris s # impact of fi%ed costs & variability of $K,T & Financial ris s # impact of interest cost-financial charges & variability of $KT! 5xample: L:M ltd has the following nos: Contribution # Rs!0// lacs, fi%ed cost # Rs!>1 lacs, Financial Charges-debt cost # Rs!=/ lacs!

Contribution Fi%ed cost 5AI4 ,nterest cost 5A4 B'C @td. has following: 6perating le"erage Contribution - $K,T 5 0// - <1 5 0!?? ,t is always preferable to have low operating ris employed &R;C$) N ,nterest cost on debt funds) & high financial ris &sub+ect to Return on capital

3e can conclude that, L:M ltd &"OC) is having a optimum capital structure & manageable ris !

Question *b: 4he follo#ing figures relate to t#o companies D1(E


P CTD! Hales Dariable costs Contribution Fi%ed costs Fi%ed Cost ,nterest Profit before ta% 1// >// 66666 ?// 01/ 66666 01/ 1/ 66666 0// P CTD! (In Rs. Lakhs) 0,/// ?// 66666666 <// =// 66666666 =// 0// 66666666 >//

You are required to: (i) Calculate the operating, financial and combined leverages for the two companiesJ and Comment on the relative ris position of them

Ans#er *b:
%articulars Hales Dariable costs ;ontibution Fi%ed cost %AI4 1 5AI4 ,nterest %rofit before 4ax 1 5A4 ;omputation:

aE 6pearting le"era 5 Contribution - $K,T bE Financial le"erage: 5 $K,T - $KT

cE ;ombined le"era 5 Contirbution - $ ;omments:

Question +a: <efine "arious concepts of cost of capital. 5xplain the procedure of calculating #eighted a"erage cost of capital. Ans#er +a:
;oncepts of ;ost of ;apital: a) (ll source of finance have its own cost! ;ut of long source finance, e2uity mode of sourcing is costlier than debt financing because of e%pectation of shareholders! b) &ISF 8S. ;6S4: $2uity mode of finance will have low ris but costlier as against debt funds which will have high ris but relatively cheaper & have ta% advantage thus reducing the net cost of debt! ;rganiIations have to effectively trade off between ris , cost & control! c) 6ptimum ;apital Structure: 3hen the firm - organiIation has a combination of debt and e2uity, such that the wealth of the firm is ma%imum! (t this point, cost of capital is minimum & mar et price of a share is ma%imum! %rocedure of calculating Weighted A"erage ;ost of ;apital DWA;;E: ,t is computed by reference to proportion of each component of capital &boo value or mar et value as specified) as weights! WA;; 0 Sum Gproportion of each component of capital D#eightsE H indi"idual cost of capitalI 7ote: Ta% rates needs to be ad+usted in respect of debt funds!

Question +b: 4he follo#ing items ha"e been extracted from the liabilities side of the balance sheet of B'C ;ompan as on *1st <ecember )((,.
Paid up capital: =, //,/// e2uity shares of Rs each Loans: 07@ non6convertible debentures 0>@ institutional loans ;ther information about the company as relevant is given below: ?0st dec >//1 =/,//,/// >/,//,/// 7/,//,///

Dividend

$arning

average mar et price

Per share per share per share <!> 0/!1/ 71 :ou are re2uired to calculate the weighted average cost of capital, using boo values as weights and earnings-price ratio as the basis of cost of e2uity! (ssume 9!>@ ta% rate

Ans#er +b:
;omputation of Weighted A"erage ;ost of ;apital DWA;;E:

Oature of Capital

a) $2uity Capital

b) 07@ non6convertible debentures

c) 0>@ institutional loans

4otal Wor!ing 7ote: 1 ;ost of e=uit : $arnings per P r i c e e

Question ,a: A compan has issued debentures of &s. ,( @a!hs to be repaid after J ears. :o# much should the compan in"est in a sin!ing fund earning 1)3 in order to be able to repa debentures? Sho# the procedure of loan amorti?ation and capital reco"er through an example. Ans#er ,a:
Debentures to be redeemed after < years $%pected rate of return 6 on sin ing fund investment to be created Discount rateQ0>@, < yrs Present value of e%pected repayment of debentures Q0>@ < yrs 1,///,/// 0>@

therefore, company has to invest Rs!>>,70,<=7 Q 0>@ earning in Hin ing fund to cover the repayment e%pected < years from n

@oan Amorti?ation ( loan amortiIation schedule is a repayment plan that is calculated before repayment of a loan begins!

(mortiIation schedules are used for fi%ed interest long # term loans such as mortgages, e%penses li e R& D e%penses, Purchase of 'oodwill, Doluntary Retirement payment e%pense %rocedure #ith 5x:

"-s!L:M ltd has incurred a Rs!1/, //,/// as lump sum payment towards voluntary retirement separation charges during the a L:M ltd have planned to amortiIe the above e%penses for a period of 0/ years commencing from F:!/960/ Therefore, the schedule of amortiIation for 0/ year period as follows: Rs! 1//,///-6 per years for 0/ years

Question ,b: A ban! has offered to ou an annuit of &s. 1/2(( for 1( ears if ou in"est &s. 1)/((( toda . What is the rate of return ou #ould earn? ! Ans#er ,b:
Return e%pected per annum Fi%ed return-annuity for no of years Total return e%pected ,nvestment re2uired today Oett return e%pected from investment %ercentage of return for 1( ears %ercentage of return per annum

Assignment - ;

Question 1: 4he proforma of cost-sheet of :@@ pro"ides the follo#ing data:


Cost &perunit): Raw materials Direct labour ;verheads Total cost &per unit): Profit Helling price Rs! 1>!/ 09!1 ?9!/ 00/!1 09!1 0?/!/

The following is the additional information available: (verage raw material in stoc : one monthJ (verage materials in process: half monthJ Credit allowed by suppliers: one monthJ Credit allowed to debtors: two monthsJ Time lag in payment of wages: one and half wee sJ ;verheads: one month! ;ne6fourth of sales are on cash basis! Cash balance e%pected to be Rs! 0>,///! :ou are re2uired to prepare a statement showing the wor ing capital needed o finance a level of activity of </,/// units of output! :ou may assume that production is carried on evenly throughout the year and wages and overheads accrue similarly!

Ans#er 1:

Particular

Raw "aterial Direct Cabour %rime cost ;verheads Total cost Profit Hales

Statement of Wor!ing ;apital for :@@ - J(/((( units production per ear:

%articulars ;urrent Assets: DAE Raw material stoc Process stoc 6 3or in progress &3,P) Debtors 6 customers Cash balance e%pected to maintain 4otal of ;K&&574 ASS54S - DAE

;urrent @iabilities: DAE

Creditors 6 suppliers 3ages ;utstanding

;verheads outstanding 4otal of ;K&&574 @IAAI@I4I5S - DAE 7544 W6&FI7L ;A%I4A@ &5QKI&5<

Question )a: 4hrough =uantitati"e anal sis pro"e that %I is a better techni=ue than 7%8 in ;apital Audgeting. Ans#er )a:
P, # Profitability ,nde% & OPD # Oet Present Dalue both are capital budgeting techni2ues! %rofitabilit Index D%IE %I 5 Present value of inflows - Present value of outflows ,deal 5 should be N 0 Quantitati"e anal sis: Present value of inflows 5 Rs! >//,/// Present value of outflows 5 Rs! 0//,/// P, 5 > OPD techni2ue is better than P, techni2ue for capital budgeting decisions! OPD shows wealth at the end in absolute amount, which will be helpful to ma e decisions clearly, whereas the same advantage is not available with P, techni2ue! *owever, P, shows # return over investment in times, which will be very useful for immediate decision ma ing! 'enerally, over the years, organiIations prefer OPD techni2ue for capital budgeting decisions than P, techni2ue!

Question )b: A compan is considering the follo#ing in"estment proMects:


Pro+ects

( K C D ,! according to each of the following methods: &0!) Paybac , &>!) (RR, &?!) ,RR, &=!) OPD assuming discount rates of 0/ and ?/ percent! ,,! (ssuming the pro+ect is independent, which one should be accepted4 ,f the pro+ects are mutually e%clusive, which pro+ect is the best4

Ans#er )b:
IE Methods &0) Paybac Q0/@ discount rate Q?/@ discount rate &>) (ccounting rate of return &(RR) &?) OPD Q0/@ discount rate Q?/@ discount rate &=) ,RR Independent proMect: Pro+ect with higher OPD needs to be selected, which shows wealth in absolute value at the end of the pro+ect 4herefore/ %roMect ; needs to be accepted. IIE In case proMects are mutuall exclusi"e: First disparity between pro+ects needs to be resolved! OPD selects Pro+ect C whereas ,RR selects Pro+ect D, therefore, disparity e%ists! Hince cash outflows &Rs!0/, ///-6) are same for both the pro+ects, the disparity arisen is called as Cash flow disparity! ,t can be resolved by using Incremental cash flo# techni=ue! (fter resolving, the right pro+ect can be accepted! Wor!ings are as follo#s: %&6$5;4 A: The following has been calculated assuming discount rates of 0/@ & ?/@ separately: 1E %a bac! period: time period to reco"er initial in"estment aE <iscounted N1(3

:ears

Cash flows

&0)

&>)

&0/,///)

0 0/,/// 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year Paybac period 5 Kase year A E&unrecovered disocunted cash flow of base year -

disocunted cash flows of ne%t year) 80>F

%a bac! period exceed 1 ear/ since unreco"ered cash flo#s turns positi"e onl from IInd r on#ards where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period Q 0/@ & ?/@ discount rate 5 0 A years 01O ears

)E Accounting rate of return: rate of return on initial in"estment made: given as: investmen Hince no consider

+E 7%8 Dnet present "alueE: therefore aE <iscounted N1(3 5 :ears

bE <iscounted N*(3 Cash flows

&0)

&>)

/ 0 7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

&0/,/// ) 0/,///

*E I&& DInternal rate of returnE: #hich is the rate of return at #hich 7%8 0 ( ,n pro+ect ( , ,RR is G/G@ at which OPD 5/ &i!e! there is no return from the pro+ect)

%&6$5;4 A: The following has been calculated assuming discount rates of 0/@ & ?/@ separately: 1E %a bac! period: time period to reco"er initial in"estment aE <iscounted N1(3

:ears

Cash flows

&0)

&>)

/ 0 > 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

&0/,///) <,1// <,1//

Paybac period 5 Kase year A E&unrecovered disocunted cash flow of base year disocunted cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period Q 0/@ discount rate5 0 A E&?0.>-?/0<)80>F 01.1* ears Paybac period Q ?/@ discount rate5 0 A E&=>?0->/<)80>F 01.), ears

)E Accounting rate of return: rate of return on initial in"estment made: given as: (verage profit after depriciation & Ta% - ,nitial investment Hince no information on profits, depreciation & ta%es, it is treated cash inflows considered as profits after depreciation & ta%es therefor e5 &01,/// &inflow) - 0/,/// &investment)) 8 0//

accounting rate of return 5 01/@J effectively 1/@ return

+E 7%8 Dnet present "alueE: aE <iscounted N1(3

:ears

&0)

/ 0 >

7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

*E I&& DInternal rate of returnE: #hich is the rate of return at #hich 7%8 0 ( For pro+ect K , ,RR is calculated as below: I&& 0 @1 O G7%8@1 1 D7%8@1 - 7%8@)EI H D@) - @1E where C0 5 guess rate &depend on OPD, disocunted at given re2uired rate of return) rate C> 5 one more guess

bE <iscounted N*(3

:ears

&elationship bet#een discount rate and 7%8: in"erse relationship: Discount rate goes up Discount rate comes down OPD falls OPD goes up

Cet us assume @1 0 *(3 &why, because as could be seen at ?/@ Q discount rate OPD is Ave by applying the relationship, increased disocunt rate) Cet us calculate C> 5 ?>@ <iscounted N*)3 Dassumed rateE :ears

&0)

/ 0 >

7%8 therefore, ,RR for Pro+ect K 5 ?/@ A E>/< -& >/<A0=)F8?>@ 6 ?/@ *(3 O I&& 1.2J* *1.2J3

%&6$5;4 ;: The following has been calculated assuming discount rates of 0/@ & ?/@ separately: 1E %a bac! period: time period to reco"er initial in"estment aE <iscounted N1(3

:ears

Cash flows

&0)

&>)

/ 0 > ? 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

&0/,///) >,/// =,/// 0>,///

Paybac period 5 Kase year A E&unrecovered disocunted cash flow of base year - disocunted

cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period Q 0/@ discount rate5 > A E&=.<7-=0=/)80>F 0).1+ ears Paybac period Q ?/@ discount rate5 e%ceeds ? years 0*O ears

)E Accounting rate of return: rate of return on initial in"estment made: given as: (verage profit after depriciation & Ta% - ,nitial investment Hince no information on profits, depreciation & ta%es, it is treated cash inflows considered as profits after depreciation & ta%es therefor e5 &0.,/// &inflow) - 0/,/// &investment)) 8 0//

accounting rate of return 5 0./@J effectively ./@ return

+E 7%8 Dnet present "alueE:

aE <iscounted N1(3 bE <iscounted N*(3 :ears :ears

&0)

/ 0 > ? 7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

*E I&& DInternal rate of returnE: #hich is the rate of return at #hich 7%8 0 ( For pro+ect C , ,RR is calculated as below: I&& 0 @1 O G7%8@1 1 D7%8@1 - 7%8@)EI H D@) - @1E where C0 5 guess rate &depend on OPD, disocunted at given re2uired rate of return) rate C> 5 one more guess

&elationship bet#een discount rate and 7%8: in"erse relationship: Discount rate goes up Discount rate comes down OPD falls OPD goes up

Cet us assume @1 0 *(3 &why, because as could be seen at ?/@ Q discount rate OPD is 6ve by applying the relationship, reduced disocunt rate) Cet us calculate C> 5 >7@ <iscounted N)-3 Dassumed rateE

:ears

&0)

/ 0 > ? 7%8 therefore, ,RR for Pro+ect K 5 ?/@ A E67?? -& 67??6 0/7)F8>7@ 6 ?/@ *(3 I&& %&6$5;4 <: The following has been calculated assuming discount rates of 0/@ & ?/@ separately: *.+* )-.,J

1E %a bac! period: time period to reco"er initial in"estment aE <iscounted N1(3

:ears

Cash flows

&0)

&>)

/ 0 > ? 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

&0/,///) 0/,/// ?,/// ?,///

Paybac period 5 Kase year A E&unrecovered disocunted cash flow of base year disocunted cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period Q 0/@ discount rate5 0 A E&9/9-01</)80>F 01.J ears Paybac period Q ?/@ discount rate5 > A E&1??-.??)80>F 0 ).2 ears

)E Accounting rate of return: rate of return on initial in"estment made: given as: (verage profit after depriciation & Ta% - ,nitial investment Hince no information on profits, depreciation & ta%es, it is treated cash inflows considered as profits after depreciation & ta%es therefor e5 &07,/// &inflow) - 0/,/// &investment)) 8 0//

accounting rate of return 5 07/@J effectively 7/@ return

+E 7%8 Dnet present "alueE: aE <iscounted N1(3 bE <iscounted N*(3

:ears :ears

&0)

/ 0 > ? 7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

*E I&& DInternal rate of returnE: #hich is the rate of return at #hich 7%8 0 ( For pro+ect C , ,RR is calculated as below: I&& 0 @1 O G7%8@1 1 D7%8@1 - 7%8@)EI H D@) - @1E where C0 5 guess rate &depend on OPD, disocunted at given re2uired rate of return) rate C> 5 one more guess

&elationship bet#een discount rate and 7%8: in"erse relationship: Discount rate goes up Discount rate comes down OPD falls OPD up goes

Cet us assume @1 0 *(3 &why, because as could be seen at ?/@ Q discount rate OPD isAve by applying the relationship, increased disocunt rate) Cet us calculate C> 5 ?.@

<iscounted N*23 Dassumed rateE

:ears

&0)

/ 0 > ? 7%8 therefore, ,RR for Pro+ect K 5 ?/@ A E.?? -& .??A?<)F8?.@ 6 ?/@ *(3 O I&& J.-*J.--3

1E 7%8 Dnet present "alueE: for increments cash flo#s aE <iscounted N1(3 bE <iscounted N*(3

:ears :ears

&0)

/ 0 > ? 7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year

*E I&& DInternal rate of returnE: #hich is the rate of return at #hich 7%8 0 ( For pro+ect C , ,RR is calculated as below: I&& 0 @1 O G7%8@1 1 D7%8@1 - 7%8@)EI H D@) - @1E where C0 5 guess rate &depend on OPD, disocunted at given re2uired rate of return) rate C> 5 one more guess

&elationship bet#een discount rate and 7%8: in"erse relationship: Discount rate goes up Discount rate comes down OPD falls OPD goes up

Cet us assume @1 0 1(3 &why, because as could be seen at ?/@ Q discount rate OPD isAve by applying the relationship, increased disocunt rate) Cet us calculate C> 5 0?@ <iscounted N1*3 Dassumed rateE

:ears

&0)

/ 0 > ? 7%8 therefore, ,RR for Pro+ect K 5 0/@ A E?07 -& ?07A19)F80?@ 6 0/@ 1(3 O I&& )., 1).,(3 Target return 5 0/@ ,RR for incremental cash flows 5 0>!1@

since I&& for incremental cash flo#s P 4arget return/ select 1 accept %roMect ;

Question *a: >Firm should follo# a polic of "er high di"idend pa -outQ 4a!ing example of t#o organi?ation comment on this statement> Ans#er *a:
The statement not necessarily be true! Cet us ta e > companiesJ :igh di"idend pa out compan R 1((3 pa out a) Cess retained earnings b) Hlower - lower growth rate c) Cower mar et price d) Cost of e2uity &Re) N ,RR &r 5 rate of return earned by company on its investment! e) ,ndicates that company is declining!

,t must be noted that, dividend is a trade off between retaining money for capital e%penditure and issuing new shares!

Question *b: An in"estor gains nothing from bonus share >;riticall anal se the statement through some real life situation of recent past. Ans#er *b:
The statement is false! (n investor gains bonus shares at Iero cost, *owever, the mar et price of the stoc will come down & over the long period, the investor definitely ma%imiIes his wealth due to bonus shares! From company angle, bonus issue is only an accounting entry & it doesnSt change the wealth-value of the firm! Recently, Kharti (irtel have issued bonus share >:0, due to which, the investors have gained Konus shares at Iero cost & the mar et have come down to the e%tent of bonus issue & immediately went up & investors have cashed the bonus shares thus ma%imiIed their wealth! *owever, currently it is trading down due to varied reasons!

;AS5 S4K<'

Ques 1: 'ou are re=uired to ma!e these calculations and in the light thereof/ ad"ise the finance manager about the suitabilit / or other#ise/ of machine A or machine A. Solution:
Ad"ise to finance manager of Aro#n metals ltd/ to select the appropriate machine: %articulars 0) OPD >) Profitability inde% ?) Pay Kac period =) Discounted pay bac period It is ad"ised to go in for Machine A #ith enhanced capacit / #hich #ill add more "alue to the firm. 7%8 is higher in respect of Machine A as compared to Machine A S therefore machine #ith higher 7%8 needs to be in"ested. Wor!ings are as follo#s: DaE to bu machine A #hich is similar to the existing machine: :ears

&0)

/ 0 > ? = 1 7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year 0) Oet Present value 5 Present value of inflows 6 Present value of outflows 5 1) &as computed above) >) Profitability ,nde% 5 Present value of inflows - present value of outflows which should be N0 ?< - >1 1.+2 ?) Paybac period 5 Kase year A E&unrecovered cash flow of base year - cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period 5 > A E&>/-/)80>F 0 ) ears

&>1 1 >/ 0= 0=

=) Discounted Paybac period 5 Kase year A E&unrecovered disocunted cash flow of base year - disocunted cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period 5 ? A E&7-=)80>F 0*.12 ears

DbE to go in for machine A #hich is more expensi"e S has much greater capacit : :ears

&0)

/ 0 > ? = 1 7%8 8 disocunt rate computed using formule 5 0 - &0Ar) to the power nJ where r 5 disocunt rate & n 5 year 0) Oet Present value 5 Present value of inflows 6 Present value of outflows 5 1+ &as computed above) >) Profitability ,nde% 5 Present value of inflows - present value of outflows which should be N0 1= - =/ 1.*,

&=/ 0/ 0= 07 0< 01

?) Paybac period 5 Kase year A E&unrecovered cash flow of base year - cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period 5 ? A E&07-/)80>F 0 * ears

=) Discounted Paybac period 5 Kase year A E&unrecovered disocunted cash flow of base year - disocunted cash flows of ne%t year) 80>F where base year 5 year in which unrecovered cash flows turns / or Ave Paybac period 5 ? A E&<-=)80>F 0*.)1 ears

Assignment - ;
1. 4he main function of a finance manager is &a) capital budgeting &b) capital structuring &c) management of wor ing capital &d) &a),&b)and&c) Ans#er R DdE ). 5arning per share &a) refers to earning of e2uity and preference shareholders! &b) refers to mar et value per share of the company! &c) reflects the value of the firm! &d) refers to earnings of e2uity shareholders after all other obligations of the company have been met! Ans#er R DdE *. If the cut off rate of a proMect is greater than I&&/ #e ma &a) accept the proposal! &b) re+ect the proposal! &c) be neutral about it! &d) wait for the ,RR to increase and match the cut off rate! Ans#er R DbE +. ;ost of e=uit share capital is &a) e2ual to last dividend paid to e2uity shareholders! &b) e2ual to rate of discount at which e%pected dividends are discounted to determine their PD! &c) less than the cost of debt capital! &d) e2ual to dividend e%pectations of e2uity shareholders for coming year! Ans#er R DbE ,. <egree of the total le"erage D<4@E can be calculated b the follo#ing formula E'iven degree of operating leverage &D;C) and degree of financial leverage &DFC)F &a) D;C A DFC &b) D;C -DFC &c) DFC6D;C &d) D;C % DFC Ans#er R DdE -. &is!- &eturn trade off implies &a) increasing the profits of the firm through increased production &b) not ta ing any loans which increase the ris of the firm &c) ta ing decisions in a way which optimiIes the balance between ris and return &d) not granting credit to ris y customers Ans#er R DcE J. 4he goal of a firm should be &a) ma%imiIation of profit &b) ma%imiIation of earning per share &c) ma%imiIation of value of the firm &d) ma%imiIation of return on e2uity Ans#er R DcE

2. ;urrent Assets minus current liabilities is e=ual to &a) 'ross wor ing capital &b) Capital employed &c) Oet worth &d) Oet wor ing capital! Ans#er R DdE 9. &a) &b) &c) 4he indifference le"el of 5AI4 is one at #hich $PH increases $PH remains the same $PH decreases

&d) $K,T5$PH! Ans#er R DdE 1(. Mone has time "alue since &a) The value of money gets compounded as time goes by &b) The value of money gets discounted as time goes by &c) "oney in hand today is more certain than money in future &d) &b) and &c) Ans#er R DbE 11. 7et #or!ing capital is &a) e%cess of gross current assets over current liabilities &b) same as net worth &c) same as capital employed &d) same as total assets employed Ans#er R DaE 1). 4he internal rate of return of a proMect is the discount rate at #hich 7%8 is &a) positive &b) negative &c) Iero &d) negative minus positive Ans#er R DcE 1*. ;ompounding techni=ue is &a) same as discounting techni2ue &b) slightly different from discounting techni2ue &c) e%actly opposite of discounting techni2ue &d) one where interest is compounded more than once in a year! Ans#er R DcE 1+. For determining the "alue of a share on the basis of %15 ratio/ information is re=uired regarding: &a) earning per share &b) normal rate of return &c) capital employed in the business &d) contingent liabilities Ans#er R DaE 1,. 4andon committee suggested in"entor and recei"able norms for &a) 01 ma+or industries &b) >/ minor industries &c) >1 ma+or and minor industries &d) ?/ ma+or and minor industries Ans#er R DcE 1-. ;apital structure of AA; @td. consists of e=uit share capital of &s. 1/((/((( D1(/((( share of &s. 1( eachE and 23 debentures of &s. ,(/((( S earning before interest and tax is &s. )(/(((. 4he degree of financial le"erage is

(a) (b) (c)

1.00 1.25 2.50

&d) >!// Ans#er R DbE 0<! The following data is given for a company! Bnit HP 5 Rs! >, Dariable cost-unit 5 Re! /!</, Total fi%ed cost6 Rs! 0,//,/// ,nterest Charges Rs! ?,77., ;utput60,//,/// units! The degree of operating leverage is

(a) 4.00
&b) =!?? &c) =!<1 &d) 1!?? Ans#er R DbE 0.! "ar et price of e2uity share of a company is Rs! >1 and the dividend e%pected a year hence is Rs! 0/!

The e%pected rate of dividend growth is 1@! The cost of e2ual capital to company will be &a) =/@ &b) =1@ &c) ?1@ &d) 1/@ Ans#er R DbE 19. 4he dilemma of >li=uidit 8s profitabilit > arise in case of &a) Potentially sic unit &b) (ny business organiIation &c) ;nly public sector unites &d) Purely trading companies Ans#er R DbE )(. 4he present "alue of &s. 1,((( recei"able in J ears at a discount rate of 1,3 is

(a)

&b) &c) &d) Ans#er R DaE )1. A bond of &s. 1((( bearing coupon rate of 1)3 is redeemable at par in 1( rs. If the re=uired rate of return is 1(3 the "alue of bond is &a) &b)

(c)
Ans#er R DaE &d)

)). 4he 5%S of AA; @td. is &s. 1( S cost of capital is 1(3.4he mar!et price of share at return rate of 1,3 and di"idend pa out ratio of +(3 is &a) &b) &c) &d)

Ans#er R DaE

)*. 4he credit term offered b a supplier is *11( net -(.4he annuali?ed interest cost of not a"ailing the cash discount is &a) >>!1.@ &b) ><!=1@ &c) ?<!<1@ &d) ?.!1/@ Ans#er R DaE )+. 4he costliest of long term sources of finance is &a) Preference share capital &b) Retained earnings &c) $2uity share capital &d) Debentures Ans#er R DcE ),. Which of the follo#ing approaches ad"ocates that the cost of e=uit capital S debit capital remains the degree of le"erages "aries &a) Oet income approach &b) Oet operating income approach &c) Traditional approach &d) "odigliani6"iller approach Ans#er R DbE S DdE )-. &a) &b) &c) Which of the follo#ing is not a feature of an optimal capital structure. Profitability Hafety Fle%ibility

&d) Control Ans#er R DbE )J. While calculating #eighted a"erage cost of capital &a) Retained earnings are e%cluded &b) Kan borrowings for wor ing capital are included &c) Cost of issues are included &d) 3eights are based on mar et value or on boo value Ans#er R DaE )2. Which of the follo#ing factors influence the capital structure of a business entit ? &a) Kargaining power with suppliers &b) Demand for product of company &c) $%pected income &d) Technology adopted Ans#er R DcE )9. According to the Walters model/ a firm should ha"e 1((3 di"idend pa -out ratio #hen. &a) r 5 e &b) r T e &c) r N e &d) g N e Ans#er R DaE *(. 6perating c cle can be dela ed b &a) ,ncrease in 3,P period &b) Decrease in raw material storage period &c) Decrease in credit payment period &d) Koth a & c above Ans#er R DdE *1. If net #or!ing capital is negati"e/ it signifies that &a) The li2uidity position is not comfortable &b) The current ratio is less then 0 &c) Cong term uses are met out of short6 term sources &d) (ll of a, b and c above Ans#er R DdE *). Which of the follo#ing models on di"idend polic stresses on in"estors preference for the current di"idend &a) Traditional model &b) 3alters model &c) 'ordon model &d) "" model Ans#er R DdE **. Which of the follo#ing is a techni=ue for monitoring the status of recei"ables &a) ageing schedule &b) outstanding creditors &c) selection matri% &d) credit evaluation Ans#er R DaE *+. A"erage collection period is e=ual to &a) ?7/- Receivables Turnover Ratio &b) (verage Creditors - Hales per day &c) Hales - Debtors &d) Purchases - Debtors Ans#er R DaE *,. &a) &b) &c) &d) In I&&/ the cash flo#s are assumed to be rein"ested in the proMect at ,nternal rate of return cost of capital "arginal cost of capital ris free rate

Ans#er R DdE *-. In a capital budgeting decision/ incremental cash flo# mean &a) cash flows which are increasing! &b) cash flows occurring over a period of time &c) cash flows directly related to the pro+ect &d) difference between cash inflows and outflows for each and every e%penditure! Ans#er R DdE *J. 4he simple 56Q model #ill not hold good under #hich of the follo#ing conditions &a) Htochastic demand &b) constant unit price &c) Mero lead time &d) Fi%ed ordering costs Ans#er R DaE *2. 4he opportunit cost of capital refers to the &a) net present value of the investment! &b) return that is foregone by investing in a pro+ect! &c) re2uired investment in a pro+ect! &d) future value of the investments cash flows! Ans#er R DbE *9. Which of the follo#ing factors does not influence the composition of Wor!ing ;apital re=uirements &a) Oature of the business &b) seasonality of operations &c) availability of raw materials &d) amount of fi%ed assets Ans#er R DdE +(. 4he capital structure ratio measure the &a) Financial Ris &b) Kusiness Ris &c) "ar et Ris &d) operating ris s Ans#er R DaE