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Problems
Unit 1: Introduction to Financial Management
1) Find out from the following:
a) P.V. Ratio
b) Fixed cost
c) Sales volume to earn a profit of Rs.40,000
Sales
Profit
Variable Cost
Rs.1,00,000
Rs.10,000
70%
2) The sales turnover and profit during two years were as follows:
Year
Sales (Rs.)
2002
1,40,000
2003
1,60,000
You are required to calculate:
Profit (Rs.)
15,000
20,000
a) P/V Ratio
b) Sales required to earn a profit of Rs. 40,000
c) Profit when sales are Rs.1,20,000
3) From the following information, calculate the break-even point in units and in sales value:
Output
Selling price per unit
Variable Cost per unit
Total fixed cost
3,000 units
Rs.30
Rs.20
Rs.20,000
Rs.90,000
Rs.5
Rs.2
100% of Direct labour
Rs.12
a) P/V Ratio
b) Break-even point
c) Margin of safety
Total Sales
Selling price per unit
Variable Cost per unit
Fixed cost
Rs.3,60,000
Rs.100
Rs. 50
Rs.1,00,000
7) If you deposit Rs. 5,000 today at 6% rate of interest, in how many years will this amount
double?
8) Calculate the compound value of Rs. 10,000 at the end of 3 years at 12% rate of interest,
when interest is calculated on (a) yearly basis and (b) quarterly basis.
9) A company offers 12% rate of interest on deposits. What is the effective rate of interest if
the compounding is done (a) half yearly (b) quarterly and (c) monthly?
10) Mr. A deposits Rs. 1,000 at the end of every year for 4 years and the deposit earns a
compound interest @ 10% p.a. Determine how much money he will have at the end of 4
years?
11) Mr. X is to receive Rs. 5,000 after 5 years from now. His time preference from money (rate
of interest) is 10% p.a. Calculate its present value by using discount factor tables.
12) Calculate present value of the following cash flows assuming a discount rate of 10%.
Year
5,000
10,000
10,000
3,000
2,000
Rs. 6,00,000
5 years
10%
Q.4. From the following information calculate the net present value of the two projects and
suggest which of the two projects should be accepted assuming a discount rate of 10%.
Particulars
Initial investment
Estimated life
Scrap value
Project X
Rs. 20,000
5 years
Rs. 1,000
Project Y
Rs. 30,000
5 years
Rs. 2,000
The profits before depreciation and after taxes (cash flows) are as follows:
Projects
Project X
Project Y
Year 1 (Rs.)
5,000
20,000
Year 2 (Rs.)
10,000
10,000
Year 3 (Rs.)
10,000
5,000
Year 4 (Rs.)
3,000
3,000
Year 5 (Rs.)
2,000
2,000
Q.5. No project is acceptable unless the yield is 10%. Cash inflows of a certain project alongwith
cash outflows are given below:
Years
Outflows (Rs.) Inflows (Rs.)
0
1,50,000
1
30,000
20,000
2
30,000
3
60,000
4
80,000
5
30,000
The salvage value at the end of the 5th year is Rs. 40,000.
Calculate Net Present Value.
Rs. 60,000
4 years
15,000
20,000
30,000
20,000
Q.7. The initial cash outlay of a project is Rs. 50,000 and it generates cash inflows of Rs. 20,000,
Rs.15,000, Rs. 25,000 and Rs. 10,000 in four years.
Using present value index method, appraise profitability of the proposed investment assuming
10% rate of discount.
(Hint: First calculate Net present value and then calculate Profitability index)
Q.8. Using the information given below, compute the payback period under:
(a) Traditional payback method
(b) Discounted pay-back method
Initial outlay
Rs. 80,000
Estimated Life
5 years
Profit after tax:
End of 1st year
6,000
nd
End of 2 year
14,000
End of 3rd year
24,000
th
End of 4 year
16,000
th
End of 5 year
nil
Depreciation has been calculated under straight line method.
The cost of capital may be taken at 20% p.a. and the P.V. of Rupee 1 at 20% is given below:
Year
P.V. Factor
1
0.83
2
0.69
3
0.58
4
0.48
5
0.40
Q.9. X ltd. is considering the purchase of a machine. Two machines are available E and F. The cost
of each machine is Rs. 60,000. Each machine has an expected life of 5 years.
Net profits before tax and after depreciation during the expected life of the machines are given
below:
Year
Machine E (Rs.) Machine F (Rs.)
1
15,000
5,000
2
20,000
15,000
3
25,000
20,000
4
15,000
30,000
5
10,000
20,000
Total
85,000
90,000
Following the method of Average Return on Average Investment ascertain which of the
alternatives will be more profitable. The average rate of tax may be taken at 50%.
same in the future also .Compute the cost of equity capital. Will it make any difference if the
market price of equity share is Rs.160 ?s
Q.8. (a) A company plan to issue 1000 new shares of Rs.100 each at par. The floatation costs are
expected to be 5% of the share price. The company pays a dividend of Rs.10 per share initially and
the growth in dividends is expected to be 5%. Compute the cost of new issue of equity shares.
(b)If the current market price of an equity share is Rs.150, calculate the cost of existing equity
share capital.
Q.9. The shares of a company are selling at Rs.40 per share and it had paid a dividend of Rs. 4 per
share last year. The investors market expects a growth rate of 5 per cent per year.
(a) Compute the companys equity cost of capital;
(b) If the anticipated growth rate is 7 per cent per annum, calculate the indicated market price per
share.
Q.10. A firm is considering an expenditure of Rs. 60 Lakhs for expanding its operations. The
relevant information is as follows:
Number of existing equity shares
10 Lakhs
Market value of existing shares
Rs.60
Net earnings
90 Lakhs
Compute the cost of existing equity share capital and of new equity capital assuming that new
shares will be issued at a price of Rs. 52 per share and the costs of new issue will be Rs.2 per share.
Q.11. You are given the following facts about a firm:
(i) Risk-free rate of return is 11%.
(ii) Beta co-efficient, i, of the firm is 1.25.
Compute the cost of equity capital using Capital Asset pricing Model (CAPM) assuming a
market return of 15 per cent next year. What would be the cost of equity if i rises to 1.75.
Q.12. A firm has the following capital structure and after tax costs for the different sources of
funds used:
Sources of funds
Amount (Rs.)
Proportion (%)
After tax cost (%)
Debt
15,00,000
25
5
Preference shares
12,00,000
20
10
Equity shares
18,00,000
30
12
Retained earnings
15,00,000
25
11
Total
60,00,000
100
You are required to compute the weighted average cost of capital.
Q.13. Continuing the above question, if the firm has 18,000 equity shares of Rs. 100 each
outstanding and the current market price is Rs. 300 per share, calculate the market value weighted
average cost of capital assuming that the market values and book values of the debt and
preference capital are the same.
Q.14. In considering the most desirable capital structure for a company, the following estimates of
the debt and equity capital (after tax) have been made at various levels of debt-equity mix:
Debt as a percentage of total
Cost of debt Cost of
capital employed
(%)
equity (%)
0
5.00
12.00
10
5.00
12.00
20
5.00
12.50
30
5.50
13.00
40
6.00
14.00
50
6.50
16.00
60
7.00
20.00
You are required to determine the optimal debt equity mix for the company by calculating
composite cost of capital.
Q.15. The following is the capital structure of Saras Ltd. as on 31st December, 2003:
Particulars
Equity shares- 20,000 shares of Rs. 100 each
10% Preference shares of Rs. 100 each
12% Debentures
Rs.
20,00,000
8,00,000
12,00,000
40,00,000
The market price of the companys share is Rs. 110 and it is expected that a dividend of Rs.10 per
share would be declared after 1 year. The dividend growth rate is 6%.
(i) If the company is in the 50% tax bracket, compute the weighted average cost of capital
(ii) Assuming that in order to finance an expansion plan, the company intends to borrow a fund of
Rs. 20 lakhs bearing 14% rate of interest, what will be the companys revised weighted average
cost of capital? This financing decision is expected to increase dividend from Rs. 10 to Rs. 12 per
share. However, the market price of equity share is expected to decline from Rs. 110 to Rs. 105 per
share.
The companys existing earnings before interest and tax (EBIT) is Rs. 1,50,000. The corporate rate
of tax is 50%.
You are required to determine the earnings per share (EPS) in each plan and comment on the
implications of financial leverage.
Q.2. XYZ company has currently an equity share capital of Rs.40,00,000 consisting of 40,000 equity
shares of Rs.100 each. The management is planning to raise another Rs.30,00,000 to finance a
major programme of expansion through one of the four possible financing plans.
The options are:
a) Entirely through equity shares
b) Rs. 15,00,000 in equity shares of Rs.100 each and the balance in 8% debentures
c) Rs. 10,00,000 in equity shares of Rs.100 each and the balance through long-term borrowing
at 9% interest p.a.
d) Rs. 15,00,000 in equity shares of Rs.100 each and the balance through preference shares
with 5% dividend
The companys expected earnings before interest and taxes (EBIT) will be Rs.15,00,000. Assuming
corporate tax rate of 50%, you are required to determine the earnings per share (EPS) and
comment on the financial leverage that will be authorized under each of the above scheme of
financing.
Q.3. A company has sales of Rs.5,00,000, variable costs of Rs.3,00,000, fixed costs of Rs.1,00,000
and long term loans of Rs.4,00,000 at 10% rate of interest. Calculate the composite leverage.
Q.4. The following figures relate to two companies:
Particulars
Sales
Variable costs
Contribution
Fixed costs
Interest
Profit before Tax
Company A
3:1
Rs.200
4:1
66 2/3 %
45%
Company B
4:1
Rs.300
5:1
75%
45%
Company C
2:1
Rs.1,000
3:1
50%
45%