INTER C.A.

– FINANCIAL MANAGEMENT

INDEX

Sr. No Topic Page No.

1. ACCOUNTING RATIOS 1 – 11

ES
2. LEVERAGE 12 – 17
3. CAPITAL STRUCTURE 18 – 22
4. COST OF CAPITAL 23 – 28

SS
5. CAPITAL BUDGETING 29 – 34
6. ESTIMATION OF WORKING CAPITAL 35 – 48
7. RECEIVABLE MANAGEMENT
LA 49 – 58
8. CASH BUDGET 59 – 63
C
9. CAPITAL BUDGETING AND RISK ANALYSIS 64 – 66
10. LEASING 67 – 76
AH

11. DIVIDEND DECISIONS 77 – 80

SH
K
J
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

ACCOUNTING RATIOS
To be Discussed only in classroom
(Sol-1)
(a) Workings Notes:
1. Net Working Capital = Current Assets – Current Liabilities
= 2.5 – 1=1.5
Net Working Capital × 2.5
Thus, Current Assets =
1.5

ES
4,50,000×2.5
= =Rs.7,50,000
1.5
Current Liabilities = Rs. 7,50,000 – Rs. 4,50,000 = Rs. 3,00,000

SS
2. Sales = Total Assets Turnover × Total Assets
= 2 x (Fixed Assets + Current Assets)
= 2 × (Rs. 10,00,000 + Rs. 7,50,000) = Rs. 35,00,000
3. Cost of Goods Sold =
=
LA
100% – 20%= 80% of Sales
80% of Rs. 35,00,000 = Rs. 28,00,000
Cost of Good Sold
4. Average Stock =
C
Stock Turnover Ratio
Rs.28,00,000
= =Rs.4,00,000
AH

7
Closing Stock = (Average Stock ×2) – Opening Stock
= (Rs. 4,00,000 × 2) – Rs. 3,80,000 = Rs. 4,20,000
SH

Quick Assets = Current Assets – Closing Stock

= Rs. 7,50,000 – Rs. 4,20,000 = Rs. 3,30,000
Debt 1
= , Or Proprietary fund = 1.5 Debt.
Equity ( here Proprietary fund ) 1.5
K

Total Asset = Proprietary Fund (Equity) + Debt

Or 17,50,000 = 1.5 Debt + Debt
J

Rs.17,50,000
Or Debt = =Rs.7,00,000
2.5
Proprietary fund = 7,00,000 x 1.5 = Rs. 10,50,000
17,50,000×1.5
= =Rs.10,50,000
2.5

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
5. Profit after tax (PAT) = Total Assets × Return on Total Assets
= Rs. 17,50,000 × 15% = Rs. 2,62,500
(i) Calculation of Quick Ratio
Quick Assets Rs.3, 30, 000
Quick Ratio = = = 1.1:1
Current Liabilities Rs.3, 00, 000
(ii) Calculation of Fixed Assets Turnover Ratio
Sales Rs.35, 00, 000
Fixed Assets Turnover Ratio = = = 3.5
Fixed Assets Rs.10, 00, 000
(iii) Calculation of Proprietary Ratio

ES
Proprietary fund
Proprietary Ratio =
Total Assets
Rs.10,50,000
= 0.6 :1

SS
=
Rs.17, 50, 000
(iv) Calculation of Earnings per Equity Share (EPS)

LA PAT - Preference Share Dividend

Earnings per Equity Share (EPS) =
Number of Equity Shares
Rs.2,62,500-Rs.18,000 (9% of 2,00,000)
=
60, 000
C
= Rs. 4.075 per share
(v) Calculation of Price-Earnings Ratio (P/E Ratio)
AH

Market Price of Equity Share Rs.16

P/E Ratio = = = 3.926
EPS Rs.4.075
(Sol-2)
SH

Working Notes:
1. Computation of Current Assets (CA) and Current Liabilities (CL)
Current Assets
Current Ratio =
Current Liabilities
K

CA 1.5
=
CL 1
J

∴ CA = 1.5 CL
CA – CL = Rs.1,50,000
1.5 CL-CL = Rs.1,50,000
0.5 CL = Rs.1,50,000
1,50, 000
CL = = Rs.3, 00, 000
0.5
CA = 1.5 x 3,00,000 = Rs. 4,50,000

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
2. Computation of Bank Credit (BC) and Other Current Liabilities (OCL)
Bank Credit 2
=
Other CL 1
BC = 2 OCL
BC + OCL = CL
2 OCL + OCL = Rs. 3,00,000
3 OCL = Rs. 3,00,000
OCL = Rs. 1,00,000
Bank Credit = 2 × 1,00,000 = Rs. 2,00,000

ES
3. Computation of Inventory
Quick Assets
Quick Ratio =
Current Liabilities

SS
Current Assets - Inventories
=
Current Liabilities
4,50,000 - Inventories
0.8 =
Rs.3,00,000
LA
0.8 × Rs. 3,00,000 = Rs. 4,50,000 – Inventories
Inventories = Rs. 4,50,000 – Rs. 2,40,000 = Rs. 2,10,000
C
4. Computation of Debtors
Inventory Turnover = 5 times
Cost of goods sold ( COGS)
AH

Average Inventory =
Inventory Turnover
COGS = Rs. 2,10,000 × 5 = Rs. 10,50,000
Average Collection Period (ACP) = 1.5 months = 45 days
SH

360 360
Debtors Turnover = = =8
ACP 45
Sales - COGS
Gross Margin = x 100 = 25%
Sales
K

25 x Sales
Sales-COGS =
100
J

Sales – 0.25 Sales = COGS

0.75 Sales = Rs. 10,50,000
Rs.10,50,000
Sales = = Rs.14, 00, 000
0.75
Sales
Debtors =
Debtors Turnover
Rs.14,00,000
= = Rs.1, 75, 000
8

3|Page
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
5. Computation of Bank and Cash
Bank & Cash = CA - (Debtors + Inventory)
= Rs. 4,50,000 – (Rs. 1,75,000 + 2,10,000)
= Rs. 4,50,000 – 3,85,000 = Rs. 65,000
6. Computation of Reserves & Surplus
Reserves & Surplus
Bank & Cash
Reserves & Surplus = 4 × Rs. 65,000 = Rs. 2,60,000
Balance Sheet of SONA Ltd. as on March 31, 2016

ES
Liabilities Rs. Assets Rs.
Share Capital 5,75,000 Fixed Assets 6,85,000
Reserves & Surplus 2,60,000 Current Assets:

SS
Current Liabilities: Inventories 2,10,000
Bank Credit 2,00,000 Debtors 1,75,000
Other Current Liabilities 1,00,000 Bank & Cash 65,000
11,35,000
LA 11,35,000

(Sol-3)
C
Ratios for the year 2015-2016
(i) (a) Inventory turnover ratio
AH

COGS 20,860
= = = 7.91
Average Inventory ( 2,867 + 2, 407 )
2
(b) Financial leverage
SH

2015-16 2014-15
170 586
EBIT = =
= = 5 481
EBIT-I
= 2.98 = 1.22
K

(c) ROCE
J

EBIT (1-t ) 57 (1 − 0.4 ) 34.2

= = = X 100 = 0.651%
Average Capital Employed  5,947 + 4,535  5251
 
 2 
[Here Return on Capital Employed (ROCE) is calculated after Tax]
(d) ROE
Profits after tax 34 34
= = = = 1.77%
Average shareholders’ funds ( 2,377 + 1, 472 ) 1, 924.5
2

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(e) Average Collection Period*
22,165
Average Sales per day = = 60.73 lakhs
365
(1, 495 + 1,168)
Average Debtors 2 1331.5
Average collection period = = = = 22 days
Average sales per day 60.73 60.73
*Note: In the above solution, 1 year = 365 days has been assumed. Alternatively, it may
be solved on the basis of 1 year = 360 days.
(ii) Brief Comment on the financial position of JKL Ltd.

ES
The profitability of operations of the company are showing sharp decline due to increase
in operating expenses. The financial and operating leverages are becoming adverse.
The liquidity of the company is under great stress.

SS
Homework
(Sol-1) LA
Net worth = Capital + Reserves and surplus
= 4,00,000 + 6,00,000 = Rs.10,00,000
C
Total Debt 1
= =
Networth 2
∴ Total debt = Rs. 5,00,000
AH

Total Liability side = Rs. 4,00,000 + Rs. 6,00,000 + Rs. 5,00,000

= Rs. 15,00,000
= Total Assets
SH

Sales
Total Assets Turnover =
Total Assets
Sales
2 =
Rs.15,00,000
K

∴ Sales = Rs.30,00,000
Gross Profit on Sales : 30% i.e. Rs. 9,00,000
J

∴ Cost of Goods Sold (COGS) = Rs. 30,00,000 – Rs. 9,00,000

= Rs. 21,00,000
COGS
Inventory turnover =
Inventory
Rs.21,00,000
3 =
Inventory
∴ Inventory = Rs. 7,00,000

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Aerage Debtors
Average collection period =
Sales/Day
Debtors
40 =
Rs.30,00,000/360

∴ Debtors = Rs. 3,33,333.

Current Assets - Stock ( Quick Asset )
Acid test ratio =
Current liabilities
Current Assets - 7,00,000
0.75 =
Rs.5,00,000

ES
∴ Current Assets = Rs.10,75,000.
∴ Fixed Assets = Total Assets – Current Assets
= Rs. 15,00,000 – Rs. 10,75,000 = Rs. 4,25,000

SS
Cash and Bank balance = Current Assets – Inventory – Debtors
= Rs. 10,75,000 – Rs. 7,00,000 – Rs. 3,33,333 = Rs. 41,667.
Balance Sheet as on March 31, 2016
LA
Liabilities Rs. Assets Rs.
Equity Share Capital 4,00,000 Plant and Machinery and other Fixed 4,25,000
Assets
C
Reserves & Surplus 6,00,000 Current Assets:
Total Debt : Current 5,00,000 Inventory 7,00,000
AH

Liabilities
Debtors 3,33,333
Cash 41,667
15,00,000 15,00,000
SH

(Sol-2)
Gross Profit Rs. 54,000
Gross Profit Margin 20%
K

Gross Profit
∴ Sales = Rs.54,000 / 0.20 = Rs.2,70,000
Gross Profit Margin
J

Credit Sales to Total Sales = 80%

∴ Credit Sales = Rs. 2,70,000×0.80 = Rs. 2,16,000
Total Assets Turnover = 0.3 times
Sales
∴ Total Assets =
Total Assets Turnover
Rs.2,70,000
= = Rs. 9,00,000
0.3

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Sales – Gross Profit = COGS
∴ COGS = Rs. 2, 70,000 – 54,000 = Rs. 2, 16,000
Inventory turnover = 4 times
COGS 2,16,000
Inventory = = =Rs.54,000
Inventory turnover 4
Average Collection Period = 20 days
360
∴ Debtors turnover = = 360 / 20 = 18
Average Collection Period
Credit Sales Rs.2,16,000

ES
∴ Debtors = = = Rs.12,000
Debtors turnover 18
Current ratio = 1.8
Debtors + Inventory + Cash

SS
1.8 =
Creditors
1.8 Creditors = (Rs. 12,000 + Rs. 54,000 + Cash)
1.8 Creditors = Rs. 66,000 + Cash .......................... (i)
LA
Long-term Debt to Equity = 40%
Shareholders’ Funds = Rs. 6, 00,000
∴ Long-term Debt
C
= Rs. 6, 00,000 × 40% = Rs. 2, 40,000
Creditors (Balance figure) = 9, 00,000 – (6, 00,000 + 2, 40,000) = Rs. 60,000
∴ Cash = (60,000×1.8) – 66,000 = Rs. 42,000 [From equation (i)]
AH

Balance Sheet
Liabilities Rs. Assets Rs.
SH

Creditors (Bal. Fig) 60,000 Cash 42,000

Debtors 12,000
Long- term debt 2,40,000 Inventory 54,000
Shareholders’ funds 6,00,000 Fixed Assets (Bal fig.) 7,92,000
K

9,00,000 9,00,000
J

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-3)
(i) Computation of Average Inventory
Gross Profit = 25% of Rs. 30, 00,000 = Rs. 7,50,000
Cost of goods sold (COGS) = Sales - Gross Profit = Rs. 30,00,000 – Rs. 7,50,000
= Rs. 22,50,000
COGS
Inventory Turnover Ratio =
Average Inventory
Rs.22,50,000
6 =
Average Inventory

ES
Average inventory = Rs. 3,75,000
(ii) Computation of Purchases
Purchases = COGS + (Closing Stock – Opening Stock) = Rs. 22,50,000 + 80,000*

SS
Purchases = Rs. 23,30,000
* Increase in Stock = Closing Stock – Opening Stock = Rs. 80,000
(iii) Computation of Average Debtors

Let Credit Sales be Rs. 100, Cash sales =

LA 25
x 100 = Rs. 25
100
C
Total Sales = 100 + 25= Rs. 125
Total sales is Rs. 125 credit sales is Rs. 100
Rs.30, 00, 000 x 100
AH

If total sales is Rs. 30,00,000, then credit sales is =

125
Credit Sales = Rs. 24,00,000
Cash Sales = (Rs. 30,00,000 – Rs. 24,00,000) = Rs. 6,00,000
SH

Net Credit Sales Rs.24, 00, 000

Debtors Turnover Ratio = =8= =8
Average debtors Average debtors
Rs.24,00,000
Average Debtors =
8
K

Average Debtors = Rs. 3,00,000

(iv) Computation of Average Creditors
J

Credit Purchases = Purchases – Cash Purchases

= Rs. 23,30,000 – Rs. 2,30,000 = Rs. 21,00,000
Credit Purchases
Creditors Turnover Ratio =
Average Creditors
21, 00, 000
10 =
Average Creditors
Average Creditors = Rs. 2,10,000

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(v) Computation of Average Payment Period
Average Creditors
Average Payment Period =
Average Daily Credit Purchases
Rs.2,10,000 Rs.2,10,000
= =
 Credit Purchases   Rs.21,00,000 
   
 365   365 
Rs.2,10,000
= x 365* = 36.5 days
Rs.21, 00, 000
Alternatively

ES
Average Payment Period = 365/Creditors Turnover Ratio
365 *
= = 36.5 days
10

SS
(vi) Computation of Average Collection Period
Average Collection Period =
Average Debtors Rs.3, 00, 000
= x 365* = x 365 = 45.625 days ×365 *
LA
Net Credit Sales Rs.24, 00, 000
Alternatively
365*
C
Average collection period =
Debtors Turnover Ratio
365
= = 45.625 days
AH

8
* 1 year is taken as 365 days.
(vii) Computation of Current Assets
Current Assets ( CA )
SH

Current Ratio = =2.4 2.4

Current Liabilities ( CL )

2.4 Current Liabilities = Current Assets or CL = CA/2.4

Further, Working capital = Current Assets – Current liabilities
K

So, Rs. 2,80,000 = CA-CA/2.4

Rs. 2,80,000 = 1.4 CA/2.4 Or, 1.4 CA = Rs. 16,72,000
J

CA = Rs. 4,80,000
(viii) Computation of Current Liabilities
4,80,000
Current liabilities = =Rs.2,00,000
2.4

9|Page
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-4)

Cost of goods sold

(a) Inventory turnover =
Average inventory

Since gross profit margin is 15 percent, the cost of goods sold should be 85 percent of the
sales.
Cost of goods sold = 0.85 x Rs.6,40,000 = Rs.5,44,000.
Rs.5, 44,000
Thus, = =5
Average inventory
Rs.5,44,000
Average inventory = = Rs.1,08,800
5

ES
Average Receivables
(b) Average collection period = x 360 days
Credit Sales
( Opening Receivables+ Closing Receivables )
Average Receivables =

SS
2
Closing balance of receivables is found as follows:
Rs. Rs.

Less: Inventories
LA
Current assets (2.5 of current liabilities)
48,000
2,40,000

Cash 16,000 64,000

C
∴ Receivables 1,76,000

( Rs.1,76,000 + Rs. 80,000 )

Average Receivables =
2
AH

= Rs. 2,56,000 ÷2 = Rs. 1,28,000

Rs.1, 28,000
Average collection period = x 360 = 72 days
Rs.6, 40,000
SH

(Sol-5)

Long term debt Long term debt

= 0.5 =
Net Worth 2,00,000
K

Long term debt = Rs.1,00,000

J

Total liabilities and net worth = Rs.4,00,000

Total assets = Rs.4,00,000
Sales Sales
=2.5= =Sales=Rs.10,00,000
Total Assets 4,00,000

Cost of goods sold = (0.9) (Rs.10,00,000) = Rs.9,00,000

Cost of goods sold 9,00,000
= = 9 = Inventory = Rs.1,00,000
Inventory Inventory

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Receivables x 360
= 18 days
10,00,000

Receivables = Rs.50,000
Cash + 50,000
=1
1,00,000

Cash= Rs.50,000

Plant and equipment = Rs. 2,00,000.

Balance Sheet

ES
Rs. Rs.
Cash 50,000 Notes and payables 1,00,000
Accounts receivable 50,000 Long-term debt 1,00,000

SS
Inventory 1,00,000 Common stock 1,00,000
Plant and equipment 2,00,000 Retained earnings 1,00,000
Total assets 4,00,000 Total liabilities and equity 4,00,000
LA
C
AH
SH
K
J

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
LEVERAGE
TO BE DISCUSSED ONLY IN CLASSROOM
(Sol-1)
Contribution
Profit Volume Ratio = x100
Sales
Contribution
So, 25.55 = x 100 Or, Contribution = 42,00,000 x 25.55
Rs.42,00,000
Contribution = Rs.10,73,100
Income Statement

ES
Particulars (Rs.)
Sales 42,00,000
Variable Cost (Sales - Contribution) 31,26,900

SS
Contribution 10,73,100
Fixed Cost 3,48,000
EBIT LA 7,25,000
Interest 2,03,500
EBT(EBIT – Interest) 5,21,600
Tax 1,82,500
C
Profit after Tax (EBT – Tax) 3,39,040
AH

Contribution
(i) Operating Leverage =
Earnings before interest and tax ( EBIT )

Contribution Rs.10,73,100
Or, =
Contribution-Fixed Cost Rs.10,73,100 - Rs.3,48,000
SH

Rs.10,73,100
= =1.48
Rs.7,25,100
(ii) Combined Leverage = Operating Leverage x Financial Leverage
K

= 1.48 x 1.39 = 2.06

Contribution Rs.10,73,100
Or, i.e. =2.06
J

EBT Rs.5,21,600
(iii) Earnings per Share (EPS)
PAT Rs.3,39,040
EPS = = =1.3561
No. of Share Rs.2,50,000
EPS = 1.36

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-2)
Operating Leverage: Situation-I Situation-II
(Rs.) (Rs.)
Sales (S) 90,000 90,000
3000 units @ Rs. 30/- per unit
Less: Variable Cost (VC) @ Rs. 15 per unit 45,000 45,000
Contribution (C) 45,000 45,000
Less: Fixed Cost (FC) 15,000 20,000
Operating Profit (OP) 30,000 25,000

ES
(EBIT)

(i) Operating Leverage

C 45, 000 45, 000

SS
= Rs. Rs.
OP 30, 000 25, 000
= 1.5 1.8
(ii) Financial Leverages LA A (Rs.) B (Rs.)
Situation I
C
Operating Profit (EBIT) 30,000 30,000
Less: Interest on debt 2,000 1,000
PBT 28,000 29,000
AH

OP 30,000 30,000
Financial Leverage = =Rs. =1.07 Rs. =1.04
PBT 28,000 24,000
SH

A (Rs.) B (Rs.)
Situation-II
Operating Profit (OP) 25,000 25,000
(EBIT)
K

Less: Interest on debt 2,000 1,000

PBT 23,000 24,000
J

OP 25,000 25,000
Financial Leverage = =Rs. =1.09 Rs. =1.04
PBT 23,000 24,000
(iii) Combined Leverages
A B
(Rs.) (Rs.)
(a) Situation I 1.5 x 1.07 =1.61 1.5 x 1.04 = 1.56
(b) Situation II 1.8 x 1.09 =1.96 1.8 x 1.04 =1.87

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Homework
(Sol-1)
Calculation of Leverages

Particulars (Rs.)
Sales 60,00,000
 100  40,00,000
Less: Variable Cost  Sales x 
 150 
Contribution 20,00,000
Less: Fixed Cost 5,00,000

ES
EBIT 15,00,000
Less: Interest on Debentures 3,30,000
EBT 11,70,000

SS
Contribution Rs.20,00,000
Operating Leverage = = =1.3333
EBIT Rs.15,00,000

Financial Leverage =
EBIT Rs.15,00,000
=
EBT Rs.11,70,000
=1.2821
LA
Contribution
Combined Leverage = OL × FL or
C
EBT
Rs.20,00,000
= 1.3333 × 1.2821 or =1.7094
Rs.11,70,000
AH

(Sol-2)
SH

Income Statements of Company A and Company B

Company A (Rs.) Company B (Rs.)
Sales 91,000 1,05,000
Less: Variable cost 56,000 63,000
K

Contribution 35,000 42,000

Less: Fixed Cost 20,000 31,500
Earnings before interest and tax (EBIT) 15,000 10,500
J

Less: Interest 12,000 9,000

Earnings before tax (EBT) 3,000 1,500
Less: Tax @ 30% 900 450
Earnings after tax (EAT) 2,100 1,050

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Working Notes:
Company A
EBIT
(i) Financial Leverage =
EBT i.e. EBIT - Interest
EBIT
So, 5 =
EBIT-12,000
Or, 5 (EBIT – 12,000) = EBIT
Or, 4 EBIT = 60,000
Or, EBIT = Rs.15,000

ES
(ii) Contribution = EBIT + Fixed Cost
= Rs. 15,000 + Rs. 20,000 = Rs. 35,000
(iii) Sales = Contribution + Variable cost

SS
= Rs. 35,000 + Rs. 56,000
= Rs. 91,000
Company B LA
(i) Contribution = 40% of Sales (as Variable Cost is 60% of Sales)
= 40% of 1,05,000 = Rs. 42,000
C
Contribution Rs.42,000
(ii) Operating Leverage = Or, 4 =
EBIT EBIT
Rs.42,000
AH

EBIT = =Rs.10,500
4
(iii) Fixed Cost = Contribution – EBIT = 42,000 – 10,500 = Rs. 31,500
SH

(Sol-3)
Estimation of Degree of Operating Leverage (DOL), Degree of Financial Leverage (DFL) and
Degree of Combined Leverage (DCL)
K

P Q R
Output (in units) 2,50,000 1,25,000 7,50,000
Rs. Rs. Rs.
J

Selling Price (per unit) 7.50 7 10

Sales Revenues (Output × Selling 18,75,000 8,75,000 75,00,000
Price)
Less: Variable Cost (Output × 12,50,000 2,50,000 56,25,000
Variable Cost )
Contribution Margin 6,25,000 6,25,000 18,75,000
Less: Fixed Cost 5,00,000 2,50,000 10,00,000
Earnings before Interest and Tax 1,25,000 3,75,000 8,75,000

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(EBIT)
Less : Interest Expense 75,000 25,000 -
Earnings before Tax (EBT) 50,000 3,50,000 8,75,000
Contribution 5 1.67 2.14
DOL =
EBIT
EBIT 2.5 1.07 1.00
DFL =
EBT
DCL= DOL x DFL 12.5 1.79 2.14
Comment Aggressive Moderate Moderate Policy with no
Policy Policy financial leverage

ES
(Sol-4)
Sales in units 60,000 50,000

SS
(Rs.) (Rs.)
Sales Value 7,30,000 6,00,000
Variable Cost (4,80,000) (4,00,000)
Contribution
Fixed expenses
LA 2,40,000
(1,00,000)
2,00,000
(1,00,000)
EBIT 1,40,000 1,00,000
C
Debenture Interest (50,000) (50,000)
EBT 90,000 50,000
Tax @ 30% (27,000) (15,000)
AH

Profit after tax (PAT) 63,000 35,000

63, 000 35, 000

(i) Earnings per share (EPS) = = Rs.12.6 = Rs.7
SH

5, 000 5, 000
Decrease in EPS = 12.6 – 7 = 5.6
5.6
% decrease in EPS = x 100 = 44.44%
12.6
K

Contribution Rs.2,40,000 Rs.2,00,000

(ii) Operating leverage = =
EBIT Rs.1, 40, 000 Rs.1, 00, 000
J

= 1.71 2
EBIT Rs.1,40,000 Rs.1,00,000
(iii) Financial Leverage = =
EBT Rs.90,000 Rs.50,000
= 1.56 2

16 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-5)
Calculation of Operating and Financial Leverage
(Rs.)
Sales 40,00,000
Less: Variable cost 25,00,000
Contribution (C) 15,00,000
Less: Fixed cost 6,00,000
EBIT 9,00,000
Less: Interest 3,00,000
EBT 6,00,000

ES
C Rs.15,00,000
Operating leverage = = =1.67
EBIT Rs.9,00,000

SS
EBIT Rs.9,00,000
Financial leverage = = =1.50
EBT Rs.6,00,000
(Sol-6)
Workings:
EBIT
LA EBIT
(i) Financial Leverage = Or, 2 = Σ
EBIT - Interest EBIT-Rs.2,000
C
Or, EBIT = R.4,000
Contribution Contribution
(ii) Operating Leverage = Or, 3 =
AH

EBIT Rs.4, 000

Or, Contribution = Rs. 12,000
Contribution Rs.12,000
(iii) Sales = = =Rs.48,000
P/VRatio 25%
SH

(iv) Fixed Cost = Contribution – Fixed cost = EBIT

= Rs.12,000 – Fixed cost = Rs.4,000 Or, Fixed cost = Rs. 8,000
Income Statement for the year ended 31st December 2014
K

Particulars Amount (Rs.)

Sales 48,000
Less: Variable Cost (75% of Rs. 48,000) (36,000)
J

Contribution 12,000
Less: Fixed Cost (Contribution - EBIT) (8,000)
Earnings Before Interest and Tax (EBIT) 4,000
Less: Interest (2,000)
Earnings Before Tax (EBT) 2,000
Less: Income Tax @ 30% (600)
Earnings After Tax (EAT or PAT) 1,400

17 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

CAPITAL STRUCTURE
To be discussed only in classroom

(Sol-1)

Sources of Capital Plan I Plan II Plan III Plan IV

Present Equity Shares 1,00,000 1,00,000 1,00,000 1,00,000
New Issue 60,000 40,000 30,000 30,000
Equity share capital (Rs.) 16,00,000 14,00,000 13,00,000 13,00,000

ES
No. of Equity shares 1,60,000 1,40,000 1,30,000 1,30,000
12% Long term loan (Rs.) - 2,00,000 - -
9% Debentures (Rs.) - - 3,00,000 -
6% Preference Shares (Rs.) - - - 3,00,000

SS
Computation of EPS and Financial Leverage
Sources of Capital LA Plan I Plan II Plan III Plan IV
EBIT (Rs.) 4,00,000 4,00,000 4,00,000 4,00,000
Interest on 12% Loan (Rs.) - 24,000 - -
Interest on 9% debentures (Rs.) - - 27,000 -
C
EBT (Rs.) 4,00,000 3,76,000 3,73,000 4,00,000
Less : Tax@ 40% 1,60,000 1,50,400 1,49,200 1,60,000
AH

EAT (Rs.) 2,40,000 2,25,600 2,23,800 2,40,000

Less: Preference Dividends (Rs.) - - - 18,000
(a)Net Earnings available for equity shares (Rs.) 2,40,000 2,25,600 2,23,800 2,22,000
(b) No. of equity shares 1,60,000 1,40,000 1,30,000 1,30,000
SH

(c) EPS (a ÷ b) Rs. 1.50 1.61 1.72 1.71

 EBIT   EBIT  1.00 1.06 1.07 1.08
Financial leverage-   or  
 EBIT-I   EBT* 
K

* EBT is Earnings before tax but after interest and preference dividend in case of Plan IV.
Comments: Since the EPS and financial leverage both are highest in plan III, the management
J

could accept it.

18 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-2)
(i) Calculation of Leverages and Earnings per Share (EPS)
Income Statement
Particulars (Rs.)
Sales Revenue 90,00,000
Less: Variable Cost @ 60% 54,00,000
Contribution 36,00,000
Less: Fixed Cost other than Interest 10,00,000
Earnings before Interest and Tax (EBIT) 26,00,000

ES
Less: Interest (12% on Rs. 40,00,000) 4,80,000
Earnings before tax (EBT) 21,20,000
Less: Tax @ 30% 6,36,000

SS
Earnings after tax (EAT)/ Profit after tax (PAT) 14,84,000

1. Calculation of Operating Leverage (OL)

Contribution Rs.36,00,000
LA
Operating Leverage = = =1.3846
EBIT 26,00,000
2. Calculation of Financial Leverage (FL)
C
EBIT Rs.26,00,000
Financial Leverage = = =1.2264
EBT Rs.21,20,000
3. Calculation of Combined Leverage (CL)
AH

Combined Leverage = OL × FL = 1.3846 × 1.2264 = 1.6981

Contribution Rs.36,00,000
Or, = =1.6981
EBT Rs.21,20,000
SH

4. Calculation of Earnings per Share (EPS)

EAT/PAT Rs.14,84,000
EPS = = =3.71
Number of Equity Shares 4,00,000
K

(ii) Calculation of likely levels of EBIT at Different EPS

( EBIT-I )(1-T )
EPS =
Number of Equity Shares
J

(1) If EPS is Rs. 4

( EBIT-4,80,000 )(1-0.3) Rs.16,00,000
= Or, EBIT - Rs.4,80,000 =
4,00,000 0.70
EBIT – Rs. 4,80,000 = Rs. 22,85,714 Or, EBIT = Rs. 27, 65,714

19 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(2) If EPS is Rs. 2
( EBIT-Rs.4,80,000 )(1-0.3) Rs.8,00,000
2= Or, EBIT - Rs.4,80,000 =
Rs.4,00,000 0.70
EBIT – Rs. 4,80,000 = Rs. 11,42,857 Or, EBIT = Rs. 16, 22,857
(3) If EPS is Rs. Zero
( EBIT-Rs.4,80,000 )(1-0.3)
0= Or, EBIT = Rs.4,80,000
Rs.4,00,000

ES
(Sol-3)
16000000

SS
P-1 P-2
15% Deb. ESC 16000000
16000000 (1000000 x 16)
Expected EBIT
LA
= (250 x 0.10) + (450 x 0.30) + (540 x 0.50) + (630 x 0.10)
= 493 (lakh)
P-1 P-2
C
EBIT 493 493
(-) Interest (74) 50)
AH

EBT 419 443

(-) Tax (216.83) (229.25)
PAT 202.17 213.75
(-) PD - -
SH

Profit for ESH 202.17 213.75

÷ No. of equity shares 50 60
EPS 4.04 3.56
K

Homework
(Sol-1)
J

2,00,000

Plan-1 Plan-2
15% deb. 1,00,000 ESC 2,00,000
ESC 1,00,000 (2,000 x 100)
(1,000 x 100)

20 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
( x − I )(1 − t ) − PD
(1) IDP =
n
Plan-1 = Plan-2
( x − 15000 ) 0.65 ( x )0.65
=
1000 2000
0.65 x
0.65 x – 9750 =
2
1.3 x – 19500 = 0.165x
x = 30000

ES
Verification :
( 30000 − 15000 ) 0.65
Plan-1 = = 9.75
1000

SS
( 30000 ) 0.65
Plan-2 = = 9.75
2000
(2) LA
Plan-1 (u=100000) Plan-1 (u = 100000)
Sales @ 2 2,00,000 2,00,000
(-) V.C. @ 1 (1,00,000) (1,00,000)
C
C 1,00,000 1,00,000
(-) F.C. (50,000) (50,000)
EBIT 50,000 50,000
AH

(-) Int. (15,000) -

EBT 35000 50,000
(-) Tax (12,250) (17,500)
22,750 32,500
- -
SH

22,750 32,500
1000 2000
22.75 16.25

C 10, 000
K

(3) DCL = = = 2.8571

EBIT 35, 000
% ∆ in EPS
= 2.8571
J

Now, DCL =
% ∆ in sales
% ∆ in EPS
∴ DCL = = 2.8571
+20%
% ∆ in EPS = 57.1429%
∴ New EPS
= 22.75 + 57.1429%
= 35.75

21 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-2)
The capital investment can be financed in two ways i.e.
(i) By issuing equity shares only worth Rs.4.5 crore or
(ii) By raising capital through taking a term loan of Rs. 3 crores and Rs. 1.50 crores through
issuing equity shares (as the company has to comply with the 2 : 1 Debt Equity ratio
insisted by financing agencies).
In first option interest will be Zero and in second option the interest will be Rs. 36,00,000
Point of Indifference between the above two alternatives =

( EBIT -Interest ) x (1-t )

ES
EBIT1 x (1-t ) 2
=
No. of equity shares ( N1 ) No. of equity shares ( N )2

EBIT (1 − 0.50 ) ( EBIT-Rs.36,00,000 ) x (1-0.50 )

SS
Or, =
45, 00, 000 shares 15,00,000 shares
Or, 0.5 EBIT = 1.5 EBIT – Rs. 54,00,000
EBIT = Rs. 54,00,000
LA
EBIT at point of Indifference will be Rs. 54 Lakhs.
(The face value of the equity shares is assumed as Rs.10 per share. However, indifference point
C
will be same irrespective of face value per share).

(Sol-3)
AH

Computation of Rate of Preference Dividend

( EBIT-Interest )(1-t ) EBIT (1-t ) - Preference Dividend
=
No. of Equity Shares ( N1 ) No. of Equity Shares ( N 2 )
SH

( Rs.2,40,000-Rs.24,000 )(1-0.30 ) Rs.2,40,000 (1 − 0.30 ) − Preference Dividend

=
40,000 shares 40, 000 shares

Rs.2,16,000 (1-0.30 ) Rs.1,68,000 - Preference Dividend

K

=
40,000 shares 40, 000 shares
Rs. 1,51,200 = Rs. 1,68,000 – Preference Dividend
J

Preference Dividend = Rs. 1,68,000 – Rs. 1,51,200 = Rs. 16,800

Preference Dividend Rs.16,800
Rate of Dividend = x 100 = x 100 = 8.4%
Preference share capital Rs.2, 00, 000

22 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

COST OF CAPITAL

To be discussed only in classroom

(Sol-1)
Calculation of Weighted Average Cost of Capital (WACC)
Source Amount (Rs.) Weight Cost of Capital after tax WACC
Equity Capital 65,00,000 0.619 0.163 0.1009
12% Preference Capital 12,00,000 0.114 0.120 0.0137

ES
15% Redeemable Debentures 20,00,000 0.190 0.105* 0.020
10% Convertible Debentures 8,00,000 0.076 0.07** 0.0053
Total 1,05,00,000 1.0000 0.1399
* Cost of Debentures (after tax) = 15 (1 – 0.30) = 10.5% = 0.105

SS
** Cost of Debentures (after tax) = 10 (1 – 0.30) = 7% = 0.07
Weighted Average Cost of Capital = 0.1399 = 13.99%
(Note: In the above solution, the Cost of Debentures has been computed in the above manner
LA
without considering the impact of special
(Sol-2)
C
WACC
B/U
ESC 45,000 45 14% 6.30
AH

Res 15,000 15 14% 2.10

PSC 10,000 10 10% 1
SH

Deb. 30000 30 5% 1.50

100000 100 10.9%

M/U
K

ESC 67,500 48.21 14% 6.75

Res. 22,500 16.07 14% 2.25
J

PSC 15,000 10.72 10% 1.078

Deb. 35,000 25 5% 1.25
1,40,000 100 10.84%

23 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-3)
(a) The cost of Equity Capital is :
D1 Rs.2
ke = +g= + .07 = 0.1 + .07 = .17 or 17%.
P0 Rs.20

The cost of 8% debentures, after tax is 8 (1-3.3) = 5.6%

STATEMENT SHOWING WEIGHTED COST OF CAPITAL

Existing Amount After tax Cost Weights Weighted Cost

Equity share capital Rs.40,00,000 .170 .500 .0850

ES
Preference share capital 10,00,000 .060 .125 .0075
Debentures 30,00,000 .056 .375 .0210
.1135

SS
So, Weighted Average cost of capital (k0) is 11.35%.
D1 Rs.3
ke = +g= + .07 = .20 + .07 = .27 or 27%
P0 Rs.15
LA
The cost of capital of new debenture (after tax) is 10% (1-.3) = 7%.
STATEMENT SHOWING WEIGHTED AVERAGE COST OF CAPITAL

Amount After tax Cost Weights Weighted Cost

C
Equity share capital Rs.40,00,000 .270 .40 .108
6% Preference Share Capital 10,00,000 .060 .10 .006
AH

8% Debentures 30,00,000 .056 .30 .017

10% Debentures 20,00,000 .070 .20 .014
.145
SH

So, Weighted Average Cost of Capital (K0) 14.50%

D1 Rs.3
ke = +g= + .10 = .20 + .10 = .30 or 30%
P0 Rs.15
K

STATEMENT SHOWING WEIGHTED AVERAGE COST OF CAPITAL

Amount After tax Cost Weights Weighted Cost

J

Equity share capital Rs.40,00,000 .300 .40 .120

6% Preference Share Capital 10,00,000 .060 .10 .006
8% Debentures 30,00,000 .056 .30 .017
10% Debentures 20,00,000 .070 .20 .014
.157

So, Weighted Average cost of capital (K0) 15.70%

24 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-4)
Traditional Approach

0% 30% 50%
10% D= 600000 12% D = 100000
EBIT 3,00,000 3,00,000 3,00,000
(-) Int. - (60,000) (1,20,000)
NI 3,00,000 2,40,000 1,80,000
Value of firm
V=D+E

ES
Debt - 6,00,000 1,00,000
NI 18,75,000 14,11,765 9,00,000
Eq =
Ke (300000 / 15%) (24,00,000/17%) (8000

SS
V 18,75,000 20,11,765 19,00,000
EBIT 16% 14.91% 15.79%
Ko =
V

Homework
LA
(Sol-1)
C
Workings:
D1 Rs.3
(i) Cost of Equity (Ke) = +g= +0.07=0.1+0.07 =0.17=17%
AH

P0 Rs.30

(ii) Cost of Debentures (Kd) = I (1 - t) = 0.09 (1 - 0.4) = 0.054 or 5.4%

Computation of Weighted Average Cost of Capital (WACC using market value weights)
SH

Market Value of Cost of WACC

Source of capital Weight
capital (Rs.) capital (%) (%)
9% Debentures 30,00,000 0.30 5.40 1.62
12% Preference Shares 10,00,000 0.10 12.00 1.20
K

Equity Share Capital (Rs.30 × 60,00,000 0.60 17.00 10.20

2,00,000 shares)
Total 1,00,00,000 1.00 13.02
J

25 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-2)
 RV − SU 
PD +  
KP =  n
x 100
 RV + SV 
 2 

110 − 103 
12 +  
=  10 x 100
110 + 103 
 2 

ES
= 11.92%

(Sol-3)

SS
Working Notes:
Determination of Cost of capital:
(i) Cost of Debentures (Kd)

Kd =
RV-NP
I (1-t ) +
n
LA
RV+NP
2
C
Where,
I = Annual Interest Payment
AH

NP = Net proceeds of debentures net of flotation costs

RV = Redemption value of debentures
t = Income tax rate
SH

n = Life of debentures
Rs.100-Rs.96*
Rs.8 (1-0.5 ) +
20 years Rs.4.20
Kd = = =0.0429 or 4.29%
Rs.100+Rs.96* Rs.98
K

2
* Net Proceeds = Par value per shares - 4% Flotation cost per share
J

= Rs.100 – 4% of Rs.100 = Rs.96

(ii) Cost of Preference Shares (Kp)
RV-NP
PD+
Kp = n
RV+NP
2
Where,
PD = Preference Dividend per share

26 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
NP = Net proceeds of share net of flotation costs
RV = Redemption value of shares
n = Life of preference shares
Rs.100-Rs.95*
Rs.10+
15 years Rs.10.33
Kp = = =0.106 or 10.60%
Rs.100+Rs.95* Rs.97.5
2
* Net Proceeds = Par value per shares - 5% Flotation cost per share
= Rs.100 – 5% of Rs.100 = Rs.95

ES
(iii) Cost of Equity (Ke)
Expected Dividend (D1 ) Rs.2
Ke = + Growth rate ( g ) = +0.05=0.15 or 15%
Current market price ( P0 ) Rs.22-Rs.2

SS
(i) Computation of Weighted Average Cost of Capital based on Book Value Weights
Source of Book Value Weights to Total After tax Cost of WACC
Capital (Rs.) Capital capital (%) (%)
Debentures
Preference
8,00,000
LA
0.40 4.29 1.716

2,00,000 0.10 10.60 1.060

Shares
C
Equity Shares 10,00,000 0.50 15.00 7.500
20,00,000 1.00 10.276
AH

(ii) Computation of Weighted Average Cost of Capital based on Market Value Weights
Market Value Weights to Total After tax Cost of WACC
Source of Capital
(Rs.) Capital capital (%) (%)
SH

Debentures (8,000 units ×

8,80,000 0.2651 4.29 1.137
Rs.110)
Pref. Shares (2,000 shares
2,40,000 0.0723 10.60 0.766
× Rs.120)
Equity Shares (1,00,000
K

22,00,000 0.6626 15.00 9.939

shares × Rs.22)
33,20,000 1.00 11.842
J

27 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-4)
Pattern of raising Capital:
Portion of Debt = Rs. 20,00,000 × 25% = Rs. 5,00,000 and
Portion of Equity = Rs. 20,00,000 × 75% = Rs. 15,00,000, of this Rs. 4,00,000 is from retained
earnings and Rs.11,00,000 by issuing fresh equity shares.
Total Interest (1-t )
(i) Cost of Debt (Kd) =
Debt
(10% of Rs.2,00,000+13% of Rs.3,00,000 )(1 − 0.3) Rs.59, 000 (1 − 0.3)
= = = 0.0826 or 8.26%
Rs.5, 00, 000 Rs.5, 00, 000

ES
EPS x Payout ratio (1 + g )
(ii) Cost of Equity (Ke) = +g
P0

Rs.12 x 0.5 (1 + 0.1)

SS
= + 0.1 = 0.11 + 0.10 = 0.21 or 21%
Rs.60
Cost of retained earnings (Ks) = Ke (1 – tp) = 0.21(1 ƒ{ 0.2) = 0.168 or 16.8%
(iii) Weighted average cost of capital (Ko)
Source of Amount
LA
Proportion of total Cost of Capital WACC
capital (Rs.) Capital (%) (%)
C
Equity Capital 11,00,000 0.55 21.00 11.550
Retained earning 4,00,000 0.20 16.80 3.360
Debt 5,00,000 0.25 8.26 2.065
AH

Total 20,00,000 1.00 16.975

SH
K
J

28 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

CAPITAL BUDGETING
To be discussed only in classroom

(Sol-1)
(i) Net Present Value at different discounting rates
Project 0% 10% 15% 30% 40%
Rs. Rs. Rs. Rs. Rs.
C 8,000 4,139 2,654 -632 - 2,158
{Rs. 2,000 x {Rs. 2,000 x {Rs. 2,000 x {Rs. 2,000
{Rs. 2,000

ES
0.909 0.8696 0.7692 x0.7143
+Rs. 4,000 x + Rs. 4,000 x + Rs. 4,000 x + Rs. 4,000 x
+Rs. 4,000
0.8264 0.7561 0.5917 0.5102
+Rs. 12,000 x + Rs. 12,000 x +Rs. 12,000 x + Rs. 12,000 x

SS
+Rs. 12,000
0.7513 0.6575 0.4552 0.3644
-Rs. 10,000} - Rs. 10,000} - Rs. 10,000} - Rs. 10,000} - Rs. 10,000}
Ranking I I II II II
D 6,000

{Rs. 10,000
LA
3,823
{Rs. 10,000 x
2,937
{Rs. 10,000 x
833
{Rs. 10,000 x
- 233
{Rs. 10,000 x
0.909 0.8696 0.7692 0.7143
+Rs. 3,000 x +Rs. 3,000 x + Rs. 3,000 x +Rs. 3,000 x
C
+Rs. 3,000
0.8264 0.7561 0.5917 0.5102
+Rs. 3,000 x +Rs. 3,000 x + Rs. 3,000 x +Rs. 3,000 x
+Rs. 3,000
0.7513 0.6575 0.4552 0.3644
AH

- Rs. 10,000} - Rs. 10,000} - Rs. 10,000} - Rs. 10,000} - Rs. 10,000}
Ranking II II I I I
SH

The conflict in ranking arises because of skewness in cash flows. In the case of Project C
cash flows occur later in the life and in the case of Project D, cash flows are skewed
towards the beginning.
At lower discount rate, project C’s NPV will be higher than that of project D. As the
K

discount rate increases, Project C’s NPV will fall at a faster rate, due to compounding
effect.
J

After break even discount rate, Project D has higher NPV as well as higher IRR.
(ii) If the opportunity cost of funds is 10%, project C should be accepted because the firm’s
wealth will increase by Rs. 316 (Rs. 4,139 - Rs. 3,823)

29 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

The following statement of incremental analysis will substantiate the above point.
Cash Flows (Rs. )
NPV at 10%
Project C0 C1 C2 C3 IRR 12.5%
Rs.
Rs. Rs. Rs. Rs.
C- D 0 - 8,000 1,000 9,000 316 0
{- 8,000 x 0.909 {- 8,000 x 0.88884
+1,000 x 0.8264 + 1,000 x 0.7898
+ 9,000 x 0.7513} + 9,000 x 0.7019}

Hence, the project C should be accepted, when opportunity cost of funds is 10%.

ES
(Sol-2)
(i) Estimation of net present value (NPV) of the Project ‘P’ and ‘J ’ using 15% as the

SS
hurdle rate:
NPV of Project ‘P’ :

= −40, 000 +
13, 000
(1.15)
1
+
8, 000
(1.15)
2
+
14, 000
(1.15 )
3
LA
+
12, 000
(1.15)
4
+
11, 000
(1.15)
5
+
15, 000
(1.15)
6

= - 40,000 + 11,304.35 + 6,049.15 + 9,205.68 + 6,861.45 + 5,469.37 + 6,485.65

C
= Rs. 5,375.65 or Rs. 5,376
NPV of Project ‘J’
AH

7, 000 13, 000 12, 000

= −20, 000 + 1
+ 2
+ 3
(1.15 ) (1.15 ) (1.15 )
= - 20,000 + 6,086.96 + 9,829.87 + 7,890.58
SH

= Rs. 3,807.41
(ii) Estimation of internal rate of return (IRR) of the Project ‘P’ and ‘J’
Internal rate of return r (IRR) is that rate at which the sum of cash inflows after
discounting equals to the discounted cash out flows. The value of r in the case of given
K

projects can be determined by using the following formula:

CF0 CF1 CFn SV + WC
J

CO0 = 0
+ 1
+−−−−−+ n
+ n
(1 + r ) (1 + r ) (1 + r ) (1 + r )
Where,
C0 = Cash flows at the time O
CFt = Cash inflow at the end of year t
r = Discount rate
n = Life of the project
SV & WC = Salvage value and working capital at the end of n years.

30 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

In the case of project ‘P’ the value of r (IRR) is given by the following relation:
13, 000 8, 000 14, 000 12, 000 11, 000 15, 000
40,000 = 1
+ 2
+ 3
+ 4
+ 5
+ 6
(1 + r % ) (1 + r % ) (1 + r % ) (1 + r % ) (1 + r % ) (1 + r % )
r = 19.73%
Similarly we can determine the internal rate of return for the project ‘J’. In the case of
project ‘J’ it comes to:
r = 25.20%
(iii) The conflict between NPV and IRR rule in the case of mutually exclusive project situation

ES
arises due to re-investment rate assumption. NPV rule assumes that intermediate cash
flows are reinvested at k and IRR assumes that they are reinvested at r. The assumption
of NPV rule is more realistic.

SS
(iv) When there is a conflict in the project choice by using NPV and IRR criterion, we would
prefer to use “Equal Annualized Criterion”. According to this criterion the net annual cash
inflow in the case of Projects ‘P’ and ‘J’ respectively would be:
Project ‘P’
LA
= (Net present value/ cumulative present value of Re.1 p.a. @15% for
6 years)
= (Rs. 5,375.65 / 3.7845) = Rs. 1,420.44
C
Project ‘J’ = (Rs. 3807.41/2.2832) = Rs. 1667.58
Advise : Since the cash inflow per annum in the case of project ‘J’ is more than that of project ‘P’,
AH

so Project J is recommended.

(Sol-3)
SH

(i) Computation of NPV and IRR

For Project A:
Years Cash flows Rs.000 PVF 10% P.V. ‘000 PVF 20% P.V. ‘000
0 -500 1.00 -500.00 1.00 -500.00
K

1 85 0.91 77.35 0.83 70.55

2 200 0.83 166.00 0.69 138.00
J

3 240 0.75 180.00 0.58 139.20

4 220 0.68 149.60 0.48 105.60
5 70 0.62 43.40 0.41 28.70
NPV +116.35 -17.95

NPV of Project A at 10% (Cost of Capital) is Rs. 1,16,350.

IRR of Project A may be calculated by interpolation method as under:

31 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

NPV at 20% is (-) 17.95 (Rs. Rs.000)

NPV at 10% is + 116.35 (Rs. Rs.000)
116.35
∴ IRR = 10 + ( 20-10 ) %=18.66%
116.35- ( -17.95 )

For Project B:
Years Cash flows (Rs.’000) PVF 10% P.V. (Rs. ‘000) PVF 20% P.V. (Rs. ‘000)
0 -500 1.00 -500 1.00 -500
1 480 0.91 436.80 0.83 398.40

ES
2 100 0.83 83.00 0.69 69.00
3 70 0.75 52.50 0.58 40.60
4 30 0.68 20.40 0.48 14.40
5 20 0.62 12.40 0.41 8.20

SS
NPV +105.10 + 30.60

NPV of Project B at 10% (Cost of Capital) is Rs. 1,05,100.

LA
IRR of Project B is calculated by interpolation method as under:
NPV at 10% = + 105.10 (Rs. Rs.000)
NPV at 20% = + 30.60 (Rs. Rs.000)
C
105.10
IRR = 10 + ( 20 − 10 ) % = 24.10
105.10 − 30.60
AH

(Note: Though in above solution discounting factors of 10% and 20% have been used.
However, instead of 20%, students may assume any rate beyond 20%, say 26%, and then
NPV becomes negative. In such a case, the answers of IRR of Project may slightly vary
SH

from 24.10%.)
(ii) The ranking of the projects will be as under:
NPV IRR
Project A 1 2
K

Project B 2 1
J

There is a conflict in ranking. IRR assumes that the project cash flows are reinvested at
IRR whereas the cost of capital is 10%. The two projects are mutually exclusive. In the
circumstances, the project which yields the larger NPV will earn larger cash flows. Hence
the project with larger NPV should be chosen. Thus Project A qualifies for selection.
(iii) Inconsistency in ranking arises because if NPV criterion is used, Project A is preferable. If
IRR criterion is used, Project B is preferable. The inconsistency is due to the difference in
the pattern of cash flows.

32 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

Where an inconsistency is experienced, the projects yielding larger NPV is preferred

because of larger cash flows which it generates. IRR criterion is rejected because of the
following reasons:
(a) IRR assumes that all cash flows are re-invested at IRR.
(b) IRR is a percentage but the magnitude of cash flow is important.
(c) Multiple IRR may arise if the projects have non-conventional cash flows.

(Sol-4)

ES
(a) Working Notes:
1. Annual Depreciation of Machines
Rs.8,00,000-Rs.20,000
Depreciation of Machine ‘MX’ = = Rs.1,30, 000

SS
6
Rs.10,20,000-Rs.30,000
Depreciation of Machine ‘MY ’= = Rs.1, 65, 000
6
1. Calculation of Cash Inflows LA Years
Machine ‘MX’
1 2 3 4 5 6
C
Income before Depreciation &
2,50,000 2,30,000 1,80,000 2,00,000 1,80,000 1,60,000
Tax
Less: Depreciation 1,30,000 1,30,000 1,30,000 1,30,000 1,30,000 1,30,000
AH

Profit before Tax 1,20,000 1,00,000 50,000 70,000 50,000 30,000

Less : Tax @ 30% 36,000 30,000 15,000 21,000 15,000 9,000
Profit after Tax (PAT) 84,000 70,000 35,000 49,000 35,000 21,000
SH

Add: Depreciation 1,30,000 1,30,000 1,30,000 1,30,000 1,30,000 1,30,000

Cash Inflows 2,14,000 2,00,000 1,65,000 1,79,000 1,65,000 1,51,000

Years
Machine ‘MY’
K

1 2 3 4 5 6
Income before Depreciation &
2,70,000 3,60,000 3,80,000 2,80,000 2,60,000 1,85,000
Tax
J

Less: Depreciation 1,65,000 1,65,000 1,65,000 1,65,000 1,65,000 1,65,000

Profit before Tax 1,05,000 1,95,000 2,15,000 1,15,000 95,000 20,000
Less : Tax @ 30% 31,500 58,500 64,500 34,500 28,500 6,000
Profit after Tax (PAT) 73,500 1,36,500 1,50,500 80,500 66,500 14,000
Add: Depreciation 1,65,000 1,65,000 1,65,000 1,65,000 1,65,000 1,65,000
Cash Inflows 2,38,500 3,01,500 3,15,500 2,45,500 2,31,500 1,79,000

33 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

(i) Calculation of Payback Period

Cumulative Cash Inflows
Years
1 2 3 4 5 6
Machine ‘MX’ 2,14,000 4,14,000 5,79,000 7,58,000 9,23,000 10,74,000
Machine ‘MY’ 2,38,500 5,40,000 8,55,500 11,01,000 13,32,500 15,11,500

Pay-back Period for ‘MX’

( 8, 00, 000 − 7, 58, 000 )

ES
=4+
1, 65, 000
= 4.25 years or 4 years and 3 months.
Pay-back Period for ‘MY’

SS
(10, 20, 000 − 8,55, 500 )
=3+ = 3 + 0.67 = 3.67 years
2, 45, 500

(ii)
Or, 3 years and 8 months.
Calculation of Net Present Value (NPV)
LA
Machine ‘MX’ Machine ‘MY’
C
PV Cash Inflows Present Value Cash Inflows Present Value
Year
Factor Rs. Rs. Rs. Rs.
0 1.000 (8,00,000) (8,00,000) (10,20,000) (10,20,000)
AH

1 0.909 2,14,000 1,94,526 2,38,500 2,16,797

2 0.826 2,00,000 1,65,200 3,01,500 2,49,039
3 0.751 1,65,000 1,23,915 3,15,500 2,36,941
SH

4 0.683 1,79,000 1,22,257 2,45,500 1,67,677

5 0.621 1,65,000 1,02,465 2,31,500 1,43,762
6 0.564 1,51,000 85,164 1,79,000 1,00,956
Scrap Value 0.564 20,000 11,280 30,000 16,920
K

Net Present
4,807 1,12,092
Value (NPV)
J

(iii) Recommendation
Machine Rs.MX’ Machine Rs.MY’
Ranking according to Pay-back Period II I
Ranking according to Net Present Value (NPV) II I
Advise: Since Machine Rs.MY’ has higher ranking than Machine Rs.MX’ according to both
parameters, i.e. Payback Period as well as Net Present Value, therefore, Machine Rs.MY’ is
recommended.

34 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

ESTIMATION OF WORKING CAPITAL

To be discussed only in classroom

(Sol-1)
Working Notes:
1. Raw material inventory: The cost of materials for the whole year is 60% of the Sales value.
60
Hence it is 60,000 units x Rs. 5 x = Rs. 1,80,000. The monthly consumption of raw
100
material would be Rs. 15,000. Raw material requirements would be for two months; hence
raw materials in stock would be Rs. 30,000.

ES
2. Work-in-process: (Students may give special attention to this point). It is stated that each unit
of production is expected to be in process for one month).
Rs.
(a) Raw materials in work-in-process (being one

SS
month’s raw material requirements) 15,000
(b) Labour costs in work-in-process 1,250
(It is stated that it accrues evenly during the month. Thus, on the first day
LA
of each month it would be zero and on the last day of month the
work-in-process would include one month’s labour costs. On an
C
average therefore, it would be equivalent to ½ of the
 10% of ( 60, 000 x Rs.5 ) 
month’s labour costs)  x 0.5 month 
AH

 12 months 
(c) Overheads
(For ½ month as explained above) 2,500
SH

 20% of ( 60,000 x Rs.5 ) 

 x 0.5 month  Total work-in process 18,750
 12 months 
3. Finished goods inventory:
K

(3 month’s cost of production)

 60% of ( 60, 000 xRs.5 ) 
Raw materials  x 3 months  45,000
12 mnonths
J

 
 10% of ( 60, 000 x Rs.5 ) 
Labour  x 3 months  7,500
 12 months 
 20% of ( 60, 000 x Rs.5 ) 
Overheads  x 3 months  15,000 67,500
 12 months 

35 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
4. Debtors: The total cost of sales = 2,70,000.
3
Therefore, debtors = Rs.2,70,000 × = Rs.67,500
12
Total Cost of Sales = RM + Wages + Overheads + Opening Finished goods inventory –
Closing finished goods inventory.
= Rs.1,80,000 + Rs.30,000 + Rs.60,000 + Rs.67,500 – Rs.67,500 = Rs.2,70,000.
5. Creditors: Suppliers allow a two months’ credit period. Hence, the average amount of
creditors would be two months consumption of raw materials i.e.
 60% of ( 60, 000 x Rs.5) 

ES
 x 2 months  = Rs.30, 000
 12 months 
 10% of ( 60, 000 x Rs.5 ) 
6. Direct Wages payable:  x 1 month  = Rs.2,500

SS
 12 months 
 20% of ( 60,000 xRs.5 ) 
7. Overheads Payable:  x 1 month  = Rs.5,000
 12 months 
LA
Here it has been assumed that inventory level is uniform throughout the year, therefore
opening inventory equals closing inventory.
C
Statement of Working Capital Required:
------------------------------------------------------------------------------------------------------------------------------------------------
Rs. Rs.
AH

------------------------------------------------------------------------------------------------------------------------------------------------
Current Assets
Raw materials inventory (Refer to working note 1) 30,000
SH

Debtors (Refer to working note 2) 67,500

Working–in-process (Refer to working note 3) 18,750
Finished goods inventory (Refer to working note 4) 67,500
Cash 20,000 2,03,750
K

Current Liabilities
Creditors (Refer to working note 5) 30,000
J

Direct wages payable (Refer to working note 6) 2,500

Overheads payable (Refer to working note 7) 5,000 37,500
Estimated working capital requirements 1,66,250
------------------------------------------------------------------------------------------------------------------------------------------------

36 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-2)
Preparation of Statement of Working Capital Requirement for MNP Company Ltd.
(Rs.) (Rs.)
A. Current Assets
(i) Inventories :

 Rs.9, 00, 000  75,000

Material (1 month)  x 1 month 
 12 months 
Finished goods (1 month) 2,20,000

ES
 1
 26, 40, 000 x 
 12 
(ii) Receivables (Debtors)

SS
 1 1,68,333
For Domestic Sales  20, 20, 000 x 
 12 

 3 2,52,500
For Export Sales  10,10, 000 x 
 12  LA
(iii)  Rs.1,50, 000  37,500
Prepayment of Sales promotion expenses  x 3 months 
 12 months 
C
(iii) Cash in hand and at bank 1,75,000
Total Current Assets 9,47,759
AH

B. Current Liabilities :
(i)  Rs.9,00,000  1,50,000
Payables (Creditors) for materials (2 months)  x 2 months 
 12 months 
(ii)  Rs.7,20,000  30,000
SH

Outstanding wages (0.5 months)  x 0.5 month 

 12 months 
(iii)  Rs.10,20,000  85,000
Outstanding manufacturing expenses  x 1 month 
 12 months 
K

(iv)  Rs.2,40,000  20,000

Outstanding administrative expenses  x 1 month 
 12 months 
J

(v) Income tax payable 56,250

Total Current Liabilities 3,41,250
Net Working Capital (A-B) 6,06,509
Add : 12% Contingency margin 72,781
Total Working Capital Required 6,79,290

37 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Working Note :
1. Calculation of Cost of Goods Sold and Cost of Sales
Domestic Export Total (Rs.)
(Rs.) (Rs.)
Domestic Sales 24,00,000 10,80,000 34,80,000
Less : Gross Profit @ 20% on domestic sales and 11.11% on export (4,80,000) (1,20,000) (6,00,000)
sales (Working Note-2)
Cost of Goods Sold 19,20,000 9,60,000 28,80,000
Add : Sales promotion expenses (Working Note-3) 1,03,448 46,552 1,50,000

ES
Cash Cost of Sales 20,23,448 1,06,552 30,30,000

2. Calculation of gross profit on Export Sales :

SS
Let domestic selling price is Rs.100. Gross profit is Rs.20, and then cost per unit is Rs.80.
Export price is 10% less than the domestic price i.e. Rs.100- (1-0.1) = Rs.90.
Now gross profit will be Rs.90-Rs.80=Rs.10. LA Rs.10
Therefore Gross profit at domestic price will be x 100 = 10%.
Rs.100
Rs.10
C
Or , gross profit at export price will be x 100 = 11.11%.
Rs.90
3. Apportionment of Sales Promotion expenses between Domestic and Exports Sales :
AH

Apportionment on the basis of sales value :

Rs.1,50,000
Domestic Sales = x Rs.24,00,000 =Rs.1,03,448
Rs.34,80, 000
SH

Rs.1,50,000
Export Sales = x 10,80,000 = Rs.46,552
Rs.34,80, 000
4. Assumptions
(i) It is assumed that administrative expenses relating to production activities.
K

(ii) Value of opening and closing stocks are equal.

J

38 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-3)
Calculation of Net Working Capital requirement:
(Rs.) (Rs.)
A. Current Assets:
Inventories:
- Raw material stock (Refer to Working note 3) 6,64,615
- Work in progress stock (Refer to Working note 2) 5,00,000
- Finished goods stock(Refer to Working note 4) 13,60,000
Receivables (Debtors) (Refer to Working note 5) 25,40,769

ES
Cash and Bank balance 25,000
Gross Working Capital 50,60,384 50,60,384
B. Current Liabilities:
Creditors for raw materials (Refer to Working note 6) 7,15,740

SS
Creditors for wages (Refer to Working note 7) 91,731
8,07,471 8,07,471
Net Working Capital (A - B) 42,52,913

Working Notes:
LA
1. Annual cost of production
C
(Rs.)
Raw material requirements {(1,04,000 units × Rs. 80)+ Rs.3,20,000} 86,40,000
AH

Direct wages {(1,04,000 units × Rs. 30) + Rs.60,000} 31,80,000

Overheads (exclusive of depreciation) {(1,04,000 × Rs. 60)+ Rs.1,20,000} 63,60,000
Gross Factory Cost 1,81,80,000
SH

Less: Closing W.I.P (5,00,000)

Cost of Goods Produced 1,76,80,000
Less: Closing Stock of Finished Goods (Rs.1,76,80,000 × 8,000/1,04,000) (13,60,000)
Total Cash Cost of Sales 1,63,20,000
K

2. Work in progress stock

(Rs.)
J

Raw material requirements (4,000 units × Rs. 80) 3,20,000

Direct wages (50% × 4,000 units × Rs. 30) 60,000
Overheads (50% × 4,000 units × Rs. 60) 1,20,000
5,00,000

39 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
3. Raw material stock
It is given that raw material in stock is average 4 weeks consumption. Since, the
company is newly formed, the raw material requirement for production and work in
progress will be issued and consumed during the year.
Hence, the raw material consumption for the year (52 weeks) is as follows:
(Rs.)
For Finished goods (1,04,000 × Rs. 80) 83,20,000
For Work in progress (4,000 × Rs. 80) 3,20,000
86,40,000

ES
Rs.86,40,000
Raw material stock x 4 weeks i.e. Rs.6,64,615
52 weeks

SS
4. Finished goods stock: 8,000 units @ Rs. 170 per unit = Rs. 13,60,000
8
5. Debtors for sale: 1,63,20,000 x = Rs.25,10,769
52
6. Creditors for raw material:
LA
Material Consumed (Rs. 83,20,000 + Rs. 3,20,000) Rs. 86,40,000
Add: Closing stock of raw material Rs. 6,64,615
C
Rs. 93,04,615
Rs.93,04,615
Credit allowed by suppliers = x 4 weeks = Rs.7,15,740
AH

52 weeks
7. Creditors for wages
Rs.93,04,615
Outstanding wage payment = x 1.5 weeks= Rs.91,731
SH

52 weeks
K
J

40 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Homework
(Sol-1)
Statement of Working Capital requirements (cash cost basis)
(Rs.) (Rs.)
A. Current Asset
Inventory:
 Rs.9,00,000 
Raw materials :  x 1 month  75,000
 12 months 

ES
 Rs.25,80,000 
Finished Goods :  x 1 month  2,15,000
 12 months 
 Rs.29,40,000 
Receivables (Debtors) :  x 2 months  4,90,000
 12 months 

SS
Sales Promotion expenses paid in advance
 Rs.1,20,000 
 x 3 months  30,000
 12 months  LA
Cash balance 1,00,000 9,10,000
Gross Working Capital 9,10,000
C
B. Current Liabilities:
AH

Payables:
 Rs.9,00,000 
Creditors for materials  x 2 months  1,50,000
 12 months 
SH

 Rs.7,20,000 
Wages outstanding  x 1 month  60,000
 12 months 
Manufacturing expenses outstanding
 Rs.9,60,000 
K

 x 1 month  80,000
 12 months 
Administrative expenses outstanding
J

 Rs.2,40,000 
 x 1 month  20,000 3,10,000
 12 months 

Net working capital (A - B) 6,00,000

Add: Safety margin @ 20% 1,20,000
Total Working Capital requirements 7,20,000

41 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Working Notes:
(i) Computation of Annual Cash Cost of Production (Rs.)
Material consumed 9,00,000
Wages 7,20,000
Manufacturing expenses 9,60,000
Total cash cost of production 25,80,000
(ii) Computation of Annual Cash Cost of Sales: (Rs.)
Cash cost of production as in (i) above 25,80,000
Administrative Expenses 2,40,000

ES
Sales promotion expenses 1,20,000
Total cash cost of sales 29,40,000

Since, the cash manufacturing expenses is already given in the question hence, the amount of

SS
depreciation need not to be computed. However, if it were required to be then it could be
computed as follows:

Sales
LA (Rs.)
36,00,000
Less: Gross profit (25% of Rs.36,00,000) (9,00,000)
C
Cost of Production (including depreciation) 27,00,000
Less: Cash Cost of Production (as calculated above) (25,80,000)
Depreciation (Balancing figure) 1,20,000
AH

(Sol-2)
SH

(a) Computation of Operating Cycle

(1) Raw Material Storage Period (R)
Average Stock of Raw Material
Raw Material Storage Period (R) =
Daily Average Consumption of Raw Material
(1,80, 000 + 2, 00, 000 ) / 2 = 63.33 Days
K

=
10,80, 000 / 360
Raw Material Consumed = Opening Stock + Purchases – Closing Stock
J

= 1,80,000 + 11,00,000 – 2,00,000 = Rs.10,80,000

(2) Conversion/Work-in-Process Period (W)
Average Stock of WIP
Conversion/Processing Period =
Daily Average Production Cost

=
( 60, 000 + 1, 00, 000 ) / 2 = 18.7 days
15, 40, 000 / 360

42 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Production Cost:
Opening Stock of WIP = 60,000
Add: Raw Material Consumed = 10,80,000
Add: Wages = 3,00,000
Add: Production Expenses = 2,00,000
16,40,000
Less: Closing Stock of WIP = 1,00,000
Production Cost 15,40,000
(3) Finished Goods Storage Period (F)
Average Stock of Finished Goods
Finished Goods Storage Period =
Daily Average Cost of Goods Sold
( 2, 60, 000 + 3, 00, 000 ) / 2 = 67.19 Days

ES
=
15, 00, 000 / 360
Cost of Goods Sold Rs.
Opening Stock of Finished Goods 2,60,000
Add: Production Cost 15,40,000

SS
18,00,000
Less: Closing Stock of Finished Goods 3,00,000
15,00,000
(4) Debtors Collection Period (D) LA
Debtors Collection Period =
Average Debtors
=
(1,50, 000 + 2, 00, 000 ) / 2 = 31.5 Days
Daily Average Sales 20,00, 000 / 360
(5) Creditors Payment Period (C)
C
Average Creditors
Creditors Payment Period =
Daily Average Purchase
( 2, 00, 000 + 2, 40, 000 ) / 2 =
AH

= 72 Days
11,00, 000 / 360
(6) Duration of Operating Cycle (O)
O = R+W+F+D–C
= 63.33 + 18.7 + 67.19 + 31.5 – 72
SH

= 108.73 days
Computation of Working Capital
(i) Number of Operating Cycles per Year
= 360/Duration Operating Cycle = 360/108.72 = 3.311
(ii) Total Operating Expenses Rs.
K

Total Cost of Production 15,00,000

Add: Administration Expenses 1,75,000
Selling Expenses 75,000
J

17,50,000

(iii) Working Capital Required

Total Operating Expenses
Working Capital Required =
Number of Operating Cycles per year
17,50,000
= =Rs.5,28,541
3.311
[Note : The solution can also be solved by taking of 365 days a year.]

43 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-3)
Estimation of Working Capital Needs
(Amount in Rs.) (Amount in Rs.)
A. Current Assets
(i) Inventories:
Raw material (4 weeks)
 78, 000 units x Rs.117 
 x 4 weeks  7,02,000
 52 weeks 

ES
WIP Inventory (2 weeks)
 78, 000 units x Rs.117 
- Material  x 2 weeks  x 0.80 2,80,800
 52 weeks 

SS
- Labour and Overheads (other than depreciation) 5,13,000
 78, 000 units x Rs.129 
 x 2 weeks  x 0.60
 52 weeks 
Finished goods (3 weeks)
 78, 000 units x Rs.246 
LA
 x 3 weeks  11,07,000 26,02,800
 52 weeks 
C
(ii) Receivables (Debtors) (6 weeks)
 78, 000 units x Rs.246  4
 x 6 weeks  x 17,71,200
  5th
AH

52 weeks
(iii) Cash and bank balance 2,50,000
Total Current Assets 43,43,200
SH

B. Current Liabilities:
(i) Payables (Creditors) for materials (8 weeks)
 78, 000 units x Rs.117 
 x 8 → weeks  14,04,000
 52 weeks 
K

(ii) Outstanding wages (1 week)

 78, 000 units x Rs.49 
 x 1 week  73,500
J

 52 weeks 
(iii) Outstanding overheads (2 weeks)
 78, 000 units x Rs.80 
 x 2 weeks  2,40,000
 52 weeks 
Total Current Liabilities 17,17,500
Net Working Capital Needs (A – B) 26,25,700

44 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-4)
Working Notes:
1. Raw material inventory: The cost of materials for the whole year is 60% of the Sales
value.
54,000 units x ( 60% of Rs.200 )
= x 2 months = Rs.10,80,000
12 months
2. Work-in-process: (Each unit of production is expected to be in process for one month):
(Rs.)

ES
(a) Raw materials in work-in-process (being one month’s raw
material requirements) 5,40,000
(b) Labour costs in work-in-process

SS
 54,000 units x (10% of Rs.200 ) 
 x 1 month  x 0.5 45,000
 12 months 
(c) Overheads
 54,000 units x ( 20% of Rs.200 )

12 months
LA 
x 1 month  x 0.5 90,000
 
C
6,75,000

54,000 units x ( 90% of Rs.200 )

AH

3. Finished goods inventory: x 1 month = Rs.8,10,000

12 months
54,000 units x ( 90% of Rs.200 )
4. Receivables: x 1.5 month = Rs.12,15,000
12 months
SH

54,000 units x ( 60% of Rs.200 )

5. Payable to suppliers: x 1 month = Rs.5,40,000
12 months
54,000 units x (10% of Rs.200 )
6. Direct Wages payable: x 1 month = Rs.90,000
K

12 months
Calculation of Working Capital Requirement
J

(Rs.) (Rs.)
A. Current Assets
(i) Inventories:
- Raw Materials 10,80,000
- Work-in-process 6,75,000
- Finished goods 8,10,000 25,65,000
(ii) Receivables 12,15,000
(iii) Cash in hand (40% of Rs.6,30,000) 2,52,000

45 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Total Current Assets 40,32,000
B. Current Liabilities:
(i) Payables for raw materials 5,40,000
(ii) Direct wages payables 90,000
6,30,000
Net Working Capital (A – B) 34,02,000
Add: Safety margin (15% of Net Working Capital) 5,10,300
Working capital requirement 39,12,300

(Sol-5)

ES
Effect of Alternative Working Capital Policies

SS
Working Capital Policy Conservative Moderate Aggressive
(Rs.) (Rs.) (Rs.)
Sales 20,00,000 20,00,000 20,00,000
Earnings before Interest and Taxes
(EBIT)
LA 2,00,000 2,00,000 2,00,000

Current Assets 5,00,000 4,00,000 3,00,000

Fixed Assets 5,00,000 5,00,000 5,00,000
C
Total Assets 10,00,000 9,00,000 8,00,000
*Return on Total Assets (EBIT÷ Total 20% 22.22% 25%
AH

Assets)
Current Assets/Fixed Assets 1.00 0.80 0.60

The aforesaid calculation shows that the conservative policy provides greater liquidity
SH

(solvency) to the firm, but lower return on total assets. On the other hand, the aggressive policy
gives higher return, but low liquidity and thus is very risky. The moderate policy generates
return higher than Conservative policy but lower than aggressive policy. This is less risky than
K

aggressive policy but more risky than conservative policy.

In determining the optimum level of current assets, the firm should balance the
J

profitability – solvency tangle by minimizing total costs – Cost of liquidity and cost of illiquidity.
PAT
*Normally we use ROTA = x 100 but in this sum we assume EBIT = PAT.
TA

46 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-6)
Statement showing W.C. requirement
--------------------------------------------------------------------------------------------------------------------------
Particulars Amount (Rs.)
--------------------------------------------------------------------------------------------------------------------------
Current Assets :
Stock :
Raw material (800000 x 3/17) 2,00,000
WIP -

ES
F.G. 3,25,000
Debtors (2440000 x 15/12) 3,05,000
Cash 60,000

SS
(A) 8,90,000
Current Liabilities :
Creditors (800000 + 200000 x 4/12) 3,33,333
O/S Wages (600000 x 1/12) LA 50,000
O/S O/H (F + A + S) (1365000 x 0.5/12) 36,875
(B) (4,40,208)
W.C. requirement (A-B) 90% 4,.49,792
C
(+) Safety Margin 10% 49,977
100% 4,99,769
AH

--------------------------------------------------------------------------------------------------------------------------
W.N.
Material 8,00,000 (20 x 40,000)
SH

(+) Wages 6,00,000 (15 x 40,000)

(+) FOH (V) 6,00,000 (15 x 40,000)
(F) 6,00,000 (10 x 60,000)
COP 26,00,000
K

(+) Op. Stock FG -

 26, 00, 000 
(-) Closing Stock – FG  x 5000  (3,05,000)
 40, 000 
J

COG 22,75,000
(+) S&D
(V) 1,05,000 (3 x 35,000)
(F) 60,000 (1 x 60,000)
COS 24,40,000
--------------------------------------------------------------------------------------------------------------------------

47 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-7)
Statement of Working Capital
--------------------------------------------------------------------------------------------------------------------------
Particulars Amount (Rs.)
--------------------------------------------------------------------------------------------------------------------------
Current Assets :
Stock
R/M (6,00,000 x 2/12) 50,000
FG (166,80,000 x 1/12) 1,40,000

ES
Cash balance 80,000
Debtors (1905000 x 2/12) 3,17,500
Prepaid Sales Exp. (75000 x 3/12) 18,750

SS
(A) 6,06,250
Current Liabilities :
Creditors (6,00,000 x 2/12) 1,00,000
O/S Wages (4,80,000 x 1/12)
LA 40,000
O/S Manufacturing Exps. (6,00,000 x 1/12) 50,000
O/S Admin. Exp. (1,50,000 x 1/12) 12,500
C
(B) (2,02,500)
Working Capital 4,03,750
AH

(+) SM @ 10% 40,375

W.C.R. 4,44,125
W.N.1 : Cost Structure
SH

Material 6,00,000
(+ Wages 4,80,000
(+) Manufacturing Exps. 6,00,000
K

COP 16,80,000
(+) Admin. Exps. 1,50,000
(+) Sales Exps. 75,000
J

COS 19,05,000

48 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

RECEIVABLE MANAGEMENT

To be discussed only in classroom

(Sol-1)
Statement showing the Evaluation of Proposal
Particulars Rs.
A. Expected Profit:
Net Sales 1,00,000
Less: Production and Selling Expenses @ 80% 80,000

ES
Profit before providing for Bad Debts 20,000
Less: Bad Debts @10% 10,000
Profit before Tax 10,000

SS
Less: Tax @ 50% 5,000
Profit after Tax 5,000
B. Opportunity Cost of Investment in Receivables 2,500
C. Net Benefits (A – B)
LA 2,500

Advise: The sales manager’s proposal should be accepted.

C
Working Note: Calculation of Opportunity Cost of Funds
Collection period Required Rate of Return
Opportunity Cost = Total Cost of Credit Sales x x
AH

12 100
1.5 25
= Rs.80,000 x x =Rs.2,500
12 100
Statement showing the Acceptable Degree of Risk of Non-payment
SH

Particulars Required Rate of Return

30% 40% 60%
Sales 1,00,000 1,00,000 1,00,000
Less: Production and Sales Expenses 80,000 80,000 80,000
K

Profit before providing for Bad Debts 20,000 20,000 20,000

Less: Bad Debts (assume X) X X X
J

Profit before tax 20,000 – X 20,000 – X 20,000 – X

Less: Tax @ 50% (20,000 – X) 0.5 (20,000 – X) 0.5 (20,000 – X) 0.5
Profit after Tax 10,000 –0.5X 10,000 –0.5X 10,000 –0.5X
Required Return (given) 30% of 10,000* 40% of 10,000* 60% of 10,000*
= Rs. 3,000 = Rs. 4,000 = Rs. 6,000

49 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Collection period
*Average Debtors = Total Cost of Credit Sales x
12
1.5
= Rs.80,000 x = Rs.10, 000
12
Computation of the value and percentage of X in each case is as follows:
Case I 10,000 – 0.5x = 3,000
0.5x = 7,000
X = 7,000/0.5 = Rs. 14,000
Bad Debts as % of sales = Rs. 14,000/Rs.1,00,000 x 100 = 14%

ES
Case II 10,000 – 0.5x = 4,000
0.5x = 6,000
X = 6,000/0.5 = Rs. 12,000

SS
Bad Debts as % of sales = Rs. 12,000/Rs.1,00,000 x 100 = 12%
Case III 10,000 – 0.5x = 6,000
0.5x = 4,000 LA
X = 4,000/0.5 = Rs. 8,000
Bad Debts as % of sales = Rs. 8,000/Rs.1,00,000 x 100 = 8%
C
Thus, it is found that the Acceptable Degree of risk of non-payment is 14%, 12% and 8% if
required rate of return (after tax) is 30%, 40% and 60% respectively.
AH

(Sol-2)
Statement Showing Evaluation of Credit Policies
(Rs. in lakhs)
SH

Current Option I
Option II (2 Option III
Particulars position (1.5 months) (3 months)
(1 month) months)
Sales 200 210 220 250
K

Contribution @ 40% 80 84 88 100

Increase in contribution over current - 4 8 20 (A)
J

level
Debtors = 1x200 1.5x210 2x220 3x250
=16.67 =16.67 =36.67 =62.50
 Average Collection period x Credit Sale  12 12 12 12
 
 12 

Increase in debtors over current - 9.58 20.00 45.83

level
Cost of funds for additional amount - 1.92 4.00 9.17 (B)
of debtors @ 20%

50 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Credit administrative cost 1.20 1.30 1.50 3.00
Increase in credit administration cost - 0.10 0.30 1.80 (C)
over present level
Bad debts 4.00 5.25 6.60 12.50
Increase in bad debts over current - 1.25 2.60 8.50 (D)
levels
Net gain/loss A – (B + C + D) - 0.73 1.10 0.53

Advise: It is suggested that the company JKL Ltd. should implement Option II with a net gain of
Rs.1.10 lakhs which has a credit period of 2 months.

ES
(Sol-3)
In this case, the contribution is 20% i.e., (Rs.1,000 – Rs.800) on Rs.1,000.

SS
Increase of sales by 25% on Rs.48,00,000 (Rs.1,000 x 400 x 12 months) = Rs.12,00,000. The 20%
contribution on Rs.12,00,000 = Rs.2,40,000
LA Old Customers Only new
customers
Contribution on Additional Sales Rs.2,40,000 Rs.2,40,000
C
Present average receivable (1/12 of 4,00,000 -
Rs.48,00,000)
Revised average receivable 10,00,000 2,00,000
AH

(1/6 of (1/6 of Rs.12,00,000)

Rs.60,00,000)
Increased receivable 6,00,000 2,00,000
- Contribution @ 20% 1,20,000 40,000
SH

Investment in receivable 4,80,000 1,60,000

+ Increase in stock 2,00,000 2,00,000
6,80,000 3,60,000
K

- Increase in creditors 1,00,000 1,00,000

Additional working capital 5,80,000 2,60,000
J

Desired Return on additional WC @ 40% 2,32,000 1,04,000

Contribution on additional sales 2,40,000 2,40,000
Net contribution 8,000 1,36,000

Though both schemes are acceptable, but margin is better in second scheme.

51 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(Sol-4)
Analysis of the receivables of Jackson Company by the bank in order to identify acceptable
collateral for a short-term loan:
(i) The Jackson Company’s credit policy is 2/10 net 30.
The bank lends 80 per cent on accounts where customers are not currently overdue and
where the average payment period does not exceed 10 days past the net period i.e. thirty
days. From the schedule of receivables of Jackson Company Account No. 91 and Account
No. 114 are currently overdue and for Account No. 123 the average payment period
exceeds 40 days. Hence Account Nos. 91, 114 and 123 are eliminated. Therefore, the
selected Accounts are Account Nos. 74, 107, 108 and 116.
(ii) Statement showing the calculation of the amount which the bank will lend on a
pledge of receivables if the bank uses a 10 per cent allowances for cash discount

ES
and returns
Account No. Amount (Rs.) 90 per cent of amount (Rs.) 80% of amount (Rs.)
(a) (b)=90% of (a) (c)=80% of (b)

SS
74 25,000 22,500 18,000
107 11,500 10,350 8280
108 2,300 2,070 1,656
116 29,000 LA 26,100 20,880
Total loan amount 48,816

(Sol-5)
C
New level of sales will be 15,00,000 x 1.15 = Rs. 17,25,000
Variable costs are 80% x 75% = 60% of sales
Contribution from sales is therefore 40% of sales
AH

Fixed Cost are 20 % x 75% = 15% of sales

Particulars Rs. Rs.
Proposed investment in debtors = Variable Cost + Fixed
SH

Cost* = (17,25,000 x 60%) + (15,00,000 x 15%)

60 2,10,000
= (10,35,000 + 2,25,000) x
360
Current investment in debtors = [(15,00,000 x 60%) + (15,00,000 x 15%)] x 93,750
30
K

360
Increase in investment in debtors 1,16,250
J

Increase in contribution = 15% x 15,00,000x 40% 90,000

New level of bad debts = (17,25,000x 4% ) 69,000
Current level of bad debts (15, 00,000 x 1%) 15,000
Increase in bad debts (54,000)
Additional financing costs = 1,60,274x 12% = (13,950)
Savings by introducing change in policy 22,050
* Fixed Cost is taken at existing level in case of proposed investment as well
Advise: Mosaic Limited should introduce the proposed policy.

52 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Homework
(Sol-1)
Statement showing Evaluation of Credit Policies
Present Policy Proposed Policy
Particulars
(1 month) (2 months)
A. Expected Profit:
(a) Net Credit Sales (Sales units × Rs. 40) 8,40,000 9,07,200
(b) Less: Total Cost:
Variable (Sales units × Rs. 25) 5,25,000 5,67,000

ES
Fixed Cost 2,10,000 2,10,000
7,35,000 7,77,000
(c) Expected Profit [(a)-(b)] 1,05,000 1,30,200
B. Opportunity Cost of Investment in Receivables 15,313 32,375

SS
C. Net Benefits [A-B] 89,687 97,825

Recommendation: Proposed Policy should be implemented since the net benefit under this
LA
policy are higher than those under present policy.
Working Note: Calculation of Opportunity Cost
C
Collection Period
Opportunity Cost = Total Cost x x Rate of Return
12
1 25
AH

Present Policy = Rs.7,35,000 x x =Rs.15,313

2 100
2 25
Present Policy = Rs.7,77,000 x x =Rs.32,375
12 100
SH

(Sol-2)
Interest Rate = 24% p.a.
Interest Rate for 30 Days
= 24 x 30/365 = 1.9726%
K

Hence, value of Re today will become 1.019726 after 30 days


∴ PV today = . = 0.780656
J

Hence discount rate to be offered today for RS 1 to be received after 30 days

= 1 – 0.980656 = 0.019344 @ 1.93%
(Sol-3)
Working Notes:-
Average level of Receivables = 12,00,000 x 90/360 3,00,000
Factoring Commission = 3,00,000 x 2/100 6,000
Factoring Reserve = 3,00,000 x 10/100 30,000

53 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Amount Available for Advance = Rs. 3,00,000-(6,000+30,000) 2,64,000
Factor will deduct his interest @ 16% :-
Rs.2,64,000x16x90
Interest = =Rs.10,560
360x100

Advance to be paid = Rs. 2,64,000 – Rs. 10,560 = Rs. 2,53,440

Statement Showing Evaluation of Factoring Proposal

Particulars Rs.

ES
A. Annual Cost of Factoring to the Firm:
Factoring Commission (Rs. 6,000 x 360/90) 24,000
Interest Charges (Rs. 10,560 x 360/90) 42,240

SS
Total 66,240
B. Firm’s Savings on taking Factoring Service: Rs.
Cost of Administration Saved 50,000

Total
LA
Cost of Bad Debts (Rs. 12,00,000 × 1.5/100) avoided 18,000
68,000
C. Net Benefit to the Firm (Rs. 68,000 – Rs. 66,240) 1,760
C
(Sol-4)
Statement showing evaluation of Credit Po
AH

Particulars Present 30 days A 45 days B 60 days C 75 days E 90 days

Exp. Profit
Sales 5000000 56000000 6000000 6200000 6300000
SH

(-) V.C.@ 80% (4000000) (4480000) (4800000) (4960000) (5040000)

(-) F.C. (600000) (600000) (600000) (600000) (600000)
400000 520000 600000 640000 660000
(-) COID (W.N.1) (76667) (127000) (180000) (231667) (282000)
K

N.B. 323333 393000 420000 408333 378000

COID
J

Present : 10 = 383333
C = 76667 (383333 x 20%)
A : ID = 635000 (5080000 x 45/350)
C = 127000 (688000 x 20%)
B : ID = 900000 (5000000 x 60/365)
C = 180000 (900000 x 20%)
C : ID = 1158333 (5560000 x 75/360)

54 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
C = 231667 (1158333 x 20%)
D : ID = 1410000 (5640000 x 20/360)
C = 282000 (1410000 x 20%)
It is advisable to consider Policy B

(Sol-5)

ES
A. Statement showing the Evaluation of Debtors Policies (Total Approach)
Present Proposed Proposed Proposed Proposed
Particulars Policy 30 Policy A 40 Policy B 50 Policy C 60 Policy D 75

SS
days days days days days
Rs. Rs. Rs. Rs. Rs.
A. Expected Profit:
(a) Credit Sales
(b) Total Cost other
6,00,000
LA
6,30,000 6,48,000 6,75,000 6,90,000

than Bad Debts

C
(i) Variable Costs 4,00,000 4,20,000 4,32,000 4,50,000 4,60,000
[Sales x Rs. 2/Rs.
3]
AH

(ii) Fixed Costs 50,000 50,000 50,000 50,000 50,000

4,50,000 4,70,000 4,82,000 5,00,000 5,10,000
(c) Bad Debts 6,000 9,450 12,960 20,250 27,600
SH

(d) Expected Profit 1,44,000 1,50,550 1,53,040 1,54,750 1,52,400

[(a) – (b) – (c)]
B. Opportunity Cost 7,500 10,444 13,389 16,667 21,250
of Investments in
Receivables
K

C. Net Benefits (A – 1,36,500 1,40,106 1,39,651 1,38,083 1,31,150

B)
J

Recommendation: The Proposed Policy A (i.e. increase in collection period by 10 days or total
40 days) should be adopted since the net benefits under this policy are higher as compared to
other policies.
Working Notes:
(i) Calculation of Fixed Cost
= [Average Cost per unit – Variable Cost per unit] x No. of Units sold

55 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
= [Rs. 2.25 - Rs. 2.00] x (Rs. 6,00,000/3)
= Rs. 0.25 x 2,00,000 = Rs. 50,000
(ii) Calculation of Opportunity Cost of Average Investments
Collection period Rate of Return
Opportunity Cost = Total Cost x x
360 100
30 20
Present Policy = 4,50,000 x x =7,500
360 100
40 20
Policy A = 4,70,000 x x =10,444
360 100

ES
50 20
Policy B = 4,82,000 x x =13,389
360 100
60 20
Policy C = 5,00,000 x x =16,667

SS
360 100
75 20
Policy D = 5,10,000 x x =21,250
360 100
B. Another method of solving the problem is Incremental Approach. Here we assume that
LA
sales are all credit sales.
Present Proposed Proposed Proposed Proposed
Particulars Policy 30 Policy A 40 Policy B 50 Policy C 60 Policy D 75
C
days days days days days
Rs. Rs. Rs. Rs. Rs.
A. Incremental
AH

Expected Profit:
(a) Incremental 30,000 48,000 75,000 90,000
Credit Sales
(b) Incremental Costs
SH

(i) Variable Costs 4,00,000 20,000 32,000 50,000 60,000

(ii) Fixed Costs 50,000 - - - -
(c) Incremental Bad 6,000 3,450 6,960 14,250 21,600
Debt Losses
(d) Incremental 6,550 9,040 10,750 8,400
Expected Profit (a
K

– b –c)]
B. Required Return
on Incremental
J

Investments:
(a) Cost of Credit 4,50,000 4,70,000 4,82,000 5,00,000 5,10,000
Sales
(b) Collection period 30 40 50 60 75
(c) Investment in 37,500 52,222 66,944 83,333 1,06,250
Receivable (a x
b/360)
(d) Incremental - 14,722 29,444 45,833 68,750
Investment in
Receivables

56 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(e) Required Rate of 20 20 20 20
Return (in %)
(f) Required Return - 2,944 5,889 9,167 13,750
on Incremental
Investments (d x
e)
C. Net Benefits (A – - 3,606 3,151 1,583 5,350
B)

Recommendation: The Proposed Policy A should be adopted since the net benefits under this
policy are higher than those under other policies.

ES
C. Another method of solving the problem is by computing the Expected Rate of Return.
Incremental Expected Profit
Expected Rate of Return = x100
Incremental Investment in Receivables

SS
Rs.6,550
For Policy A = x100=44.49%
Rs.14,722

For Policy B =
LA
Rs.9,040
Rs.29,444
x100=30.0%

Rs.10,750
For Policy C = x100=23.45%
C
Rs.45,833
Rs.8,400
For Policy D = x100=12.22%
AH

Rs.68,750
Recommendation: The Proposed Policy A should be adopted since the Expected Rate of Return
(44.49%) is more than the Required Rate of Return (20%) and is highest among the given
SH

policies compared.

(Sol-6)
Statement showing evaluation of credit policy
K

(in Lakh Rs.)

Particulars Present (20 d) P-I (30 d) P-II (40 d) P-III (50 d) P-IV (60 d)
J

EP
Saus 60 65 70 74 75
(-) V.C.@70% (42) (45.5) (49) (51.8) (52.5
(-) F.C. (8) (8) (3) (8) (8)
10 11.5 15 14.2 14.5
(-) COID (0.600) (1.115) (1.583) (2.076) (2.520)
N.B. 9.306 10.385 11417 12.124 18.979

57 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
COID : Present : 10 : 42 + 8 = 50 x 20/360 = 2.778
(=2.778 x 25% = 0.694)
P-I : ID = 45 : 5 + 8 = 53.5% 30.360 = 4.458
(4.458 x 25% = 1.115)
P-II : ID = 49 + 8 = 57 x 40/360 = 6.33
(= 6.33 x 25% = 1.583
P-III : ID = 541.8 + 8 = 59.6 x 50/360 = 8.306
(= 8.306 x 25% = 2.076)

ES
P-IV : ID = 52.5 + 8 = 60.5 x 60/360 = 10.083
(= 10.083 x 25% = 2.521)
Company should consider policy III, (50 d credit) as it will give higher N.B.

SS
(Sol-7)
Statement showing evaluation of Credit Policy
(in lakh Rs.)

Particulars
EP
LA
Present P-I P-2

Sales 87.5 105 118

C
(-) VC @70% (61.25) (735) (82.6)
(-) Bad Debts (2.63) (5.25) (7.88)
23.62 26.25 27.52
AH

(-) COID (W.N.1) (2.625) (4.2) (5.90)

N.B. 20.995 22.05 21.62
SH

COID
Present : ID = 8.75
C = 2.625 (8.75 x 30%)
P-1 : ID = 14 (73.5 x 1/525)
K

C = 4.2 (14 x 30%)

P-II : ID = 19.67 (82.6 x
J

C = 5.90 (19.67 x 50%)

58 | P a g e
J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
CASH BUDGET
To be discussed only in classroom

(Sol-1)
Workings: Rs. in ‘000
(1) Payments to creditors: Jan. 2014 Feb.2014 March, 2014
Cost of Sales 1,635 1,405 1,330
Add Closing Stocks 1,200 1,100 1,000
2,835 2,505 2,330

ES
Less: Opening Stocks 1,300 1,200 1,100
Purchases 1,535 1,305 1,230
Add: Trade Creditors, Opening balance 2,110 2,000 1,950

SS
3,645 3,305 3,180
Less: Trade Creditors, closing balance 2,000 1,950 1,900
Payment 1,645 1,355 1,280
(2) Receipts from debtors:
Debtors, Opening balances
LA 2,570 2,600 2,500
Add: Sales 2,100 1,800 1,700
4,670 4,400 4,200
C
Less: Debtors, closing balance 2,600 2,500 2,350
Receipt 2,070 1,900 1,850
AH

CASH BUDGET
(a) 3 months ending 31st March, 2014 (Rs., in 000’s)
SH

January, 2014 Feb. 2014 March, 2014

Opening cash balances 545 315 65
Add: Receipts:
From Debtors 2,070 1,900 1,850
K

Sale of Investments — 700 —

Sale of Plant — — 50
Total (A) 2,615 2,915 1,965
J

Deduct: Payments
Creditors 1,645 1,355 1,280
Expenses 255 210 195
Capital Expenditure — 800 —
Payment of dividend — 485 —
Purchase of investments 400 — 200
Total payments (B) 2,300 2,850 1,675
Closing cash balance (A - B) 315 65 290

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(b) Statement of Sources and uses of Funds for the Three Month Period Ending 31st
March, 2014
Sources: Rs. ‘000 Rs. ‘000
Funds from operation:
Net profit 390
Add: Depreciation 180 570
Sale of plant 50
620
Decrease in Working Capital 665

ES
Total 1,285
0BUses:
Purchase of plant 800
Payment by dividends 485

SS
Total 1,285

Statement of Changes in Working Capital

LA
January,14 March, 14 Increase Decrease
Rs. 000 Rs. 000 Rs. 000 Rs. 000
Current Assets
C
Cash in hand and at Bank 545 290 255
Short term Investments 300 200 100
AH

Debtors 2,570 2,350 220

Stock 1,300 1,000 300
4,715 3,840
Current Liabilities
SH

Trade Creditors 2,110 1,900 210 —

Other Creditors 200 200 — —
Tax Due 320 320 — —
2,630 2,420
K

Working Capital 2,085 1,420

Decrease 665 665
J

2,085 2,085 875 875

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(Sol-2)
Projected Profit and Loss Account for the year 3
Year 2 Year 2
Year 3 Year 3
Actual Actual
Projected Projected
(Rs. in (Rs. in
(Rs. in lakhs) (Rs. in lakhs)
lakhs) lakhs)
To Materials 350 420 By Sales 1,000 1,200
consumed
To Stores 120 144 By Misc. 10 10
Income

ES
To Mfg. Expenses 160 192
To Other expenses 100 150
To Depreciation 100 100
To Net profit 180 204

SS
1,010 1,210 1,010 1,210

Cash Flow:
LA (Rs. in lakhs)
Profit 204
Add: Depreciation 100
C
304
Less: Cash required for increase in stock 50
AH

Net cash inflow 254

Available for servicing the loan: 75% of Rs. 2,54,00,000 or Rs. 1,90,50,000
Working Notes:
SH

(i) Material consumed in year 2: 35% of sales.

35
Likely consumption in year 3 : Rs.1,200 x or 420 (lakhs)
100
K

(ii) Stores are 12% of sales, as in year 2.

(iii) Manufacturing expenses are 16% of sales.
J

Note : The above also shows how a projected profit and loss accounts is prepared.

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Homework
(Sol-1)
Cleared Funds Forecast
11 Jan
7 Jan 14 8 Jan 14 9 Jan 14 10 Jan 14
14
(Monday) (Tuesday) (Wednesday) (Thursday) (Friday)
Rs. Rs. Rs. Rs. Rs.
Receipts
W Ltd 1,30,000 0 0 0 0

ES
X Ltd 0 0 0 1,80,000 0
(a) 1,30,000 0 0 1,80,000 0
Payments
A Ltd 45,000 0 0 0 0

SS
B Ltd 0 0 75,000 0 0
C Ltd 0 0 95,000 0 0
Wages 0 0 0 0 12,000
Salaries
Petty Cash
56,000
200
LA 0
0
0
0
0
0
0
0
Stationery 0 0 300 0 0
C
(b) 1,01,200 0 1,70,300 0 12,000
Cleared excess Receipts 28,800 0 (170,300) 80,000 (12,000)
over payments (a) – (b)
AH

Cleared balance b/f 200,000 228,800 228,800 58,500 238,500

Cleared balance c/f (c) 2,28,800 2,28,800 58,500 2,38,500 2,26,500
Uncleared funds float
SH

Receipts 180,000 180,000 180,000 0 0

Payments (170,000) (170,300) 0 (6,500) (6,500)
(d) 10,000 9,700 180,000 (6,500) (6,500)
Total book balance c/f (c) + 2,38,800 2,38,500 2,38,500 2,32,000 2,20,000
(d)
K
J

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(Sol-2)
Workings:
Collection from debtors:
(Amount in Rs. )
February March April May June July August September
Total sales 1,20,000 1,40,000 80,000 60,000 80,000 1,00,000 80,000 60,000
Credit sales (80% 96,000 1,12,000 64,000 48,000 64,000 80,000 64,000 48,000
of total sales)
Collections: One 72,000 84,000 48,000 36,000 48,000 60,000 48,000
month

ES
Two months 24,000 28,000 16,000 12,000 16,000 20,000
Total collections 1,08,000 76,000 52,000 60,000 76,000 68,000

SS
Monthly Cash Budget for Six months, April to September, 2014
(Amount in Rs. )
Receipts: April May June July August September
Opening balance
Cash sales
20,000
16,000
LA
20,000
12,000
20,000
16,000
20,000
20,000
20,000
16,000
20,000
12,000
Collection from debtors 1,08,000 76,000 52,000 60,000 76,000 68,000
C
Total cash available (A) 1,44,000 1,08,000 88,000 1,00,000 1,12,000 1,00,000
Payments:
Purchases 48,000 64,000 80,000 64,000 48,000 80,000
AH

Wages & salaries 9,000 8,000 10,000 10,000 9,000 9,000

Interest on debentures 3,000 — — 3,000 — —
Tax payment — — — 5,000 — —
SH

Total payments (B) 60,000 72,000 90,000 82,000 57,000 89,000

Minimum cash balance 20,000 20,000 20,000 20,000 20,000 20,000
desired
Total cash needed (C) 80,000 92,000 1,10,000 1,02,000 77,000 1,09,000
Surplus - deficit (A-C) 64,000 16,000 (22,000) (2,000) 35,000 (9,000)
K

Investment/financing
Temporary Investments (64,000) (16,000) — — (35,000) —
J

Liquidation of temporary — — 22,000 2,000 — 9,000

investments or temporary
borrowings
Total effect of (64,000) (16,000) 22,000 2,000 (35,000) 9,000
investment/financing (D)
Closing cash balance (A+D- 20,000 20,000 20,000 20,000 20,000 20,000
B)

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CAPITAL BUDGETING AND RISK ANALYSIS

To be discussed only in classroom

(Sol-1)
Sensitivity Analysis
Note :
Base NPV
Year CF DF @ 10% PV
1 20000 (60-40) = 400000 0.9091 3,63,640

ES
2 30000 (60-40) = 600000 0.8264 4,95,840
3 30000 (60-40) = 600000 0.7513 450180
1310260
(-) PV (0.(1000000)

SS
NPV 310260

Sensitivity Analysis LA
(a) ↓ 10%)
S.P. (↓
C
Year CF DF @ 10% PV
1 20000 (54-40) = 280000 0.9091
2 30000 (54-40) = 420000 0.6264
AH

3 30000 (54-40) = 420000 0.7513 917182

(-) (1000000)
npv 82818
SH

310260 − ( 82818 )
% of Sens = x 100
310260
= 126.69%
K

(b) ↑ 10%)
Unit Cost (↑
Year CF DF @ 10% PV
J

1 20000 (60-44) = 320000 0.9091

2 30000 (60-44) = 480000 0.8264
3 30000 (60-44) = 480000 0.7513 1048208
(1000000)
48208

310260 − 48208
% of Sens = x 100 = 84.46%
310260

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(c) ↓ 10%)
Sales Volume (↓
Year CF DF @ 10% PV
1 18000 (60-40) = 360000 0.9091
2 27000 (60-40) = 540000 0.8264
3 27000 (60-40) = 540000 0.7513 1179234
(1000000)
179234

310260 − 179234
% of Sens : = x 100 = 42.23%

ES
310260
(d) ↑ 10%)
Initial Invt (↑
Revised NPV = 310260 – 1000000

SS
= 210260
310260 − 210260
% of Sens = x 100
310260

(e)
= 32.23%
Project Life Time
LA
C
Year Disc. CF/PV CCF
1 363640 363640
AH

2 495840 859480
3 450780

140580
SH

= 2 years + (1000000 = 859480)

450780
= 2.31 years
3 − 2.31
% of Sens = x 100 = 23%
3
K

(Sol-2) The Risk Adjusted Discount Rate (RADR) is determined by the following formula:
RADR = Rf + [Rj X (k-Rf)]
J

where Rf = Risk free rate

k = Cost of capital
Rj = Risk index for the project
Calculation of Risk Adjusted Discount Rate (RADR):
Zeta-10= 10 + [1.80 X (.15-.10)] = 0.19 or 19%
Meta-10= 10 + [1.00 X (.15-.10)] = 0.15 or 15%
Neta-10= 10 + [0.60 X (.15- 10)] = 0.13 or 13%

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Calculation of Risk Adjusted NPV
Zeta - 10
Annual Inflows Rs. 6,00,000
pvaf(194) 2.639
PV of Inflows (Rs. 6,00,000 X 2.639) Rs. 15,83,400
Cost of Investment 15,00,000
Net Present Value 83,400
Meta - 10

ES
Year Cash inflows PV(15,n) Present Value
1 Rs. 6,00,000 0.870 Rs. 5,22,000
2 4,00,000 0.756 3,02,400
3 5,00,000 0.658 3,29,000

SS
4 2,00,000 0.572 1,14,000
Total PV 12,67,400
Cost of Investment 11,00,000
Net Present Value
LA 1,67,400

Neta -10
C
Year Cash inflows PV(13,n) Present Value
1 Rs. 4,00,000 0.885 Rs. 3,54,000
AH

2 6,00,000 0.783 4,69,860

3 8,00,000 0.693 5,54,400
4 12,00,000 0.613 7,35,600
Total PV 21,13,860
SH

Cost of Investment 19,00,000

Net Present Value 2,13,860

Project Neta - 10 has the highest Net Present Value (NPV). It should be accepted by the
K

management for implementation.

Homework
J

(Sol-1)
10,00,000x ( 0.90 ) 15,00,000x ( 0.85 ) 20,00,000x ( 0.82 ) 25,00,000x ( 0.78 )
NPV = + + +
(1.05 ) (1.05)
2
(1.05 )
3
(1.05 )
4

- 45,000 = Rs.5,34,570

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LEASE FINANCING
To be discussed only in classroom

(Sol-1)
Discounting Factor:
Cost of finance 20% - Tax 35% = 13%.
(i) PV of cash outflows under leasing alternative
Year-end Lease rent after taxes P.A. PVIFA at 13% Total P.V.
1-5 Rs. 3,90,000 3.517 Rs. 13,71,630

ES
PV of cash outflows under buying alternative
Year Loan Tax advantage Tax advantage on Net Cash PVIF at Total PV

SS
end Installment on Interest Depreciation Outflow 13%
1 6,68,673 1,40,000 1,75,000 3,53,673 0.885 3,13,001
2 6,68,673 1,21,193 1,31,250 4,16,230 0.783 3,25,908
3
4
6,68,673
6,68,673
98,624
71,542
LA 98,438
73,828
4,71,611
5,23,303
0.693
0.613
3,26,826
3,20,785
5 6,68,673 38,819 55,371 5,74,483 0.543 3,11,944
C
Total PV outflows 15,98,464
Less: PV of Salvage Value (Rs. 4,00,000 *0.543) 2,17,200
13,81,264
AH

Less: PV of tax saving on short term capital loss (4,74,609 – 4,00,000) * 35% * .543
14,179
NPV of Cash outflow 13,67,085
SH

Working Notes:
(1) Schedule of Debt Payment
Opening Interest @ Closing Principal
K

Yearend Repayment
balance 20% Balance Amount
1 20,00,000 4,00,000 6,68,673 17,31,327 2,68,673
J

2 17,31,327 3,46,265 6,68,673 14,08,919 3,22,408

3 14,08,919 2,81,784 6,68,673 10,22,030 3,86,889
4 10,22,030 2,04,406 6,68,673 5,57,763 4,64,267
5 5,57,763 1,10,910* 6,68,673 0 5,57,763
*Balancing Figure

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(2) Schedule of Depreciation

Year Opening WDV Depreciation Closing WDV
1 20,00,000 5,00,000 15,00,000
2 15,00,000 3,75,000 11,25,000
3 11,25,000 2,81,250 8,43,750
4 8,43,750 2,10,938 6,32,812
5 6,32,812 1,58,203 4,74,609

(3) EMI = Rs. 20,00,000 / Annuity for 5 years @ 20% = i.e. Rs. 20,00,000 / 2.991 =

ES
Rs.6,68,673.
Advice: Company is advised to borrow and buy not to go for leasing as NPV of cash

SS
outflows is lower in case of buying alternative.
Note: Students may note that the cost of capital of the company given in the question is
14% at which cash flows may also be discounted.
(ii) Evaluation from Lessor’s Point of View
(1)
LA(2) (3) (4) (5)
Lease Rent 6,00,000 6,00,000 6,00,000 6,00,000 6,00,000
C
Less: Depreciation 5,00,000 3,75,000 2,81,250 2,10,938 1,58,203
EBT 1,00,000 2,25,000 3,18,750 3,89,062 4,41,797
Less: Tax @ 35% 35,000 78,750 1,11,563 1,36,172 1,54,629
AH

EAT 65,000 1,46,250 2,07,187 2,52,890 2,87,168

Add: Depreciation 5,00,000 3,75,000 2,81,250 2,10,938 1,58,203
Cash Inflows 5,65,000 5,21,250 4,88,437 4,63,828 4,45,371
SH

PV factor @ 14% 0.877 0.769 0.675 0.592 0.519

PV of inflows 4,95,505 4,00,841 3,29,695 2,74,586 2,31,148
Evaluation:
Aggregate PV of cash inflows 17,31,775
K

Add: PV of salvage value (4,00,000 x 0.519) 2,07,600

Add: Tax shelter on short-term capital loss (4,74,609 – 4,00,000) x 0.35 x 0.519 13,553
J

PV of all cash inflows 19,52,928

Cost of the machine 20,00,000
NPV -47,072
Hence, leasing at this rate is not feasible.
(Sol-2)
(i) The loan amount is repayable together with the interest at the rate of 16% on loan
amount and is repayable in equal installments at the end of each year. The PVAF at the
rate of 16% for 4 years is 2.798, the amount payable will be

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Rs.5, 00, 000

Annual Payment = = Rs. 1,78,699 (rounded)
2.798
Schedule of Debt Repayment

End of Total Principal Interest Principal Principal Amount Outstanding

Year Rs. Rs. Rs. Rs.
1 5,00,000 80,000 98,699 4,01,301
2 4,01,301 64,208 1,14,491 2,86,810
3 2,86,810 45,890 1,32,809 1,54,001

ES
4 1,54,001 24,698* 1,54,001 ———
* Balancing Figure
Tax Benefit on Interest and Depreciation

SS
Year Interest Depreciation Total Tax Benefit
1 80,000 75,000 1,55,000 54,250
2 64,208 75,000 1,39,208 48,723
3
4
45,890
24,698
LA
75,000 1,20,890
75,000 99,698
42,312
34,894
C
Present Value of Cash Flows under Borrow and Buying proposal

Installment Salvage Value Tax Benefit Net Flow PVF @

Year PV (Rs.)
AH

Rs. (Rs.) (Rs.) (Rs.) 10.4%

1 1,78,699 54,250 1,24,449 0.906 1,12,751
2 1,78,699 48,723 1,29,976 0.820 1,06,580
3 1,78,699 42,312 1,36,387 0.743 1,01,336
SH

4 1,78,699 (2,00,000) 34,894 -56,195 0.673 -37,819

3.142 2,82,848
Present Value of Cash Flows under Leasing Option
K

Rs. 1,00,000 (1- 0.35) x 3.142 = Rs. 2,04,230

Hence leasing should be preferred as cash flow is least in this option.
J

(ii) Analyzing financial viability from Lessor’s point of view

(a) Determination of Cash Flow after Tax

Rs.
Annual Rent 1,00,000
Less: Depreciation 75,000
EBT 25,000
Less: Tax @ 35% 8,750

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

Profit after Tax 16,250

Add: Depreciation 75,000
91,250
(b) Computation of Net Present Value

Rs.
Present Value of Cash inflow (Rs. 91,250 x 2.914) 2,65,903
Add: PV of Salvage Value (Rs. 2,00,000 x 0.592) 1,18,400
3,84,303

ES
Purchase Price (5,00,000)
NPV (1,15,697)
Thus proposal is not financially viable from lessor’s point of view.

SS
(iii) Break Even Lease Rent

Rs.
Cost of Computer LA 5,00,000
Less: PV of Salvage Value (Rs. 2,00,000 x 0.592) 1,18,400
3,81,600
C
PVIAF (14%,4) 2.914
CFAT Desired 1,30,954
Less: Depreciation 75,000
AH

EAT 55,954
Add: Taxes 30,129
EBT 86,083
SH

Add: Depreciation 75,000

Lease Rental (Desired) 1,61,083
K
J

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Homework
(Sol-1)
From the view point of lessee
(i) Lease
Initial Investment
CF
Lease Rent (900000)
Tax Deb. @ 40% 3,60,000

ES
(5,40,000)
NPV
Year CF DF @ 9% Net CF

SS
1-5 (5,40,000) 3.890) 21,00,600

DF/COC = I (1-t)
= 15 (1-0.4)
LA
Year Op. Int. @ 15% Principal CI
C
1 30,00,000 4,50,000 4,44,935 25,55,065
2 25,55,065 3,83,262 5116.75 2093390
AH

3 20,43,390 3,06,509 5,88,426 14,59,964

4 14,54,964 2,18,245 6,76,690 7,78,274
5 7,78,274 1,16,661 7,78,274
SH

Depreciation (WDV 25%)

Year Op. WDV CI
1 30,00,000 7,50,000
K

2 5,62,500
3 4,21,875
J

4 3,16,406
5 2,37,305 7,11,914

Salvage 2,00,000
(711914-200000) x 40% 2,04,766
4,04,766
CF

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Year First (I+P) Tax Deb. @ 40% (x+D) Net CF

1 (894935) 480000 (414935)
2 (894935) 378304 (576631)
3 (894935) 291354 (603581)
4 (894935) 213860 (681075)
5 (894935) 141580 (753349)

NPV

ES
Year CF DF @ 9% PV
1 (414935) 0.9174 (380661)
2 (516631) 0.8417 (434848)

SS
3 (603581) 0.7722 (4682297)
4 (681075) 0.7084 (482473)
5 LA
(753349) + 404766 0.6499 (226544)
(1992755)
(-) -
C
(1992755)
AH

(Sol-2)
Option I: To buy the asset:
In this option the firm has to pay Rs. 10,000 down and the balance Rs. 1,00,000 together with
SH

interest @ 15% is payable in 10 annual equal instalments. The instalment amount may be
calculated by dividing Rs. 1,00,000 by the PVAF for 10 years at 15% i.e.
Annual repayment = Rs. 1,00,000/5.0188 = Rs. 19,925
The cash flows of the borrowing and purchase option may be computed as follows:
K

Year Instalment Interest Repayment Balance

Rs. Rs. Rs. Rs.
J

1 19,925 15,000 4,925 95,075

2 19,925 14,261 5,664 89,411
3 19,925 13,412 6,513 82,898
4 19,925 12,435 7,490 75,408
5 19,925 11,311 8,614 66,794
6 19,925 10,019 9,906 56,888
7 19,925 8,533 11,392 45,496

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8 19,925 6,824 13,101 32,395

9 19,925 4,859 15,066 17,329
10 19,925 2,596* 17,329 -
* Difference between the outstanding balance and the last instalment (i.e. Rs. 19,925 – Rs.
17,329 = Rs. 2,596)
Tax Shield Net
Year Installment Interest Depreciation PVF PV
50% (2 + 3) CF(1-4)
(1) (2) (3) (4) (5) (6) (7)

ES
Rs. Rs. Rs. Rs. Rs. Rs.
0 10,000 - - - - 1.000 10,000
1 19,925 15,000 11,000 13,000 6,925 .870 6,025
2 19,925 14,261 11,000 12,631 7,294 .756 5,514

SS
3 19,925 13,412 11,000 12,206 7,719 .658 5,079
4 19,925 12,435 11,000 11,718 8,207 .572 4,694
5 19,925 11,311 11,000
LA 11,156 8,769 .497 4,358
6 19,925 10,019 11,000 10,510 9,415 .432 4,067
7 19,925 8,533 11,000 9,767 10,158 .376 3,819
8 19,925 6,824 11,000 8,912 11,013 .327 3,601
C
9 19,925 4,859 11,000 7,930 11,995 .284 3,407
10 19,925 2,596 11,000 6,798 13,127 .247 3,242
AH

Present value of total

-53,806
outflows
Salvage value (after
10 10,000 - - .247 +2,470
tax)
SH

Net present value of

-51,336
outflows

It may be noted that (i) depreciation of Rs. 11,000 has been provided for all the 10 years.
K

This is 10% of the original cost of Rs. 1,10,000. (ii) The asset is fully depreciated during its
life of 10 years, therefore, the book value at the end of 10th year would be zero. As the
J

asset is having a salvage value of Rs. 20,000, this would be capital gain and presuming it
to be taxable at the normal rate of 50%, the net cash inflow on account of salvage value
would be Rs. 10,000 only. This is further discounted to find out the present value of this
inflow.
Option II – Evaluation of Lease Option:
In case the asset is acquired on lease, there is a lease rent of Rs. 15,000 payable at the end
of next 10 years. This lease rental is tax deductible, therefore, the net cash outflow

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

would be only Rs. 7,500 (after tax). The PVAF for 10 years @ 15% is 5.0188. So, the
present value of annuity of Rs. 7,500 is
Present value of annuity of outflow = Rs. 7,500 ´ 5.0188 = Rs. 37,641.
Advice: If the firm opts to buy the asset, the present value of outflow comes to Rs. 51,336;
and in case of lease option, the present value of outflows comes to Rs. 37,641. Hence,
the firm should opt for the lease option. In this way, the firm will be able to reduce its
costs by Rs. 13,695 i.e. Rs. 51,336 – Rs. 37,641. This may also be referred to as Net Benefit
of Leasing.

ES
Note: Students may also discount cash flows under both alternatives at after tax cost i.e.
15% (1 – 0.5) = 7.5%. Discounting will not have any impact on this decision since any
discount factor will lead to present value of lease to be less than that of present value of

SS
debt.
(Sol-3)
Borrowing option: LA
Annual Instalment = Rs.5,00,000/- / 5 = Rs.1,00,000/-
Annual depreciation = Rs.5,00,000/- / 5 = Rs.1,00,000/-
C
Computation of net cash outflow:

Tax Saving
Principal Interest Total Depn. Net cash PV @ Total PV
AH

Year
(Rs.) (Rs.) (Rs.) &Interest Outflow(Rs.) 8%† (Rs.)
(Rs.)
1 1,00,000 50,000 1,50,000 45,000 1,05,000 0.926 97,230
SH

2 1,00,000 40,000 1,40,000 42,000 98,000 0.857 83,986

3 1,00,000 30,000 1,30,000 39,000 91,000 0.794 72,254
4 1,00,000 20,000 1,20,000 36,000 84,000 0.735 61,740
5 1,00,000 10,000 1,10,000 33,000 77,000 0.681 52,437
K

3,67,647
Less: Present value of Inflows at the end of 5th year (Rs.50,000/- x 0.7) or Rs.35,000
23,835
x 0.681 =
J

PV of Net Cash outflows 3,43,812

Calculation of lease rentals:
Therefore, Required Annual after tax outflow = 3,43,812/3.993 = Rs.86,104/-*
Therefore, Annual lease rental = 86,104/0.70 = Rs.1,23,006/-
* If it is assumed that installment is payable in the beginning of the year then lease rent shall be
computed as follows:
Required Annual after tax outflow = 3,43,812/4.312 = Rs.79,734/-

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

Therefore, Annual lease rental = 79,734/0.70 = Rs.1,13,906/-

Further, if it is assumed that the lease rent is payable in the beginning of the year and tax benefit
accrue in arrears then lease rent shall be computed as follows:
Let ‘R' be the lease rent
PV of Lease Rent = 4.312R
PV of Tax Benefits = 3.933 x 0.30R = 1.1979R
Accordingly
3,43,812 = 4.312R - 1.1979R

ES
R = 1,10,405
Thus, lease rent at which lessor will be Break Even = Rs. 1,10,405
† Alternatively it can also be discounted at post tax cost of debt i.e. 8.00% (1 - 0.30) = 5.60%.

SS
(Sol-4)
Workings LA
60, 000
(i) Annual loan repayment: Rs. Rs. 12,000
5
(ii) Residual sale value at year 5 Rs.1,500
C
(-) Commission at 8% 120
Profit on sale 1,380
AH

(-) Tax @ 30% 414

Net cash flow (Rs. 1,380 - Rs. 414) Rs.966
(iii) Net cash outflow under loan option –
SH

Year 1 Rs. 2 Rs. 3 Rs. 4 Rs. 5 Rs. Total

Rs.
Principal repayment 12,000 12,000 12,000 12,000 12,000 60,000
Payment of Interest 7,200 5,760 4,320 2,880 1,440 21,600
K

(-) Tax Savings @ 30% on (3,600) (3,600) (3,600) (3,600) (3,600) (18,000)
depreciation
J

Tax savings on Interest (2,160) (1,728) (1,296) (864) (432) (6,480)

Net out flow 13,440 12,432 11,424 10,416 9,408 57,120
Discount factor at 11% 0.901 0.812 0.731 0.659 0.593 3.696
PV of cash outflow 12,109 10,095 8,351 6,864 5,579 42,998
Less: PV of Post tax inflow at the end (573)
of year 5 (Rs. 966×0.593)
PV of net Cash outflows in 5 years 42,425

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT

Computation of Annual Lease Rentals :

PV of post tax Annual Lease Rentals in 5 years should not exceed Rs.42,425.
Or say, PV of Post-tax Lease Rental for one year. Should not exceed
42, 425
Rs. = Rs.11, 479
3.696
Rs.11479 post-tax = [ Rs. 11,479/(1-t)] pretax
= Rs. 11,479/(1 - 0.30) = Rs.16,398
Therefore, maximum pre-tax annual rental should be Rs.16,398

ES
SS
LA
C
AH
SH
K
J

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
DIVIDEND DECISIONS
HOMEWORK
(Sol-1)
Goldilocks Ltd.
(i) Walter’s model is given by

D+ ( E-D ) ( r/K e )
P=
Ke

Where,

ES
P = Market price per share.
E = Earnings per share = Rs. 10
D = Dividend per share = Rs. 8

SS
r = Return earned on investment = 10%
Ke = Cost of equity capital = 1/12.5 = 8%
0.10 0.10
8+ (10-8 ) x 8+2x LA
P= 0.08 = 0.08
0.08 0.08
= Rs. 131.25
C
(ii) According to Walter’s model when the return on investment is more than the cost of
equity capital, the price per share increases as the dividend pay-out ratio decreases.
AH

Hence, the optimum dividend pay-out ratio in this case is nil.

So, at a pay-out ratio of zero, the market value of the company’s share will be:
0.10
0+ (10-0 )
0.08 =Rs.156.25
SH

0.08

(Sol-2)
K

(a) M/s XY Ltd.

(i) Walter’s model is given by

D+ ( E-D ) ( r/K e )
J

P=
Ke
Where,
P = Market price per share.
E = Earnings per share = Rs.5
D = Dividend per share = Rs.3
r = Return earned on investment = 15%

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
Ke = Cost of equity capital = 12%
0.15 0.15
3+ ( 5-3) x 3+2x
P= 0.12 = 0.12
0.12 0.12
= Rs.45.83
(ii) According to Walter’s model when the return on investment is more than the cost of
equity capital, the price per share increases as the dividend pay-out ratio decreases.
Hence, the optimum dividend pay-out ratio in this case is nil.
So, at a pay-out ratio of zero, the market value of the company’s share will be:

ES
0.15
0+ ( 5-0 )
0.12 =Rs.52.08
0.12

SS
(Sol-3)
Modigliani and Miller (M-M) – Dividend Irrelevancy Model:
P1 +D1
P0 =

Where,
1+K e LA
P0 = Existing market price per share i.e. Rs. 120
C
P1 = Market price of share at the year-end (to be determined)
D1 = Contemplated dividend per share i.e. Rs. 6.4
AH

Ke = Capitalisation rate i.e. 9.6%.

(i) (a) Calculation of share price when dividend is declared:
P1 +D1
P0 =
SH

1+K e

P1 +6.4
120=
1+0.096
120 × 1.096 = P1 + 6.4
K

P1 = 120 × 1.096 – 6.4

= 125.12
J

(b) Calculation of share price when dividend is not declared:

P1 +D1
P0 =
1+K e

P1 +0
120=
1+0.096
120 × 1.096 = P1 + 0
P1 = 131.52

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
(ii) Calculation of No. of shares to be issued:

(Rs. in lakhs)

Particulars If dividend If dividend not

declared declared
Net Income 160 160
Less: Dividend paid 51.20 —
Retained earnings 108.80 160
Investment budget 320 320
Amount to be raised by issue of new shares (i) 211.20 160

ES
Market price per share (ii) 125.12 131.52
No. of new shares to be issued (ii) 1,68,797.95 1,21,654.50
Or say 1,68,798 1,21,655

SS
(Sol-4)

A.

(a)
When dividend is paid

Price per share at the end of year 1

LA
1
C
100=
1.109
( Rs.5+P1 )
110 = Rs. 5 + P1
AH

P1 = 105

(b) Amount required to be raised from issue of new shares

SH

Rs. 10,00,000 – (Rs. 5,00,000 – Rs. 2,50,000)

Rs. 10,00,000 – Rs. 2,50,000 = Rs. 7,50,000

(c) Number of additional shares to be issued

7, 50, 000 1,50, 000
K

= = shares or say 7143 shares

105 21

(d) Value of ABC Ltd.

J

(Number of shares × Expected Price per share)

i.e., (50,000 + 7,143) × Rs. 105 = Rs. 60,00,015

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J.K.SHAH CLASSES INTER C.A. – FINANCIAL MANAGEMENT
B. When dividend is not paid

(a) Price per share at the end of year 1

P1
100=
1.10

P1 = 110

(b) Amount required to be raised from issue of new shares

Rs. 10,00,000 – Rs. 5,00,000 = Rs. 5,00,000

(c) Number of additional shares to be issued

ES
5, 00, 000 50, 000
= = shares or say 4545 shares.
110 11

(d) Value of ABC Ltd.,

SS
(50,000 + 4,545) × Rs.110

= Rs. 59,99,950
LA
Thus, as per M.M. approach the value of firm in both situations will be the same.
C
AH
SH
K
J

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