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FINANCIAL MANAGEMENT
SUGGESTIONS
1. Mr. X needs 1,00,000 at the end of 10 years. He has two options:

Option 1: Deposit some lump sum amount today at 6% rate of interest.

Option 2: Make equal payments into a bank account starting a year from now, on which he earns 6% rate of
interest.

You are required to:

(a) Find out the amount to be deposited under Option 1 today.

(b) Ascertain what amount must be deposited annually into the bank account under Option 2.𝐶𝑉𝐼𝐹(6% 10)
= 1.791 , 𝐶𝑉𝐼𝐹𝐴(6% 10) = 13.181 , 𝑃𝑉𝐼𝐹𝐴(6% 10)= 7,360 , 𝑃𝑉𝐼𝐹(6% 10) = 0.558.

2. Mr. X retires at the age of 60 and his employer gives him two options: Option one is a lump sum of
12,00,000 on retirement, and Option two is to accept a pension of 1.50,000 per year for rest of his life. It
is expected that he will survive for another 15 years. If the rate of interest is 9% p.a. and 𝑃𝑉𝐼𝐹𝐴(9% 15)=
8.061 , advice Mr. X about his best alternative.

3. X decides to invest₹ 6,000 at the end of each year at the compound rate of interest of 12% p.a. for 8
years. What total amount he will get at the end of 8th year? [FVAF at 12% for 8 years 12-30]

4. You are working in a firm having ROI 18% and Cost of Capital 12%. For a proposed pro- ject with effective
life of 3 years, the inflows are estimated as ₹67,500, ₹76,500 and ₹56,700. Calculate the present value of
benefits from the project.

5. A sum of₹ 5,000 is invested for 2 years at 10% interest rate compounded biannually. Find the maturity
amount.

6. A company has following amounts of capital with corresponding specific cost of each type:

Type of capital BOOK VALUE (Rs) MARKET VALUE (RS)

Equity capital (25,000 shares of ₹10 each) 2,50,000 4,50,000
13% Preference capital (500 shares of ₹100 each) 50,000 45,000
Reserves and surplus 1,50,000 ---
14% Debentures (1,500 Debentures of ₹100 each) 1,50,000 1,45,000

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The expected dividend per share is ₹1.40 and the dividend per share is expected to grow at a rate of 8% forever.
Preference shares are redeemable after 5 years at par, whereas deben- tures are redeemable after 6 years at par. The
tax rate for the company is 50 per cent. You are required to compute weighted average cost of capital using market
value as weight.

7. Calculate weighted average cost of capital (WACC) considering market values for AD Ltd. from the
following details:

Sources of Capital

Equity share capital (10 each) Rs 12,00,000

Retained Earnings Rs 28,00,000

14% Preference shares (issued at a premium of 8%) Rs90,000

15% Debentures Rs 3,60,000

Other information:

-Applicable corporate tax rate 30%

-Market price per share ₹50, Dividend per share is expected to be ₹6. AD Ltd. main- tains a growth of 5% in this
regards.

-Debentures of face value ₹1,000 each were issued at 3% discount (with an additional underwriters' commission of
1.5% on face value). Tenure of Debenture 10 years.

8. X Ltd. opts for the following capital structure:

Equity Shares (1,00,000 shares of ₹10 each) 15,00,000

10% Debentures 15,00,000

-----------------------

25,00,000

------------------------

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The company is expected to declare a dividend of 2 per share. The market price per share is 20. The dividend is
expected to grow at 10%. Compute the weighted average cost of capital assuming 50% tax rate.

9. A company's share is currently quoted in the market at 30. The company paid a dividend of 25 per share
last year and the investors expect a growth rate of 5% per year, You are required to calculate (i) cost of
equity share capital of the company and (ii) the market price per share, if the anticipated growth rate of
dividend is 10%.

10. A company's share is currently quoted in the market at 20. The company pays a dividend of 2 per share
and the investors expect a growth rate of 5% per year.

Calculate: (i) cost of equity capital of the company and (ii) the market price per share if the anticipated
growth rate of dividend is 7%.

11. The selected financial data for two companies namely X and Y for the year ended March 2019 are as
follows:
Particulars X Y
Variable expenses as a percentage of sales 75 50
Interest (in lakhs) 300 1000
Degree of operating leverage 6 2
Degree of financial leverage 4 2
Income tax rate 0.35 0.35

(a) Prepare income statements for X and Y.

(b) Comment on the financial position of the companies

12. Relevant information about two companies are given below:

X Y
Annual production capacity (Units) 1,00,000 1,50,000
Capacity utilisation and sales 75% 75%
Unit selling price (₹) 40 50
Unit variable cost (₹) 15 15
Fixed cost for the year (Rs) 2,00,000 3,00,000
Equity capital (10 per share) 5,00,000 7,00,000
10% Preference share capital (₹) 50,000
15% Debentures (₹) 1,00,000 2,00,000

Determine the degree of Operating Leverage, degree of Financial Leverage, degree of Combined Leverage
and Earning per Share of two companies. (Tax rate 40%).

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13. Calculate different kinds of leverage from the following information of XYZ Company:

Production and Sales 16,000

Selling price per unit Rs30

Variable cost per unit Rs20

Fixed Operating Costs:

Situation A Rs 4000

Situation B Rs 2000

Situation C Rs 6000

Financial alternatives: PLAN

I II III

Equity Rs 15,000 Rs 10,000 Rs 5,000

Debt Carrying 10% interest Rs 5,000 Rs 10,000 Rs15,000

14. A firm has sales of ₹10,00,000, variable cost of ₹7,00,000 and fixed cost of ₹2,00,000. The company has
debt capital of ₹3,00,000 at 10% rate of interest. Compute operating, financial and combined leverages. If
the firm wants to double its earnings before interest and tax (EBIT), how much rise in sales would be
required?

15. The following details of P Ltd. for the year ended 31.3.2016 are furnished:

Operating leverage 3:1

Financial leverage 2:1

Interest charges per annum 20 lakhs

Corporate tax rate 50%

Variable cost as the percentage sales 60%

Prepare the income statement of the company

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16. Estimate the working capital requirement on profit basis for the coming year from the following
information of a manufacturing company. Expected annual sales is 1,56,000 units of 10 per unit. The
anticipated ratios of cost to selling price are: Raw materials 50% and Direct wages 15%. Budgeted cash
overhead is 42,000 and depreciation is ₹10,000 per annum. Planned stock will include raw material for
₹45,000 and 9,000 units of finished goods. Credit allowed to debtors is 1 month. Credit expected to be
received from suppliers in 3 weeks. Overhead and wages payment will be made 1 week after their
occurrence. Material will stay in the process for 14 days. Cash in hand to be maintained is 15% of total
working capital. Assume that production is carried on evenly throughout the year. Raw materials are
introduced at the beginning of the process and wages and overhead accrue evenly during processing

17. With the following information, prepare a statement showing the working capital required to finance a
level of activity of 10,400 units per annum:

(i) Selling price @ 25 per unit.

(ii) The expected ratios of cost to selling prices are:

(a) Raw materials 40%

(b) Direct wages 10%

(c) Overhead 30%

(d) Profit 20%

(iii) Raw Materials are expected to remain in store for an average period of two months before being used for
production and materials are in process on an average period of six weeks.

(iv) Finished goods will stay in store approximately for six weeks before dispatch to customers.

(v) Credit allowed to debtors is for a period of two months.

(vi) Credit allowed by creditors for a period of two months.

(vii) Lag in payment of wages and overheads is for a period of two weeks.

(viii) Cash in hand and bank is expected to be ₹10,000.

It may be noted that production is carried on evenly during the year and wages and over- heads accrue similarly.
Assume 4 weeks a month.

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18. The capacity of your company is to produce 40.000 units of valve per annum. The com- pany expects to
operate at 60% of the capacity level. You are required to ascertain the working capital requirement at the
current level of operation.
Elements of costs PER UNIT (Rs)

Raw-material 6
Direct labour 3
Overhead 4

Total cost 13
Profit 3

Selling price 16
Raw-materials are in stock, on an average, for 2 months. The duration of the production process is half a
month. Finished goods are in stock, on an average for 1 month. Credit allowed to customers is 3 months
and that obtained from suppliers is 1.5 months, lag in payment of wages is half a month. There is usually
no lag in payment of overhead.

19. Between two periods of a company, there is an increase of debt collection period and raw ma- terial
conversion period by 20 days and 5 days respectively, whereas its creditors payment
period and finished goods conversion period is reduced by 10 days and 5 days respectively. Calculate the
change in operating cycle of the company.

20. The following information is provided by X Ltd. for the year ending 31.3.2017.

Raw Material storage period 45 days

WIP conversion period 18 days

Finished goods storage period 22 days

Debt collection period 30 days

Creditors payment period 55 days

Annual cash cost of operation 18 Lakhs

(1 year 360 days)

You are required to calculate:

(i) Operating Cycle Period.

(ii) Number of Operating Cycles in a year.

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21. Calculate payback period from the following information:

Cost of machine: ₹1,00,000; Depreciation 10% p.a. under reducing balance method. Corporate tax rate
40%.
YEAR 1 2 3 4 5
Expected PBT (000) NIL 54 88 104 125

22. A firm is considering the proposal of buying a machine with installation cost of ₹5,00,000. The machine
will have a useful life of 4 years after which it can be sold for ₹70,000. Depreciation is to be charged
under straight line method. Additional working capital of ₹50,000 will be introduced. Profits before
depreciation and tax are expected to be ₹1,72.000, ₹1,98,000. ₹2,18,000 and ₹1,80,000 in those four
years. If applicable tax rate is 30%, calculate ARR of the project

23. L. Ltd. provides you the following information:

(a) Purchase price of machine Rs 1,73,500

(b) Useful life of machine 3 YEARS

(c) Salvage value at the end of useful life NIL

(d) Cost of Capital 10%

(e) Cash Flow after Tax (CFAT): Year-1 ₹1,00,000

Year-2 ₹1,00,000

Year-3 ₹80,000

Note: Present Value factors @ 10% are as follows:

Year: 1 2 3

PV Factor: 0.909 0.826 0.751

Calculate the Discounted Payback Period.

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24. Which one of the following two projects should be selected based on discounted payback method of
appraisal while both involve capital outlay of ₹10 crore and likely to generate same amount of cash flow
over their lives.
Cash flow stream (in lakh)
YEAR
PROJECT A (Rs) PROJECT B (Rs)

1 200 500

2 300 400

3 400 300

4 500 200

Cost of capital of the firm: 10%

PV of 1 at 10% to be received at the end of each year is as below.

YEAR 1 2 3 4

PV. Factor 0.91 0.83 0.75 0.68

25. SMB Ltd. has considered two projects with economic life of 6 years having follow- ing cash inflows after
tax:
END OF 1 2 3 4 5 6 TOTAL (RS)
THE YEAR
Project 1 1,00,000 80,000 75,000 70,000 68,000 62,000 4,55,000
Project 2 62,000 68,000 70,000 75,000 80,000 1,00,000 4,55,000

As the total cash inflows are identical and investment amount is ₹3,30,000 for both the projects, the
management of SMB Ltd. has decided to go for any one of the given projects. Do you support their decision?
Justify your answer.

The post-tax cost of capital of SMB Ltd. is calculated as 10%, and the required dis- counting factors are given
below:

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YEAR 1 2 3 4 5 6
DF @ 10% 0.909 0.826 0.751 0.683 0.621 0.564

(b) Project A and Project B are the two mutually exclusive projects under consideration. While Project A has a higher
NPV, Project B has a higher IRR. Which project should be selected and why?

26. From the following information, determine the theoretical market price of each equity share of a
company as per Walter's Model:
Earnings of the Company 10,00,000

Dividend paid 5,00,000

No. of equity shares outstanding 2,00,000

Cost of Equity capital 12%

Rate of return on investment 15%

27. Determine the market price of equity shares of company from the following information using Walter
Model:

Earnings of Company 5,00,000

Dividend paid 3,00,000

Number of Shares 1,00,000

Price earning ratio 8

Rate of Return on Investment 15%

Are you satisfied with the dividend policy of the firm? If not, what should be the optimal dividend payout ratio and
the consequent market price of equity shares of the company according to Walter Model?

28. The earning per share of a company is 8 and the rate of capitalization applicable is 10%.

The company has before it, an option of adopting (a) 50%. (b) 75%, and (c) 100% dividend pay-out ratio.

Compute the market price of the company's quoted share as per Gordon's Model if the company can earn a return of
(a) 15% (b) 10% and (c) 5%

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29. The following information is acquired from XYZ Ltd.: Net earnings₹ 1,00,000; Equity Capital 5,000 shares
of ₹10 each; Cost of capital 10%: Expected rate of return: (i) 9%, (ii) 10% and (iii) 12%.

Assuming the dividend payout ratios are 0%, 50% and 100% respectively, determine the effect of different dividend
policies on the share price of XYZ Ltd. for the above men- igned three alternative levels of return using Gordon
Model.

30. Virat Ltd. has a capital of 15 lakh in equity shares of ₹100 each. The shares are currently quoted at par.
The company is expected to pay dividend of 20 per share at the end of the current financial year. The
company belongs to a risk class of which appropriate capitalisation rate is 10%.

Using MM model (with no taxes), calculate the market price of share at the end of the year if:

(i) dividend is declared.

(ii) dividend is not declared.

iii) Assuming that the company pays the dividend and has net profit of ₹ 5.30.000 and makes new investment of
5,00,000 during the period, how many new shares should be issued?

THEORY QUESTIONS

31. How do financial manager take financing and investment decisions?

32. What do you mean by financial management? State two important functions of financial management
full stop discuss its importance. State its objectives
33. Specify the limitations of "maximization of profit" as the objective of a firm
34. Explain the role of chief financial officer CFO in the modern business environment
35. Why is it inappropriate to seek profit maximization as the legal goal of financial decision making?
36. Briefly state the concept of risk and return
37. What are the basic components of the financial environment in which a firm has to operate?
38. State the reasons of having time preference for money.
39. Discuss the Relationship between risk and return
40. Financial Institutions in India play an important role in providing long term finance two industrial units
in India. Describe briefly the criteria applied by these institutions in sanctioning term finance to industrial
units.
41. Discuss the advantages and disadvantages of taking long term public deposits.
42. What do you mean by Term Financing? Write down its features briefly.
43. What is Retained Earnings?
44. What do you mean by Cost of Equity Capital?
45. What is meant by cost of capital? Explain the factors that influence the cost of capital?
46. Mention the causes of Over-Capitalization in a Company

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47. How will you determine the cost of equity share capital in growth company?
48. Write short notes on relationship between margin of safety and degree of operating leverage.
49. State the difference between operating risk and financial risk
50. What do you mean by operating leverage and financial leverage? Distinguish between the two.
51. Explain in brief return on investment.
52. Explain Indifference point in EBIT-EPS analysis. How is it measured?
53. What will be the effect of taxation on the value of a form under M & M approach?
54. Briefly discuss the relationship between cost of equity and financial leverage in accordance with M
& M proposition
55. Discuss critically Modigliani and Miller approach of the capital structure theory
56. Critically discuss the net operating income (NOI) approach of capital structure theory
57. State the factors to be considered in determining working capital of a firm
58. Briefly discuss the relevance of liquidity and profitability in Working Capital Management
59. What are the objectives of Working Capital Management?
60. What is working capital turnover
61. What do you mean by permanent working capital?
62. Write a short note on the recommendations of Chore committee
63. Distinguish between conservative and aggressive strategies of Financing current assets
64. Give a brief idea about the different sources of finance of working capital
65. What are the factors in determining the size of debtors?
66. Discuss the merits and demerits of the following sources of finance 1 Equity shares
67. Differentiate between discounted and non discounted cash flow techniques
68. State factors influencing capital expenditure decisions
69. Specify the distinguishing features of capital expenditure decision.
70. What is the reinvestment rate and what are its assumption under the NPV and IRR method?
71. What do you mean by Dividend policy? Explain the factors that influence dividend policy of a company
72. Discuss with example the constant dividend payout ratio and stable dividend per share policy of
distribution of dividend by a company.
73. Why dividend decision is significant to the firm ?
74. Write a note on cash flow statement
75. Explain the steps in financial control. State its importance. Describe the Essential elements of an effective
financial control system
76. State the objectives of financial control
77. Explain the concept of Ratio Analysis as a tool of financial control. Discuss its merits and
demerits.

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