0% found this document useful (0 votes)

9 views

MTP Combination FM

Uploaded by

Poornima Prajapati

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PDF, TXT or read online on Scribd

0% found this document useful (0 votes)

9 views

MTP Combination FM

Uploaded by

Poornima Prajapati

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PDF, TXT or read online on Scribd

You are on page 1/ 112

Downloaded From www.castudynotes.

com

Test Series: October, 2018

MOCK TEST PAPER – 2
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
Time Allowed – 3 Hours Maximum Marks – 100

PAPER 8A : FINANICAL MANAGEMENT (60 Marks)

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
1. Answer the following:
(a) PQR Ltd. has the following capital structure on October 31, 20X8:

m
Sources of capital (Rs.)

o
Equity share capital (2,00,000 shares of Rs.10 each) 20,00,000

.c
Reserves & surplus es 20,00,000
12% Preference share capital 10,00,000
ot
9% Debentures 30,00,000
80,00,000
yn

The market price of equity share is Rs. 30. It is expected that the company will pay next year a
d

dividend of Rs. 3 per share, which will grow at 7% forever. Assume 40% income tax rate.
tu

You are required to COMPUTE weighted average cost of capital using market value weights.
as

(b) NSG Ltd. has a sale of Rs.75,00,000, variable cost of Rs.42,00,000 and fixed cost of Rs.6,00,000.
The Present capital structure of NSG is as follows:
.c

Equity Shares Rs. 55,00,000

Debt (12%) Rs. 45,00,000

Total Rs. 1,00,00,000

(i) DETERMINE the ROCE of NSG Ltd.

(ii) Does NSG have a favourable financial leverage? ANALYSE.
(iii) If the industry average of asset turnover is 3, does it have a high or low asset leverage?
DETERMINE
(iv) COMPUTE the leverages of NSG?
(v) DETERMINE, at what level of sales, will the EBT be zero?
(c) Following information relate to a concern:
Debtors Velocity 3 months
Credits Velocity 2 months
Stock Turnover Ratio 1.5
Gross Profit Ratio 25%

Join Us on Telegram http://t.me/canotes_ipcc

Bills Receivables Rs. 25,000

Bills Payables Rs. 10,000
Gross Profit Rs. 4,00,000
Fixed Assets to turnover Ratio 4
Closing stock of the period is Rs. 10,000 above the opening stock.
CALCULATE
(i) Sales and cost of goods sold
(ii) Sundry Debtors
(iii) Sundry Creditors
(iv) Closing Stock
(v) Fixed Assets
(d) RST Ltd. has a capital of Rs. 10,00,000 in equity shares of Rs. 100 each. The shares are currently
quoted at par. The company proposes to declare a dividend of Rs. 10 per share at the end of the

m
current financial year. The capitalization rate for the risk class of which the company belongs is
12%. COMPUTE the market price of the share at the end of the year, if

o
.c
(i) a dividend is not declared?
(ii) a dividend is declared? es
(iii) assuming that the company pays the dividend and has net profits of Rs.5,00,000 and makes
ot
new investments of Rs.10,00,000 during the period, how many new shares must be issued?
Use the MM model. (4 × 5 Marks = 20 Marks)
yn

2. JKL Ltd. has the following book-value capital structure as on March 31, 20X8.
d

(Rs.)
tu

Equity share capital (2,00,000 shares) 40,00,000

11.5% Preference shares 10,00,000

10% Debentures 30,00,000
.c

80,00,000
w

The equity shares of the company are sold at Rs. 20. It is expected that the company will pay next year
w

a dividend of Rs. 2 per equity share, which is expected to grow by 5% p.a. forever. Assume a 35%
w

corporate tax rate.

Required:
(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital
structure.
(ii) COMPUTE the new WACC, if the company raises an additional Rs. 20 lakhs debt by issuing 12%
debentures. This would result in increasing the expected equity dividend to Rs. 2.40 and leave the
growth rate unchanged, but the price of equity share will fall to Rs.16 per share. (10 Marks)
3. RST Limited is considering relaxing its present credit policy and is in the process of evaluating two
proposed polices. Currently, the firm has annual credit sales of Rs 225 lakhs and accounts receivable
turnover ratio of 5 times a year. The current level of loss due to bad debts is Rs.7,50,000. The firm is
required to give a return of 20% on the investment in new accounts receivables. The company’s variable
costs are 60% of the selling price. Given the following information, DETERMINE which is a better
option?

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(Amount in lakhs)
Present Policy Policy Policy
Option I Option II
Annual credit sales (Rs) 225 275 350
Accounts receivable turnover ratio 5 4 3
Bad debt losses (Rs) 7.5 22.5 47.5
(10 Marks)
4. The management of Z Company Ltd. wants to raise its funds from market to meet out the financial
demands of its long-term projects. The company has various combinations of proposals to raise its
funds. You are given the following proposals of the company:
Proposal Equity shares (%) Debts (%) Preference shares (%)
P 100 - -
Q 50 50 -
R 50 - 50

m
(i) Cost of debt and preference shares is 10% each.

o
(ii) Tax rate – 50%

.c
(iii) Equity shares of the face value of Rs. 10 each will be issued at a premium of Rs. 10 per share.
es
(iv) Total investment to be raised Rs. 40,00,000.
ot
(iv) Expected earnings before interest and tax Rs. 18,00,000.
yn

From the above proposals the management wants to take advice from you for appropriate plan
after computing the following:
d

• Earnings per share

• Financial break-even-point
as

COMPUTE the EBIT range among the plans for indifference. Also indicate if any of the plans dominate.
(10 Marks)
.c

5. X Limited is considering to purchase of new plant worth Rs. 80,00,000. The expected net cash flows
w

after taxes and before depreciation are as follows:

Year Net Cash Flows (Rs.)

1 14,00,000
2 14,00,000
3 14,00,000
4 14,00,000
5 14,00,000
6 16,00,000
7 20,00,000
8 30,00,000
9 20,00,000
10 8,00,000

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
The rate of cost of capital is 10%.
You are required to CALCULATE
(i) Pay-back period
(ii) Net present value at 10 discount factor
(iii) Profitability index at 10 discount factor
(iv) Internal rate of return with the help of 10% and 15% discount factor
The following present value table is given for you:

Present value of Rs. 1 at Present value of Rs. 1 at

Year
10% discount rate 15% discount rate
1 .909 .870
2 .826 .756
3 .751 .658
4 .683 .572
5 .621 .497

m
6 .564 .432

o
7 .513 .376
8 .467 .327

.c
9 .424 .284 es
10 .386 .247
(10 Marks)
ot
6. (a) DISCUSS the three major decisions taken by a finance manager to maximize the wealth of
yn

shareholders.
(b) STATE the disadvantages of the Certainty equivalent Method. EXPLAIN its differences with Risk
d

Adjusted discount rate.

(c) STATE the advantages of Stock-Splits. (4 + 4 + 2 =10 Marks)

as
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: October 2018

MOCK TEST PAPER – 2
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
ANSWERS
1. (a) Workings:
D1 `3
(i) Cost of Equity (K e) = g =  0.07  0.1  0.07 = 0.17 = 17%
P0 ` 30

(ii) Cost of Debentures (K d) = 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)
Source of capital Market Value of Weight Cost of capital WACC (%)
capital (Rs.) (%)

m
9% Debentures 30,00,000 0.30 5.40 1.62

co
12% Preference Shares 10,00,000 0.10 12.00 1.20
Equity Share Capital 60,00,000 0.60 17.00 10.20
(Rs. 30 × 2,00,000 shares)
s.
te
Total 1,00,00,000 1.00 13.02
no

EBIT Rs. 27,00,000

(b) (i) ROCE = = × 100 = 27%
Captial employed Rs. 1,00,00,000
dy

Workings:
tu

(I) Calculation of EBT: Rs.

Sales 75,00,000
Less: Variable costs 42,00,000
.c

Contribution 33,00,000
w

Less: Fixed costs 6,00,000

EBIT 27,00,000
w

Less: Interest (12 % of Rs. 45,00,000) 5,40,000

EBT 21,60,000
Capital employed = Debt + Equity Shares = Rs. 1,00,00,000.
(ii) Since ROCE (27%) is higher than the interest payable on debt (12%). NSG has a
favourable financial leverage.
(iii) Capital employed = Total assets = Rs. 1,00,00,000
Net sales = Rs.75,00,000
Rs. 75,00,000
Therefore, turnover ratio = = 0.75
Rs. 1,00,00,000
The industry average is 3 against NSG’s ratio of 0.75. Hence NSG Ltd. has very low asset
leverage.

Join Us on Telegram http://t.me/canotes_ipcc

Contribution Rs. 33,00,000

(iv) Operating leverage = = = 1.22
EBIT Rs. 27,00,000

EBIT Rs. 27,00,000

Financial Leverage = = = 1.25
EBT Rs. 21,60,000

Contribution Rs. 33,00,000

Combined leverage = = = 1.53
EBT Rs. 21,60,000

Or
DCL = DOL × DFL = 1.22 × 1.25 = 1.53
(v) For EBT to become zero, a 100% reduction in the EBT is required. As the combined
leverage is 1.53, sales have to drop approx. by 100/1.53 = 65.36%. Hence, the new sales
will be:
Rs. 75,00,000 × (1 – 0.6536) = Rs. 25,98,000 (approx.)
(c) (i) Determination of Sales and Cost of goods sold:
om
Gross Profit Ratio =
Gross Profit
Sales
× 100
. c
25 Rs.4,00,000
e s
Or,
100
=
Sales
o t
Or, Sales =
4,00,00,000
25
y
= Rs. 16,00,000n
t ud
Cost of Goods Sold = Sales – Gross Profit
= Rs. 16,00,000 - Rs. 4,00,000 = Rs. 12,00,000

a
(ii) Determination of Sundry Debtors:s
.c
Debtors velocity is 3 months or Debtors’ collection period is 3 months,

w
So, Debtors’ turnover ratio =
12months
3months
=4

w
w
Debtors’ turnover ratio =
Credit Sales
Average AccountsReceivable
Rs.16,00,000
= =4
Bills Receivable+ SundryDebtors
Or, Sundry Debtors + Bills receivable = Rs. 4,00,000
Sundry Debtors = Rs. 4,00,000 – Rs. 25,000 = Rs. 3,75,000
(iii) Determination of Sundry Creditors:
Creditors velocity of 2 months or credit payment period is 2 months.
12 months
So, Creditors’ turnover ratio = =6
2 months

Join Us on Telegram http://t.me/canotes_ipcc

CreditPurchases *
Creditors turnover ratio =
Average AccountsPayables
Rs.12,10,000
= =6
Sundry Creditors+ Bills Payables
So, Sundry Creditors + Bills Payable = Rs. 2,01,667
Or, Sundry Creditors + Rs. 10,000 = Rs. 2,01,667
Or, Sundry Creditors = Rs. 2,01,667 – Rs. 10,000 = Rs. 1,91,667
(iv) Closing Stock
Cost of Goods Sold Rs.12,00,000
Stock Turnover Ratio = = =1.5
Average Stock Average Stock
So, Average Stock = Rs. 8,00,000
Opening Stock+ Closing Stock
Now Average Stock =
2
Opening Stock+ (Opening Stock+ Rs.10,000) o m
Or
2 c
= Rs. 8,00,000
.
Or, Opening Stock = Rs. 7,95,000
es
t
So, Closing Stock= Rs. 7,95,000 + Rs. 10,000 = Rs. 8,05,000
o
(v) Calculation of Fixed Assets

y n
Cost of GoodsSold
Fixed Assets Turnover Ratio =

u d
FixedAssets
=4

Or,
Rs.12,00,000
=4
s t
Fixed Assets
a
.c
Or, Fixed Asset = Rs. 3,00,000
Workings:
w
w
* Calculation of Credit purchases:

w
Cost of goods sold = Opening stock + Purchases – Closing stock
Rs. 12,00,000 = Rs. 7,95,000 + Purchases – Rs. 8,05,000
Rs. 12,00,000 + Rs. 10,000 = Purchases
Rs. 12,10,000 = Purchases (credit).
Assumption:
(i) All sales are credit sales
(ii) All purchases are credit purchase
(iii) Stock Turnover Ratio and Fixed Asset Turnover Ratio may be calculated either
on Sales or on Cost of Goods Sold.

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(d) As per MM model, the current market price of equity share is:
1
P0 = ×(D1 + P1 )
1+ k e
(i) If the dividend is not declared:
1
100 = (0 + P1 )
1+ 0.12
P1
100 = = P1 = Rs.112
1.12
The Market price of the equity share at the end of the year would be Rs.112.
(ii) If the dividend is declared:
1
100 = ×(10 + P1 )
1+ 0.12
10+ P1

m
100 =
1.12

o
112 = 10 + P 1

.c
P1 = 112 – 10 = Rs.102
es
The market price of the equity share at the end of the year would be Rs.102.
(iii) In case the firm pays dividend of Rs.10 per share out of total profits of Rs. 5,00,000 and plans
ot
to make new investment of Rs. 10,00,000, the number of shares to be issued may be found
yn

as follows:
Total Earnings Rs.5,00,000
ud

- Dividends paid (1,00,000)

Retained earnings 4,00,000

Total funds required 10,00,000
a
.c

Fresh funds to be raised 6,00,000

Market price of the share 102

Number of shares to be issued (Rs.6,00,000 / 102) 5,882.35

or, the firm would issue 5,883 shares at the rate of Rs.102
2. (i) Computation of Weighted Average Cost of Capital based on existing capital structure
Existing Capital Weights After tax cost WACC (%)
Source of Capital
structure (Rs.) of capital (%)
(a) (b) (a)  (b)
Equity share capital (W.N.1) 40,00,000 0.500 15.00 7.500
11.5% Preference share capital 10,00,000 0.125 11.50 1.437
(W.N.2)
10% Debentures (W.N.3) 30,00,000 0.375 6.50 2.438
80,00,000 1.000 11.375

Join Us on Telegram http://t.me/canotes_ipcc

Working Notes (W.N.)

1. Cost of equity capital:
Expected Dividend (D1)
Ke = + Growth(g)
Current Market Price per Share (P 0)

Rs. 2
= + 0.05 = 0.15 or 15%
Rs. 20
2. Cost of preference share capital:
Annual preference share dividend (PD)
=
Net proceeds in the issue of preference share (NP)

Rs. 1,15,000
= = 0.115 or 11.5%
Rs. 10,00,000
3. Cost of 10% Debentures:

=
I(1  t)
=
Rs. 3,00,000 (1- 0.35)
= 0.065 or 6.5%
o m
NP Rs. 30,00,000
. c
s
(ii) Computation of Weighted Average Cost of Capital based on new capital structure

e
Source of Capital New Capital
structure (Rs.)
ot Weights After tax cost
of capital (%)
WACC (%)

Equity share capital (W.N. 4) y n

40,00,000
(b)
0.40
(a)
20.00
(a)  (b)
8.00
Preference share (W.N. 2)
u d 10,00,000 0.10 11.50 1.15
10% Debentures (W.N. 3)
12% Debentures (W.N.5)
a st 30,00,000
20,00,000
0.30
0.20
6.50
7.80
1.95
1.56

.c 1,00,00,000 1.00 12.66

Working Notes (W.N.):
w
4.
w
Cost of equity capital:

Ke = wExpectedDividend(D1 )
CurrentMarketPr iceper share(P0 )
 Growth(g) =
` 2.40
` 16
 5%  20%

5. Cost of 12% Debentures

`2,40,000(1- 0.35)
Kd = = 0.078 or 7.8%
`20,00,000
3. Statement showing Evaluation of Credit Policies (Amount in lakhs)
Particulars Present Policy Proposed Proposed
Policy I Policy II
(Rs.) (Rs.) (Rs.)
A Expected Profit :
(a) Credit Sales 225.00 275.00 350.00
(b) Total Cost other than Bad Debts:

Join Us on Telegram http://t.me/canotes_ipcc

Variable Costs 135.00 165.00 210.00

(c) Bad Debts 7.50 22.50 47.50
(d) Expected Profit [(a)-(b)-(c)] 82.50 87.50 92.50
B Opportunity Cost of Investment in Receivables* 5.40 8.25 14.00
C Net Benefits [A-B] 77.10 79.25 78.50
Recommendation: The Proposed Policy I should be adopted since the net benefits under this policy is
higher than those under other policies.
Working Note:
*Calculation of Opportunity Cost of Average Investments
Collection Period Rate of Return
Opportunity Cost = Total Cost  
12 100
Present Policy = Rs.135 lakhs × 2.4/12 × 20% = Rs. 5.40 lakhs
Proposed Policy I = Rs. 165 lakhs × 3/12 × 20% = Rs. 8.25 lakhs

om
Proposed Policy II = Rs. 210 lakhs × 4/12 × 20% = Rs. 14.00 lakhs
4. (i) Computation of Earnings per Share (EPS)

.c
Plans P (Rs.) Q (Rs.) R (Rs.)
Earnings before interest & tax (EBIT)
es
18,00,000 18,00,000 18,00,000
Less: Interest charges -- (2,00,000) --
ot
Earnings before tax (EBT) 18,00,000 16,00,000 18,00,000
n

Less: Tax @ 50% (9,00,000) (8,00,000) (9,00,000)

Earnings after tax (EAT) 9,00,000 8,00,000 9,00,000

Less: Preference share dividend -- -- (2,00,000)

Earnings available for equity shareholders 9,00,000 8,00,000 7,00,000

No. of equity shares 2,00,000 1,00,000 1,00,000
.c

E.P.S 4.5 8 7
w

(ii) Computation of Financial Break-even Points

Proposal ‘P’ =0
w

Proposal ‘Q’ = Rs. 2,00,000 (Interest charges)

Proposal ‘R’ = Earnings required for payment of preference share dividend i.e.
Rs. 2,00,000  0.5 (Tax Rate) = Rs. 4,00,000
(iii) Computation of Indifference Point between the Proposals
Combination of Proposals
(a) Indifference point where EBIT of proposal “P” and proposal ‘Q’ is equal
EBIT(1- 0.5) (EBIT -Rs.2,00,000)(1- 0.5)
=
2,00,000shares 1,00,000shares
0.5 EBIT = EBIT – Rs. 2,00,000
EBIT = Rs. 4,00,000

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(b) Indifference point where EBIT of proposal ‘P’ and proposal ‘R’ is equal:
EBIT(1- 0.50) EBIT(1- 0.50) -Rs.2,00,000
=
2,00,000shares 1,00,000shares
0.5EBIT 0.5EBIT -Rs.2,00,000
=
2,00,000shares 1,00,000shares
0.25 EBIT = 0.5 EBIT – Rs. 2,00,000
Rs.2,00,000
EBIT = = Rs. 8,00,000
0.25
(c) Indifference point where EBIT of proposal ‘Q’ and proposal ‘R’ are equal
(EBIT -Rs.2,00,000)(1- 0.5) EBIT(1- 0.5) -Rs.2,00,000
=
1,00,000shares 1,00,000shares
0.5 EBIT – Rs.1,00,000 = 0.5 EBIT – Rs.2,00,000
There is no indifference point between proposal ‘Q’ and proposal ‘R’

om
Analysis: It can be seen that financial proposal ‘Q’ dominates proposal ‘R’, since the financial
break-even-point of the former is only Rs. 2,00,000 but in case of latter, it is Rs . 4,00,000.

.c
5. (i) Calculation of Pay-back Period
Cash Outlay of the Project es = Rs. 80,00,000
Total Cash Inflow for the first five years = Rs. 70,00,000
ot
Balance of cash outlay left to be paid back in the 6 th year Rs. 10,00,000
n

Cash inflow for 6 th year = 16,00,000

So the payback period is between 5 th and 6th years, i.e.,

Rs.10,00,000
5 years + = 5.625 years or 5 years 7.5 months
Rs.6,00,000
as

(ii) Calculation of Net Present Value (NPV) @10% discount rate:

Year Net Cash Inflow Present Value at Present Value

(Rs.) Discount Rate of 10% (Rs.)

(a) (b) (c) = (a) × (b)

1 14,00,000 0.909 12,72,600

2 14,00,000 0.826 11,56,400
3 14,00,000 0.751 10,51,400
4 14,00,000 0.683 9,56,200
5 14,00,000 0.621 8,69,400
6 16,00,000 0.564 9,02,400
7 20,00,000 0.513 10,26,000
8 30,00,000 0.467 14,01,000
9 20,00,000 0.424 8,48,000
10 8,00,000 0.386 3,08,800
97,92,200
Net Present Value (NPV) = Cash Outflow – Present Value of Cash Inflows
7

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
= Rs. 80,00,000 – Rs. 97,92,200 = 17,92,200
(iii) Calculation of Profitability Index @ 10% discount rate:
Present Value of Cash inflows
Profitability Index =
Cost of the investment
Rs.97,92,200
= = 1.224
Rs.80,00,000
(iv) Calculation of Internal Rate of Return:
Net present value @ 10% interest rate factor has already been calculated in (ii) above, we will
calculate Net present value @15% rate factor.
Year Net Cash Inflow Present Value at Discount Present Value
(Rs.) Rate of 15% (Rs.)
(a) (b) (c) = (a)× (b)
1 14,00,000 0.870 12,18,000
2
3
14,00,000
14,00,000
0.756
0.658 om 10,58,400
9,21,200
4 14,00,000
.
0.572 c 8,00,800
5 14,00,000 s
0.497 6,95,800
6
7
16,00,000
20,00,000 o te
0.432
0.376
6,91,200
7,52,000
8 30,00,000
y n 0.327 9,81,000
9 20,00,000

u d 0.284 5,68,000
10 8,00,000

s t 0.247 1,97,600
78,84,000

ca
Net Present Value at 15% = Rs. 78,84,000 – Rs. 80,00,000 = Rs. -1,16,000
.
As the net present value @ 15% discount rate is negative, hence internal rate of return falls in

w
between 10% and 15%. The correct internal rate of return can be calculated as follows:

IRR = L w
NPVL
H  L 
w
NPVL  NPVH
Rs.17,92,200
= 10% + 15% -10% 
Rs.17,92,200-(-Rs. 1,16,000)
Rs.17,92,200
= 10% + ×5% = 14.7%
Rs.19,08,200
6. (a) To achieve wealth maximization, a finance manager has to take careful decision in respect of:
(i) Investment decisions: These decisions relate to the selection of assets in which funds will
be invested by a firm. Funds procured from different sources have to be invested in various
kinds of assets. Long term funds are used in a project for various fixed assets and also for
current assets. The investment of funds in a project has to be made after careful assessment
of the various projects through capital budgeting. A part of long term funds is also to be kept
for financing the working capital requirements. Asset management policies are to be laid down
regarding various items of current assets. The inventory policy would be determined by the
8

Join Us on Telegram http://t.me/canotes_ipcc

production manager and the finance manager keeping in view the requirement of production
and the future price estimates of raw materials and the availability of funds.
(ii) Financing decisions: These decisions relate to acquiring the optimum finance to meet
financial objectives and seeing that fixed and working capital are effectively managed. The
financial manager needs to possess a good knowledge of the sources of available funds and
their respective costs and needs to ensure that the company has a sound capital structure,
i.e. a proper balance between equity capital and debt. Financing decisions also call for a
good knowledge of evaluation of risk, e.g. excessive debt carried high risk for an
organization’s equity because of the priority rights of the lenders.
(iii) Dividend decisions: These decisions relate to the determination as to how much and how
frequently cash can be paid out of the profits of an organisation as income for its
owners/shareholders. The dividend decision thus has two elements – the amount to be paid
out and the amount to be retained to support the growth of the organisation, the latter being
also a financing decision; the level and regular growth of dividends re present a significant
factor in determining a profit-making company’s market value, i.e. the value placed on its
shares by the stock market.

m
All three types of decisions are interrelated, the first two pertaining to any kind of organisation
while the third relates only to profit-making organisations, thus it can be seen that financial

o
management is of vital importance at every level of business activity, from a sole trader to the

.c
largest multinational corporation.
(b) Disadvantages of Certainty Equivalent Method es
1. There is no Statistical or Mathematical model available to estimate certainty Equivalent.
ot
Assumption of risk being subjective, it varies on the perception of the risk by the management
because of bias and individual opinions involved.
yn

2. There is no objective or mathematical method to estimate certainty equivalents. Certainty

Equivalent are subjective and vary as per each individual’s estimate.

3. Certainty equivalents are decided by the management based on their perception of risk.
However the risk perception of the shareholders who are the money lenders for the project is
as

ignored. Hence it is not used often in corporate decision making .

Risk-adjusted Discount Rate Vs. Certainty-Equivalent

Certainty Equivalent Method is superior to Risk Adjusted Discount Rate Method as it does not
w

assume that risk increases with time at constant rate. Each year's Certainty Equivalent Coefficient
w

is based on level of risk impacting its cash flow. Despite its soundness, it is not preferable like Risk
w

Adjusted Discount Rate Method. It is difficult to specify a series of Certainty Equivalent Coefficients
but simple to adjust discount rates.
(c) Various advantages of Stock Spills are as follows:
1. It makes the share affordable to small investors.
2. Number of shares may increase the number of shareholders; hence the potential of
investment may increase.

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: August, 2018

MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
Time Allowed – 3 Hours Maximum Marks – 100

PAPER 8A : FINANICAL MANAGEMENT (60 Marks)

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
1. Answer the following:
(a) From the following information, PREPARE a summarised Balance Sheet as at 31 st March, 20X6:

m
Working Capital Rs.2,40,000

o
Bank overdraft Rs.40,000

.c
Fixed Assets to Proprietary ratio 0.75 es
Reserves and Surplus Rs.1,60,000
ot
Current ratio 2.5
Liquid ratio 1.5
yn

(b) An enterprise is investing Rs.100 lakhs in a project. The risk-free rate of return is 7%. Risk premium
d

expected by the management is 7%. The life of the project is 5 years. Following are the cash flows
tu

that are estimated over the life of the project.

Year Cash flows (Rs.)

1 25,00,000
.c

2 60,00,000
w

3 75,00,000
w

4 80,00,000
w

5 65,00,000
CALCULATE Net Present Value of the project based on Risk free rate and also on the basis of
Risks adjusted discount rate.
(c) M Ltd. belongs to a risk class for which the capitalization rate is 10%. It has 25,000 outstanding
shares and the current market price is Rs. 100. It expects a net profit of Rs. 2,50,000 for the year
and the Board is considering dividend of Rs. 5 per share.
M Ltd. requires to raise Rs. 5,00,000 for an approved investment expenditure. ANALYSE, how the
MM approach affects the value of M Ltd. if dividends are paid or not paid.
(d) PQR Ltd. has the following capital structure on October 31, 20X8:
Sources of capital (Rs.)
Equity Share Capital (2,00,000 Shares of Rs. 10 each) 20,00,000
Reserves & Surplus 20,00,000

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com

12% Preference Shares 10,00,000

9% Debentures 30,00,000
80,00,000
The market price of equity share is Rs. 30. It is expected that the company will pay next year a
dividend of Rs. 3 per share, which will grow at 7% forever. Assume 40% income tax rate.
You are required to COMPUTE weighted average cost of capital using market value weights.
(4 × 5 = 20 Marks)
2. A newly formed company has applied to the commercial bank for the first time for financing its working
capital requirements. The following information is available about the projections for the current year:
Estimated level of activity: 1,04,000 completed units of production plus 4,000 units of work-in progress.
Based on the above activity, estimated cost per unit is:
Raw material Rs. 80 per unit
Direct wages Rs. 30 per unit
Overheads (exclusive of depreciation) Rs. 60 per unit

m
Total cost Rs. 170 per unit

o
Selling price Rs. 200 per unit

.c
Raw materials in stock: Average 4 weeks consumption, work-in-progress (assume 50% completion
es
stage in respect of conversion cost) (materials issued at the start of the processing).
ot
Finished goods in stock 8,000 units
Credit allowed by suppliers Average 4 weeks
yn

Credit allowed to debtors/receivables Average 8 weeks

Lag in payment of wages 1

Average 1 weeks
tu

2
as

Cash at banks (for smooth operation) is expected to be Rs.25,000

Assume that production is carried on evenly throughout the year (52 weeks) and wages and overheads
.c

accrue similarly. All sales are on credit basis only.

CALCULATE
w

(i) Net Working Capital required;

(ii) Maximum Permissible Bank finance under first and second methods of financing as per Tandon
Committee Norms. (10 Marks)
3. A company has to make a choice between two projects namely A and B. The initial capital outlay of two
Projects are Rs.1,35,00,000 and Rs.2,40,00,000 respectively for A and B. There will be no scrap value
at the end of the life of both the projects. The opportunity cost of capital of the company is 16%. The
annual incomes are as under:
Year Project A Project B Discounting factor @ 16%
1 -- 60,00,000 0.862
2 30,00,000 84,00,000 0.743
3 1,32,00,000 96,00,000 0.641
4 84,00,000 1,02,00,000 0.552
5 84,00,000 90,00,000 0.476

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com
You are required to CALCULATE for each project:
(i) Discounted payback period
(ii) Profitability index
(iii) Net present value (10 Marks)
4. The Modern Chemicals Ltd. requires Rs.25,00,000 for a new plant. This plant is expected to yield
earnings before interest and taxes of Rs. 5,00,000. While deciding about the financial plan, the company
considers the objective of maximising earnings per share. It has three alternatives to finance the project-
by raising debt of Rs.2,50,000 or Rs.10,00,000 or Rs.15,00,000 and the balance, in each case, by
issuing equity shares. The company’s share is currently selling at Rs. 150, but is expected to decline to
Rs.125 in case the funds are borrowed in excess of Rs.10,00,000. The funds can be borrowed at the
rate of 10% upto Rs. 2,50,000, at 15% over Rs.2,50,000 and upto Rs.10,00,000 and at 20% over
Rs.10,00,000. The tax rate applicable to the company is 50%.
DETERMINE, which form of financing should the company choose? (10 Marks)
5. From the following, PREPARE Income Statement of Company A and B.
Company A B

m
Financial leverage 3:1 4:1

o
Interest Rs.20,000 Rs.30,000

.c
Operating leverage 4:1 5:1
Variable Cost as a Percentage to Sales
es 2
66 % 75%
3
ot
Income tax Rate 45% 45%
yn

(10 Marks)
d

6. (a) STATE Agency Cost. DISCUSS the ways to reduce the effect of it.
tu

(b) EXPLAIN the importance of trade credit and accruals as source of short-term finance. DISCUSS
the cost of these sources?
as

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com

Test Series: August, 2018

MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Working notes:
(i) Current assets and Current liabilities computation:
Current assets 2.5
=
Current liabilities 1

Current Assets Current Liabilities

Or, = = k (say)
2.5 1

m
Or, Current Assets = 2.5 k and Current Liabilities = k
Or, Working capital = (Current Assets  Current Liabilities)

o
.c
Or, Rs.2,40,000 = k (2.5  1) = 1.5 k
Or, k = Rs.1,60,000 es
 Current Liabilities = Rs. 1,60,000
ot
Current Assets = Rs.1,60,000  2.5 = Rs.4,00,000
yn

(ii) Computation of stock

Liquid assets
Liquid ratio =
tu

Current liabilities
as

Current Assets - Stock

Or,1.5 =
Rs.1,60,000
.c

Or, 1.5  Rs.1,60,000 = Rs.4,00,000  Stock

Or, Stock = Rs.1,60,000

(iii) Computation of Proprietary fund; Fixed assets; Capital and Sundry payables (creditors)
w

Fixed assets
Proprietary ratio = = 0.75
Proprietary fund
 Fixed assets = 0.75 Proprietary fund
and Net working capital = 0.25 Proprietary fund
Or, Rs.2,40,000/0.25 = Proprietary fund
Or, Proprietary fund = Rs.9,60,000
and Fixed assets = 0.75 proprietary fund
= 0.75  Rs.9,60,000
= Rs.7,20,000
Equity Capital = Proprietary fund  Reserves & Surplus
= Rs.9,60,000  Rs.1,60,000
1

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com
= Rs.8,00,000
Sundry payables (creditors) = (Current liabilities  Bank overdraft)
= (Rs.1,60,000  Rs.40,000) = Rs.1,20,000
Balance Sheet
Liabilities (Rs.) Assets (Rs.)
Equity Capital 8,00,000 Fixed assets 7,20,000
Reserves & Surplus 1,60,000 Stock 1,60,000
Bank overdraft 40,000 Current assets 2,40,000
Sundry payables 1,20,000
11,20,000 11,20,000

(b) The Present Value of the Cash Flows for all the years by discounting the cash flow at 7% is
calculated as below:
Year Cash flows Discounting factor @ Present value of cash

m
Rs. in lakhs 7% flows Rs. in lakhs

o
1 25,00,000 0.935 23,37,500

.c
2 60,00,000 0.873 52,38,000
3 75,00,000 0.816 es 61,20,000
4 80,00,000 0.763 61,04,000
ot
5 65,00,000 0.713 46,34,500
yn

Total of present value of Cash flow 2,44,34,000

Less: Initial investment 1,00,00,000
d

Net Present Value (NPV) 1,44,34,000

When the risk-free rate is 7% and the risk premium expected by the management is 7 %. So the
as

risk adjusted discount rate is 7% + 7% =14%.

Discounting the above cash flows using the Risk Adjusted Discount Rate would be as below:
w

Year Cash flows Discounting factor @14% Present Value of cash flows
Rs. in lakhs Rs. in lakhs
w

1 25,00,000 0.877 21,92,500

2 60,00,000 0.769 46,14,000

3 75,00,000 0.675 50,62,500
4 80,00,000 0.592 47,36,000
5 65,00,000 0.519 33,73,500
Total of present value of Cash flow 1,99,78,500
Initial investment 1,00,00,000
Net present value (NPV) 99,78,500
(c)
A When dividend is paid
(a) Price per share at the end of year 1

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com

1
100 = (Rs. 5+ P 1)
1.10
110 = Rs. 5 + P1
P1 = 105
(b) Amount required to be raised from issue of new shares
Rs.5,00,000 – (Rs.2,50,000 – Rs.1,25,000)
Rs.5,00,000 – Rs.1,25,000 = Rs.3,75,000
(c) Number of additional shares to be issued
3,75,000 75,000
 shares or say 3,572 shares
105 21
(d) Value of M Ltd.
(Number of shares × Expected Price per share)
i.e., (25,000 + 3,572) × Rs.105 = Rs.30,00,060
B When dividend is not paid

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

o
P1

.c
100=
1.10 es
P1 = 110
(b) Amount required to be raised from issue of new shares
ot
Rs.5,00,000 – 2,50,000 = 2,50,000
yn

(c) Number of additional shares to be issued

2,50,000 25,000
d

 shares or say 2,273 shares.

110 11
(d) Value of M Ltd.,
as

(25,000 + 2273) × Rs.110

= Rs.30,00,030
Whether dividend is paid or not, the value remains the same.
w

(d) Workings:
w

D1 `3
w

(i) Cost of Equity (K e) = g=  0.07  0.1  0.07 = 0.17 = 17%

P0 ` 30
(ii) Cost of Debentures (K d) = 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)
Source of capital Market Value Weight Cost of capital (%) WACC (%)
of capital (Rs.)
9% Debentures 30,00,000 0.30 5.40 1.62
12% Preference Shares 10,00,000 0.10 12.00 1.20
Equity Share Capital 60,00,000 0.60 17.00 10.20
(Rs.30 × 2,00,000 shares)
Total 1,00,00,000 1.00 13.02

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com
2. (i) Estimate of the Requirement of Working Capital
(Rs.) (Rs.)
A. Current Assets:
Raw material stock 6,64,615
(Refer to Working note 3)
Work in progress stock 5,00,000
(Refer to Working note 2)
Finished goods stock 13,60,000
(Refer to Working note 4)
Debtors/ Receivables 29,53,846
(Refer to Working note 5)
Cash and Bank balance 25,000 55,03,461
B. Current Liabilities:
Creditors for raw materials 7,15,740

m
(Refer to Working note 6)

o
Creditors for wages 91,731 (8,07,471)

.c
(Refer to Working note 7) ________
Net Working Capital (A-B)
es 46,95,990
ot
(ii) The maximum permissible bank finance as per Tandon Committee Norms
First Method:
yn

75% of the net working capital financed by bank i.e. 75% of Rs.46,95,990
d

(Refer to (i) above)

= Rs. 35,21,993
as

Second Method:
.c

(75% of Current Assets) - Current liabilities

= 75% of Rs. 55,03,461 - Rs. 8,07,471
w

(Refer to (i) above)

= Rs. 41,27,596 – Rs. 8,07,471

= Rs. 33,20,125
Working Notes:
1. Annual cost of production
Rs.
Raw material requirements (1,04,000 units  Rs. 80) 83,20,000
Direct wages (1,04,000 units  Rs. 30) 31,20,000
Overheads (exclusive of depreciation) (1,04,000  Rs. 60) 62,40,000
1,76,80,000
2. Work in progress stock
Rs.
Raw material requirements (4,000 units  Rs. 80) 3,20,000
4

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com

Direct wages (50%  4,000 units  Rs. 30) 60,000

Overheads (50%  4,000 units  Rs.60) 1,20,000
5,00,000
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 83,20,000
For Work in progress 3,20,000
86,40,000
Rs. 86, 40,000
Raw material stock × 4 weeks i.e. Rs. 6,64,615
52 weeks

m
4. Finished goods stock

o
8,000 units @ Rs. 170 per unit = Rs. 13,60,000

.c
5. Debtors for sale
Credit allowed to debtors
es Average 8 weeks
ot
Credit sales for year (52 weeks) i.e. (1,04,000 units-8,000 units) 96,000 units
Selling price per unit Rs.200
yn

Credit sales for the year (96,000 units Rs. 200) Rs. 1,92,00,000
d

Debtors Rs. 1,92,00,000

× 8 weeks i.e. Rs. 29,53,846
tu

52 weeks
as

(Debtor can also be calculated based on Cost of goods sold)

6. Creditors for raw material:
.c

Credit allowed by suppliers Average 4 weeks

Purchases during the year (52 weeks) i.e. Rs. 93,04,615

(Rs. 83,20,000 + Rs. 3,20,000 + Rs. 6,64,615)

(Refer to Working notes 1,2 and 3 above)

Creditors Rs. 93,04,615
× 4 weeks i.e. Rs. 7,15,740
52 weeks
7. Creditors for wages
Lag in payment of wages 1
Average 1 weeks
2
Direct wages for the year (52 weeks) i.e. Rs. 31,80,000
(Rs. 31,20,000 + Rs. 60,000)
(Refer to Working notes 1 and 2 above)
Creditors Rs.31,80,000 1
× 1 weeks i.e. Rs. 91,731
52 weeks 2

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com
3. (1) Computation of Net Present Values of Projects (Amount in Rs. ‘000)
Year Cash flows Discount Discounted Cash flow
Project A Project B factor @ 16 % Project A Project B
(Rs.) (Rs.) (Rs.) (Rs.)
(1) (2) (3) (3)  (1) (3)  (2)
0 (13,500) (24,000) 1.000 (13,500) (24,000)
1 -- 6,000 0.862 -- 5,172
2 3,000 8,400 0.743 2,229 6,241.2
3 13,200 9,600 0.641 8,461.2 6,153.6
4 8,400 10,200 0.552 4,636.8 5,630.4
5 8,400 9,000 0.476 3,998.4 4,284
Net present value 5,825.4 3,481.2
(2) Computation of Cumulative Present Values of Projects Cash inflows

m
(Amount in Rs. ‘000)
Project A Project B

o
.c
Year PV of Cumulative PV of Cumulative
cash inflows (Rs.) PV (Rs.) cash inflows (Rs.) PV (Rs.)
1 -- --
es 5,172 51,72
ot
2 2,229 22,29 6,241.2 11,413.2
3 8,461.2 10,690.2 6,153.6 17,566.8
yn

4 4,636.8 15,327 5,630.4 23,197.2

5 3,998.4 19,325.4 4,284 27,481.2

(i) Discounted payback period: (Refer to Working note 2)

Cost of Project A = Rs.1,35,00,000

Cost of Project B = Rs.2,40,00,000
.c

Cumulative PV of cash inflows of Project A after 4 years = Rs.1,53,27,000

Cumulative PV of cash inflows of Project B after 5 years = Rs.2,74,81,200

A comparison of projects cost with their cumulative PV clearly shows that the project A’s cost
w

will be recovered in less than 4 years and that of project B in less than 5 years. The exact
duration of discounted payback period can be computed as follows:
Project A Project B
Excess PV of cash 18,27,000 34,81,200
inflows over the project (Rs.1,53,27,000  Rs.1,35,00,000) (Rs. 2,74,81,200  Rs.2,40,00,000)
cost (Rs.)
Computation of period 0.39 year 0.81 years
required to recover (Rs. 18,27,000 ÷ Rs.46,36,800) (Rs.34,81,200 ÷ Rs. 42,84,000)
excess amount of
cumulative PV over
project cost (Refer to
Working note 2)
Discounted payback 3.61 year 4.19 years
period (4  0.39) years (5  0.81) years
6

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com

Sum of discounted cash inflows

(ii) Profitability Index: =
Initian cash outlay
Rs.1,93,25,400
Profitability Index (for Project A) = = 1.43
Rs.1,35,00,000
Rs.2,74,81,200
Profitability Index (for Project B) = = 1.15
Rs.2,40,00,000
(iii) Net present value (for Project A) = Rs.58,25,400 (Refer to Working note 1)
Net present value (for Project B) = Rs.34,81,200
4. Calculation of Earnings per share for three alternatives to finance the project
Alternatives
I II III
Particulars To raise debt of Rs. To raise debt of To raise debt of
2,50,000 and equity Rs.10,00,000 and Rs.15,00,000 and
of Rs. 22,50,000 equity of Rs.15,00,000 equity of Rs. 10,00,000

m
(Rs.) (Rs.) (Rs.)

o
Earnings before interest and tax 5,00,000 5,00,000 5,00,000

.c
Less: Interest on debt at the rate 25,000 1,37,500 2,37,500
of (10% on Rs.2,50,000) es(10% on Rs.2,50,000)
(15% on Rs. 7,50,000)
(10% on Rs. 2,50,000)
(15% on Rs.7,50,000)
ot
(20% on Rs.5,00,000)
Earnings before tax 4,75,000 3,62,500 2,62,500
yn

Less: Tax @ 50% 2,37,500 1,81,250 1,31,250

Earnings after tax: (A) 2,37,500 1,81,250 1,31,250

Number of shares: (B) (Equity/ 15,000 10,000 8,000

Market price of Share)
as

(Rs.22,50,000/Rs.150) (Rs.15,00,000/Rs.150) (Rs.10,00,000/Rs.125)

Earnings per share: [(A)/(B)] 15.833 18.125 16.406
.c

The company should raise Rs.10,00,000 from debt and Rs.15,00,000 by issuing equity shares, as it
w

gives highest EPS.

5. Working Notes:
w

Company A
EBIT 3
Financial leverage= = = Or, EBIT = 3× EBT (1)
EBT 1
Again EBIT – Interest = EBT
Or, EBIT- 20,000 = EBT (2)
Taking (1) and (2) we get
3 EBT- 20,000 = EBT
Or, 2 EBT = 20,000 or EBT = Rs.10,000
Hence EBIT = 3EBT = Rs.30,000
Contribution 4
Again, we have operating leverage = =
EBIT 1

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com
EBIT = Rs. 30,000, hence we get
Contribution = 4 × EBIT = Rs.1,20,000
2
Now variable cost = 66 % on sales
3
2 1
Contribution = 100 - 66 % i.e. 33 % on sales
3 3
1,20,000
Hence, sales = = Rs. 3,60,000
1
33 %
3
Same way EBIT, EBT, contribution and sales for company B can be worked out.
Company B
EBIT 4
Financial leverage = = or EBIT = 4 EBT (3)
EBT 1

m
Again EBIT – Interest = EBT or EBIT – 30,000 = EBT (4)

o
Taking (3) and (4) we get, 4EBT- 30,000 = EBT

.c
Or, 3EBT = 30,000 Or, EBT=10,000
Hence, EBIT = 4 × EBT= 40,000
es
Contribution 5
ot
Again, we have operating leverage = =
EBIT 1
yn

EBIT= 40,000; Hence we get contribution = 5 × EBIT = 2,00,000

Now variable cost =75% on sales
d
tu

Contribution = 100- 75% i.e. 25% on sales

2,00,000
Hence Sales = = Rs. 8,00,000
25%
.c

Income Statement
w

A (Rs.) B (Rs.)
w

Sales 3,60,000 8,00,000

Less: Variable Cost 2,40,000 6,00,000

Contribution 1,20,000 2,00,000
Less: Fixed Cost (bal. Fig) 90,000 1,60,000
EBIT 30,000 40,000
Less: Interest 20,000 30,000
EBT 10,000 10,000
Less: Tax 45% 4,500 4,500
EAT 5,500 5,500
6. (a) Agency Cost: In a sole proprietorship firm, partnership etc., owners participate in management
but in corporate, owners are not active in management so, there is a separation between owner/
shareholders and managers. In theory managers should act in the best interest of shareholders
however in reality, managers may try to maximise their individual goal like salary, perks etc., so
there is a principal-agent relationship between managers and owners, which is known as Agency
8

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com
Problem. In a nutshell, Agency Problem is the chances that managers may place personal goals
ahead of the goal of owners. Agency Problem leads to Agency Cost. Agency cost is the additional
cost borne by the shareholders to monitor the manager and control their behaviour so as to
maximise shareholders wealth. Generally, Agency Costs are of four types (i) monitoring (ii) bonding
(iii) opportunity (iv) structuring
However, following efforts can be made to address Agency Cost:
Managerial compensation to be linked to profit of the company to some extent with the long term
objectives of the company.
Employees’ Stock option plan (ESOP) is also designed to address the issue with the underlying
assumption that maximisation of the stock price is the objective of the investors.
Effective monitoring through corporate governance can be done.
(b) Trade credit and accruals as source of short-term finance like working capital refers to credit facility
given by suppliers of goods during the normal course of trade. It is a short term source of finance.
Micro small and medium enterprises (MSMEs) in particular are heavily dependent on this source
for financing their working capital needs. The major advantages of trade credit are  easy
availability, flexibility and informality.

m
There can be an argument that trade credit is a cost free source of finance. But it is not. It involves

o
implicit cost. The supplier extending trade credit incurs cost in the form of opportunity cost of funds

.c
invested in trade receivables. Generally, the supplier passes on these costs to the buyer by
increasing the price of the goods or alternatively by not extending cash discount facility.
es
(c) Advantages of Walter Model
ot
1. The formula is simple to understand and easy to compute.
yn

2. It can envisage different possible market prices in different situations and considers internal
rate of return, market capitalisation rate and dividend payout ratio in the determination o f
d

market value of shares.

tu
as
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Downloaded From www.castudynotes.com

Test Series: March, 2019

MOCK TEST PAPER – 1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
Time Allowed – 3 Hours Maximum Marks – 100
PAPER 8A : FINANCIAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If a
candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Maximum Marks – 60
1. Answer the following:

om
(a) With the help of following figures CALCULATE the market price of a share of a company by using:
(i) Walter’s formula

c
(ii) Dividend growth model (Gordon’s formula)
Earnings per share (EPS) s. Rs. 10
te
Dividend per share (DPS) Rs. 6
o
Cost of capital (k) 20%
yn

Internal rate of return on investment 25%

Retention Ratio 60%

(b) From the following details of X Ltd., PREPARE the Income Statement for the year ended 31 st
st

March, 20X8:
a

Financial Leverage 2
.c

Interest Rs. 5,000

Operating Leverage 3
w

Variable cost as a percentage of sales 75%

Income tax rate 30%

(c) Using the following information, PREPARE and complete the Balance Sheet given below:
(i) Total debt to net worth : 1:2
(ii) Total assets turnover : 2
(iii) Gross profit on sales : 30%
(iv) Average collection period : 40 days
(Assume 360 days in a year)
(v) Inventory turnover ratio based on cost of goods sold and year-end inventory : 3
(vi) Acid test ratio : 0.75

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
Balance Sheet
as on March 31, 20X8
Liabilities Rs. Assets Rs.
Equity Shares Capital 4,00,000 Plant and Machinery 
Reserves and Surplus 6,00,000 and other Fixed Assets
Total Debt: Current Assets:
Current Liabilities  Inventory 
Debtors 
- Cash 

(d) Determine the risk adjusted net present value of the following projects:
X Y Z
Net cash outlays (Rs.) 2,10,000 1,20,000 1,00,000

om
Project life 5 years 5 years 5 years
Annual Cash inflow (Rs.) 70,000 42,000 30,000

c
Coefficient of variation 1.2 0.8 0.4

s.
The Company selects the risk-adjusted rate of discount on the basis of the coefficient of variation:
te
Coefficient of Variation Risk-Adjusted Rate of Return P.V. Factor 1 to 5 years At risk
o
adjusted rate of discount
yn

0.0 10% 3.791

0.4 12% 3.605

0.8 14% 3.433
st

1.2 16% 3.274

1.6 18% 3.127

2.0 22% 2.864

More than 2.0 25% 2.689

[4 × 5 = 20 Marks]
w

2. (a) LIST the factors determining the dividend policy of a company. [3 Marks]
(b) A bank is analysing the receivables of J Ltd. in order to identify acceptable collateral for a short-
term loan. The company’s credit policy is 2/10 net 30. The bank lends 80 percent on accounts
where customers are not currently overdue and where the average payment period does not
exceed 10 days past the net period. A schedule of J Ltd.’s receivables has been prepared.
ANALYSE, how much will the bank lend on pledge of receivables, if the bank uses a 10 per cent
allowance for cash discount and returns?
Account Amount Days Outstanding in days Average Payment Period historically
Rs.
74 25,000 15 20
91 9,000 45 60
107 11,500 22 24
108 2,300 9 10
2

Join Us on Telegram http://t.me/canotes_ipcc

114 18,000 50 45
116 29,000 16 10
123 14,000 27 48
1,08,800
[7 Marks]
3. X Ltd. is considering to select a machine out of two mutually exclusive machines. The company’s cost
of capital is 15 per cent and corporate tax rate is 30 per cent. Other information relating to both machines
is as follows:
Machine – I Machine – II
Cost of Machine Rs. 30,00,000 Rs. 40,00,000
Expected Life 10 years. 10 years.
Annual Income
(Before Tax and Depreciation) Rs. 12,50,000 Rs. 17,50,000

om
Depreciation is to be charged on straight line basis:
You are required to CALCULATE:

c
(i) Discounted Pay Back Period
(ii) Net Present Value
s.
te
(iii) Profitability Index
o
The present value factors of Re.1 @ 15% are as follows:
yn

Year 01 02 03 04 05
ud

PV factor @ 15% 0.870 0.756 0.658 0.572 0.497.

[10 Marks]
st

4. A Company earns a profit of Rs.6,00,000 per annum after meeting its interest liability of Rs.1,20,000 on
12% debentures. The Tax rate is 50%. The number of Equity Shares of Rs.10 each are 80,000 and the
a

retained earnings amount to Rs.18,00,000. The company proposes to take up an expansion scheme for
.c

which a sum of Rs.8,00,000 is required. It is anticipated that after expansion, the company will be able
w

to achieve the same return on investment as at present. The funds required for expansion can be raised
either through debt at the rate of 12% or by issuing equity shares at par.
w

Required:
w

(i) COMPUTE the Earnings per Share (EPS), if:

➢ The additional funds were raised as debt
➢ The additional funds were raised by issue of equity shares.
(ii) ADVISE the company as to which source of finance is preferable . [10 Marks]
5. A company needs Rs.31,25,000 for the construction of a new plant. The following three plans are
feasible:
I The company may issue 3,12,500 equity shares at Rs. 10 per share.
II The company may issue 1,56,250 equity shares at Rs. 10 per share and 15,625 debentures of
Rs. 100 denomination bearing a 8% rate of interest.
III The company may issue 1,56,250 equity shares at Rs. 10 per share and 15,625 cumulative
preference shares at Rs. 100 per share bearing a 8% rate of dividend.

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(i) if the company's earnings before interest and taxes are Rs. 62,500, Rs. 1,25,000,
Rs. 2,50,000, Rs. 3,75,000 and Rs. 6,25,000, DETERMINE earnings per share under each of
three financial plans? Assume a corporate income tax rate of 40%.
(ii) IDENTIFY which alternative would you recommend and why?
(iii) DETERMINE the EBIT -EPS indifference points by formulae between Financing Plan I and
Plan II and Plan I and Plan III. [10 Marks]
6. (a) EXPLAIN the difference between Business risk and Financial risk
(b) EXPLAIN as to how the wealth maximisation objective is superior to the profit maximisation
objective What is the cost of these sources?
(c) DISCUSS the dividend-price approach to estimate cost of equity capital [4 + 4+ 2 =10 Marks]

c om
s.
o te
yn
ud
a st
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: March, 2019

MOCK TEST PAPER – 1
INTERMEDIATE (IPC): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints

1. (a) Market price per share by

r
D+ (E - D)
(i) Walter’s formula: P = Ke
Ke

0.25
6+ (10 - 6)
P = 0.20
0.20

om
P = Rs.55
(ii) Gordon’s formula (Dividend Growth model): When the growth is incorporated in earnings

.c
and dividend, the present value of market price per share (P o) is determined as follows:
Gordon’s theory: s
te
E1(1  b)
P0 
no

Ke  br
Where,
dy

P0 = Price per share

E1 = Earnings per share

b = Retention ratio; (1 - b = Payout ratio)

Ke = Cost of capital
.c

r = IRR
w

br = Growth rate (g)

10 (1- 0.60) 4
w

Po = = Rs. = Rs.80
0.20 - (0.60  0.25) 0.05
(b) Workings:
EBIT EBIT
(i) Financial Leverage = Or, 2=
EBIT  Interest EBIT  Rs.5,000
Or, EBIT = Rs.10,000
Contribution
(ii) Operating Leverage =
EBIT
Contribution
Or, 3 =
Rs.10,000
Or, Contribution = Rs.30,000

Join Us on Telegram http://t.me/canotes_ipcc

Contribution Rs.30,000
(iii) Sales = = = Rs.1,20,000
P / VRatio 25%
(iv) Fixed Cost = Contribution – Fixed cost = EBIT
= Rs.30,000 – Fixed cost = Rs.10,000
Or, Fixed cost = Rs. 20,000
Income Statement for the year ended 31 st March, 20X8
Particulars Amount (Rs.)
Sales 1,20,000
Less: Variable Cost (75% of Rs.1,20,000) (90,000)
Contribution 30,000
Less: Fixed Cost (Contribution - EBIT) (20,000)
Earnings Before Interest and Tax (EBIT) 10,000
Less: Interest (5,000)

m
Earnings Before Tax (EBT) 5,000

co
Less: Income Tax @ 30% (1,500)
Earnings After Tax (EAT or PAT) 3,500

.
(c) Net worth = Capital + Reserves and surplus
es
ot
= 4,00,000 + 6,00,000 = Rs.10,00,000
yn

Total Debt 1

Networth 2
ud

 Total debt = Rs. 5,00,000

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

= Rs. 15,00,000
.c

= Total Assets
w

Sales
Total Assets Turnover =
w

Total assets
w

Sales
2=
Rs.15,00,000

 Sales = Rs. 30,00,000

Gross Profit on Sales : 30% i.e. Rs. 9,00,000
 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

Join Us on Telegram http://t.me/canotes_ipcc

Average 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 - Rs.7,00,000
0.75 =
Rs.5,00,000

 Current Assets = Rs.10,75,000.

 Fixed Assets = Total Assets – Current Assets
= Rs.15,00,000 – Rs.10,75,000 = Rs.4,25,000
Cash and Bank balance = Current Assets – Inventory – Debtors
o m
= Rs.10,75,000 – Rs.7,00,000 – Rs.3,33,333 = Rs.41,667
. c
Balance Sheet as on March 31, 20X8

e s
ot
Liabilities Rs. Assets Rs.
Equity Share Capital 4,00,000 Plant and Machinery and other

yn
Reserves & Surplus 6,00,000 Fixed Assets 4,25,000
Total Debt: Current Assets:
Current liabilities

t ud
5,00,000 Inventory
Debtors
7,00,000
3,33,333
s Cash 41,667

.ca 15,00,000
(d) Statement showing the determination of the risk adjusted net present value
15,00,000

Projects Net w
Coefficient Risk Annual PV factor Discounted Net present
cash w of adjusted cash 1-5 years cash inflow value
w
outlays variation discount inflow
rate
( Rs.) ( Rs.) ( Rs.) ( Rs.)
(i) (ii) (iii) (iv) (v) (vi) (vii) = (v)  (viii) = (vii)
(vi)  (ii)
X 2,10,000 1.20 16% 70,000 3.274 2,29,180 19,180
Y 1,20,000 0.80 14% 42,000 3.433 1,44,186 24,186
Z 1,00,000 0.40 12% 30,000 3.605 1,08,150 8,150
2. (a) Factors Determining the Dividend Policy of a Company
(i) Liquidity: In order to pay dividends, a company will require access to cash. Even very
profitable companies might sometimes have difficulty in paying dividends if resources are tied
up in other forms of assets.
(ii) Repayment of debt: Dividend payout may be made difficult if debt is scheduled for repayment.
3

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(iii) Stability of Profits: Other things being equal, a company with stable profits is more likely to
pay out a higher percentage of earnings than a company with fluctuating profits.
(iv) Control: The use of retained earnings to finance new projects preserves the company’s
ownership and control. This can be advantageous in firms where the present disposition of
shareholding is of importance.
(v) Legal consideration: The legal provisions lay down boundaries within which a company can
declare dividends.
(vi) Likely effect of the declaration and quantum of dividend on market prices.
(vii) Tax considerations and
(viii) Others such as dividend policies adopted by units similarly placed in the industry,
management attitude on dilution of existing control over the shares, fear of being branded as
incompetent or inefficient, conservative policy Vs non-aggressive one.
(ix) Inflation: Inflation must be taken into account when a firm establishes its dividend policy.
(b) Analysis of the receivables of J Ltd. by the bank in order to identify acceptable collateral for a short-
term loan:
(i) The J Ltd.’s credit policy is 2/10 net 30.
o m
. c
The bank lends 80 per cent on accounts where customers are not currently overdue and

s
where the average payment period does not exceed 10 days past the net period i.e. thirty
days. From the schedule of receivables of J Ltd. Account No. 91 and Account No. 114 are
e
o t
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.

y n
(ii) Statement showing the calculation of the amount which the bank will lend on a pledge of
d
receivables if the bank uses a 10 per cent allowances for cash discount and returns
u
st
Account No. Amount 90 per cent of amount 80% of amount
(Rs.) (Rs.) (Rs.)

ca
(a) (b) = 90% of (a) (c) = 80% of (b)
74
. 25,000 22,500 18,000
107
w 11,500 10,350 8280

w
108 2,300 2,070 1,656

w
116 29,000
Total loan amount
26,100 20,880
48,816
3. Working Notes:
30,00,000
Depreciation on Machine – I = = Rs. 3,00,000
10
40,00,000
Depreciation on Machine – II = = Rs. 4,00,000
10
Particulars Machine-I (Rs.) Machine – II (Rs.)
Annual Income (before Tax and Depreciation) 12,50,000 17,50,000
Less: Depreciation 3,00,000 4,00,000
Annual Income (before Tax) 9,50,000 13,50,000
Less: Tax @ 30% (2,85,000) (4,05,000)

Join Us on Telegram http://t.me/canotes_ipcc

Annual Income (after Tax) 6,65,000 9,45,000

Add: Depreciation 3,00,000 4,00,000
Annual Cash Inflows 9,65,000 13,45,000

Machine – I Machine - II
Year PV of Re Cash PV Cumulative Cash flow PV Cumulative PV
1 @ 15% flow PV

1 0.870 9,65,000 8,39,550 8,39,550 13,45,000 11,70,150 11,70,150

2 0.756 9,65,000 7,29,540 15,69,090 13,45,000 10,16,820 21,86,970
3 0.658 9,65,000 6,34,970 22,04,060 13,45,000 8,85,010 30,71,980
4 0.572 9,65,000 5,51,980 27,56,040 13,45,000 7,69,340 38,41,320
5 0.497 9,65,000 4,79,605 32,35,645 13,45,000 6,68,465 45,09,785

(i) Discounted Payback Period

Machine – I
o m
Discounted Payback Period = 4 +
(30,00,000  27,56,040)
. c
4,79,605

e s
=4+
2,43,960
4,79,605
= 4 + 0.5087 t
= 4.5087 years or 4 years 6.10 months
o
Machine – II

d yn
(40,00,000  38,41,320)
Discounted Payback Period = 4+

t u 6,68,465

=4+
1,58,680
6,68,465
= 4 + 0.2374
a s
= 4.2374 years or 4 years 2.85 months

(ii) Net Present Value (NPV) . c

Machine – I w
w
NPV = 32,35,645 – 30,00,000 = Rs. 2,35,645
Machine – II w
NPV = 45,09,785 – 40,00,000 = Rs. 5,09,785
(iii) Profitability Index
Machine – I
32,35,645
Profitability Index = = 1.08
30,00,000

Machine – II
45,09,785
Profitability Index = = 1.13
40,00,000

Join Us on Telegram http://t.me/canotes_ipcc

Conclusion:
Method Machine - I Machine - II Rank
Discounted Payback Period 4.51 years 4.24 years II
Net Present Value Rs. .2,35,645 Rs. 5,09,785 II
Profitability Index 1.08 1.13 II
4. Working Notes:
1. Capital employed before expansion plan:
(Rs.)
Equity shares (Rs.10 × 80,000 shares) 8,00,000
Debentures {(Rs.1,20,000/12)  100} 10,00,000
Retained earnings 18,00,000
Total capital employed 36,00,000
2. Earnings before the payment of interest and tax (EBIT):
(Rs.)
om
Profit (EBT) 6,00,000
.c
Add: Interest 1,20,000
e s
3.
EBIT
Return on Capital Employed (ROCE):
7,20,000

o t
ROCE =
EBIT
Capital employed
×100 =
d yn
Rs.7,20,000
Rs.36,00,000
×100 = 20%

4.
t u
Earnings before interest and tax (EBIT) after expansion scheme:

as
After expansion, capital employed = Rs.36,00,000 + Rs.8,00,000

.c
= Rs.44,00,000
Desired EBIT = 20%  Rs.44,00,000 = Rs.8,80,000
(i) w
Computation of Earnings Per Share (EPS) under the following options:
w Expansion scheme
w Present situation
Additional funds raised as
Debt Equity
(Rs.) (Rs.) (Rs.)
Earnings before Interest and 7,20,000 8,80,000 8,80,000
Tax (EBIT)
Less: Interest - Old capital 1,20,000 1,20,000 1,20,000
- New capital -- 96,000 --
(Rs.8,00,000  12%)
Earnings before Tax (EBT) 6,00,000 6,64,000 7,60,000
Less: Tax (50% of EBT) 3,00,000 3,32,000 3,80,000
PAT 3,00,000 3,32,000 3,80,000
No. of shares outstanding 80,000 80,000 1,60,000

Join Us on Telegram http://t.me/canotes_ipcc

Earnings per Share (EPS) 3.75 4.15 2.38

 Rs.3,00,000   Rs.3,32,000   Rs.3,80,000 
     1,60,000 
 80,000   80,000   
(ii) Advise to the Company: When the expansion scheme is financed by additional debt, the
EPS is higher. Hence, the company should finance the expansion scheme by raising debt.
5. (i) Computation of EPS under three-financial plans.
Plan I: Equity Financing
( Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.)
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Interest 0 0 0 0 0
EBT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Tax @ 40% 25,000 50,000 1,00,000 1,50,000 2,50,000
PAT 37,500 75,000 1,50,000 2,25,000 3,75,000
No. of equity shares 3,12,500 3,12,500 3,12,500 3,12,500 3,12,500

om
EPS 0.12 0.24 0.48 0.72 1.20
Plan II: Debt – Equity Mix

.c
( Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.)
EBIT 62,500 1,25,000
es 2,50,000 3,75,000 6,25,000
Less: Interest 1,25,000 1,25,000 1,25,000 1,25,000 1,25,000
ot
EBT (62,500) 0 1,25,000 2,50,000 5,00,000
yn

Less: Tax @ 40% 25,000* 0 50,000 1,00,000 2,00,000

PAT (37,500) 0 75,000 1,50,000 3,00,000
ud

No. of equity shares 1,56,250 1,56,250 1,56,250 1,56,250 1,56,250

EPS (Rs. 0.24) 0 0.48 0.96 1.92
st

* The Company can set off losses against the overall business profit or may carry forward it to next financia l
a

years.
.c

Plan III: Preference Shares – Equity Mix

( Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.)

EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000

Less: Interest 0 0 0 0 0
w

EBT 62,500 1,25,000 2,50,000 3,75,000 6,25,000

Less: Tax @ 40% 25,000 50,000 1,00,000 1,50,000 2,50,000
PAT 37,500 75,000 1,50,000 2,25,000 3,75,000
Less: Pref. dividend 1,25,000* 1,25,000* 1,25,000 1,25,000 1,25,000
PAT after Pref. dividend. (87,500) (50,000) 25,000 1,00,000 2,50,000
No. of Equity shares 1,56,250 1,56,250 1,56,250 1,56,250 1,56,250
EPS (0.56) (0.32) 0.16 0.64 1.60
* In case of cumulative preference shares, the company has to pay cumulativ e dividend to preference
shareholders, when company earns sufficient profits.
(ii) From the above EPS computations tables under the three financial plans we can see that when
EBIT is Rs. 2,50,000 or more, Plan II: Debt-Equity mix is preferable over the Plan I and Plan III, as
rate of EPS is more under this plan. On the other hand an EBIT of less than Rs.2,50,000, Plan I:

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
Equity Financing has higher EPS than Plan II and Plan III. Plan III Preference share-Equity mix is
not acceptable at any level of EBIT, as EPS under this plan is lower.
The choice of the financing plan will depend on the performance of the company and other macro-
economic conditions. If the company is expected to have higher operating profit Plan II: Debt –
Equity Mix is preferable. Moreover, debt financing gives more benefit due to availability of tax
shield.
(iii) EBIT – EPS Indifference point : Plan I and Plan II
EBIT1 ×(1- t) (EBIT2 - Interest) ×(1- t)
=
No.of equity shares(N1) No.of equity shares(N2 )
EBIT(1- 0.40) (EBIT -Rs.1,25,000)×(1- 0.40)
=
3,12,500shares 1,56,250shares
0.6 EBIT = 1.2 EBIT – Rs.1,50,000
Rs.1,50,000
EBIT = = Rs. 2,50,000
0.6
Indifference points between Plan I and Plan II is Rs. 2,50,000
o m
EBIT – EPS Indifference Point: Plan I and Plan III
EBIT1 ×(1- t)
=
EBIT3 ×(1- t)  Pr ef.dividend
s.c
No.of equity shares(N1 ) No.of equity shares(N3 )
t e
EBIT1(1- 0.40)
3,12,500shares
=
EBIT3(1- 0.40) -Rs.1,25,000
1,56,250shares
n o
0.6 EBIT = 1.2 EBIT – Rs. 2,50,000
d y
EBIT =
Rs.2,50,000
0.6 tu
= Rs. 4,16,667

a s
Indifference points between Plan I and Plan III is Rs. 4,16,667.
6.
.
(a) Business Risk and Financial Risk
c
Business risk refers to the risk associated with the firm’s operations. It is an unavoidable risk
w
because of the environment in which the firm has to operate and the business risk is represented
w
by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by

w
revenues and expenses. Revenues and expenses are affected by demand of firm’s products,
variations in prices and proportion of fixed cost in total cost.
Whereas, Financial risk refers to the additional risk placed on firm’s shareholders as a result of
debt use in financing. Companies that issue more debt instruments would have high er financial
risk than companies financed mostly by equity. Financial risk can be measured by ratios such as
firm’s financial leverage multiplier, total debt to assets ratio etc.
(b) A firm’s financial management may often have the following as their objectives:
(i) The maximisation of firm’s profit.
(ii) The maximisation of firm’s value / wealth.
The maximisation of profit is often considered as an implied objective of a firm. To achieve the
aforesaid objective various type of financing decisions may be taken. Options resulting into
maximisation of profit may be selected by the firm’s decision makers. They even sometime may
adopt policies yielding exorbitant profits in short run which may prove to be unhealthy for the

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
growth, survival and overall interests of the firm. The profit of the firm in this case is measured in
terms of its total accounting profit available to its shareholders.
The value/wealth of a firm is defined as the market price of the firm’s stock. The market price of a
firm’s stock represents the focal judgment of all market participants as to what the value of the
particular firm is. It takes into account present and prospective future earnings per share, the timing
and risk of these earnings, the dividend policy of the firm and many other factors that bear upon
the market price of the stock.
The value maximisation objective of a firm is superior to its profit maximisation objective due to
following reasons.
1. The value maximisation objective of a firm considers all future cash flows, dividends, earning
per share, risk of a decision etc. whereas profit maximisation objective does not consider the
effect of EPS, dividend paid or any other returns to shareholders or the wealth of the
shareholder.
2. A firm that wishes to maximise the shareholders wealth may pay regular dividends whereas
a firm with the objective of profit maximisation may refrain from dividend payment to its
shareholders.

m
3. Shareholders would prefer an increase in the firm’s wealth against its generation of increasing

co
flow of profits.
4. The market price of a share reflects the shareholders expected return, considering the long-

s.
term prospects of the firm, reflects the differences in timings of the returns, considers risk and
recognizes the importance of distribution of returns.
te
The maximisation of a firm’s value as reflected in the market price of a share is viewed as a proper
no

goal of a firm. The profit maximisation can be considered as a part of the wealth maximisation
strategy.
dy

(c) In dividend price approach, cost of equity capital is computed by dividing the expected dividend by
market price per share. This ratio expresses the cost of equity capital in relation to what yield the
tu

company should pay to attract investors. It is computed as:

D1
Ke 
P0
.c

Where,
w

D1 = Dividend per share in period 1

P0 = Market price per share today.

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: April, 2019

MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) The proportion and required return of debt and equity was recorded for a company with its

om
increased financial leverage as below:
Debt (%) Required return Equity Required Return (Ke) Weighted Average Cost of

c
(Kd ) (%) (%) (%) Capital (WACC) (K o )(%)

0 5 100 s.
15 15
te
20 6 80 16 ?
o
40 7 60 18 ?
yn

60 10 40 23 ?
ud

80 15 20 35 ?
You are required to complete the table and IDENTIFY which capital structure is most beneficial for
st

this company. (Based on traditional theory, i.e., capital structure is relevant).

(b) Annova Ltd is considering raising of funds of about Rs.250 lakhs by any of two alternative methods,
.c

viz., 14% institutional term loan and 13% non-convertible debentures. The term loan option would
w

attract no major incidental cost and can be ignored. The debentures would have to be issued at a
discount of 2.5% and would involve cost of issue of 2% on face value.
w

ADVISE the company as to the better option based on the effective cost of capital in each case.
w

Assume a tax rate of 50%.

(c) Probabilities for net cash flows for 3 years of a project of Ganesh Ltd are as follows:
Year 1 Year 2 Year 3
Cash Flow Probability Cash Flow Probability Cash Flow Probability
(Rs.) (Rs.) (Rs.)
2,000 0.1 2,000 0.2 2,000 0.3
4,000 0.2 4,000 0.3 4,000 0.4
6,000 0.3 6,000 0.4 6,000 0.2
8,000 0.4 8,000 0.1 8,000 0.1
CALCULATE the expected net cash flows and the present value of the expected cash flow, using
10 per cent discount rate. Initial Investment is Rs. 10,000

Join Us on Telegram http://t.me/canotes_ipcc

(d) With the help of the following information ANALYSE and complete the Balance Sheet of Anup Ltd.:
Equity share capital Rs. 1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt 0.40
Total debt to Equity share capital 0.60
Fixed assets to Equity share capital 0.60
Total assets turnover 2 Times
Inventory turnover 8 Times
(4 × 5 = 20 Marks)
2. (a) The capital structure of Anshu Ltd. as at 31.3.2019 consisted of ordinary share capital of
Rs. 5,00,000 (face value Rs. 100 each) and 10% debentures of Rs. 5,00,000 (Rs. 100 each). In
the year ended with March 2019, sales decreased from 60,000 units to 50,000 units. During this
year and in the previous year, the selling price was Rs. 12 per unit; variable cost stood at Rs. 8 per
unit and fixed expenses were at Rs. 1,00,000 p.a. The income tax rate was 30%.

om
You are required to CALCULATE the following:
(i) The percentage of decrease in earnings per share.

c
(ii) The degree of operating leverage at 60,000 units and 50,000 units.

s.
(iii) The degree of financial leverage at 60,000 units and 50,000 units. (6 Marks)
te
(b) EXPLAIN the limitations of Leasing? (4 Marks)
3. (a) Navya Ltd has annual credit sales of Rs. 45 lakhs. Credit terms are 30 days, but its management
o
of receivables has been poor and the average collection period is 50 days, Bad debt is 0.4 per cent
yn

of sales. A factor has offered to take over the task of debt administration and credit checking, at
an annual fee of 1 per cent of credit sales. Navya Ltd. estimates that it would save Rs. 35,000 per
ud

year in administration costs as a result. Due to the efficiency of the factor, the average collection
period would reduce to 30 days and bad debts would be zero. The factor would advance 80 per
st

cent of invoiced debts at an annual interest rate of 11 per cent. Navya Ltd. is currently financing
a

receivables from an overdraft costing 10 per cent per year.

If occurrence of credit sales is throughout the year, COMPUTE whether the factor’s services should
be accepted or rejected. Assume 365 days in a year. (6 Marks)
w

(b) EXPLAIN the principles of “Trading on equity”. (4 Marks)

4. (a) Prem Ltd has a maximum of Rs. 8,00,000 available to invest in new projects. Three possibilities
w

have emerged and the business finance manager has calculated Net present Value (NPVs) for
each of the projects as follows :
Investment Initial cash outlay NPV
Rs. Rs.
Alfa (α) 5,40,000 1,00,000
Beta(β) 6,00,000 1,50,000
Gama (γ) 2,60,000 58,000
DETERMINE which investment/combination of investments should the company invest in, if we
assume that the projects can be divided? (6 Marks)

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(b) Invest Corporation Ltd. adjusts risk through discount rates by adding various risk premiums to the
risk free rate. Depending on the resultant rate, the proposed project is judged to be a low, medium
or high risk project.
Risk level Risk free rate Risk Premium
(%) (%)
Low 8 4
Medium 8 7
High 8 10

DEMONSTRATE the acceptability of the project on the basis of Risk Adjusted rate. (4 Marks)
5. The following information is supplied to you:
Rs.
Total Earnings 2,00,000
No. of equity shares (of Rs. 100 each) 20,000

om
Dividend paid 1,50,000
Price/ Earnings ratio 12.5

c
Applying Walter’s Model
(i)
s.
DETERMINE whether the company is following an optimal dividend policy.
te
(ii) IDENTIFY, what should be the P/E ratio at which the dividend policy will have no effect on the
value of the share.
o
yn

(iii) Will your decision change, if the P/E ratio is 8 instead of 12.5? ANALYSE. (10 Marks)
6. (a) DESCRIBE Bridge Finance.
ud

(b) STATE Virtual Banking? DISCUSS its advantages.

(c) EXPLAIN Concentration Banking (4 + 4 + 2 = 10 Marks)

a
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: April 2019

MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Computation of Weighted Average Cost of Capital (WACC) for each level of Debt-equity mix.
Debt Required Equity Required Kd × Proportion of debt + Weighted Average
(%) return (%) return (K e) Ke Proportion and equity Cost of Capital
(Kd )(%) (%) (WACC)(K o )(%)
0 5 100 15 0%(5%)+100%(15%) 15
20 6 80 16 20%(6%)+80%(16%) 14
40 7 60 18 40%(7%)+60%(18%) 13.6

om
60 10 40 23 60%(10%)+40%(23%) 15.2
80 15 20 35 80%(15%)+20%(35%) 19

.c
The optimum mix is 40% debt and 60% equity, as this will lead to lowest WACC value i.e., 1 3.6%.
(b) Calculation of Effective Cost of Capital
s
te
Particulars Option 1 Option 2
14% institutional 13% Non-convertible
no

Term loan Debentures

(Rs. in Lakhs) (Rs. in lakhs)
dy

(A) Effective capital to be raised Face value 250.00 250.00

Less: Discount Nil (6.25)
tu

250.00 243.75
as

Less: Cost of issue Nil 5.00

Effective amount of capital 250.00 238.75
.c

(B) Annual interest charges on face value of

Rs. 250 lakhs
w

35.0 32.50
Less: Tax benefit on interest @ 50% 17.5 16.25
w

17.5 16.25
w

(C) Effective cost of capital after tax B 16.25

x 100 x100
A 238.75
= 7.0% = 6.81% (approx)
So, the better option is raising of funds of Rs.250 lakhs by issue of 13% Non-convertible Debenture
(c)
Year 1 Year 2 Year 3
Cash Probability Expected Cash Probability Expected Cash Probability Expecte
Flow Value Flow Value Flow d Value
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
2,000 0.1 200 2,000 0.2 400 2,000 0.3 600
4,000 0.2 800 4,000 0.3 1200 4,000 0.4 1,600
6,000 0.3 1,800 6,000 0.4 2400 6,000 0.2 1,200

Join Us on Telegram http://t.me/canotes_ipcc

8,000 0.4 3,200 8,000 0.1 800 8,000 0.1 800

ENCF 6,000 4,800 4,200
The present value of the expected value of cash flow at 10 per cent discount rate has been
determined as follows:
ENCF1 ENCF2 ENCF3
Present Value of cash flow = + +
(1+ k)1 (1+ k)2 (1+ k)3
6,000 4,800 4,200
=  
(1.1)1 (1.1)2 (1.1)3
= (6,000 × 0.909) + (4,800 × 0.826) + (4,200 + 0.751)
= 12,573
Expected Net Present value = Present Value of cash flow - Initial Investment
= Rs. 12,573 – Rs.10,000 = Rs.2,573.
(d) MNOP Ltd.

om
Balance Sheet
Liabilities Rs. Assets Rs.

c
Equity share capital 1,00,000 Fixed assets 60,000
Current debt s.
24,000 Cash (balancing figure) 60,000
te
Long term debt 36,000 Inventory 40,000
o
1,60,000 1,60,000
yn

Working Notes
ud

1. Total debt = 0.60 x Equity share capital = 0.60 Rs. 1,00,000 = Rs. 60,000
Further, Current debt to total debt = 0.40. So, current debt = 0.40 × Rs.60,000 = Rs.24,000,
st

Long term debt = Rs.60,000 - Rs.24,000= Rs. 36,000

2. Fixed assets = 0.60 × Equity share Capital = 0.60 × Rs. 1,00,000 = Rs. 60,000
.c

3. Total assets to turnover = 2 Times : Inventory turnover = 8 Times

Hence, Inventory /Total assets = 2/8=1/4, Total assets = Rs. 1,60,000

Therefore Inventory = Rs. 1,60,000/4 = Rs. 40,000

2. (a)
Sales in units 60,000 50,000
Rs. Rs.
Sales Value 7,20,000 6,00,000
Variable Cost (4,80,000) (4,00,000)
Contribution 2,40,000 2,00,000
Fixed expenses 1,00,000 1,00,000
EBIT 1,40,000 1,00,000
Debenture Interest (50,000) (50,000)
EBT 90,000 50,000
Tax @ 30% (27,000) (15,000)

Join Us on Telegram http://t.me/canotes_ipcc

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

63,000 35,000
(i) Earning per share (EPS) = = Rs. 12.6 = Rs. 7
5,000 5,000
Decrease in EPS = 12.6 – 7 = 5.6
5.6
% decrease in EPS =  100 = 44.44%
12.6
Contribution 2,40,000 2,00,000
(ii) Operating leverage = =
EBIT 1,40,000 1,00,000
= 1.71 2
EBIT 1,40,000 1,00,000
(iii) Financial Leverage = =
EBT 90,000 50,000
= 1.56 2

m
(b) Limitations are:

co
1) The lease rentals become payable soon after the acquisition of assets and no moratorium
period is permissible as in case of term loans from financial institutions. The lease
s.
arrangement may, therefore, not be suitable for setting up of the new projects as it would
te
entail cash outflows even before the project comes into operation.
2) The leased assets are purchased by the lessor who is the owner of equipment. The seller’s
no

warranties for satisfactory operation of the leased assets may sometimes not be available to
lessee.
dy

3) Lessor generally obtains credit facilities from banks etc. to purchase the leased equipment
which are subject to hypothecation charge in favour of the bank. Default in payment by the
tu

lessor may sometimes result in seizure of assets by banks causing loss to the lessee.
as

4) Lease financing has a very high cost of interest as compared to interest charged on term loans
by financial institutions/banks.
.c

Despite all these disadvantages, the flexibility and simplicity offered by lease finance is bound to
w

make it popular. Lease operations will find increasing use in the near future.
w

3. (a)
w

Rs.
Present level of receivables is 45 lakh× 50/365 6,16,438

In case of factor, receivables would reduce to 45 lakhs× 30/365 3,69,863

The costs of the existing policy are as follows:

Cost of financing existing receivables: 6,16,438×10% 61,644
Cost of bad debts: 45 lakhs × 0.4% 18,000
Cost of current policy 79,644
The cost under the factor are as follows:
Cost of financing new receivable through factor:
(Rs. 3,69,863 × 0.8 × 0.11) + (Rs. 3,69,863 × 0.2 × 0.10) 39,945
= (32,548 + 7,397)
3

Join Us on Telegram http://t.me/canotes_ipcc

Factor’s annual fee: 45 Lakhs × 0.01 45,000

Administration costs saved: (35,000)
Net cost under factor: 49,945
From the above analysis it is clear that the factor’s services are cheaper than Existing policy by
Rs. 29,699 (Rs. 79,644 - Rs.49,945) per year. Hence, the services of the factor should be
accepted.
(b) The term trading on equity means debts are contracted and loans are raised mainly on the basis
of equity capital. Those who provide debt have a limited share in the firm’s earning and hence
want to be protected in terms of earnings and values represented by equity capital. Since fixed
charges do not vary with firm’s earnings before interest and tax, a magnified effect is produced on
earning per share. Whether the leverage is favourable, in the sense, increase in earnings per
share more proportionately to the increased earnings before interest and tax, depends on the
profitability of investment proposal. If the rate of returns on investment exceeds their explicit cost,
financial leverage is said to be positive.
4. (a) Since funds available are restricted, the normal Net Present Value (NPV) rule of accepting

m
investments decisions with the highest NPVs cannot be adopted straight way. Further, as the
projects are divisible, a Profitability Index (PI) can be utilized to provide the most beneficial

o
combination of investment for Rio Ltd.

.c
Project PV Per Rs. es Rank as per PI
Alfa (α) Rs. 6,40,000 / Rs. 5,40,000 = 1.185 III
ot
Beta (β) Rs. 7,50,000 / Rs. 6,00,000 = 1.250 I
yn

Gama (γ) Rs. 3,18,000 / Rs. 2,60,000 = 1.223 II

Therefore Rio Ltd should invest Rs. 6,00,000 into project β (Rank I) earnings Rs. 1,50,000 and
Rs.2,00,000 into project γ (Rank II) earning Rs.44,615 Rs. 2,00,000 / Rs. 2,60,000 × Rs. 58,000
st

So, total NPV will be Rs.1,94,615 Rs. 1,50,000 + Rs. 44,615 from Rs. 8,00,000 of investment.
a
.c

(b) Calculation of Risk Adjusted rate

Risk level Risk free rate (%) Risk Premium (%) Risk adjusted rate (%)
w

Low 8 4 12
w

Medium 8 7 15
High 8 10 18

The cash flows of the project considered are as following:

Point in time (yearly intervals) 0 1 2
Cash flow (Rs. in crore) (100) 45 80
If the project is judged to be Low risk
Years 0 1 2
PV (Rs. in crore) (100) 45 80
 40.18  63.78
1  0.12 (1  0.12)2

NPV = 40.18 + 63.78 – 100 = 3.96: Accept

Join Us on Telegram http://t.me/canotes_ipcc

If the project is judged to be Medium risk

Years 0 1 2
PV (Rs. in crore) (100) 45 80
 39.13  60.49
1  0.15 (1  0.15)2

NPV = 39.13 + 60.49 – 100 = (0.38): Reject

If the project is judged to be High risk
Years 0 1 2
PV (Rs. in crore) (100) 45 80
 38.14  57.45
1  0.18 (1  0.18)2

NPV = 38.14 + 57.45 – 100 = (4.41): Reject

5. (i) The EPS of the firm is Rs. 10 (i.e., Rs. 2,00,000/ 20,000). The P/E Ratio is given at 12.5 and the
cost of capital, ke, may be taken at the inverse of P/E ratio. Therefore, k e is 8 (i.e., 1/12.5). The
firm is distributing total dividends of Rs. 1,50,000 among 20,000 shares, giving a dividend per share

m
of Rs. 7.50. the value of the share as per Walter’s model may be found as follows:

co
D (r / K e )(E  D) 7.50 (.10 / .08)(10  7.5)
P  =  = Rs. 132.81
Ke Ke .08 .08

s.
The firm has a dividend payout of 75% (i.e., Rs. 1,50,000) out of total earnings of Rs. 2,00,000.
te
since, the rate of return of the firm, r, is 10% and it is more than the k e of 8%, therefore, by
distributing 75% of earnings, the firm is not following an optimal dividend policy. The optimal
no

dividend policy for the firm would be to pay zero dividend and in such a situation, the market price
would be
dy

D (r / K e )(E  D) 0 (.10 / .08)(10 - 0)

P=  =  = Rs. 156.25
tu

ke Ke .08 .08
as

So, theoretically the market price of the share can be increased by adopting a zero payout.
(ii) The P/E ratio at which the dividend policy will have no effect on the value of the share is such at
.c

which the ke would be equal to the rate of return, r, of the firm. The K e would be 10% (=r) at the
w

P/E ratio of 10. Therefore, at the P/E ratio of 10, the dividend policy would have no effect on the
value of the share.
w

(iii) If the P/E is 8 instead of 12.5, then the Ke which is the inverse of P/E ratio, would be 12.5 and in
w

such a situation ke> r and the market price, as per Walter’s model would be
D (r / K e )(E  D) 7.50 (.1/ .125) (10  7.5)
P=  = + = Rs. 76
Ke Ke .125 .125

6. (a) Bridge finance refers, normally, to loans taken by the business, usually from commercial banks for
a short period, pending disbursement of term loans by financial institutions, normally it takes time
for the financial institution to finalise procedures of creation of security, tie-up participation with
other institutions etc. even though a positive appraisal of the project has been made. However,
once the loans are approved in principle, firms in order not to lose further time in starting their
projects arrange for bridge finance. Such temporary loan is normally repaid out of the proceeds of
the principal term loans. It is secured by hypothecation of moveable assets, personal guarantees
and demand promissory notes. Generally rate of interest on bridge finance is higher as compared
with that on term loans.

Join Us on Telegram http://t.me/canotes_ipcc

(b) Virtual Banking and its Advantages

Virtual banking refers to the provision of banking and related services through the use of
information technology without direct recourse to the bank by the customer.
The advantages of virtual banking services are as follows:
➢ Lower cost of handling a transaction.
➢ The increased speed of response to customer requirements.
➢ The lower cost of operating branch network along with reduced staff costs leads to cost
efficiency.
Virtual banking allows the possibility of improved and a range of services being made available to
the customer rapidly, accurately and at his convenience.
(c) Concentration Banking: In concentration banking the company establishes a number of strategic
collection centres in different regions instead of a single collection centre at the head office. This
system reduces the period between the time a customer mails in his remittances and the time when
they become spendable funds with the company. Payments received by the different collection
centers are deposited with their respective local banks which in turn transfer all surplus funds to

om
the concentration bank of head office

c
s.
o te
yn
ud
a st
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: October, 2019

MOCK TEST PAPER 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A : FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) The following figures are collected from the annual report of XYZ Ltd.:

c om
Net Profit Rs.60 lakhs
Outstanding 10% preference shares
s. Rs.100 lakhs
te
No. of equity shares 5 lakhs
Return on Investment 20%
o
yn

Cost of capital i.e. (Ke) 14%

CALCULATE price per share using Gordon’s Model when dividend pay-out is (i) 25%;
ud

(ii) 50% and (iii) 100%.

(b) RPS Company presently has Rs. 36,00,000 in debt outstanding bearing an interest rate of 10 per
cent. It wishes to finance a Rs. 40,00,000 expansion programme and is considering three
a

alternatives: additional debt at 12 per cent interest, preferred stock with an 11 per cent dividend,
.c

and the sale of common stock at Rs. 16 per share. The company presently has 8,00,000 shares
w

of common stock outstanding and is in a 40 per cent tax bracket.

(i) If earnings before interest and taxes are presently Rs. 15,00,000, CALCULATE earnings per
w

share for the three alternatives, assuming no immediate increase in profitability?

(ii) CALCULATE indifference point between debt and common stock.

(c) MNP Limited has made plans for the year 2019 -20. It is estimated that the company will employ
total assets of Rs.50,00,000; 30% of assets being financed by debt at an interest cost of 9% p.a.
The direct costs for the year are estimated at Rs. 30,00,000 and all other operating expenses are
estimated at Rs. 4,80,000. The sales revenue are estimated at Rs. 45,00,000. Tax rate is assumed
to be 40%. CALCULATE:
(i) Net profit margin (After tax);
(ii) Return on Assets (After tax);
(iii) Asset turnover; and
(iv) Return on Equity.
(d) A Ltd. and B Ltd. are identical in every respect except capital structure. A Ltd. does not employ
debts in its capital structure whereas B Ltd. employs 12% Debentures amounting to Rs.100 lakhs.
Assuming that :
1

Join Us on Telegram http://t.me/canotes_ipcc

(i) All assumptions of M-M model are met;

(ii) Income-tax rate is 30%;
(iii) EBIT is Rs. 25,00,000 and
(iv) The Equity capitalization rate of ‘A' Ltd. is 20%.
CALCULATE the value of both the companies and also find out the Weighted Average Cost of
Capital for both the companies. [4 × 5 = 20 Marks]
2. (a) B LLP. has the following balance sheet and Income statement information:
Balance Sheet as on March 31st 2019
Liabilities (Rs.) Assets (Rs.)
Partners’ Capital 80,00,000 Net Fixed Assets 1,00,00,000
Term Loan 60,00,000 Inventories 45,00,000
Retained Earnings 35,00,000 Trade Receivables 40,50,000
Trade Payables 15,00,000 Cash & Bank 4,50,000

om
1,90,00,000 1,90,00,000
Income Statement for the year ending March 31st 2019

c
(Rs.)
Sales
s. 34,00,000
te
Operating expenses (including Rs. 6,00,000 depreciation) 12,00,000
o
EBIT 22,00,000
yn

Less: Interest 6,00,000

Earnings before tax 16,00,000
ud

Less: Taxes 5,60,000

Net Earnings (EAT) 10,40,000
st

COMPUTE the degree of operating, financial and combined leverages at the current sales level, if
a

all operating expenses, other than depreciation, are variable costs. [3 Marks]
.c

(b) H Ltd. is considering a new product line to supplement its range of products. It is anticipated that
w

the new product line will involve cash investments of Rs.70,00,000 at time 0 and Rs.1,00,00,000
w

in year 1. After-tax cash inflows of Rs. 25,00,000 are expected in year 2, Rs.30,00,000 in year 3,
Rs.35,00,000 in year 4 and Rs.40,00,000 each year thereafter through year 10. Although the
w

product line might be viable after year 10, the company prefers to be conservative and end all
calculations at that time.
(i) If the required rate of return is 15 per cent, FIND OUT the net present value of the project? Is
it acceptable?
(ii) COMPUTE NPV if the required rate of return were 10 per cent?
(iii) COMPUTE the internal rate of return? [7 Marks]
3. You are given the following information:
(i) Estimated monthly Sales are as follows:
Rs. Rs.
January 1,00,000 June 80,000
February 1,20,000 July 1,00,000

Join Us on Telegram http://t.me/canotes_ipcc

March 1,40,000 August 80,000

April 80,000 September 60,000
May 60,000 October 1,00,000

(ii) Wages and Salaries are estimated to be payable as follows:

Rs. Rs.
April 9,000 July 10,000
May 8,000 August 9,000
June 10,000 September 9,000
(iii) Of the sales, 80% is on credit and 20% for cash. 75% of the credit sales are collected within one
month and the balance in two months. There are no bad debt losses.
(iv) Purchases amount to 80% of sales and are made and paid for in the month preceding the sales.
(v) The firm has taken a loan of Rs.1,20,000. Interest @ 10% p.a. has to be paid quarterly in January,
April and so on.

om
(vi) The firm is to make payment of tax of Rs. 5,000 in July, 2019.
(vii) The firm had a cash balance of Rs. 20,000 on 1 St April, 2019 which is the minimum desired level

c
of cash balance. Any cash surplus/deficit above/below this level is made up by tempora ry

s.
investments/liquidation of temporary investments or temporary borrowings at the end of each
month (interest on these to be ignored).
te
Required
o
PREPARE monthly cash budgets for six months beginning from April, 2019 on the basis of the above
yn

information. [10 Marks]

4. ABC Ltd. has the following capital structure which is considered to be optimum as on 31st March, 2019
(Rs.)
st

14% Debentures 30,00,000

11% Preference shares 10,00,000

Equity Shares (10,000 shares) 1,60,00,000

2,00,00,000
w

The company share has a market price of Rs. 236. Next year dividend per share is 50% of year 2019
w

EPS. The following is the trend of EPS for the preceding 10 years which is expected to continue in
future.
Year EPS (Rs.) Year EPS Rs.)
2010 10.00 2015 16.10
2011 11.00 2016 17.70
2012 12.10 2017 19.50
2013 13.30 2018 21.50
2014 14.60 2019 23.60
The company issued new debentures carrying 16% rate of interest and the current market price of
debenture is Rs. 96.
Preference share Rs. 9.20 (with annual dividend of Rs. 1.1 per share) were also issued. The company
is in 50% tax bracket.
3

Join Us on Telegram http://t.me/canotes_ipcc

(A) CALCULATE after tax:

(i) Cost of new debt
(ii) Cost of new preference shares
(iii) New equity share (consuming new equity from retained earnings)
(B) CALCULATE marginal cost of capital when no new shares are issued.
(C) COMPUTE the amount that can be spent for capital investment before new ordinary shares must
be sold. Assuming that retained earnings for next year’s investment are 50 percent of 2019.
(D) COMPUTE marginal cost of capital when the funds exceeds the amount calculated in (C), assuming
new equity is issued at Rs. 200 per share? [10 Marks]
5. (a) CALCULATE Variance and Standard Deviation on the basis of following information:
Project A Project B
Possible
Cash Flow Probability Cash Flow Probability
Event
(Rs.) (Rs.)
A 80,000 0.10 2,40,000 0.10

om
B 1,00,000 0.20 2,00,000 0.15
C 1,20,000 0.40 1,60,000 0.50

c
D 1,40,000 0.20
s.
1,20,000 0.15
te
E 1,60,000 0.10 80,000 0.10
o
[8 Marks]
yn

(b) A firm maintains a separate account for cash disbursement. Total disbursement are Rs.10,50,000
per month or Rs. 1,26,00,000 per year. Administrative and transaction cost of transferring cash to
ud

disbursement account is Rs.20 per transfer. Marketable securities yield is 8% per annum.
COMPUTE the optimum cash balance according to William J. Baumol model. [2 Marks]
st

6. (a) DISCUSS the Inter relationship between investment, financing and dividend decisions.
a

(b) What is debt securitisation? EXPLAIN the basics of debt securitisation process.
.c

(c) EXPLAIN the concept of discounted payback period. (4 + 4+ 2 =10 Marks)

w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: October, 2019

MOCK TEST PAPER – 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints

1. (a)
Rs. in lakhs
Net Profit 60
Less: Preference dividend 10
Earning for equity shareholders 50
Therefore earning per share 50/5 = Rs.10.00

m
Price per share according to Gordon’s Model is calculated as follows:

co
E1(1  b)
P0 
Ke  br
Here, E1 = 10, Ke = 14%, r = 20%
s.
te
(i) When dividend pay-out is 25%
no

10  0.25 2.5
P0  = = -250
0.14  (0.75  0.2) 0.14  0.15
dy

As per the Gordon’s Dividend relevance model, the Cost of equity (K e) should be greater than
tu

the growth rate i.e. br. In this case Ke is 14% and br = 15%, hence, the equity investors would
prefer capital appreciation than dividend.
as

(ii) When dividend pay-out is 50%

10  0.5 5
P0  = = 125
0.14  (0.5  0.2) 0.14  0.10
w
w

(iii) When dividend pay-out is 100%

10 1 10
P0  = = 71.43
0.14  (0  0.2) 0.14
(b) (i) (Rs. in thousands)
Debt Preferred Common
Stock Stock
Rs. Rs. Rs.
EBIT 1,500 1,500 1,500
Interest on existing debt 360 360 360
Interest on new debt 480  
Profit before taxes 660 1,140 1,140
Taxes 264 456 456
Profit after taxes 396 684 684
1

Join Us on Telegram http://t.me/canotes_ipcc

Preferred stock dividend  440 

Earnings available to common 396 244 684
shareholders
Number of shares 800 800 1,050
Earnings per share .495 .305 .651
(ii) Mathematically, the indifference point between debt and common stock is (Rs in thousands):
EBIT *  Rs. 840 EBIT *  Rs. 360

800 1,050

EBIT* (1,050) – Rs. 840(1,050) = EBIT* (800) – Rs. 360 (800)

250EBIT* = Rs. 5,94,000
EBIT* = Rs. 2,376
(c) The net profit is calculated as follows:
Rs.

m
Sales Revenue 45,00,000

co
Less: Direct Costs 30,00,000
Gross Profits 15,00,000

.
Less: Operating Expense
es 4,80,000
Earnings before Interest and tax (EBIT) 10,20,000
t
no

Less: Interest on debt (9% × 15,00,000) 1,35,000

Earnings before Tax) (EBT) 8,85,000
dy

Less: Taxes (@ 40%) 3,54,000

Profit after Tax (PAT) 5,31,000

(i) Net Profit Margin (After Tax)

EBIT (1 - t) Rs.10,20,000×(1- 0.4)
Net Profit Margin = ×100 = = 13.6%
.c

Sales Rs.45,00,000
w

(ii) Return on Assets (ROA) (After tax)

EBIT (1-t)
ROA =
w

Total Assets
Rs.10,20,000 (1- 0.4) Rs.6,12,000
= =
Rs.50,00,000 Rs.50,00,000
= 0.1224 = 12.24 %
(iii) Asset Turnover
Sales Rs. 45,00,000
Asset Turnover = = = 0.9
Assets Rs.50,00,000
Asset Turnover = 0.9 times
(iv) Return on Equity (ROE)
PAT Rs.5,31,000
ROE = = = 15.17%
Equity Rs.35,00,000

Join Us on Telegram http://t.me/canotes_ipcc

ROE = 15.17%
(d) (i) Calculation of Value of ‘A Ltd.’ and ‘B Ltd’ according to MM Hypothesis
Market Value of ‘A Ltd’ (Unlevered)
EBIT 1 - t  Rs.25,00,000 1 - 0.30  Rs.17,50,000
Vu = = = = Rs. 87,50,000
Ke 20% 20%
Market Value of ‘B Ltd.’ (Levered)
Vg = Vu + TB
= Rs. 87,50,000 + (Rs.1,00,00,000 × 0.30)
= Rs. 87,50,000 + Rs.30,00,000 = Rs.1,17,50,000
(ii) Computation of Weighted Average Cost of Capital (WACC)
WACC of ‘A Ltd.’ = 20% (i.e. Ke = Ko)
WACC of ‘B Ltd.’

m
B Ltd. (Rs.)

co
EBIT 25,00,000
Interest to Debt holders (12,00,000)
EBT
s. 13,00,000
te
Taxes @ 30% (3,90,000)
no
Income available to Equity Shareholders 9,10,000
Total Value of Firm 1,17,50,000
dy

Less: Market Value of Debt (1,00,00,000)

Market Value of Equity 17,50,000
tu

Return on equity (Ke) = 9,10,000 / 17,50,000 0.52

Computation of WACC B. Ltd

Component of Capital Amount Weight Cost of Capital WACC

Equity 17,50,000 0.149 0.52 0.0775

Debt 1,00,00,000 0.851 0.084* 0.0715

Total
w

1,17,50,000 0.1490
*Kd= 12% (1- 0.3) = 12% × 0.7 = 8.4%
WACC = 14.90%
2. (a) Computation of Degree of Operating (DOL), Financial (DFL) and Combined leverages (DCL).
Rs. 34,00,000 - Rs. 6,00,000
DOL = = 1.27
Rs. 22,00,000
Rs.22,00,000
DFL = = 1.38
Rs. 16,00,000
DCL = DOLDFL = 1.271.38 = 1.75

Join Us on Telegram http://t.me/canotes_ipcc

(b) (i)
Year Cash flow Discount Factor Present value
(15%)
(Rs.) (Rs.)
0 (70,00,000) 1.000 (70,00,000)
1 (1,00,00,000) 0.870 (87,00,000)
2 25,00,000 0.756 18,90,000
3 30,00,000 0.658 19,74,000
4 35,00,000 0.572 20,02,000
510 40,00,000 2.163 86,52,000
Net Present Value (11,82,000)

As the net present value is negative, the project is unacceptable.

(ii) Similarly, NPV at 10% discount rate can be computed as follows:

m
Year Cash flow Discount Factor Present value

co
(10%)
(Rs.) (Rs.)
0 (70,00,000)
s.
1.000 (70,00,000)
te
1 (1,00,00,000) 0.909 (90,90,000)
no

2 25,00,000 0.826 20,65,000

3 30,00,000 0.751 22,53,000
dy

4 35,00,000 0.683 23,90,500

510 40,00,000 2.974 1,18,96,000

Net Present Value 25,14,500
as

Since NPV = Rs.25,14,500 is positive, hence the project would be acceptable.

NPVat LR
(iii) IRR = LR   (HR  LR)
w

NPVat LR  NPV at HR
w

Rs.25,14,500
= 10% +  (15%  10%)
w

Rs.25,14,500  ( )11,82,000
= 10% + 3.4012 or 13.40%
3. Computation – Collections from Debtors
Particulars Feb Mar Apr May Jun Jul Aug Sep
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
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)
Collection
(within one month) 72,000 84,000 48,000 36,000 48,000 60,000 48,000

Join Us on Telegram http://t.me/canotes_ipcc

Collection
24,000 28,000 16,000 12,000 16,000 20,000
(within two months)
Total Collections 1,08,000 76,000 52,000 60,000 76,000 68,000

Monthly Cash Budget for Six Months: April to September, 2019

Particulars April May June July August Sept.
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
Receipts:
Opening Balance 20,000 20,000 20,000 20,000 20,000 20,000
Cash Sales 16,000 12,000 16,000 20,000 16,000 12,000
Collections fr om 1,08,000 76,000 52,000 60,000 76,000 68,000
Debtors
Total Receipts (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

m
Wages and Salaries 9,000 8,000 10,000 10,000 9,000 9,000

co
Interest on Loan 3,000 ----- ----- 3,000 ----- -----
Tax Payment ----- ----- ----- 5,000 ----- -----
Total Payment (B) 60,000 72,000 90,000
s. 82,000 57,000 89,000
te
Minimum Cash Balance 20,000 20,000 20,000 20,000 20,000 20,000
Total Cash Required (C) 80,000 92,000 1,10,000 1,02,000 77,000 1,09,000
no

Surplus/ (Deficit) (A)-(C) 64,000 16,000 (22,000) (2,000) 35,000 (9,000)

Investment/F inancing:
Total effect of
tu

(Invest)/ Financing (D) (64,000) (16,000) 22,000 2,000 (35,000) 9,000

Closing Cash Balance 20,000 20,000 20,000 20,000 20,000 20,000
as

(A) + (D) - (B)

4. (A) (i) Cost of new debt

I(1  t)
Kd =
P0
w

16 (1  0.5)
w

=  0.0833
96
(ii) Cost of new preference shares
PD 1.1
Kp =   0.12
P0 9.2
(iii) Cost of new equity shares
D1
Ke = g
P0
11.80
  0.10  0.05 + 0.10 = 0.15
236
Calculation of D1
D1 = 50% of 2019 EPS = 50% of 23.60 = Rs. 11.80
5

Join Us on Telegram http://t.me/canotes_ipcc

(B) Calculation of marginal cost of capital

Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debenture 0.15 0.0833 0.0125
Preference Share 0.05 0.12 0.0060
Equity Share 0.80 0.15 0.1200
Marginal cost of capital 0.1385

(C) The company can spend the following amount without increasing marginal cost of capital and
without selling the new shares:
Retained earnings = (0.50) (236 × 10,000) = Rs. 11,80,000
The ordinary equity (Retained earnings in this case) is 80% of total capital
11,80,000 = 80% of Total Capital
Rs.11,80,000
Capital investment before issuing equity = = Rs.14,75,000

om
0.80
(D) If the company spends in excess of Rs.14,75,000 it will have to issue new shares.

c
Rs. 11.80
The cost of new issue will be =

The marginal cost of capital will be:

200
+ 0.10 = 0.159
e s.
ot
Type of Capital Proportion Specific Cost Product
yn

(1) (2) (3) (2) × (3) = (4)

Debentures 0.15 0.0833 0.0125

Preference Shares 0.05 0.1200 0.0060

Equity Shares (New) 0.80 0.1590 0.1272

0.1457
.c

5. (a) Calculation of Expected Value for Project A and Project B

Project A Project B
w

Possible Net Cash Probability Expected Cash Flow Probability Expected

Event Flow Value (Rs.) Value

(Rs.) (Rs.) (Rs.)
A 80,000 0.10 8,000 2,40,000 0.10 24,000
B 1,00,000 0.20 20,000 2,00,000 0.15 30,000
C 1,20,000 0.40 48,000 1,60,000 0.50 80,000
D 1,40,000 0.20 28,000 1,20,000 0.15 18,000
E 1,60,000 0.10 16,000 80,000 0.10 8,000
ENCF 1,20,000 1,60,000
Project A
Variance (σ2) = (80,000 – 1,20,000)2 × (0.1) + (1,00,000 -1,20,000)2 × (0.2) + (1,20,000 – 1,20,000)2
× (0.4) + (1,40,000 – 1,20,000)2 × (0.2) + (1,60,000 – 1,20,000)2 × (0.1)

Join Us on Telegram http://t.me/canotes_ipcc

= 16,00,00,000 + 8,00,00,000 + 0 + 8,00,00,000 + 16,00,00,000

= 48,00,00,000
Standard Deviation (σ) = Variance(2 ) = 48,00,00,000 = 21,908.90

Project B:
Variance(σ2) = (2,40,000 – 1,60,000)2 × (0.1) + (2,00,000 – 1,60,000)2 × (0.15) + (1,60,000 –
1,60,000)2 ×(0.5) + (1,20,000 – 1,60,000)2 × (0.15) + (80,000 – 1,60,000)2 × (0.1)
= 64,00,00,000 + 24,00,00,000 + 0 + 24,00,00,000 + 64,00,00,000
= 1,76,00,00,000
Standard Deviation (σ) = 1,76,00,00,000 = 41,952.35

2×Rs.1,26,00,000×Rs.20
(b) The optimum cash balance C = = Rs.79,372.54
0.08
6. (a) Inter-relationship between Investment, Financing and Dividend Decisions: The finance

om
functions are divided into three major decisions, viz., investment, financing and dividend decisions.
It is correct to say that these decisions are inter-related because the underlying objective of these
three decisions is the same, i.e. maximisation of shareholders’ wealth. Since investment, financing

c
and dividend decisions are all interrelated, one has to consider the joint impact of these decisions
s.
on the market price of the company’s shares and these decisions should also be solved jointly. The
te
decision to invest in a new project needs the finance for the investment. The financing decision, in
turn, is influenced by and influences dividend decision because retained earnings used in internal
no

financing deprive shareholders of their dividends. An efficient financial management can ensure
optimal joint decisions. This is possible by evaluating each decision in relation to its effect on the
dy

shareholders’ wealth.
The above three decisions are briefly examined below in the light of their inter-relationship and to
tu

see how they can help in maximising the shareholders’ wealth i.e. market price of the company’s
as

shares.
Investment decision: The investment of long term funds is made after a careful assessment of
.c

the various projects through capital budgeting and uncertainty analysis. However, only that
investment proposal is to be accepted which is expected to yield at least so much return as is
w

adequate to meet its cost of financing. This have an influence on the profitability of the company
w

and ultimately on its wealth.

Financing decision: Funds can be raised from various sources. Each source of funds involves
different issues. The finance manager has to maintain a proper balance between long -term and
short-term funds. With the total volume of long-term funds, he has to ensure a proper mix of loan
funds and owner’s funds. The optimum financing mix will increase return to equity shareholders
and thus maximise their wealth.
Dividend decision: The finance manager is also concerned with the decision to pay or declare
dividend. He assists the top management in deciding as to what portion of the profit should be paid
to the shareholders by way of dividends and what portion should be retained in the business. An
optimal dividend pay-out ratio maximises shareholders’ wealth.
The above discussion makes it clear that investment, financing and dividend decisions are
interrelated and are to be taken jointly keeping in view their joint effect on the shareholders’ wealth .

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(b) Debt Securitisation: It is a method of recycling of funds. It is especially beneficial to financial
intermediaries to support the lending volumes. Assets generating steady cash flows are packaged
together and against this asset pool, market securities can be issued, e.g. housing finance, auto
loans, and credit card receivables.
Process of Debt Securitisation
(i) The origination function – A borrower seeks a loan from a finance company, bank, HDFC. The
credit worthiness of borrower is evaluated and contract is entered into with repayment
schedule structured over the life of the loan.
(ii) The pooling function – Similar loans on receivables are clubbed together to create an
underlying pool of assets. The pool is transferred in favour of Special purpose Vehicle (SPV),
which acts as a trustee for investors.
(iii) The securitisation function – SPV will structure and issue securities on the basis of asset pool.
The securities carry a coupon and expected maturity which can be asset-based/mortgage
based. These are generally sold to investors through merchant bankers. Investors are –
pension funds, mutual funds, insurance funds.
The process of securitization is generally without recourse i.e. investors bear the credit risk

om
and issuer is under an obligation to pay to investors only if the cash flows are received by him
from the collateral. The benefits to the originator are that assets are shifted off the balance

c
sheet, thus giving the originator recourse to off-balance sheet funding.
(c) Concept of Discounted Payback Period
s.
te
Payback period is time taken to recover the original investment from project cash flows. It is also
termed as break even period. The focus of the analysis is on liquidity aspect and it suffers from the
o
limitation of ignoring time value of money and profitability. Discounted payback period consi ders
yn

present value of cash flows, discounted at company’s cost of capital to estimate breakeven period
i.e. it is that period in which future discounted cash flows equal the initial outflow. The shorter the
ud

period, better it is. It also ignores post discounted payback period cash flows.
a st
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: May, 2020

MOCK TEST PAPER- 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT

Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium. If
a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60
1. Answer the following:

m
(a) The data relating to two companies are as given below:

o
Company A Company B

.c
Equity Capital Rs.6,00,00,000 Rs.3,50,00,000
15% Debentures Rs.40,00,000
es Rs.65,00,000
Output (units) per annum 6,00,000 1,50,000
ot
Selling price/ unit Rs.60 Rs.500
yn

Fixed Costs per annum Rs.70,00,000 Rs.1,40,00,000

Variable Cost per unit Rs.30 Rs.275
d
tu

You are required to CALCULATE the Operating leverage, Financial leverage and Combined
leverage of the two Companies.
as

(b) ABC Limited has the following book value capital structure:
.c

Equity Share Capital (1 crore shares @ Rs.10 each) Rs.1,000 lakh

Reserves and Surplus Rs.2,250 lakh

9% Preference Share Capital (5 lakh shares @ Rs.100 each) Rs.500 lakh

8.5% Debentures (1.5 lakh debentures @ Rs.1,000 each) Rs.1,500 lakh

12% Term Loans from Financial Institutions Rs.500 lakh

- The debentures of ABC Limited are redeemable at par after five years and are quoting at Rs.985
per debenture.
- The current market price per equity share is Rs.60. The prevailing default-risk free interest rate on
10-year GOI Treasury Bonds is 5.5%. The average market risk premium is 7%. The beta of the
company is 1.85
- The preference shares of the company are redeemable at 10% premium after 5 years is currently
selling at Rs.102 per share.
The applicable income tax rate for the company is 35%.
Required:
CALCULATE weighted average cost of capital of the company using market value weights.
1

Join Us on Telegram http://t.me/canotes_ipcc

(c) A company proposes to install a machine involving a Capital Cost of Rs.72,00,000. The life of the
machine is 5 years and its salvage value at the end of the life is nil. The machine will produce the
net operating income after depreciation of Rs.13,60,000 per annum. The Company’s tax rate is
35%.
The Net Present Value factors for 5 years are as under:
Discounting Rate : 14 15 16 17 18 19
Cumulative factor : 3.43 3.35 3.27 3.20 3.13 3.06
You are required to COMPUTE the internal rate of return (IRR) of the proposal.
(d) A&R Ltd. is an all equity financed company with a market value of Rs.25,000 lakh and cost of equity
(Ke) 18%. The company wants to buyback equity shares worth Rs.5,000 lakh by issuing and
raising 10% debentures redeemable at 10% premium after 5 years. Rate of tax may be taken as
35%. Applying Modigliani-Miller (MM) (with taxes), you are required to CALCULATE after
restructuring:
(i) Market value of A&R Ltd.

m
(ii) Cost of Equity (Ke)

o
.c
(iii) Weighted average cost of capital (using market weights). [4 × 5 Marks = 20 Marks]
2. es
ZX Ltd. has a paid-up share capital of Rs.1,00,00,000, face value of Rs.100 each. The current market
price of the shares is Rs.100 each. The Board of Directors of the company has an agenda of meeting to
ot
pay a dividend of 50% to its shareholders. The company expects a net income of Rs.75,00,000 at the
end of the current financial year. Company also plans for a capital expenditure for the next financial year
yn

for a cost of Rs.95,00,000, which can be financed through retained earnings and issue of new equity
shares.
d
tu

Company’s desired rate of investment is 15%.

Required:
as

Following the Modigliani- Miller (MM) Hypothesis, DETERMINE value of the company when:
.c

(i) It does not pay dividend and

(ii) It does pay dividend [10 Marks]

3. A&R Ltd. has undertaken a project which has an initial investment of Rs.2,000 lakhs in plant & machinery
w

and Rs.800 lakhs for working capital. The plant & machinery would have a salvage value of Rs. 474.61
lakhs at the end of the fifth year. The plant & machinery would depreciate at the rate of 25% p.a. on
WDV method. The other details of the project for the five year period are as follows:
Sales 10,00,000 units p.a.
Selling price per unit Rs.500
Variable cost 50% of selling price
Fixed overheads (excluding depreciation) Rs.300 lakh p.a.
Corporate tax rate 35%
Rate of interest on bank loan 12%
After tax required rate of return 15%

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
Required:
(i) CACULATE net present value (NPV) of the project and DETERMINE the viability of the project.
(ii) DETERMINE the sensitivity of project’s NPV under each of the following condition:
a. Decrease in selling price by 10%;
b. Increase in cost of plant & machinery by 10%.
PV factor Year-1 Year-2 Year-3 Year-4 Year-5
12% 0.892 0.797 0.711 0.635 0.567
15% 0.869 0.756 0.657 0.571 0.497

[10 Marks]
4. The following accounting information and financial ratios of A&R Limited relate to the year ended 31st
March, 2020:
Inventory Turnover Ratio 6 Times
Creditors Turnover Ratio 10 Times

m
Debtors Turnover Ratio 8 Times

o
Current Ratio 2.4

.c
Gross Profit Ratio 25%es
Total sales Rs.6,00,00,000; cash sales 25% of credit sales; cash purchases Rs.46,00,000; working
ot
capital Rs.56,00,000; closing inventory is Rs.16,00,000 more than opening inventory.
yn

You are required to CALCULATE:

(i) Average Inventory
d

(ii) Purchases
tu

(iii) Average Debtors

(iv) Average Creditors

(v) Average Payment Period

(vi) Average Collection Period

(vii) Current Assets

(viii) Current Liabilities.

Take 365 days a year [10 Marks]
5. (a) Cost sheet of A&R Ltd. provides the following particulars:
Amount per unit (Rs.)
Raw materials cost 200.00
Direct labour cost 75.00
Overheads cost 150.00
Total cost 425.00
Profit 75.00
Selling Price 500.00

Join Us on Telegram http://t.me/canotes_ipcc

The Company keeps raw material in stock, on an average for four weeks; work-in-progress, on an
average for one week; and finished goods in stock, on an average for two weeks.
The credit allowed by suppliers is three weeks and company allows four weeks credit to its debtors.
The lag in payment of wages is one week and lag in payment of overhead expenses is two weeks.
The Company sells one-fifth of the output against cash and maintains cash-in-hand and at bank
put together at Rs.2,50,000.
Required:
PREPARE a statement showing estimate of Working Capital needed to finance an activity level of
2,60,000 units of production. Assume that production is carried on evenly throughout the year, and
wages and overheads accrue similarly. Work-in-progress stock is 80% complete in all respects.
(b) The following information is provided by the P Ltd. for the year ending 31 st March, 2020.
Raw Material storage period 52 days
Work in progress conversion period 18 days

m
Finished Goods storage period 20 days

o
Debt Collection period 75 days

.c
Creditors' payment period 25 days
Annual Operating Cost
es 45 crore
ot
(Including depreciation of Rs.42,00,000)
yn

(1 year = 360 days)

You are required to CALCULATE Operating Cycle period and Number of Operating Cycles in a
d

year. [8 + 2 = 10 Marks]
tu

6. Answer the followings:

(a) EXPLAIN in brief the Pecking order theory.

(b) EXPLAIN Over-capitalisation. STATE its causes and consequences.

(c) EXPLAIN in short the term Letter of Credit.

OR
w

"Financing a business through borrowing is cheaper than using equity." Briefly EXPLAIN.
[4+4+2 = 10 Marks]

Join Us on Telegram http://t.me/canotes_ipcc

Test Series: May, 2020

MOCK TEST PAPER- 1
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Suggested Answers/ Hints

1. (a) Computation of Operating leverage, Financial leverage and Combined leverage of two
companies
Company A Company B
Output units per annum 6,00,000 1,50,000
(Rs.) (Rs.)
Selling price / unit 60 500
Sales revenue 3,60,00,000 7,50,00,000

m
(6,00,000 units × Rs.60) (1,50,000 units × Rs.500)

o
Less: Variable costs 1,80,00,000 4,12,50,000

.c
(6,00,000 units × Rs.30) (1,50,000 units × Rs.275)
Contribution (C)
es 1,80,00,000 3,37,50,000
Less: Fixed costs 70,00,000 1,40,00,000
ot
EBIT (Earnings before Interest and tax) 1,10,00,000 1,97,50,000
yn

Less: Interest @ 15% on debentures 6,00,000 9,75,000

PBT 1,04,00,000 1,87,75,000

Contribution 1.64 1.71

Operating Leverage =
EBIT (Rs.1,80,00,000 ÷ (Rs.3,37,50,000 ÷
1,10,00,000) Rs. 1,97,50,000)
.c

Financial Leverage =
EBIT 1.06 1.05
w

PBT (Rs.1,10,00,000 ÷ (Rs.1,97,50,000 ÷

Rs.1,04,00,000) Rs. 1,87,75,000)

Combined Leverage = DOL × DFL 1.74 1.80
w

(1.64 × 1.06) (1.71 × 1.05)

(b) Working Notes:
(1) Computation of cost of debentures (Kd) :
(1,000 − 985)
Rs.85(1 − 0.35) +
5 55.25 + 3
Kd = = = 0.0586 or 5.86%
(1,000 + 985) 992.5
2
(2) Computation of cost of term loans (KT) :
= r (1− t)
= 0.12 (1− 0.35) = 0.078 or 7.8%

Join Us on Telegram http://t.me/canotes_ipcc

(3) Computation of cost of preference capital (KP) :

Preference Dividend + (RV - NP) / n
Kp =
(RV + NP) / 2

(110 − 102)
Rs.9 +
5 9 + 1.6
= = = 0.1 or 10%
(110 + 102) 106
2
(4) Computation of cost of equity (Ke) :
= Rf + ß(Rm – Rf)
Or, = Risk free rate + (Beta × Risk premium)
= 0.055 + (1.85 × 0.07) = 0.1845 or 18.45%
Calculation of Weighted Average cost of capital Using market value weights
Source of Capital Market value of capital Weights After tax cost WACC (%)

m
structure (Rs. in lakh) of capital (%)

o
Equity share capital

.c
6,000 0.71 18.45 13.09
(1 crore shares × Rs.60 )
9% Preference share
es
capital 510 0.06 10.00 0.60
ot
(5 lakh shares × Rs.102)
yn

8.5 % Debentures
1,477.5 0.17 5.86 0.99
(1.5 lakh × Rs.985)
d

12% Term loans 500 0.06 7.80 0.47

8,487.50 1.000 15.15

Computation of cash inflow per annum Rs.

Net operating income per annum 13,60,000

Less: Tax @ 35% 4,76,000

Profit after tax 8,84,000
w

Add: Depreciation (Rs.72,00,000 / 5 years) 14,40,000

Cash inflow 23,24,000

The IRR of the investment can be found as follows:

NPV = − Rs. 72,00,000 + Rs. 23,24,000 (PVAF5, r) = 0
Rs.72,00,000
or PVA F5 r ( Cumulative factor) = = 3.09
Rs.23,24,000
Computation of Internal Rate of Return (IRR)
Discounting rate 15% 19%
Cumulative factor 3.35 3.06
Total NPV (Rs.) 77,85,400 71,11,440
2

Join Us on Telegram http://t.me/canotes_ipcc

(Rs.23,24,000 × 3.35) ( Rs.23,24,000 × 3.06)

Internal outlay (Rs.) 72,00,000 72,00,000
Surplus (Deficit) (Rs.) 5,85,400 (88,560)
NPV at LR
IRR = LR + ×(HR -LR)
NPV at LR - NPV at HR
5,85,400
= 15% + ×(19% -15%)
5,85,400 - (-88,560)

= 15% +3.47 =18.47%

(d) Value of a company (V) = Value of equity (S) + Value of debt (D)
A&R Ltd. is all equity financed company, its value would equal to value of equity.
Net Income (NI)
Market value of equity = =
Ke

In the question, market value of equity is Rs.25,000 lakh and cost of equity (Ke) is 18%. The Net

m
Income (NI) is calculated as follows:

o
Net income (NI) for equity - holders

.c
= Market Value of Equity
Ke es
Net income (NI) for equity holders
= 25,000 lakh
ot
0.18
yn

Net income for equity holders = 4,500 lakh

Net Income (NI) is after tax income, the before tax income would be
d
tu

4,500lakh
EBT= = 6,923.07 lakh.
(1 − 0.35)
as

Since, A&R Ltd. is an all equity financed and there is no interest expense, so here EBT is equal to EBIT.
.c

After issuing 10% debentures, the A&R Ltd would become a levered company.
w

(i) The value of A&R Ltd. after issuing debentures would be calculated as follows:
w

Value of a levered company (Vg)

= Value of an unlevered company (Vu) + Tax benefit (TB)

= Rs.25,000 lakh + (Rs.5,000 lakh × 35%)
= Rs.25,000 + Rs.1,750 = Rs.26,750
(ii) Cost of Equity (Ke)
Total Value = Rs.26,750 lakh
Less: Value of Debt = Rs. 5,000 lakh
Value of Equity = Rs. 21,750
4,175lakh
Ke = =0.1919 = 19.19%
21,750lakh

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(iii) WACC (on market value weight)
Components of Costs Amount (lakh) Cost of Capital (%) Weight WACC (%)
Equity 21,750 19.19 0.81 15.54
Debt 5,000 8.10 0.19 1.54
26,750 17.08
Workings Note:
1. (Rs. in lakh)
All Equity Debt and Equity
EBIT (as calculated above) 6,923.07 6,923.07
Interest to debt-holders - 500.00
EBT 6,923.07 6,423.07
Taxes (35%) 2,423.07 2,248.07
Income available to equity shareholders 4,500.00 4,175.00

m
Income to debt holders plus income available to shareholders 4,500.00 4,675.00

o
(5,500 − 5,000)

.c
Rs.500(1 − 0.35) +
2. Cost of Debenture (Kd) = es 5
(5,500 + 5,000)
2
ot
Rs.325 + 100
= = 0.081 or 8.1%
yn

5,250
2. As per MM Hypothesis, value of firm/ company is calculated as below:
d
tu

(n + Δn)P1 - I + E
Vf or nP₀ =
(1+ K e )
as

Where,
.c

Vf = Value of firm in the beginning of the period

n = number of shares in the beginning of the period

∆n = number of shares issued to raise the funds required

I = Amount required for investment

E = total earnings during the period
(i) Value of the ZX Ltd. when dividends are not paid.
(n + Δn)P1 - I + E
nPₒ =
1+ K e

 20,00,000 
 1,00,000 +  ×Rs.115 - Rs.95,00,000 + Rs.75,00,000
 115 
nP₀ =
(1+ 0.15)

Rs.1,35,00,000 - Rs.95,00,000 + Rs.75,00,000

= = Rs.1,00,00,000
(1+ 0.15)

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
Working notes:
1. Price of share at the end of the period (P1)
P1 + D1
Pₒ =
1+ K e
P1 + 0
100 = or, P₁= 115
1+ 0.15
2. Calculation of funds required for investment
Earnings Rs.75,00,000
Dividend distributed Nil
Fund available for investment Rs.75,00,000
Total Investment Rs.95,00,000
Balance Funds required Rs.20,00,000

m
3. Calculation of no. of shares required to be issued for balance fund

o
Funds required 20,00,000
No. of shares (∆n) = = shares

.c
Price at end (P1 ) 115
(ii) Value of the ZX Ltd. when dividends are paid. es
(n + Δn)P1 - I + E
nPₒ =
ot
1+ K e
yn

 70,00,000 
 1,00,000 +  ×Rs.65 - Rs.95,00,000 + Rs.75,00,000
 65 
d

nP₀ =
(1+ 0.15)
tu
as

Rs.1,35,00,000 - Rs.95,00,000 + Rs.75,00,000

= = Rs.1,00,00,000
(1+ 0.15)
.c

Working notes:
w

4. Price of share at the end of the period (P1)

P1 + D1
w

Pₒ =
1+ K e
P1 + 50
100 = or, P₁= Rs.65
1+ 0.15
5. Calculation of funds required for investment
Earnings Rs.75,00,000
Dividend distributed Rs.50,00,000
Fund available for investment Rs.25,00,000
Total Investment Rs.95,00,000
Balance Funds required Rs.70,00,000

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
6. Calculation of no. of shares required to be issued for balance fund
Funds required 70,00,000
No. of shares (∆n) = = =1,07,693 shares(approx.)
Price at end (P1 ) 65

Note- As per MM-hypothesis of dividend irrelevance, value of firm remains same irrespective of
dividend paid. In the solution, there may be variation in value, which is due to rounding off error.

3. (i) Calculation of Net Present Value (NPV):

Year-1 Year-2 Year-3 Year-4 Year-5
Sales volume (Qty. in lakh) 10 10 10 10 10
Contribution per unit (Rs.) 250 250 250 250 250
(Selling price – variable cost)
Total contribution (Rs.in lakh) 2,500 2,500 2,500 2,500 2,500
Less: Fixed overheads (Rs. In 300 300 300 300 300
lakh)

m
PBDT 2,200 2,200 2,200 2,200 2,200

o
Less: Depreciation (Rs. in lakh) 500 375 281.25 210.94 158.20

.c
(Working note-1)
PBT 1,700
es
1,825 1,918.75 1,989.06 2,041.80
Less: Tax @ 35% 595 638.75 671.56 696.17 714.63
ot
PAT 1,105 1,186.25 1,247.19 1,292.89 1,327.17
yn

Add: Depreciation 500 375 281.25 210.94 158.20

Add: Salvage value of plant & - - - - 474.61
d

machinery
tu

Add: Working capital - - - - 800

Net Cash inflow 1,605 1,561.25 1,528.44 1,503.83 2,759.98

P.V factor @15% 0.869 0.756 0.657 0.571 0.497

P.V of cash inflows 1,394.74 1,180.31 1,004.18 858.68 1,371.71
w
w

Net Present Value = P.V of cash inflows – P.V of cash outflows

= Rs. (1,394.74+1,180.31+1,004.18+858.68+1,371.71) – Rs.2,000

= Rs.3,809.62 lakh
The NPV of the project is positive, hence, the project is viable.
Working note-1:
Year-1 Year-2 Year-3 Year-4 Year-5
Opening balance 2,000 1,500 1,125 843.75 632.81
Depreciation @25% 500 375 281.25 210.94 158.20
Closing WDV 1,500 1,125 843.75 632.81 474.61

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(ii) Determination of sensitivity of NPV w.r.t.
a. Decrease in selling price by 10%
Year-1 Year-2 Year-3 Year-4 Year-5
Sales volume (Qty. in lakh) 10 10 10 10 10
New Selling price 450 450 450 450 450
Variable cost 250 250 250 250 250
Contribution per unit (Rs.) 200 200 200 200 200
(Selling price – variable cost)
Total contribution (Rs.in lakh) 2,000 2,000 2,000 2,000 2,000
Less: Fixed overheads (Rs. In 300 300 300 300 300
lakh)
PBDT 1,700 1,700 1,700 1,700 1,700
Less: Depreciation (Rs. in 500 375 281.25 210.94 158.20
lakh) (Working note-1)

m
PBT 1,200 1,325 1,418.75 1,489.06 1,541.80

o
Less: Tax @ 35% 420 463.75 496.56 521.17 539.63

.c
PAT 780 861.25
es 922.19 967.89 1,002.17
Add: Depreciation 500 375 281.25 210.94 158.20
ot
Add: Salvage value of plant & - - - - 474.61
machinery
yn

Add: Working capital - - - - 800

Net Cash inflow 1,280 1,236.25 1,203.44 1,178.83 2,434.98
d
tu

P.V factor @15% 0.869 0.756 0.657 0.571 0.497

P.V of cash inflows 1,112.32 934.61 790.66 673.11 1,210.18
as

NPV = (1,112.32+934.61+790.66+673.11+1,210.18) – 2,000

= 4,720.88 – 2,000 = 2,720.88 lakh

10% reduction in selling price reduces the NPV by 28.58% (3,809.62-2,720.88/3809.62)

b. Increase in project cost by 10%

Year-1 Year-2 Year-3 Year-4 Year-5

PBDT 2,200 2,200 2,200 2,200 2,200
Less: Depreciation (Rs. in 550 412.5 309.37 232.03 174.03
lakh) (Working note-2)
PBT 1,650 1,787.50 1,890.63 1,967.97 2,025.97
Less: Tax @ 35% 577.50 625.63 661.72 688.79 709.09
PAT 1072.50 1,161.87 1,228.91 1,279.18 1,316.88
Add: Depreciation 550 412.5 309.37 232.03 174.03
Add: Salvage value of - - - - 474.61
plant & machinery
Add: Working capital - - - - 800
Net Cash inflow 1,622.50 1,574.37 1,538.28 1,511.21 2,765.52
7

Join Us on Telegram http://t.me/canotes_ipcc

P.V factor @15% 0.869 0.756 0.657 0.571 0.497

P.V of cash inflows 1,409.95 1,190.22 1,010.65 862.90 1,374.46
NPV = (1,409.95+1,190.22+1,011.65+862.90+1,374.46) – 2,200
= 5,849.18 – 2,200 = 3,649.18 lakh
10% increase in project cost reduces the NPV only by 4.21% (3,809.62 -
3,649.18/3809.62)
Working note-2:
Year-1 Year-2 Year-3 Year-4 Year-5
Opening balance 2,200 1,650 1,237.50 928.13 696.10
Depreciation @25% 550 412.5 309.37 232.03 174.03
Closing WDV 1,650 1,237.50 928.13 696.10 522.07

4. (i) Computation of Average Inventory

m
Gross Profit = 25% of Rs.6,00,00,000 = Rs.1,50,00,000

o
Cost of goods sold (COGS) = Sales - Gross Profit

.c
= Rs.6,00,00,000 – Rs.1,50,00,000
= Rs.4,50,00,000
es
ot
COGS
Inventory Turnover Ratio =
Average Inventory
yn

Rs.4, 50,00,000
6=
d

Average inventory
tu

Average inventory = Rs.75,00,000

(ii) Computation of Purchases

Purchases = COGS + (Closing Stock – Opening Stock)

= Rs.4,50,00,000 + 16,00,000*
w

Purchases = Rs.4,66,00,000
w

* Increase in Stock = Closing Stock – Opening Stock = Rs.16,00,000

(iii) Computation of Average Debtors
25
Let Credit Sales be Rs.100, Cash sales = × 100 = Rs.25
100
Total Sales = 100 + 25= Rs.125
Total sales is Rs.125 credit sales is Rs.100
Rs. 6,00,00,000 × 100
If total sales is Rs.6,00,00,000, then credit sales is =
125
Credit Sales = Rs.4,80,00,000
Cash Sales = (Rs.6,00,00,000 – Rs.4,80,00,000) = Rs.1,20,00,000

Join Us on Telegram http://t.me/canotes_ipcc

Net Credit Sales

Debtors Turnover Ratio = =8
Average debtors

Rs.4,80,00,000
= =8
Average debtors
Rs.4,80,00,000
Average Debtors =
8
Average Debtors = Rs.60,00,000
(iv) Computation of Average Creditors
Credit Purchases = Purchases – Cash Purchases
= Rs.4,66,00,000 – Rs.46,00,000 = Rs.4,20,00,000
Credit Purchases
Creditors Turnover Ratio =
Average Creditors
Rs.4, 20,00,000

m
10 =
Average Creditors

o
Average Creditors = Rs.42,00,000

.c
(v) Computation of Average Payment Period es
Average Creditors
Average Payment Period =
Average Daily Credit Purchases
ot
Rs. 42,00,000 Rs. 42,00,000
yn

= Credit Purchases = Rs. 4,20,00,000

� � � �
365 365
d

Rs.42,00,000
tu

= × 365 = 36.5 days

Rs.4,20,00,000
as

Alternatively
Average Payment Period = 365/Creditors Turnover Ratio
.c

365
w

= = 36.5 days
10
w

(vi) Computation of Average Collection Period

Average Debtors
Average Collection Period = ×365
Net Credit Sales
Rs.60,00,000
= × 365 = 45.625 days
Rs.4,80,00,000
Alternatively
365
Average collection period =
Debtors Turnover Ratio
365
= = 45.625 days
8

Join Us on Telegram http://t.me/canotes_ipcc

(vii) Computation of Current Assets

Current Assets (CA)
Current Ratio =  2.4
Current Liabilities (CL)
2.4 Current Liabilities = Current Assets
CA
or CL =
2.4
Further, Working capital = Current Assets – Current liabilities
CA
So, Rs.56,00,000 = CA -
2.4
1.4CA
Rs.56,00,000 = Or, 1.4 CA = Rs.1,34,40,000
2.4
CA = Rs.96,00,000
(viii) Computation of Current Liabilities

m
Rs.96,00,000
Current liabilities = = Rs.40,00,000

o
2.4

.c
5. (a) Statement showing Estimate of Working Capital Needs
es (Amount in Rs.) (Amount in Rs.)
A. Current Assets
ot
(i) Inventories:
yn

Raw material (4 weeks)

 2,60,000units×Rs.200 
 × 4 weeks 
tu

 52 weeks  40,00,000
as

WIP Inventory (1 week)

 2,60,000units×Rs.425 
×1week  × 0.8 17,00,000
.c


 52 weeks 
w

Finished goods inventory (2 weeks)

 2,60,000units×Rs.425  99,50,000
 × 2 weeks  42,50,000
w

 52 weeks 
(ii) Receivables (Debtors) (4 weeks)
 2,60,000units×Rs.425  4
 × 4 weeks  × 68,00,000
 52 weeks  5th
(iii) Cash and bank balance 2,50,000
Total Current Assets 1,70,00,000
B. Current Liabilities:
(i) Payables (Creditors) for materials (3 weeks)
 2,60,000units×Rs.200  30,00,000
 × 3 weeks 
 52 weeks 

Join Us on Telegram http://t.me/canotes_ipcc

(ii) Outstanding wages (1 week)

 2,60,000units×Rs.75  3,75,000
 ×1week 
 52 weeks 
(iii) Outstanding overheads (2 weeks)
 2,60,000units×Rs.150 
 × 2 weeks 
 52 weeks  15,00,000
Total Current Liabilities 48,75,000
Net Working Capital Needs (A – B) 1,21,25,000
(b) Calculation of Operating Cycle Period and number of Operating Cycle in a Year
Operating Cycle Period = R + W + F + D – C
= 52 + 18 + 20 + 75 – 25 = 140 days
360
Number of Operating Cycle in a Year =
Operating Cycle Period

m
= 360/140 = 2.57 times

o
6. (a) This theory states that firms prefer to issue debt when they are positive about future earnings.

.c
Equity is issued when they are doubtful and internal finance is insufficient.
es
The pecking order theory argues that the capital structure decision is affected by manager’s choice
of a source of capital that gives higher priority to sources that reveal the least amount of
ot
information.
yn

Pecking order theory suggests that managers may use various sources for raising of fund in the
following order.
d

1. Managers first choice is to use internal finance

2. In absence of internal finance they can use secured debt, unsecured debt, hybrid debt etc.
as

3. Managers may issue new equity shares as a last option.

So briefly under this theory rules are
.c

Rule 1: Use internal financing first.

Rule 2: Issue debt next

Rule 3: Issue of new equity shares at last

(b) Over-capitalization and its Causes and Consequences

It is a situation where a firm has more capital than it needs or in other words assets are worth less
than its issued share capital, and earnings are insufficient to pay dividend and interest.
Causes of Over Capitalization
Over-capitalisation arises due to following reasons:
(i) Raising more money through issue of shares or debentures than company can employ
profitably.
(ii) Borrowing huge amount at higher rate than rate at which company can earn.
(iii) Excessive payment for the acquisition of fictitious assets such as goodwill etc.
(iv) Improper provision for depreciation, replacement of assets and distribution of dividends at a
higher rate.
(v) Wrong estimation of earnings and capitalization.
11

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
Consequences of Over-Capitalisation
Over-capitalisation results in the following consequences:
(i) Considerable reduction in the rate of dividend and interest payments.
(ii) Reduction in the market price of shares.
(iii) Resorting to “window dressing”.
(iv) Some companies may opt for reorganization. However, sometimes the matter gets worse and
the company may go into liquidation.
(c) Letter of Credit: It is an arrangement by which the issuing bank on the instructions of a customer
or on its own behalf undertakes to pay or accept or negotiate or authorizes another bank to do so
against stipulated documents subject to compliance with specified terms and conditions.
Or
“Financing a business through borrowing is cheaper than using equity”
(i) Debt capital is cheaper than equity capital from the point of its cost and interest being
deductible for income tax purpose, whereas no such deduction is allowed for dividends.

m
(ii) Issue of new equity dilutes existing control pattern while borrowing does not result in dilution
of control.

o
.c
(iii) In a period of rising prices, borrowing is advantageous. The fixed monetary outgo decreases
in real terms as the price level increases. es
ot
d yn
tu
as
.c
w
w
w

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
Test Series: October, 2020
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi
medium. If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued.
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

m
1. Answer the following:

o
(a) ABC Pvt. Ltd. is considering relaxing its present credit policy for accounts receivable and is in the

.c
process of evaluating two proposed policies. Currently, the company has annual credit sales of
` 50 lakhs and accounts receivable turnover ratio of 4 times a year. The current level of loss due
es
to bad debts is ` 1,50,000. The company is required to give a return of 20% on the investment in
new accounts receivable. The company’s variable costs are 70% of the selling price. Given the
ot
following information, IDENTIFY which is the better policy?
yn

(Amount in `)
Particulars Present Policy Proposed Policy 1 Proposed Policy 2
d
tu

Annual credit sales 50,00,000 60,00,000 67,50,000

Accounts receivable turnover ratio 4 times 3 times 2.4 times

Bad debt losses 1,50,000 3,00,000 4,50,000
.c

(b) The annual report of XYZ Ltd. provides the following information for the Financial Year 2019-20:
w

Particulars Amount (`)

Net Profit 50 lakhs

Outstanding 15% preference shares 100 lakhs

No. of equity shares 5 lakhs
Return on Investment 20%
Cost of capital i.e. (K e) 16%

CALCULATE price per share using Gordon’s Model when dividend pay-out is-
(i) 25%;
(ii) 50%;
(iii) 100%.

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
(c) ABC Ltd. is considering a project “X” with an initial outlay of ` 16,00,000 and the possible three
cash inflow attached with the project is as follows:
(Amount in ` ‘000)
Particular Year 1 Year 2 Year 3
Scenario 1 550 500 800
Scenario 2 650 550 900
Scenario 3 750 600 1000
Assuming the cost of capital as 9%.
(i) DETERMINE NPV in each scenario.
(ii) If ABC Ltd. is certain about the 1st and 2nd year’s results in scenario 2 but uncertain about the
third year’s cash flow, DETERMINE NPV expecting scenario 1 in the third year.
Year 1 2 3
DF @ 9% 0.917 0.842 0.772

m
(d) Using the information given below, PREPARE the Balance Sheet of SKY Private Limited:

o
(i) Current ratio 1.6 :1

.c
(ii) Cash and Bank balance 15% of total current assets
(iii) Debtors turnover ratio
es 12 times
(iv) Stock turnover (cost of goods sold) ratio 16 times
ot
(v) Creditors turnover (cost of goods sold) ratio 10 times
yn

(vi) Gross profit ratio 20%

(vii) Capital gearing ratio 0.6
d

(viii) Depreciation rate 15% on W.D.V.

(ix) Net fixed Assets 20% of total assets

(Assume all purchase and sales are on credit)

Balance Sheet of SKY Private Limited as at 31.03.2020

Liabilities Amount in ` Assets Amount in `

Share Capital 25,00,000 Fixed assets

Reserve & surplus ? Opening WDV ?

12% Long term debt ? Less: Depreciation ? ?
Current liabilities
Creditors ? Current Assets
Provisions & outstanding
Stock ?
expenses ? 68,50,000
Debtors ?
Cash and bank balance ? ?
Total ? Total ?
(Detailed working notes are not required to be shown) [4 × 5 Marks = 20 Marks]

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
2. Sinha Steel Ltd. requires ` 30,00,000 for a new plant which expects to yield earnings before interest
and taxes of ` 5,00,000. While deciding about the financial plan, the company considers the objective
of maximizing earnings per share. It has three alternatives to finance the project as follows -
Alternative Debt Equity Shares
1 ` 2,50,000 balance
2 ` 10,00,000 balance
3 ` 15,00,000 balance
The company's share is currently selling at ` 200, but is expected to decline to ` 160 in case the funds
are borrowed in excess of ` 10,00,000.
Slab wise interest rate for fund borrowed are as follows -
Fund Limit Applicable Interest rate
up-to ` 2,50,000 10%
over ` 2,50,000 and up-to ` 10,00,000 15%

m
over ` 10,00,000 20%

o
The tax rate applicable to the company is 50 percent.

.c
ANALYSE which form of financing should the company choose? [10 Marks]
3.
es
P Ltd. has the following capital structure at book-value as on 31 st March, 2020:
Particulars (`)
ot
Equity share capital (10,00,000 shares) 3,00,00,000
yn

11.5% Preference shares 60,00,000

10% Debentures 1,00,00,000

4,60,00,000
as

The equity shares of the company are sold for ` 300. It is expected that the company will pay next year
a dividend of ` 15 per equity share, which is expected to grow by 5% p.a. forever. Assume a 35%
.c

corporate tax rate.

Required:
w

(i) COMPUTE weighted average cost of capital (WACC) of the company based on the existing capital
w

structure.
(ii) COMPUTE the new WACC, if the company raises an additional ` 50 lakhs debt by issuing 12%
debentures. This would result in increasing the expected equity dividend to ` 20 and leave the
growth rate unchanged, but the price of equity share will fall to ` 250 per share. [10 Marks]
4. A firm can make investment in either of the following two projects. The firm anticipates its cost of capital
to be 10%. The pre-tax cash flows of the projects for five years are as follows:
Year 0 1 2 3 4 5
Project A (`) (2,00,000) 35,000 80,000 90,000 75,000 20,000
Project 8 (`) (2,00,000) 2,18,000 10,000 10,000 4,000 3,000
Ignore Taxation.
An amount of ` 35,000 will be spent on account of sales promotion in year 3 in case of Project A. This
has not been taken into account in calculation of pre-tax cash flows.

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Downloaded From www.castudynotes.com
The discount factors are as under:
Year 0 1 2 3 4 5
PVF (10%) 1 0.91 0.83 0.75 0.68 0.62
You are required to calculate for each project:
(i) The payback period
(ii) The discounted payback period
(iii) Desirability factor
(iv) Net Present Value [10 Marks]
5. (a) Following Balance Sheet and Income Statement have been obtained from the books of accounts
of Benaca Pvt. Ltd.
Balance Sheet as on March 31 st 2020
Liabilities Amount (`) Assets Amount (`)
Equity Capital (`10 per share) 80,00,000 Net Fixed Assets 1,00,00,000

m
10% Debt 60,00,000 Current Assets 90,00,000

o
Retained Earnings 35,00,000

.c
Current Liabilities 15,00,000
es
1,90,00,000 1,90,00,000
Income Statement for the year ending March 31 st 2020
ot
Particulars Amount (`)
yn

Sales 34,00,000
d

Less: Operating expenses (including ` 6,00,000 depreciation) (12,00,000)

EBIT 22,00,000
as

Less: Interest (6,00,000)

Earnings before tax 16,00,000
.c

The tax rate applicable to the company is 35 percent.

(i) DETERMINE the degree of operating, financial and combined leverages at the current sales
w

level, if all operating expenses, other than depreciation, are variable costs.
w

(ii) If total assets remain at the same level, but sales (i) increase by 20 percent and (ii) decrease
by 20 percent, COMPUTE the earnings per share at the new sales level? [8 Marks]
(b) EXPLAIN certainty equivalents, one of the techniques of risk analysis. [2 Marks]
6. (a) DISCUSS Agency Problem and Agency Cost. [4 Marks]
(b) EXPLAIN in brief the features of Commercial Papers. [4 Marks]
(c) EXPLAIN Billing float and Mail float with reference to management of cash.
Or
STATE any four factors which need to be considered while planning for working capital
requirement. [2 Marks]

Join Us on Telegram http://t.me/canotes_ipcc

© The Institute of Chartered Accountants of India
Test Series: October, 2020
MOCK TEST PAPER
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A : FINANCIAL MANAGEMENT
Suggested Answers/ Hints
1. (a) Statement showing the Evaluation of Accounts Receivable Policies
(Amount in `)
Particulars Present Proposed Proposed
Policy Policy 1 Policy 2
A Expected Profit:
(a) Credit Sales 50,00,000 60,00,000 67,50,000
(b) Total Cost other than Bad Debts:
(i) Variable Costs 35,00,000 42,00,000 47,25,000
(c) Bad Debts 1,50,000 3,00,000 4,50,000
(d) Expected Profit [(a) – (b) – (c)] 13,50,000 15,00,000 15,75,000
B Opportunity Cost of Investments in 1,75,000 2,80,000 3,93,750
Accounts Receivable (Working Note)
C Net Benefits (A – B) 11,75,000 12,20,000 11,81,250

Recommendation: The Proposed Policy 1 should be adopted since the net benefits under this
policy are higher as compared to other policies.
Working Note:
Calculation of Opportunity Cost of Average Investments
Opportunity Cost = Total Cost × Collection period/12 × Rate of Return/100
Present Policy = ` 35,00,000 × 3/12 × 20% = ` 1,75,000
Proposed Policy 1 = ` 42,00,000 × 4/12 × 20% = ` 2,80,000
Proposed Policy 2 = ` 47,25,000 × 5/12 × 20% = ` 3,93,750
(b) Price per share according to Gordon’s Model is calculated as follows:
Particulars Amount in `
Net Profit 50 lakhs
Less: Preference dividend 15 lakhs
Earnings for equity shareholders 35 lakhs
Therefore, earning per share 35 lakhs/5 lakhs = ` 7.00
Price per share according to Gordon’s Model is calculated as follows:
E1(1  b)
P0 
Ke  br
Here, E1 = 7, Ke = 16%
(i) When dividend pay-out is 25%
1

7  0.25 1.75
P0  = = 175
0.16  (0.75  0.2) 0.16  0.15
(ii) When dividend pay-out is 50%
7  0.5 3.5
P0  = = 58.33
0.16  (0.5  0.2) 0.16  0.10
(iii) When dividend pay-out is 100%
7 1 7
P0  = = 43.75
0.16  (0  0.2) 0.16
(c) (i) The possible outcomes under different scenario will be as follows:
(Amount in ` ‘000)
Year PVF Scenario 1 Scenario 2 Scenario 3
@ 9%
Cash Flow PV Cash Flow PV Cash Flow PV
0 1.000 (1600) (1600) (1600) (1600) (1600) (1600)
1 0.917 550.00 504.35 650.00 596.05 750.00 687.75
2 0.842 500.00 421.00 550.00 463.10 600.00 505.20
3 0.772 800.00 617.60 900.00 694.80 1000.00 772.00
NPV (57.05) 153.95 364.95
(ii) The company is bit confident about the estimates in the first two years, but not sure about the
third year’s cash inflow, the NPV in such case expecting scenario 1 in the third year will be
as follows:
= -16,00,000 + (6,50,000 × 0.917 + 5,50,000 × 0.842 + 8,00,000 × 0.772)
= -16,00,000 + (5,96,050 + 4,63,100 + 6,17,600)
= ` 76,750
(d) Working Notes
1. Computation of Current Assets and Cash & Bank Balance
Current Assets (CA)
Current Ratio = = 1.6
Current Liabilities (CL)
Current Assets = 1.6 Current Liabilities = 1.6 × ` 68,50,000 = ` 1,09,60,000/-
So, Cash and Bank Balance=15% of Current Assets = ` 16,44,000
2. Computation of Total Assets, Fixed assets and Depreciation
Total Assets = Net Fixed assets+ Current Asset
Or, Total Assets = 20% of Total Asset + ` 1,09,60,000
Or, Total Assets = ` 1,37,00,000
So, Net Fixed assets = 20% of Total Asset = ` 27,40,000
27,40,000
Depreciation = ´ 15% = Rs4,83,529
85%
Fixed Assets = ` 27,40,000 + Rs4,83,529 = ` 32,23,529

3. Calculation of stock, Debtors and Creditors
Stock + Debtors = Current Assets – Cash & Bank
= ` 1,09,60,000 – ` 16,44,000
= ` 93,16,000
Now, let Sales be x
Credit Sales x
So, Debtors (Credit Sales) = =
Debtors turnover ratio 12
Sales - 20% of Sales
Further, Stock (on Cost of Goods Sold) =
16
x - 20% of x
=
16
x 4x
x-
= 5 = 5
16 16
x
=
20
x x
So, + = Rs. 93,16,000
12 20
10x + 6x
Or, = Rs. 93,16,000
120
16x
Or, = Rs. 93,16,000
120
Or, x = ` 6,98,70,000
So, Sales = ` 6,98,70,000
Cash of Goods Sold (COGS) = ` 5,58,96,000
Stock (COGS/16) = ` 34,93,500
Debtors (Sales/12) = ` 58,22,500
Creditors (COGS/10) = ` 55,89,600
4. Calculation of Provision of outstanding Expenses
= ` 68,50,000 – ` 55,89,600
= ` 12,60,400
5. Share Capital + Reserve of surplus + long term debt = Total Asset or total liability –
Current liability
Or, Reserve & surplus + long term debt = ` 1,37,00,000 – 68,50,000 – 25,00,000
= ` 43,50,000

Calculation of long term Debt and Reserve & Surplus
Now, Capital Earning ratio = 0.6
12% long term Debt
So, = 0.6
Equity Share Capital + Reserve & Surplus
43,50,000 - Reserve & Surplus
Or, = .6
25,00,000 + Reserve & Surplus

Or, Reserve & Surplus = ` 17,81,250

So, 12% long term debt = ` 25,68,750
Balance Sheet of SKY Private Limited as at 31.03.2020
Liabilities ` Assets `
Share Capital 25,00,000 Fixed assets
Reserve & Surplus 17,81,250 Opening WDV 32,23,529
12% Long term debt 25,68,750 Less: Depreciation 4,83,529 27,40,000
Current Liabilities
Creditors 55,89,600 Current Assets
Provisions & Stock 34,93,500
outstanding
expenses 12,60,400 68,50,000
Debtors 58,22,500
Cash and bank 16,44,000
balance 1,09,60,000
Total 1,37,00,000 1,37,00,000
2. Alternative I = Raising Debt of ` 2.5 lakh + Equity of ` 27.5 lakh.
Alternative II = Raising Debt of ` 10 lakh + Equity of `20 lakh.
Alternative III = Raising Debt of ` 15 lakh + Equity of ` 15 lakh.
Calculation of Earnings per share (EPS):
(Amount in `)
Particulars FINANCIAL ALTERNATIVES
Alternative I Alternative II Alternative III
Expected EBIT 5,00,000 5,00,000 5,00,000
Less: Interest (working note i) (25,000) (1,37,500) (2,37,500)
Earnings before taxes 4,75,000 3,62,500 2,62,500
Less: Taxes @ 50% (2,37,500) (1,81,250) (1,31,250)
Earnings after taxes (EAT) 2,37,500 1,81,250 1,31,250
Number of shares (working note ii) 13,750 10,000 9,375
Earnings per share (EPS) 17.27 18.125 14.00
Financing Alternative II (i.e. Raising debt of `10 lakh and issue of equity share capital of ` 20 lakh) is
the option which maximises the earnings per share.

Working Notes:
(i) Calculation of interest on Debt (Amount in `)
Alternative I (2,50,000 × 10%) 25,000
Alternative II (2,50,000 × 10%) 25,000
(7,50,000 × 15%) 1,12,500 1,37,500
Alternative III (2,50,000 × 10%) 25,000
(7,50,000 × 15%) 1,12,500
(5,00,000 × 20%) 1,00,000 2,37,500
(ii) Number of equity shares to be issued
Alternative I = ` 27,50,000/ ` 200 (Market Price of share)
= 13,750 shares
Alternative II = ` 20,00,000/ ` 200
= 10,000 shares
Alternative III = ` 15,00,000/ ` 160
= 9,375 shares
3. (i) Computation of Weighted Average Cost of Capital based on existing capital structure
Source of Capital Existing Capital Weights After tax cost WACC (%)
structure (`) of capital (%)
(a) (b) (a) × (b)
Equity share capital (W.N.1) 3,00,00,000 0.652 10.00 6.52
11.5% Preference share capital 60,00,000 0.130 11.50 1.50
10% Debentures (W.N.2) 1,00,00,000 0.218 6.50 1.42
Total 4,60,00,000 1.000 9.44

Working Notes:
1. Cost of Equity Capital:
Expecteddividend(D1 )
Ke =  Growth(g)
Current Market Pr ice(P0 )

` 15
= + 0.05
` 300
= 10%
2. Cost of 10% Debentures
Interest(1  t)
Kd =
Net proceeds

` 1,00,000 (1 - 0.35)
=
` 1,00,00,000
= 0.065 or 6.5%

(ii) Computation of Weighted Average Cost of Capital based on new capital structure
Source of Capital New Capital Weights After tax cost WACC (%)
structure (`) of capital (%)
(a) (b) (a) x (b)
Equity share capital (W.N.3) 3,00,00,000 0.588 13.00 7.64
11.5% Preference share capital 60,00,000 0.118 11.50 1.36
10% Debentures (W.N.2) 1,00,00,000 0.196 6.50 1.27
12% Debentures (W.N.4) 50,00,000 0.098 7.80 0.76
Total 5,10,00,000 1.000 11.03

Working Notes:
3. Cost of Equity Capital:
` 20
Ke = + 0.05
` 250
= 13%
4. Cost of 12% Debentures
` 6,00,000 (1- 0.35)
Kd =
` 50,00,000
= 0.078 or 7.8%
4. Calculation of Present Value of cash flows
Year PV factor Project A Project B
@ 10% Cash flows (`) Discounted Cash flows (`) Discounted
Cash flows Cash flows
0 1.00 (2,00,000) (2,00,000) (2,00,000) (2,00,000)
1 0.91 35,000 31,850 2,18,000 1,98,380
2 0.83 80,000 66,400 10,000 8,300
3 0.75 55,000(90,000-35,000) 41,250 10,000 7,500
4 0.68 75,000 51,000 4,000 2,720
5 0.62 20,000 12,400 3,000 1,860
Net Present Value 2,900 18,760
(i) The Payback period of the projects:
Project-A: The cumulative cash inflows up-to year 3 is `1,70,000 and remaining amount required
to equate the cash outflow is ` 30,000 i.e. (` 2,00,000 – ` 1,70,000) which will be recovered from
year-4 cash inflow. Hence, Payback period will be calculated as below:
` 30,000
3 years + = 3.4 years Or 3 years 4.8 months Or 3 years 4 months and 24 days
` 75,000
Project-B: The cash inflow in year-1 is ` 2,18,000 and the amount required to equate the cash
outflow is ` 2,00,000, which can be recovered in a period less than a year. Hence, Payback period
will be calculated as below:

` 2,00,000
= 0.917 years Or 11 months
` 2,18,000
(ii) Discounted Payback period for the projects:
Project-A: The cumulative discounted cash inflows up-to year 4 is ` 1,90,500 and remaining
amount required to equate the cash outflow is ` 9,500 i.e. (` 2,00,000 – ` 1,90,500) which will be
recovered from year-5 cash inflow. Hence, Payback period will be calculated as below:
` 9,500
4 years + = 4.766 years Or 4 years 9.19 months Or 4 years 9 months and 6 days
` 12,400
Project-B: The cash inflow in year-1 is `1,98,380 and remaining amount required to equate the
cash outflow is ` 1,620 i.e. (` 2,00,000 – ` 1,98,380) which will be recovered from year-2 cash
inflow. Hence, Payback period will be calculated as below:
` 1,620
1 year + = 1.195 years Or 1 Year 2.34 months Or 1 Year 2 months and 10 days.
` 8,300
(iii) Desirability factor of the projects
DiscountedvalueCashInflows
Desirability Factor (Profitability Index) =
Discountedvalue of CashOutflows
` 2,02,900
Project A = = 1.01
` 2,00,000
` 2,18,760
Project B = = 1.09
` 2,00,000
(iv) Net Present Value (NPV) of the projects:
Please refer the above table.
Project A- ` 2,900
Project B- ` 18,760
5 (a) (i) Degree of operating, financial and combined leverages at the current sales level-
Contribution
DOL =
EBIT
` 34,00,000 - ` 6,00,000
= = 1.27
` 22,00,000
EBIT
DFL =
EBT
` 22,00,000
= = 1.375
` 16,00,000
DCL = DOL × DFL = 1.27 × 1.38 = 1.75
(ii) Earnings per share at the new sales level
(Amount in `)
Particulars Increase by 20% Decrease by 20%
Sales level 40,80,000 27,20,000
Less: Variable expenses 7,20,000 4,80,000
7

Less: Fixed cost 6,00,000 6,00,000
Earnings before interest and taxes 27,60,000 16,40,000
Less: Interest 6,00,000 6,00,000
Earnings before taxes 21,60,000 10,40,000
Less: Taxes @35% 7,56,000 3,64,000
Earnings after taxes (EAT) 14,04,000 6,76,000
Number of equity shares 8,00,000 8,00,000
EPS 1.76 0.85

Working Notes:
Variable Costs = ` 6,00,000 (total cost - depreciation)
Variable Costs at:
(i) Sales level, ` 40,80,000 = ` 7,20,000 (increase by 20%)
(ii) Sales level, ` 27,20,000 = ` 4,80,000 (decrease by 20%)
(b) Certainty Equivalents: As per CIMA terminology, “An approach to dealing with risk in a capital
budgeting context. It involves expressing risky future cash flows in terms of the certain cashflow
which would be considered, by the decision maker, as their equivalent, that is the decision maker
would be indifferent between the risky amount and the (lower) riskless amount considered to be its
equivalent.”
The certainty equivalent is a guaranteed return that the management would accept rather than
accepting a higher but uncertain return. This approach allows the decision maker to incorporate
his or her utility function into the analysis. In this approach a set of risk less cash flow is generated
in place of the original cash flows.
6 (a) Agency Problem and Agency Cost: Though in a sole proprietorship firm, partnership etc., owners
participate in management but incorporates, owners are not active in management so, there is a
separation between owner/ shareholders and managers. In theory, managers should act in the best
interest of shareholders however in reality, managers may try to maximise their individual goal like
salary, perks etc., so there is a principal agent relationship between managers and owners, which
is known as Agency Problem. In a nutshell, Agency Problem is the chances that managers may
place personal goals ahead of the goal of owners. Agency Problem leads to Agency Co st. Agency
cost is the additional cost borne by the shareholders to monitor the manager and control their
behaviour to maximise shareholders wealth. Generally, Agency Costs are of four types (i)
monitoring (ii) bonding (iii) opportunity (iv) structuring.
(b) Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the
form of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in
the year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources of
short- term borrowings and to provide an additional instrument to investors. Subsequently, in
addition to the Corporate, Primary Dealers and All India Financial Institutions have also been
allowed to issue Commercial Papers. Commercial papers are issued in denominations of ` 5 lakhs
or multiples thereof and the interest rate is generally linked to the yield on the one-year government
bond.
All eligible issuers are required to get the credit rating from Credit Rating Info rmation Services of
India Ltd, (CRISIL), or the Investment Information and Credit Rating Agency of India Ltd (ICRA) or
the Credit Analysis and Research Ltd (CARE) or the FITCH Ratings India Pvt. Ltd or any such
other credit rating agency as is specified by the Reserve Bank of India.
8

(c) Billing Float: An invoice is the formal document that a seller prepares and sends to the purchaser
as the payment request for goods sold or services provided. The time between the sale and the
mailing of the invoice is the billing float.
Mail Float: This is the time when a cheque is being processed by post office, messenger service
or other means of delivery.
OR
Some of the factors which need to be considered while planning for working capital
requirement are-
(i) Cash: Identify the cash balance which allows for the business to meet day- to-day expenses,
but reduces cash holding costs.
(ii) Inventory: Identify the level of inventory which allows for uninterrupted production but
reduces the investment in raw materials and hence increases cash flow; the techniques like
Just in Time (JIT) and Economic order quantity (EOQ) are used for this.
(iii) Receivables: Identify the appropriate credit policy, i.e., credit terms which will attract
customers, such that any impact on cash flows and the cash conversion cycle will be offset
by increased revenue and hence Return on Capital (or vice versa). The tools like Discounts
and allowances are used for this.
(iv) Short-term Financing Options: Inventory is ideally financed by credit granted by the
supplier; dependent on the cash conversion cycle, it may however, be necessary to utilize a
bank loan (or overdraft), or to “convert debtors to cash” through “factoring” in order to finance
working capital requirements.
(v) Nature of Business: For e.g. in a business of restaurant, most of the sales are in Cash.
Therefore, need for working capital is very less.
(vi) Market and Demand Conditions: For e.g. if an item’s demand far exceeds its production,
the working capital requirement would be less as investment in finished goods inventory would
be very less.
(vii) Technology and Manufacturing Policies: For e.g. in some businesses the demand for
goods is seasonal, in that case a business may follow a policy for steady production through
out over the whole year or instead may choose policy of production only during the demand
season.
(viii) Operating Efficiency: A company can reduce the working capital requirement by eliminating
waste, improving coordination etc.
(ix) Price Level Changes: For e.g. rising prices necessitate the use of more funds for maintaining
an existing level of activity. For the same level of current assets, higher cash outlays ar e
required. Therefore, the effect of rising prices is that a higher amount of working capital is
required.

Test Series: April, 2021
MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
Answers are to be given only in English except in the case of the candidates who have opted for Hindi medium.
If a candidate has not opted for Hindi medium his/ her answers in Hindi will not be valued .
Question No. 1 is compulsory.
Attempt any four questions from the remaining five questions.
Working notes should form part of the answer.
Time Allowed – 3 Hours (Total time for 8A and 8B) Maximum Marks – 60

1. Answer the following:

(a) Kee Ltd. and Lee Ltd. are identical in every respect except for capital structure. Kee Ltd. does not
employ debt in its capital structure, whereas Lee Ltd. employs 12% debentures amounting to
Rs. 20 lakhs. Assuming that:
(i) All assumptions of MM model are met;
(ii) The income tax rate is 30%;
(iii) EBIT is Rs. 5,00,000 and
(iv) The equity capitalization rate of Kee Ltd. is 25%.
CALCULATE the average value of both the Companies.
(b) The following data is available in respect of N Ltd. for the year ended 31 st March, 2021:
Rs. (in Crore)
Share capital (@ Rs. 10 per share) 25.00
Reserves 15.00
Profit after tax (PAT) 3.70
Dividends paid 3.00
P/E ratio 26.70
Using Walter’s Model:
(i) COMMENT on the firm’s dividend policy;
(ii) DETERMINE the optimum payout ratio and
(iii) DETERMINE the P/E ratio at which dividend payout will have no effect on share price.
(c) XYZ Ltd. has Owner's equity of Rs. 2,00,000 and the ratios of the company are as follows:
Current debt to total debt 0.3
Total debt to Owner's equity 0.5
Fixed assets to Owner's equity 0.6

1
Total assets turnover 2 times
Inventory turnover 10 times
COMPLETE the following Balance Sheet from the information given above:
Liabilities (Rs.) Assets (Rs.)
Current Debt - Cash -
Long-term Debt - Inventory -
Total Debt - Total Current Assets -
Owner's Equity - Fixed Assets -

(d) In March, 2021 Tiruv Ltd.'s share was sold for Rs. 219 per share. A long term earnings growth rate
of 11.25% is anticipated. Tiruv Ltd. is expected to pay dividend of Rs. 5.04 per share.
(i) DETERMINE the rate of return an investor can expect to earn assuming that dividends are
expected to grow along with earnings at 11.25% per year in perpetuity?
(ii) It is expected that Tiruv Ltd. will earn about 15% on book equity and shall retain 60% of
earnings. In this case, whether, there would be any change in growth rate and cost of equity?
ANALYSE. (4 × 5 = 20 Marks)
2. (a) SG Ltd. is considering a project “Z” with an initial outlay of Rs. 7,50,000 and life of 5 years. The
estimates of project are as follows:
Lower Estimates Base Upper Estimates
Sales (units) 4,500 5,000 5,500
(Rs.) (Rs.) (Rs.)
Selling Price p.u. 175 200 225
Variable cost p.u. 100 125 150
Fixed Cost 50,000 75,000 1,00,000
Depreciation included in Fixed cost is Rs. 35,000 and corporate tax is 25%.
Assuming the cost of capital as 15%, DETERMINE NPV in three scenarios i.e worst, base and best
case scenario.
PV factor for 5 years at 15% are as follows:
Years 1 2 3 4 5
P.V. factor 0.870 0.756 0.658 0.572 0.497
(7 Marks)
(b) Development Finance Corporation issued zero interest deep discount bonds of face value of
Rs. 1,50,000 each issued at Rs. 3,750 & repayable after 25 years. COMPUTE the cost of debt if
there is no corporate tax. (3 Marks)
3. WQ Limited is considering relaxing its present credit policy and is in the process of evaluating two
proposed polices. Currently, the firm has annual credit sales of Rs. 180 lakh and Debtors turnover ratio
of 4 times a year. The current level of loss due to bad debts is Rs. 6 lakh. The firm is required to give a
return of 25% on the investment in new accounts receivables. The company’s variable costs are 60% of
the selling price. Given the following information, DETERMINE which is a better Policy?

2
(Amount in lakhs)
Present Proposed Policy
Policy Option I Option II
Annual credit sales (Rs.) 180 220 280
Debtors turnover ratio 4 3.2 2.4
Bad debt losses (Rs.) 6 18 38
(10 Marks)
4. City Clap Ltd. is in the business of providing housekeeping services. There is a proposal before the
company to purchase a mechanized cleaning system for a sum of Rs. 40 lakhs. The present system of
the company is to use manual labour for the cleaning job. You are provided with the following
information:
Proposed Mechanized System:
Cost of the machine Rs. 40 lakhs
Life of the machine 7 years
Depreciation (on straight line basis) 15%
Operating cost of mechanized system Rs. 20 lakhs per annum
Present system (Manual):
Manual labour 350 persons
Cost of manual labour Rs. 15,000 per person per annum
The company has an after-tax cost of fund at 10% per annum.
The applicable tax rate is 50%.
PV factor for 7 years at 10% are as follows:
Years 1 2 3 4 5 6 7
P.V. factor 0.909 0.826 0.751 0.683 0.621 0.564 0.513

You are required to DETERMINE whether it is advisable to purchase the mechanized cleaning system.
Give your recommendations with workings. (10 Marks)
5. Following data of MT Ltd. under Situations 1, 2 and 3 and Financial Plan A and B is given:
Installed Capacity (units) 3,600
Actual Production and Sales (units) 2,400
Selling price per unit (Rs.) 30
Variable cost per unit (Rs.) 20
Fixed Costs (Rs.): Situation 1 3,000
Situation 2 6,000
Situation 3 9,000

3
Capital Structure :
Particulars Financial Plan
A B
Equity Rs. 15,000 Rs. 22,500
Debt Rs. 15,000 Rs. 7,500
Cost of Debt 12% 12%
Required:
(i) CALCULATE the operating leverage and financial leverage.
(ii) FIND out the combinations of operating and financial leverage which give the highest value and
the least value. (10 Marks)
6. (a) EXPLAIN in brief the features of Commercial Paper.
(b) DESCRIBE how agency problem can be addressed.
(c) DEFINE Debt Securitisation.
Or
EXPLAIN the principles of “Trading on equity”. (4 + 4 + 2 =10 Marks)

4
Test Series: April 2021
MOCK TEST PAPER – II
INTERMEDIATE (NEW): GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT& ECONOMICS FOR FINANCE
PAPER 8A: FINANICAL MANAGEMENT
SUGGESTED ANSWERS/HINTS
1. (a) Kee Ltd. (pure Equity) i.e. unlevered company:
EAT = EBT (1 – t)
= EBIT (1 - 0.3) = Rs. 5,00,000 × 0.7 = Rs. 3,50,000
(Here, EBIT = EBT as there is no debt)
EAT
Value of unlevered company Kee Ltd. =
Equity capitalization rate

Rs. 3,50,000
= = Rs. 14,00,000
25%
Lee Ltd. (Equity and Debt) i.e levered company:
Value of levered company = Value of Equity + Value of Debt
= Rs. 14,00,000 + (Rs. 20,00,000 × 0.3)
= Rs. 20,00,000
(b) Workings:
PAT Rs. 3.7 crores
1. Earnings per share (E) = = = Rs. 1.48
No. of shares 2.5 crore shares
PAT Rs. 3.7 crores
2. Return on Investment (r) = x 100 = x 100 = 9.25%
Net worth Rs. (25 + 15) crores
Dividend paid Rs. 3 crores
3. Dividend per share (D) = = = Rs. 1.2
No. of shares 2.5 crore shares
Dividend Rs. 3 crores
Dividend payout ratio = x 100 = x 100 = 81.08%
PAT Rs. 3.7 crores
4. Current Market Price (P o) = P/E Ratio x E = 26.7 x Rs. 1.48 = Rs. 39.52
5. Growth rate (g) =bxr = (1 - 0.8108) x 0.0925 = 1.75%
D(1+g) Rs. 1.2 (1 + 0.0175)
6. Cost of Capital (K e) = +g = + 0.0175= 4.84%
Po Rs. 39.52
(i) The value of the share as per Walter’s model:
r
D+ (E-D) 1.2 + 0.0925 (1.48-1.2)
P= Ke =
0.0484
= Rs. 35.85
Ke 0.0484
The firm has a dividend payout of 81.08% (i.e., Rs. 3 crores) out of Profit after tax of
Rs. 3.7 crores with value of the share at Rs. 35.85. The rate of return on investment (r)
1
is 9.25% and it is more than the K e of 4.84%, therefore, by distributing 81.08% of
earnings, the firm is not following an optimal dividend policy.
(ii) Under Walter’s model, when return on investment is more than cost of capital (r > K e),
the market share price will be maximum if 100% retention policy is followed. So, t he
optimal payout ratio would be to pay zero dividend and in such a situation, the market
price would be:
0.0925
0 + 0.0484 (1.48 - 0)
P= = Rs. 58.44
0.0484
(iii) The P/E ratio at which dividend payout will have no effect on share price is at which the
Ke would be equal to the rate of return (r) of the firm i.e. 9.25%.
D (1+g)
So, Ke = +g
Po
Rs. 1.2 (1 + 0.0175)
0.0925 = + 0.0175
Po
 Po = Rs. 16.28
If Po is Rs. 16.28, then, P/E Ratio will be:
Po Rs. 16.28
= = = 11 times
E Rs. 1.48
Therefore, at the P/E ratio of 11, the dividend payout will have no effect on share price.
(c) Balance Sheet
Liabilities (Rs.) Assets (Rs.)
Current debt 30,000 Cash (balancing figure) 1,20,000
Long term debt 70,000 Inventory 60,000
Total Debt 1,00,000 Total Current Assets 1,80,000
Owner's Equity 2,00,000 Fixed Assets 1,20,000
Total liabilities 3,00,000 Total Assets 3,00,000
Workings:
1. Total debt = 0.50 x Owner's Equity = 0.50 x Rs. 2,00,000 = Rs. 1,00,000
Further, Current debt to Total debt = 0.30
So, Current debt = 0.30 × Rs. 1,00,000 = Rs. 30,000
Long term debt = Rs. 1,00,000 - Rs. 30,000 = Rs. 70,000
2. Fixed assets = 0.60 × Owner's Equity = 0.60 × Rs. 2,00,000 = Rs. 1,20,000
3. Total Liabilities = Total Debt + Owner’s Equity
= Rs. 1,00,000 + Rs. 2,00,000 = Rs. 3,00,000
Total Assets = Total Liabilities = Rs. 3,00,000
Total assets to turnover = 2 Times; Inventory turnover = 10 Times
Hence, Inventory /Total assets = 2/10=1/5,
Therefore Inventory = Rs. 3,00,000/5 = Rs. 60,000

2
(d) (i) According to Dividend Discount Model approach the firm’s expected or required return
on equity is computed as follows:
D1
Ke   g
P0
Where,
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
5.04
Therefore, K e   0.1125 = 13.55%
219
(ii) With rate of return on retained earnings (r) of 15% and retention ratio (b) of 60%, new
growth rate will be as follows:
g = br = 0.60 x 0.15 = 0.09 or 9%
Accordingly, dividend will also get changed and to calculate this, first we shall calculate
previous retention ratio (b 1) and then EPS assuming that rate of return on retained
earning (r) is same.
With previous Growth Rate of 11.25% and r =15%, the retention ratio comes out to be:
0.1125 = b1 x 0.15
b1 = 0.75 and payout ratio = 0.25
With 0.25 payout ratio, the EPS will be as follows:
5.04
EPS = = Rs. 20.16
0.25
With new payout ratio of 40% (1 – 0.60) the new dividend will be:
D1 = Rs. 20.16 x 0.40 = Rs. 8.064
Accordingly new Ke will be:
8.064
Ke   0.09 = 12.68%
219
2. (a) (i) Calculation of Yearly Cash Inflow
In worst case: High costs and Low price (Selling price) and volume(Sales units) are taken.
In best case: Low costs and High price(Selling price) and volume(Sales units) are taken.
Worst Case Base Best Case
Sales (units) (A) 4,500 5,000 5,500
(Rs.) (Rs.) (Rs.)
Selling Price p.u. 175 200 225
Less: Variable cost p.u. 150 125 100
Contribution p.u. (B) 25 75 125
Total Contribution (A x B) 1,12,500 3,75,000 6,87,500
Less: Fixed Cost 1,00,000 75,000 50,000
EBT 12,500 3,00,000 6,37,500
Less: Tax @ 25% 3,125 75,000 1,59,375
3
EAT 9,375 2,25,000 4,78,125
Add: Depreciation 35,000 35,000 35,000
Cash Inflow 44,375 2,60,000 5,13,125
(ii) Calculation of NPV in different scenarios
Worst Case Base Best Case
Initial outlay (A) (Rs.) 7,50,000 7,50,000 7,50,000
Cash Inflow (c) (Rs.) 44,375 2,60,000 5,13,125
Cumulative PVF @ 15% (d) 3.353 3.353 3.353
PV of Cash Inflow (B = c x d) (Rs.) 1,48,789.38 8,71,780 17,20,508.13
NPV (B - A) (Rs.) (6,01,210.62) 1,21,780 9,70,508.13
(b) Here,
Redemption Value (RV)= Rs.1,50,000
Net Proceeds (NP) = Rs. 3,750
Interest = 0
Life of bond = 25 years
There is huge difference between RV and NP therefore in place of approximation method we
should use trial & error method.
FV = PV x (1 + r) n
1,50,000 = 3,750 x (1 + r) 25
40 = (1 + r) 25
Trial 1: r = 15%, (1.15) 25 = 32.919
Trial 2: r = 16%, (1.16) 25 = 40.874
Here:
L = 15%; H = 16%
NPVL = 32.919 - 40 = - 7.081
NPVH = 40.874 - 40 = + 0.874
NPVL
IRR = L+ (H - L)
NPVL - NPVH
-7.081
= 15% + × (16% - 15%)= 15.89%
-7.081 - (0.874)
3. Statement showing evaluation of Credit Policies
(Amount in lakhs)
Particulars Present Proposed Policy
(Rs.) (Rs.)
Option I Option II
A Expected Profit:
(a) Credit Sales 180 220 280
(b) Total Cost other than Bad Debts:
Variable Costs (60%) 108 132 168

4
(c) Bad Debts 6 18 38
(d) Expected Profit [(a)-(b)-(c)] 66 70 74
B Opportunity Cost of Investment in Debtors (Refer 6.75 10.31 17.5
workings)
C Net Benefits [A - B] 59.25 59.69 56.5
Recommendation: The Proposed Policy I should be adopted since the net benefits under this
policy is higher than those under other policies.
Workings:
Calculation of Opportunity Cost of Investment in Debtors
Collection Period * Rate of Return
Opportunity Cost = Total Cost  
12 100
*Collection period (in months) = 12/Debtors turnover ratio
12/4 25
Present Policy = Rs. 108 × × = Rs. 6.75 lakhs
12 100
12/3.2 25
Proposed Policy I = Rs. 132 × × = Rs. 10.31 lakhs
12 100
12/2.4 25
Proposed Policy II = Rs. 168 × × = Rs. 17.5 lakhs
12 100
4. Calculation of NPV
(Rs.) (Rs.)
Cost of Manual System (Rs. 15,000 x 350) 52,50,000
Less: Cost of Mechanised System:
Operating Cost 20,00,000

Depreciation (Rs. 40,00,000 x 0.15) 6,00,000 26,00,000

Saving per annum 26,50,000
Less: Tax (50%) 13,25,000
Saving after tax 13,25,000
Add: Depreciation 6,00,000
Cash flow per annum 19,25,000
Cumulative PV Factor for 7 years @ 10% 4.867
Present value of cash flow for 7 years 93,68,975
Less: Cost of the Machine 40,00,000
NPV 53,68,975
The mechanized cleaning system should be purchased since NPV is positive by
Rs. 53,68,975.

5
5. (i) Operating Leverage
Situation 1 Situation 2 Situation 3
(Rs.) (Rs.) (Rs.)
Sales (S)
2,400 units @ Rs. 30 per unit 72,000 72,000 72,000
Less: Variable Cost (VC) @ Rs. 20 per unit 48,000 48,000 48,000
Contribution (C) 24,000 24,000 24,000
Less: Fixed Cost (FC) 3,000 6,000 9,000
EBIT 21,000 18,000 15,000
C Rs. 24,000 Rs. 24,000 Rs. 24,000
Operating Leverage =
EBIT Rs. 21,000 Rs. 18,000 Rs. 15,000
= 1.14 = 1.33 = 1.60

Financial Leverage
Financial Plan
A (Rs.) B (Rs.)
Situation 1
EBIT 21,000 21,000
Less: Interest on debt 1,800 900
(Rs. 15,000 x 12%);(Rs. 7,500 x 12%)
EBT 19,200 20,100
EBIT Rs. 21,000 Rs. 21,000
Financial Leverage = = 1.09 = 1.04
EBT Rs. 19,200 Rs. 20,100
Situation 2
EBIT 18,000 18,000
Less: Interest on debt 1,800 900
EBT 16,200 17,100
EBIT Rs. 18,000 Rs. 18,000
Financial Leverage = = 1.11 = 1.05
EBT Rs. 16,200 Rs. 17,100
Situation 3
EBIT 15,000 15,000
Less: Interest on debt 1,800 900
EBT 13,200 14,100
EBIT Rs. 15,000 Rs. 15,000
Financial Leverage = = 1.14 = 1.06
EBT Rs. 13,200 Rs. 14,100

6
(ii) Combined Leverages
CL = OL x FL
Financial Plan
A (Rs.) B (Rs.)
(a) Situation 1 1.14 x 1.09 = 1.24 1.14 x 1.04 = 1.19
(b) Situation 2 1.33 x 1.11 = 1.48 1.33 x 1.05 = 1.40
(c) Situation 3 1.60 x 1.14 = 1.82 1.60 x 1.06 = 1.70
The above calculations suggest that the highest value is in Situation 3 financed by Financial
Plan A and the lowest value is in the Situation 1 financed by Financia l Plan B.
6. (a) A Commercial Paper is an unsecured money market instrument issued in the form of a
promissory note. The Reserve Bank of India introduced the commercial paper scheme in the
year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources
of short-term borrowings and to provide an additional instrument to investors. Subsequently,
in addition to the Corporate, Primary Dealers and All India Financial Institutions have also
been allowed to issue Commercial Papers. Commercial papers are issued in denominations
of Rs. 5 lakhs or multiples thereof and the interest rate is generally linked to the yield on the
one-year government bond.
(b) Agency problem between the managers and shareholders can be addressed if the interests
of the managers are aligned to the interests of the shareholders. It is easier said than done.
However, following efforts have been made to address these issues:
 Managerial compensation is linked to profit of the company to some extent and also with
the long term objectives of the company.
 Employee is also designed to address the issue with the underlying assumption that
maximisation of the stock price is the objective of the investors.
 Effecting monitoring can be done.
(c) Debt Securitisation is a process in which illiquid assets are pooled into marketable securities
that can be sold to investors. The process leads to the creation of financial instruments that
represent ownership interest in, or are secured by a segregated income producing asset or
pool of assets. These assets are generally secured by personal or real property such as
automobiles, real estate, or equipment loans but in some cases are unsecured.
Or
The use of long-term fixed interest-bearing debt and preference share capital along with equity
share capital is called financial leverage or trading on equity. The use of long-term debt
increases the earnings per share if the firm yields a return higher than the cost of debt. The
earnings per share also increase with the use of preference share capital but due to the fact
that interest is allowed to be deducted while computing tax, the leverage impact of debt is
much more. However, leverage can operate adversely also if the rate of interest on long -term
loan is more than the expected rate of earnings of the firm. Therefore, it needs caution to plan
the capital structure of a firm.

7
Test Series: September 2023
MOCK TEST PAPER 1
INTERMEDIATE: GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
PAPER – 8A: FINANCIAL MANAGEMENT
Question No. 1 is compulsory.
Attempt any four questions out of the remaining five questions.
In case, any candidate answers extra question(s)/ sub-question(s) over and above the required number,
then only the requisite number of questions first answered in the answer book shall be valued and
subsequent extra question(s) answered shall be ignored.
Working notes should form part of the answer.
1. (a) Bhaskar Manufactures Ltd. have Equity Share Capital of ` 5,00,000 (face value `100) to meet the
expenditure of an expansion programme, the company wishes to raise ` 3,00,000 and is having
following four alternative sources to raise the funds:
Plan A: To have full money from equity shares.
Plan B: To have ` 1 lakhs from equity and ` 2 lakhs from borrowing from the financial institution
@ 10% p.a.
Plan C: Full money from borrowing @ 10% p.a.
Plan D: `1 lakh in equity and ` 2 lakhs from preference shares at 8% p.a.
The company is expected to have an earning of ` 1,50,000. The corporate tax is 50%. Suggest a
suitable plan of the above four plans to raise the required funds. (5 Marks)
(b) Following information has been provided from the books of Laxmi Pvt. Ltd. for the year ending on
31st March 2022:
Net Working Capital ` 5,40,000
Bank overdraft ` 1,00,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus ` 4,80,000
Current ratio 2.5
Liquid ratio (Quick Ratio) 1.5
You are required to PREPARE a summarised Balance Sheet as of 31 st March 2022 assuming that
there is no long-term debt. (5 Marks)
(c) A new project “Ambar” requires an initial outlay of ` 4,50,000. The company uses certainty
equivalent method approach to evaluate the project. The risk-free rate is 7%. Following information
is available:
Year Cash Flow After Tax (`) Certainty Equivalent Coefficient
1 1,50,000 0.90
2 2,25,000 0.80
3 1,75,000 0.58
4 1,50,000 0.56
5 70,000 0.50

1
PV Factor at 7%
Year 1 2 3 4 5
PV Factor 0.935 0.873 0.816 0.763 0.713

Is investment in the project beneficial based on above information? (5 Marks)

(d) ABC Company’s equity share is quoted in the market at ` 30 per share currently. The company
pays a dividend of ` 3 per share and the investor’s market expects a growth rate of 7% per year.
You are required to:
(i) CALCULATE the company’s cost of equity capital.
(ii) If the company issues 10% debentures of face value of ` 100 each and realises ` 95 per
debenture while the debentures are redeemable after 10 years at a premium of 10%,
CALCULATE cost of debenture using YTM?
Assume Tax Rate to be 50%. (5 Marks)
2. ZX Ltd. has a paid-up share capital of ` 2,00,00,000, face value of ` 100 each. The current market price
of the shares is ` 100 each. The Board of Directors of the company has an agenda of meeting to pay a
dividend of 50% to its shareholders. The company expects a net income of ` 1,50,00,000 at the end of
the current financial year. Company also plans for a capital expenditure for the next financial year for a
cost of ` 1,90,00,000, which can be financed through retained earnings and issue of new equity shares.
Company’s desired rate of investment is 15%.
Required:
Following the Modigliani- Miller (MM) Hypothesis, DETERMINE value of the company when:
(i) It does not pay dividend and
(ii) It does pay dividend (10 Marks)
3. Following are the selected financial information of A Ltd. and B Ltd. for the current Financial Year:
A Ltd. B Ltd.
Variable Cost Ratio 60% 50%
Interest ` 30,000 ` 1,20,000
Operating Leverage 6 3
Financial Leverage 4 3
Tax Rate 30% 30%
You are required to FIND out:
(i) EBIT
(ii) Sales
(iii) Fixed Cost
(iv) Identify the company which is better placed with reasons based on leverages. (10 Marks)
4. A company needs ` 42,50,000 for the construction of a new plant. The following three plans are feasible:
I The company may issue 4,25,000 equity shares at ` 10 per share.
II The company may issue 2,12,500 equity shares at ` 10 per share and 21,250 debentures of ` 100
denominations bearing an 8% rate of interest.

2
III The company may issue 2,12,500 equity shares at ` 10 per share and 21,250 cumulative
preference shares at ` 100 per share bearing an 8% rate of dividend.
(i) The company's earnings before interest and taxes are ` 75,000, ` 1,50,000,
` 3,00,000, ` 4,50,000 and ` 7,50,000. DETERMINE earnings per share under each of
three financial plans? Assume a corporate income tax rate of 40%.
(ii) IDENTIFY which alternative would you recommend and why?
(iii) DETERMINE the EBIT-EPS indifference points by formulae between Financing Plan I and
Plan II and Plan I and Plan III. (10 Marks)
5. A firm can make investment in either of the following two projects. The firm anticipates its cost of capital
to be 10%. The pre-tax cash flows of the projects for five years are as follows:
Year 0 1 2 3 4 5
Project A (`) (3,00,000) 55,000 1,20,000 1,30,000 1,05,000 40,000
Project 8 (`) (3,00,000) 3,18,000 20,000 20,000 8,000 6,000
Ignore Taxation.
An amount of ` 45,000 will be spent on account of sales promotion in year 3 in case of Project A. This
has not been considered in calculation of pre-tax cash flows.
The discount factors are as under:
Year 0 1 2 3 4 5
PVF (10%) 1 0.91 0.83 0.75 0.68 0.62
You are required to calculate for each project:
(i) The payback period
(ii) The discounted payback period
(iii) Desirability factor
(iv) Net Present Value (10 Marks)
6. (a) EXPLAIN the difference between Business risk and financial risk. (4 Marks)
(b) EXPLAIN in brief the features of Commercial Papers. (4 Marks)
(c) EXPLAIN in short, the term Letter of Credit. (2 Marks)
OR
"Financing a business through borrowing is cheaper than using equity." Briefly EXPLAIN.

3
Test Series: September 2023
MOCK TEST PAPER – 1
INTERMEDIATE : GROUP – II
PAPER – 8: FINANCIAL MANAGEMENT & ECONOMICS FOR FINANCE
8A: FINANCIAL MANAGEMENT
SUGGESTED ANSWERS/ HINTS
1. (a) Statement showing the EPS under the four plans
Plan A Plan B Plan C Plan D
Equity share capital ` 8,00,000 ` 6,00,000 ` 5,00,000 ` 6,00,000
8% Pref. Share capital - - - ` 2,00,000
Borrowing @ 10% - ` 2,00,000 ` 3,00,000 -
` 8,00,000 ` 8,00,000 ` 8,00,000 ` 8,00,000
E.B.I.T ` 1,50,000 ` 1,50,000 ` 1,50,000 ` 1,50,000
Less: Interest @ 10% ` 20,000 ` 30,000
E.B.T ` 1,50,000 ` 1,30,000 `1,20,000 ` 1,50,000
Less: Tax ` 75,000 `65,000 `60,000 ` 75,000
Less: Pref Divided ` 16,000
Earnings available to equity ` 75,000 ` 65,000 ` 60,000 ` 59,000
share holders
No.of equity shares (`100) 8,000 6,000 5,000 6,000
Earning per share ` 9.38 ` 10.83 ` 12.00 ` 9.83

Plan C given the highest EPS and therefore to be accepted.

(b) Working notes:
(i) Computation of Current Assets and Current Liabilities
Current assets
= 2.5
Current liabilities
Current assets = 2.5 Current liabilities
Now, Working capital = Current assets − Current liabilities
` 5,40,000 = 2.5 Current liability − Current liability
Or 1.5 Current liability = ` 5,40,000
 Current Liabilities = ` 3,60,000
So, Current Assets = ` 3,60,000  2.5 = ` 9,00,000
(ii) Computation of Inventories
Liquid assets
Liquid ratio =
Current liabilities
Current assets - Inventories
1.5 =
` 3,60,000

1
1.5  ` 3, 60,000 = ` 9,00,000 − Inventories
Inventories =` 9,00,000 – ` 5,40,000 = ` 3,60,000
(iii) Computation of Proprietary fund; Fixed assets; Capital and Sundry creditors

Fixed Asset to Proprietary ratio = Fixed assets = 0.75

Proprietary fund
 Fixed Assets = 0.75 Proprietary fund
Proprietary fund = Fixed Assets + Net Working Capital - Long Term Debt
= 0.75 Proprietary fund + ` 5,40,000 - 0
 Proprietary fund = ` 21,60,000
And Fixed Assets = 0.75 proprietary fund
= 0.75  ` 21,60,000 = ` 16,20,000
Capital = Proprietary fund − Reserves & Surplus
= ` 21,60,000 − ` 4,80,000 = ` 16,80,000
Sundry Creditors = Current liabilities − Bank overdraft
= ` 3,60,000 − ` 1,00,000 = ` 2,60,000
Balance Sheet as of 31st March 2022
Liabilities ` Assets `
Capital 16,80,000 Fixed Assets 16,20,000
Reserves & Surplus 4,80,000 Inventories 3,60,000
Bank overdraft 1,00,000 Other Current Assets 5,40,000
Sundry creditors 2,60,000 (Balancing figure)
25,20,000 25,20,000

(c) Calculation of Net Present Value of the Project

Year Cash Inflows After C.E. Adjusted Cash Present Value Present Value
Tax (in `) Inflows (in `) Factor (in `)
1 1,50,000 0.90 1,35,000 0.935 1,26,225
2 2,25,000 0.80 1,80,000 0.873 1,57,140
3 1,75,000 0.58 1,01,500 0.816 82,824
4 1,50,000 0.56 84,000 0.763 64,092
5 70,000 0.50 35,000 0.713 24,955
Total Present Value of Cash Inflows 4,55,236
Less: Initial Investment or Cash Outflow required for “Ambar” (4,50,000)
Net Present Value 5,236

Conclusion: As the Net Present Value of the project after considering the Certainty Equivalent
factors is still positive, it may be advised to invest in project “Ambar”.
(d) (i) Cost of Equity Capital (K e):
Expected dividend per share(D1)
Ke = + Growth rate(g)
Market price per share(P0)
2
` 3×1.07
= + 0.07 = 0.177 or 17.7%
` 30
(ii) Cost of Debenture (K d):
Using Present Value method (YTM)
Identification of relevant cash flows

Year Cash flows

0 Current market price (P 0) = ` 95
1 to 10 Interest net of tax [I(1-t)] = 10% of ` 100 (1 – 0.5) = ` 5
10 Redemption value (RV) = ` 100 (1.10) = ` 110

Calculation of Net Present Values (NPV) at two discount rates

Year Cash Discount factor Present Discount factor Present
flows (`) @ 5% (L) Value (`) @ 10% (H) Value (`)
0 (95) 1.000 (95.00) 1.000 (95.00)
1 to 10 5 7.722 38.61 6.145 30.725
10 110 0.614 67.54 0.386 42.46
NPV +11.15 -21.815
Calculation of IRR
NPVL
IRR = L+ (H-L )
NPVL -NPVH

` 11.15 ` 55.75
= 5% + (10% - 5% ) = 5% + = 6.69%
` 11.15-(` - 21.815) ` 32.965

Therefore, K d = 6.69%
2. As per MM Hypothesis, value of firm/ company is calculated as below:
(n + Δn)P1 - I + E
Vf or nP₀ =
(1+ K e )
Where,
Vf = Value of firm in the beginning of the period
n = number of shares in the beginning of the period
∆n = number of shares issued to raise the funds required
I = Amount required for investment
E = total earnings during the period
(i) Value of the ZX Ltd. when dividends are not paid.
(n + Δn)P1 - I + E
nPₒ =
1+ K e

3
 40,00,000 
 2,00,000 +  × `115 - Rs.1,90,00,000 + `1,50,00,000
 115 
nP₀ =
(1+ 0.15)

`2,70,00,000 -`1,90,00,000 + `1,50,00,000

= = ` 2,00,00,000
(1+ 0.15)

Working notes:
1. Price of share at the end of the period (P 1)
P1 + D1
Pₒ =
1+ K e
P1 + 0
100 = or, P₁= 115
1+ 0.15
2. Calculation of funds required for investment
Earnings `1,50,00,000
Dividend distributed Nil
Fund available for investment ` 1,50,00,000
Total Investment ` 1,90,00,000
Balance Funds required ` 40,00,000
3. Calculation of no. of shares required to be issued for balance fund
Funds required 40,00,000
No. of shares (∆n) = = shares
Price at end (P1 ) 115
(ii) Value of the ZX Ltd. when dividends are paid.
(n + Δn)P1 - I + E
nPₒ =
1+ K e

 1,40,00,000 
 2,00,000 +  × `65 -`1,90,00,000 + `1,50,00,000
 65 
nP₀ =
(1+ 0.15)

`2,70,00,000 -`1,90,00,000 + `1,50,00,000

= = ` 2,00,00,000
(1+ 0.15)

Working notes:
4. Price of share at the end of the period (P 1)
P1 + D1
Pₒ =
1+ K e
P1 + 50
100 = or, P₁= `65
1+ 0.15

4
5. Calculation of funds required for investment
Earnings ` 1,50,00,000
Dividend distributed ` 1,00,00,000
Fund available for investment ` 50,00,000
Total Investment ` 1,90,00,000
Balance Funds required ` 1,40,00,000
6. Calculation of no. of shares required to be issued for balance fund
Funds required 1, 40,00,000
No. of shares (∆n) = = = 2,15,385 shares(approx.)
Price at end (P1 ) 65

Note- As per MM-hypothesis of dividend irrelevance, value of firm remains same irrespective of
dividend paid. In the solution, there may be variation in value, which is due to rounding off error.

3. Company A
EBIT
(i) Financial Leverage =
EBT i.e EBIT Interest
EBIT
So, 4 =
EBIT - ` 30,000

Or, 4 (EBIT – 30,000) = EBIT

Or, 3 EBIT = 1,20,000
Or, EBIT = 40,000
Contribution Contribution
(ii) Operating Leverage = Or, 6=
EBIT ` 40,000
Or Contribution = ` 2, 40,000
Contribution ` 2,40,000
Sales = P/V Ratio (1 - variable cost ratio) = = ` 6,00,000
40%
(iii) Fixed Cost = Contribution – EBIT
= ` 2, 40,000 – 40,000
Or Fixed cost = ` 2,00,000
Company B
EBIT
(i) Financial Leverage =
EBT i.e EBIT Interest
EBIT
So, 3 =
EBIT -1,20,000

Or, 3 (EBIT – `1,20,000) = EBIT

Or, 3 EBIT -` 3,60,000 = EBIT
Or, 2 EBIT = ` 3,60,000
Or, EBIT = ` 1,80,000
5
Contribution
(ii) Operating Leverage =
EBIT
Contribution
Or, 3 =
`1,80,000
Or, Contribution = ` 5,40,000
Contribution ` 5,40,000
Sales = = = ` 10,80,000
P/V Ratio (1 - variable cost ratio) 50%
(iii) Fixed Cost = Contribution – EBIT
= ` 5,40,000 – ` 1,80,000
Or, Fixed cost = ` 3,60,000
Income Statements of Company A and Company B
Company A (`) Company B (`)
Sales 6,00,000 10,80,000
Less: Variable cost 3,60,000 5,40,000
Contribution 2,40,000 5,40,000
Less: Fixed Cost 2,00,000 3,60,000
Earnings before interest and tax (EBIT) 40,000 1,80,000
Less: Interest 30,000 1,20,000
Earnings before tax (EBT) 10,000 60,000
Less: Tax @ 30% 3,000 18,000
Earnings after tax (EAT) 7,000 42,000
Comment based on Leverage
Comment based on leverage – Company B is better than company A of the following reasons:
• Capacity of Company B to meet interest liability is better than that of companies A (from
EBIT/Interest ratio)
` 40,000 `1,80,000
[A = = 1.33, B = = 1.50]
`30,000 `1,20,000
Company B has the least financial risk as the total risk (business and financial) of company B is
lower (combined leverage of Company A – 24 and Company B- 9)
4. (i) Computation of EPS under three-financial plans.
Plan I: Equity Financing

(`) (`) (`) (`) (`)

EBIT 75,000 1,50,000 3,00,000 4,50,000 7,50,000
Interest 0 0 0 0 0
EBT 75,000 1,50,000 3,00,000 4,50,000 7,50,000
Less: Tax @ 40% 30,000 60,000 1,20,000 1,80,000 3,00,000
PAT 45,000 90,000 1,80,000 2,70,000 4,50,000

6
No. of equity shares 4,25,000 4,25,000 4,25,000 4,25,000 4,25,000
EPS 0.11 0.21 0.42 0.64 1.06

Plan II: Debt – Equity Mix

(`) (`) (`) (`) (`)
EBIT 75,000 1,50,000 3,00,000 4,50,000 7,50,000
Less: Interest 1,70,000 1,70,000 1,70,000 1,70,000 1,70,000
EBT (95,000) (20,000) 1,30,000 2,80,000 5,80,000
Less: Tax @ 40% 38,000* 8000* 52,000 1,12,000 2,32,000
PAT (57,000) (12,000) 78,000 1,68,000 3,48,000
No. of equity shares 2,12,500 2,12,500 2,12,500 2,12,500 2,12,500
EPS (` 0.27) (0.056) 0.37 0.79 1.64

* The Company can set off losses against the overall business profit or may carry forward it to next
financial years.
Plan III: Preference Shares – Equity Mix
(`) (`) (`) (`) (`)
EBIT 75,000 1,50,000 3,00,000 4,50,000 7,50,000
Less: Interest 0 0 0 0 0
EBT 75,000 1,50,000 3,00,000 4,50,000 7,50,000
Less: Tax @ 40% 30,000 60,000 1,20,000 1,80,000 3,00,000
PAT 45,000 90,000 1,80,000 2,70,000 4,50,000
Less: Pref. dividend 1,70,000* 1,70,000* 1,70,000 1,70,000 1,70,000
PAT after Pref. dividend. (1,25,000) (80,000) 10,000 1,00,000 2,80,000
No. of Equity shares 2,12,500 2,12,500 2,12,500 2,12,500 2,12,500
EPS (0.59) (0.38) 0.05 0.47 1.32

* In case of cumulative preference shares, the company must pay cumulative dividend to
preference shareholders, when company earns sufficient profits.
(ii) From the above EPS computations tables under the three financial plans we can see that when
EBIT is ` 4,50,000 or more, Plan II: Debt-Equity mix is preferable over the Plan I and Plan III, as
rate of EPS is more under this plan. On the other hand, an EBIT of less than `4,50,000, Plan I:
Equity Financing has higher EPS than Plan II and Plan III. Plan III Preference Share-Equity mix is
not acceptable at any level of EBIT, as EPS under this plan is lower.
The choice of the financing plan will depend on the performance of the company and other macro -
economic conditions. If the company is expected to have higher operating profit Plan II: Debt –
Equity Mix is preferable. Moreover, debt financing gives more benefit due to availability of tax
shield.
(iii) EBIT – EPS Indifference point: Plan I and Plan II
EBIT1 ×(1- t) (EBIT2 - Interest) ×(1- t)
=
No.of equity shares(N1) No.of equity shares(N2 )

7
EBIT(1- 0.40) (EBIT - `1,70,000)×(1- 0.40)
=
4,25,000 shares 2,12,500shares
0.6 EBIT = 1.2 EBIT – `2,04,000
`2,04,000
EBIT = = ` 3,40,000
0.6
Indifference points between Plan I and Plan II is ` 3,40,000
EBIT – EPS Indifference Point: Plan I and Plan III
EBIT1 ×(1- t) EBIT3 ×(1- t) − Pr ef.dividend
=
No.of equity shares(N1 ) No.of equity shares(N3 )
EBIT1(1- 0.40) EBIT3(1- 0.40) -Rs.1,70,000
=
4,25,000shares 2,12,500shares
0.6 EBIT = 1.2 EBIT – ` 3,40,000
`3,40,000
EBIT = = ` 5,66,667
0.6
Indifference points between Plan I and Plan III is ` 5,66,667.
5. Calculation of Present Value of cash flows
Year PV factor @ Project A Project B
10% Cash flows (`) Discounted Cash flows Discounted
Cash flows (`) Cash flows
0 1.00 (3,00,000) (3,00,000) (3,00,000) (3,00,000)
1 0.91 55,000 50,050 3,18,000 2,89,380
2 0.83 1,20,000 99,600 20,000 16,600
3 0.75 85,000(1,30,000-45,000) 63,750 20,000 15,000
4 0.68 1,05,000 71,400 8,000 5,440
5 0.62 40,000 24,800 6,000 3,720
Net Present Value 9,600 30,140
(i) The Payback period of the projects:
Project-A: The cumulative cash inflows up-to year 3 is `2,60,000 and remaining amount required
to equate the cash outflow is ` 40,000 i.e. (` 3,00,000 – ` 2,60,000) which will be recovered from
year-4 cash inflow. Hence, Payback period will be calculated as below:
40,000
3 years + = 3.381 years or 3 years, 4 months, 9 days (approx.)
1,05,000
Project-B: The cash inflow in year-1 is ` 3,18,000 and the amount required to equate the cash
outflow is ` 3,00,000, which can be recovered in a period less than a year. Hence, Payback period
will be calculated as below:
3,00,000
= 0.943 years or 11 months
3,18,000

8
(ii) Discounted Payback period for the projects:
Project-A: The cumulative discounted cash inflows up-to year 4 is ` 2,84,800 and remaining
amount required to equate the cash outflow is ` 15,200 i.e. (` 3,00,000 – ` 2,84,800) which will
be recovered from year-5 cash inflow. Hence, Payback period will be calculated as below:
15,200
4 years + = 4.613 years or 4 years, 2 months, and 11 days
24,800
Project-B: The cash inflow in year-1 is `2,89,380 and remaining amount required to equate the
cash outflow is ` 10,620 i.e. (` 3,00,000 – ` 2,89,380) which will be recovered from year-2 cash
inflow. Hence, Payback period will be calculated as below:
10,620
1 year + = 1.640 years or 1 Year, 7 months and 23 days.
16,600
(iii) Desirability factor of the projects
Discounted value Cash Inflows
Desirability Factor (Profitability Index) =
Discounted value of Cash Outflows

3,09,600
Project A = = 1.032
3,00,000
3,30,140
Project B = = 1.100
3,00,000
(iv) Net Present Value (NPV) of the projects:
Please refer the above table.
Project A- ` 9,600
Project B- ` 30,140
6. (a) Business Risk and Financial Risk
Business risk refers to the risk associated with the firm’s operations. It is an unavoidable risk
because of the environment in which the firm must operate, and the business risk is represented
by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by
revenues and expenses. Revenues and expenses are affected by demand of firm’s products,
variations in prices and proportion of fixed cost in total cost.
On the other hand, financial risk refers to the additional risk placed on firm’s shareholders because
of debt use in financing. Companies that issue more debt instruments would have higher financial
risk than companies financed mostly by equity. Financial risk can be measured by ratios such as
firm’s financial leverage multiplier, total debt to assets ratio etc.
(b) Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the
form of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in
the year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources of
short- term borrowings and to provide an additional instrument to investors. Subsequently, in
addition to the Corporate, Primary Dealers and All India Financial Institutions have also been
allowed to issue Commercial Papers. Commercial papers are issued in denominations of ` 5 lakhs
or multiples thereof and the interest rate is generally linked to the yield on the one-year government
bond.
9
All eligible issuers are required to get the credit rating from Credit Rating Information Services of
India Ltd, (CRISIL), or the Investment Information and Credit Rating Agency of India Ltd (ICRA) or
the Credit Analysis and Research Ltd (CARE) or the FITCH Ratings India Pvt. Ltd or any such
other credit rating agency as is specified by the Reserve Bank of India.
(c) Letter of Credit: It is an arrangement by which the issuing bank on the instructions of a customer
or on its own behalf undertakes to pay or accept or negotiate or authorizes another bank to do so
against stipulated documents subject to compliance with specified terms and conditions.
Or
“Financing a business through borrowing is cheaper than using equity”.
(i) Debt capital is cheaper than equity capital from the point of its cost and interest being
deductible for income tax purpose, whereas no such deduction is allowed for dividends.
(ii) Issue of new equity dilutes existing control pattern while borrowing does not result in dilution
of control.
(iii) In a period of rising prices, borrowing is advantageous. The fixed monetary outgo decreases
in real terms as the price level increases.

Attachment - PDF - Kami Export - Yamou Sanneh - Entrepreneurship - and - Small - Business - V.2 - Student - Workbook
100% (1)
Attachment - PDF - Kami Export - Yamou Sanneh - Entrepreneurship - and - Small - Business - V.2 - Student - Workbook
75 pages
MTP Oct. 2018 FM and Eco Question
No ratings yet
MTP Oct. 2018 FM and Eco Question
6 pages
RTP May2022 - Paper 8 FM Eco
No ratings yet
RTP May2022 - Paper 8 FM Eco
30 pages
FM Eco RTP Nov 18 Inter New
No ratings yet
FM Eco RTP Nov 18 Inter New
32 pages
Paper - 8: Financial Management and Economics For Finance Part A: Financial Management Questions Ratio Analysis
No ratings yet
Paper - 8: Financial Management and Economics For Finance Part A: Financial Management Questions Ratio Analysis
29 pages
CA Inter FM ECO RTP Nov23 Castudynotes Com
No ratings yet
CA Inter FM ECO RTP Nov23 Castudynotes Com
23 pages
SFM - 1
No ratings yet
SFM - 1
3 pages
2820003
No ratings yet
2820003
3 pages
6_FM & SM MTP 1
No ratings yet
6_FM & SM MTP 1
13 pages
MTP Oct. 2018 FM and Eco Answer
No ratings yet
MTP Oct. 2018 FM and Eco Answer
16 pages
FM ECO Q
No ratings yet
FM ECO Q
5 pages
FM MTP Merged
No ratings yet
FM MTP Merged
330 pages
Paper 8 Financial Management & Economics For Finance PDF
No ratings yet
Paper 8 Financial Management & Economics For Finance PDF
5 pages
2820003
No ratings yet
2820003
5 pages
Finance question
No ratings yet
Finance question
4 pages
FinancialManagement MB013 Question
50% (2)
FinancialManagement MB013 Question
31 pages
Paper - 8: Financial Management & Economics For Finance Part A: Financial Management Questions Ratio Analysis
No ratings yet
Paper - 8: Financial Management & Economics For Finance Part A: Financial Management Questions Ratio Analysis
32 pages
CA Inter - Nov 2018 - F M & Eco For Finance - Suggested Answers
No ratings yet
CA Inter - Nov 2018 - F M & Eco For Finance - Suggested Answers
25 pages
RTP - FM Eco - Upto Nov 21
No ratings yet
RTP - FM Eco - Upto Nov 21
159 pages
84 Paper-8FinancialManagement&EconomicsforFinance
No ratings yet
84 Paper-8FinancialManagement&EconomicsforFinance
28 pages
FM Eco New MTP Inter Oct 19 Q
No ratings yet
FM Eco New MTP Inter Oct 19 Q
6 pages
CA Inter FM Eco RTP May 2023
No ratings yet
CA Inter FM Eco RTP May 2023
27 pages
Test Paper: Chapter-1: Cost of Capital
No ratings yet
Test Paper: Chapter-1: Cost of Capital
13 pages
CA Inter FM SM Q MTP 2 Jan 2025 Exam castudynotes com
No ratings yet
CA Inter FM SM Q MTP 2 Jan 2025 Exam castudynotes com
12 pages
CA Inter FM ECO Suggested Answer May2023
No ratings yet
CA Inter FM ECO Suggested Answer May2023
35 pages
Fmsm Mtp1 May 24
No ratings yet
Fmsm Mtp1 May 24
25 pages
Paper - 8: Financial Management and Economics For Finance Part A: Financial Management Questions Ratio Analysis
No ratings yet
Paper - 8: Financial Management and Economics For Finance Part A: Financial Management Questions Ratio Analysis
27 pages
48 17228rtp Ipcc Nov09 Paper3b
No ratings yet
48 17228rtp Ipcc Nov09 Paper3b
33 pages
FM Previous Year Questions 2020-2023
No ratings yet
FM Previous Year Questions 2020-2023
18 pages
CA Intermediate Mock Test Eco FM 16.10.2018 EM Only Question
No ratings yet
CA Intermediate Mock Test Eco FM 16.10.2018 EM Only Question
6 pages
5_6204156314352882781
No ratings yet
5_6204156314352882781
12 pages
FM MTP Question Paper Nov 19
No ratings yet
FM MTP Question Paper Nov 19
6 pages
Untitled
No ratings yet
Untitled
18 pages
Financial Management PYQ?
No ratings yet
Financial Management PYQ?
12 pages
CA Inter Fm Eco Rtp Nov22
No ratings yet
CA Inter Fm Eco Rtp Nov22
30 pages
73153bos58999 p8
No ratings yet
73153bos58999 p8
27 pages
FM & SM-Question
No ratings yet
FM & SM-Question
9 pages
Time Value of Money Sums
No ratings yet
Time Value of Money Sums
13 pages
CA - FM - P8 - May 23
No ratings yet
CA - FM - P8 - May 23
35 pages
CAP_II_December_2024_All_section_Finance_Kartik_28,2081_Final_Mock
No ratings yet
CAP_II_December_2024_All_section_Finance_Kartik_28,2081_Final_Mock
6 pages
Inter FMSM MTP2
No ratings yet
Inter FMSM MTP2
16 pages
Gujarat Technological University
No ratings yet
Gujarat Technological University
3 pages
75573bos61147 p8
No ratings yet
75573bos61147 p8
23 pages
2024 Sem3advanced-Financial-Management-Pattern-2019mba
No ratings yet
2024 Sem3advanced-Financial-Management-Pattern-2019mba
4 pages
ADL 13 Ver2+
100% (1)
ADL 13 Ver2+
9 pages
CA Inter-FM-ECO-Question Paper November 2023 WWW Castudynotes
No ratings yet
CA Inter-FM-ECO-Question Paper November 2023 WWW Castudynotes
12 pages
Paper - 8: Financial Management and Economics For Finance Section - A: Financial Management
No ratings yet
Paper - 8: Financial Management and Economics For Finance Section - A: Financial Management
27 pages
MTP-fm-sm-que-series-2 (1)
No ratings yet
MTP-fm-sm-que-series-2 (1)
10 pages
MTP 17 53 Questions 1710507531
No ratings yet
MTP 17 53 Questions 1710507531
9 pages
Ca Inter May 2023 Imp
No ratings yet
Ca Inter May 2023 Imp
23 pages
Inter FM Eco Ques
No ratings yet
Inter FM Eco Ques
6 pages
2022 Financial Management
No ratings yet
2022 Financial Management
4 pages
FM RTP Merge File
No ratings yet
FM RTP Merge File
311 pages
(5946) - 202 M.B.A. Gc-08: Financial Management (2019 Pattern) (Semester-II)
No ratings yet
(5946) - 202 M.B.A. Gc-08: Financial Management (2019 Pattern) (Semester-II)
9 pages
8 RTP Nov 21 1
No ratings yet
8 RTP Nov 21 1
27 pages
J8. CAPII - RTP - June - 2023 - Group-II
No ratings yet
J8. CAPII - RTP - June - 2023 - Group-II
162 pages
FM SM Q MTP 2 Sept 2024
No ratings yet
FM SM Q MTP 2 Sept 2024
10 pages
FMSM MTP2 Sept 24
No ratings yet
FMSM MTP2 Sept 24
26 pages
FM-SM-EM-Question-11.08.2024
No ratings yet
FM-SM-EM-Question-11.08.2024
8 pages
Financial Reporting IFRS
From Everand
Financial Reporting IFRS
Azhar ul Haque Sario
No ratings yet
Leveraging Technology for Property Tax Management in Asia and the Pacific–Guidance Note
From Everand
Leveraging Technology for Property Tax Management in Asia and the Pacific–Guidance Note
Asian Development Bank
No ratings yet
TCDN Slide
No ratings yet
TCDN Slide
171 pages
F3 Passcards CIMA BPP 2015
No ratings yet
F3 Passcards CIMA BPP 2015
128 pages
Phái sinh đi thi
No ratings yet
Phái sinh đi thi
8 pages
Dissertation On Portfolio Management
100% (2)
Dissertation On Portfolio Management
7 pages
Revised Corporation Code of the Philippines
No ratings yet
Revised Corporation Code of the Philippines
4 pages
NISM Series XIXA Alternative Investment Fund Category I and II Distributors Workbook Jan 2021
No ratings yet
NISM Series XIXA Alternative Investment Fund Category I and II Distributors Workbook Jan 2021
263 pages
Xyzzzzzzzzz
No ratings yet
Xyzzzzzzzzz
13 pages
3.EF232. FIM IL II Solution CMA September 2022 Exam.
No ratings yet
3.EF232. FIM IL II Solution CMA September 2022 Exam.
5 pages
Ambika Brickwell LLP-10!04!2019
No ratings yet
Ambika Brickwell LLP-10!04!2019
5 pages
16 candlestick patterns every trader should know
No ratings yet
16 candlestick patterns every trader should know
12 pages
Linear Regression Candles With OB and Target by LEO
0% (1)
Linear Regression Candles With OB and Target by LEO
33 pages
Critical Appraisal of The Concept of Insider Trading Under Nigerian Company Law
No ratings yet
Critical Appraisal of The Concept of Insider Trading Under Nigerian Company Law
1 page
DBB1104-Unit 15 Recent Trends in Marketing
No ratings yet
DBB1104-Unit 15 Recent Trends in Marketing
16 pages
Entrep Reviewer
No ratings yet
Entrep Reviewer
4 pages
Chapter 4 Others Income 26092021
No ratings yet
Chapter 4 Others Income 26092021
24 pages
Marketing Research and Analytics
No ratings yet
Marketing Research and Analytics
11 pages
Era of Cross-Border M&A - How Current Market Dynamics Are Changing The M&A Landscape - 2008
No ratings yet
Era of Cross-Border M&A - How Current Market Dynamics Are Changing The M&A Landscape - 2008
16 pages
International Accounting Issues
No ratings yet
International Accounting Issues
16 pages
Q4 2022 Earnings Presentation FINAL 2.6.23 2pm v4
No ratings yet
Q4 2022 Earnings Presentation FINAL 2.6.23 2pm v4
11 pages
Success Story of DMart
No ratings yet
Success Story of DMart
5 pages
Study - Id89350 - Buy Now Pay Later BNPL PDF
No ratings yet
Study - Id89350 - Buy Now Pay Later BNPL PDF
40 pages
Presented To: Dr. Ashraf Labib: Implemented by Group 5
No ratings yet
Presented To: Dr. Ashraf Labib: Implemented by Group 5
15 pages
Sheet1
No ratings yet
Sheet1
2 pages
Business Plan Template Excel
No ratings yet
Business Plan Template Excel
11 pages
KimesHo RMinLuxuryHotels
No ratings yet
KimesHo RMinLuxuryHotels
6 pages
venturecapital-vanacker-manigart
No ratings yet
venturecapital-vanacker-manigart
38 pages
Revenue Generation
No ratings yet
Revenue Generation
11 pages
Case 9.2 A Rising Star From China Haier Group PDF
No ratings yet
Case 9.2 A Rising Star From China Haier Group PDF
8 pages
Masala Bonds
No ratings yet
Masala Bonds
3 pages