SUGGESTED SOLUTION

CA INTERMEDIATE
SUBJECT- FINANCIAL MANAGEMENT AND
STRATEGIC MANAGEMENT

Test Code – INP 2406

BRANCH - () (Date :)

Head Office : Shraddha, 3rd Floor, Near Chinai College, Andheri (E), Mumbai – 69.
Tel : (022) 26836666

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MULTIPLE CHOICE QUESTIONS

NO. ANSWER MARKS

1 D All the above 1
2 C Both 1 and 2 2
3 B 16 times 2
4 10 times 2
A
5 A Cash flows can be re – invested at the projects IRR. 1
6 Rs. 30 2
A
7 Financial management 1
C
8 Prepaid expenses 1
D
9 Tandon Committee 1
B
10 Short – term debt instruments 1
A
11 Lock Box system 1
B

ANSWER : 1(A)

Cost Structure for 52000 units

Particulars Amount (Rs.)
Raw Material @ Rs.400 2,08,00,000
Direct Wages @ Rs. 150 78,00,000
Manufacturing Overheads@ Rs. 200 1,04,00,000
Selling and Distribution OH@ Rs. 100 52,00,000
Total Cost 4,42,00,000
Sales@ Rs. 1000 5,20,00,000

Particulars Calculation Amount (Rs.)

(A) Current Assets :

Raw Material Stock 2,08,00,000  16,00,000

Work in Progress (WIP) 23,00,000

Stock 2,08,00,000 + ( )

Finished Goods Stock 34,00,000

4,42,00,000 
Receivables 80,00,000
5,20,00,000 
Cash 50,000

(B) Current Liabilities

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 Creditors 16,00,000
2,08,00,000 

(C) Working Capital Estimates 1,37,50,000

(A – B)

(5 MARKS)

ANSWER : 1(B)

Break Even Sales = Rs. 68,00,000  0.75 = Rs. 51,00,000

Income Statement (Amount in Rs.)

Original Calculation of Interest at Now at

BEP (backward calculation) present level
Sales 68,00,000 51,00,000 68,00,000
Less : Variable Cost 40,80,000 30,60,000 40,80,000
Contribution 27,20,000 20,40,000 27,20,000
Less : Fixed Cost 16,32,000 16,32,000 16,32,000
EBIT 10,88,000 4,08,000 10,88,000
Less : Interest (EBIT – PBT) ? 3,93,714 3,93,714
PBT ? 14,286 (10,000 /70%) 6,94,286
Less : Tax @ 30% (or PBT – ? 10,000 (Nil + 10,000) 4,86,000
PAT)
Less : Preference Dividend 10,000 10,000 10,000
Earnings for Equity Share ? Nil (at BEP) 4,76,000
holders
Number of Equity Shares 1,50,000 1,50,000 1,50,000
EPS ? - 3.1733
So Interest= Rs. 3,93,714, EPS= Rs. 3.1733, Amount of debt= 3,93,714/12%= Rs. 32,80,950
(5 MARKS)
ANSWER : 1(C)

Statement showing the Evaluation of Accounts Receivable Policies

(Amount in Rs.)
Particulars Present Proposed Proposed
Policy Policy 1 Policy 2
A Expected Profit:
(a) Credit Sales 55,00,000 65,00,000 70,00,000
(b) Total Cost other than Bad Debts:
(i) Variable Costs (75%) 41,25,000 48,75,000 52,50,000
(c) Bad Debts 2,00,000 3,50,000 5,00,000
(d) Expected Profit [(a) – (b) – (c)] 11,75,000 12,75,000 12,50,000
B Opportunity Cost of Investments in 1,23,750 1,82,813 2,62,500
AccountsReceivable (Working Note)
C Net Benefits (A – B) 10,51,250 10,92,187 9,87,500

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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 = Rs. 41,25,000 × 2.4/12 × 15% = Rs. 1,23,750
Proposed Policy 1 = Rs. 48,75,000× 3/12 × 15% = Rs. 1,82,813
Proposed Policy 2 = Rs. 52,50,000× 4/12 × 15% = Rs. 2,62,500

(5 MARKS)

ANSWER : 2(A)

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

Particulars Amount in Rs.

Net Profit 78 lakhs
Less: Preference dividend (120 Lakhs @15%) 18 lakhs
Earnings for equity shareholders 60 lakhs
Earnings Per Share 60 lakhs/6 lakhs = Rs. 10.00

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

P0 =

Here, E1 = 10, Ke = 16%

(i) When dividend pay – out is 30%

P0 = = Rs. 150

(ii) When dividend pay – out is 50%

P0 = = Rs. 83.33

(iii) When dividend pay – out is 100%

P0 = = Rs. 62.5

(5 MARKS)

ANSWER : 2(B)

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 =

Rs. 3,02,400 = Rs. 3,36,000 – Preference Dividend

Preference Dividend = Rs. 3,36,000  Rs. 3,02,400 = Rs. 33,600

Rate of Dividend =

= = 8.4%

(5 MARKS)
ANSWER : 3

Calculation of Equity Share Capital and Reserves and surplus :

Alternative 1 :

Equity Share Capital = rs. 20,00,000 + = Rs. 21,50,000

Reserves = Rs. 10,00,000 + = Rs. 10,50,000

Alternative 2 :

Equity Share Capital = Rs. 20,00,000 + = Rs. 27,20,000

Reserves = Rs. 10,00,000 + = Rs. 11,80,000

Capital Structure Plan

Amount in Rs.

Capital Alternative 1 Alternative 2

Equity Share capital 21,50,000 27,20,000

Reserves and surplus 10,50,000 11,80,000

10% long term debt 15,00,000 15,00,000

14% Debentures 8,00,000 -

8% Irredeemable Debentures - 1,00,000

Total Capital Employed 55,00,000 55,00,000

Computation of Present Earnings before interest and tax (EBIT)

EPS (Rs.) 21

No. of equity shares 20,000

Earnings for equity shareholders (I x II) (Rs.) 4,20,000

Profit Before Tax (III/75%) (Rs.) 5,60,000

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 Interest on long term loan (1500000 x 10%) (Rs.) 1,50,000

EBIT (IV + V) (Rs.) 7,10,000

EBIT after expansion = Rs. 7,10,000 +Rs. 2,00,000 = Rs. 9,10,000

Evaluation of Financial Plans on the basis of EPS, MPS and Financial Leverage

(Amount in Rs.)
Particulars Alternative I Alternate II
EBIT 9,10,000 9,10,000
Less: Interest: 10% on long term loan (1,50,000) (1,50,000)
14% on Debentures (1,12,000) Nil
8% on Irredeemable Debentures Nil. (8000)
PBT 6,48,000 7,52,000
Less: Tax @25% (1,62,000) (1,88,000)
PAT 4,86,000 5,64,000
No. of equity shares 21,500 27,200
EPS 22.60 20.74
Applicable P/E ratio (Working Note 1) 7 8.5
MPS (EPS X P/E ratio) 158.2 176.29
Financial Leverage EBIT/PBT 1.40 1.21
Working Note 1

Alternative I Alternative II
Debt:
Rs. 15,00,000 + Rs. 8,00,000 23,00,000 -
Rs. 15,00,000 + Rs. 1,00,000 - 16,00,000
Total capital Employed (Rs.) 55,00,000 55,00,000
Debt Ratio (Debt/Capital employed) = 0.4182 =0.2909
= 41.82% =29.09%
Change in Equity: 21,50,000 - 20,00,000 1,50,000
27,20,000 - 20,00,000 7,20,000
Percentage change in equity 7.5% 36%
Applicable P/E ratio 7 8.5
Calculation of Cost of equity and various type of debt

Alternative I Alternative II
(A) Cost of equity
EPS 22.60 20.74
DPS (EPS X 60%) 13.56 12.44
Growth (g) 10% 10%
Po (MPS) 158.2 176.29
Ke= Do (1 + g)/ Po

=9.43% =7.76%
(B) Cost of Debt:

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 10% long term debt 10% + (1 - 0.25) 10% + (1 - 0.25)
= 7.5% = 7.5%
14% redeemable Nil
debentures
= 10.5 + 1 / 10.5
= 10.95%
8% irredeemable NA 8000 (1-0.25)/1,00,00 = 6%
debenture

Calculation of Weighted Average cost of capital (WACC)

Alternative 1 Alternative 2

Capital Weights Cost WACC Weights Cost WACC

(%) (%)

Equity Share Capital 0.3909 9.43 3.69% 0.4945 7.76 3.84%

Reserves and Surplus 0.1909 9.43 1.80% 0.2145 7.76 1.66%

10% Long term Debt 0.2727 7.50 2.05% 0.2727 7.50 2.05%

14% Debenture 0.1455 10.95 1.59%

8% Irredeemable - 0.0182 6 0.11%

Debentures

9.12% 7.66%

Calculation Marginal Cost of Capital (MACC)

Alternative 1 Alternative 2
Amount Cost MACC Amount Cost MACC
Capital (weight) (%) (weight) (%)
Rs. Rs.
Equity Share Capital 1,50,000(0.15) 9.43 1.41% 7,20,000(0.72) 7.76 5.59%
Reserves and Surplus 50,000(0.05) 9.43 0.47% 1,80,000(0.18) 7.76 1.40%
14% Debenture 8,00,000(0.80) 10.95 8.76% - 0.00%
8% Irredeemable
Debentures - 1,00,000(0.10) 6 0.60%
Total Capital Employed 10,00,000 10.65% 10,00,000 7.58%
Summary of solution:

Alternate I Alternate II
Earning per share (EPS) 22.60 20.74
Market price per share (MPS) 158.20 176.29
Financial leverage 1.4043 1.2101
Weighted Average cost of capital (WACC) 9.12% 7.66%
Marginal cost of capital (MACC) 10.65% 7.58%

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Alternative 1 of financing will be preferred under the criteria of EPS, whereas Alternative II of
financing will be preferred under the criteria of MPS, Financial leverage, WACC and
marginal cost of capital.

(10 MARKS)

ANSWER : 4

(a) Assuming no tax as per MM Approach.

Calculation of Value of Firms ‘A Ltd.’ and ‘B Ltd.’ according to MM Hypothesis

Market Value of ‘B Ltd’ (Unlevered (u)+

Total Value of Unlevered Firm (Vu) = [NOI/ke] = 18,00,000/0.18 = Rs. 1,00,00,000

Ke of Unlevered Firm (given) = 0.18

Ko of Unlevered Firm (Same as above = ke as there is no debt) = 0.18

Market Value of ‘A Ltd’ *Levered Firm (I)+

Total Value of Levered Firm (VL) = Vu + (Debt  Nil)

= Rs. 1,00,00,000 + (54,00,000  nil)

= Rs. 1,00,00,000

Computation of Equity Capitalization Rate and

Weighted Average Cost of Capital (WACC)

Particulars A Ltd. B Ltd.

A. Net Operating Income (NOI) Rs. 18,00,000 Rs. 18,00,000
B. Less : Interest on Debt (I) Rs. 6,48,000 -
C. Earnings of Equity Shareholders (NI) Rs. 11,52,000 Rs. 18,00,000
D. Overall Capitalization Rate (ko) 0.18 0.18
E. Total Value of Firm (V = NOi/Ko) Rs. 1,00,00,000 Rs. 1,00,00,000
F. Less : Market Value of Debt Rs. 54,00,000 -
G. Market Value of Equity (S) Rs. 46,00,000 Rs. 1,00,00,000
H. Equity Capitalization Rate [ke = NI/S] 0.2504 0.18
I. Weighted Average Cost of Capital [WACC (Ko)]*ko 0.18 0.18
= (ke  S/V) + (kd  D/V)

* Computation of WACC A Ltd.

Component of Capital Amount Weight Cost of Capital WACC

Equity Rs. 46,00,000 0.46 0.2504 0.1152
Debt Rs. 54,00,000 0.54 0.12* 0.0648
Total Rs. 1,00,00,000 0.18
*Kd = 12% (since there is no tax)

WACC = 18%

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(b) Assuming 40% taxes as per MM Approach

Calculation of Value of Firms ‘A Ltd’. ‘B Ltd.’ according to MM Hypothesis

Market Value of ‘B Ltd’ (Unlevered(u)]

Total Value of unlevered Firm (Vu) = [NOI (1 – t)/ke] = 18,00,000 (1 – 0.40)/0.18

= Rs. 60,00,000

Ke of unlevered Firm (given) = 0.18

Ko of unlevered Firm (Same as above = ke as there is no debt) = 0.18

Market Value of ‘A Ltd.’ [Levered Firm (I)]

Total Value of Levered Firm (VL) = Vu + (Debt  Tax)

= Rs. 60,00,000 + (Rs. 54,00,000  0.4)

= Rs. 81,60,000

Computation of Weighted Average Cost of Capital (WACC) of ‘B Ltd.’

= 18% (i.e. Ke = Ko)

Computation of Equity Capitalization Rate and

Weighted Average Cost of Capital (WACC) of A Ltd.

Particulars A Ltd. (Rs.)

Net Operating Income (NOI) 18,00,000
Less : Interest on Debt (I) 6,48,000
Earning Before Tax (EBT) 11,52,000
Less : tax @ 40% 4,60,800
Earnings for equity shareholders (NI) 6,91,200
Total Value of Firm (V) as calculated above 81,60,000
Less : Market value of Debt 54,00,000
Market Value of Equity (S) 27,60,000
Equity Capitalization Rate (ke = NI/S] 0.2504
Weighted Average Cost of Capital (ko)* 13.23
ko = (ke  S/V) + (kd + D/V)

* Computation of WACC A Ltd.

Components of Capital Rs. Weight Cost of Capital WACC

Equity 27,60,000 0.338 0.2504 0.0846
Debt 54,00,000 0.662 0.072* 0.0477
Total 81,60,000 0.1323
*Kd = 12% (1 – 0.4) = 12%  0.6 = 7.2%

WACC = 13.23%

(10 MARKS)
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 Section B

MULTIPLE CHOICE QUESTIONS :

NO. ANSWER MARKS

1 A 2
2 B 2
3 B 2
4 D 2
5 D 2
6 D 1
7 A 2
8 C 1
9 C 1

DESCRIPTIVE ANSWERS:

ANSWER : 1(A)

Functional managers provide most of the information that makes it possible for business and
corporate level managers to formulate realistic and attainable strategies.

This is so because functional managers like Dharam Singh are closer to the customers/ suppliers/
operations than the typical general manager is. A functional manager may generate important
ideas that subsequently may become major strategies for the company. Thus, it is important for
general managers to listen closely to the ideas of their functional managers and invoice them in
decision making.

An equally great responsibility for managers at the operational level is strategy implementation the
execution of corporate and business level plans, and if they are involved in formulation, the clarity
of thoughts while implementation can benefit too.

Thus, the approach of Cylcix Corporate management is not right. They should involve Dharam
Singh, as well as other functional managers too in strategic management.

(5 MARKS)

ANSWER : 1(B)

To gain a deep understanding of a company’s industry and competitive environment, managers do

not need to gather all the information they can find and waste a lot of time digesting it. Rather, the
task is much more focused. A powerful and widely used tool for systematically diagnosing the
significant competitive pressures in a market and assessing the strength and importance of each is
the Porter’s five – forces model of competition. This model holds that the state of competition in an
industry is a composite of competitive pressures operating in five areas of the overall market :

 Competitive pressures associated with the market manoeuvring and jockeying for buyer
patronage that goes on among rival sellers in the industry.
 Competitive pressures associated with the threat of new entrants into the market.

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  Competitive pressures coming from the attempts of companies in other industries to win
buyers over to their own substitute products.
 Competitive pressures steaming from supplier bargaining power and supplier – seller
collaboration.
 Competitive pressures steaming from buyer bargaining power and seller – buyer
Collaboration.

(5 MARKS)

ANSWER : 1(C)

The Ansoff’s product market growth matrix (proposed by Igor Ansoff) is a useful tool that helps
businesses decide their product and market growth strategy. This matrix further helps to analyse
different strategic directions. According to Ansoff there are four strategies that orgnisation might
follow.

(i) Market Penetration: A leading producer of toothpaste, advises its customers to brush teeth
twice a day to keep breath fresh. It refers to a growth strategy where the business focuses
on selling existing products into existing markets.

(ii) diversification : A business giant in hotel industry decides to enter into dairy business. It
refers to a growth strategy where a business markets new products in new markets.

(iii) Market Development : One of India’s premier utility vehicles manufacturing company
ventures to foray into foreign markets. It refers to a growth strategy where the business
seeks to sell its existing products into new markets.

(iv) Product Development : A renowned auto manufacturing company launches ungeared

scooters in the market. It refers to a growth strategy where business aims to introduce new
products into existing markets.

(5 MARKS)

ANSWER : 2(A)

A core competence is a unique strength of an organization which may not be shared by others.
Core competencies are those capabilities that are critical to a business achieving competitive
advantage. In order to qualify as a core competence, the competency should differentiate the
business from any other similar businesses. A core competency for a firm is whatever it does is
highly beneficial to the organization.
‘Value for Money’ is the ledger on account of its ability to keep costs low. The cost advantage that
‘Value for Money’ has created for itself has allowed the retailer to price goods lower than
competitors. The core competency in this case is derived from the company’s ability to generate
large sales volume, allowing the company to remain profitable with low profit margin.

(5 MARKS)
ANSWER : 2(B)
Strategy is partly proactive and partly reactive. In proactive strategy, organizations will analyze
possible environmental scenarios and crate strategic framework after proper planning and set
procedures and work on these strategies in a predetermined manner. However, in reality no

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company can forecast both internal and external environment exactly. Everything cannot be
planned in advance. It is not possible to anticipate moves of rival firms, consumer behavior,
evolving technologies and so on.

There can be significant deviations between what was visualized and what actually happens.
Strategies need to be attuned or modified in the light of possible environmental changes. There can
be significant or major strategic changes when the environment demands. Reactive strategy is
triggered by the changes in the environment and provides ways and means to cope with the
negative factors or take advantage of emerging opportunities.

(5 MARKS)

ANSWER : 3(A)

Organo is a large supermarket chain. By opting backward integration and purchase a number of
farms, it will have greater control over its supply chain. Backward integration is a step towards,
creation of effective supply by entering business of input providers. Strategy employed to expand
profits and gain greater control over production of a product whereby a company will purchase or
build a business that will increase its own supply capability or lessen its cost of production.

(5 MARKS)

ANSWER : 3(B)

Ramesh is a follower of transactional leadership style that focuses on designing systems and
controlling the organization’s activities. Such a leader believes in using authority of its office to
exchange rewards, such as pay and status. They prefer a more formalized approach to motivation ,
setting clear goals with explicit rewards or penalties for achievement or non – achievement.
Transactional leaders try to build on the existing culture and enhance current practices. The style is
better suited in persuading people to work efficiently and run operations smoothly.

On the other hand, Yashpal is follower of transformational leadership style. The style uses charisma
and enthusiasm to inspire people to exert them for the goo of the organization. Transformational
leaders offer excitement, vision, intellectual stimulation and personal satisfaction. They inspire
involvement in a mission, giving followers a ‘dream’ or ‘vision’ of a higher calling so as to elicit more
dramatic changes in organizational performance. Such a leadership motivates followers to do more
than originally affected to do by stretching their abilities and increasing their self – confidence, and
also promote innovation throughout the organization.

(5 MARKS)

ANSWER : 4(A)

Steps to understand the competitive landscape :

(i) Identify the competitor : The first step to understand the competitive landscape is to
identify the competitors in the firm’s industry and have actual data about their respective
market share.

(ii) Understand the competitors : Once the competitors have been identified, the strategist can
use market research report, internet, newspapers, social media, industry reports, and

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 various other sources to understand the products and services offered by them in different
markets.

(iii) Determine the strengths of the competitors : What is the strength of the competitors ?
What do they do well ? Do they offer great products ? Do they utilize marketing in a way
that comparatively reaches out to more consumers ? Why do customers give them their
business ?

(iv) Determine the weaknesses of the competitors : Weaknesses (and strengths) can be
identified by going through consumer reports and reviews appearing in various media. After
all, consumers are often willing to give their opinions, especially when the products or
services are either great or very poor.

(v) Put all of the information together : At this stage, the strategist should put together all
information about competitors and draw inference about what they are not offering and
what the firm can do to fill in the gaps. The strategist can also know the areas which need to
be strengthen by the firm.

(5 MARKS)

ANSWER : 4(B)

Managers implement strategy by converting major plans into concrete, sequential actions that form
incremental steps. Implementation control is directed towards assessing the need for changes in
the overall strategy in light of unfolding events and results associated with incremental steps and
actions.

Strategic implementation control is not a replacement to operational control. Strategic

implementation control, unlike operational controls continuously monitors the basic direction of
the strategy. The two basic forms of implementation control are :

(i) Monitoring strategic thrusts : Monitoring strategic thrusts help managers to determine
whether the overall strategy is progressing as desired or whether there is need for
readjustments.

(ii) Milestone Reviews : All key activities necessary to implement strategy are segregated in
terms of time, events or major resource allocation. It normally involves a complete
reassessment of the strategy. It also assesses the need to continue or refocus the direction
of an organization.

(5 MARKS)

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