Course: CA Intermediate

Paper: FM SM Marks: 100

Test: Prelim Time Allowed: 3 Hours
Model Answer

Section A: Financial Management

All Questions are compulsory

MULTIPLE CHOICE QUESTIONS

SET A
1) The term "capital structure" means:
(a) Long-term debt, preferred stock, and equity shares
(b) Current assets and current liabilities
(c) Net working capital
(d) Shareholder’s equity Marks 1

2) The traditional approach towards the valuation of a firm assumes:

(a) That the overall capitalization rate changes in financial leverage.
(b) That there is an optimum capital structure.
(c) That the total risk is not changed with the changes in the capital structure.
(d) That the markets are perfect. Marks 1

3) Given: risk-free rate of return = 5 %; market return = 10%; cost of equity = 15%; value of beta (β) is:
(a) 1.9
(b) 1.8
(c) 2.0
(d) 2.2 Marks 2

4) A company has a financial structure where equity is 70% of its total debt plus equity. Its cost of equity is
10% and gross loan interest is 5%. Corporation tax is paid at 30%. What is the company’s weighted
average cost of capital (WACC)?
(a) 7.55%
(b) 7.80%
(c) 8.70%
(d) 8.05% Marks 2

5) Which of the following statement is correct with respect to Gordon’s model?

(a) When IRR is greater than cost of capital, the price per share increases and dividend pay-out decreases.
(b) When IRR is greater than cost of capital, the price per share decreases and dividend pay-out increases.
(c) When IRR is equal to cost of capital, the price per share increases and dividend pay-out decreases.
(d) When IRR is lower than cost of capital, the price per share increases and dividend pay-out decreases.
Marks 1

6) What is the Internal rate of return for a project having cash flows of Rs. 40,000 per year for 10 years and
a cost of Rs. 2,26,009?
(a) 8%
(b) 9%
(c) 10%
(d) 12% Marks 2

7) If degree of financial leverage is 3 and there is 15% increase in Earning per share (EPS), then EBIT will be:
(a) Decrease by 15%
(b) Increase by 45%
(c) Decrease by 45%
(d) Increase by 5% Marks 2

8) A company has net profit margin of 5%, total assets of Rs. 90,00,000 and return on assets of 9%. Its total
asset turnover ratio would be:
(a) 1.6
(b) 1.7
(c) 1.8
(d) 1.9 Marks 2

9) Which of the following are micro economic variables that help define and explain the discipline of
finance?
(a) Risk and return
(b) Capital structure
(c) Inflation
(d) All of the above. Marks 1

10) Debt capital refers to:

(a) Money raised through the sale of shares.
(b) Funds raised by borrowing that must be repaid.
(c) Factoring accounts receivable.
(d) Inventory loans. Marks 1

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

Q1) Answer the following:

a) X Co. has made plans for the next year. It is estimated that the company will employ total assets
of Rs. 8,00,000; 50 per cent of the assets being financed by borrowed capital at an interest cost of 8
per cent per year. The direct costs for the year are estimated at Rs. 4,80,000 and all other operating
expenses are estimated at Rs. 80,000. the goods will be sold to customers at 150 per cent of the direct
costs. Tax rate is assumed to be 50 per cent.
You are required to calculate: (i) net profit margin; (ii) return on assets; (iii) asset turnover and (iv) return on
owners’ equity. Marks 5
Answer
The net profit is calculated as follows:

Particulars Rs. Rs.

Sales (150% of Rs. 4,80,000) 7,20,000
Direct costs 4,80,000
Gross profit 2,40,000
Operating expenses 80,000
Interest changes (8% of Rs. 4,00,000) 32,000 1,12,000
Profit before taxes 1,28,000
 Taxes (@ 50%) 64,000
Net profit after taxes 64,000

b) A firm had been paid dividend at Rs.2 per share last year. The estimated growth of the dividends from the
company is estimated to be 5% p.a. Determine the estimated market price of the equity share if the estimated
growth rate of dividends (i) rises to 8%, and (ii) falls to 3%. Also find out the present market price of the share,
given that the required rate of return of the equity investors is 15.5%. Marks 3
Answer

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Q2) Answer the following:
a) RBML is proposing to sell a 5-year bond of Rs. 5,000 at 8 per cent rate of interest per annum. The bond amount
will be amortised equally over its life. What is the bond’s present value for an investor if he expects a minimum
rate of return of 6 per cent? Marks 5
Answer

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b) A Ltd. is evaluating a project involving an outlay of Rs. 10,00,000 resulting in an annual cash inflow of Rs.
2,50,000 for 6 years. Assuming salvage value of the project is zero; DETERMINE the IRR of the project. Marks 4
Answer
Q3) Answer the following:
a) From the following information of XYZ Ltd., you are required to calculate:
(a)Net operating cycle period.
(b) Number of operating cycles in a year.
(Rs.)
(i) Raw material inventory consumed during the year 6,00,000
(ii) Average stock of raw material 50,000
(iii) Work-in-progress inventory 5,00,000
(iv) Average work-in-progress inventory 30,000
(v) Finished goods inventory 8,00,000
(vi) Average finished goods stock held 40,000
(vii) Average collection period from debtors 45 days
(viii) Average credit period availed 30 days
(ix) No. of days in a year 360 days Marks 5
Answer
b) A Company produces and sells 10,000 shirts. The selling price per shirt is Rs. 500. Variable cost is Rs. 200 per
shirt and fixed operating cost is Rs. 25,00,000.
(a) Calculate operating leverage.
(b) If sales are up by 10%, then what is the impact on EBIT? Marks 4
Answer
Q4) Answer the following:
a) The cash flows of projects C and D are reproduced below:
Cash Flow NPV
Project C0 C1 C2 C3 at 10% IRR
C  Rs. 10,000 + 2,000 + 4,000 + 12,000 + Rs. 4,139 26.5%
D  Rs. 10,000 + 10,000 + 3,000 + 3,000 + Rs. 3,823 37.6%

(i) Why there is a conflict of rankings?

(ii) Why should you recommend project C in spite of lower internal rate of return?
Period
Time 1 2 3
PVIF0.10, t 0.9090 0.8264 0.7513
PVIF0.14, t 0.8772 0.7695 0.6750
PVIF0.15, t 0.8696 0.7561 0.6575
PVIF0.30, t 0.7692 0.5917 0.4552
PVIF0.40, t 0.7143 0.5102 0.3644
Marks 6
Answer
(i) Net Present Value at different discounting rates

Project 0% 10% 15% 30% 40%

Rs. Rs. Rs. Rs. Rs.
C 8,000 4,139 2,654 632 2,158
{Rs. 2,000 {Rs. 2,000  {Rs. 2,000  {Rs. 2,000  {Rs. 2,000 
0.909 0.8696 0.7692 0.7143
+Rs. 4,000 +Rs. 4,000  + Rs. 4,000  + Rs. 4,000  + Rs. 4,000 
0.8264 0.7561 0.5917 0.5102
+Rs. 12,000 +Rs. 12,000  + Rs. 12,000  +Rs. 12,000  + Rs. 12,000 
0.7513 0.6575 0.4552 0.3644
Rs. 10,000} Rs. 10,000}  Rs. 10,000}  Rs. 10,000}  Rs. 10,000}
Ranking I I II II II
D 6,000 3,823 2,937 833  233
{Rs. 10,000 {Rs. 10,000  {Rs. 10,000  {Rs. 10,000  {Rs. 10,000 
0.909 0.8696 0.7692 0.7143
+Rs. 3,000 +Rs. 3,000  +Rs. 3,000  + Rs. 3,000  +Rs. 3,000 
0.8264 0.7561 0.5917 0.5102
+Rs. 3,000 +Rs. 3,000  +Rs. 3,000  + Rs. 3,000  +Rs. 3,000 
0.7513 0.6575 0.4552 0.3644
 Rs. 10,000}  Rs. 10,000}  Rs. 10,000}  Rs. 10,000}  Rs. 10,000}
Ranking II II I I I

The conflict in ranking arises because of skewness in cash flows. In the case of Project C cash flows occur later in
the life and in the case of Project D, cash flows are skewed towards the beginning.
At lower discount rate, project C’s NPV will be higher than that of project D. As the discount rate increases,
Project C’s NPV will fall at a faster rate, due to compounding effect.
After break even discount rate, Project D has higher NPV as well as higher IRR.
(ii) If the opportunity cost of funds is 10%, project C should be accepted because the firm’s wealth will
increase by Rs. 316 (Rs. 4,139 - Rs. 3,823)
The following statement of incremental analysis will substantiate the above point.
Cash Flows (Rs.) NPV at IRR
Project C0 C1 C2 C3 10% 12.5%
R R R Rs.
s. s. s.
CD 0 8,000 1,000 9,000 316 0
{8,000  0.909 {8,000  0.88884
+1,000  0.8264 + 1,000  0.7898
+ 9,000  0.7513} + 9,000  0.7019}
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b) EXPLAIN the followings:
(a) Floating Rate Bonds
(b) Packing Credit. Marks 3
Answer
(a) Floating Rate Bonds: These are the bonds where the interest rate is not fixed and is allowed to float
depending upon the market conditions. These are ideal instruments which can be resorted to by the issuers to
hedge themselves against the volatility in the interest rates. They have become more popular as a money
market instrument and have been successfully issued by financial institutions like IDBI, ICICI etc.
(b) Packing Credit: Packing credit is an advance made available by banks to an exporter. Any exporter,
having at hand a firm export order placed with him by his foreign buyer on an irrevocable letter of credit
opened in his favour, can approach a bank for availing of packing credit. An advance so taken by an exporter is
required to be liquidated within 180 days from the date of its commencement by negotiation of export bills or
receipt of export proceeds in an approved manner. Thus Packing Credit is essentially a short-term advance.

PART B – SM

MULTIPLE CHOICE QUESTIONS

SET B (15 x 1 Mark)
1) Which of the following term is not associated with strategy?
(a) Flexible
(b) Dynamic
(c) Focused
(d) Rigid

2) According to , strategy is a unified, comprehensive and integrated plan designed to achieve objectives of
the entity.
(a) Michael Porter
(b) C.K. Prahalad
(c) Peter F. Drucker
(d) William F. Glueck

3) In large organisations, there are total _______levels at which strategies are formulated.
(a) Only one
(b) Two
(c) Three
(d) Four

4) In an environment which is quite stable and don’t have much unanticipated developments, the actual
corporate strategy will have strategy as a dominant portion.
(a) Offensive
(b) Defensive
(c) Proactive
(d) Reactive

5) Which of the following is first step involved in understanding the competitive landscape?
(a) Determine the strengths of the competitors
(b) Determine the weaknesses of competitors
(c) Identify the competitor
(d) Put all of the information together

6) ‘Who are the competitors’ question is usually asked at the ________step of understanding the
competitive landscape.
(a) Second
(b) First
(c) Fifth
(d) Third

7) Which of the following constitute Demographic Environment?

(a) Nature of economy i.e. capitalism, socialism, Mixed
(b) Size, composition, distribution of population, sex ratio
(c) Foreign trade policy of Government
(d) Economic policy i.e. fiscal and monetary policy of Government

8) In which phase of strategic management are annual objectives especially important?

(a) Formulation
(b) Control
(c) Evaluation
(d) Implementation

9) The complete absorption of one company by another, wherein the acquiring firm retains its identity and
the acquired firm may cease to exist, is called a________.
(a) Merger
(b) Acquisition
(c) Tender offer
(d) Spinoff

10) The acquisition of a firm whose business is not related to that of the bidder is called a________
acquisition.
(a) Conglomerate
(b) Vertical
(c) Backward
(d) Horizontal

11) Given below are some of the reasons of the divestment strategy:
(i) To raise cash
(ii) To unload unprofitable operations
(iii) To improve the strategic fit of a firm's various divisions
(iv) To comply with industry policies
Which of the above statements are correct?
 (a) (i), (ii), (iii) only
(b) (i), (iii) only
(c) (ii), (iii), (iv) only
(d) (i), (iv) only

12) Porter's Five Forces Model is essentially a model about_________.

(a) Market segmentation
(b) Profitability analysis
(c) Competitive rivalry
(d) Corporate strategy evaluation

13) The power of suppliers will be high when:

(a) Customers have many substitutes
(b) Many producers dominate industry
(c) Just a few producers dominate industry
(d) Both (a) & (b)

14) ‘Strategic group mapping’ helps in-

(a) Identifying the strongest rival companies
(b) Identifying weakest rival companies
(c) Identifying weakest and strongest rival companies
(d) None of the above

15) Two kinds of linkages exists between strategy formulation and implementation. These linkages are
_________&_______.
(a) Horizontal, Vertical
(b) Related, Unrelated
(c) Forward, Backward
(d) Strong, Weak

Answer
1) D
2) D
3) C
4) C
5) C
6) B
7) B
8) D
9) B
10) A
11) A
12) C
13) C
14) C
15) C
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Q5) Answer the following:
a) Explain Kurt Lewin’s Model of Change, Also explain its steps. Marks 5
Answer
Kurt Lewin’s Model of Change: To make the change lasting, Kurt Lewin proposed three phases of the change
process for moving the organization from the present to the future. These stages are unfreezing, changing
and refreezing.
(a) Unfreezing the situation: The process of unfreezing simply makes the individuals aware of the
necessity for change and prepares them for such a change. Lewin proposes that the changes should not
 come as a surprise to the members of the organization. Sudden and unannounced change would be socially
destructive and morale lowering. The management must pave the way for the change by first “unfreezing
the situation”, so that members would be willing and ready to accept the change.
Unfreezing is the process of breaking down the old attitudes and behaviours, customs and traditions so that
they start with a clean slate. This can be achieved by making announcements, holding meetings and
promoting the new ideas throughout the organization.
(b) Changing to the new situation: Once the unfreezing process has been completed and the members
of the organization recognise the need for change and have been fully prepared to accept such change, their
behaviour patterns need to be redefined. H.C. Kellman has proposed three methods for reassigning new
patterns of behaviour. These are compliance, identification and internalization.
● Compliance: It is achieved by strictly enforcing the reward and punishment strategy for good or bad
behaviour. Fear of punishment, actual punishment or actual reward seems to change behaviour for the
better.
● Identification: Identification occurs when members are psychologically impressed upon to identify
themselves with some given role models whose behaviour they would like to adopt and try to become like
them.
● Internalization: Internalization involves some internal changing of the individual’s thought processes
in order to adjust to the changes introduced. They have given freedom to learn and adopt new behaviour in
order to succeed in the new set of circumstances.
(c) Refreezing: Refreezing occurs when the new behaviour becomes a normal way of life. The new
behaviour must replace the former behaviour completely for successful and permanent change to take
place. In order for the new behaviour to become permanent, it must be continuously reinforced so that this
new acquired behaviour does not diminish or extinguish.
Change process is not a one-time application but a continuous process due to dynamism and ever
changing environment. The process of unfreezing, changing and refreezing is a cyclical one and remains
continuously in action.
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b) Organo is a large supermarket chain. It is considering the purchase of a number of farms that provides Organo
with a significant amount of its fresh produce. Organo feels that by purchasing the farms, it will have greater
control over its supply chain.Identify and explain the type of diversification opted by Organo? Marks 3
Answer
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.
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Q6) Answer the following:
a) Suresh Singhani a is the owner of an agri-based private company in Sangrur, Punjab. His unit is producing
puree, ketchups and sauces. While its products have significant market share in the northern part of
country, the sales are on decline in last couple of years. He seeks help of a management expert who advises
him to first understand the competitive landscape.
Explain the steps to be followed by Suresh Singhania to understand competitive landscape. Marks 5
Answer
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 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.
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b) Explain Experience curve and its features. Marks 4
Answer
Experience curve akin to a learning curve which explains the efficiency increase gained by workers through
repetitive productive work. Experience curve is based on the commonly observed phenomenon that unit
costs decline as a firm accumulates experience in terms of a cumulative volume of production. It is based on
the concept, “we learn as we grow”.
The implication is that larger firms in an industry would tend to have lower unit costs as compared to those
for smaller companies, thereby gaining a competitive cost advantage.
Experience curve results from a variety of factors such as learning effects, economies of scale, product
redesign and technological improvements in production.
Experience curve has following features:
♦ As business organization grow, they gain experience.
♦ Experience may provide an advantage over the competition. Experience is a key barrier to entry.
♦ Large and successful organization possess stronger “experience effect”.
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Q7) Answer the following:
a) Aurobindo, the pharmaceutical company wants to grow its business. Draw Ansoff’s Product Market Growth
Matrix to advise them of the available options. Marks 5
Answer
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. With the use of this matrix, a business can get a fair idea
about how its growth depends upon its markets in new or existing products in both new and existing
markets.
The Ansoff’s product market growth matrix is as follows:

Based on the matrix, Aurobindo may segregate its different products. Being in pharmaceuticals,
development of new products is result of extensive research and involves huge costs. There are also social
dimensions that may influence the decision of the company. It can adopt penetration, product development,
market development or diversification simultaneously for its different products.
Market penetration refers to a growth strategy where the business focuses on selling existing products into
existing markets. It is achieved by making more sales to present customers without changing products in any
major way.
Market development refers to a growth strategy where the business seeks to sell its existing products into
new markets. It is a strategy for company growth by identifying and developing new markets for the existing
products of the company.
Product development refers to a growth strategy where business aims to introduce new products into
existing markets. It is a strategy for company growth by offering modified or new products to current
markets.
Diversification refers to a growth strategy where a business markets new products in new markets. It is a
strategy by starting up or acquiring businesses outside the company’s current products and markets.
As market conditions change overtime, a company may shift product-market growth strategies. For example,
when its present market is fully saturated a company may have no choice other than to pursue new market.
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b) Mr. Banerjee is head of marketing department of a manufacturing company. His company is in direct
competition with thirteen companies at national level. He wishes to study the market positions of rival
companies by grouping them into like positions.
Name the tool that may be used by Mr. Banerjee? Explain the procedure that may be used to implement the
technique. Marks 4
Answer
A tool to study the market positions of rival companies by grouping them into like positions is strategic group
mapping. Grouping competitors is useful when there are many competitors such that it is not practical to
examine each onein-depth. In the given scenario there are thirteen competitors. A strategic group consists of
those rival firms which have similar competitive approaches and positions in the market.
The procedure for constructing a strategic group map and deciding which firms belong in which strategic group
is as follows:
• Identify the competitive characteristics that differentiate firms in the industry typical variables that are
price/quality range (high, medium, low); geographic coverage (local, regional, national, global); degree of
vertical integration (none, partial, full); product-line breadth (wide, narrow); use of distribution channels (one,
some, all); and degree of service offered (no-frills, limited, full).
• Plot the firms on a two-variable map using pairs of these differentiating characteristics.
• Assign firms that fall in about the same strategy space to the same strategic group.
Draw circles around each strategic group making the circles proportional to the size of the group's respective
share of total industry sales revenues
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Q8) Answer the following:
a) Write a short note on Product Life Cycle (PLC) and its significance in portfolio diagnosis. Marks 5
Answer
Product Life Cycle is an important concept in strategic choice and S-shaped curve which exhibits the
relationship of sales with respect of time for a product that passes through the four successive stages.
The first stage of PLC is the introduction stage in which competition is almost negligible, prices are relatively
high and markets are limited. The growth in sales is also at a lower rate.
The second stage of PLC is the growth stage, in which the demand expands rapidly, prices fall, competition
increases and market expands.
The third stage of PLC is the maturity stage, where in the competition gets tough and market gets stabilized.
Profit comes down because of stiff competition.
The fourth stage is the declining stage of PLC, in which the sales and profits fall down sharply due to some
new product replaces the existing product.

Product Life Cycle

PLC can be used to diagnose a portfolio of products (or businesses) in order to establish the stage at which each of
them exists. Particular attention is to be paid on the businesses that are in the declining stage. Depending on the
diagnosis, appropriate strategic choice can be made. For instance, expansion may be a feasible alternative for
businesses in the introductory and growth stages. Mature businesses may be used as sources of cash for
investment in other businesses which need resources. A combination of strategies like selective harvesting,
retrenchment, etc. may be adopted for declining businesses. In this way, a balanced portfolio of businesses may be
built up by exercising a strategic choice based on the PLC concept.
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b) Why should an organization have a mission? Marks 4
Answer
• To ensure unanimity of purpose within the organisation.
• To develop a basis, or standard, for allocating organizational resources.
• To provide a basis for motivating the use of the organisation’s resources.
• To establish a general tone or organisational climate, to suggest a business-like operation.
• To serve as a focal point for those who can identify with the organisation’s Purpose and direction.
• To facilitate the translation of objective and goals into a work structure involving the assignment of tasks to
responsible elements within the organisation.
• To specify organisational purposes and the translation of these purposes into goals in such a way that cost,
time, and performance parameters can be assessed and controlled.