7.10.

11

FINANCIAL MGT. OBJECTIVES

ROI =

Net PAT X 100

Total Assets

ROI =
ROI =

Assets Turnover =

ROI means Return on Investment = EBIT

X 100
Total Capital Employed

=================================================================================================

CHAPTER 2
CAPITAL EXPENDITURE PROJECTS
II
1

CAPITAL EXPENDITURE PROJECTS EVALUATION METHODS

PAYBACK PERIOD METHOD
A --( when every year same amount of cash inflow )
PAYBACK PERIOD=

B ---( when every

Initial Investment (ie. Cost of m

Average Annual Cash Inflow

year amount of cash inflow is not same )

cumulative cash inflows should be found
PAYBACK PERIOD =
completed years X

C ---( when

annual

cost

savings are given )

PAYBACK PERIOD=

Initial Investment
Annual Cost Savings

Conclusion : Within

____ Payback period , the cost of project will be ex

The project with the lowest payback period shoul
--------------------------------- -------------------------------------------------------------------------Payback Profitability = [Avg. Annual Cash Inflow X( Expected life of project

Payback Profitability = [Total Earnings from the Project - Cost of Project

Payback Profitability = Surplus Life Profitability

Conclusion :

The project with the highest payback pr

Better indicator than Payback Period becau
remaining after recovering original cost.
-------------------------------------------------------------------------Payback Profitability Index =
( Also called Benefit Cost Index )
Payback Profitability Index =

Conclusion :
The project with the highest payback pr
-----------------------------------------------------------------------------------------------------------ARR -- Average Rate of Return Method OR Accounting Rate of Retu
ARR =

Avg. PAT
Original Investment

ARR =

Avg. PAT
Avg. Investment

Avg. Investment =

( When existing Profits and Profits after investment give

Incremental Earnings or Profit
Incremental Investment

ARR =

Incremental Earnings or Profit =

Incremental

III

Investment

ARR =

( When Profits from existing machine and new machi

( PAT from new machine - PAT from old machine
( Investment in new machine - sale proceeds of old

ARR =

( When Profits from machine 'A ' and machine 'B" giv
( PAT from machine 'A' - PAT from new machine 'B'
( Investment in machine 'A' - Investment in machine 'B

DISCOUNTED CASH FLOW METHODS

a) PRESENT VALUE METHOD
b) NET PRESENT VALUE METHOD
c) PROFITABILITY INDEX ( PI ) or BENEFIT - COST
d) IRR---- Internal Rate of Return
e) DISCOUNTED PAYBACK PERIOD

RATIO (B/C RATIO)

a) PRESENT VALUE METHOD

Info : Cost 500000, W Cap. 60000, Scrap 40000, PV factor
Year

Profit before
Dep. & Tax
1
2

100000
200000

Dep

115000
115000

3
4

Dep as per SLM

250000
300000

115000
115000

850000

460000

Cost of Asset -Scrap value

Estimated life of Asset

Dep as per WDV method =

Dep % X Opg. Bal. Of Asset

PV Factor / % also called as

If Total PV
If Total PV
If Total PV
Conclusion

b) NET

Post Tax Cutoff Rate

> Cost of Project ----- Accept Project

< Cost of Project ----- Reject Project
= Cost of Project ----- Indifferent ie Neither profit nor loss from Project
:
Since Total Present Values of Cash Inflows Rs 533043/- is

PRESENT VALUE METHOD

Info : Cost 500000, W Cap. 60000, Scrap 40000, PV factor

Year
0
0
1
2
3
4

Profit before
Dep. & Tax
Cost of machine
Working Capital
100000
200000
250000
300000

4 Release of WCap.
4 Sale of Scrap
850000

Dep

115000
115000
115000
115000

460000

If NPV > Zero ----- Accept Project

If NPV < Zero ----- Reject Project
If NPV = Zero ----- Indifferent
Conclusion :
Since Net Present Values of Cash Inflows Rs. 36642.50

c) PROFITABILITY INDEX ( PI )

or

BENEFIT - COST

PI =

PV of cash inflows
PV of cash outflows

PI =

Benefits
Cost

PI > 1 accept project ---- (NPV + ve )

PI < 1 reject project --- (NPV - ve)
PI = 1 indifferent --- (NPV zero )
Conclusion :
Since Profitability Index

1.07

RATIO (B/C RATIO)

is more than one,

the p

d) IRR---- Internal Rate of Return

Internal Rate of Return is that rate of profit expected from the investment in the project w
IRR is the rate at which Total Cash Inflow = Cost of Project
IRR is that rate at which Profitability Index is 1 . ( because Total PV of Cash Inflows =
eg. If discounting factors are given for 10 % and 14%
IRR =
10% + (Total PV at 10% - Cost of Asset ) X ( 14 - 10
(Total PV at 10% -Total PV at 14% )
Conclusion : IRR of the given project is x % . It means at x% of cost of capital (
At this rate of cost there will be neither profit nor loss .
-------------------------------------------------------------------------------------------------------------------------------e) Discounted Payback Period

Use discounted cash inflows ie. Present values of cash inflows , then calculate cumu
Calculate Payback Period on Cumulative Present Values.
-------------------------------------------------------------------------------------------------------------------------------NOTES :
Cost for conducting study / research for project is a sunk c

================================================================================
CHAPTER 4
CASH BUDGET
RECEIPTS
JULY
AUG.
SEPT.
Opg. Balance
12000
12000
12000
Cash Sales
57000
60800
38000
Receipts from Debtors
1st month
53544
69840
74496
2nd month
112000
128800
168000
Dividend on Investment
TOTAL RECEIPTS

14500
249044

271440

Less : PAYMENTS
Cash Purchases
52000
60000
Paid Creditors
66000
78000
Wages
24000
32000
Expenses in advance
6667
3333
Cash Expenses
13333
13333
Furniture purchased
90000
Machine purchased
20000
10000
TOTAL PAYMENTS
182000
286667
Purchase of Investments
55044
( If Receipts are more than payments + Bal required)
Sale of Investments
27227
(If Payments + Bal required are more than Receipts )
Clg. Bal
12000
12000

292496

40000
90000
32000
0
6667
10000
178667
101829

12000

Calculations July -Cash Sales

60000 less Discount 60000 X 5%
=
Receipt from Debtors 1mth
240000 -- 30% in Aug =
Receipt from Debtors 2mth
--70% in Sept =
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------Cash bal not to exceed 20000. Excess to be deposited in SB A/c.on which int @ 3% is rec
JULY
AUG.
SEPT.

Opg Cash Bal

Receipts
Int on SB deposit
Total Receipts

75
150000

Payments
Total Payments
100000
Clg Bal ( to be adjusted)
50000
Deposited in SB A/c.
30000
Clg Bal
20000
--------------------------------------------------------------------------------------------------------------------------------------------Receipt cycle ( Systems of Collection from Debtors )
QuestionAverage daily receipts
=Rs.
Collection period reduced due to concentration banking
=
Annual Cost of concentration banking
=Rs.
=
Income from investment
=
Collection period reduced due to lock box system
= =
Cash released by concentration banking
==Rs.
Should the Co. Adopt Concentration banking or Lock Box System ?

--------------------------------------------------------------------------------------------------------------------------------------------Co. Has annual turnover (Sales) of 100 lakh. 50 working weeks. Receipts on Mondays , Tu
Cost of banking is 1400 per day. Int rate of bank overdraft is 15% pa.
Advise whether daily , twice a week on Wednesdays and Fridays or only on Fridays.

================================================================================

Defn. :

Cost of Capital is the minimum required rate of earnings or the c

Cost of Capital is the cost that is incurred in retaining the funds o

Utility :

Designing a firm's capital structure.

Evaluation of investment alternatives.
Assessment of Financial Performance.

Components of Cost Of Capital

1) Cost of Debt ( Kd)--- Rate of Interest Less Tax benefit
2) Cost of Equity Share Capital ( Ke )-- Expected rate of dividen
3) Cost of Retained Earnings -- Opportunity cost of dividends fore
4) Cost of Preference Share Capital -- Fixed rate of dividend

Two Approaches of Calculating Cost of Capital

A) Overall Cost of Capital = Weighted Average Cost of Capital
In case of New Company Overall Cost of Capital is equal t
B) Marginal Cost of Capital = Increase in Cost of Capital due to
In case of New Company Overall Cost of Capital is equal t
It helps to know what rate of return/profit the new project sho

Calculation of Weighted Average Cost of Capital ( WACC )

Source of Capital
Equity Sh. Capital(10/-)
10% Pref. Sh. Capital
11% Debentures
12% Loan
TOTAL
1)

WACC =

2)

Cost of Equity

Amount
100000
200000
300000
400000
1000000
9.07%

Proportion
0.10
0.20
0.30
0.40
1.00

Cost of
Capital
14%
10%
11%
12%

If DPS =Rs.14/-. MPS = Rs. 120/- . Expected growth in Dividend = 4%.

Cost of Equity ( Ke ) =
DPS
X 100 + G
MPS
Cost of Equity ( Ke ) =
(
14 X 100 )+ 4%
= 11.67 % + 4% =
120
Cost of Equity ( Ke ) =

EPS
MPS

Cost of Preference Share Capital

Kp = Preference dividend
If redeemable preference shares

X 100 + G

>> if addnl info not given

Kp = [ Pref Div.amt + (FV - NP)/ N ]

[FV + NP]/2
Cost of Debt
Cost of Debt ( Kd ) =

x 100

>> FV = face value(par value) of on

NP = Net Proceeds= Face value

Int. Rate ( 1 - tax rate)

Cost of redeemable Debt

Kp = [ Interest + (FV - NP)/ N ]
[FV + NP]/2

x (1 - tax rate )>> FV = face value(par value) of on

NP = Net Proceeds= Face value

Yield to maturity = [ Interest amt p.a. + (FV - PP)/ N ]

[FV - PP]/2

Cost of retained Earnings

Kre = Ke
3)

Rate of Return on Equity Share Capital

If ROI = 25%
EBIT
250000
Less : Int. on Deb.
33000
Int. on Loan
48000

x 100

EBT
Less : Tax
PAT
Less: Pref. Div.
Profit Available to
Equity Shareholders

169000
50700
118300
20000
98300

Therefore , Rate of Return on Equity =

EPS
4)

Market Value of the Firm

Market Value of Equity

Market Value of Debt =

Market Value of Pref. Sh. =
Market Value of the Firm

98300
100000

9.83

=
=

PAES
=
Cost of Eq. Capital
Debenture + loan =
Pref. S. Cap.
=
>>>>>>

================================================================================

CHAPTER 6

CAPITAL STRUCTURE PLANNING

Capital Structure Planning means having such a combination of capital resources which gives
Capital Structure Planning means determining the Composition of Owned Capital & B
a) Minimum Cost of Capital
b) Minimum Risk
\
c) Maximum Market Value of Equity ;
d) Maximises EPS
Essentials of Optimum Capital Structure :
1 Flexibility-- increase/decrease and change in composition of Capital should be possible.
2 Economy--Minimum Cost of Capital

3
4
5
6

Solvency--No excessive debt requiring mortgaging of assets.

Efficiency-- Just adequate capital ensuring intensive utilization of funds.
Control-- Controlling position of Equity Shareholders should be maintained.
Liquidity -- Adequate cash and liquid resources should be maintained for smooth functioning o

INDIFFERENCE POINT
It is the EBIT which would keep the Equity Shareholders indifferent to the alternative capital p
Two alternative Capital Plans which give the same EPS
EPS as per Plan 1
=
EPS as per Plan 2
[(EBIT - I1)(1 - t )] - PD1
=
[(EBIT - I2)(1 - t )] - PD2
E1
E2

I1= Interest as per plan 1

I2= Interest as per plan 2
t = Tax Rate
PD1 = Pref. Dividend as per plan 1
PD2 = Pref. Dividend as per plan 2
E1 = No. of Eq. Sh. As per plan 1
E2 = No. of Eq. Sh. As per plan 2
Using the above equation Indifference Level of EBIT should be found.
-------------------------------------------------------------------------------------------------------------------------------Financial Breakeven
Financial Breakeven is that level of EBIT where EPS is exactly equal to zero .
Financial charges ie. Interest on loans /debt capital is just exactly covered by EBIT and P
It is the minimum level of EBIT which is just adequate to pay interest on debt capital
At financial Breakeven level of EBIT --the firm's EPS is Zero.
-PAT = Pref. Dividend
-EBIT = Interest
-EPS = 0
-------------------------------------------------------------------------------------------------------------------------------Theories of Capital Structure
Theories to explain relationship between capital structure , cost of capital and value of firm
1 Net Income Approach

-->>

Firm can minimize WACC and increase value of firm

because Int rate < Div. rate PLUS due to Tax ben
Change in Capital Structure affects market value o
Debt -Equity Mix influences WACC
The optimal Capital Structure is one which uses

2 Net Operating Income Approach--

3 Traditional Approach

--

4 Modigliani Miller Approach --

1)

Average cost of capital is equal to capitalization rate

No corelation between cost of capital and market
Debt -Equity Mix does not influence WACC

Problem
1400000
Value of Firm under Net Income Approach =
Market Value of Equity + Market Valu
Market Value of Equity
=
PAT less Pref. Dividend ( ie. PAES )
Capitalization rate of Equity
Market Value of Debt

2)

No corelation between cost of capital and market

Change in Capital Structure does not affect mark
Debt -Equity Mix does not influence WACC
There is no optimal Capital Structure
Change in Capital Structure does affect market v
WACC is minimized if Debt Equity Ratio is incre
There is optimal Capital Structure
Weakness-- As debt increases financial risk inc
leading to increase in cost of capital

Borrrowed Capital

Value of Firm under Net Operating Income Approach =

================================================================================

CHAPTER 9

BUSINESS RESTRUCTURING
Definition : Process by which business orgn. Alters its present structure , either asset structu
BR. is done through Merger, Amalgamation, Demerger , Joint Venture , Takeover

Importance

BR gains importance due to--Changes in laws, competitive world , cost cutting

Financial implications
Financial Implications means the valuation of the business from the point of view of
Value is dependent on bargaining powers of buyer and seller of business and their e
Valuation is dynamic and not static since it changes with the time .
Valuations

Types of Bus. Restructuring

Mergers-- combination of two/more companies into one large company.
a) Horizontal Merger-- combination of companies producing similar products> >anticom
b) Vertical Merger-- combination of companies at different stages in production of same
bachward integration moving towards sources of rawmaterial, for
c) Congeneric Merger - Firms in Same general industry but are not buyer- supplier
d) Conglomerate merger--firms in different industry >> for diversifying business ris

a)

PROBLEM ON AMALGAMATION
Book Values ( Given)
A Co
B Co
Fixed Assets
300000
200000
Current Assets
100000
29000
Total
400000
229000
Eq Capital ( of Rs 10 each)
Res. & Surplus
12% Pref Cap
13% Deb
Current Liab
Total

b)

Revalued figures

250000
14000
80000
36000

192000

20000

12000

400000

229000

10000
15000

Fixed Assets
Current Assets
Total

A Co
B Co
350000
90000
440000

20000
30000
50000

c)

New Co. formed from the amalgamation of A Co and B Co is

AB Co.

d)
e)
f)

15% Deb to be issued to existing Deb holders so that they get same amount of int as they are n
Eq shares of new AB Co. shall be issued 30000 shares to existing shareholders of A Co. an
11% Pref shares to be issued to current Pref. share holders.
Calculate Debentures , Pref shares and Equity shares to be issued .
Prepare Balancesheet of new Co. after amalgamation.
------------------------------------------------------------------------------------------------------------------------------ANSWER

A )

Calculation of Net Assets taken over

Fixed Assets
Current Assets
Total
Current Liab

20000

12000

32000

Total

20000

12000

32000

420000

38000

458000

Net Assets taken over

a)

b)

Revalued figures if given

A Co
B Co
Total
350000
20000
370000
90000
30000
120000
440000
50000
490000

Purchase consideration Paid by New Co.

To Pref Shareholders
A Co
B Co
11% Pref Shares of AB Co
80000

10000

90000

To Deb. Holders
15% Deb of AB Co.

13000

44200

31200

Total

c)

To Equity Shareholders
Equity Shares of AB Co.

275109
386309.2

24891
47891

Goodwill
(If Purch Con more than Net Assets )

9891

Total

(B)

300000
434200

Capital Reserve
33691
(If Purch Con less than Net Assets )

Liabilities
Equity Share Capital
11% Pref. Share Cap.
15% Deb.

BALANCE SHEET OF AB Co.

Amount
300000 Fixed Assets
90000 Current Assets
44200

Capital Reserve
Current Liab.
TOTAL

33691 Goodwill
32000
499891
TOTAL

-------------------------------------------------------------------------------------------------------------------------------MERGER / TAKEOVER
From the following Balance Sheets + info Calculate Purchase Consideration and prepare re
AAA Ltd. shall purchase BBB Ltd.
Liabilities
AAALtd BBB Ltd
Equity Shares (Rs 100/-)
400000
100000
Pref. Shares (Rs.100/-)
50000
Reserve & Surplus
100000
20000
9% Debentures
10% Debentures
Bank Loans

130000
50000

100000
40000

Current Liabilities

55000
785000

20000
280000

BBB Ltd. Is seller / vendor company .

a) BBB Ltd's Assets & liabilities are valued as under :
Land & Bldg.
140000
Machinery
110000
Furniture
5000
Investments
book value
Current Assets
provide for bad debts 1000
Current Liabilities
consider unrecorded liab. 2000
b ) Purchase consideration is paid
9% Debentures
100000 To Debentureholders of BBB Ltd.
1000 Shares of AAA Ltd. at premium of Rs.10/ Balance in cash
ANSWER
Calculation of Purchase Consideration of BBB Ltd.
Assets of BBB Ltd.
Revalued figures
Land & Bldg.
140000
Machinery
110000
Furniture
5000
Investments
10000
Current Assets
9000
274000
Less : Liabilities of BBB Ltd.
Bank Loans
Current Liabilities

Net Assets takenover

40000
22000
62000
212000

Purchase Consideration Paid as

9% Debentures
100000

Shares of AAA Ltd.

Share Premium
Balance in cash

100000
10000
2000
212000

REVISED Balance Sheet of AAA Ltd. ( after merg

Liabilities
Equity Shares (Rs 100/-)
Pref. Shares (Rs.100/-)
Reserve & Surplus
9% Debentures
Bank Loans
Current Liabilities
TOTAL

Amount
500000
50000
110000
230000
90000
77000
1057000

P Co
MPS
No. of Equity shares
Earnings after Tax

25
200000
400000

S Co
15
100000
120000

P Co is merging with S Co that is , P Co is purchasing S Co

Merger will be effected by Stock Swap ( exchange of shares)
a)
b)
b)
c)

a )

Find pre-merger EPS and P/E Ratios of both Cos.

What is the exchange ratio based on current MPS?
What will be post -merger EPS?
What must be the exchange ratio so that pre-merger and post-merger EPS to be same ?
What is exchange ratio based on current MPS?
ANSWER
Purchasing Co
Sold Co.
EPS and P/E
P Co
S Co
EPS = PAT
400000
120000

No of Eq Sh
= Rs.
P/E = MPS
EPS
=
b)

200000
2

100000
1.2

25
2
12.5

15
1.2
12.5

Exchange ratio based on current MPS

Current MPS
25
Exchange ratio=Eq Sh of S Co X MPS of S Co
MPS of P Co
Exchange Ratio

15

100000 X 15
25
=
60000 shares
Shareholders of S Co will exchange their 100000 shares for 60000 shares of P Co.
c )

d )

Post merger EPS

Total PAT = PAT of P. Co. + PAT of S Co.
= 400000+ 120000 =520000
Total shares = 200000 +60000 =260000 shares
Post merger EPS = Total PAT
Total shares
= 520000
=
260000

Exchange Ratio to earn same EPS

Total No of Shares in post merger Co = Post merger Earnings
Pre merger EPS of P Co
=

520000
=
2
No of new shares required to be issued = Total no. of shares in post merger Co - No o
=
260000 - 200000 =
Exchange Ratio

60000 X 1.2 =
120000

0.6

=================================================================================================

LEVERAGES
Income Structure
Contribution
Less : Fixed Costs
EBIT
Less : Interest
EBT

260
100
160
60
100

60 = 12% of 500 loans

Debt Equity Ratio =

Borrowed Capital
Owned Capital

Interest Coverage Ratio =

EBIT
Interest on loan & debenture

Operating Leverage

Financial Leverage

= Contribution
EBIT
=

Combined Leverage =

EBIT
EBT

Contribution
EBT

=================================================================================================

2011 PRELIM PAPER SOLUTION

PRELIM MORF Co.
Q3

EVALUATION OF ALTERNATIVE CAPITAL PLANS

Source of Capital

Existing

Equity Sh. Capital(10/-)

13% Pref. Sh. Capital
15% Debentures
14% Debentures
Share Premium
TOTAL
ROI = 3307143/8000000 =
EBIT
Less : Int. on 15% Deb.
Less : Int. on 14% Deb.
EBT
Less : Tax @30%
PAT (given)
Less: Pref. Div.
Profit Available to
Equity Shareholders

Option 1

4000000
1000000
3000000

8166667
1000000
3000000

8000000

833333
13000000

Option 2
4000000
3500000
3000000
2500000
13000000

41.34 %
3307143
450000

5374107
450000

2857143
857142.9
2000000
130000
1870000

4924107
1477232
3446875
130000
3316875

5374107
450000
350000
4574107
1372232
3201875
455000
2746875

No.of Eq Shares
400000
816667
400000
EPS
4.675
4.06
6.87
Grading >>>
II
III
I
-------------------------------------------------------------------------------------------------------------------------------Not given in PRELIM Problem
If P/E given
6
7
4
MPS = P/E X EPS
28.05
28.43
27.47
Grading >>>
II
I
III
It is the prime function of Finance Manager to maximise wealth of shareholders
Hence Option maximising MPS should be chosen.

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

PRELIM
Q2
Year

PBDT
Dep.
PBT
1 1000000
500000
500000
2 1075000
375000
700000

3 1081250
281250
4 1743750
843750
4 Release of W. Cap
4 Sale of Scrap Mach.
4900000
2000000
Total Present Values of Cash Inflows

800000
900000

2900000

Less : Present Values of Cash Outflows

Investment in Machine
Investment in Working Capital
Total Present Values of Cash Outflows
NET PRESENT VALUE

NOTE : If Research Cost, Project preparation cost is incurred it is a sunk cost and does not affe
NOTE :

Dep Mach -WDV Method

Year 1
Year 2
Year 3
Year 4

Opg. Bal Dep @25%

2000000
500000
1500000
375000
1125000
281250
843750
843750 bal fig.
2000000
2000000

Discounted PAYBACK PERIOD =

ARR ( Accounting Rate of Return )

Average Investment =
=
=
ARR =

2 +

Average PAT
X
Average Investment
+ W Cap + Scrap Value

(Cost - Scrap value)

2
(2000000 - 200000)
+400000+200000
2
900000 + 400000+200000 =
507500 X 100
1500000

Payback Profitability = Annual Cash Inflow X ( Life of project - Payback Period ) --->>
Payback Profitability = Total Cash Inflows - Total Cash Outflows
--->
=
4630000
-2400000 =

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

PRELIM Maximum Permissible Bank Finance

QI B i
Category 1 -- Minimum Risk Borrowers
MPBF =
0.75 ( CA - CL )
MPBF =
MPBF =
MPBF =

0.75 ( 230000 - 120000)

0.75(110000)
82500

Category 2 -- Medium Risk Borrowers

MPBF =
(0.75 X CA) - CL
MPBF =
( 0.75 X 230000) - 120000
MPBF =
172500 - 120000
MPBF =
52500

Category 3 -- High Risk Borrowers

MPBF =
0.75 ( CA - CCA ) - CL
MPBF =
0.75( 230000 - 69000 ) - 120000
MPBF =
0.75 (161000 ) - 120000
MPBF =
120750 - 120000
MPBF =
750
As risk magnitude increases MPBF decreases.
-------------------------------------------------------------------------------------------------------------PRELIM
QI B ii Calculation of Working Capital ( Normal )
Current Assets
Finished Goods
Debtors
Other Current Assets( bal. fig.)
Total Current Assets
Less : Current Liabilities
Current Liabilities
Total Current Liabs.
W. Cap.

134000
150000
166000
450000

200000
200000
250000

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

PRELIM
QI B iii Weighted Average cost of Capital ( WACC )
Tax rate is 30%.

Dividend expected by Eq Shareholders is 15%

Capital Item
Eq. Sh. Capital
Retained Earnings
10% Pref. Share Capital
12% Borrowed Capital
TOTAL
WACC is

Amount Proportion
Cost
350000
0.45
120000
0.16
100000
0.13
200000
0.26
770000

1.00

15%
15%
10%
12%
0.52

12.64 %

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

PRELIM SERA SERA Co.

Q5
EVALUATION OF CREDIT POLICIES

CreditSales
Less :Variable Cost 65%
Contribution
Less : Fixed cost
PROFIT
Less : COSTS
Total Costs =FC+VC
Debtors' Turnover Ratio
Investment in debtors
1 Opportunity Cost @25%pa
2 Bad Debts
3 Recovery Cost
Total Costs
NET BENEFIT
RANKING

Existing Option I
Option II
Policy
2200000
2500000
3000000
1430000
1625000
1950000
770000
875000
1050000
200000
200000
200000
570000
675000
850000

1630000
7
232857.1

1825000
6
304167

2150000
5
430000

58214
20000
0
78214

76042
30000
0
106042

107500
40000
0
147500

491786
3

568958
2

702500
1

Option II should be selected since it gives highest Net Benefit

Debtors = Sales /Debtors Turnover Ratio

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

PRELIM
Q4
Calculation of Working Capital
Cost Structure
Raw Material
+ Wages
+Overheads
Cost
+ Profit
SALES

10000 units
per unit TOTAL
54.00
540000
12.00
120000
9.90
99000
75.90
759000
44.10
441000
120.00
1200000

CURRENT ASSETS
1 Stock of Raw Material ( 1 mth. ) =

=540000 X 1/12mth =

Stock of WIP ( Prodn. Period 0.5 mth.)

-- Material
= 540000 X 0.5/12mth=
--Wages
= 120000 X 0.5/12mthX1/2=
--Overheads
= 99000 X 0.5/12mthX1/2=

Stock of Finished goods ( 2 mth of Prodn. Cost)

=759000 X 2/12mth

Debtors ( 1mth of Cost of sales )

=1200000 X 1/12mth =
=759000 X 1/12 mth =

Overheads in advance (1/2 mth)

=99000 X 0.5 /12mth =

Cash Balance
TOTAL CURRENT ASSETS

Less : CURRENT LIABILITIES

Creditors ( 1 mth)
= 540000 X 1 mth/12 mth=

2
3

O/s. Wages ( 1/2 mth )

Bank overdraft

=120000 X 0.5/12 mth =

TOTAL CURRENT LIABILITIES
WORKING CAPITAL

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

BMS .
FINANCIAL MANAGEMENT.

Net Profit Margin X

Total Assets Turnover

PAT
Net Sales

Net Sales
Total assets

ssets Turnover =

X 100

Sales
Total Assets

===================================================================================

ENDITURE PROJECTS

UATION

METHODS

h inflow )

itial Investment (ie. Cost of mach)

verage Annual Cash Inflow

w is not same )
s should be found
ompleted years X

( Balance Amt. X
12 mths. )
( next year's annual cash inflow )

itial Investment
nnual Cost Savings

he cost of project will be exactly recovered.

owest payback period should be chosen.
----------------------------------------------------------------------------------------ow X( Expected life of project - Payback Period) ] + sale of scrap

he Project - Cost of Project ] + sale of scrap

with the highest payback profitability should be chosen.

r than Payback Period because it considers total net cash inflows
er recovering original cost.
----------------------------------------------------------------------------------------Total Cash Inflows + Scrap Value
Cost of asset

Surplus Life Profitability + Cost of Asset

Cost of asset
with the highest payback profitability index should be chosen.
---------------------------------------------------------------------Accounting Rate of Return Method
X 100

X 100

( Initial cost of machine - Salvage value )

2

and Profits after investment given )

X 100

Increase in Profit after Investment

=

Investment in Project

isting machine and new machine given )

ne - PAT from old machine
)
chine - sale proceeds of old machine )

X 100

chine 'A ' and machine 'B" given )

- PAT from new machine 'B'
)
'A' - Investment in machine 'B' )

X 100

OST

RATIO (B/C RATIO)

. 60000, Scrap 40000, PV factor 12% , Life 4 years.

PBT

Tax
30%
-15000
85000

PAT

0
25500

Cash Inflow
(PAT+Dep)
-15000
59500

100000
174500

135000
185000

40500
55500

94500
129500

209500
244500

390000

121500

268500

728500

500000-40000
4 years
115000

Dep % X Opg. Bal. Of Asset

her profit nor loss from Project

s of Cash Inflows Rs 533043/- is more than Cost Rs500000/- the project should be accepted.

. 60000, Scrap 40000, PV factor 12% , Life 4 years.

PBT

Tax

-15000
85000
135000
185000

390000

PAT

0
25500
40500
55500

121500

-15000
59500
94500
129500

Cash Inflow
(PAT+Dep)
-500000
-60000
100000
174500
209500
244500

268500

60000
40000
268500

s of Cash Inflows Rs. 36642.50

OST

1.07

is more than zero ( positive)

the project should be accepted.

RATIO (B/C RATIO)

=
=

is more than one,

Discounted cash inflows

Discounted cash outflows
596642.5 =
560000

1.07

the project should be accepted.

om the investment in the project which covers the cost of capital invested in the project.
of Project
ause Total PV of Cash Inflows = Total PV of Cash Outflows )

% - Cost of Asset ) X ( 14 - 10 )
% -Total PV at 14% )
eans at x% of cost of capital ( int rate or Div rate ) the income of the project will just exactly cover
e will be neither profit nor loss .
---------------------------------------------------------------------------------------------------------------

cash inflows , then calculate cumulative PV of Cash inflows

--------------------------------------------------------------------------------------------------------------/ research for project is a sunk cost ( ie already incurred ) and hence not to be considered while evaluati

=========================================================================================

000 X 5%

May
Sales
Purchases
Wages
Expenses

200000
100000
20000
15000

June
230000
110000
24000
16000

1 SALES
2
3
4
5
6

20% are cash sales. 5% discount is given on cash sales.

Out of the credit sales 30% pay in the next month with3% discount an
PURCHASES
Cash purchases are 40%
WAGES
Wages are paid in the next month = lag in payment is 1 mth = wages
CASH
Cash balance on 1.07.11 is Rs 12000
Cash bal. to be maintained at 12000 every month.
EXPENSES1/3 Expenses are paid 1 month in advance.
ASSET
Machine of 50000 to be purchased in July . Down payment is 20000 a
Furniture purchased in Aug. Rs 90000
INCOME Dividend on Investment is received in July Rs 14500

=
57000
72000 less 3% discount
=
69840
168000
-------------------------------------------------------------------------------------------------in SB A/c.on which int @ 3% is received monthly.

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

4000000
2 days
75000
8%
4 days
120000
ck Box System ?

ANSWER >>>

a) Cash released by concentration banking =

Savings in concentration banking =
Net benefit from concentration banking =

b)Cash released by Lock box system =

Savings in Lock box system =
Net benefit from Lock box system =
Since the net benefit from Lock Box System is m
------------------------------------------------------------------------------------------------------------------------------------------------------------g weeks. Receipts on Mondays , Tuesdays and Wednesdays are twice on other 2 days o the week.
erdraft is 15% pa.
Fridays or only on Fridays.

=========================================================================================
CHAPTER

COST OF CAPITAL

mum required rate of earnings or the cut-off rate of Capital Expenditure.

hat is incurred in retaining the funds obtained from various sources and employed in business.

erformance.

e of Interest Less Tax benefit

tal ( Ke )-- Expected rate of dividend --Highest cost of capital
s -- Opportunity cost of dividends foregone
Capital -- Fixed rate of dividend

= Weighted Average Cost of Capital ( WACC ). Considers Cost of all types of Long Term Sources of Capital.
y Overall Cost of Capital is equal to Marginal Cost of Capital.
= Increase in Cost of Capital due to increase in Capital Structure.
y Overall Cost of Capital is equal to Marginal Cost of Capital.
te of return/profit the new project should earn to cover Cost of Capital.

Average Cost of Capital ( WACC )

Tax Shield
After Tax Weighted Cost
Tax Rate30% Cost
of Capital
NIL
14%
1.40%
NIL
10%
2.00%
3.30%
7.70%
2.31%
3.60%
8.40%
3.36%
9.07%

Dividend = 4%.
G= growth rate in dividend

= 11.67 % + 4% =

15.67%

> FV = face value(par value) of one pref share

NP = Net Proceeds= Face value + premium - dicount - issue expenses per share

Cost of loan =
Cost of Debentures =

12 ( 1 - 0.30)
11 ( 1 - 0.30)

=
=

8.40
7.70

> FV = face value(par value) of one pref share

NP = Net Proceeds= Face value + premium - dicount - issue expenses per share
>> FV = face value(par value) of one pref share
PP = Purchase Price
N= No of years to maturity

X 100 =

98300 =
15.67%

98.3 %

627,313

700,000
200,000
1,527,313

=====================================================================================

ation of capital resources which gives Highest EPS.

mposition of Owned Capital & Borrowed Capital, having following features :.

of Capital should be possible.

zation of funds.
uld be maintained.
maintained for smooth functioning of business.

ndifferent to the alternative capital plans.

PS as per Plan 2
EBIT - I2)(1 - t )] - PD2
E2

= Interest as per plan 2

D2 = Pref. Dividend as per plan 2

2 = No. of Eq. Sh. As per plan 2
should be found.
------------------------------------------------------------------------------

is exactly equal to zero .

ust exactly covered by EBIT and PAT = Pref. Dividend. Leaving neither profit nor loss to the Equity share
e to pay interest on debt capital and preference dividend .
e firm's EPS is Zero.
AT = Pref. Dividend
BIT = Interest

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

e , cost of capital and value of firm.

ze WACC and increase value of firm and MPS, by increasing debt capital to maximum.
< Div. rate PLUS due to Tax benefit net interest cost is reduced still further.
al Structure affects market value of firm
influences WACC
pital Structure is one which uses maximum debt capital.

ween cost of capital and market value of firm.

al Structure does not affect market value of firm
does not influence WACC
imal Capital Structure
al Structure does affect market value of firm
mized if Debt Equity Ratio is increased .
al Capital Structure
debt increases financial risk increases leading to higher expectation of dividend.
ding to increase in cost of capital.

capital is equal to capitalization rate of pure equity stream .

ween cost of capital and market value of firm.
does not influence WACC

arket Value of Equity + Market Value of Debt

Dividend ( ie. PAES )
e of Equity

EBIT (1 - T )
Capitalization rate of Equity

T = Tax rate

===================================================================================

HAPTER 9

USINESS RESTRUCTURING
resent structure , either asset structure or liability structure or both.
Demerger , Joint Venture , Takeover .

ve world , cost cutting

usiness from the point of view of buyer and seller.

nd seller of business and their expectations of income from the business being takenover.
es with the time .

e large company.
producing similar products> >anticompetitive , advantage over other competitors.
fferent stages in production of same product. Noncompetiting firms
towards sources of rawmaterial, forward integration --moving towards consumers by eliminating distributors.
industry but are not buyer- supplier of eachother, but are co-related--eg. Bank and insurance
stry >> for diversifying business risk.

Co is

AB Co.

get same amount of int as they are now getting.

o existing shareholders of A Co. anf B Co. in proportion to their existing share values .

to be issued .

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

Calculation
13% Debentures

A Co
36000

Currently the Deb holders are getting int @13%

4680
15% Deb of AB Co to be issued
31200
( 4680/15 X 100)
A Co
No. of Equity Shares of AB Co. to be issued
Equity Share Capital @ Rs10/-.

Assets
xed Assets
urrent Assets

27511
275109

Amount
370000
120000

9891
TOTAL

499891

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

chase Consideration and prepare revised Balance sheet of company AAA Ltd.
Assets

AAALtd

BBB Ltd

Land & Bldg.

Machinery
Furniture

340000
319000
45000

100000
150000
10000

Investments

56000

10000

Current Assets

25000

10000

olders of BBB Ltd.

785000

280000

ce Sheet of AAA Ltd. ( after merger )

Assets
Amount
Land & Bldg.
Machinery
Furniture

480000
429000
50000

Investments

66000

Current Assets

32000

TOTAL

nd post-merger EPS to be same ?

ed on current MPS?

1057000

times

s for 60000 shares of P Co.

260000 shares

f shares in post merger Co - No of shares in pre merger P Co

60000 shares
: 1

====================================================================================

= 12% of 500 loans

500
245

2.04

160
60

2.67

260
160

1.63

160
100

1.6

260
100

2.6
s

===============================================================================================

ATIVE CAPITAL PLANS

NOTE:

Option 1 Equity shares at 20% premium

Eq. Share Capital= 5000000 X 100 =
120
Share Premium=
5000000-4166667 =

=PAT + Tax
=PAT / 70 X 30

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

se wealth of shareholders

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

Tax @ 30%
PAT
Cash Inflow
PV Factor
150000
350000
850000
0.909
210000
490000
865000
0.826

240000
270000

560000
630000

870000

2030000

841250
1473750
400000
200000
4630000

0.751
0.683
0.683
0.683

2000000

400000
2400000

is a sunk cost and does not affect the ranking of the projects hence and to be considered for above calcula

(2000000-1487140) years
631779

verage PAT
X
verage Investment
W Cap + Scrap Value

= 2 +
=2.81 years

0.81

100

400000+200000
1500000
34 %

of project - Payback Period ) --->>> If Annual Cashinflow same every year.

ash Outflows
--->>> If Annual Cashinflow not same every year.
2230000

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

CA = Current Assets =230000

CL = Current Liabilities= 120000

CCA = Core Current Assets = CA X 30%=230000 X 30%=69000

If core CA not given , assume all current assets other than Marketable Securities ar

-------------------------------Calculation of Working Capital ( at Cost )

Current Assets
Finished Goods
134000
Debtors(Sales - Profit)
117000
Other Current Assets( bal. fig.)
166000
Total Current Assets
417000
Less : Current Liabilities
Current Liabilities
Total Current Liabs.

200000
200000

W. Cap.
217000
( Only Debtors change)
--------------------------------------------------------------------------------------------------------------

olders is 15%
After Tax Cost WACC %
15%
6.82
15%
2.34
10%
1.30
8.40%
2.18
0.48

(12 less 35% of 12)

(13 less 35% of 13)

12.64

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

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

W Cap
W Cap
Normal
at Cost
45000

22500
2500
2063

45000

27063

27063

126500

126500

100000
63250

4125

4125

10000

10000

312688

275938

45000

45000

5000
14000
64000
248688

5000 fortnight = 15 days = 1/2 mth.

14000
64000
211938

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

=========================

2 mths. )

Example 1.

Sales in 1st. Year 50 Lakh shall do

Net Profit margin( PAT ) is 50%. Ini
Year
1
17% 0.8555
18%
0.847
Calculate A) Payback Period . B) Pa
A) Payback Period .
Dep. =

---------------] + sale of scrap

B) Payback Profitability.
C) Payback Profitability Index =
( Also called Benefit Cost Index )
Payback Profitability Index =
( when PV available )
net cash inflows

D) NPV @17%.

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

be chosen.

E)

Conclusion :
------------------------------------IRR ( Internal Rate of Return

+ Addnl. W. Cap. + Salvage Value

=
=

=
=

F ) ARR =

Present value
Factor @ 12 %

PV
(Present Value)
0.893
89300
0.797 139076.5

0.712
0.636

149164
155502

533042.5

00/- the project should be accepted.

Present value
Factor @ 12 %

N PV
(Net Present Value)
1
1

0.893
0.797
0.712
0.636
0.636
0.636

-500000
-60000
89300
139076.5
149164
155502
38160
25440
36642.5

tive)

the project should be accepted.

capital invested in the project.

e income of the project will just exactly cover

the cost of project.

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

------------------------) and hence not to be considered while evaluating the different projects.

=====================================================
July
300000
130000
32000
20000

August
Sept
320000
150000
32000
20000

200000
100000
22000
10000

% discount is given on cash sales.

30% pay in the next month with3% discount and balance in the second month with no discount.

next month = lag in payment is 1 mth = wages payable one mth in arrear.
11 is Rs 12000
ined at 12000 every month.
d 1 month in advance.
be purchased in July . Down payment is 20000 and balance in 3 equal instalments.
in Aug. Rs 90000
ent is received in July Rs 14500

ash released by concentration banking =

avings in concentration banking =
et benefit from concentration banking =

4000000
8000000
640000

X
X
-

2
8%
75000

ash released by Lock box system =

4000000
X
4
avings in Lock box system =
16000000
X
8%
et benefit from Lock box system =
1280000
120000
nce the net benefit from Lock Box System is more than from Concentration banking, Lock box system s
----------------------------------------------------------------------------------------------------------------------------------------------------------re twice on other 2 days o the week.

=============================================

ces and employed in business.

of all types of Long Term Sources of Capital.

sue expenses per share

%
%

sue expenses per share

=====================================

following features :.

EBIT = Interest
EPS = 0

debt capital to maximum.

educed still further.

PAT = Pref. Dividend

expectation of dividend.

= Tax rate

===================================

from the business being takenover.

other competitors.

owards consumers by eliminating distributors.

related--eg. Bank and insurance

eir existing share values .

B Co
15000

1950
13000
( 1950/15 X 100)
B Co

ompany AAA Ltd.

2489
24891

==========================

=====================================

at 20% premium
00000 X 100 =

4166667

00000-4166667 =

833333.3

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

Present Value

Cumulative Present Value

772650
772650
714490
1487140

631779
1006571
273200
136600
3535290
3535290

2000000
400000
2400000
1135290

ojects hence and to be considered for above calculations.

years

ame every year.

not same every year.

2118919
3125490
3398690
3535290

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

0 X 30%=69000
urrent assets other than Marketable Securities are Core Current Assets

Calculation of Working Capital ( at Cash Cost )

Current Assets
Finished Goods(Cost - Dep)
115240
Debtors(Sales -Profit-Dep)
100620
Other Current Assets( bal. fig.)
166000
Total Current Assets
381860
Less : Current Liabilities
Current Liabilities
Total Current Liabs.

Note:
Cash (other) Cost
Dep
Total Cost
Add : Profit
Sales

200000
200000

W. Cap.
181860
( Finished Goods, WIP stock and Debtors change)
---------------------------------------------------------------------------------------------------------------------------------------------------------

2 less 35% of 12)

3 less 35% of 13)

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

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

rtnight = 15 days = 1/2 mth.

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

1st. Year 50 Lakh shall double every year . Salvage 1 crore.

margin( PAT ) is 50%. Initial Outlay 5 crore . W. Cap. 1 crore, Dep SLM.
2
3
4
0.731
0.624
0.534
0.718
0.609
0.516
A) Payback Period . B) Payback Profitability.NPV @ 17 % & @18% . M51

k Period .
Cost of Asset - Salvage
Estimated Life
Year

Sales

==

5,00,00,000 - 1,00,00,000 =

Net Profit

Dep

1
2
3
4

5,000,000
10,000,000
20,000,000
40,000,000
75,000,000.00
Payback Period =

k Profitability.

2,500,000
5,000,000
10,000,000
20,000,000
37,500,000.00
3 years +

10,000,000
10,000,000
10,000,000
10,000,000
40,000,000.00
(50000000- 47500000) X 12mths.
30,000,000.00

= (Total Cash Inflow + Salvage) - Cost = 7,75,00,000 + 1,00,00,000 - 5,00,0

ck Profitability Index =
ed Benefit Cost Index )

ck Profitability Index =
PV available )

Year

Cash Inflow
1
2
3
4
4

Total Cash Inflows + Scrap Value =

Cost of asset
PV of cash inflows =
PV of cash outflows

PV Factor @17% PV of C.inflow

12,500,000
15,000,000
20,000,000
30,000,000
10,000,000
( Salvage )
4
10,000,000
( W. Cap. )
Total PV of Cash Inflows
Less :
Initial Outlay
Less :
Initial W Cap.
Net Present Value

7,75,00,00

0.855
0.731
0.624
0.534
0.534

10,687,500
10,965,000
12,480,000
16,020,000
5,340,000

0.534

5,340,000
60,832,500
50,000,000
10,000,000
832,500

Conclusion :
Project with negative NPV should be avoided . Between projects with po
---------------------------------------------------------------------------------------------------------------------------( Internal Rate of Return )

17 +
17 +

60832500-60000000
60832500-59337500
832,500
1,495,000

17 +
17.56%

0.56

Avg. PAT
X 100 =
Avg. Investment

(18-17)
X

9,375,000.00 X 100
40000000

Avg. Investment =

( Initial cost of machine - Salvage value )

2

(50000000 - 10000000 )
2
40000000

10000000+ 10000

nth with no discount.

=
=
=

8000000
640000
565000

=
=
=

16000000
1280000
1160000

n banking, Lock box system should be adopted.

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

Cash (other) Cost

Total Cost
Add : Profit

for finished goods for debtors

86%

115240

100620

14%
100%

18760
134000

16380
117000
33000
150000

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

Dep SLM.

18% .

M51

00 - 1,00,00,000 =
4 years
Cash Inflow

1,00,00,000

Cum. Cash Inflow

12,500,000
15,000,000
20,000,000
30,000,000
77,500,000.00
00- 47500000) X 12mths.

12,500,000
27,500,000
47,500,000
77,500,000
165,000,000.00
= 3 years and 10 mths.

5,00,000 + 1,00,00,000 - 5,00,00,000 = 37,50,00,000

p Value =

7,75,00,000+ 100,00,000
5,00,00,000
60,832,500
60,000,000

1.75

1.0139

Year

Cash Inflow

PVF@18%

1
2
3
4
4

12,500,000
0.847
15,000,000
0.718
20,000,000
0.609
30,000,000
0.516
10,000,000
0.516
( Salvage )
4
10000000
0.516
( W. Cap. )
Total PV of Cash Inflows
Less :
Initial Outlay
Less :
Initial W Cap.
Net Present Value

ed . Between projects with positive NPV , project with highest NPV should be chosen.
-----------------------------------

23.44 %

Salvage value )
+

+ Addnl. W. Cap. + Salvage Value

10000000+ 10000000

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

PV of C.inflow
10,587,500
10,770,000
12,180,000
15,480,000
5,160,000
5,160,000
59,337,500
50,000,000
10,000,000
(662,500)

st NPV should be chosen.